-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, NGjq8Oj1CNLlflBzdHurkyiOADsDcDguV/voKPkAqxuttGKzdoKi/jXQnlLQmUmS hdj1I0n/C/KTFmteB7ElXw== 0000950137-06-011060.txt : 20061016 0000950137-06-011060.hdr.sgml : 20061016 20061016163301 ACCESSION NUMBER: 0000950137-06-011060 CONFORMED SUBMISSION TYPE: 10-K PUBLIC DOCUMENT COUNT: 8 CONFORMED PERIOD OF REPORT: 20060701 FILED AS OF DATE: 20061016 DATE AS OF CHANGE: 20061016 FILER: COMPANY DATA: COMPANY CONFORMED NAME: SALTON INC CENTRAL INDEX KEY: 0000878280 STANDARD INDUSTRIAL CLASSIFICATION: ELECTRIC HOUSEWARES & FANS [3634] IRS NUMBER: 363777824 STATE OF INCORPORATION: DE FISCAL YEAR END: 0626 FILING VALUES: FORM TYPE: 10-K SEC ACT: 1934 Act SEC FILE NUMBER: 001-14857 FILM NUMBER: 061146674 BUSINESS ADDRESS: STREET 1: 1955 FIELD COURT STREET 2: - CITY: LAKE FOREST STATE: IL ZIP: 60045 BUSINESS PHONE: 8478034600 MAIL ADDRESS: STREET 1: 1955 FIELD COURT CITY: LAKE FOREST STATE: IL ZIP: 60045 FORMER COMPANY: FORMER CONFORMED NAME: SALTON MAXIM HOUSEWARES INC DATE OF NAME CHANGE: 19930328 10-K 1 c08712e10vk.txt FORM 10-K UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-K [X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For The Fiscal Year Ended July 1, 2006 OR [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For The Transition Period From to COMMISSION FILE NUMBER 0-19557 SALTON, INC. (Exact Name Of Registrant As Specified In Its Charter) DELAWARE 36-3777824 (State or other jurisdiction of (I.R.S. Employer Incorporation or Organization) Identification No.) 1955 FIELD COURT 60045 LAKE FOREST, ILLINOIS (Zip Code) (Address of Principal Executive Offices)
(847) 803-4600 Registrant's Telephone Number, Including Area Code: SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT:
TITLE OF CLASS NAME OF EACH EXCHANGE ON WHICH REGISTERED - -------------- ----------------------------------------- Common Stock, $0.01 par value New York Stock Exchange Rights to Purchase Series B Junior Participating New York Stock Exchange Preferred Stock
SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT: NONE [ ] YES [X] NO Indicate by check mark of the registrant is well-known seasoned issuer, as defined in Rule 405 of the Securities Act. [ ] YES [X] NO Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15 (d) of the Act. [X] YES [ ] NO Indicate by check mark whether this 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. [ ] Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. Indicate by check mark whether the registrant is large accelerated filer, an accelerated filer or a non-accelerated filer. Large Accelerated Filer [ ] Accelerated Filer [ ] Non-Accelerated Filer [X] [ ] YES [X] NO Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). The aggregate market value of the Common Stock held by non-affiliates of the Registrant as of December 31, 2005 was approximately $27,856,787 computed on the basis of the last reported sale price per share $2.06 of such stock on the NYSE. This determination of affiliate status is not necessarily a conclusive determination for other purposes. The number of shares of the Registrant's Common Stock outstanding as of September 30, 2006 was 14,384,390. DOCUMENTS INCORPORATED BY REFERENCE Part III of this Form 10-K incorporates by reference certain information from the Registrant's proxy statement relating to its 2006 Annual Meeting of Stockholders (the "2006 Proxy Statement"). SALTON, INC. INDEX TO FORM 10-K FOR THE FISCAL YEAR ENDED JULY 1, 2006
PAGE PART I ITEM 1. Business 4 ITEM 1A. Risk Factors 9 ITEM 2. Properties 17 ITEM 3. Legal Proceedings 18 ITEM 4. Submission of Matters to a Vote of Security Holders 19 ITEM 4A. Executive Officers of the Registrant 19 PART II ITEM 5. Market for the Registrant's Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities 20 ITEM 6. Selected Financial Data 23 ITEM 7. Management's Discussion and Analysis of Financial Conditions and Results of Operation 24 ITEM 7A. Quantitative and Qualitative Disclosures about Market Risk 41 ITEM 8. Financial Statements and Supplementary Data 42 ITEM 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure 42 ITEM 9A. Controls and Procedures 42 ITEM 9B. Other Information 44 PART III ITEM 10. Directors and Executive Officers of the Registrant 44 ITEM 11. Executive Compensation 44 ITEM 12. Security Ownership of Certain Beneficial Owners and Management 44 ITEM 13. Certain Relationships and Related Transactions 45 ITEM 14. Principal Accounting Fees and Services 45 PART IV ITEM 15. Exhibits and Financial Statement Schedules 46
2 CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING INFORMATION This annual report on Form 10-K includes forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934, including without limitation the statements under "Risk Factors," and "Management's Discussion and Analysis of Financial Condition and Results of Operations." The words "believes," "anticipates," "plans," "expects," "intends," "estimates" and similar expressions are intended to identify forward-looking statements. These forward-looking statements involve known and unknown risks, uncertainties and other factors, which may cause our actual results, performance or achievements, or industry results, to be materially different from any future results, performance, or achievements expressed or implied by such forward-looking statements. Such factors include, among others, the following: - - our ability to repay or refinance our indebtedness as it matures and satisfy the redemption obligations under our preferred stock; - - our ability to continue to realize the benefits we expect from our U.S. restructuring plan; - - our substantial indebtedness and our ability to comply with restrictive covenants in our debt instruments; - - our ability to access the capital markets on attractive terms or at all; - - our relationship and contractual arrangements with key customers, suppliers, strategic partners and licensors; - - unfavorable outcomes from pending legal proceedings; - - cancellation or reduction of orders; - - the timely development, introduction and customer acceptance of our products; - - dependence on foreign suppliers and supply and marketing constraints; - - competitive products and pricing; - - economic conditions and the retail environment; - - international business activities; - - the cost and availability of raw materials and purchased components for our products; - - the risks related to intellectual property rights; and - - the risks relating to regulatory matters and other risks and uncertainties detailed from time to time in our Securities and Exchange Commission Filings. All forward looking statements included in this annual report on Form 10-K are based on information available to us on the date of this annual report. We undertake no obligation to publicly update or revise any forward-looking statement, whether as a result of new information, future events or otherwise. All subsequent written and oral forward-looking statements attributable to us or persons acting on our behalf are expressly qualified in their entirety by the cautionary statements contained throughout this annual report on Form 10-K. PART I As used in this annual report on Form 10-K, "we," "us," "our," "Salton" and "the Company" refer to Salton, Inc. and our subsidiaries, unless the context otherwise requires. On September 29, 2005, we completed the sale of our 52.6% ownership interest in Amalgamated Appliance Holdings ("AMAP"), a leading distributor and marketer of small appliances and other products in South Africa, to a group of investors led by Interactive Capital (Proprietary) Limited. Accordingly, we have reported the sale of AMAP as discontinued operations in the financial statements and all statistical data reported excludes AMAP for the periods presented. 3 ITEM 1. Business GENERAL Salton, Inc. is a leading designer, marketer and distributor of branded, high quality small appliances, home decor and personal care products. Our product mix includes a broad range of small kitchen and home appliances, electronics for the home, time products, lighting products and personal care and wellness products. We sell our products under our portfolio of well recognized brand names such as Salton(R), George Foreman(R), Westinghouse(TM), Toastmaster(R), Melitta(R), Russell Hobbs(R), Farberware(R), Ingraham(R) and Stiffel(R). We believe our strong market position results from our well-known brand names, our high quality and innovative products, our strong relationships with our customer base and our focused outsourcing strategy. We currently market and sell our products in North America, Europe, Asia, Australia, New Zealand, South America and the Middle East through an internal sales force and a network of independent commissioned sales representatives. We predominantly sell our products to mass merchandisers, department stores, specialty stores and mail order catalogs. Our customers include many premier retailers, such as Target Corporation, Wal-Mart, Argos Limited, Sears, J.C. Penney Company, Bed, Bath & Beyond, Federated Department Stores, Dixon Stores Group Limited, Linens 'N Things, QVC, Inc. and Kohl's Department Stores. We also sell certain of our products directly to consumers through paid half-hour television programs referred to as infomercials, our Internet websites and our retail outlets. We outsource most of our production to independent manufacturers, located primarily in the Far East. The Company has substantial experience with and expertise in managing production relationships with third-party suppliers. We work with our suppliers to provide the lowest possible cost for our customers while maintaining reasonable gross margins for us. Salton was incorporated in Delaware in October 1991. Our common stock traded on the NASDAQ National market under the symbol "SALT" until February 1999. The Company moved to the New York Stock Exchange at that time and our common stock has traded under the symbol "SFP" since. Our principal corporate offices are located at 1955 Field Court, Lake Forest, Illinois 60045. Our fiscal year ends on the Saturday closest to June 30. Unless otherwise stated, references to years in this report relate to fiscal years rather than calendar years. The effect of the additional week in 2004 had an insignificant impact on results.
FISCAL YEAR YEAR ENDED WEEKS - ----------------------------------- 2006 July 1, 2006 52 2005 July 2, 2005 52 2004 July 3, 2004 53
RECENT DEVELOPMENTS In June 2005, the Securities and Exchange Commission approved certain amendments to the continued listing criteria for issuers with a class of securities registered on the New York Stock Exchange (the "NYSE"), under Rule 802.01 of the NYSE's Listed Company Manual. Under these continued listing requirements, as they apply to Salton, we would be considered "below criteria" if our average market capitalization is less than $75 million over a 30 trading-day period and, at the same time, our stockholders' equity is less than $75 million. On May 19, 2006, we received official notice from the NYSE that we had fallen "below criteria" under the new continued listing requirements, as our total market capitalization was less than $75 million over a 30 trading-day period and our stockholders' equity was less than $75 million as of our fiscal quarter ended April 1, 2006. Salton reported total stockholders' equity of approximately $62.4 million as of April 1, 2006. In addition, based on 14,386,390 shares outstanding as of May 21, 2006, and the reported closing price of our common stock on the NYSE on that date ($2.56), we had a market capitalization of approximately $36.8 million as of that date. 4 On July 3, 2006, we presented a plan to the NYSE demonstrating how we intend to comply with the continued listing standards. On August 18, 2006, the NYSE notified us that it has accepted our proposed plan for continued listing on the NYSE. As a result of the acceptance, Salton's common stock will continue to be listed on the NYSE pending quarterly reviews by the NYSE's Listing and Compliance Committee during an 18 month period (which started on May 19, 2006) to ensure our compliance with the goals and initiatives outlined in the plan. BUSINESS SEGMENT AND PRODUCT INFORMATION Salton consists of a single operating segment which designs, sources, markets and distributes a diversified product mix for use in the home. Our product mix consists of small kitchen and home appliances, electronics for the home, time products, lighting products, picture frames and personal care and wellness products. We believe this segmentation is appropriate based upon Management's operating decisions and performance assessment. Nearly all of our products are consumer goods within the housewares market, procured through independent manufacturers, primarily in the Far East. Our products are distributed through similar distribution channels and customer base using the marketing efforts of our Global Marketing Team. BRAND PORTFOLIO Our brand portfolio contains many time-honored traditions as well as recently established names within the international housewares industry. We believe this brand portfolio contains many brands with strong consumer recognition throughout the world. While many of our brands are owned, we continue to enhance our portfolio through licensing agreements and strategic alliances. Our brands include: Salton(R) Westinghouse(TM) Toastmaster(R) Big Ben(R) George Foreman(R) One:One(TM) Westclox(R) Santa Fe(TM) Russell Hobbs(R) Breadman(R) Stiffel(R) Haden(TM) Melitta(R) Andrew Collinge(TM) Carmen(R) Ultrasonex(TM) Farberware(R) Ingraham(R) Juiceman(R) Beyond(TM) Carmengirls.com(TM) iCEBOX(R)
We develop and introduce a wide selection of new products and enhance existing products to satisfy the various tastes, preferences and budgets of consumers and to service the needs of a broad range of customers. Our product groups include Small Appliances and Electronics for the Home, Home Decor, and Personal Care and Wellness. In an effort to focus the Company on its core products, we made certain planned reductions in all product groups as part of our actions to return to profitability. However, such actions do not completely eliminate or preclude future product innovations in any product group. The following table sets forth the approximate amounts of our net sales by product group during the periods shown.
JULY 1, 2006 JULY 2, 2005 JULY 3, 2004 - ------------------------------------------------------------------------------------------------------- (IN THOUSANDS) Small Appliances and Electronics for the Home $ 565,511 $ 648,869 $ 716,334 Home Decor 41,820 80,241 85,164 Personal Care and Wellness 28,629 52,626 43,262 - ------------------------------------------------------------------------------------------------------- Total $ 635,960 $ 781,736 $ 844,760 - -------------------------------------------------------------------------------------------------------
5 SMALL APPLIANCES AND ELECTRONICS FOR THE HOME We design, market and distribute an extensive line of small appliances and electronics for the home. These products consist of heating appliances, motor driven appliances, beverage makers, cookware and floor care. Within our small appliance and electronics group, Salton is known for the George Foreman branded product line which started as a single grill in 1995. Since 1995, Salton has sold over 83 million units of the George Foreman line worldwide. We have established the George Foreman name as a significant product brand, representing approximately 39.9%, 38.4%, and 40.3% of our sales in the fiscal years ended July 1, 2006, July 2, 2005, and July 3, 2004, respectively. In recognition of the continued success of the George Foreman line, Salton shipped to retailers the 10th Anniversary George Foreman grill during the first quarter of fiscal 2006. In the second quarter of fiscal 2006, Salton made its first shipment of the "G5" Next Grilleration grills, the first series of new George Foreman Grills with removable plates. The "G5" features five interchangeable, dishwasher safe plates which can be used as a grill or griddle and for baking as well as making waffles. In addition to Foreman, the Company sells appliances using time honored brands such as Russell Hobbs, Toastmaster, Juiceman, Breadman, Melitta, Farberware, Westinghouse, Haden and Salton. HOME DECOR This broad range of products consists of time and lighting products marketed by our Salton At Home Group. Our time products include a variety of clocks and timers under well recognized brand names such as Ingraham, Westclox and Timex. Salton also markets lighting products under the Stiffel brand. PERSONAL CARE AND WELLNESS Salton offers a broad range of personal care and wellness products including hair care, beauty and oral health care items. NEW PRODUCT DEVELOPMENT We believe that the enhancement and extension of our existing products and the development of new products are necessary for our continued success and growth. We design style, features and functionality of our products to meet customer requirements for quality, performance, product mix and pricing. We work closely with both retail customers and suppliers to identify consumer needs and preferences and to generate new product ideas. We evaluate new ideas and seek to develop and acquire new products and improve existing products to satisfy industry requirements and changing consumer preferences. STRATEGIC ALLIANCES We continue to participate in joint product development relationships with several third parties to develop, market and distribute new products. These strategic alliances enable us to (a) further expand the scope of our product offerings and (b) benefit from the manufacturing expertise and/or strong brand names of our strategic partners. Some current alliances involve equity investments by us in privately held equity securities or investments with no observable quoted market value and include other contractual arrangements involving expense and profit sharing. Our exposure to loss related to these strategic alliances is generally limited to our equity investments. The foregoing strategic alliances provide the opportunity for recurring revenues through the sale of various products, including coffee pods and brewing machines. There may be arrangements for sharing the profits derived from each of these strategic alliances once all expenses incurred by us and/or the other members of the alliance are reimbursed from cash flow generated by such alliances. Each of these strategic alliances generally also provides for certain license fees and royalties to our strategic partners and contain minimum sales requirements and other obligations that, if not satisfied, may result in termination of the strategic alliance. 6 CUSTOMERS AND DISTRIBUTION CHANNELS We currently market and sell our products in North America, Europe, Asia, Australia, New Zealand, South America and the Middle East through an internal sales force and a network of commissioned sales representatives. We predominately sell our products to mass merchandisers, department stores, specialty stores and mail order catalogs. We also sell products directly to consumers through infomercials, Internet websites and our own retail outlets. We provide promotional support for our products with the aid of television, radio and print advertising, cooperative advertising with retailers and in-store displays and product demonstrations. We believe that these promotional activities are important to strengthening our brand name recognition. Our total net sales to our five largest customers during fiscal 2006 were 33.6% of net sales, with Target Inc. representing 9.8% of our net sales, Wal-Mart Stores Inc. representing 9.3% of our net sales and Argos Ltd. representing 5.9% of our net sales. Our total net sales to our five largest customers during fiscal 2005 were 37.3% of net sales, Target Inc. representing 12.6% of our net sales, Wal-Mart Stores Inc. representing 8.5% of our net sales and Argos Ltd. representing 7.1% of our net sales. In fiscal 2004, our total net sales to our five largest customers were 41.0% of net sales, with Target Inc. representing 11.6% of our net sales, Wal-Mart Stores Inc. representing 10.5% of our net sales and Sears Roebuck & Co. representing 7.9% of our net sales. During fiscal 2006, 2005, and 2004, sales recorded outside of North America accounted for 42.1%, 43.2%, and 37.1% of total net sales, respectively. These figures include shipments directly imported to customers in North America. See Note 17 of the Notes to Consolidated Financial Statements for information regarding revenues of the Company's geographic areas for each of the three fiscal years ended July 1, 2006, July 2, 2005, and July 3, 2004. SOURCES OF SUPPLY Most of our products are manufactured to our specifications by manufacturers located primarily in the Far East. We believe that we maintain good business relationships with our overseas manufacturers. We do not maintain long-term purchase contracts with manufacturers and operate principally on a purchase order basis. We believe we are not currently dependent on any single manufacturer. However, one supplier located in China accounted for approximately 37% of our product purchases during 2006, 32% of our product purchases during 2005, and 31% of purchases in 2004. We believe that the loss of any one supplier would not have a long term material adverse effect on our business because other suppliers with which we do business would be able to increase production to fulfill our requirements. However, the loss of a supplier could, in the short term, adversely affect our business until alternative supply arrangements are secured. BACKLOG Although we obtain firm purchase orders from our customers, customers typically do not make firm orders for delivery of products more than 30 to 90 days in advance. In addition, customers may reschedule or cancel firm orders. Therefore, we do not believe that the backlog of expected product sales covered by firm purchase orders is a meaningful measure of future sales. COMPETITION We compete in the global housewares market. While the Domestic and Western European markets are strongly developed, the remainder of the global market is less developed and offers, we believe, significant opportunities for business expansion. We compete with established companies, some of which have substantially greater facilities, personnel, financial and other resources than we have. Competition is based upon price, access to retail shelf space, product features and enhancements, brand names, new product introductions and marketing. 7 The retail industry continues to consolidate leaving fewer retail outlets and increased competition for shelf space. We expect retailers will continue to consolidate their vendor base by dealing primarily with a smaller number of suppliers that can offer a diversified product mix, meet logistical and volume requirements and offer comprehensive levels of customer service and marketing support. We believe our competitive pricing, high level of customer service, strategic acquisitions and alliances, as well as our portfolio of well recognized brand names, new technology and innovative products, position us to compete and benefit from this environment. SEASONALITY Due to holiday buying patterns, sales are traditionally higher in the second fiscal quarter than in the other quarterly periods and the Company typically earns a disproportionate share of operating income in this quarter. TRADEMARKS, PATENTS AND LICENSING ARRANGEMENTS We hold numerous patents and trademarks registered in the United States and foreign countries for various products and processes. We have registered certain of our trademarks with the United States Patent and Trademark Office and we consider these trademarks to be of considerable value and of material importance to our business. The Company's right to use these trademarks continues as long as it uses these names. Salton maintains many licensing and contractual relationships to market and distribute products under specific names and designs. These licensing arrangements generally require certain license fees and royalties. Some of our agreements contain minimum sales requirements that, if not satisfied, may result in the termination of the agreements. Some of our agreements contain minimum royalty payments, which are reflected in the Contractual Obligations table in Management's Discussion and Analysis of Financial Conditions and Results of Operations. REGULATION We are subject to federal, state and local regulations concerning consumer products safety. Foreign jurisdictions also have regulatory authorities overseeing the safety of consumer products. In general, we have not experienced difficulty complying with such regulations and compliance, with them, has not had an adverse effect on our business. Our small electric appliance products sold in the United States are listed by Underwriters Laboratory, Inc. (UL) or ETL. Similar products sold in other countries are listed with local organizations similar to UL if required. PRODUCT WARRANTIES Our products are generally sold with a limited one year warranty from the date of purchase. In the case of defects in material workmanship, we agree to replace or repair the defective product without charge while under the warranty time frame. EMPLOYEES As of August 1, 2006, we employed approximately 984 persons. ADDITIONAL INFORMATION We file annual, quarterly and periodic reports, proxy statements and other information with the SEC. You may obtain and copy any document we file with the SEC at the SEC's Public Reference Room at 100 F Street, N.E., Room 1580, Washington, D.C. 20549. You may obtain information on the operation of the SEC's public reference facilities by calling the SEC at 1-800-SEC-0330. You can request copies of these documents, upon payment of a duplicating fee, by writing to the SEC at its principal office at 100 F Street, N.E., Washington, D.C. 20549. The SEC maintains an Internet website at http://www.sec.gov that 8 contains reports, proxy and information statements, and other information regarding issuers that file electronically with the SEC. Our SEC filings are accessible through the Internet at that website. Our reports on Forms 10-K, 10-Q and 8-K, and amendments to those reports, are available for download, free of charge, as soon as reasonably practicable after these reports are filed with the SEC, at our website at http://www.saltoninc.com. The content of our website is not a part of this report. You may request a copy of our SEC filings, at no cost to you, by writing or telephoning us at: Salton, Inc., 1955 Field Court, Lake Forest, Illinois 60045, attention: Marc Levenstein, Assistant Secretary, telephone: (847) 803-4600. We will not send exhibits to the documents, unless the exhibits are specifically requested and you pay our fee for duplication and delivery. In addition, the Company has made the following available free of charge through its website at http://www.saltoninc.com: - - Audit Committee Charter - - Compensation Committee Charter - - Nominating and Corporate Governance Committee Charter - - Corporate Governance Guidelines, and - - Code of Business Conduct and Ethics. ITEM 1A. Risk Factors Prospective investors should carefully consider the following risk factors, together with the other information contained in this annual report on Form 10-K, in evaluating us and our business before purchasing our securities. In particular, prospective investors should note that this annual report on Form 10-K contains forward-looking statements within the meaning of Section 27A of the Securities Act and Section 21E of the Exchange Act and that actual results could differ materially from those contemplated by such statements. See "Cautionary Statement Regarding Forward-Looking Information." The factors listed below represent certain important factors which we believe could cause such results to differ. These factors are not intended to represent a complete list of the general or specific risks that may affect us. It should be recognized that other risks may be significant, presently or in the future, and the risks set forth below may affect us to a greater extent than indicated. OUR SUBSTANTIAL INDEBTEDNESS COULD ADVERSELY AFFECT OUR FINANCIAL HEALTH AND PREVENT US FROM FULFILLING OUR PAYMENT OBLIGATIONS. We have a significant amount of indebtedness relative to our equity size. As of October 6, 2006, we had total consolidated indebtedness of approximately $338.1 million, including approximately $129.7 million under our senior secured credit facility, $103.3 million of Second Lien Notes, approximately $59.7 million of 2008 Notes, excluding $1.6 million related to the fair value of a monetized fixed to floating interest rate swap on the 2008 Notes, and $35.7 million under our European facility agreement. We may incur additional indebtedness in the future, including through additional borrowings under the second lien credit agreement (which permits the issuance of up to an additional $6.7 million principal amount of Second Lien Notes),our senior secured credit agreement, and our European facility agreement, subject to availability. Our ability to service our debt obligations and to fund planned working capital needs and capital expenditures will depend upon our future operating performance, which will be affected by prevailing economic conditions in the markets we serve and financial, business and other factors, certain of which are beyond our control. Based on our fiscal year 2007 operating plan, we believe existing sources of liquidity will be sufficient to meet cash needs during fiscal 2007. Notwithstanding our beliefs, we can not assure you that our business will generate sufficient cash flow from operations or that future borrowings will be available under our senior secured credit facility or other sources of funds in an amount sufficient to enable us to service our indebtedness or to fund our other liquidity needs. If we are unable to satisfy such liquidity needs, we could be required to adopt one or more alternatives, such as reducing or delaying capital expenditures, borrowing additional funds, restructuring indebtedness, selling other assets or operations 9 and/or reducing expenditures for new product development, cutting other costs, and some of such actions would require the consent of our senior lenders, the holders of the Second Lien Notes, the holders of the 2008 Notes and/or the lenders under our European facility agreement. Notwithstanding our beliefs, we can not assure you that any of such actions could be effected, or if so, on terms favorable to us, that such actions would enable us to continue to satisfy our liquidity needs, that such actions would not dilute the ownership interest of stockholders and/or that such actions would be permitted under the terms of our senior secured credit facility, the second lien credit agreement, the indenture governing the 2008 Notes or the European facility agreement. Our high level of debt could have important consequences for you, such as: - - our debt level makes us more vulnerable to general adverse economic and industry conditions; - - our ability to obtain additional financing for acquisitions, or to fund future working capital, capital expenditures or other general corporate requirements may be limited; - - we will need to use a substantial portion of our cash flow from operations for the payment of the principal of, and interest on, our indebtedness (thereby reducing the amount of money available to fund working capital, capital expenditures or other general corporate purposes); - - our flexibility in planning for, or reacting to, changes in our business and the industry in which we compete may be limited; our debt level could impact our ability to maintain favorable credit terms with our suppliers; - - our debt level could limit our ability or increase the costs to refinance indebtedness; and - - our debt level may place us at a competitive disadvantage to our less leveraged competitors. OUR DEBT INSTRUMENTS CONTAIN RESTRICTIVE COVENANTS THAT COULD ADVERSELY AFFECT OUR BUSINESS BY LIMITING OUR FLEXIBILITY. Our senior secured credit agreement, the second lien credit agreement, the indenture governing the 2008 Notes and the European facility agreement impose restrictions that affect, among other things, our ability to incur debt, pay dividends, sell assets, create liens, make capital expenditures and investments, merge or consolidate, enter into transactions with affiliates, and otherwise enter into certain transactions outside the ordinary course of business. Our senior secured credit agreement, the second lien credit agreement and the European facility agreement also require us to maintain specified financial ratios. Our ability to comply with these covenants and restrictions may be affected by events beyond our control. If we are unable to comply with the terms of our senior secured credit agreement, the second lien credit agreement, indenture governing the 2008 Notes or the European facility agreement, or if we fail to generate sufficient cash flow from operations, or to refinance our debt as described below, we may be required to refinance all or a portion of our indebtedness or to obtain additional financing. If cash flow is insufficient and refinancing or additional financing is unavailable because of our high levels of debt and the debt incurrence restrictions under our debt instruments, we may default on our debt instruments. In the event of a default under the terms of any of our indebtedness, the debt holders may accelerate the maturity of our obligations, which could cause defaults under our other obligations. WE MUST EITHER REPAY OR REFINANCE OUR DEBT MATURING IN DECEMBER 2007 AND THEREAFTER. We have significant maturities of debt in periods subsequent to the next twelve months. These maturities are December 31, 2007 under the senior secured credit agreement, March 31, 2008 under the second lien credit agreement, April 15, 2008 under the indenture governing the 2008 Notes and December 22, 2008 under the European facility agreement. In addition, on September 15, 2008 we are required to exchange all of the outstanding shares of Series A convertible preferred stock for an aggregate of $40.0 million in cash or shares of our common stock. We will not have sufficient cash flow from operations to repay all of our indebtedness at maturity, satisfy our redemption obligations under our preferred stock agreement and fund our other liquidity needs. We believe that these obligations can be satisfied through a 10 combination of repayment, refinancing and sales of assets, however, to accomplish potential sales of businesses or assets, we would need to extend or refinance all or a portion of our indebtedness on or before maturity. Notwithstanding our beliefs, we cannot assure you that we will be able to do so on attractive terms or at all. WE HAVE EXPERIENCED A DECLINE IN DOMESTIC MARKET SALES AND CONTINUE TO IMPLEMENT A DOMESTIC RESTRUCTURING PLAN. Our domestic sales have decreased in fiscal 2006 as compared to fiscal 2005. A portion of that decline is attributable to our sale of the tabletop business in September 2005, discontinued product lines and delays in production from suppliers. We continue to implement our domestic cost reduction plan, and we expect additional cost reductions in fiscal 2007. The cost savings will principally come from a rationalization of operations, brands and SKUs and the costs related to them. Although the restructuring of our domestic operations through workforce layoffs, consolidation of facilities and reduction of certain marketing and advertising programs has reduced our operating expenses, such actions may have an adverse effect on our domestic sales. In addition, our current and prospective customers and suppliers may decide to delay or not purchase or supply our products due to the perceived uncertainty caused by our indebtedness and the domestic restructuring plan. We may be required to take charges in the future relating to our restructuring plan, which could have a material and adverse effect on our operating results. We cannot assure you that the domestic restructuring plan will allow us to better align our domestic cost structure with our current sales levels. OUR INTERNATIONAL OPERATIONS, AND EXPANSION OF THESE OPERATIONS, SUBJECTS US TO ADDITIONAL BUSINESS RISKS AND MAY CAUSE OUR PROFITABILITY TO DECLINE DUE TO INCREASED COSTS. During fiscal 2006, 2005 and 2004, sales recorded outside of North America accounted for 42.1%, 43.2% and 37.1% of total net sales, respectively. Our pursuit of international growth opportunities may require significant investments for an extended period before returns on these investments, if any, are realized. International operations are subject to a number of other risks and potential costs, including: - - the risk that because our brand names may not be locally recognized, we must spend significant amounts of time and money to build a brand identity without certainty that we will be successful; - - local and economic conditions; - - unexpected changes in regulatory requirements; - - inadequate protection of intellectual property in foreign countries; - - foreign currency fluctuations; - - transportation costs; - - adverse tax consequences; and - - political and economic instability, as a result of terrorist attacks, natural disasters or otherwise. For example, our foreign sales in fiscal 2006 were adversely impacted by weak consumer demand in the housewares sector in the United Kingdom and unfavorable foreign currency fluctuations. We cannot assure you that we will not incur significant costs in addressing these potential risks. OUR MARGINS HAVE BEEN ADVERSELY IMPACTED BY INCREASES IN RAW MATERIAL PRICES. The cost of our products has been impacted by global increases in the price of petroleum based plastic materials, steel, copper and corrugated materials. Although we have increased the prices of certain of our goods to our customers, we cannot assure you that we will be able to pass all of these cost 11 increases on to our customers. As a result, our margins may continue to be adversely impacted by such cost increases. OUR ABILITY TO OBTAIN PRODUCTS MAY BE ADVERSELY IMPACTED BY WORLDWIDE DEMAND ON RAW MATERIAL. Our products are predominately made from petroleum based plastic materials, steel and corrugated materials. Our suppliers contract separately for the purchase of them. We can provide no assurance that our sources of supply will not be interrupted should our suppliers not be able to obtain these materials due to worldwide demand or other events that interrupt material flow. IF WE WERE TO LOSE ONE OR MORE OF OUR MAJOR CUSTOMERS, OR SUFFER A MAJOR REDUCTION OF ORDERS FROM THEM, OUR FINANCIAL RESULTS WOULD SUFFER. Our success depends on our sales to our significant customers. Our total net sales to our five largest customers during fiscal 2006 were 33.6% of net sales with Target Corporation representing 9.8% of our net sales and Wal-Mart representing 9.3% of our net sales. Our total net sales to our five largest customers during fiscal 2005 were 37.3% of net sales, with Target Corporation representing 12.6% of our net sales and Wal-Mart representing 8.5% of our net sales. Our total net sales to our five largest customers during fiscal 2004 were 41.0% of net sales, with Target Corporation representing 11.6% of our net sales and Wal-Mart representing 10.5% of our net sales. We do not have long-term agreements with our major customers, and purchases are generally made through the use of individual purchase orders. A significant reduction in purchases by any of these major customers or a general economic downturn in retail sales could have a material adverse effect on our business, financial condition and results of operations. OUR DEPENDENCE ON FOREIGN SUPPLIERS SUBJECTS US TO THE RISKS OF DOING BUSINESS ABROAD. We depend upon unaffiliated foreign companies for the manufacture of most of our products. Our arrangements with our suppliers are subject to the risks of doing business abroad, including: - - import duties; - - trade restrictions; - - production delays due to unavailability of parts or components; - - increase in transportation costs and transportation delays, including those resulting from terrorist activity; - - work stoppages; - - foreign currency fluctuations; and - - political and economic instability and civil unrest, which could lead to the business failure of major suppliers. Any reduction in trade credit from our suppliers could materially adversely affect our operations and financial condition. We depend on the continuing willingness of our suppliers to extend credit to us to finance our inventory purchases. If suppliers become concerned about our ability to generate liquidity and service our debt, they may delay shipments to us or require payment in advance. Because of our limited access to sources of liquidity, any such actions by our suppliers could have a material adverse effect on our ability to continue our business. 12 THE SMALL HOUSEHOLD APPLIANCE INDUSTRY IS HIGHLY COMPETITIVE AND WE MAY NOT BE ABLE TO COMPETE EFFECTIVELY. We believe that competition is based upon several factors, including: - - price; - - access to retail shelf space; - - product features and enhancements; - - brand names; - - new product introductions; and - - marketing support and distribution approaches. We compete with established companies, some of which have substantially greater facilities, personnel, financial and other resources than we have. Significant new competitors or increased competition from existing competitors may adversely affect our business, financial condition and results of operations. IF THE HOUSEWARES SECTOR OF THE RETAIL INDUSTRY CONTINUES TO EXPERIENCE AN ECONOMIC SLOWDOWN, OUR FINANCIAL RESULTS WILL BE ADVERSELY AFFECTED. We sell our products to consumers through major retail channels, primarily mass merchandisers, department stores, specialty stores and mail order catalogs. As a result, our business and financial results can fluctuate with the financial condition of our retail customers and the retail industry. The current general slowdown in the retail sector has adversely impacted our net sales of products, our operating margins and our net income. If such conditions continue or worsen, including any further weakness in consumer confidence as a result of terrorist activity, or otherwise, it could have a material adverse effect on our business, financial condition and results of operations. The current general slowdown in the retail sector has resulted in, and we expect it to continue to result in, additional pricing and marketing support pressures on us. Certain of our retail customers have filed for bankruptcy protection in recent years. We continually monitor and evaluate the credit status of our customers and attempt to adjust sales terms as appropriate. Despite these efforts, a bankruptcy filing by, or other adverse change in the financial condition of, a significant customer could adversely affect our financial results. LONG LEAD TIMES, POTENTIAL MATERIAL PRICE INCREASES AND CUSTOMER DEMANDS MAY CAUSE US TO PURCHASE MORE INVENTORY THAN NECESSARY. Due to manufacturing lead times and a strong concentration of our sales occurring during the second fiscal quarter, as well as potential material price increases, we may purchase products and thereby increase inventories based on anticipated sales and forecasts provided by our customers and our sales personnel. In an extended general economic slowdown, we cannot assure you that our customers will order these inventories as anticipated. IF WE DO NOT ATTRACT AND RETAIN SKILLED PERSONNEL, OUR ABILITY TO GROW AND DEVELOP OUR BUSINESS WILL SUFFER. Our continued success will depend significantly on the efforts and abilities of Leonhard Dreimann, Chief Executive Officer and William M. Lutz, Chief Financial Officer. The loss of the services of one or both of these individuals could have a material adverse effect on our business. In addition, as our business develops and expands, we believe that our future success will depend greatly on our ability to attract and retain highly qualified and skilled personnel. We do not have, and do not intend to obtain, key-man life insurance on our executive officers. 13 OUR OUTSTANDING CONVERTIBLE PREFERRED STOCK CONTAINS REDEMPTION AND OTHER PROVISIONS WHICH COULD HAVE A MATERIAL ADVERSE EFFECT ON, AND SIGNIFICANTLY DILUTE, THE INTERESTS OF HOLDERS OF OUR COMMON STOCK. On July 28, 1998, we issued 40,000 shares of convertible preferred stock in connection with a Stock Purchase Agreement dated July 15, 1998. The convertible preferred stock is non-dividend bearing except if we breach, in any material respect, any of the material obligations in the preferred stock agreement or our restated certificate of incorporation relating to the convertible preferred stock, the holders of the convertible preferred stock are entitled to receive quarterly cash dividends on each share from the date of the breach until it is cured at a rate per annum equal to 12 1/2% of the Liquidation Preference (defined below). The preferred shares are convertible into 3,529,411 shares of our common stock (reflecting an $11.33 per share conversion price). The holders of the convertible preferred stock are entitled to one vote for each share of our common stock that the holder would receive upon conversion of the convertible preferred stock. In the event of a change in control, each preferred shareholder has the right to require us to redeem the shares at a redemption price equal to the Liquidation Preference (defined below) plus interest accrued thereon at a rate of 7% per annum compounded annually each anniversary date from July 28, 1998 through the earlier of the date of such redemption or July 28, 2003. The satisfaction of this redemption obligation would have to be satisfied before any proceeds from a change in control are available to holders of common stock. In the event of a liquidation, dissolution or winding up, whether voluntary or involuntary, holders of the convertible preferred stock are entitled to be paid out of the assets of the Company available for distribution to its stockholders an amount in cash equal to $1,000 per share, plus the amount of any accrued and unpaid dividends thereon (the "Liquidation Preference"), before any distribution is made to the holders of any our common stock or any other of its capital stock ranking junior as to liquidation rights to the convertible preferred stock. We may optionally convert in whole or in part, the convertible preferred stock at any time on and after July 15, 2003 at a cash price per share of 100% of the then effective Liquidation Preference per share, if the daily closing price per share of our common stock for a specified 20 consecutive trading day period is greater than or equal to 200% of the then current conversion price. On September 15, 2008, we will be required to exchange all outstanding shares of convertible preferred stock at a price equal to the Liquidation Preference per share (or an aggregate of $40.0 million), payable at our option in cash or shares of our common stock. Our inability to satisfy this redemption obligation in cash could result in significant dilution of the ownership interest of holders of common stock. OUR CREDIT RATINGS HAVE BEEN DOWNGRADED AND COULD BE DOWNGRADED FURTHER. Our credit ratings on our senior subordinated debt have been downgraded several times during the last two years. On July 14, 2005, Standard & Poor's withdrew its "D" corporate credit and "D" subordinated debt ratings. Such downgrades can have a negative impact on our liquidity by reducing attractive financing opportunities and could make our efforts to raise capital more difficult and have an adverse impact on our financial condition and results of operations. IF WE HAVE TO EXPEND SIGNIFICANT AMOUNTS TO REMEDIATE ENVIRONMENTAL LIABILITIES, OUR FINANCIAL RESULTS WILL SUFFER. Prior to 2003, we manufactured certain of our products at our owned plants in the United States and Europe. Our previous manufacturing of products at these sites exposes us to potential liabilities for environmental damage that these facilities may have caused or may cause nearby landowners. During the ordinary course of our operations, we have received, and we expect that we may in the future receive, citations or notices from governmental authorities asserting that our facilities are not in compliance with, or 14 require investigation or remediation under, applicable environmental statutes and regulations. Any citations or notices could have a material adverse effect on our business, results of operations and financial condition. THE SEASONAL NATURE OF OUR BUSINESS COULD ADVERSELY IMPACT OUR OPERATIONS. Our business is highly seasonal, with operating results varying from quarter to quarter. We have historically experienced higher sales during the second fiscal quarter primarily due to increased demand by customers for our products attributable to holiday sales. This seasonality has also resulted in additional interest expense for us during this period due to an increased need to borrow funds to maintain sufficient working capital to finance product purchases and customer receivables for the seasonal period. Lower sales than expected by us during this period, a lack of availability of product, a general economic downturn in retail sales or the inability to service additional interest expense due to increased borrowings could have a material adverse effect on our business, financial condition and results of operations. PRODUCT RECALLS OR LAWSUITS RELATING TO DEFECTIVE PRODUCTS COULD ADVERSELY IMPACT OUR FINANCIAL RESULTS. We face exposure to product recalls and product liability claims in the event that our products are alleged to have manufacturing or safety defects or to have resulted in injury or other adverse effects. We cannot assure you that we will be able to maintain our product liability insurance on acceptable terms, if at all, or that product liability claims will not exceed the amount of our insurance coverage. As a result, we cannot assure you that product recalls and product liability claims will not adversely affect our business. THE INFRINGEMENT OR LOSS OF OUR PROPRIETARY RIGHTS COULD HAVE AN ADVERSE EFFECT ON OUR BUSINESS. We regard our copyrights, trademarks, service marks and similar intellectual property as important to our success. We rely on copyright and trademark laws in the United States and other jurisdictions to protect our proprietary rights. We seek to register our trademarks in the United States and elsewhere. These registrations could be challenged by others or invalidated through administrative process or litigation. If any of these rights were infringed or invalidated, our business could be materially adversely affected. We license various trademarks and trade names from third parties for use on our products. These licenses generally place marketing obligations on us and require us to pay fees and royalties based on net sales or profits. Typically, each license may be terminated if we fail to satisfy minimum sales obligations or if we breach the license. The termination of these licensing arrangements could adversely affect our business, financial condition and results of operations. WE MAY BE SUBJECT TO LITIGATION AND INFRINGEMENT CLAIMS, WHICH COULD CAUSE US TO INCUR SIGNIFICANT EXPENSES OR PREVENT US FROM SELLING OUR PRODUCTS. We cannot assure you that others will not claim that our proprietary or licensed products are infringing their intellectual property rights or that we do not in fact infringe those intellectual property rights. If someone claimed that our proprietary or licensed products infringed their intellectual property rights, any resulting litigation could be costly and time consuming and would divert the attention of management and key personnel from other business issues. We also may be subject to significant damages or an injunction against use of our proprietary or licensed products. A successful claim of patent or other intellectual property infringement against us could harm our financial condition. COMPLIANCE WITH GOVERNMENTAL REGULATIONS COULD SIGNIFICANTLY INCREASE OUR OPERATING COSTS OR PREVENT US FROM SELLING OUR PRODUCTS. Most federal, state and local authorities require certification by Underwriters Laboratory, Inc., an independent, not-for-profit corporation engaged in the testing of products for compliance with certain public safety standards, or other safety regulation certification prior to marketing electrical appliances. 15 Foreign jurisdictions also have regulatory authorities overseeing the safety of consumer products. Our products, or additional electrical appliances which may be developed by us, may not meet the specifications required by these authorities. A determination that we are not in compliance with these rules and regulations could result in the imposition of fines or an award of damages to private litigants. THE REQUIREMENTS OF COMPLYING WITH THE SARBANES-OXLEY ACT MAY STRAIN OUR RESOURCES, AND OUR INTERNAL CONTROL OVER FINANCIAL REPORTING MAY NOT BE SUFFICIENT TO ENSURE TIMELY AND RELIABLE EXTERNAL FINANCIAL REPORTS. We are subject to various regulatory requirements, including the Sarbanes-Oxley Act of 2002. We have incurred, and expect to continue to incur, substantial costs related to our compliance with the Sarbanes-Oxley Act. The Sarbanes-Oxley Act requires, among other things, that we maintain effective disclosure controls and procedures, corporate governance standards and internal control over financial reporting and that our auditors provide an attestation relative to management's assessment process and conclusions. Due to market capitalization levels, we are not currently required to comply with Section 404. However, we must continue to maintain and assess our system of internal controls over financial reporting, and under current regulations, compliance with Section 404 will be required in fiscal 2008. In order to maintain and improve the effectiveness of our disclosure controls and procedures and internal control over financial reporting, significant resources and management oversight have been, and will continue to be, required. We have devoted additional financial resources, time and personnel to legal, financial and accounting activities to ensure our ongoing compliance with public company reporting requirements. In the future, if our management identifies one or more material weaknesses in our internal control over financial reporting, we may be unable to assert that our internal control over financial reporting is effective as of the end of the preceding year or our auditors may be unable to attest that our management's report is fairly stated or to express an opinion on the effectiveness of our internal controls, even if our auditors issue an unqualified opinion on our financial statements for the preceding fiscal year. If the auditors are unable to provide an unqualified attestation of our assessment of our internal control over financial reporting, it could result in a loss of investor confidence in our financial reports, adversely affect our stock price and our ability to access the capital markets or borrow money, and may subject us to sanctions or investigation by regulatory authorities. OUR STOCK PRICE MAY CONTINUE TO BE VOLATILE. The trading price of our common stock is subject to significant fluctuations in response to variations in quarterly operating results; changes in earnings estimates by analysts; announcements of new products by us or our competitors; changes in the domestic and international economic, political and business conditions; general conditions in the housewares industry; the recent lack of confidence in corporate governance and accounting practices; the open short interest in our Common Stock; our ability to continue the listing of our common stock on New York Stock Exchange; and other events or factors. In addition, the stock market in general has experienced extreme price and volume fluctuations that have affected the market prices for many companies that have been unrelated to the operating performance of these companies. These market fluctuations have adversely affected and may continue to adversely affect the market price of our common stock. OUR COMMON STOCK COULD BE DELISTED BY THE NEW YORK STOCK EXCHANGE IF WE DO NOT COMPLY WITH ITS CONTINUED LISTING STANDARDS. Our common stock is listed on the New York Stock Exchange, or NYSE. The NYSE continued listing standards require that all listed companies maintain an average global capitalization of at least $25 million over a consecutive 30 trading-day period or undergo prompt suspension and delisting procedures. In May 2006 we received notice from the NYSE that we are not in compliance with this requirement. In order to maintain the continued listing of our common stock on the NYSE, we are following the NYSE's rules and procedures applicable to listed companies which fail to meet the continued listing standards. We are currently subject to quarterly monitoring by the NYSE for compliance with its continued listing standards. 16 We cannot assure you that the NYSE will maintain our listing in the future. In the event that our common stock is delisted by the NYSE, or if it becomes apparent to us that we will be unable to meet the NYSE's continued listing criteria in the foreseeable future, we will seek to have our stock listed or quoted on another national securities exchange or quotation system. However, we cannot assure you that, if our common stock is listed or quoted on such other exchange or system, the market for our common stock will be as liquid as it has been on the NYSE. As a result, if we are delisted by the NYSE or transfer our listing to another exchange or quotation system, the market price for our common stock may become more volatile than it has been historically. Delisting of our common stock would likely cause a reduction in the liquidity of an investment in our common stock. Delisting also could reduce the ability of holders of our common stock to purchase or sell our securities as quickly and inexpensively as they would have been able to do had our common stock remained listed. This lack of liquidity also could make it more difficult for us to raise capital in the future. TAKEOVER DEFENSE PROVISIONS WHICH WE HAVE IMPLEMENTED MAY ADVERSELY AFFECT THE MARKET PRICE OF OUR COMMON STOCK. Our stockholder rights plan and various provisions of Delaware corporation law and of our corporate governance documents may inhibit changes in control not approved by our board of directors and may have the effect of depriving stockholders of an opportunity to receive a premium over the prevailing market price of our common stock in the event of an attempted hostile takeover or may deter takeover attempts by third parties. In addition, the existence of these provisions may adversely affect the market price of our common stock. These provisions include: - - a classified board of directors; - - a prohibition on stockholder action through written consent; - - a requirement that special meetings of stockholders be called only by the board of directors; - - availability of "blank check" preferred stock. WE DO NOT ANTICIPATE PAYING DIVIDENDS. We have not paid dividends on our common stock and we do not anticipate paying dividends in the foreseeable future. We intend to retain future earnings, if any, to finance the expansion of our operations and for general corporate purposes, including future acquisitions. In addition, our senior secured credit facility, the second lien credit agreement and the Europe credit facility contain restrictions on our ability to pay dividends on our capital stock. ITEM 2. Properties Salton leases its principal executive offices based in Lake Forest, Illinois. A summary of Salton's principal leased operating facilities is as follows:
AREA LOCATION DESCRIPTION (SQ. FEET) - ------------------------------------------------------------------------------------------------------- Redlands, CA Warehouse 983,986 Wolverhampton, England Warehouse 136,750 Victoria, Australia Sales and administrative office and warehouse 75,348 Lake Forest, IL Corporate offices and showrooms 58,680 Sales and administrative office, warehouse, and Shenzhen, China factory 10,000 Hong Kong, China Sales and administrative office and warehouse 9,459
17 In addition, Salton owns the following properties:
AREA LOCATION DESCRIPTION (SQ. FEET) - ------------------------------------------------------------------------------------------------------- Wolverhampton, England Warehouse 312,000 Laurinburg, NC Sales office and warehouse 223,000 Macon, MO Warehouse and repair facility 171,000 Manchester, England Sales and administrative office and warehouse 170,756 Boonville, MO Warehouse 169,000 Moberly, MO(1) Warehouse 134,000 Burntwood, England Warehouse 121,000 Columbia, MO Administrative offices 62,000
- --------------- (1) Subsequent to year end, the Company entered into an agreement for the sale of this warehouse We believe our facilities will be suitable and adequate for our current level of operations, as well as support future growth. ITEM 3. Legal Proceedings PRODUCT LIABILITY On or about October 27, 2004, a lawsuit entitled DiNatale vs. Salton was filed in the New York State Supreme Court against the Company. The plaintiffs, who seek unspecified damages, allege that they were injured by water contaminated with lead taken from a tea kettle sold by the Company under its Russell Hobbs brand. The plaintiffs' attorney had been seeking to convert the lawsuit into a class action suit; no class action suit has been filed to date. The manufacturer of the product and its insurer are defending this lawsuit. The Company's attorneys and its insurers are cooperating in the defense of the lawsuit. JAY KORDICH V. SALTON, INC. On October 19, 2005, a lawsuit named Jay Kordich v. Salton, Inc. was filed in the United States District Court for the Southern District of California. The plaintiff in this action is seeking a judicial determination that a covenant not to compete in an agreement between him and Salton is invalid and unenforceable against him plus attorneys' fees and costs. Salton believes that the lawsuit is without merit. The outcome of the foregoing legal matters cannot be predicted with certainty, however Salton does not believe that these actions will have a material adverse affect on its business, financial condition or results of operations. Therefore, no amounts have been accrued for such claims. ENVIRONMENTAL The Company has accrued approximately $0.2 million for the anticipated costs of environmental remediation at four of our current and previously owned sites. Although such costs could exceed that amount, Salton believes any such excess will not have a material adverse effect on the financial condition or annual results of operations of the Company. OTHER The Company is a party to various other actions and proceedings incident to its normal business operations. The Company believes that the outcome of any such litigation will not have a material adverse effect on our business, financial condition or results of operations. The Company also has product liability and general liability insurance policies in amounts believed to be reasonable given its current level of business. Although historically the Company has not had to pay any material product liability claims, it is conceivable that the Company could incur claims for which we are not insured. 18 ITEM 4. Submissions of Matters to a Vote of Security Holders None ITEM 4A. Executive Officers of the Registrant Our executive officers and their respective ages as of September 11, 2006, are as follows:
NAME AGE POSITION - ----------------------------------------------------------------------------------------------------- Leonhard Dreimann 58 Chief Executive Officer William B. Rue 59 President and Chief Operating Officer William M. Lutz 48 Chief Financial Officer
LEONHARD DREIMANN has served as Chief Executive Officer and a director of the Company since its inception in August 1988 and is a founder of the Company. From 1988 to July 1998, Mr. Dreimann served as President of the Company. From 1987 to 1988, Mr. Dreimann served as president of the Company's predecessor Salton, Inc., a wholly-owned subsidiary of SEVKO, Inc. Prior to 1987, Mr. Dreimann served as managing director of Salton Australia Pty. Ltd., a distributor of Salton brand kitchen appliances. WILLIAM B. RUE has been a director of the Company since August 1998. Mr. Rue has served as President of the Company since August 1998, as Chief Operating Officer of the Company since December 1994 and as Chief Financial Officer and Treasurer of the Company from September 1988 to January 1999. He is also a founder of the Company. From 1985 to 1988, he was Treasurer of SEVKO, Inc. and from 1982 to 1984 he was Vice President-Finance of Detroit Tool Industries Corporation. Prior to that time, Mr. Rue had been employed since 1974 by the accounting firm of Touche Ross & Co. WILLIAM M. LUTZ has served as Chief Financial Officer since December 2005. From March 2003 to December 2005, Mr. Lutz served as the Company's Vice President, Finance. Mr. Lutz also oversees all Corporate Accounting and Finance functions. Prior to joining the Company, Mr. Lutz served as head of corporate consolidation and subsidiary accounting at Capital One Financial since February 2002. Prior to that time, he held various senior finance positions with manufacturing, consumer products and service companies. 19 PART II ITEM 5. Market for the Registrant's Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities The registrant's common stock has traded on the New York Stock Exchange under the symbol "SFP" since February 26, 1999. From October 1991 until February 25, 1999, our common stock traded on the NASDAQ National Market under the symbol "SALT." The following table sets forth, for the periods indicated, the high and low sales prices for the common stock as reported on the New York Stock Exchange.
HIGH LOW - --------------------------------------------------------------------------- FISCAL 2006 First Quarter 4.40 1.00 Second Quarter 3.29 1.87 Third Quarter 4.13 1.26 Fourth Quarter 3.75 1.56 FISCAL 2005 First Quarter 7.46 4.14 Second Quarter 7.35 4.80 Third Quarter 6.23 2.01 Fourth Quarter 2.96 0.98
DIVIDENDS We have not paid dividends on our common stock and we do not anticipate paying dividends in the foreseeable future. We intend to retain future earnings, if any, to finance the expansion of our operations and for general corporate purposes, including future acquisitions. In addition, our senior secured credit agreement, the second lien credit agreement and the Europe credit facility contain restrictions on our ability to pay dividends on our capital stock. STOCKHOLDER RIGHTS PLAN On June 28, 2004, the Board of Directors of Salton adopted a stockholder rights plan (the "Rights Plan") pursuant to which a dividend consisting of one preferred stock purchase right (a "Right") was distributed for each share of Common Stock held as of the close of business on July 9, 2004, and is to be distributed to each share of Common Stock issued thereafter until the earlier of (i) the Distribution Date (as defined in the Rights Plan), (ii) the Redemption Date (as defined in the Rights Plan) or (iii) June 28, 2014. The Rights Plan is designed to deter coercive takeover tactics and to prevent an acquirer from gaining control of us without offering fair value to our stockholders. The Rights will expire on June 28, 2014, subject to earlier redemption or exchange as provided in the Rights Plan. Each Right entitles the holder thereof to purchase from us one one-thousandth of a share of a new series of Series B Junior Participating Preferred Stock at a price of $45.00 per one one-thousandth of a share, subject to adjustment. The Rights are generally exercisable only if a Person (as defined) acquires beneficial ownership of 25 percent or more of our outstanding Common Stock. A complete description of the Rights, the Rights Agreement between us and UMB Bank, N.A., as Rights Agent, and the Series B Junior Participating Preferred Stock is hereby incorporated by reference from the information appearing under the caption "Item 1. Description of the Registrant's Securities to be Registered" contained in the Registration Statement on Form 8-A filed on June 28, 2004. 20 COMMON STOCK The Certificate of Incorporation authorizes the issuance of 40,000,000 common shares, par value $0.01 per share. As of September 11, 2006, there were approximately 373 holders of record of our common stock. CONVERTIBLE PREFERRED STOCK The Certificate of Incorporation authorizes the issuance of 2,000,000 preferred shares, par value $0.01 per share. We have 40,000 outstanding shares of convertible preferred stock. The convertible preferred stock is generally non-dividend bearing; however, if we breach in any material respect any of our material obligations in the preferred stock agreement or the Certificate of Incorporation relating to the convertible preferred stock, the holders of convertible preferred stock are entitled to receive quarterly cash dividends on each share of convertible preferred stock from the date of such breach until it is cured at a rate per annum equal to 12 1/2% of the Liquidation Preference as defined below. The payment of dividends is limited by the terms of our senior secured credit agreement, the second lien credit agreement and the Europe credit facility. Each holder of the convertible preferred stock is generally entitled to one vote for each share of Salton common stock which such holder could receive upon the conversion of the convertible preferred stock. Each share of convertible preferred stock is convertible at any time into that number of shares of Salton common stock obtained by dividing $1,000 by the Conversion Price in effect at the time of conversion. The "Conversion Price" is equal to $11.33, subject to certain anti-dilution adjustments. In the event of a Change of Control (as defined), each holder of shares of convertible preferred stock has the right to require us to redeem such shares at a redemption price equal to the Liquidation Preference plus an amount equivalent to interest accrued thereon at a rate of 7.0% per annum compounded annually on each anniversary date of July 28, 1998 for the period from July 28, 1998 through the earlier of the date of such redemption or July 28, 2003. In the event of a liquidation, dissolution or winding up of the Company, whether voluntary or involuntary, holders of the Convertible Preferred Stock are entitled to be paid out of the assets of the Company available for distribution to its stockholders an amount in cash equal to $1,000 per share, plus the amount of any accrued and unpaid dividends thereon (the "Liquidation Preference"), before any distribution is made to the holders of any Salton common stock or any other of our capital stock ranking junior as to liquidation rights to the convertible preferred stock. We may optionally convert in whole or in part, the convertible preferred stock at any time on and after July 15, 2003 at a cash price per share of 100% of the then effective Liquidation Preference per share, if the daily closing price per share of our common stock for a specified 20 consecutive trading day period is greater than or equal to 200% of the then current Conversion Price. On September 15, 2008, we will be required to exchange all outstanding shares of convertible preferred stock at a price equal to the Liquidation Preference per share, payable at the Company's option in cash or shares of Salton common stock. As of September 11, 2006 there were 40,000 shares of the convertible preferred stock outstanding, held by 8 shareholders of record. There is no established market for the convertible preferred stock. SERIES C PREFERRED STOCK On August 26, 2005, we issued 135,217 shares of Series C preferred stock with a total liquidation preference of $13.5 million. Salton's restated certificate of incorporation authorizes the Company to issue up to 150,000 shares of Series C preferred stock. The Series C preferred stock is non-dividend bearing and ranks, as to distribution of assets upon the Company's liquidation, dissolution or winding up, whether voluntary or involuntary, (a) prior to all shares of convertible preferred stock from time to time outstanding, (b) senior, in preference of, and prior to all other 21 classes and series the Company's preferred stock and (c) senior, in preference of, and prior to all of the Company's now or hereafter issued common stock. Except as required by law or by certain protective provisions in the Company's restated certificate of incorporation, the holders of shares of Series C preferred stock, by virtue of their ownership thereof, have no voting rights. In the event of the Company's liquidation, dissolution or winding up, whether voluntary or involuntary, holders of the Series C preferred stock will be paid out of the Company's assets available for distribution to the Company's stockholders an amount in cash equal to $100 per share (the "Series C Preferred Liquidation Preference"), before any distribution is made to the holders of the Company's convertible preferred stock, common stock or any other capital stock ranking junior as to liquidation rights to the Series C preferred stock. In the event of a change of control (as defined in the Company's restated certificate of incorporation), each holder of shares of Series C preferred stock will have the right to require the Company to redeem such shares at a redemption price equal to the Series C Preferred Liquidation Preference plus an amount equivalent to interest accrued thereon at a rate of 5% per annum compounded annually on each anniversary date of the issuance date for the period from the issuance date through the change of control. The redemption price is payable on a date after a change of control that is 91 days after the earlier of (x) the date on which specified debt (including indebtedness under the Company's senior secured credit facility, the second lien credit agreement, the indentures under which the Subordinated Notes were issued, and restatements and refinancings of the foregoing) matures and (y) the date on which all such specified debt is repaid in full, in an amount equal to the Series C Preferred Liquidation Preference plus an amount equivalent to interest accrued thereon at a rate of 5% per annum compounded annually on each anniversary date of the issuance date for the period from the issuance date through such change of control payment date. The certificate of designation for the Series C preferred stock provides that, in the event of a change of control, the Company shall purchase all outstanding shares of Series C preferred stock with respect to which the holder has validly exercised the redemption right before any payment with respect to the redemption of convertible preferred stock upon such change of control. The Company may optionally redeem, in whole or in part, the Series C preferred stock at any time at a cash price per share of 100% of the then effective Series C Preferred Liquidation Preference per share. On the fifth anniversary of the issuing date, we will be required to redeem all outstanding shares of Series C preferred stock at a price equal to the Series C Preferred Liquidation Preference per share, payable in cash. 22 ITEM 6. Selected Financial Data The following financial data as of and for the fiscal years ended July 1, 2006, July 2, 2005, July 3, 2004, June 28, 2003 and June 29, 2002 have been derived from and should be read in conjunction with, our audited consolidated financial statements, including the notes thereto.
FIVE-YEAR SUMMARY OF FINANCIAL DATA -------------------------------------------------------------------- JULY 1, JULY 2, JULY 3, JUNE 28, JUNE 29, 2006 2005 2004(1) 2003(4) 2002(4) - ------------------------------------------------------------------------------------------------------- (IN THOUSANDS) STATEMENT OF OPERATIONS: Net sales $ 635,960 $ 781,736 $ 844,760 $ 872,814 $ 922,479 Cost of goods sold 447,530 539,583 577,225 561,440 544,147 Distribution expenses 44,079 54,679 62,771 57,005 60,831 - ------------------------------------------------------------------------------------------------------- Gross profit 144,351 187,474 204,764 254,369 317,501 Selling, general, and administrative expenses 172,075 207,810 248,474 205,903 223,577 Lawsuit settlements, net -- -- -- -- 2,580 Impairment loss on goodwill and intangible assets 21,967 3,211 40,855 800 -- Restructuring costs 867 1,015 1,798 -- -- - ------------------------------------------------------------------------------------------------------- Operating (loss) income (50,558) (24,562) (86,363) 47,666 91,344 Interest expense, net 36,968 51,703 39,783 40,109 44,431 Fair market value adjustment on derivatives -- -- -- (2,515) 2,372 (Gain)/Loss -- Early settlement of debt (21,721) -- 5,049 -- -- - ------------------------------------------------------------------------------------------------------- (Loss) Income before income taxes and minority interest (65,805) (76,265) (131,195) 10,072 44,541 Income tax expense (benefit) 36,229 (22,340) (27,434) 2,390 14,394 - ------------------------------------------------------------------------------------------------------- Net (loss) income from continuing operations $ (102,034) $ (53,925) $ (103,761) $ 7,682 $ 30,147 Income from discontinued operations, net of tax 1,735 2,138 8,589 289 -- Gain on sale of discontinued operations, net of tax 32,332 -- -- -- -- - ------------------------------------------------------------------------------------------------------- Net (loss) income $ (67,967) $ (51,787) $ (95,172) $ 7,971 $ 30,147 - ------------------------------------------------------------------------------------------------------- Weighted average common shares outstanding 13,393 11,374 11,258 14,682 14,535 Net (loss) income per share: Basic (Loss) income from continuing operations $ (7.62) $ (4.74) $ (9.22) $ 0.52 $ 2.07 Income from discontinued operations, net of tax 0.13 0.19 0.77 0.02 -- Gain of sale of discontinued operation, net of tax 2.41 -- -- -- -- - ------------------------------------------------------------------------------------------------------- Net (loss) income per share: Basic(2) $ (5.08) $ (4.55) $ (8.45) $ 0.54 $ 2.07
23
FIVE-YEAR SUMMARY OF FINANCIAL DATA -------------------------------------------------------------------- JULY 1, JULY 2, JULY 3, JUNE 28, JUNE 29, 2006 2005 2004(1) 2003(4) 2002(4) - ------------------------------------------------------------------------------------------------------- (IN THOUSANDS) Weighted average common shares and common Equivalent shares outstanding 13,393 11,374 11,258 15,114 15,042 Net (loss) income per share: Diluted (Loss) income from continuing operations $ (7.62) $ (4.74) $ (9.22) $ 0.51 $ 2.00 Income from discontinued operations, net of tax 0.13 0.19 0.77 0.02 -- Gain of sale of discontinued operation, net of tax 2.41 -- -- -- -- - ------------------------------------------------------------------------------------------------------- Net (loss) income per share: Diluted $ (5.08) $ (4.55) $ (8.45) $ 0.53 $ 2.00 BALANCE SHEET DATA (at period end): Working capital 182,647 205,882 $ 299,993 $ 353,492 $ 279,519 Total assets 553,532 813,243 855,822 812,372 823,927 Total debt(3) 335,457 444,159 418,405 373,560 460,066 Convertible preferred stock 40,000 40,000 40,000 40,000 40,000 Stockholders' equity 19,188 79,928 133,576 213,904 205,036 Dividends Paid -- -- -- -- --
- --------------- (1) Includes the effect of costs related to our U.S. restructuring plan and other items excluded from senior management's assessment of the operating performance of Salton's business (See "U.S. Restructuring Plan" in Management's Discussion and Analysis of Financial Condition and Results of Operations) which on a combined basis, decreased income before income taxes $73.2 million, $57.0 million after tax ($5.06 per basic share). (2) Includes the effect of participation rights of our convertible preferred stock, when that effect is not anti-dilutive, in accordance with EITF Issue No. 03-6. See Note 11 to our audited financial statements. (3) Excludes $0.9 million in fiscal 2005, $4.5 million in fiscal 2004, $4.6 million in fiscal 2003, and $18.2 million in fiscal 2002 related to the loan notes to Pifco shareholders which were fully cash collateralized and excludes $1.8 million in fiscal 2006, $7.1 million in fiscal 2005, $9.6 million in fiscal 2004, $12.1 million in fiscal 2003, and $8.4 million in fiscal 2002 related to the fair value of a monetized fixed to floating interest rate swap on the notes due 2008. (4) The Company has revised its presentation of basic earnings per share to adjust the basic earnings per share calculation under the "two-class" method, when the effect was dilutive. ITEM 7. Management's Discussion and Analysis of Financial Condition and Results of Operations INTRODUCTION Salton designs, markets and distributes small home appliances and electronics for the home, home decor and personal care products under recognized brand names in the International Housewares Industry. Our product mix consists of kitchen and home appliances, electronics, time products, lighting products and personal care and wellness products. In recent years, we have expanded our international presence and strengthened our product offerings through strategic acquisitions and alliances as well as internal international growth. DISCONTINUED OPERATIONS We report discontinued operations in accordance with the guidance from SFAS No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets." Accordingly, we have reported the sale of Amalgamated Appliance Holdings ("AMAP") as discontinued operations for the periods presented. NEW YORK STOCK EXCHANGE CONTINUED LISTING PLAN In June 2005, the Securities and Exchange Commission approved certain amendments to the continued listing criteria for issuers with a class of securities registered on the New York Stock Exchange (the "NYSE"), under Rule 802.01 of the NYSE's Listed Company Manual. Under these continued listing 24 requirements, as they apply to Salton, we would be considered "below criteria" if our average market capitalization is less than $75 million over a 30 trading-day period and, at the same time, our stockholders' equity is less than $75 million. On May 19, 2006, we received official notice from the NYSE that we have fallen "below criteria" under the new continued listing requirements, as our total market capitalization was less than $75 million over a 30 trading-day period and our stockholders' equity was less than $75 million as of our fiscal quarter ended April 1, 2006. Salton reported total stockholders' equity of approximately $62.4 million as of April 1, 2006. In addition, based on 14,386,390 shares outstanding as of May 21, 2006 and the reported closing price of our common stock on the NYSE on that date ($2.56), we had a market capitalization of approximately $36.8 million as of that date. On July 3, 2006, we presented a plan to the NYSE demonstrating how we intend to comply with the continued listing standards. On August 18, 2006, the NYSE notified us that it has accepted our proposed plan for continued listing on the NYSE. As a result of the acceptance, Salton's common stock will continue to be listed on the NYSE pending quarterly reviews by the NYSE's Listing and Compliance Committee during an 18 month period (which started on May 19, 2006) to ensure our compliance with the goals and initiatives outlined in the plan. PRIVATE DEBT EXCHANGE On August 26, 2005, we completed a private debt exchange offer for the outstanding 2005 Notes and the outstanding 2008 Notes. We accepted for exchange an aggregate of approximately $75.2 million in principal amount of 2005 Notes (approximately 60.1% of the then outstanding 2005 Notes) and approximately $90.1 million in principal amount of 2008 Notes (approximately 60.1% of the outstanding 2008 Notes) that were validly tendered in the debt exchange offer. Upon closing of the debt exchange offer, we issued an aggregate of approximately $99.2 million in principal amount of senior second lien notes (the "Second Lien Notes"), 2,041,420 shares of Salton common stock and 135,217 shares of Series C preferred stock with a total liquidation preference of $13.5 million. The Second Lien Notes mature on March 31, 2008 and bear interest at LIBOR plus 7.0%, payable in cash on January 15th and July 15th of each year, beginning in January 2006. The Series C preferred stock is generally non-dividend bearing and is mandatorily redeemable by us in cash at the liquidation amount on August 26, 2010. We also granted certain registration rights for approximately 1,837,455 shares of Salton common stock and 121,707 shares of Series C preferred stock received by certain former holders of Subordinated Notes. In connection with the debt exchange offer, we obtained the consent of the holders of a majority of the outstanding 2005 Notes and a majority of the outstanding 2008 Notes to amend the indentures governing such Subordinated Notes to eliminate substantially all of the restrictive covenants and certain events of default contained in such indentures. We have entered into supplements to the indentures governing the 2005 Notes and the 2008 Notes to reflect such amendments. As a consequence of the debt exchange offer: - - We reduced our total interest-bearing debt by approximately $66.0 million; - - We reduced the aggregate principal amount of 2005 Notes outstanding immediately after the closing of the debt exchange offer to approximately $50 million; - - We increased the aggregate number of outstanding shares of common stock by 2,041,420 or approximately 18% of the 11,376,292 shares of common stock outstanding immediately prior to the debt exchange offer; - - We issued 135,217 shares of Series C preferred stock with a total liquidation preference of $13.5 million; - - Mr. Lester C. Lee, a new independent director designated by certain former holders of the Subordinated Notes, was elected to serve on our board of directors; and 25 - - In the first quarter of fiscal 2006 we recorded a pre-tax gain on cancellation of indebtedness of approximately $21.7 million, net of approximately $9.2 million of expenses. SALE OF AMAP AND TABLETOP ASSETS On September 29, 2005, we completed the sale of our 52.6% ownership interest in AMAP, a leading distributor and marketer of small appliances and other products in South Africa, to a group of investors led by Interactive Capital (Proprietary) Limited. In the first quarter of fiscal 2006, we received proceeds, net of expenses, of approximately $81.0 million in connection with the transaction and recorded a gain of approximately $32.3 million, net of tax. We licensed our George Foreman(R), Russell Hobbs(R) and Carmen(R) branded products to AMAP following the transaction. On September 16, 2005, we completed the sale of certain tabletop assets at cost to Lifetime Brands, Inc. for $14.2 million. In connection with this transaction, we divested our Block(R) and Sasaki(R) brands, licenses to Calvin Klein(R) and Napa Style(TM) tabletop products and distribution of upscale crystal products under the Atlantis(R) brand. In addition, we entered into a new license with Lifetime Brands enabling it to market tabletop products under the Stiffel(R) brand. PRIVATE EXCHANGE On September 28, 2005, we completed a private exchange transaction in which we issued $4.1 million of Second Lien Notes in exchange for $4.0 million of 2005 Notes. OTHER STRATEGIC OPTIONS We continue to explore strategic options to satisfy our liquidity needs and improve our overall balance sheet position and enhance our operating performance. These strategic options include potential sales of assets or businesses, the creation of new foreign debt, repurchases of outstanding Subordinated Notes in the open market and/or through privately negotiated transactions for cash or other securities (including Second Lien Notes, common stock and/or Series C preferred stock) and further reductions in expenses. YEAR IN REVIEW For fiscal 2006 (fifty-two weeks ended July 1, 2006), we continued our focus on returning to profitability by expanding efforts to lower inventory, rationalize SKUs and reduce operating expenses. While we continued to reduce domestic operating costs, domestic sales were reduced or adversely impacted by the sale of the tabletop assets in September 2005, price increases, inventory shortages, vendor and customer uncertainty, post-holiday overstocks at retailers and planned product discontinuation. While we maintained our market share position in the United Kingdom, our foreign sales continued to be impacted by a weak retail market. Customer interest for our new products is positive with many new products hitting retailer shelves in time for the upcoming holiday season. U.S. RESTRUCTURING PLAN As part of an effort to improve our domestic operations, we continue to implement our U.S. restructuring plan to better align domestic operating costs with current sales levels. Through our cost reduction programs and consolidation of U.S. operations, we have already reduced cumulative domestic operating expenses by more than $90 million. Our reductions have exceeded our previously announced plans and expectations. We continue to take actions through additional planned reductions in fiscal 2007. In addition to operational reductions, we have reduced domestic interest expense through our debt restructuring activities and asset sales. 26 FISCAL YEAR 2006 We recorded certain pretax charges as follows: - - $0.9 million of restructuring charges comprised of $0.3 million for continued U.S. warehouse rationalization and severance costs, as well as $0.6 million for closure costs related to a Salton Europe subsidiary. FISCAL YEAR 2005 We recorded certain pretax charges as part of the finalization of the (fiscal 2004) initial U.S. Restructuring Plan as follows: - - $1.0 million for consulting and legal fees, termination and severance costs and costs involved in the closure of certain distribution facilities. FISCAL YEAR 2004 On May 11, 2004, in response to declining domestic sales volumes in 2004, we announced a U.S. restructuring plan to better align domestic operating costs with current sales levels. We completed the initial phase of this U.S. restructuring plan by reducing salaried headcount in the domestic operations by approximately 25.0% in the fourth quarter of fiscal 2004. Additionally, we made decisions to reduce the capacity of our warehousing and distribution network through the rationalization of existing facilities. In connection with the U.S. restructuring plan and subsequent valuation reviews in light of those decisions, we recorded certain pretax charges in the fourth quarter of fiscal 2004 totaling $33.9 million. Of the total costs recorded in fiscal 2004, $20.2 million was associated with the write-down of certain inventory identified for liquidation as part of our decision to rationalize warehouse and distribution facilities and $3.8 million related to the write-off of tooling. These amounts were included in cost of goods sold in the Consolidated Statement of Operations. The total restructuring costs in fiscal 2004 also included a $1.7 million write-down associated with several marketing programs that were canceled or discontinued, which were included in selling, general and administrative expenses. Included within restructuring costs on the Consolidated Statement of Operations are $1.2 million in consulting and legal costs directly associated with the development and implementation of the U.S. restructuring plan and $0.5 million in termination and severance costs associated with the headcount reduction. Also in connection with the U.S. restructuring plan, we recorded a $6.5 million intangible asset impairment charge for trade names associated with products that will no longer be sold. Such charge is included in impairment loss on goodwill and intangible assets in the Consolidated Statement of Operations. The restructuring costs and other items listed above affected comparability of reported operating income, net income and earnings per share for fiscal year 2006, 2005 and 2004. 27 RESULTS OF OPERATIONS The following table sets forth our results of operations as a percentage of net sales for the years ended:
FISCAL YEAR ENDED ------------------------------------------- JULY 1, 2006 JULY 2, 2005 JULY 3, 2004 - ------------------------------------------------------------------------------------------------------- Net sales 100.0% 100.0% 100.0% Cost of goods sold 70.4 69.0 68.3(1) Distribution expenses 6.9 7.0 7.4 - ------------------------------------------------------------------------------------------------------- Gross profit 22.7 24.0 24.3 Selling, general and administrative expense 27.1 26.6 29.4 Impairment loss on goodwill and intangible assets 3.4(3) 0.4 4.8(2) Restructuring costs 0.1 0.1 0.2 - ------------------------------------------------------------------------------------------------------- Operating loss (7.9)% (3.1)% -10.1% - -------------------------------------------------------------------------------------------------------
(1) Includes $24.0 million (2.2% of net sales ) of fourth quarter restructuring costs (See "U.S. Restructuring Plan"). (2) Consists of an aggregate of $40.9 million of impairment charges (See "Impairment Loss on Goodwill and Intangible Assets"). (3) Consists of $21.9 million of impairment charges (See "Impairment Loss on Goodwill and Intangible Assets"). 2006 COMPARED TO 2005 NET SALES AND GROSS PROFIT Salton's annual worldwide sales were $636.0 million in 2006 compared to $781.7 million in 2005, a decline of $145.7 million. Domestic sales were reduced or adversely impacted by the sale of the tabletop assets in September 2005, price increases, inventory shortages, vendor and customer uncertainty, post- holiday overstocks at retailers and planned product discontinuation. While we maintained our market share position in the United Kingdom, our foreign sales continued to be impacted by a continuing weak retail market. The market conditions were the leading cause of the $16.1 million decrease in foreign sales. In addition, Salton incurred $5.5 million in unfavorable foreign currency fluctuation. In order to focus on core business, Salton continues with its efforts to rationalize SKU's, move less attractive inventory and have better utilization of working capital. Gross profit for 2006 declined $43.1 million from $187.5 million in 2005 to $144.4 million in 2006. As a percent of net sales, gross profit was 22.7% in 2006 compared to 24.0% in 2005, a decrease of 1.3%. The fiscal 2006 decreases are primarily a result of global material cost increases in plastics, copper, steel and corrugated materials. These costs were offset by a $10.6 million domestic decline in distribution expenses primarily as a result of our U.S. cost reduction programs. The outlook for material costs remains volatile. Although we have implemented price increases on certain products to compensate for higher material costs, the impact of the price increases is uncertain due to potential reactions of our retailers and the uncertainty of consumer acceptance. SELLING, GENERAL AND ADMINISTRATIVE EXPENSES Selling, general and administrative expenses decreased to $172.1 million in 2006 compared to $207.8 million for 2005. U.S. operations reduced selling, general and administrative expenses by $23.9 million. We reduced foreign selling, general and administrative expenses, primarily in the United Kingdom, by $4.6 million. In addition, we had $7.1 million in favorable foreign currency fluctuations. Domestic selling, general and administrative expense decreases for fiscal year 2006 were primarily driven by a $10.0 million decline in promotional expenditures for television, royalty expense, certain other media and cooperative advertising, and trade show expenses. The $10.0 million decrease included a $7.0 million reduction in direct and infomercial advertising expenditures. In addition, we reduced selling, 28 general and administrative salary expenses by $4.8 million. These decreases were primarily from the efforts of our cost reduction programs. IMPAIRMENT LOSS ON GOODWILL AND INTANGIBLE ASSETS At the end of the fourth quarter of fiscal year 2006, we performed the annual impairment test on the indefinite lived intangible assets, as required by SFAS No. 142, "Goodwill and Other Intangible Assets." Upon completion of the test, it was determined that a pre-tax impairment charge of $21.1 million was necessary to reflect an expectation of lower future cash flows from certain trade names that are considered outside of the Company's core business and had experienced recent declines. In addition, the Company also recorded a $0.8 million impairment charge against certain patents that were being amortized, to reflect management's decisions regarding discontinuing these product lines. At the end of the fourth quarter of fiscal year 2005, we performed the annual impairment test required by SFAS No. 142, "Goodwill and Other Intangible Assets." Upon completion of the test, it was determined that a pre-tax impairment charge of $3.2 million was necessary to reflect management's decisions regarding certain underperforming product lines and related trademarks. RESTRUCTURING COSTS As a result of our U.S. restructuring plan, we incurred $0.9 million of restructuring charges comprised of $0.3 million for continued U.S. warehouse rationalization and severance costs, as well as $0.6 million for closure costs related to a Salton Europe subsidiary. See "U.S. Restructuring Plan" for a discussion of certain pretax charges in fiscal 2005 in connection with our U.S. restructuring plan. NET INTEREST EXPENSE Net interest expense was $37.0 million for fiscal 2006 and $51.7 million for fiscal 2005. Excluding amortization of fees, interest expense as a percent of the average carrying value of debt outstanding was a weighted average annual rate of 8.1% in fiscal 2006 compared to 9.5% in fiscal 2005. The average amount of all debt outstanding was $381.9 million for fiscal 2006 compared to $473.9 million for fiscal 2005. INCOME TAXES Income tax expense was $36.2 million in fiscal 2006, compared to a tax benefit of $22.3 million in fiscal 2005. The effective tax rate for federal, state, and foreign income taxes was approximately (55.0)% in fiscal 2006 versus a tax benefit of 29.2% in fiscal 2005. The effective tax rate in fiscal 2006 is different than the statutory U.S. federal rate mainly due to the establishment of valuation allowances against domestic and certain foreign net deferred tax asset balances as well as U.S. taxes on deemed foreign subsidiaries' dividends. In addition, approximately $16.8 million of federal and state income tax expense was incurred as a result of the sale of the Company's South African subsidiary, AMAP. This income tax expense was netted against the gain on the sale of discontinued operations. In fiscal 2005, the tax benefit of 29.2% differed from the statutory U.S. federal and state rates due to $2.4 million of additional tax adjustments to certain deferred tax accounts related to various prior periods, and foreign tax rates that differ from those in the U.S. 2005 COMPARED TO 2004 NET SALES AND GROSS PROFIT Salton's annual worldwide sales were $781.7 million in 2005 and $844.8 million in 2004. Domestic sales decreased $66.0 million which was partially offset by increases in our foreign market. The domestic sales were adversely impacted in the first half of the year by inventory shortages and lower retail purchases over the prior year and the uncertainty of our suppliers and customers resulting from our increased liquidity 29 issues in the second half of the year. Fiscal 2005 sales of the new George Foreman Grills with removable plates (The Next Grilleration) had a positive impact on domestic sales, which helped offset the decline faced in the domestic market. Gross profit for 2005 declined $17.3 million from $204.8 million in 2004 to $187.5 million in 2005. The 2004 gross profit included $24.0 million of fourth quarter charges in connection with the U.S. restructuring plan announced on May 11, 2004. As a percent of net sales, gross profit was 24.0% in 2005 compared to 24.2% in 2004, a decrease of 0.2%. The decrease would have been greater if the fourth quarter charges in connection with our U.S. restructuring plan were excluded from gross profit for the fiscal year 2004. The fiscal 2005 decreases are primarily a result of global material cost increases in plastics, steel and corrugated materials, partially offset by a $10.5 million domestic decline in distribution expenses primarily as a result of our U.S. cost reduction programs. The outlook for material costs remains uncertain. Although we have recently implemented price increases on certain products to compensate for higher material costs, the impact of the price increases is uncertain due to potential reactions of our competitors and the uncertainty of consumer acceptance. SELLING, GENERAL AND ADMINISTRATIVE EXPENSES Selling, general and administrative expenses decreased to 26.6% of net sales or $207.8 million in 2005 compared to 29.4% of net sales or $248.5 million for 2004. U.S. operations reduced selling, general and administrative expenses by $52.3 million. These decreases were partially offset by $5.8 million in international increases driven by our European expansion as well as $5.8 million from foreign currency increases. Domestic selling, general and administrative expense decreases for fiscal year 2005 were primarily driven by a $32.8 million decline in promotional expenditures for television, royalty expense, certain other media and cooperative advertising, and trade show expenses. The $32.8 million decreases included a $20.6 million reduction in cooperative advertising and an $11.0 million decrease in direct and infomercial advertising expenditures. In addition, we reduced selling, general and administrative salary expenses by $7.5 million. These decreases were primarily from the efforts of our cost reduction programs. IMPAIRMENT LOSS ON GOODWILL AND INTANGIBLE ASSETS At the end of the fourth quarter of fiscal year 2005, we performed the annual impairment test required by SFAS No. 142, "Goodwill and Other Intangible Assets." Upon completion of the test, it was determined that a pre-tax impairment charge of $3.2 million was necessary to reflect management's decisions regarding certain underperforming product lines and related trade names. At the end of the third quarter of fiscal 2004, management determined that the combination of the shortfall in meeting projected operating results along with the Company's inability to meet its financial debt covenant requirements for its senior secured credit facility and a downgrade in its debt rating could have an adverse affect on the comparison of fair value to carrying value for goodwill and other intangible assets. An interim impairment test was conducted at that time and we determined that the implied fair value of goodwill and the fair value of certain other indefinite lived intangible assets were less than their carrying values. We recorded a non-cash impairment charge totaling $34.3 million pre-tax or $29.9 million net of tax, consisting of consolidated goodwill of $28.2 million and certain other indefinite lived intangible assets associated with iCEBOX, of $6.1 million. Upon completion of its annual impairment test at the end of the fourth quarter 2004, we determined that an additional charge of $6.5 million was necessary against trade names impacted by the adoption of its U.S. restructuring plan. RESTRUCTURING COSTS As a result of our U.S. restructuring plan, we incurred $1.0 million in restructuring costs during 2005 consisting of consulting and legal costs as well as termination and severance costs associated with the U.S. headcount reduction. See "U.S. Restructuring Plan" for a discussion of certain pretax charges in the fourth quarter of fiscal 2004 in connection with our U.S. restructuring plan. 30 NET INTEREST EXPENSE Net interest expense was $51.7 million for fiscal 2005 and $39.8 million for fiscal 2004. Excluding amortization of fees, interest expense as a percent of the average carrying value of debt outstanding was a weighted average annual rate of 9.5% in fiscal 2005 compared to 8.8% in fiscal 2004. The average amount of all debt outstanding was $473.9 million for fiscal 2005 compared to $412.9 million for fiscal 2004. INCOME TAXES Income tax expense was a tax benefit of $22.3 million in fiscal 2005, compared to a tax benefit of $27.4 million in fiscal 2004. The effective tax benefit rate for federal, state, and foreign income taxes was approximately 29.2% in 2005 versus approximately 20.9% in 2004. The effective tax benefit rate in 2005 is lower than the statutory U.S. Federal and State rates due to $2.4 million of additional tax adjustments to certain year end deferred tax accounts related to various prior periods and foreign rates which differ from those in the U.S. In 2004 the tax benefit rate differed from the statutory U.S. Federal and State rates due to $13.3 million of non-deductible goodwill that was written off as a result of an impairment charge $6.9 million of tax reserves provided as a valuation allowance against certain foreign income tax credits that have a ten year life for U.S. tax purposes and the effect of foreign rates that differ from those in the U.S. LIQUIDITY AND CAPITAL RESOURCES CASH FLOW FROM OPERATIONS Our primary sources of liquidity are our cash flow from operations and borrowings under our senior secured credit facility and European facility agreement. In 2006, Salton's operations used $8.0 million in cash flow, compared with a use of $17.3 million in 2005. This improvement was a result of planned inventory reductions associated with the sale of the tabletop business and the planned exit of certain product lines in an effort to focus on the core business and improve utilization of working capital. While we continue to experience tightening credit terms from our sources of supply, accounts payable increased slightly as vendors comfort was slightly restored from the second half of fiscal 2005. As disclosed in the discussion above, we do face foreign currency fluctuation, however, we believe our results of operations for the periods discussed have not been significantly affected by inflation or foreign currency fluctuation. We generally negotiate our purchase orders with our foreign manufacturers in United States dollars. Thus, our cost under any purchase order is not subject to change after the time the order is placed due to exchange rate fluctuations. However, the weakening of the United States dollar against local currencies could result in certain manufacturers increasing the United States dollar prices for future product purchases. Given the seasonal nature of our business, borrowings and availability tend to be highest in mid-fall and early winter. The Company also currently uses foreign exchange contracts to hedge anticipated foreign currency transactions, primarily U.S. dollar inventory purchases. The contracts generally mature within one year and are designed to limit exposure to exchange rate fluctuations, primarily the British Pound Sterling and Australian Dollar against United States dollars. INVESTING ACTIVITIES In 2006, we had $69.9 million in proceeds, net of cash sold, from the sale of discontinued operations as a result of the AMAP transaction and $16.3 million in proceeds from the sale of assets and investments, primarily from the sale of our tabletop assets and a warehouse facility in the U.S. FINANCING ACTIVITIES In 2006, we repaid $33.5 million on our worldwide credit facilities. In addition, we incurred $13.6 million of financing costs associated with our debt restructuring and Salton Europe Credit Facility and $50.5 million primarily associated with the repayment of the 2005 Notes. 31 SENIOR SECURED CREDIT FACILITY On June 15, 2004, we entered into an amended and restated senior secured credit facility with Silver Point Finance, LLC which currently provides us with the ability to borrow up to approximately $188 million pursuant to a revolving line of credit, letters of credit and a $100.0 million term loan. Advances under the revolving line of credit are primarily based upon percentages of eligible accounts receivable and inventories. The facility has a maturity date of December 31, 2007 and is subject to a prepayment premium of 3.50% if the facility is repaid after June 15, 2006. As of October 6, 2006, we had borrowed $129.7 million under the senior secured credit facility and had approximately $5.0 million available under this facility for future borrowings. Borrowings under our senior secured credit facility accrue interest, at our option, at either: LIBOR, plus 6.5% (effective August 15, 2006) equaling 12.0% at October 6, 2006; or the Base Rate (prime rate), plus 4.5% (effective August 15, 2006) equaling 12.8% at October 6, 2006. The Company has the option to convert any base rate loan to LIBOR rate loan. Our senior indebtedness contains a number of significant covenants that, among other things, restrict our ability to dispose of assets, incur additional indebtedness, prepay other indebtedness, pay dividends, repurchase or redeem capital stock, enter into certain investments, enter into sale and lease-back transactions, make certain acquisitions, engage in mergers and consolidations, create liens, or engage in certain transactions with affiliates and otherwise restrict our corporate and business activities. In addition, under our senior secured credit facility, we are required to comply with a minimum EBITDA and consolidated fixed charge coverage ratio. We are also required to deposit all proceeds from collection of accounts receivable and sale of collateral with an account under the exclusive dominion and control of the senior lenders. Subsequent to July 1, 2006, the Company entered into a ninth amendment to, and waiver, under the senior secured credit facility, which suspends the consolidated fixed charge coverage ratio and minimum EBITDA covenants through and including March 2007 and adds a monthly cash flow covenant through March 2007. (See Note 22, "Subsequent Events"). Events of default under our senior secured credit facility include, but are not limited to: (a) our failure to pay principal or interest when due; (b) our material breach of any representation or warranty; (c) covenant defaults; (d) our default with respect to any other debt with an outstanding principal amount in excess of $1.0 million if the effect thereof is to accelerate or permit the acceleration of such debt; and (e) events of bankruptcy. The senior secured credit facility is secured by all of our tangible and intangible assets and all of the tangible and intangible assets of our domestic subsidiaries and a pledge of the capital stock of our domestic subsidiaries and the capital stock of certain of our foreign subsidiaries. The senior secured credit facility is unconditionally guaranteed by each of our direct and indirect domestic subsidiaries. SECOND LIEN CREDIT AGREEMENT On August 26, 2005, in connection with the closing of our debt exchange offer, we entered into a second lien credit agreement with The Bank of New York, as agent, which provides for the issuance of up to $110 million aggregate principal amount of Second Lien Notes. We issued approximately $99.2 million of Second Lien Notes in connection with our debt exchange offer. We subsequently issued an additional $4.1 million of Second Lien Notes in connection with our private exchange. A gain of $21.7 million (approximately $1.52 per share) was realized on the debt exchange. We may add additional lenders under the second lien credit agreement through the issuance of additional Second Lien Notes as long as the aggregate principal amount of the Second Lien Notes does not exceed $110 million. The second lien credit agreement and the Second Lien Notes have a maturity date of March 31, 2008. The interest rate with respect to the Second Lien Notes is the six month LIBOR plus 7%, equaling 11.72125% as of July 1, 2006, payable in cash on January 15th and July 15th of each year. The default rate is LIBOR plus 10%. 32 The Second Lien Notes are redeemable by us at our option, in whole or in part, at any time at a redemption price equal to the following percentage of the principal amount so redeemed, plus accrued and unpaid interest up to the redemption date: - - if the redemption occurs prior to the first anniversary of the consummation of the debt exchange offer, 102%; - - if the redemption occurs between the first anniversary and second anniversary of the closing of the debt exchange offer, 101%; and thereafter, 100%. The second lien credit agreement contains covenants that are substantially the same as the covenants contained in our senior secured credit facility. Under the terms of the second lien credit agreement, to the extent that the lenders under our senior secured credit facility amend or modify the covenants under such facility, the parallel covenants under the second lien credit agreement shall be automatically deemed amended or modified; provided that the lenders under our senior secured credit facility may not amend or modify the covenant limiting the maximum amount of our senior secured credit facility to the difference between (x) $287 million and (y) the aggregate principal amount of Second Lien Notes issued in connection with our debt exchange offer. The second lien credit agreement allows us, subject to the conditions in our senior secured credit facility, to purchase, prepay or redeem Subordinated Notes at any time after the debt exchange offer; provided that, with respect to 2008 Notes, (1) we must have a minimum level of availability under our senior secured credit facility of at least $4 million after giving effect to any such purchases and (2) the aggregate amount spent by us to purchase 2008 Notes does not exceed $11 million. Notwithstanding the foregoing, we may spend more than $11 million in the aggregate to purchase 2008 Notes if we meet the foregoing conditions and we optionally prepay or redeem on a ratable basis a cumulative portion of the Second Lien Notes as follows (percentages and amounts assume that we issued $110 million of aggregate principal amount of Second Lien Notes in connection with the debt exchange offer):
PERMITTED ADDITIONAL CUMULATIVE PERCENTAGE AMOUNTS AVAILABLE TO OF THE SECOND LIEN NOTES REDEEMED PURCHASE 2008 NOTES - ---------------------------------------------------------------------------------- 9% $ 2 million 18% $ 5 million 27% $ 9 million 36% $14 million 45% $20 million 54% $27 million 63% $35 million 72% $44 million 81% $54 million 90% $66 million 100% $78 million
Subject to the Intercreditor Agreement described below, if an event of default (other than an event of default resulting from certain events of bankruptcy, insolvency or reorganization) occurs and is continuing, the second lien agent and the holders of at least 66 2/3% in principal amount of Second Lien Notes then outstanding may declare the principal of and accrued but unpaid interest on all of the Second Lien Notes to be due and payable. If an event of default relating to certain events of bankruptcy, insolvency or reorganization occurs and is continuing, the principal of and interest on all of the Second Lien Notes shall automatically become immediately due and payable without notice or demand of any kind. The Second Lien Notes are our senior secured obligations and rank: (a) senior in right of payment to all of our existing and future subordinated debt, including the Subordinated Notes; and (b) equal in right of 33 payment with all of our other existing and future senior debt, including indebtedness outstanding under our senior secured credit facility. The Second Lien Notes are secured by a second-priority lien on substantially all of our domestic assets and a pledge of the capital stock of our domestic subsidiaries and certain of our foreign subsidiaries. The Second Lien Notes are also unconditionally guaranteed by each of direct and indirect domestic subsidiaries. INTERCREDITOR AGREEMENT The agent and co-agent for our senior secured credit facility, on the one hand, and the second lien agent for our second lien credit agreement entered into an intercreditor agreement dated as of August 26, 2005 which provides that, among other things, any lien on collateral held by or on behalf of the second lien agent or any holder of the Second Lien Notes that secures all or any portion of the Second Lien Notes will in all respects be junior and subordinate to all liens granted to the lenders under our senior secured credit facility. At any time that the agent or co-agent under our senior secured credit facility notifies the second lien agent in writing that an event of default has occurred and is continuing under such facility, then the second lien agent and the holders of the Second Lien Notes will not have any right to exercise any secured creditor remedies (including without limitation, foreclosing or otherwise realizing upon collateral) or take certain other actions (including, without limitation, commencing or causing to be commenced or joining with any creditor in commencing any insolvency proceeding) until the first to occur of (a) payment in full in cash of all obligations under our senior secured credit facility after or concurrently with termination of all commitments to extend credit thereunder, (b) the date upon which the agent or co-agent under our senior secured credit facility shall have waived or acknowledged in writing the termination of such event of default or (c) 270 days following receipt of such notice by the second lien agent (a "standstill period"). Only two standstill periods may be commenced within any 360 day period, and no subsequent standstill period may be commenced within 60 days after the termination of the immediately preceding standstill period. The intercreditor agreement also substantially limits the rights of the second lien agent and the holders of the Second Lien Notes in an insolvency proceeding. The intercreditor agreement requires the net proceeds from the sale of collateral to be applied first to our obligations under our senior secured credit facility and then to our obligations under the second lien credit agreement. SENIOR SUBORDINATED NOTES On April 23, 2001, the Company issued $150.0 million of 12 1/4% Senior Subordinated notes (the "2008 Notes") due April 15, 2008. Proceeds of the 2008 Notes were used to repay outstanding indebtedness and for the acquisition of Pifco Holdings PLC (Salton Europe). On August 26, 2005, the Company completed a private debt exchange for approximately $90.1 million of the 2008 Notes (See "Private Debt Exchange"). In connection with our debt exchange offer, we obtained the consent of the holders of a majority of the outstanding 2008 Notes to amend the indenture governing such Subordinated Notes to eliminate substantially all of the substantive covenants (other than these dealing with certain asset sales and the application of proceeds therefrom and changes of control) and certain events of default (other than these dealing with the payment of interest and principal when due) contained in such indentures. We have entered into supplements to the indentures governing the 2008 Notes to reflect such amendments. Our Subordinated Notes are general unsecured obligations and are subordinated to all our current and future senior debt, including all borrowings under our senior secured credit facility and the Second Lien Notes. The Subordinated Notes rank equally with all our other existing and future senior subordinated indebtedness. Our current and future domestic restricted subsidiaries jointly and severally guarantee our payment obligations under the Subordinated Notes on a senior subordinated basis. The guarantees rank junior to all 34 senior debt of the guarantors (including guarantees under our senior secured credit facility) and equally with all other senior subordinated indebtedness of the guarantors. SALTON EUROPE FACILITY AGREEMENT On December 23, 2005, Salton Holdings Limited, Salton Europe Limited and certain affiliates entered into a Facility Agreement with Burdale Financial Limited, as agent and security trustee, and a financial institution group as lender. The provisions of the Facility Agreement allow certain of the Company's European subsidiaries to borrow funds as needed in an aggregate amount not to exceed L61.0 million (approximately $112.8 million). The Facility Agreement matures on December 22, 2008 and bears a variable interest rate of LIBOR plus 7% on term loans and LIBOR plus 2.75% on revolver loans, payable on the last business day of each month. At July 1, 2006, these rates for borrowings denominated in the Great Britain Pound were approximately 13.66% and 9.41% for term and revolver loans, respectively. The rate for revolver loan borrowings denominated in the U.S. Dollar was 10.09%. The Facility Agreement consists of a Revolving Credit Facility with an aggregate maximum availability of L50.0 million (approximately $92.5 million) and two Term Loan Facilities of L5.0 million and L6.0 million (approximately $9.2 million and $11.1 million, respectively). The Company has used borrowings under these facilities to repay existing debt and for working capital purposes. As of July 1, 2006, under the Revolving Credit Facility, the Company had outstanding borrowings denominated in the Great Britain Pound of L9.5 million (approximately $17.6 million) and borrowings denominated in the U.S. Dollar of $2.0 million. Under the Term Loan Facilities, the Company had L0.8 million (approximately $1.5 million) classified as current debt, and the remainder classified under long-term debt. The Facility Agreement contains a number of significant covenants that, among other things, restrict the ability of certain of the Company's European subsidiaries to dispose of assets, incur additional indebtedness, prepay other indebtedness, pay dividends, repurchase or redeem capital stock, enter into certain investments, make certain acquisitions, engage in mergers and consolidations, create liens, or engage in certain transactions with affiliates and otherwise restrict corporate and business activities. In addition, the Company is required to comply with a fixed charge coverage ratio. Subsequent to July 1, 2006, the Company entered into an amendment and restatement to the Facility Agreement, which waives compliance with the fixed charge coverage ratio for the months of April and May 2006 and amends the definition of such covenant thereafter. OTHER CREDIT FACILITIES We maintain credit facilities outside of the United States that locally support our foreign subsidiaries operations and working capital requirements. These facilities are at current market rates in those localities and at certain peak periods of the year, are secured by various assets. SERIES C PREFERRED STOCK On August 26, 2005, we issued 135,217 shares of our Series C preferred stock with a total liquidation preference of $13.5 million. Our restated certificate of incorporation authorizes us to issue up to 150,000 shares of Series C preferred stock. The Series C preferred stock is non-dividend bearing and ranks, as to distribution of assets upon our liquidation, dissolution or winding up, whether voluntary or involuntary, (a) prior to all shares of convertible preferred stock from time to time outstanding, (b) senior, in preference of, and prior to all other classes and series our preferred stock and (c) senior, in preference of, and prior to all of our now or hereafter issued common stock. Except as required by law or by certain protective provisions in our restated certificate of incorporation, the holders of shares of Series C preferred stock, by virtue of their ownership thereof, have no voting rights. In the event of our liquidation, dissolution or winding up, whether voluntary or involuntary, holders of the Series C preferred stock will be paid out of our assets available for distribution to our stockholders an 35 amount in cash equal to $100 per share (the "Series C Preferred Liquidation Preference"), before any distribution is made to the holders of our convertible preferred stock, our common stock or any other of our capital stock ranking junior as to liquidation rights to the Series C preferred stock. In the event of a change of control (as defined in our restated certificate of incorporation), each holder of shares of Series C preferred stock will have the right to require us to redeem such shares at a redemption price equal to the Series C Preferred Liquidation Preference plus an amount equivalent to interest accrued thereon at a rate of 5% per annum compounded annually on each anniversary date of the issuance date for the period from the issuance date through the change of control. The redemption price is payable on a date after a change of control that is 91 days after the earlier of (x) the date on which specified debt (including indebtedness under our senior secured credit facility, the second lien credit agreement, the indentures under which the Subordinated Notes were issued, and restatements and refinancings of the foregoing) matures and (y) the date on which all such specified debt is repaid in full, in an amount equal to the Series C Preferred Liquidation Preference plus an amount equivalent to interest accrued thereon at a rate of 5% per annum compounded annually on each anniversary date of the issuance date for the period from the issuance date through such change of control payment date. The certificate of designation for the Series C preferred stock provides that, in the event of a change of control, we shall purchase all outstanding shares of Series C preferred stock with respect to which the holder has validly exercised the redemption right before any payment with respect to the redemption of convertible preferred stock upon such change of control. We may optionally redeem, in whole or in part, the Series C preferred stock at any time at a cash price per share of 100% of the then effective Series C Preferred Liquidation Preference per share. On the fifth anniversary of the issuing date, we will be required to redeem all outstanding shares of Series C preferred stock at a price equal to the Series C Preferred Liquidation Preference per share, payable in cash. CONVERTIBLE PREFERRED STOCK On July 28, 1998, the Company issued $40.0 million of convertible preferred stock in connection with a Stock Purchase Agreement dated July 15, 1998. The convertible preferred stock is non-dividend bearing except if the Company breaches, in any material respect, any of the material obligations in the preferred stock agreement or the certificate of incorporation relating to the convertible preferred stock, the holders of the convertible preferred stock are entitled to receive quarterly cash dividends on each share from the date of the breach until it is cured at a rate per annum to 12 1/2% of the Liquidation Preference (defined below). In addition to the dividend provided above, in the event the Board of Directors of the Corporation shall determine to pay any cash or non-cash dividends or distributions on its Common Stock (other than dividends payable in shares of its Common Stock) the holders of shares of Convertible Preferred Stock shall be entitled to receive cash and non-cash dividends or distributions in an amount and of a kind equal to the dividends or distributions that would have been payable to each such holder as if the Convertible Preferred Stock held by such holder had been converted into Common Stock immediately prior to the record date for the determination of the holders of Common Stock entitled to each such dividend or distribution; provided, however, that if the Corporation shall dividend or otherwise distribute rights to all holders of Common Stock entitling the holders thereof to subscribe for or purchase shares of capital stock of the Corporation, which rights (i) until the occurrence of a specified event or events are deemed to be transferred with such shares of Common Stock and are not exercisable and (ii) are issued in respect of future issuances of Common Stock, the holders of shares of the Convertible Preferred Stock shall not be entitled to receive any such rights until such rights separate from the Common Stock or become exercisable, whichever is sooner. The preferred shares are convertible into 3,529,411 shares of Salton common stock (reflecting a $11.33 per share conversion price). The holders of the convertible preferred stock are entitled to one vote for each share of Salton common stock that the holder would receive upon conversion of the convertible preferred stock. In connection with the convertible preferred stock issuance, two individuals representing the purchasers of the preferred stock were appointed to serve on the Company's Board of Directors. 36 In the event of a change in control of the Company, each preferred shareholder has the right to require the Company to redeem the shares at a redemption price equal to the Liquidation Preference (defined below) plus interest accrued thereon at a rate of 7% per annum compounded annually each anniversary date from July 28, 1998 through the earlier of the date of such redemption or July 28, 2003. In the event of a liquidation, dissolution or winding up of the Company, whether voluntary or involuntary, holders of the Convertible Preferred Stock are entitled to be paid out of the assets of the Company available for distribution to its stockholders an amount in cash equal to $1,000 per share, plus the amount of any accrued and unpaid dividends thereon (the Liquidation Preference), before any distribution is made to the holders of any Salton common stock or any other of its capital stock ranking junior as to liquidation rights to the convertible preferred stock. The Company may optionally convert in whole or in part, the convertible preferred stock at any time on and after July 15, 2003 at a cash price per share of 100% of the then effective Liquidation Preference per share, if the daily closing price per share of the Company common stock for a specified 20 consecutive trading day period is greater than or equal to 200% of the then current Conversion Price. On September 15, 2008, the Company will be required to exchange all outstanding shares of convertible preferred stock at a price equal to the Liquidation Preference per share, payable at the Company's option in cash or shares of Salton common stock. In accordance with Emerging Issues Task Force Topic No. D-98 "Classification and Measurement of Redeemable Securities", the convertible preferred stock is classified as a separate line item apart from permanent equity on the Company's balance sheet, as redemption thereof in shares of common stock is outside of the Company's control. NEW ACCOUNTING PRONOUNCEMENTS In February 2006, the Financial Accounting Standards Board (FASB) issued Statement No. 155, "Accounting for Certain Hybrid Financial Instruments," which amends Statement No. 133, "Accounting for Derivative Instruments and Hedging Activities" and Statement No. 140, "Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities." This statement permits fair value remeasurement for any hybrid financial instrument that contains an embedded derivative that otherwise would require bifurcation. In addition, it establishes a requirement to evaluate interests in securitized financial assets to identify interests that are freestanding derivatives or that are hybrid financial instruments that contain an embedded derivative requiring bifurcation. This statement is effective for all financial instruments acquired, issued or subject to a new basis occurring after the beginning of an entity's first fiscal year that begins after September 15, 2006. The Company is currently evaluating the impact of this statement on its financial statements. In March 2006, the FASB issued Statement No. 156, "Accounting for Servicing of Financial Assets," which amends Statement No. 140, "Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities." This statement provides guidance addressing the recognition and measurement of separately recognized servicing assets and liabilities, common with mortgage securitization activities. This statement is effective for all separately recognized servicing assets and liabilities acquired or issued after the beginning of an entity's fiscal year that begins after September 15, 2006. The Company does not expect the adoption of this statement to have a material effect on its financial condition, results of operations, or cash flows. In June 2006, the FASB issued FASB Interpretation No. 48, "Accounting for Uncertainty in Income Taxes -- an Interpretation of FASB Statement No. 109" to clarify the accounting for uncertainty in income taxes recognized in an enterprise's financial statements in accordance with FASB Statement No. 109, "Accounting for Income Taxes." This interpretation prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. This interpretation also provides guidance on derecognition, classification, interest and penalties, accounting in interim periods, disclosure, and transition. This interpretation is effective for fiscal 37 years beginning after December 15, 2006. The Company is currently evaluating the impact of the interpretation on the consolidated financial statements. In June 2006 the FASB ratified a consensus on the EITF Issue No. 06-3, "How Taxes Collected from Customers and Remitted to Governmental Authorities Should Be Presented in the Income Statement (That Is, Gross Versus Net Presentation)" regarding the classification of certain sales, value added and excise taxes within the income statement. This EITF is effective for financial reports for interim and annual reporting periods beginning after December 15, 2006. The Company is currently evaluating the impact of the EITF on its presentation of such taxes on the statement of operations. In September 2006, the FASB issued Statement No. 157, "Fair Value Measurements." This statement defines fair value, establishes a framework for measuring fair value in generally accepted accounting principles, and expands disclosures about fair value measurements. This statement is effective for financial statements issued for fiscal years beginning after November 15, 2007. We are currently evaluating the impact of adopting this statement on the consolidated financial statements. In September 2006, the FASB issued Statement No. 158, "Employers' Accounting for Defined Benefit Pension and Other Postretirement Benefit Plans." This statement requires companies to recognize the overfunded or underfunded status of a defined benefit postretirement plan as an asset or liability in its statement of financial position. This statement is effective for financial statements as of the end of the fiscal year ending after December 15, 2006. We are currently evaluating the impact of adopting this statement on the consolidated financial statements. In September 2006, the Securities and Exchange Commission issued Staff Accounting Bulletin No. 108, (SAB 108). SAB 108 considers the effects of prior year misstatements when quantifying misstatements in current year financial statements. It is effective for financial statements issued after November 15, 2006. We do not believe the adoption of SAB 108 will have a material impact on the consolidated financial statements. DISCUSSION OF CRITICAL ACCOUNTING POLICIES Our financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America, which require us to make estimates and judgments that significantly affect the reported amounts of assets, liabilities, revenues and expenses and related disclosure of contingent assets and liabilities. We regularly evaluate these estimates, including those related to our allowance for doubtful accounts, reserve for inventory valuation, reserve for returns and allowances, valuation of intangible assets having indefinite lives, cooperative advertising accruals, pension benefits and depreciation and amortization. We base these estimates on historical experience and on assumptions that are believed by management to be reasonable under the circumstances. Actual results may differ from these estimates, which may impact the carrying value of assets and liabilities. The following critical accounting policies required the most significant estimates used in the preparation of our consolidated financial statements: ALLOWANCE FOR DOUBTFUL ACCOUNTS -- The Company calculates allowances for estimated losses resulting from the inability of customers to make required payments. The Company utilizes a number of tools to evaluate and mitigate customer credit risk. Management evaluates each new customer account using a combination of some or all of the following sources of information: credit bureau reports, industry credit group reports, customer financial statement analysis, customer supplied credit references and bank references. Appropriate credit limits are set in accordance with company credit risk policy and monitored on an on-going basis. Existing customers are monitored and credit limits are adjusted according to changes in their financial condition. Based on the procedures outlined herein, and the fact that no customer accounted for greater than 10% of the gross accounts receivable at July 1, 2006, and only one customer accounted for 10.6% of the gross accounts receivable at July 2, 2005, the Company believes there is no concentration of credit risk. 38 ESTIMATES OF CREDITS TO BE ISSUED TO CUSTOMERS -- Salton regularly receives requests for credits from retailers for returned products or in connection with sales incentives, such as cooperative advertising, volume rebate agreements, product markdown allowances and other promotional allowances. The Company reduces sales or increases selling, general, and administrative expenses, depending on the nature of the credits, for estimated future credits to customers. Estimates of these amounts are based either on historical information about credits issued, relative to total sales, or on specific knowledge of incentives offered to retailers. This process entails a significant amount of inherent subjectivity and uncertainty. These incentives are accounted for in accordance with Emerging Issues Task Force Issue No. 01-9, "Accounting for Consideration Given by a Vendor to a Customer" ("EITF 01-9"). In instances where there is an agreement with the customer to provide advertising funds, reductions in amounts received from customers as a result of cooperative advertising programs are included in the consolidated statement of income on the line entitled "Selling, general, and administrative expenses." Returns, markdown allowances, cash discounts, and volume rebates are all recorded as reductions of net sales. INVENTORIES -- The Company values inventory at the lower of cost or market, and regularly reviews the book value of discontinued product lines and stock keeping units (SKUs) to determine if these items are properly valued. If market value is less than cost, the Company writes down the related inventory to the estimated net realizable value. The Company regularly evaluates the composition of inventory to identify slow-moving and obsolete inventories to determine if additional write-downs are required. The Company's domestic inventories are generally determined by the last-in, first-out (LIFO) method. These inventories account for approximately 49.6% and 60.7% of the Company's inventories of continuing operations as of July 1, 2006 and July 2, 2005, respectively. All remaining inventory cost is determined on the first-in, first-out basis. See Note 6, "Inventories." PATENTS, TRADE NAMES AND OTHER IDENTIFIABLE INTANGIBLE ASSETS -- The identifiable intangible assets of the Company are primarily trade names acquired in transactions and business combinations. Identifiable intangibles with finite lives are amortized and those with indefinite lives are not amortized. The estimated useful life of an identifiable intangible asset to the Company is based upon a number of factors including the effects of demand, competition and the level of maintenance expenditures required to obtain future cash flows. The Company tests identifiable intangible assets with an indefinite life for impairment, at a minimum on an annual basis, relying on a number of factors including operating results, business plans and projected future cash flows. Identifiable intangible assets that are subject to amortization are evaluated for impairment using a process similar to that used to evaluate other long-lived assets. The impairment test for identifiable intangible assets not subject to amortization consists of a comparison of the fair value of the intangible asset with its carrying amount. An impairment loss is recognized for the amount by which the carrying value exceeds the fair value of the asset. Currently, the Company does not have material definite-lived intangible assets that are amortized. INCOME TAXES -- The Company accounts for income taxes using the asset and liability approach. If necessary, the measurement of deferred tax assets is reduced, based on available evidence, by the amount of any tax benefits that management believes is more likely than not that it will not be realized. 39 CONTRACTUAL OBLIGATIONS To facilitate an understanding of the Company's contractual obligations and commercial commitments, the following data is provided:
PAYMENTS DUE BY PERIOD ------------------------------------------ WITHIN 2-3 4-5 AFTER 5 TOTAL 1 YEAR YEARS YEARS YEARS - ---------------------------------------------------------------------------------------------------- (IN THOUSANDS) Long-Term Debt(1) $320,223 $ 12,512 $294,189 $13,522 $ -- Short-Term Debt 19,975 386 19,589 -- -- Capital Lease Obligations 39 31 8 -- -- Operating Leases 67,596 7,979 13,811 12,406 33,400 - ---------------------------------------------------------------------------------------------------- Total Contractual Cash Obligations $407,833 $ 20,908 $327,597 $25,928 $33,400 - ---------------------------------------------------------------------------------------------------- Projected Interest(2) $ 47,861 $ 27,294 $ 20,567 $ -- $ -- - ----------------------------------------------------------------------------------------------------
(1) Includes accrued interest of $11.0 million due within 1 year and $13.1 million due within 2 years. (2) Interest was projected based on average borrowings on credit facilities through their maturities at rates in affect at July 1, 2006
PAYMENTS DUE BY PERIOD ------------------------------------------ TOTAL WITHIN 2-3 4-5 AFTER 5 AMOUNTS 1 YEAR YEARS YEARS YEARS - ---------------------------------------------------------------------------------------------------- (IN THOUSANDS) License Agreements(1) $15,707 $ 5,115 $ 7,187 $ 1,790 $ 1,615 Pension Plan Contributions(2) 2,003 2,003 -- -- -- Lawsuit Settlement(3) 500 -- 500 -- -- Foreman Agreement(4) 750 750 -- -- -- Sonex Earn-Out Consideration(5) -- -- -- -- -- - ---------------------------------------------------------------------------------------------------- Total Commercial Commitments $18,960 $ 7,868 $ 7,687 $ 1,790 $ 1,615 - ----------------------------------------------------------------------------------------------------
(1) Includes non-cancelable license agreements. Several of these commitments have the option to be extended at the option of management. Payments beyond the original agreement have not been included above. (2) Contributions to the Company's defined benefit plans are determined annually based on actuarial valuations. Future period contribution reflect known commitments. (3) Settlement relating to securities class action lawsuit. (4) Agreement with George Foreman for professional appearances associated with the promotion of the George Foreman product line. (5) Additional consideration to be paid to Sonex International Corporation based on net sales after allowances, commencing after net sales of Sonex products exceed $20.0 million. As of July 1, 2006, the Company will continue to accrue and shall owe up to an additional $2.5 million. FORWARD LOOKING We anticipate capital expenditures on an ongoing basis to be at historical levels in relation to net sales. We believe that (a) future cash flow from operations based on our current level of operations, (b) available borrowings under our senior secured credit facility, second lien credit agreement and other sources of debt funding and (c) funds from the sale or monetization of certain assets will be adequate to meet our anticipated requirements for current capital expenditures, working capital requirements, interest and income tax payments and scheduled debt payments for the next twelve months. Our ability to satisfy our anticipated liquidity requirements, however, is subject to several assumptions, some of which are beyond our control, including: (a) general economic, financial, competitive and other factors; and (b) our continued compliance with covenants in our debt instruments. If we are unable to satisfy our liquidity needs, we could be required to adopt one or more alternatives, such as reducing or delaying capital expenditures, borrowing additional funds, restructuring indebtedness, selling other assets or operations and/or reducing expenditures for new product development, cutting other costs, and some or such actions would require the consent of our senior lenders, holders of Second Lien Notes and/or the holders of our Subordinated Notes. We cannot assure you that any of such actions could be effected, or if so, on terms 40 favorable to us, that such actions would enable us to continue to satisfy our liquidity needs and/or that such actions would be permitted under the terms of our senior secured credit facility, the second lien credit agreement or the indentures governing our Subordinated Notes. In addition, we have required amendments and waivers to our senior debt during recent periods due to our failure to remain in compliance with financial covenants in our senior debt. We cannot assure you that we will be able to comply with the financial covenants and other covenants in our debt instruments or that, if we fail to comply, our debt holders would waive our compliance or forbear from exercising their remedies. ITEM 7A. Quantitative and Qualitative Disclosures about Market Risk We use derivative financial instruments to manage interest rate and foreign currency risk. Our objectives in managing our exposure to interest rate changes are to limit the impact of interest rate changes on earnings and cash flows and to lower our overall borrowing costs through the use of interest rate swaps. Our objectives in managing our exposure to foreign currency fluctuations is to reduce the impact of changes in foreign exchange rates on consolidated results of operations and future foreign currency denominated cash flows. We do not enter into derivative financial instruments for trading purposes. Our policy is to manage interest rate risk through the use of a combination of fixed and variable rate debt, and hedge foreign currency commitments of future payments and receipts by purchasing foreign currency forward contracts. The following tables provide information about our market sensitive financial instruments and constitutes a "forward-looking statement." Our major risk exposures are changing interest rates in the United States and foreign currency commitments in our foreign subsidiaries. The fair values of our long-term, fixed rate debt and foreign currency forward contracts were estimated based on dealer quotes. The carrying amount of short-term debt and long-term variable-rate debt approximates fair value. All items described in the tables are non-trading.
2007 2008 2009 2010 2011 THEREAFTER TOTAL FAIR VALUE - --------------------------------------------------------------------------------------------------------------------- (DOLLARS IN THOUSANDS) FISCAL YEAR 2006 Liabilities: Short-term loan $ 386 $ 19,589 $ 19,975 $ 19,975 Average interest rate 9.50% 9.41% Long-term debt: Fixed rate amount(1) $ 59,881 $ 13,522 $ 73,403 $ 56,228 Average interest rate 12.25% (1) Variable rate amount(2)(3) $12,512 $217,949 $ 16,359 $246,820 $222,713 Average interest rates 13.66% 11.23% 13.66%
2006 2007 2008 2009 2010 THEREAFTER TOTAL FAIR VALUE - --------------------------------------------------------------------------------------------------------------------- (DOLLARS IN THOUSANDS) FISCAL YEAR 2005 Liabilities: Short-term loan $22,056 $ 22,056 $ 22,056 Average interest rate 5.42% Long-term debt: Fixed rate amount $45,990 $ 59,881 $105,871 $ 58,038 Average interest rate 10.75% 12.25% Variable rate amount $47,551 $203,098 $250,649 $204,832 Average interest rates 8.27% 9.66%
- --------------- (1) The long-term fixed rate debt amount consists of Sr. Subordinated Notes due April 15, 2008 and Series C preferred stock that is mandatorily redeemable by the Company in cash on August 26, 2010. The current carrying amount of the Series C preferred stock is $8.9 million (see Note 8, "Senior Secured Credit Facility, Letters of Credit and Long-Term Debt"). 41 (2) The variable rate amount due fiscal 2007 includes accrued interest of $11.0 million related to the Second Lien Notes. The variable rate amount due fiscal 2008 includes $100.0 million senior secured credit facility, $103.3 million of Second Lien Notes and $13.1 million of accrued interest related to the Second Lien Notes (see Note 8, "Senior Secured Credit Facility, Letters of Credit and Long-Term Debt"). (3) The average interest rate on the variable rate debt due fiscal 2008 is the weighted average rate of the senior secured credit facility and the Second Lien Notes. The variable rate senior secured credit facility is set periodically at an established base rate (equivalent to the prime rate of interest) plus an applicable margin or, at our election, a LIBOR rate plus an applicable margin. The variable rate on the Second Lien Notes is set at a LIBOR rate plus an applicable margin. The average interest rate on our outstanding debt was approximately 11.66% at July 1, 2006 compared to 9.75% at July 2, 2005, or an increase of 191 basis points, or 19.2%. An increase of 100 basis points in our average interest rate could impact us by adding $2.1 million of additional interest cost annually (based upon our debt outstanding at July 1, 2006). We are exposed to foreign currency transaction risk associated with certain sales transactions being denominated in British Pounds, Australian Dollars or Brazilian Reals, and foreign currency translation risk as the financial position and operating results of the Company's foreign subsidiaries are translated into U.S. dollars for consolidation. We use foreign currency forward contracts with terms of less than one year, to hedge our exposure to changes in foreign currency exchange rates. In managing our foreign currency exposures, we identify and aggregate naturally occurring offsetting positions and then hedge residual balance sheet exposures. At July 1, 2006, we had a forward contract outstanding for the purchase of $1.0 million over the course of the next twelve months. During fiscal year 2006, average monthly foreign exchange rates changed as follows: WEIGHTED-AVERAGE MONTHLY EXCHANGE RATE:
INCREASE FY2005 FY2006 (DECREASE) % ------ ------ ---------- ----- British Pound 1.8645 1.7762 (0.0883) (4.73) Australian Dollar 0.7512 0.7489 (0.0022) (0.29) Brazilian Real 0.3784 0.4531 0.0746 19.71
For the year ended July 1, 2006 our net sales denominated originally in currencies other than the U.S. Dollar totaled approximately $239.1 million, and stockholders' equity includes a current increase of approximately $0.9 million due to the positive impact of foreign currency exchange rates as compared to the prior year. A 10% change from the 2006 average foreign currency exchange rates would have resulted in an increase or decrease in our annual net sales and stockholders' equity of 3.7% and 37.7%, respectively. The risk analyses provided above do not represent actual gains or losses in fair value that we will incur. It is important to note that the changes in value represent the potential for change in fair value under certain assumptions, and actual results may be materially different. ITEM 8. Financial Statements and Supplementary Data The consolidated financial statements of the Company, including the notes to all such statements and other supplementary data are included in this report beginning on page F-1. ITEM 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure NONE ITEM 9A. Controls and Procedures Salton carried out an evaluation, under the supervision and with the participation of Salton's management, including Salton's principal executive officer and principal financial officer, of the effectiveness of the design and operation of Salton's disclosure controls and procedures pursuant to Rule 13a-15 under the Securities Exchange Act of 1934, as amended (the "Exchange Act"), as of July 1, 2006. Based upon that evaluation, the principal executive officer and principal financial officer concluded that Salton's disclosure 42 controls and procedures were effective to ensure that information required to be disclosed by the Company (including its consolidated subsidiaries) in the reports the Company files or submits under the Exchange Act, is recorded, processed, summarized and reported within the periods specified in the SEC's rules and forms. INTERNAL CONTROL OVER FINANCIAL REPORTING In fiscal year 2006, Salton exited from accelerated filer status as a result of its total market capitalization falling below the required threshold of $50 million as of the end of the second fiscal quarter. As a result, Salton is not required to provide the prescribed management report on internal control over financial reporting otherwise required by the Sarbanes Oxley Act, section 404. In addition, the Company's auditors are not required to audit the internal control over financial reporting, and have not done so. Management, however, recognizes its responsibility for establishing and maintaining adequate internal control over financial reporting, and has continued to conduct its testing and assessment accordingly. CHANGES IN INTERNAL CONTROL OVER FINANCIAL REPORTING The Company previously reported an internal control deficiency related to the preparation and review of its tax provision and related accounting procedures at the end of fiscal 2005. Management had determined that this control deficiency constituted a material weakness as defined by the Public Company Accounting Oversight Board's Auditing Standard No. 2. In response to the recognition of the material weakness in the tax processes and procedures, management began a remediation process that continued throughout fiscal year 2006. The remediation process included: 1. Hiring additional staff with significant domestic and international tax experience; 2. Retaining external resources to supplement the Company's tax personnel; 3. Additional training and enhanced research tools; and 4. Implementing additional policies and interim reporting requirements to ensure the accuracy of accounting and tax calculations supporting the amounts reflected in the financial statements and to ensure all significant accounts are properly reconciled on a frequent and timely basis. These actions have resulted in significant improvements in the income tax accounting processes and procedures, as of the end of fiscal 2006. In order to consider the deficiency to be fully remediated the changes must operate for an adequate period of time to be fully tested and assessed by management. The timing of the implementation of a number of the changes along with the complexity of certain tax positions did not allow management adequate time to complete its testing and assessment process. There are further actions planned in fiscal 2007, to ensure that all procedures can be completed within a period of time that is adequate to allow for full testing and assessment. Except as described above as it relates to income tax processes and procedures, there were no changes in internal control over financial reporting that occurred in the fourth quarter of fiscal 2006, that has materially affected or is reasonably likely to materially affect Salton's internal controls over financial reporting. 43 ITEM 9B. Other Information None PART III ITEM 10. Directors and Executive Officers of the Registrant The information required by this Item 10 as to the Directors of the Company is incorporated herein by reference to the information set forth under the caption "Election of Directors" in the Company's definitive Proxy Statement for the 2006 Annual Meeting of Stockholders, since such Proxy Statement will be filed with the Securities and Exchange Commission not later than 120 days after the end of our fiscal year pursuant to Regulation 14A. Information required by this Item 10 as to the executive officers of the Company is included in Part I of this Annual Report on Form 10-K. ITEM 11. Executive Compensation The information required by this Item 11 is incorporated by reference to the information set forth under the caption "Compensation of Directors and Executive Officers" in the Company's definitive Proxy Statement for the 2006 Annual Meeting of Stockholders, since such Proxy Statement will be filed with the Securities and Exchange Commission not later than 120 days after the end of our fiscal year pursuant to Regulation 14A. ITEM 12. Security Ownership of Certain Beneficial Owners and Management The information required by this Item 12 is incorporated by reference to the information set forth under the caption "Stock Ownership of Principal Holders and Management" in the Company's definitive Proxy Statement for the 2006 Annual Meeting of Stockholders, since such Proxy Statement will be filed with the Securities and Exchange Commission not later than 120 days after the end of our fiscal year pursuant to Regulation 14A. EQUITY COMPENSATION PLAN INFORMATION This table shows information about the securities authorized for issuance under our equity compensation plans as of July 1, 2006.
(A) (B) WEIGHTED-AVERAGE NUMBER OF SECURITIES TO EXERCISE PRICE OF BE ISSUED UPON EXERCISE OUTSTANDING OPTIONS, OF OUTSTANDING OPTIONS, WARRANTS AND WARRANTS AND RIGHTS RIGHTS - ---------------------------------------------------------------------------- Equity compensation plans approved by security holders(1) 1,206,516 $ 9.98 Equity compensation plans not approved by security holders(2) 957,075 $21.03 - ---------------------------------------------------------------------------- TOTAL 2,163,591 $14.87 - ---------------------------------------------------------------------------- (C) NUMBER OF SECURITIES REMAINING AVAILABLE FOR FUTURE ISSUANCE UNDER EQUITY COMPENSATION PLANS (EXCLUDING SECURITIES REFLECTED IN COLUMN (A) - ----------------------------- ----------------------- Equity compensation plans approved by security holders(1) 738,946 Equity compensation plans not approved by security holders(2) 654,928 - ----------------------------- TOTAL 1,393,874 - -----------------------------
(1) Includes: 1992 Stock Option Plan, 1995 Stock Option Plan, 1995 Non-Employee Directors Stock Option Plan, 1998 Stock Option Plan, 2002 Stock Option Plan. (2) Includes our: 1999 Stock Option Plan, 2000 Stock Option Plan, 2001 Stock Option Plan. 44 ITEM 13. Certain Relationships and Related Transactions The information required by this Item 13 is incorporated by reference to the information set forth under the caption "Certain Transactions" in the Company's definitive Proxy Statement for the 2006 Annual Meeting of Stockholders, since such Proxy Statement will be filed with the Securities and Exchange Commission not later than 120 days after the end of our fiscal year pursuant to Regulation 14A. ITEM 14. Principal Accounting Fees and Services This information is in the Proxy Statement under the heading "Independent Auditor Information" and is incorporated by reference. 45 PART IV ITEM 15. Exhibits and Financial Statement Schedules (a)1 and 2 -- An "Index to Financial Statements and Financial Statement Schedules" has been filed as a part of this Report beginning on page F-1 hereof. (a)(3) Exhibits -- An "Exhibit Index" has been filed as part of this Report beginning on page F-47 hereof and is incorporated herein by reference. 46 SIGNATURES Pursuant to the requirements of Section 13 of the Securities Exchange Act of 1934, as amended (the "Exchange Act") the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized on the 16th day of October, 2006. SALTON, INC. By: /s/ WILLIAM M. LUTZ ------------------------------------ William M. Lutz Chief Financial Officer Pursuant to the requirements of the Exchange Act, this report has been signed below by the following persons on behalf of the Registrant and in the capacities indicated on October 16, 2006.
SIGNATURE - --------- /s/ LEONHARD DREIMANN Chief Executive Officer and Director - ------------------------------------------ (Principal Executive Officer) Leonhard Dreimann /s/ WILLIAM B. RUE President and Chief Operating Officer and Director - ------------------------------------------ William B. Rue /s/ WILLIAM M. LUTZ Chief Financial Officer - ------------------------------------------ (Principal Accounting and Financial Officer) William M. Lutz /s/ BRUCE J. WALKER Director - ------------------------------------------ Bruce J. Walker /s/ STEVEN M. OYER Director - ------------------------------------------ Steven M. Oyer /s/ DANIEL J. STUBLER Director - ------------------------------------------ Daniel J. Stubler Director - ------------------------------------------ Lester C. Lee Director - ------------------------------------------ David M. Maura
47 SALTON, INC. INDEX TO FINANCIAL STATEMENTS AND FINANCIAL STATEMENT SCHEDULES YEAR ENDED JULY 1, 2006
PAGE Report of Independent Registered Public Accounting Firm F-2 Consolidated Balance Sheets F-3 Consolidated Statements of Operations F-5 Consolidated Statements of Stockholders' Equity F-6 Consolidated Statements of Cash Flows F-8 Notes to Consolidated Financial Statements F-10
F-1 REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM To the Board of Directors and Stockholders of Salton, Inc. Lake Forest, Illinois We have audited the accompanying consolidated balance sheets of Salton, Inc. and subsidiaries (the "Company") as of July 1, 2006 and July 2, 2005, and the related consolidated statements of operations, stockholders' equity, and cash flows for each of the three years in the period ended July 1, 2006. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on the financial statements based on our audits. We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. Our audits included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company's internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, such consolidated financial statements present fairly, in all material respects, the financial position of Salton, Inc. and subsidiaries as of July 1, 2006 and July 2, 2005, and the results of their operations and their cash flows for each of the three years in the period ended July 1, 2006, in conformity with accounting principles generally accepted in the United States of America. /s/ Deloitte & Touche LLP Chicago, Illinois October 13, 2006 F-2 SALTON, INC. CONSOLIDATED BALANCE SHEETS JULY 1, 2006 AND JULY 2, 2005 (IN THOUSANDS EXCEPT SHARE AND PER SHARE DATA)
2006 2005 - ---------------------------------------------------------------------------------- ASSETS Current Assets: Cash $ 18,103 $ 14,857 Compensating balances on deposit 39,516 34,355 Accounts receivable, less allowance: 2006 $9,440; 2005 -- $7,695 117,094 140,179 Inventories 143,997 195,065 Assets held for sale -- 998 Prepaid expenses and other current assets 14,809 16,048 Prepaid income taxes 1,332 -- Deferred income taxes 5,433 5,524 Current assets of discontinued operations -- 101,927 - ---------------------------------------------------------------------------------- Total current assets 340,284 508,953 Property, Plant and Equipment: Land 6,481 6,275 Buildings 13,376 14,145 Molds and tooling 44,902 41,863 Equipment and office furniture 48,069 48,222 - ---------------------------------------------------------------------------------- 112,828 110,505 - ---------------------------------------------------------------------------------- Less accumulated depreciation (72,368) (60,278) - ---------------------------------------------------------------------------------- Net Property, Plant and Equipment 40,460 50,227 Trade names 159,675 180,041 Non-Current Deferred Tax Asset 3,269 54,730 Other Assets 9,844 11,555 Non-Current Assets of Discontinued Operations -- 7,737 - ---------------------------------------------------------------------------------- TOTAL ASSETS $553,532 $813,243 - ----------------------------------------------------------------------------------
See notes to consolidated financial statements. F-3 SALTON, INC. CONSOLIDATED BALANCE SHEETS (CONTINUED) JULY 1, 2006 AND JULY 2, 2005 (IN THOUSANDS EXCEPT SHARE DATA)
2006 2005 - --------------------------------------------------------------------------------- LIABILITIES AND STOCKHOLDERS' EQUITY Current Liabilities: Revolving line of credit and other current debt $ 32,518 $ 70,730 Senior subordinated notes -- current -- 45,990 Accounts payable 91,308 86,254 Accrued expenses 28,081 34,802 Accrued interest 5,028 13,589 Income taxes payable 702 4,375 Current liabilities of discontinued operations -- 47,331 - --------------------------------------------------------------------------------- Total current liabilities 157,637 303,071 Non-Current Deferred Tax Liability 16,271 3,334 Senior Subordinated Notes due 2005 -- 79,010 Senior Subordinated Notes due 2008, including an adjustment of $1,829 and $7,082 to the carrying value related to interest rate swap agreements, respectively 61,531 156,387 Second Lien Notes, including an adjustment of $13,136 and $0 to the carrying value for accrued interest, respectively 116,407 -- Series C Preferred Stock, $.01 par value; authorized, 150,000 shares; 135,217 shares issued 8,922 -- Term Loan and Other Notes Payable 117,908 100,050 Other Long Term Liabilities 15,668 20,283 Non-Current Liabilities of Discontinued Operations -- 6,917 - --------------------------------------------------------------------------------- Total liabilities 494,344 669,052 Minority Interest -- 24,263 Convertible Preferred Stock, $.01 par value; authorized, 2,000,000 shares, 40,000 shares issued 40,000 40,000 Commitments and Contingencies Stockholders' Equity: Common stock, $.01 par value; authorized, 40,000,000 shares; shares issued and outstanding: 2006 -- 14,386,390; 2005 -- 11,376,292 178 148 Treasury stock -- 7,885,845 shares, at cost (65,793) (65,793) Additional paid-in capital 63,854 55,441 Accumulated other comprehensive income 10,297 11,513 Retained earnings 10,652 78,619 - --------------------------------------------------------------------------------- Total stockholders' equity 19,188 79,928 - --------------------------------------------------------------------------------- TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $553,532 $813,243 - ---------------------------------------------------------------------------------
See notes to consolidated financial statements. F-4 SALTON, INC. CONSOLIDATED STATEMENTS OF OPERATIONS YEARS ENDED JULY 1, 2006, JULY 2, 2005, AND JULY 3, 2004 (IN THOUSANDS EXCEPT SHARE AND PER SHARE DATA)
2006 2005 2004 - --------------------------------------------------------------------------------------------- Net sales $ 635,960 $781,736 $ 844,760 Cost of goods sold 447,530 539,583 577,225 Distribution expenses 44,079 54,679 62,771 - --------------------------------------------------------------------------------------------- Gross profit 144,351 187,474 204,764 Selling, general and administrative expenses 172,075 207,810 248,474 Impairment loss on goodwill and intangible assets 21,967 3,211 40,855 Restructuring costs 867 1,015 1,798 - --------------------------------------------------------------------------------------------- Operating loss (50,558) (24,562) (86,363) Interest expense, net 36,968 51,703 39,783 (Gain)/loss -- early settlement of debt (21,721) -- 5,049 - --------------------------------------------------------------------------------------------- Loss before income taxes (65,805) (76,265) (131,195) Income tax expense (benefit) 36,229 (22,340) (27,434) - --------------------------------------------------------------------------------------------- Net loss from continuing operations (102,034) (53,925) (103,761) Income from discontinued operations, net of tax 1,735 2,138 8,589 Gain on sale of discontinued operations, net of tax 32,332 -- -- - --------------------------------------------------------------------------------------------- Net loss $ (67,967) $(51,787) $ (95,172) - --------------------------------------------------------------------------------------------- Weighted average common shares outstanding 13,393 11,374 11,258 Weighted average common and common equivalent shares outstanding 13,393 11,374 11,258 Net loss per common share: Basic Loss from continuing operations $ (7.62) $ (4.74) $ (9.22) Income from discontinued operations, net of tax 0.13 0.19 0.77 Gain on sale of discontinued operations, net of tax 2.41 -- -- - --------------------------------------------------------------------------------------------- Net loss per common share: Basic $ (5.08) $ (4.55) $ (8.45) - --------------------------------------------------------------------------------------------- Net loss per common share: Diluted Loss from continuing operations $ (7.62) $ (4.74) $ (9.22) Income from discontinued operations, net of tax 0.13 0.19 0.77 Gain on sale of discontinued operations, net of tax 2.41 -- -- - --------------------------------------------------------------------------------------------- Net loss per common share: Diluted $ (5.08) $ (4.55) $ (8.45) - ---------------------------------------------------------------------------------------------
See notes to consolidated financial statements. F-5 SALTON, INC. CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY YEARS ENDED JULY 3, 2004, JULY 2, 2005 AND JULY 1, 2006 (IN THOUSANDS)
COMMON ADDITIONAL SHARES COMMON PAID IN OUTSTANDING STOCK CAPITAL - ------------------------------------------------------------------------------------------------- BALANCE, JUNE 28, 2003 11,187 $ 148 $ 56,179 Net loss -- -- -- Other comprehensive income: Minimum pension liability net of tax of $692 -- -- -- Derivative liability net of tax of $(2,268) -- -- -- Foreign currency translation -- -- -- Total comprehensive income -- -- -- Stock options exercised 36 -- 223 Issuance of common stock 147 -- 163 Foreman Additional Liability -- -- (418) - ------------------------------------------------------------------------------------------------- BALANCE, JULY 3, 2004 11,370 148 56,147 Net loss -- -- -- Other comprehensive income: Minimum pension liability net of tax of $(425) -- -- -- Derivative liability net of tax of $3,263 -- -- -- Foreign currency translation -- -- -- Total comprehensive income -- -- -- Stock options exercised 6 -- 27 Foreman additional liability -- -- (733) - ------------------------------------------------------------------------------------------------- BALANCE, JULY 2, 2005 11,376 $ 148 $ 55,441 - ------------------------------------------------------------------------------------------------- Net loss -- -- -- Other comprehensive income: Minimum pension liability net of tax of $835 -- -- -- Derivative liability net of tax of $2 -- -- -- Foreign currency translation -- -- -- Total comprehensive income -- -- -- Issuance of common stock 171 3 298 Stock based compensation 192 2 521 Stock options exercised 105 -- 174 Subordinated Note exchange 2,042 20 6,273 Foreman additional liability 500 5 1,147 - ------------------------------------------------------------------------------------------------- BALANCE, JULY 1, 2006 14,386 $ 178 $ 63,854 - -------------------------------------------------------------------------------------------------
See notes to consolidated financial statements. F-6
ACCUMULATED OTHER TOTAL TOTAL RETAINED TREASURY COMPREHENSIVE STOCKHOLDERS' COMPREHENSIVE EARNINGS STOCK INCOME (LOSS) EQUITY INCOME - --------------------------------------------------------------------------- $225,578 $(67,019) $ (982) $ 213,904 (95,172) -- -- (95,172) $ (95,172) -- -- 1,900 1,900 1,900 -- -- (5,381) (5,381) (5,381) -- -- 17,131 17,131 17,131 ------------- -- -- -- -- $ (81,522) ------------- -- -- -- 223 -- 1,226 -- 1,389 -- -- -- (418) - --------------------------------------------------------------------------- 130,406 (65,793) 12,668 133,576 (51,787) -- -- (51,787) $ (51,787) -- -- (1,007) (1,007) (1,007) -- -- 7,434 7,434 7,434 -- -- (7,582) (7,582) (7,582) ------------- -- -- -- -- $ (52,942) ------------- -- -- -- 27 -- -- -- (733) - --------------------------------------------------------------------------- $ 78,619 $(65,793) $ 11,513 $ 79,928 - --------------------------------------------------------------------------- (67,967) -- -- (67,967) $ (67,967) -- -- 2,759 2,759 2,759 -- -- (1,404) (1,404) (1,404) -- -- (2,571) (2,571) (2,571) ------------- -- -- -- -- $ (69,183) ------------- -- -- -- 301 -- -- -- 523 -- -- -- 174 -- -- -- 6,293 -- -- -- 1,152 - --------------------------------------------------------------------------- $ 10,652 $(65,793) $ 10,297 $ 19,188 - ---------------------------------------------------------------------------
See notes to consolidated financial statements. F-7 SALTON, INC. CONSOLIDATED STATEMENTS OF CASH FLOWS YEARS ENDED JULY 1, 2006, JULY 2, 2005, AND JULY 3, 2004 (IN THOUSANDS)
2006 2005 2004 - ----------------------------------------------------------------------------------------------- CASH FLOWS FROM OPERATING ACTIVITIES: Net loss $(67,967) $(51,787) $ (95,172) Adjustments to reconcile net loss to net cash from operating activities: Imputed interest on note payable and other non-cash items (117) (1,906) (2,254) Deferred income tax provision (benefit) 41,351 (18,042) (31,284) Stock based compensation expense 522 -- -- Depreciation and amortization 15,476 19,914 19,433 Amortization of deferred financing costs 4,925 4,624 3,501 Bad debt provision (recovery) 4,678 (1,191) 3,389 Gain on sale of discontinued operations (32,332) -- -- (Gain)/loss on disposal of property and equipment (451) 219 5,304 Inventory valuation adjustment 207 3,037 20,192 Impairment loss on goodwill and intangible assets 21,967 3,211 40,855 Foreign currency gains and losses, unrealized (183) (32) 678 (Gain)loss -- early settlement of debt (21,721) -- 5,049 Gain on sale of investment -- (861) -- Minority interest, net of tax 1,404 6,389 7,745 Changes in assets and liabilities, net of acquisitions: Accounts receivable 5,706 12,199 23,940 Inventories 18,926 12,959 (45,071) Prepaid expenses and other current assets (2,661) (618) (4,385) Other non-current assets 2,509 (311) 180 Accounts payable 13,080 (15,875) 54,848 Income taxes payable (3,379) 3,592 17,669 Accrued expenses (9,890) 7,190 (1,553) - ----------------------------------------------------------------------------------------------- Net cash from operating activities (7,950) (17,289) 23,064 - ----------------------------------------------------------------------------------------------- CASH FLOWS FROM INVESTING ACTIVITIES: Capital expenditures (5,902) (9,271) (33,108) Proceeds from sale of property and equipment 2,147 17,161 1,041 Proceeds from sale of tabletop assets 14,195 -- -- Proceeds from sale of discontinued operations, net of $10,998 cash sold 69,938 -- -- Acquisition of majority interest, net of cash acquired (4,525) -- -- Additional payment for trade names (217) -- -- Increase in compensating balances on deposit (4,867) (355) (16,600) - ----------------------------------------------------------------------------------------------- Net cash from investing activities 70,769 7,535 (48,667) - ----------------------------------------------------------------------------------------------- CASH FLOWS FROM FINANCING ACTIVITIES: Net proceeds (repayments) from revolving line of credit and other short term debt (42,704) 27,786 61,047 Proceeds from new credit agreement 48,870 -- 105,928 Repayment of terminated credit agreement (39,675) -- (105,928) Repayment of long-term debt (50,475) (1,049) (869) Distributions to minority shareholders -- (2,296) -- Costs associated with refinancing (13,637) (2,598) (4,338) Additional payment for trade names -- (1,095) (21,875) Common stock issued 175 27 223 - ----------------------------------------------------------------------------------------------- Net cash from financing activities (97,446) 20,775 34,188 - ----------------------------------------------------------------------------------------------- The effect of exchange rate changes on cash 1,939 (3,447) 2,030 - ----------------------------------------------------------------------------------------------- NET (DECREASE)/INCREASE IN CASH AND CASH EQUIVALENTS (32,688) 7,574 10,615 - ----------------------------------------------------------------------------------------------- CASH, BEGINNING OF YEAR(1), INCLUDING CASH OF DISCONTINUED OPERATIONS OF $35,934, $27,917, AND $4,143, RESPECTIVELY 50,791 43,217 32,602 - ----------------------------------------------------------------------------------------------- CASH, END OF YEAR(1), INCLUDING CASH OF DISCONTINUED OPERATIONS OF $0, $35,934, AND $27,917, RESPECTIVELY $ 18,103 $ 50,791 $ 43,217 - ----------------------------------------------------------------------------------------------- SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION: Cash paid (received) during the year for: Interest $ 39,229 $ 40,342 $ 38,450 Income taxes, net of refunds 614 5,480 (5,731)
- --------------- (1) Amounts do not agree directly to face of balance sheet. See notes to consolidated financial statements. F-8 SALTON, INC. CONSOLIDATED STATEMENTS OF CASH FLOWS YEARS ENDED JULY 1, 2006, JULY 2, 2005, AND JULY 3, 2004 SUPPLEMENTAL DISCLOSURE OF NONCASH INVESTING AND FINANCING ACTIVITIES: In the quarter ended July 1, 2006, the Company issued 500,000 shares of restricted common stock in lieu of cash under an agreement with one of the venture participants under the Foreman obligation. In the quarter ended April 1, 2006, the Company issued 171,428 shares of restricted common stock to the Agent of the Senior Secured Credit Facility. In the quarter ended December 31, 2005, the Company entered into a facility agreement allowing the Company's European subsidiaries to borrow funds in accordance with the terms of the agreement. Concurrently with the repayment of the previous credit agreement, the Company recorded $1.3 million in financing fees, funded by proceeds from the new agreement. In the quarter ended October 1, 2005, the Company issued 2,041,420 shares of its common stock, and 135,217 shares of its Series C preferred stock with a total liquidation preference of $13.5 million as part of the Debt Exchange more fully described in Note 8, "Senior Secured Credit Facility, Letters of Credit and Long-Term Debt." In fiscal 2005, the Company incurred capital lease obligations of $0.7 million In the quarter ended July 3, 2004, the Company entered into an amended and restated senior secured revolving credit facility ("amended agreement"). Concurrently with the repayment of the terminated credit agreement, the Company recorded $5.9 million in financing fees, funded by proceeds from the amended agreement. In the quarter ended March 27, 2004, the Company issued 146,902 shares of common stock out of treasury in lieu of cash for the final payment to one of the venture participants under the Foreman obligation. In the quarter ended December 27, 2003, the Company incurred a capital lease obligation of $0.7 million. See notes to consolidated financial statements. (Concluded) F-9 SALTON, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS YEARS ENDED JULY 1, 2006, JULY 2, 2005, AND JULY 3, 2004 1. SUMMARY OF SIGNIFICANT ACCOUNTING PRINCIPLES Salton, Inc. (the "Company" or "Salton") is a leading designer, marketer and distributor of branded, high quality small appliances and electronics for the home, home decor and personal care and wellness products. Salton's product mix includes a broad range of kitchen and home appliances, electronics, time products, lighting products and personal care and wellness products. Salton sells its products under its portfolio of well recognized brand names such as Salton(R), George Foreman(R), Westinghouse(TM), Toastmaster(R), Melitta(R), Russell Hobbs(R), Farberware(R), Ingraham(R) and Stiffel(R). Salton believes its strong market position results from its well-known brand names, high quality and innovative products, strong relationships with its customer base and the Company's focused outsourcing strategy. Principles of Consolidation -- The consolidated financial statements include the accounts of all majority-owned subsidiaries. Investments in affiliates, in which the Company has the ability to exercise significant influence, but not control, are accounted for by the equity method. Intercompany balances and transactions are eliminated in consolidation. Fiscal Year -- The Company's fiscal year ends on the Saturday closest to June 30. Unless otherwise stated, references to years in this report relate to fiscal years rather than calendar years. The effect of the additional week in 2004 had an insignificant impact on results.
FISCAL YEAR YEAR ENDED WEEKS - ------------------------------------------ 2006 July 1, 2006 52 2005 July 2, 2005 52 2004 July 3, 2004 53
Foreign Currency -- Salton's reporting currency is the U.S. Dollar. Salton's foreign subsidiaries functional currencies are their local currencies. Translation adjustments resulting from translating the functional currency financial statements into U.S. Dollars are reported separately in accumulated other comprehensive income in the consolidated statements of stockholders' equity. Gains and losses from foreign currency transactions are recognized in the consolidated statements of operations. The Company recorded net foreign currency transaction gains in continuing operations of $2.2 million, $3.9 million and $0.1 million in fiscal 2006, 2005 and 2004, respectively. Reclassifications -- During the quarter ended October 1, 2005, the Company sold its 52.6% ownership interest in Amalgamated Appliance Holdings Limited (AMAP), a manufacturer and distributor of small appliances and consumer electronics in South Africa. In accordance with Statement of Financial Accounting Standards ("SFAS") No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets," and the rules and regulations of the Securities and Exchange Commission (the "SEC") the Company has reclassified the reported revenue and expenses from AMAP as income from discontinued operations in the accompanying financial statements from amounts previously reported in the Company's financial statements for each of the three years included in the Company's Annual Report on Form 10-K for the fiscal year ended July 1, 2006. The Company has also reclassified all associated assets and liabilities of AMAP as assets and liabilities of discontinued operations as of July 2, 2005. Use of Estimates -- In preparing financial statements in conformity with accounting principles generally accepted in the United States of America, management is required to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the financial statements and revenues and expenses during the reporting period. Actual results could differ from those estimates. Significant estimates include the allowance for doubtful accounts, reserve for inventory valuation, reserve for returns and allowances, valuation of intangible assets having indefinite lives, cooperative advertising accruals, pension benefits and estimated lives of fixed assets and intangibles. F-10 Compensating Balances on Deposit -- The Company utilizes a facility with a bank to provide short-term documentary credits to conduct business with its suppliers in certain countries. These arrangements require that funds be held on deposit as security for this facility. Allowance for Doubtful Accounts -- The Company calculates allowances for estimated losses resulting from the inability of customers to make required payments. The Company utilizes a number of tools to evaluate and mitigate customer credit risk. Management evaluates each new customer account using a combination of some or all of the following sources of information: credit bureau reports, industry credit group reports, customer financial statement analysis, customer supplied credit references and bank references. Appropriate credit limits are set in accordance with company credit risk policy and monitored on an on-going basis. Existing customers are monitored and credit limits are adjusted according to changes in their financial condition. Based on the procedures outlined herein, and the fact that no customer accounted for greater than 10% of the gross accounts receivable at July 1, 2006, and only one customer accounted for 10.6% of the gross accounts receivable at July 2, 2005, the Company believes there is no concentration of credit risk. Estimates of Credits to be Issued to Customers -- Salton regularly receives requests for credits from retailers for returned products or in connection with sales incentives, such as cooperative advertising, volume rebate agreements, product markdown allowances and other promotional allowances. The Company reduces sales or increases selling, general, and administrative expenses, depending on the nature of the credits, for estimated future credits to customers. Estimates of these amounts are based either on historical information about credits issued, relative to total sales, or on specific knowledge of incentives offered to retailers. This process entails a significant amount of inherent subjectivity and uncertainty. These incentives are accounted for in accordance with Emerging Issues Task Force Issue No. 01-9, "Accounting for Consideration Given by a Vendor to a Customer" ("EITF 01-9"). In instances where there is an agreement with the customer to provide advertising funds, reductions in amounts received from customers as a result of cooperative advertising programs are included in the consolidated statement of income on the line entitled "Selling, general, and administrative expenses." Returns, markdown allowances, cash discounts, and volume rebates are all recorded as reductions of net sales. Inventories -- The Company values inventory at the lower of cost or market, and regularly reviews the book value of discontinued product lines and stock keeping units (SKUs) to determine if these items are properly valued. If market value is less than cost, the Company writes down the related inventory to the estimated net realizable value. The Company regularly evaluates the composition of inventory to identify slow-moving and obsolete inventories to determine if additional write-downs are required. The Company's domestic inventories are generally determined by the last-in, first-out (LIFO) method. These inventories account for approximately 49.6% and 60.7% of the Company's inventories of continuing operations as of 2006 and 2005, respectively. All remaining inventory cost is determined on the first-in, first-out basis. See Note 6, "Inventories." Property, Plant and Equipment -- Property, plant and equipment are stated at cost. Expenditures for maintenance costs and repairs are charged against income as incurred. Depreciation, which includes amortization of assets under capital leases, as well as depreciation for leasehold improvements, is based on the straight-line method over the shorter of the period of the lease or the estimated useful lives of the assets (see table below).
ASSET CATEGORY USEFUL LIFE (IN YEARS) - ------------------------------------------------------------------------------------ Buildings 10 to 50 Molds and tooling 3 to 5 Equipment and office furniture 3 to 10
Depreciation expense charged to continuing operations was $12.8 million in 2006, $14.3 million in 2005 and $16.6 million in 2004. F-11 Patents, Tradenames and Other Identifiable Intangible Assets -- The identifiable intangible assets of the Company are primarily trade names acquired in transactions and business combinations. Identifiable intangibles with indefinite lives are not amortized. The Company tests identifiable intangible assets with an indefinite life for impairment, at a minimum on an annual basis, relying on a number of factors including operating results, business plans and projected future cash flows. Identifiable intangible assets that are subject to amortization are evaluated for impairment using a process similar to that used to evaluate other long-lived assets. The impairment test for identifiable intangible assets not subject to amortization consists of a comparison of the fair value of the intangible asset with its carrying amount. An impairment loss is recognized for the amount by which the carrying value exceeds the fair value of the asset. Currently, the Company does not have material definite-lived intangible assets that are amortized. Goodwill -- Goodwill is not amortized and is tested for impairment on an annual basis, or earlier when facts and circumstances indicate that there may be a potential impairment. The test for impairment is based upon a number of factors including operating results, business plans and projected future cash flows. As a result of this test, all goodwill was written off in fiscal 2004. Long-Lived Assets -- Long-lived assets are reviewed for possible impairment whenever events or changes in circumstances indicate that the carrying amount of such assets may not be recoverable. If such review indicates that the carrying amount of long-lived assets is not recoverable, the carrying amount of such assets is reduced to the estimated recoverable value. Revenue Recognition -- The Company principally recognizes revenue at FOB shipping point which corresponds to when title and risks and rewards of ownership transfer to its customers. Fees charged for shipping and handling are included in net sales. Provision is made for the estimated cost of returns, warranties and product liability claims. Distribution Expenses -- Distribution expenses consist primarily of freight, warehousing, and handling costs of products sold. Advertising -- The Company sponsors various programs under which it participates in the cost of advertising and other promotional efforts for Company products undertaken by its retail customers. Advertising and promotion costs associated with these programs are expensed in the period in which the advertising or other promotion by the retailer occurs. The Company's trade names and, in some instances, specific products, also are promoted from time to time through direct marketing channels, primarily television. Advertising and promotion costs are expensed in the period in which the advertising and promotion occurs. Advertising expense charged to continuing operations was $59.8 million in 2006, $81.0 million in 2005, and $106.2 million in 2004. Self-Insurance -- The Company maintains a self-insurance program for health claims for Domestic employees. The Company accrues estimated future costs that will be incurred for existing employee claims. The Company does not provide any post-retirement health care benefits. Deferred Financing Costs -- The Company has incurred debt issuance costs in connection with its long-term debt. These costs are capitalized as deferred financing costs and amortized using the straight-line method over the term of the related debt. Income Taxes -- The Company accounts for income taxes using the asset and liability approach. If necessary, the measurement of deferred tax assets is reduced, based on available evidence, by the amount of any tax benefits that management believes is more likely than not that it will not be realized. Net Income (Loss) per Common and Common Equivalent Share -- Net income (loss) per common and common equivalent share is computed in accordance with FASB Statement No. 128, "Earnings Per Share," and Emerging Issues Task Force (EITF) Statement No. 03-6, "Participating Securities and the Two Class Method Under FASB Statement No. 128, Earnings Per Share." Basic net income per common share is calculated by allocating income from continuing operations to common stock and participating F-12 securities to the extent each security may share in the earnings, based on participation rights, as if all of the earnings for the period had been distributed. A convertible participating security is included in the computation of basic net income per common share if the effect is dilutive. Diluted net income per common and common equivalent share reflects the potential dilution that would occur if any outstanding options were exercised and participating securities were converted in accordance with the "if converted" method, if the effect of including these options and securities is dilutive. The two-class method of calculating diluted net income per common and common equivalent share is used in the event the "if converted" method is anti-dilutive. Stock Based Compensation -- The Company has various stock-based compensation plans, which are described more fully in Note 14, "Stock Based Compensation." Effective July 3, 2005, the Company adopted FASB Statement No. 123(R), "Share-Based Payment," which revises Statement No. 123 and supercedes ABP 25. FASB Statement No. 123(R) requires all share-based payments to employees to be recognized in the financial statements based on their fair value using an option-pricing model at the date of grant. The Company has elected to use the modified prospective method for adoption, which requires compensation expense to be recorded for all unvested stock options beginning in the first year of adoption. For all unvested options outstanding as of July 3, 2005, the previously measured but unrecognized compensation expense, based on the fair value at the original grant date, was recognized over the remaining vesting period which concluded in fiscal 2006. For share-based payments granted subsequent to July 3, 2005, compensation expense, based on the fair value on the date of grant, will be recognized from the date of grant over the applicable vesting period. The Company uses the Black-Scholes option-pricing model to determine fair value of awards on the date of grant. There were no stock option awards granted in fiscal 2006. For periods prior to July 3, 2005, the Company used the intrinsic value method in accordance with APB No. 25, "Accounting for Stock Issued to Employees," and related Interpretations. No stock-based compensation is reflected in net income, as no options granted under those plans had an exercise price less than the market value of the underlying common stock on the date of grant. The following table F-13 illustrates the effect on net income and earnings per share if the Company had applied the fair value recognition provisions of Statement No. 123(R).
2005 2004 - ------------------------------------------------------------------------------------ (IN THOUSANDS, EXCEPT PER SHARE DATA) Net loss from continuing operations -- as reported $(53,925) $(103,761) Less: Total stock-based employee compensation expense determined under fair value based method for all awards, net of related taxes (1,473) (1,517) - ------------------------------------------------------------------------------------ Net loss from continuing operations -- pro forma $(55,398) $(105,278) - ------------------------------------------------------------------------------------ Net loss -- as reported $(51,787) $ (95,172) Less: Total stock-based employee compensation expense determined under fair value based method for all awards, net of related taxes (1,473) (1,517) - ------------------------------------------------------------------------------------ Net loss -- pro forma $(53,260) $ (96,689) - ------------------------------------------------------------------------------------ Net loss from continuing operations per common share: Basic As reported $ (4.74) $ (9.22) Pro forma (4.87) (9.35) Net loss from continuing operations per common share: Diluted As reported $ (4.74) $ (9.22) Pro forma (4.87) (9.35) Net loss per common share: Basic As reported $ (4.55) $ (8.45) Pro forma (4.68) (8.59) Net loss per common share: Diluted As reported $ (4.55) $ (8.45) Pro forma (4.68) (8.59) - ------------------------------------------------------------------------------------
Fair Value of Financial Instruments -- The carrying values of financial instruments included in current assets and liabilities approximate fair values due to the short-term maturities of these instruments. The fair value of the Company's long-term, fixed rate debt was estimated based on dealer quotes. As of July 1, 2006, the fair value of the senior subordinated notes was $47.3 million versus a carrying value of $59.9 million. As of July 2, 2005, the fair value of the senior subordinated notes was $151.8 million versus a carrying value of $281.4 million. The Series C preferred stock was recorded at its fair value of $8.0 million, using an effective interest rate of 11.06% (see Note 8, "Senior Secured Credit Facility, Letters of Credit and Long-Term Debt"). The associated discount is being accreted to interest expense through the maturity date in 2010. As of July 1, 2006, the carrying value of $8.9 million of Series C preferred stock was included in long-term debt. The carrying value of the Series A preferred stock as well as other short-term debt and long-term variable-rate debt approximates fair value. New Accounting Pronouncements -- In February 2006, the Financial Accounting Standards Board (FASB) issued Statement No. 155, "Accounting for Certain Hybrid Financial Instruments," which amends Statement No. 133, "Accounting for Derivative Instruments and Hedging Activities" and Statement No. 140, "Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities." This statement permits fair value remeasurement for any hybrid financial instrument that contains an embedded derivative that otherwise would require bifurcation. In addition, it establishes a requirement to evaluate interests in securitized financial assets to identify interests that are freestanding derivatives or that are hybrid financial instruments that contain an embedded derivative requiring bifurcation. This statement is effective for all financial instruments acquired, issued or subject to a new basis occurring after the beginning of an entity's first fiscal year that begins after September 15, 2006. The Company is currently evaluating the impact of this statement on its financial statements. F-14 In March 2006, the FASB issued Statement No. 156, "Accounting for Servicing of Financial Assets," which amends Statement No. 140, "Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities." This statement provides guidance addressing the recognition and measurement of separately recognized servicing assets and liabilities, common with mortgage securitization activities. This statement is effective for all separately recognized servicing assets and liabilities acquired or issued after the beginning of an entity's fiscal year that begins after September 15, 2006. The Company does not expect the adoption of this statement to have a material effect on its financial condition, results of operations, or cash flows. In June 2006, the FASB issued FASB Interpretation No. 48, "Accounting for Uncertainty in Income Taxes -- an Interpretation of FASB Statement No. 109" to clarify the accounting for uncertainty in income taxes recognized in an enterprise's financial statements in accordance with FASB Statement No. 109, "Accounting for Income Taxes." This interpretation prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. This interpretation also provides guidance on derecognition, classification, interest and penalties, accounting in interim periods, disclosure, and transition. This interpretation is effective for fiscal years beginning after December 15, 2006. The Company is currently evaluating the impact of the interpretation on the consolidated financial statements. In June 2006 the FASB ratified a consensus on the EITF Issue No. 06-3, "How Taxes Collected from Customers and Remitted to Governmental Authorities Should Be Presented in the Income Statement (That Is, Gross Versus Net Presentation)" regarding the classification of certain sales, value added and excise taxes within the income statement. This EITF is effective for financial reports for interim and annual reporting periods beginning after December 15, 2006. The Company is currently evaluating the impact of the EITF on its presentation of such taxes on the statement of operations. In September 2006, the FASB issued Statement No. 157, "Fair Value Measurements." This statement defines fair value, establishes a framework for measuring fair value in generally accepted accounting principles, and expands disclosures about fair value measurements. This statement is effective for financial statements issued for fiscal years beginning after November 15, 2007. The Company is currently evaluating the impact of adopting this statement on the consolidated financial statements. In September 2006, the FASB issued Statement No. 158, "Employers' Accounting for Defined Benefit Pension and Other Postretirement Benefit Plans." This statement requires companies to recognize the overfunded or underfunded status of a defined benefit postretirement plan as an asset or liability in its statement of financial position. This statement is effective for financial statements as of the end of the fiscal year ending after December 15, 2006. The Company is currently evaluating the impact of adopting this statement on the consolidated financial statements. In September 2006, the Securities and Exchange Commission issued Staff Accounting Bulletin No. 108, (SAB 108). SAB 108 considers the effects of prior year misstatements when quantifying misstatements in current year financial statements. It is effective for financial statements issued after November 15, 2006. The Company does not believe the adoption of SAB 108 will have a material impact on the consolidated financial statements. 2. INTANGIBLE ASSETS Intangible assets that are not amortized are subject to a fair-value based impairment test on an annual basis or more frequently if circumstances indicate a potential impairment. The annual test for impairment of goodwill and other intangible assets is conducted at the end of the fourth quarter of each fiscal year. Salton's indefinite lived intangible assets are comprised of trade names utilized in the marketing of its products on a worldwide basis. In conducting the impairment test, the Company considers many factors including an analysis from an independent valuation consultant. In fiscal 2004, the Company recorded a non-cash, pre-tax impairment charge totaling $40.9 million consisting of the balance of its consolidated goodwill of $28.2 million and certain other indefinite lived F-15 intangible assets of $12.7 million, associated with patents and trade names impacted by the adoption of its U.S. restructuring plan. In fiscal year 2005, the Company determined that a pre-tax impairment charge against trade names of $3.2 million was necessary to reflect management's decisions regarding discontinuing certain under performing product lines associated with further restructuring activities. In the fourth quarter of fiscal year 2006, the annual impairment test was again conducted for the indefinite lived intangible assets. Upon completion of the assessment, it was determined that the carrying value of certain trade names exceeded their fair value. As a result, the Company recorded a $21.1 million impairment charge. The impairment occurred primarily among trade names that are considered outside of the Company's core business and had experienced recent declines, resulting in lower expectations regarding future cash flows. In addition, the Company also recorded a $0.8 million impairment charge against certain patents that were being amortized, to reflect management's decisions regarding discontinuing these product lines. The following tables summarize the intangible asset activity and balances:
IMPAIRMENT CURRENCY 7/2/2005 ADDITIONS CHARGES AMORTIZATION FLUCTUATIONS 7/1/2006 - ---------------------------------------------------------------------------------------------------------- (IN THOUSANDS Trade names -- indefinite lived $178,995 $ 216 $ (21,145) $ -- $ 1,609 $159,675 Trade names -- definite lived 1,046 (822) (224) -- - ---------------------------------------------------------------------------------------------------------- Total $180,041 $ 216 $ (21,967) $ (224) $ 1,609 $159,675 - ----------------------------------------------------------------------------------------------------------
IMPAIRMENT CURRENCY 7/3/2004 ADDITIONS CHARGES AMORTIZATION FLUCTUATIONS 7/2/2005 - ---------------------------------------------------------------------------------------------------------- (IN THOUSANDS Trade names -- indefinite lived $182,665 $ 758 $ (3,211) $ -- $ (1,217) $178,995 Trade names -- definite lived -- 1,793 -- (747) -- 1,046 - ---------------------------------------------------------------------------------------------------------- Total $182,665 $ 2,551 $ (3,211) $ (747) $ (1,217) $180,041 - ----------------------------------------------------------------------------------------------------------
3. DISCONTINUED OPERATIONS On September 29, 2005, the Company completed the sale of its 52.6% ownership interest in Amalgamated Appliances Holdings Limited ("AMAP"), a leading distributor and marketer of small appliances and other products in South Africa, to a group of investors led by Interactive Capital (Proprietary) Limited. In the first quarter of fiscal 2006, the Company received proceeds, net of expenses, of approximately $81.0 million in connection with the transaction and recorded a gain of $32.3 million net of tax. Also, the Company licensed its George Foreman, Russell Hobbs and Carmen branded products to AMAP following the transaction. The following is a summary of financial results included within discontinued operations:
JULY 1, 2006 JULY 2, 2005 JULY 3, 2004 - -------------------------------------------------------------------------------------------------------- (IN THOUSANDS Net sales from discontinued operations $ 68,798 $ 289,276 $ 231,975 - -------------------------------------------------------------------------------------------------------- Income from discontinued operations before income taxes 5,477 $ 20,760 $ 23,679 Income taxes 2,338 12,233 7,345 Minority Interest 1,404 6,389 7,745 - -------------------------------------------------------------------------------------------------------- Income from discontinued operations, net of tax $ 1,735 $ 2,138 $ 8,589 - --------------------------------------------------------------------------------------------------------
F-16 The following sets forth the carrying amounts of the major classes of assets and liabilities classified as assets and liabilities of discontinued operations in the accompanying balance sheet:
JULY 2, 2005 - ---------------------------------------------------------------------------- (IN THOUSANDS ASSETS Cash $ 35,934 Accounts receivable, net 25,910 Inventories, net 38,349 Prepaid expenses and other current assets 1,038 Deferred tax asset 696 - ---------------------------------------------------------------------------- Current assets of discontinued operations $ 101,927 - ---------------------------------------------------------------------------- Property, plant and equipment, net $ 4,003 Trade names 1,474 Other assets, net 2,260 - ---------------------------------------------------------------------------- Noncurrent assets of discontinued operations $ 7,737 - ---------------------------------------------------------------------------- LIABILITIES Accounts payable $ 30,955 Accrued expenses 9,334 Income taxes payable 7,042 - ---------------------------------------------------------------------------- Current liabilities of discontinued operations $ 47,331 - ---------------------------------------------------------------------------- Other notes payable $ 1,462 - ---------------------------------------------------------------------------- Deferred tax liability 5,455 - ---------------------------------------------------------------------------- Noncurrent liabilities of discontinued operations $ 6,917 - ----------------------------------------------------------------------------
4. SALE OF TABLETOP ASSETS On September 16, 2005, the Company completed the sale of certain tabletop assets at cost to Lifetime Brands, Inc. for approximately $14.2 million. With this transaction, Salton divested the Block and Sasaki brands, licenses to Calvin Klein and Napa Style(TM) tabletop products and distribution of crystal products under the Atlantis brand. In addition, the Company entered into a license with Lifetime Brands enabling it to market tabletop products under the Stiffel brand. 5. ACQUISITIONS AND ALLIANCES ACQUISITION OF THE GEORGE FOREMAN NAME In the quarter ended December 25, 1999, Salton acquired effective July 1, 1999, the right to use in perpetuity and worldwide the name George Foreman in connection with the marketing and sale of food preparation and non-alcoholic drink preparation and serving appliances. The aggregate purchase price payable to George Foreman and other participants was $137.5 million, of which $113.8 million was payable in five annual cash installments, and the remaining $23.7 million was paid through the issuance of 779,191 shares of Salton, Inc. common stock issued out of treasury. Salton issued a five-year $113.8 million non-interest bearing subordinated promissory note associated with the annual cash installments. The initial cash installment of $22.8 million was paid during the first half of fiscal year 2000 and the remaining principal of the note of $91.0 was recorded at its present value. As of July 1, 2006, all amounts due under the note had been paid. F-17 In September 2000, Salton prepaid the third installment of $20.0 million due July 2001 to George Foreman and paid the second installment of $2.75 million to the other participants by issuing 621,161 shares of common stock (546,075 to Foreman and 75,086 to other participants) at $36.625 per share, which was the market value of the common stock on the date of issuance. In connection with this stock payment, Salton agreed to pay cash or issue additional shares, at Salton's election, if the price of the stock should decline in the next year ("guarantee obligation") based on the average share price in the 90-day period preceding the first anniversary of the payment. The guarantee obligation recorded at June 30, 2001 was approximately $19.37 million. In July 2001, Salton took back 456,175 of the 546,075 shares of common stock originally issued to George Foreman in September 2000 and paid him $18.0 million. This payment, which represented the original cash installment amount of $20 million less proceeds that Foreman received from the sale on the open market of 89,900 of the 546,075 shares previously issued, terminated the guarantee obligation with respect to the shares issued to him and satisfied the third annual installment due under the note payable. The guarantee obligation as of June 29, 2002 related to the shares issued to the other participants in September 2000 was $1.4 million. During fiscal 2003, $0.6 million of the guarantee obligation was paid out in cash and the remaining guarantee obligation of $0.8 million was extinguished as the requirements for payment, per the terms of the guarantee obligation, were not met by the other participant. As of July 1, 2003, Salton settled the final installment to one of the other participants by issuing 146,902 shares of common stock at $9.36 per share, which was the market value of the common stock on the date of issuance. In connection with this stock payment, Salton agreed to pay cash or issue additional shares, at the Company's election, if the price of the stock should decline within a two year period ("new guarantee obligation") based on the average share price during the 90-day period preceding the second anniversary of the agreement. The two year period is defined as that period after the one year anniversary of the date on which the shares were delivered and before the third anniversary of the date on which the shares were delivered. The shares were delivered in February 2004. In fiscal 2006, the participant sold these shares at an average price of $2.47. In April 2006, the new guarantee obligation was settled by issuing 500,000 shares of common stock at $2.03 per share, which was the 90 day trading average prior to the issuance of the shares. All guarantee obligations were settled as of July 1, 2006. STRATEGIC ALLIANCES The Company continues to participate in joint product development relationships with several third parties to develop, market and distribute new products. These strategic alliances enables the Company to (a) further expand the scope of its product offerings and (b) benefit from the manufacturing expertise and/or strong brand names of the Company's strategic partners. Some current alliances involve equity investments by the Company in privately held equity securities or investments with no observable quoted market value and include other contractual arrangements involving expense and profit sharing. The Company's exposure to loss related to its strategic alliances is generally limited to its equity investments. The foregoing strategic alliances provide the opportunity for recurring revenues through the sale of various products, including coffee pods and brewing machines. There may be arrangements for sharing the profits derived from each of these strategic alliances once all expenses incurred by Salton and/or the other members of the alliance have been reimbursed from cash flow generated by such alliances. Each of these strategic alliances generally also provide for certain license fees and royalties to the strategic partners and contain minimum sales requirements and other obligations that, if not satisfied, may result in termination of the strategic alliance. F-18 6. INVENTORIES A summary of inventories is as follows:
JULY 1, 2006 JULY 2, 2005 - ----------------------------------------------------------------------------------------- (IN THOUSANDS Raw materials $ 3,024 $ 5,209 Finished goods 140,973 189,856 - ----------------------------------------------------------------------------------------- Total $ 143,997 $ 195,065 - -----------------------------------------------------------------------------------------
At July 1, 2006 and July 2, 2005, domestic inventories determined by the last in, first out (LIFO) inventory method amounted to $71.5 million and $118.4 million, respectively. If the first-in, first-out (FIFO) inventory method had been used to determine cost for 100.0% of the Company's inventories, they would have been $4.0 million and $3.1 million higher at July 1, 2006 and July 2, 2005, respectively, and net loss would have been $67.1 million ($5.01 per share) and $50.0 million ($4.39 per share) for fiscal 2006 and 2005, respectively. Obsolescence and valuation reserves included in inventories were $13.2 million at July 1, 2006 and $15.0 million at July 2, 2005, respectively. 7. ASSETS HELD FOR SALE The Company classifies certain assets as held for sale in accordance with Statement of Financial Accounting Standards No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets." As of July 1, 2006, the Company had no assets classified as held for sale. At July 2, 2005, the Company had a contract for the sale of a warehouse for $1.8 million. The net book value of the warehouse at July 2, 2005 was $1.0 million and was classified as asset held for sale in the 2005 consolidated balance sheet. The sale was finalized on August 12, 2005 with a gain of $0.7 million realized on the transaction. 8. SENIOR SECURED CREDIT FACILITY, LETTERS OF CREDIT AND LONG-TERM DEBT SENIOR SECURED CREDIT FACILITY -- On June 15, 2004, the Company entered into an amended and restated senior secured credit facility ("Credit Facility") consisting of a $100.0 million term loan and a revolving line of credit. Since June 15, 2004, the Company amended the Credit Facility to, among other things: (1) extend the maturity date to December 31, 2007; (2) increase the maximum size of the facility from $275.0 million to the difference between $287.0 million and the principal amount of the new second lien notes which are discussed below; (3) increase the letter of credit subfacility from $10.0 million to $15.0 million; (4) modify financial covenants including the elimination of the foreign leverage ratio; and (5) eliminate the pledges of stock of foreign subsidiaries of the Company other than the 66 2/3% of the stock of Salton International CV. The Credit Facility is secured by all of the tangible and intangible assets of domestic entities and is unconditionally guaranteed by each of the Company's direct and indirect domestic subsidiaries. The Credit Facility contains a number of significant covenants that, among other things, restrict the ability of the Company to dispose of assets, incur additional indebtedness, prepay other indebtedness, pay dividends, repurchase or redeem capital stock, enter into certain investments, enter into sale and lease- back transactions, make certain acquisitions, engage in mergers and consolidations, create liens, or engage in certain transactions with affiliates, and may otherwise restrict corporate and business activities. In addition, under its senior secured credit facility, the Company is required to comply with fixed charge coverage ratio and minimum EBITDA covenants. Subsequent to July 1, 2006, the Company entered into a Ninth Amendment, and waiver, under the senior secured credit facility, which suspends the consolidated fixed charge coverage ratio and minimum EBITDA covenants beginning with the twelve months ending July 1, 2006 through and including the twelve months ending March 2007 (see Note 22, "Subsequent Events"). The Ninth Amendment adds a monthly cash flow covenant beginning with August 2006 and ending March 2007. F-19 Information regarding borrowings under the Credit Agreement is as follows:
JULY 1, 2006 JULY 2, 2005 - ----------------------------------------------------------------------------------------- (IN THOUSANDS) Balance at end of fiscal period $100,000 $147,551 Interest rate at end of fiscal period 11.17% 8.27% Maximum amount outstanding at any month-end 157,107 194,552 Average month-end amount outstanding 127,820 163,643 Weighted average interest rate during fiscal period 9.96% 7.45% Outstanding letters of credit at end of fiscal period 289 134 Unused letters of credit at end of the fiscal period 14,711 9,866
REVOLVING LINE OF CREDIT AND OTHER CURRENT DEBT REVOLVING CREDIT FACILITY -- The revolving line of credit of the Credit Facility provides advances based primarily upon percentages of eligible accounts receivable and inventories. On July 1, 2006, the Company had no outstanding balance under the revolving facility and had $5.1 million available for future borrowings. On July 2, 2005, the Company had borrowings of $47.6 million under the revolving facility and had $8.4 million available for future borrowings. Typically, given the seasonal nature of Salton's business, borrowings and availability tend to be highest in the second fiscal quarter. At July 1, 2006, the rate plus applicable margin on the Credit Facility was 12.25% for Base (Prime) rate loans. The Company has the option to convert any base rate loan to a LIBOR rate loan, which includes an applicable margin of 6.0%. LIBOR rate loans are to be no lower than a rate of 7.0%. The revolving line of credit of the Credit Facility is classified as current as of July 2, 2005 because the agreement includes a subjective acceleration clause requiring the Company to deposit all proceeds from collection of accounts receivable and sale of collateral with an account under the exclusive dominion and control of the senior lenders. LETTERS OF CREDIT -- As of July 1, 2006, the Company had outstanding letters of credit of $0.3 million under the letter of credit subfacility of $15.0 million. SENIOR SUBORDINATED NOTES -- On December 16, 1998, the Company issued $125.0 million of 10 3/4% Senior Subordinated Notes (the "2005 Notes") due December 15, 2005. As of July 2, 2005, the outstanding balance was classified as current debt. Subsequent to July 2, 2005, the Company completed a series of private debt exchanges (see "Debt Exchange") for an aggregate of approximately $79.2 million of the 2005 Notes. During the second quarter of fiscal 2006, the Company repurchased $9.2 million in aggregate principal amount of the outstanding 2005 Notes for $9.1 million and repaid the remaining $36.6 million of outstanding 2005 Notes upon maturity. SALTON EUROPE FACILITY AGREEMENT -- On December 23, 2005, Salton Holdings Limited, Salton Europe Limited and certain affiliates entered into a Facility Agreement with Burdale Financial Limited, as agent and security trustee, and a financial institution group as lender. The provisions of the Facility Agreement allow certain of the Company's European subsidiaries to borrow funds as needed in an aggregate amount not to exceed L61.0 million (approximately $112.8 million). The Facility Agreement matures on December 22, 2008 and bears a variable interest rate of LIBOR plus 7% on term loans and LIBOR plus 2.75% on revolver loans, payable on the last business day of each month. At July 1, 2006, these rates for borrowings denominated in the Great Britain Pound were approximately 13.66% and 9.41% for term and revolver loans, respectively. The rate for revolver loan borrowings denominated in the U.S. Dollar was 10.09%. The Facility Agreement consists of a Revolving Credit Facility with an aggregate maximum availability of L50.0 million (approximately $92.5 million) and two Term Loan Facilities of L5.0 million and L6.0 million (approximately $9.2 million and $11.1 million, respectively). The Company has used borrowings under these facilities to repay existing debt and for working capital purposes. As of July 1, 2006, under the Revolving Credit Facility, the Company had outstanding borrowings denominated in the Great Britain F-20 Pound of L9.5 million (approximately $17.6 million) and borrowings denominated in the U.S. Dollar of $2.0 million. As of that date, $1.3 million was available for future borrowings. Under the Term Loan Facilities, the Company had L0.8 million (approximately $1.5 million) classified as current debt, and the remainder classified under long-term debt. The Facility Agreement is secured by all of the tangible and intangible assets of certain foreign entities, a pledge of the capital stock of certain of our subsidiaries, and is unconditionally guaranteed by certain of the Company's foreign subsidiaries. The Facility Agreement contains a number of significant covenants that, among other things, restrict the ability of certain of the Company's European subsidiaries to dispose of assets, incur additional indebtedness, prepay other indebtedness, pay dividends, repurchase or redeem capital stock, enter into certain investments, make certain acquisitions, engage in mergers and consolidations, create liens, or engage in certain transactions with affiliates and otherwise restrict corporate and business activities. In addition, the Company is required to comply with a fixed charge coverage ratio. Subsequent to July 1, 2006, the Company entered into an amendment and restatement to the Facility Agreement, which waives compliance with the fixed charge coverage ratio for the months of April and May 2006 and amends the definition of such covenant thereafter (see Note 22, "Subsequent Events"). TERM LOAN, SECOND LIEN NOTES AND OTHER LONG-TERM DEBT TERM LOAN -- At July 1, 2006 and July 2, 2005, the Company had $100.0 million outstanding under the term loan portion of the senior secured credit facility, due December 31, 2007. As of July 1, 2006, the Company had converted the $100.0 million term loan from a Base rate loan to a LIBOR rate loan, at a rate of 11.17%. SENIOR SUBORDINATED NOTES -- On April 23, 2001, the Company issued $150.0 million of 12 1/4% Senior Subordinated notes (the "2008 Notes") due April 15, 2008. Proceeds of the 2008 Notes were used to repay outstanding indebtedness and for the acquisition of Pifco Holdings PLC (Salton Europe). On August 26, 2005, the Company completed a private debt exchange for approximately $90.1 million of the 2008 Notes (see "Debt Exchange"). DEBT EXCHANGE -- On August 26, 2005, the Company completed a private debt exchange offer for outstanding Senior Subordinated Notes due December 15, 2005 ("2005 Notes") and outstanding Senior Subordinated Notes due April 15, 2008 ("2008 Notes"). The Company accepted for exchange an aggregate of approximately $75.2 million in principal amount of 2005 Notes (approximately 60.1% of the then outstanding 2005 Notes) and approximately $90.1 million in principal amount of 2008 Notes (approximately 60.1% of the then outstanding 2008 Notes) that were validly tendered in the debt exchange offer. Upon closing of the debt exchange offer, the Company issued an aggregate of approximately $99.2 million of senior second lien notes (the "Second Lien Notes"), 2,041,420 shares of its common stock, and 135,217 shares of its Series C preferred stock with a total liquidation preference of $13.5 million. A gain of $21.7 million (approximately $1.52 per share) was realized on the debt exchange. The Second Lien Notes mature on March 31, 2008 and bear interest at LIBOR plus 7%, payable in cash on January 15th and July 15th of each year, beginning in January, 2006. The Series C preferred stock is generally non-dividend bearing and is mandatorily redeemable by the Company in cash at the liquidation amount on August 26, 2010. The Company also granted certain registration rights for approximately 1,837,455 shares of Salton common stock and 121,707 shares of Series C preferred stock received by certain former holders of Subordinated Notes. The debt exchange has been accounted for as a troubled debt restructuring in accordance with Statement of Financial Accounting Standards ("SFAS") No. 15. Under SFAS No. 15, the Second Lien Notes were recorded at their principal amount plus the total estimated future interest payments. As of July 1, 2006, future interest payments of $24.1 million were accrued, of which $11.0 million was included in other current debt. In connection with the debt exchange offer, the Company obtained the consent of the holders of a majority of the outstanding 2005 Notes and a majority of the outstanding 2008 Notes to amend the F-21 indentures governing such Subordinated Notes to eliminate substantially all of the restrictive covenants and certain events of default contained in such indentures. The Company entered into supplements to the indenture governing the 2008 Notes to reflect such amendments. On September 28, 2005, the Company completed a private exchange transaction in which the Company issued an additional $4.1 million of Second Lien Notes in exchange for $4.0 million of 2005 Notes. There were no common or preferred shares issued in connection with this exchange. SERIES C PREFERRED STOCK -- In connection with the debt exchange (see "Debt Exchange"), the Company issued 135,217 shares of Series C preferred stock with a total liquidation preference of $13.5 million. The Company's restated certificate of incorporation authorizes the Company to issue up to 150,000 shares of Series C preferred stock. The Series C preferred stock was recorded at its fair value of $8.0 million, using an effective interest rate of 11.06%. The associated discount is being accreted to interest expense through the maturity date in 2010. As of July 1, 2006, the carrying value of $8.9 million of Series C preferred stock was included in long-term debt. The Series C preferred stock is non-dividend bearing and ranks, as to distribution of assets upon the Company's liquidation, dissolution or winding up, whether voluntary or involuntary, (a) prior to all shares of convertible preferred stock from time to time outstanding, (b) senior, in preference of, and prior to all other classes and series the Company's preferred stock and (c) senior, in preference of, and prior to all of the Company's now or hereafter issued common stock. Except as required by law or by certain protective provisions in the Company's restated certificate of incorporation, the holders of shares of Series C preferred stock, by virtue of their ownership thereof, have no voting rights. In the event of the Company's liquidation, dissolution or winding up, whether voluntary or involuntary, holders of the Series C preferred stock will be paid out of the Company's assets available for distribution to the Company's stockholders an amount in cash equal to $100 per share (the "Series C Preferred Liquidation Preference"), before any distribution is made to the holders of the Company's convertible preferred stock, common stock or any other capital stock ranking junior as to liquidation rights to the Series C preferred stock. In the event of a change of control (as defined in the Company's restated certificate of incorporation), each holder of shares of Series C preferred stock will have the right to require the Company to redeem such shares at a redemption price equal to the Series C Preferred Liquidation Preference plus an amount equivalent to interest accrued thereon at a rate of 5% per annum compounded annually on each anniversary date of the issuance date for the period from the issuance date through the change of control. The redemption price is payable on a date after a change of control that is 91 days after the earlier of (x) the date on which specified debt (including indebtedness under the Company's senior secured credit facility, the second lien credit agreement, the indentures under which the Subordinated Notes were issued, and restatements and refinancings of the foregoing) matures and (y) the date on which all such specified debt is repaid in full, in an amount equal to the Series C Preferred Liquidation Preference plus an amount equivalent to interest accrued thereon at a rate of 5% per annum compounded annually on each anniversary date of the issuance date for the period from the issuance date through such change of control payment date. The certificate of designation for the Series C preferred stock provides that, in the event of a change of control, the Company shall purchase all outstanding shares of Series C preferred stock with respect to which the holder has validly exercised the redemption right before any payment with respect to the redemption of convertible preferred stock upon such change of control. The Company may optionally redeem, in whole or in part, the Series C preferred stock at any time at a cash price per share of 100% of the then effective Series C Preferred Liquidation Preference per share. On the fifth anniversary of the issuing date, we will be required to redeem all outstanding shares of Series C preferred stock at a price equal to the Series C Preferred Liquidation Preference per share, payable in cash. F-22 LOAN NOTES -- Approximately $17.7 million of the purchase price of Salton Europe was paid by issuing loan notes (the "Loan Notes") in accordance with the purchase offer, with the remainder paid in cash. The Loan Notes have been fully funded by the Company, which was recorded as an escrow asset as of July 2, 2005. The remaining Loan Notes were recorded at their net present value, or $0.9 million as of July 2, 2005. As of July 1, 2006, all Loan Notes had been redeemed by shareholders. As of July 1, 2006, long-term debt matures as follows:
SECOND LIEN SUBORDINATED SERIES C TERM EUROPE FISCAL YEAR ENDED NOTES NOTES PREFERRED LOAN FACILITY OTHER TOTAL - ----------------------------------------------------------------------------------------------------------- (IN THOUSANDS) 2007 $ 10,971 $ -- $ -- $ -- $ 1,542 $ 416 $ 12,929 2008 116,407 59,881 -- 100,000 1,542 8 277,838 2009 -- -- -- -- 35,948 -- 35,948 2010 -- -- -- -- -- -- -- 2011 -- -- 13,522 -- -- -- 13,522 Thereafter -- -- -- -- -- -- -- - ----------------------------------------------------------------------------------------------------------- $ 127,378 $ 59,881 $ 13,522 $100,000 $39,032 $ 424 $340,237 - -----------------------------------------------------------------------------------------------------------
The recorded balances of the Company's long-term debt include the following components:
SECOND SUBORDINATED SUBORDINATED SERIES C EUROPE LIEN NOTES NOTES -- 2005 NOTES -- 2008 PREFERRED TERM LOAN FACILITY OTHER TOTAL - --------------------------------------------------------------------------------------------------------------------------------- JULY 1, 2006 Interest payable -- current $ 10,971 $ -- $ -- $ -- $ -- $ -- $ -- $ 10,971 Principal balance -- -- -- -- -- 21,131 416 21,547 - --------------------------------------------------------------------------------------------------------------------------------- Total current debt 10,971 -- -- -- -- 21,131 416 32,518 - --------------------------------------------------------------------------------------------------------------------------------- Interest payable -- long-term 13,136 -- -- -- -- -- 13,136 Principal balance 103,271 -- 59,881 13,522 100,000 17,901 8 294,583 Fair value adjustment -- -- 1,829 -- -- -- -- 1,829 Unamortized discount -- -- (179) (4,600) -- -- -- (4,779) - --------------------------------------------------------------------------------------------------------------------------------- Total long-term debt 116,407 -- 61,531 8,922 100,000 17,901 8 304,769 - --------------------------------------------------------------------------------------------------------------------------------- Total recorded balance $127,378 $ -- $ 61,531 $ 8,922 $100,000 $39,032 $ 424 $337,287 - --------------------------------------------------------------------------------------------------------------------------------- JULY 2, 2005 Principal balance $ -- $ 45,990 $ -- $ -- $ 47,551 $21,886 $1,382 $116,809 Unamortized discount -- -- -- -- -- -- (89) (89) - --------------------------------------------------------------------------------------------------------------------------------- Total current debt -- 45,990 -- -- 47,551 21,886 1,293 116,720 - --------------------------------------------------------------------------------------------------------------------------------- Principal balance $ -- $ 79,010 $ 150,000 $ -- $100,000 $ -- $ 50 $329,060 Fair value adjustment -- -- 7,082 -- -- -- -- 7,082 Unamortized discount -- -- (695) -- -- -- -- (695) - --------------------------------------------------------------------------------------------------------------------------------- Total long-term debt -- 79,010 156,387 -- 100,000 -- 50 335,447 - --------------------------------------------------------------------------------------------------------------------------------- Total recorded balance $ -- $ 125,000 $ 156,387 $ -- $147,551 $21,886 $1,343 $452,167 - ---------------------------------------------------------------------------------------------------------------------------------
Included in interest expense are amortized financing costs of $4.9 million, $4.6 million and $3.5 million for the fiscal years 2006, 2005 and 2004, respectively. The Company believes that (a) future cash flow from operations based on the current level of operations, (b) available borrowings under the senior secured credit facility, second lien credit agreement and other sources of debt funding and (c) funds from the sale or monetization of certain assets will be adequate to meet their anticipated requirements for current capital expenditures, working capital require- F-23 ments, interest and income tax payments and scheduled debt payments for the next twelve months. The Company's ability to satisfy their anticipated liquidity requirements, however, is subject to several assumptions, some of which are beyond their control, including: (a) general economic, financial, competitive and other factors; and (b) continued compliance with covenants in the debt instruments. If the Company is unable to satisfy its liquidity needs, it could be required to adopt one or more alternatives, such as reducing or delaying capital expenditures, borrowing additional funds, restructuring indebtedness, selling other assets or operations and/or reducing expenditures for new product development, cutting other costs, and some or such actions would require the consent of their senior lenders, holders of Second Lien Notes and/or the holders of our Subordinated Notes. 9. DERIVATIVE FINANCIAL INSTRUMENTS The Company uses derivative financial instruments to manage interest rate and foreign currency risk. The Company does not enter into derivative financial instruments for trading purposes. Interest rate swap agreements were used in the past as part of the Company's program to manage the fixed and floating interest rate mix of its total debt portfolio and related overall cost of borrowing. The Company uses forward exchange contracts to hedge foreign currency payables for periods consistent with the expected cash flow of the underlying transactions. The contracts generally mature within one year and are designed to limit exposure to exchange rate fluctuations, primarily related to the Australian dollar to the U.S. dollar. When entered into, these financial instruments are designated as hedges of underlying exposures. When a high correlation between the hedging instrument and the underlying exposure being hedged exists, fluctuations in the value of the instruments are offset by changes in the value of the underlying exposures. The estimated fair values of derivatives used to hedge or modify the Company's risks fluctuate over time. These fair value amounts should not be viewed in isolation, but rather in relation to the fair values of the underlying hedging transactions and investments and to the overall reduction in the Company's exposure to adverse fluctuations in interest rates and foreign exchange rates. The notional amounts of the derivative financial instruments do not necessarily represent amounts exchanged by the parties and, therefore, are not a direct measure of the Company's exposure from its use of derivatives. The amounts exchanged are calculated by reference to the notional amounts and by other terms of the derivatives, such as interest rates or exchange rates. INTEREST RATE MANAGEMENT -- The Company did not have any interest rate swap agreements in effect as of July 1, 2006 or July 2, 2005. Gains from early termination of prior swap contracts were deferred as adjustments to the carrying amount of the outstanding debt and are being amortized as an adjustment to interest expense related to the debt over the remaining period originally covered by the terminated swap. (See Note 8, "Senior Secured Credit Facility, Letters of Credit and Long-term Debt.") FOREIGN CURRENCY MANAGEMENT -- All foreign exchange contracts have been recorded on the balance sheet at a de minimis fair value within accrued expenses. The change in the fair value of contracts that qualify as foreign currency cash flow hedges and are highly effective was also de minimis. This amount was recorded in other comprehensive income net of tax. The Company anticipates that all gains and losses in accumulated other comprehensive income related to foreign exchange contracts will be reclassified into earnings during fiscal year 2007. At July 1, 2006, the Company had foreign exchange contracts for the purchase of 1.0 million U.S. dollars. 10. CONVERTIBLE PREFERRED STOCK On July 28, 1998, the Company issued $40.0 million of convertible preferred stock in connection with a Stock Purchase Agreement dated July 15, 1998. The convertible preferred stock is non-dividend bearing except if the Company breaches, in any material respect, any of the material obligations in the preferred stock agreement or the certificate of incorporation relating to the convertible preferred stock, the holders of the convertible preferred stock are entitled to receive quarterly cash dividends on each share from the date of the breach until it is cured at a rate per annum to 12 1/2% of the Liquidation Preference (defined below). In addition to the dividend provided above, in the event the Board of Directors of the Corporation shall F-24 determine to pay any cash or non-cash dividends or distributions on its Common Stock (other than dividends payable in shares of its Common Stock) the holders of shares of Convertible Preferred Stock shall be entitled to receive cash and non-cash dividends or distributions in an amount and of a kind equal to the dividends or distributions that would have been payable to each such holder as if the Convertible Preferred Stock held by such holder had been converted into Common Stock immediately prior to the record date for the determination of the holders of Common Stock entitled to each such dividend or distribution; provided, however, that if the Corporation shall dividend or otherwise distribute rights to all holders of Common Stock entitling the holders thereof to subscribe for or purchase shares of capital stock of the Corporation, which rights (i) until the occurrence of a specified event or events are deemed to be transferred with such shares of Common Stock and are not exercisable and (ii) are issued in respect of future issuances of Common Stock, the holders of shares of the Convertible Preferred Stock shall not be entitled to receive any such rights until such rights separate from the Common Stock or become exercisable, whichever is sooner. The preferred shares are convertible into 3,529,411 shares of Salton common stock (reflecting a $11.33 per share conversion price). The holders of the convertible preferred stock are entitled to one vote for each share of Salton common stock that the holder would receive upon conversion of the convertible preferred stock. In connection with the convertible preferred stock issuance, two individuals representing the purchasers of the preferred stock were appointed to serve on the Company's Board of Directors. In the event of a change in control of the Company, each preferred shareholder has the right to require the Company to redeem the shares at a redemption price equal to the Liquidation Preference (defined below) plus interest accrued thereon at a rate of 7% per annum compounded annually each anniversary date from July 28, 1998 through the earlier of the date of such redemption or July 28, 2003. In the event of a liquidation, dissolution or winding up of the Company, whether voluntary or involuntary, holders of the Convertible Preferred Stock are entitled to be paid out of the assets of the Company available for distribution to its stockholders an amount in cash equal to $1,000 per share, plus the amount of any accrued and unpaid dividends thereon (the Liquidation Preference), before any distribution is made to the holders of any Salton common stock or any other of its capital stock ranking junior as to liquidation rights to the convertible preferred stock. The Company may optionally convert in whole or in part, the convertible preferred stock at any time on and after July 15, 2003 at a cash price per share of 100% of the then effective Liquidation Preference per share, if the daily closing price per share of the Company common stock for a specified 20 consecutive trading day period is greater than or equal to 200% of the then current Conversion Price. On September 15, 2008, the Company will be required to exchange all outstanding shares of convertible preferred stock at a price equal to the Liquidation Preference per share, payable at the Company's option in cash or shares of Salton common stock. In accordance with Emerging Issues Task Force Topic No. D-98 "Classification and Measurement of Redeemable Securities", the convertible preferred stock is classified as a separate line item apart from permanent equity on the Company's balance sheet, as redemption thereof in shares of common stock is outside of the Company's control. 11. SHAREHOLDERS' EQUITY AND ACCUMULATED OTHER COMPREHENSIVE INCOME The Board of Directors of Salton adopted a stockholder rights plan (the "Rights Plan") dated as of June 28, 2004, as amended June 7, 2006, pursuant to which a dividend consisting of one preferred stock purchase right (a "Right") was distributed for each share of Common Stock held as of the close of business on July 9, 2004, and is to be distributed to each share of Common Stock issued thereafter until the earlier of (i) the Distribution Date (as defined in the Rights Plan), (ii) the Redemption Date (as defined in the Rights Plan) or (iii) June 28, 2014. The Rights Plan is designed to deter coercive takeover tactics and to prevent an acquirer from gaining control of the Company without offering fair value to its stockholders. The Rights will expire on June 28, 2014, subject to earlier redemption or exchange as provided in the Rights F-25 Plan. Each Right entitles the holder thereof to purchase from Salton one one-thousandth of a share of a new series Series B Junior Participating Preferred Stock at a price of $45.00 per one one-thousandth of a share, subject to adjustment. The Rights are generally exercisable only if a Person (as defined) acquires beneficial ownership of 25 percent or more of the Company's outstanding Common Stock. Comprehensive income is the change in equity of a company during a period from transactions and events other than investments by and distributions to shareholders. Comprehensive income includes both net income or loss and other comprehensive income or loss. Other comprehensive loss was $1.2 million in both 2006 and 2005. Accumulated other comprehensive income is comprised of the following:
JULY 1, 2006 JULY 2, 2005 - ----------------------------------------------------------------------------------------- (IN THOUSANDS) Minimum pension liability $ (8,173) $ (10,933) Derivative liability -- 1,404 Foreign currency translation 18,470 21,042 - ----------------------------------------------------------------------------------------- Accumulated other comprehensive income $ 10,297 $ 11,513 - -----------------------------------------------------------------------------------------
During fiscal year 2006, the Company recognized income of $1.4 million and $5.2 million related to foreign currency cash flow hedges and cumulative foreign currency translation adjustment amounts, respectively, upon the sale of discontinued operations. 12. NET LOSS PER COMMON AND COMMON EQUIVALENT SHARE Net loss per share is computed in accordance with FASB Statement No. 128, "Earnings Per Share," and Emerging Issues Task Force Statement ("EITF") No. 03-6, "Participating Securities and the Two Class Method Under FASB Statement No. 128, Earnings per Share." Under EITF 03-06, the Series A Preferred Stock is included in both basic and diluted net loss per share using the "two-class" method, if the effect is dilutive. Due to the losses in 2006, 2005 and 2004, the Company's Series A Preferred Stock was not dilutive and was excluded from the calculation of basic and diluted earnings per share. Additionally, the dilutive effect of the Company's outstanding common stock equivalents, options and warrants was excluded from the computation of diluted earnings per share as the effect would have been anti-dilutive.
YEAR ENDED YEAR ENDED YEAR ENDED JULY 1, 2006 JULY 2, 2005 JULY 3, 2004 - -------------------------------------------------------------------------------------------------------- (IN THOUSANDS, EXCEPT EARNINGS PER COMMON SHARE) Net loss from continuing operations $ (102,034) $ (53,925) $ (103,761) Income from discontinued operations, net of tax 1,735 2,138 8,589 Gain on sale of discontinued operations, net of tax 32,332 -- -- - -------------------------------------------------------------------------------------------------------- Net loss $ (67,967) $ (51,787) $ (95,172) - -------------------------------------------------------------------------------------------------------- Average common shares outstanding 13,393 11,374 11,258 Dilutive stock equivalents (stock options) -- -- -- - -------------------------------------------------------------------------------------------------------- Average common and common equivalent shares outstanding 13,393 11,374 11,258 - -------------------------------------------------------------------------------------------------------- Net loss per common share: basic and diluted From continuing operations $ (7.62) $ (4.74) $ (9.22) From discontinued operations, net of tax 0.13 0.19 0.77 Gain on sale of discontinued operations, net of tax 2.41 -- -- - -------------------------------------------------------------------------------------------------------- Net loss per common share: basic and diluted $ (5.08) $ (4.55) $ (8.45) - --------------------------------------------------------------------------------------------------------
Had the Company recognized net income in 2006, 2005 and 2004, basic shares outstanding would have increased by 3,529,412 shares with the inclusion of the Series A Preferred Stock under the two-class F-26 method. Diluted shares outstanding would have increased by 3,907,209, 3,935,861 and 3,931,070 shares in 2006, 2005 and 2004, respectively, for the effect of the Series A Preferred Stock, common stock equivalents and outstanding options. 13. EMPLOYEE BENEFIT PLANS The Company has a 401(k) defined contribution plan that covers eligible domestic employees. The employees are eligible for benefits upon completion of one year of service. Under the terms of the plan, the Company may elect to match a portion of the employee contributions. The Company's discretionary matching contribution is based on a portion of participants' eligible wages, as defined, up to a maximum amount ranging typically from two percent to six percent. The Company's total matching contributions were approximately $0.4 million, $0.4 million, and $0.5 million, in fiscal 2006, 2005 and 2004, respectively. The Company has two defined benefit plans that cover substantially all of the domestic employees of Toastmaster as of the date the plans were curtailed. Pension benefits are based on length of service, compensation, and, in certain plans, Social Security or other benefits. The Company uses March 31 as the measurement date for the Toastmaster plans for determining pension plan assets and obligations. Effective October 30, 1999, the Company's Board of Directors approved the freezing of benefits under the two Toastmaster defined benefit plans. Beginning October 31, 1999, no further benefits were accrued under the Toastmaster plans. Salton Europe operates a funded defined benefit pension plan and a defined contribution plan. The assets of the defined benefit plan are held in separate trustee administered funds. The measurement date of the Salton Europe plan is June 30. The defined benefit plan was closed to new entrants in November 2000. New employees starting after this date can now participate in a defined contribution plan, which is open to all employees. The Company matches employee contributions up to and including 5.0% of gross F-27 salary. The total matching contributions were approximately $0.1 million, $0.2 million, and $0.1 million, in fiscal 2006, 2005 and 2004, respectively.
DOMESTIC SALTON EUROPE TOTAL ----------------- ------------------- ------------------- 7/1/06 7/2/05 7/1/06 7/2/05 7/1/06 7/2/05 - ------------------------------------------------------------------------------------------------------------- (IN THOUSANDS) Change in benefit obligation: Benefit obligation at beginning of year $12,016 $12,052 $ 42,088 $ 38,290 $ 54,104 $ 50,342 Service cost 168 168 424 243 592 411 Interest cost 703 706 2,158 2,211 2,861 2,917 Actuarial (gain)/loss 81 25 (130) 3,145 (49) 3,170 Plan participant contributions -- -- 292 473 292 473 Foreign exchange impact -- -- 1,929 (1,483) 1,929 (1,483) Benefits paid and expenses (1,002) (935) (915) (791) (1,917) (1,726) - ------------------------------------------------------------------------------------------------------------- Benefit obligation at end of year $11,966 $12,016 $ 45,846 $ 42,088 $ 57,812 $ 54,104 - ------------------------------------------------------------------------------------------------------------- Change in plan assets: Fair value of plan assets at beginning of year $ 9,301 $ 8,993 $ 25,825 $ 22,859 $ 35,126 $ 31,852 Actual return on plan assets 1,127 525 4,221 3,292 5,348 3,817 Employer contribution 445 718 1,416 912 1,861 1,630 Plan participant contributions -- -- 292 473 292 473 Benefits paid from plan assets (1,002) (935) (915) (793) (1,917) (1,728) Foreign exchange impact -- -- 1,326 (918) 1,326 (918) - ------------------------------------------------------------------------------------------------------------- Fair value of plan assets at end of year $ 9,871 $ 9,301 $ 32,165 $ 25,825 $ 42,036 $ 35,126 - ------------------------------------------------------------------------------------------------------------- Funded status $(2,096) $(2,715) $(13,681) $(16,263) $(15,776) $(18,978) Unrecognized net actuarial loss 3,386 4,048 10,926 13,743 14,312 17,791 - ------------------------------------------------------------------------------------------------------------- Net amount recognized $ 1,290 $ 1,333 $ (2,755) $ (2,520) $ (1,464) $ (1,187) - ------------------------------------------------------------------------------------------------------------- Accrued benefit cost $(2,096) $(2,715) $(11,851) $(14,611) $(13,947) $(17,326) Accumulated other comprehensive income 3,386 4,048 9,096 12,091 12,482 16,139 - ------------------------------------------------------------------------------------------------------------- Net amount recognized $ 1,290 $ 1,333 $ (2,755) $ (2,520) $ (1,465) $ (1,187) - -------------------------------------------------------------------------------------------------------------
DOMESTIC SALTON EUROPE TOTAL ------------------------ --------------------------- --------------------------- 7/1/06 7/2/05 7/3/04 7/1/06 7/2/05 7/3/04 7/1/06 7/2/05 7/3/04 - ------------------------------------------------------------------------------------------------------------------- Components of net periodic benefit cost: Service cost-benefits earned during the year $ 168 $ 168 $ 168 $ 424 $ 243 $ 293 $ 592 $ 411 $ 461 Interest cost on projected benefit obligation 703 706 715 2,158 2,211 1,864 2,861 2,917 2,579 Actuarial return on plan assets (629) (623) (663) (1,848) (1,738) (1,385) (2,477) (2,361) (2,048) Net amortization and deferral 246 258 394 801 745 706 1,047 1,003 1,100 - ------------------------------------------------------------------------------------------------------------------- $ 488 $ 509 $ 614 $ 1,535 $ 1,461 $ 1,478 $ 2,023 $ 1,970 $ 2,092 - -------------------------------------------------------------------------------------------------------------------
F-28
DOMESTIC SALTON EUROPE ------------------- ------------------- 7/1/2006 7/2/2005 7/1/2006 7/2/2005 - ------------------------------------------------------------------------------------------------------- Weighted average assumptions used to determine net benefit obligation: Discount rate 6.00% 6.00% 5.20% 5.10% Rate of increase in compensation N/A N/A 4.50% 4.30%
DOMESTIC SALTON EUROPE ------------------------------ ------------------------------ 7/1/2006 7/2/2005 7/3/2004 7/1/2006 7/2/2005 7/3/2004 - ------------------------------------------------------------------------------------------------------------- Weighted average assumptions used to determine net periodic benefit cost: Discount rate 6.00% 6.00% 6.00% 5.10% 5.70% 5.50% Rate of increase in compensation N/A N/A N/A 4.50% 4.30% 4.50% Expected return on plan assets 7.00% 7.00% 9.00% 7.00% 7.00% 7.40%
DOMESTIC SALTON EUROPE ------------------- ------------------- 7/1/2006 7/2/2005 7/1/2006 7/2/2005 - ------------------------------------------------------------------------------------------------------- Information for pension plans with an accumulated benefit obligation in excess of plan assets: Projected benefit obligation $11,966 $12,016 $45,846 $42,088 Accumulated benefit obligation 11,966 12,016 44,016 40,434 Fair value of plan assets 9,870 9,301 32,165 25,824
DOMESTIC SALTON EUROPE ----------------- --------------- 3/31/06 3/31/05 7/1/06 7/2/05 - ------------------------------------------------------------------------------------------------- Allocation of Plan Assets: Equity securities 60% 58% 78% 80% Debt securities 36% 38% 9% 13% Other 4% 4% 13% 7% ------- ------- ------ ------ Total 100% 100% 100% 100%
The Company uses March 31 as the measurement date for the Domestic plans for determining pension plan assets and obligations. Domestic plan assets will be held in an investment portfolio with an active, strategic asset allocation strategy. This portfolio will be invested exclusively in mutual funds and will be highly liquid. Investments shall be diversified with the intent to minimize the risk of large losses to the Fund. Consequently, the total portfolio will be constructed and maintained to provide prudent diversification with regard to the concentration of holdings in individual issues, corporations, or industries. Over the long-term, the investment objectives for this portfolio shall be to achieve an average total annual rate of return of 9.0% for the aggregate investments. The investment strategy for the Europe plan is determined by the Trustees of the Pifco (Salton Europe) Group Pension and Life Assurance Plan ("the Plan") in consulting with the Company. The aim of the Trustees of the Plan is to ensure that while the Plan continues to operate on an ongoing basis there are enough assets in the Plan to pay the benefits as they fall due with a stable contribution rate. The overall expected rate of return of 7.0% is based on the weighted average of the expected returns on each asset F-29 class. The Trustees aim to reduce equity investment and increase debt security investment when they feel the time is right. The target allocation at any point in time is therefore equal to the actual allocation.
DOMESTIC SALTON EUROPE ------------------- ------------------- 7/1/2006 7/2/2005 7/1/2006 7/2/2005 - ------------------------------------------------------------------------------------------------------- Additional Information: Increase (decrease) in minimum liability included in other comprehensive income $ (663) $ (136) $ (3,530) $ 1,567
Under the requirements of SFAS No. 87, "Employers' Accounting for Pensions," an additional minimum pension liability for all plans, representing the excess of accumulated benefits over the plan assets and accrued pension costs, was recognized at July 1, 2006 and July 2, 2005 with the balance recorded as a separate reduction of stockholders' equity, net of deferred tax effect.
DOMESTIC SALTON EUROPE TOTAL - ----------------------------------------------------------------------------------------------- Contributions: Expected contributions in fiscal 2007 $ 487 $ 1,516 $2,003 Expected Future Benefit Payments: Fiscal 2007 $ 792 $ 949 $1,741 Fiscal 2008 804 995 1,799 Fiscal 2009 818 1,100 1,918 Fiscal 2010 827 1,193 2,020 Fiscal 2011-2015 835 1,304 2,139 Fiscal 2012-2016 4,272 11,021 15,293
F-30 14. STOCK-BASED COMPENSATION STOCK OPTIONS -- Options to purchase common stock of the Company have been granted to employees under the 1992, 1995, 1998, 1999, 2000, 2001 and 2002 stock option plans at prices equal to the fair market value of the stock on the dates the options were granted. Options have also been granted to non-employee directors of the Company, which are exercisable one year after the date of grant. All options granted expire 10 years from the date of grant, and can vest immediately or up to 3 years from the date of grant. Effective July 3, 2005, the Company adopted SFAS No. 123(R), "Share-Based Payment," which revises Statement 123 and supercedes ABP 25. FASB Statement No. 123(R) requires all share-based payments to employees to be recognized in the financial statements based on their fair value using an option-pricing model at the date of grant. The Company has elected to use the modified prospective method for adoption, which requires compensation expense to be recorded for all unvested stock options beginning in the first year of adoption. For all unvested options outstanding as of July 3, 2005, the previously measured but unrecognized compensation expense, based on the fair value at the original grant date, was recognized over the remaining vesting period which concluded in fiscal 2006. For share-based payments granted subsequent to July 3, 2005, compensation expense, based on the fair value on the date of grant, will be recognized from the date of grant over the applicable vesting period. The Company uses the Black-Scholes option-pricing model to determine fair value of awards on the date of grant. There were no stock option awards granted in fiscal 2006. For fiscal 2006, total stock-based employee compensation expense related to these plans was $0.4 million, net of related income tax of $0 (see Note 18, "Income Taxes"). The impact on basic and diluted earnings per share for fiscal 2006 was $(0.03). There is no compensation cost related to nonvested awards not yet recognized as of July 1, 2006. For periods prior to July 3, 2005, the Company used the intrinsic value method in accordance with APB No. 25, "Accounting for Stock Issued to Employees," and related Interpretations. No stock-based compensation is reflected in net income, as no options granted under those plans had an exercise price less than the market value of the underlying common stock on the date of grant. The fair value of each option grant is estimated on the date of grant using the Black-Scholes option-pricing model. The following assumptions were used during the respective years to estimate the fair value of options granted:
2006 2005 2004 - -------------------------------------------------------------------------------------------------- Dividend yield N/A 0.00% 0.00% Expected volatility N/A 66.45% 63.86% Risk-free interest rate N/A 3.31% 3.96% Expected life of options N/A 8.00 years 8.00 years
F-31 A summary of the Company's fixed stock options for the fiscal years ended July 1, 2006, July 2, 2005, and July 3, 2004, is as follows:
2006 2005 2004 ----------------- ----------------- ----------------- WEIGHTED WEIGHTED WEIGHTED AVERAGE AVERAGE AVERAGE SHARES EXERCISE SHARES EXERCISE SHARES EXERCISE (000) PRICE (000) PRICE (000) PRICE - ------------------------------------------------------------------------------------------------- Outstanding at beginning of year 2,603 $ 13.75 2,766 $ 13.50 3,155 $ 15.00 Granted -- 9 8.67 48 10.60 Exercised (105) 1.67 (6) 2.25 (36) 6.50 Expired or Canceled (334) 10.32 (166) 9.59 (401) 25.62 ------ ------ ------ Outstanding at end of year 2,164 $ 14.87 2,603 $ 13.75 2,766 $ 13.50 ====== ======== ====== ======== ====== ======== Options exercisable at end of year 2,164 $ 14.87 2,374 $ 14.21 2,242 $ 13.14 Weighted-average fair value of options granted during the year N/A $ 6.04 $ 7.30
The following information summarizes the stock options outstanding at July 1, 2006:
OPTIONS OUTSTANDING ---------------------- OPTIONS EXERCISABLE WEIGHTED -------------------- AVERAGE WEIGHTED WEIGHTED REMAINING AVERAGE AVERAGE SHARES CONTRACTUAL EXERCISE SHARES EXERCISE RANGE OF EXERCISE PRICES (000) LIFE (YEARS) PRICE (000) PRICE - ------------------------------------------------------------------------------------------------------ $5.333 - $5.833 15 0.87 $ 5.35 15 $ 5.35 $6.333 - $10.60 1,114 5.38 8.83 1,114 8.83 $13.917 - $17.50 652 3.72 14.80 652 14.80 $18.95 - $37.00 383 3.52 32.89 383 32.89 ------ ------ $5.333 - $37.00 2,164 4.52 $ 14.87 2,164 $ 14.87 ------ ------
STOCK GRANTS -- On March 9, 2006, the Company granted certain employees common stock of the Company. A total of 192,250 shares were granted, of which 101,250 vested upon issuance. The remaining 91,000 shares have a two year vesting, with 50% vesting after one year and the remaining 50% vesting after two years. The Company has recognized compensation cost for these stock grants at the fair value of the stock at the date of grant. For fiscal 2006, compensation expense related to these grants was $0.2 million, net of related income tax of $0 (see Note 18, Income Taxes). Compensation cost related to nonvested awards not yet recognized is $0.1 million and will be recognized over the requisite two year service period. 15. COMMITMENTS AND CONTINGENCIES LEASES -- The Company leases certain facilities and equipment under long-term operating leases. Rental expense for continuing operations under all leases was approximately $9.0 million, $10.0 million and $10.4 million for the fiscal years ended July 1, 2006, July 2, 2005, and July 3, 2004, respectively. Leased equipment meeting certain criteria is capitalized and the present value of the related lease payments is recorded as a liability. Amortization of capitalized leased assets is computed on the straight-line method of the term of the lease. F-32 The future minimum rental commitments as of July 1, 2006 were as follows: FISCAL YEAR ENDED
OPERATING LEASES CAPITAL LEASES - ------------------------------------------------------------------------------------------------ (IN THOUSANDS) 2007 $ 7,979 $ 32 2008 7,081 8 2009 6,730 -- 2010 6,327 -- 2011 6,079 -- Thereafter 33,400 -- - ------------------------------------------------------------------------------------------------ Total minimum lease payments $ 67,596 40 =========== Less amounts representing interest (1) - ------------------------------------------------------------------------------------------------ Present value of minimum lease payments $ 39 - ------------------------------------------------------------------------------------------------
Present value of net minimum capital lease obligations: Current portion $31 Long term portion 8 - ------------------------------------------------------------------- Total obligations $39 - -------------------------------------------------------------------
OTHER COMMITMENTS -- The Company has employment agreements with its executive officers. Such agreements provide for minimum salary levels as well as for incentive bonuses that are payable if the Company achieves specified target performance goals. The agreements also provide for lump sum severance payments upon termination of employment under certain circumstances. Salton maintains various licensing and contractual relationships to market and distribute products under specific names and designs. These licensing arrangements generally require certain license fees and royalties. Some of the agreements contain minimum sales requirements that, if not satisfied, may result in the termination of the agreements. Total royalties under these agreements charged to operations, were $6.7 million, $6.7 million and $6.3 million in fiscal 2006, 2005 and 2004, respectively. The Company has a licensing agreement with Westinghouse Electric Corporation ("Westinghouse") under which minimum royalty payments are required. The minimum royalty payment was $2.9 million for fiscal 2006. The minimum royalty payment increases by 3% each fiscal year. The contract expires on March 31, 2008 with five automatic five-year renewals. Upon prior written notice to Westinghouse, Salton has the option to terminate the agreement at the end of the original contract term or any extension term. In fiscal 2001, the Company acquired Sonex International Corporation, a designer and distributor of electrically operated toothbrushes, flossers and related products. In connection with that acquisition, the Company agreed to separate, additional consideration ("Earn-Out Consideration") to commence after net sales of Sonex products exceed $20.0 million. In fiscal 2006, the Company paid $0.2 million under the Earn-Out Consideration and as of July 1, 2006, the Company will continue to accrue and may owe up to an additional $2.5 million. In fiscal 2003, the Company entered into an agreement with George Foreman for professional appearances associated with the promotion of the George Foreman product line. The contract requires payments in installments over the life of the contract that total $9.0 million. The contract will expire on November 30, 2006. In fiscal 2006, the Company paid $3.0 million under this agreement. As of July 1, 2006, the Company owed an additional $0.8 million. F-33 In May 2004, two stockholder lawsuits were filed in the United States District Court for the Northern District of Illinois against the Company and certain Salton executives. The complaints alleged that the defendants violated the federal securities laws, specifically Sections 10(b) and 20(a) of the Securities Exchange Act of 1934 and Rule 10b-5 of the Securities and Exchange Commission, by making certain alleged false and misleading statements. On March 17, 2006, the Court approved a settlement of the lawsuits and granted a final order of dismissal and judgment of the lawsuits. Under the terms of the settlement, the Company's insurers paid $2.5 million and the remaining $0.5 million of the settlement fund is payable no later than July 16, 2007. The Company accrued the future payment in other long-term liabilities at the present value of $0.4 million. WARRANTIES AND OTHER CLAIMS -- The Company generally warrants its products against defects for a period of one to three years. Additionally, credits are issued to customers for damages sustained during shipment, claimed shortages, certain returns of undamaged product, and other general allowances. Segregating all allowances granted by discrete category for domestic operations at times require substantial judgment. Accordingly, a single accrual covering all estimated future claims, returns, and account allowances are recorded for domestic operations when products are shipped. Thus, revenue is recognized based upon management's best estimate of future returns and warranty claims considering historical experience. Management also periodically reviews the adequacy of the reserve and makes changes to the allowance accordingly. The following table summarizes the changes in the Company's aggregate accrual for returns, allowances and doubtful accounts for continuing operations:
CHARGED TO NET SALES, EXCHANGE BEGINNING COSTS AND RATE ENDING BALANCE EXPENSES DEDUCTIONS DIFFERENCES BALANCE - --------------------------------------------------------------------------------------------------- (IN THOUSANDS) Year Ended July 3, 2004: Allowance for returns, allowances and doubtful accounts $ 7,327 $ 34,229 $ (28,190) $ 202 $13,568 Year Ended July 2, 2005: Allowance for returns, allowances and doubtful accounts $ 13,568 $ 32,400 $ (38,204) $ (69) $ 7,695 Year Ended July 1, 2006: Allowance for returns, allowances and doubtful accounts $ 7,695 $ 31,565 $ (29,897) $ 77 $ 9,440
The Company's continuing foreign operations maintain a separate warranty reserve. The following table summarizes the changes in these warranty reserves:
CHARGED TO NET SALES, EXCHANGE BEGINNING COSTS AND RATE ENDING BALANCE EXPENSES DEDUCTIONS DIFFERENCES BALANCE - --------------------------------------------------------------------------------------------------- (IN THOUSANDS) Year Ended July 3, 2004: Warranty reserve $ 2,593 $ 7,356 $ (7,260) $ 65 $ 2,754 Year Ended July 2, 2005: Warranty reserve $ 2,754 $ 5,857 $ (6,214) $ (10) $ 2,387 Year Ended July 1, 2006: Warranty reserve $ 2,387 $ 5,627 $ (5,186) $ 50 $ 2,878
F-34 16. LEGAL PROCEEDINGS PRODUCT LIABILITY On or about October 27, 2004, a lawsuit entitled DiNatale vs. Salton was filed in the New York State Supreme Court against the Company. The plaintiffs, who seek unspecified damages, allege that they were injured by water contaminated with lead taken from a tea kettle sold by the Company under its Russell Hobbs brand. The plaintiffs' attorney had been seeking to convert the lawsuit into a class action suit; no class action suit has been filed to date. The manufacturer of the product and its insurer are defending this lawsuit. The Company's attorneys and its insurers are cooperating in the defense of the lawsuit. JAY KORDICH V. SALTON, INC. On October 19, 2005, a lawsuit named Jay Kordich v. Salton, Inc. was filed in the United States District Court for the Southern District of California. The plaintiff in this action is seeking a judicial determination that a covenant not to compete in an agreement between him and Salton is invalid and unenforceable against him plus attorneys' fees and costs. Salton believes that the lawsuit is without merit. The outcome of the foregoing legal matters cannot be predicted with certainty, however Salton does not believe that these actions will have a material adverse affect on its business, financial condition or results of operations. Therefore, no amounts have been accrued for such claims. ENVIRONMENTAL The Company has accrued approximately $0.2 million for the anticipated costs of environmental remediation at four of our current and previously owned sites. Although such costs could exceed that amount, Salton believes any such excess will not have a material adverse effect on the financial condition or annual results of operations of the Company. OTHER The Company is a party to various other actions and proceedings incident to its normal business operations. The Company believes that the outcome of any such litigation will not have a material adverse effect on our business, financial condition or results of operations. The Company also has product liability and general liability insurance policies in amounts believed to be reasonable given its current level of business. Although historically the Company has not had to pay any material product liability claims, it is conceivable that the Company could incur claims for which we are not insured. 17. OPERATING SEGMENTS Salton consists of a single operating segment which designs, sources, markets and distributes a diversified product mix for use in the home. The product mix consists of small kitchen and home appliances, electronics for the home, time products, lighting products and personal care and wellness products. The Company believes this segmentation is appropriate based upon Management's operating decisions and performance assessment. Nearly all of the Company's products are consumer goods within the housewares market, procured through independent manufacturers, primarily in the Far East. Salton's products are distributed through similar distribution channels and customer base using the marketing efforts of its Global Marketing Team. F-35 PRODUCT INFORMATION -- NET SALES
JULY 1, 2006 JULY 2, 2005 JULY 3, 2004 - -------------------------------------------------------------------------------------------------------- (IN THOUSANDS) Small Appliances and Electronics for the Home $ 565,511 $ 648,869 $ 716,334 Home Decor 41,820 80,241 85,164 Personal Care and Wellness 28,629 52,626 43,262 - -------------------------------------------------------------------------------------------------------- Total $ 635,960 $ 781,736 $ 844,760 - --------------------------------------------------------------------------------------------------------
GEOGRAPHIC INFORMATION -- NET SALES
JULY 1, 2006 JULY 2, 2005 JULY 3, 2004 - -------------------------------------------------------------------------------------------------------- (IN THOUSANDS) North America $ 368,486 $ 444,432 $ 531,717 European Union 185,985 216,981 216,278 Other Foreign Countries 81,489 120,323 96,765 - -------------------------------------------------------------------------------------------------------- Total $ 635,960 $ 781,736 $ 844,760 - --------------------------------------------------------------------------------------------------------
All revenues are derived from sales to unaffiliated customers. Sales are allocated to geographic areas based on point of shipment. Other Foreign Countries includes shipments directly imported to customers including customers of North America and European Union. In the opinion of management, the three-year financial data for geographic areas may not be indicative of current or future operations. GEOGRAPHIC INFORMATION -- LONG-LIVED ASSETS
JULY 1, 2006 JULY 2, 2005 - ----------------------------------------------------------------------------------------- (IN THOUSANDS) North America $ 19,165 $ 26,723 Asia 16,911 23,130 European Union 13,736 11,328 Other Foreign Countries 492 601 - ----------------------------------------------------------------------------------------- Total $ 50,304 $ 61,782 - -----------------------------------------------------------------------------------------
MAJOR CUSTOMERS AND SUPPLIERS -- The Company's net sales from continuing operations in the aggregate to its five largest customers during 2006, 2005 and 2004 were 33.6%, 37.3% and 41.0% of total net sales from continuing operations in these periods, respectively. No one customer accounted for more than 10.0% of net sales from continuing operations in 2006. One customer accounted for 12.6% and 11.6% of total net sales from continuing operations in 2005 and 2004, respectively. Another customer accounted for 10.5% of total net sales from continuing operations during 2004. Although the Company has long-established relationships with many of its customers, it does not have any significant long-term contracts with them. A significant concentration of the Company's business activity is with department stores, mass merchandisers, specialty stores, home shopping networks and warehouse clubs whose ability to meet their obligations to the Company is dependent upon prevailing economic conditions within the retail industry. During 2006, 2005, and 2004, one supplier located in China accounted for approximately 37%, 32%, and 31% of the Company's product purchases from continuing operations. F-36 18. INCOME TAXES (Loss) before income taxes is as follows:
FISCAL YEARS ENDED ------------------------------------------ JULY 1, 2006 JULY 2, 2005 JULY 3, 2004 - -------------------------------------------------------------------------------------------------------- (IN THOUSANDS) Domestic $ (47,035) $ (58,807) $ (135,771) Foreign (18,770) (17,458) 4,576 - -------------------------------------------------------------------------------------------------------- Total $ (65,805) $ (76,265) $ (131,195) - --------------------------------------------------------------------------------------------------------
Federal, state and foreign taxes were approximately as follows:
FISCAL YEARS ENDED ------------------------------------------ JULY 1, 2006 JULY 2, 2005 JULY 3, 2004 - -------------------------------------------------------------------------------------------------------- (IN THOUSANDS) Current: Federal $ (4,716) $ 997 $ (1,757) State 179 195 Foreign 52 (688) 4,114 - -------------------------------------------------------------------------------------------------------- Total current (4,485) 309 2,552 Deferred: Federal 36,995 (16,623) (24,408) State 4,424 (444) (6,455) Foreign (705) (5,582) 877 - -------------------------------------------------------------------------------------------------------- Total deferred 40,714 (22,649) (29,986) - -------------------------------------------------------------------------------------------------------- Total $ 36,229 $ (22,340) $ (27,434) - --------------------------------------------------------------------------------------------------------
Deferred taxes based upon differences between the financial statement and tax bases of assets and liabilities and available tax carryforwards consisted of:
JULY 1, 2006 JULY 2, 2005 - ----------------------------------------------------------------------------------------- (IN THOUSANDS) DEFERRED TAX ASSETS Net operating loss carryforwards $ 28,388 $ 53,871 Inventory reserves and capitalization 3,736 3,610 Foreign tax credit carryforwards 16,065 6,947 Other comprehensive income 5,375 5,750 Allowance for doubtful accounts 299 1,083 Other deferred tax assets 20,629 4,486 Valuation allowance (65,789) (8,037) - ----------------------------------------------------------------------------------------- Total deferred tax assets 8,703 67,710 DEFERRED TAX LIABILITIES Fixed assets, goodwill and trade names 15,406 8,416 Other deferred tax liabilities 866 2,374 - ----------------------------------------------------------------------------------------- TOTAL DEFERRED TAX LIABILITIES 16,272 10,790 - ----------------------------------------------------------------------------------------- NET DEFERRED TAX ASSETS/(LIABILITIES) $ (7,569) $ 56,920 - -----------------------------------------------------------------------------------------
During fiscal 2006, the Company recorded a valuation allowance against its U.S. deferred income tax asset balance and increased its valuation allowance on certain foreign entity deferred tax balances. The F-37 need for the additional valuation allowance recorded in fiscal 2006 was based primarily as a result of reduced book and taxable earnings in fiscal 2006. This non-cash charge does not limit the Company's ability to realize future tax benefits associated with its net operating loss carryforwards to the extent that future profits result in taxable income during the carryforward period. At July 1, 2006, the Company had gross deferred tax assets related to domestic net operating loss carryforwards of approximately $18.0 million. A majority of these carryforwards will expire in fiscal 2025. The remainder will expire in various periods beginning in fiscal 2009 through fiscal 2024. In addition, the Company has unused foreign tax credits of $16.1 million which expire beginning in fiscal 2011. A valuation allowance has been provided related to these foreign tax credits as it is more likely than not that they may expire unused. A reconciliation of the statutory federal income tax rate to the effective rate is as follows:
FISCAL YEARS ENDED ------------------------------------------ JULY 1, 2006 JULY 2, 2005 JULY 3, 2004 - -------------------------------------------------------------------------------------------------------- Statutory federal income tax rate 35.0% 35.0% 35.0% Effective state tax rate 0.8 3.7 3.8 Earnings of foreign subsidiaries (3.6) 1.8 (2.3) Meals and entertainment 0.2 0.2 (0.3) Impairment of non-deductible goodwill 0.0 0.0 (4.3) Deferred tax asset valuation allowance (53.9) (0.7) (6.5) Actual/Deemed dividends from foreign subsidiaries (27.4) 0.0 0.0 Foreign exchange gain-CTA (6.9) 0.0 0.0 Prior year corrections 0.0 (4.4) 0.0 Deferred tax on foreign unremitted earnings 0.0 0.0 0.0 Other permanent differences 0.8 (6.3) (4.5) - -------------------------------------------------------------------------------------------------------- Effective income tax rate (55.0)% 29.3% 20.9% - --------------------------------------------------------------------------------------------------------
The Company has not provided for U.S. deferred income taxes or foreign withholding taxes on approximately $48.6 million of undistributed earnings of its non-U.S. subsidiaries as of July 1, 2006 as these earnings are intended to be permanently reinvested. On October 22, 2004, the American Jobs Creation Act (the "AJCA") was signed into law. The AJCA provides for a deduction of 85% of certain foreign earnings that are repatriated, as defined in the AJCA. The Company has completed its evaluation of the repatriation provision of the AJCA and does not intend to apply this provision to qualifying foreign earnings repatriations. The Company currently has options to employ lower tax alternatives for potential future foreign earnings repatriations, including accumulated foreign earnings that were previously taxed in the U.S., as well as the use of the Company's U.S. net operating loss carryforward. F-38 19. QUARTERLY RESULTS OF OPERATIONS (UNAUDITED) Unaudited quarterly financial data is as follows (amounts in thousands, except per share data).
FIRST SECOND THIRD FOURTH QUARTER QUARTER(2) QUARTER QUARTER - ----------------------------------------------------------------------------------------------------- 2006(3) Net sales $148,416 $ 230,388 $127,657 $129,499 Gross profit 29,497 64,403 25,849 24,602 Net income (loss) from continuing operations 113 (27,813) (19,064) (55,270) Income from discontinued operations, net of tax 1,735 -- -- -- Gain on sale of discontinued operations, net of tax 27,816 -- -- 4,516 Net income (loss) $ 29,664 $ (27,813) $(19,064) $(50,754) Net income (loss) per share: basic From continuing operations $ 0.01 $ (2.06) $ (1.40) $ (3.89) From discontinued operations 0.11 -- -- -- Gain on sale of discontinued operations 1.76 -- -- 0.32 Net income (loss) per share: basic(1) $ 1.88 $ (2.06) $ (1.40) $ (3.57) Net income (loss) per share: diluted From continuing operations $ 0.01 $ (2.06) $ (1.40) $ (3.89) From discontinued operations 0.11 -- -- -- Gain on sale of discontinued operations 1.71 -- -- 0.32 Net income (loss) per share: diluted $ 1.83 $ (2.06) $ (1.40) $ (3.57)
- --------------- (1) The previously reported weighted average common shares outstanding used in the calculation of basic earnings per share did not include the dilutive effect of the Company's convertible Series A Preferred Stock, as required under the "two-class" method. (2) The Company has historically experienced higher sales in the August through November months due to holiday sales, which primarily impact the second quarter. (3) Total quarterly earnings per common share (EPS) may not equal the annual amount because net income per common share is calculated independently for each quarter. Common stock equivalents can change on a quarter-to-quarter basis due to their dilutive impact on the independent quarterly EPS calculation.
FIRST SECOND THIRD FOURTH QUARTER QUARTER(2) QUARTER QUARTER - ----------------------------------------------------------------------------------------------------- 2005(3) Net sales(a) $204,684 $ 272,698 $153,159 $151,195 Gross profit(b) 53,763 77,743 31,393 24,575 Net loss from continuing operations(c) (4,445) (310) (23,417) (25,753) Income from discontinued operations, net of tax 1,258 3,067 887 (3,074) Net (loss) income $ (3,187) $ 2,757 $(22,530) $(28,827) Net (loss) income per share: basic(d) From continuing operations $ (0.39) $ (0.03) $ (2.06) $ (2.26) From discontinued operations 0.11 0.27 0.08 (0.27) Net (loss) income per share: basic $ (0.28) $ 0.24 $ (1.98) $ (2.53) Net (loss) income per share: diluted(d) From continuing operations $ (0.39) $ (0.03) $ (2.06) $ (2.26) From discontinued operations 0.11 0.27 0.08 (0.27) Net (loss) income per share: diluted $ (0.28) $ 0.24 $ (1.98) $ (2.53)
- --------------- (a) The amounts have been adjusted from previously reported amounts due to operations that were classified as discontinued operations as of the first quarter of 2006 (see Note 3). As a result, the Company has reduced net sales by $69,451, $104,278, $50,206 and $65,341 for the first, second, third and fourth quarters of fiscal year 2005, respectively. (b) The amounts have been adjusted from previously reported amounts due to operations that were classified as discontinued operations as of the first quarter of 2006 (see Note 3). As a result, the Company has reduced gross profit by $9,754, $21,813, $9,180 and $14,689 for the first, second, third and fourth quarters of fiscal year 2005, respectively. (c) The amounts have been adjusted from previously reported amounts due to operations that were classified as discontinued operations as of the first quarter of 2006 (see Note 3). As a result, the Company has increased/(decreased) net loss from continuing operations by $1,258, $3,067, $887 and $(3,074) for the first, second, third and fourth quarters of fiscal year 2005, respectively. F-39 (d) The amounts have been adjusted from previously reported amounts due to operations that were classified as discontinued operations as of the first quarter of 2006 (see Note 3). As a result, the Company has increased/(decreased) net loss per share, basic and diluted, from continuing operations by $0.11, $0.27, $0.08 and $(0.27) for the first, second, third and fourth quarters of fiscal year 2005, respectively. 20. RESTRUCTURING COSTS On May 11, 2004, in response to declining domestic sales volumes in 2004, the Company announced a U.S. restructuring plan to better align domestic operating costs with current sales levels. The Company completed the initial phase of this U.S. restructuring plan by reducing salaried headcount in the domestic operations by approximately 25.0% in the fourth quarter of fiscal 2004. Additionally, the Company made decisions to reduce the capacity of its warehousing and distribution network through the rationalization of existing facilities. In connection with the U.S. restructuring plan and subsequent valuation reviews in light of those decisions, the Company recorded certain pretax charges in the fourth quarter of fiscal 2004 totaling $33.9 million. Of the total costs recorded in fiscal 2004, $20.2 million was associated with the write-down of certain inventory identified for liquidation as part of the Company's decision to rationalize warehouse and distribution facilities and $3.8 million related to the write-off of tooling. These amounts were included in cost of goods sold in the Consolidated Statement of Operations. The total restructuring costs in fiscal 2004 also included a $1.7 million write-down associated with several marketing programs that were canceled or discontinued, which were included in selling, general and administrative expenses. Included within restructuring costs on the Consolidated Statement of Operations are $1.2 million in consulting and legal costs directly associated with the development and implementation of the U.S. restructuring plan and $0.5 million in termination and severance costs associated with the headcount reduction. Also in connection with the U.S. restructuring plan, the company recorded a $6.5 million intangible asset impairment charge for trade names associated with products that will no longer be sold. Such charge is included in impairment loss on goodwill and intangible assets in the Consolidated Statement of Operations. In fiscal 2005, the Company incurred $1.0 million related to the U.S. restructuring plan primarily for consulting and legal costs directly associated with the implementation of the plan, severance costs related to the domestic headcount reduction and other expenses related to the warehouse rationalization. In fiscal 2006, restructuring charges were $0.3 million for continued U.S. warehouse rationalization and severance costs, as well as $0.6 million for closure costs related to a Salton Europe subsidiary. 21. SUPPLEMENTAL CONSOLIDATING FINANCIAL INFORMATION The payment obligations of the Company under the senior secured credit facility, the second lien notes and the senior subordinated notes are guaranteed by certain of the Company's 100% owned domestic subsidiaries (Subsidiary Guarantors). Such guarantees are full, unconditional and joint and several. In December 2005, the Company entered into a facility agreement which is guaranteed by certain of the Company's foreign subsidiaries (see Note 8, "Senior Secured Credit Facility, Letters of Credit and Long-Term Debt"). As a result of the foreign borrowing facility, primarily all of the assets in these foreign subsidiaries are restricted as to the transfer of funds to the parent in the form of cash dividends, loans, or advances. The column titled "Foreign Borrowers and Guarantor Subsidiaries" represents the financial position results of operations and cash flows of these foreign subsidiaries. The following condensed consolidating financial information sets forth, on a combined basis, balance sheets, statements of income and statements of cash flows for Salton, Inc. (Parent), the Guarantor Subsidiaries under the domestic facility, the Guarantor Subsidiaries under the foreign facility and the Company's Non-Guarantor subsidiaries (Other Subsidiaries). Investments in subsidiaries are accounted for using the equity method for purposes of the consolidating presentation. The principal elimination entries eliminate investments in subsidiaries and intercompany transactions. F-40 (This page intentionally left blank) F-41 CONSOLIDATING BALANCE SHEET AS OF JULY 1, 2006 (IN THOUSANDS)
GUARANTOR PARENT SUBSIDIARIES ELIMINATIONS TOTAL - ----------------------------------------------------------------------------------------------------- ASSETS Current Assets: Cash $ 1 $ 4,437 $ -- $ 4,438 Compensating balances on deposit -- -- -- -- Accounts receivable, net of allowances 420 71,231 -- 71,651 Inventories 5,184 85,911 (14,124) 76,971 Prepaid expenses and other current assets 1,620 1,876 -- 3,496 Intercompany 120,860 (161,298) -- (40,438) Prepaid income taxes 1,332 -- -- 1,332 Deferred income taxes -- -- -- -- - ----------------------------------------------------------------------------------------------------- Total current assets 129,417 2,157 (14,124) 117,450 Property, Plant and Equipment, 4,553 7,573 -- 12,126 Investments in Subsidiaries 144,210 145,352 (289,562) -- Trade names 111,341 10,313 -- 121,654 Non-current deferred tax asset -- -- -- -- Other Assets, net 6,877 102 -- 6,979 - ----------------------------------------------------------------------------------------------------- Total Assets $396,398 $ 165,497 $ (303,686) $258,209 - ----------------------------------------------------------------------------------------------------- LIABILITIES AND STOCKHOLDERS' EQUITY Current Liabilities: Revolving line of credit and other current debt $ 10,971 $ 30 $ -- $ 11,001 Accounts payable 7,075 4,397 172 11,644 Accrued expenses 2,395 7,150 -- 9,545 Accrued interest 2,071 2,957 -- 5,028 Income taxes payable 720 -- -- 720 - ----------------------------------------------------------------------------------------------------- Total current liabilities 23,232 14,534 172 37,938 Non-current Deferred tax liability 11,391 -- -- 11,391 Senior Subordinated Notes due 2008, including an adjustment of $1,829 to the carrying value related to interest rate swap agreements 61,531 -- -- 61,531 Second Lien Notes 116,407 -- -- 116,407 Series C Preferred Stock 8,922 -- -- 8,922 Term loan and other notes payable -- 100,008 -- 100,008 Other long term liabilities 443 2,968 -- 3,411 - ----------------------------------------------------------------------------------------------------- Total liabilities 221,926 117,510 172 339,608 Convertible Preferred Stock 40,000 -- -- 40,000 Stockholders' Equity 134,472 47,987 (303,858) (121,399) - ----------------------------------------------------------------------------------------------------- Total Liabilities and Stockholders' Equity $396,398 $ 165,497 $ (303,686) $258,209 - -----------------------------------------------------------------------------------------------------
F-42
FOREIGN BORROWERS AND GUARANTOR OTHER TOTAL OTHER CONSOLIDATED CONSOLIDATED SUBSIDIARIES SUBSIDIARIES ELIMINATIONS SUBSIDIARIES ELIMINATIONS TOTALS - ----------------------------------------------------------------------------------------------------- $ 7,247 $ 6,418 $ -- $ 13,665 $ -- $ 18,103 -- 39,516 -- 39,516 -- 39,516 30,205 15,238 -- 45,443 -- 117,094 50,599 16,427 -- 67,026 -- 143,997 3,031 8,282 -- 11,313 -- 14,809 (12,164) 52,602 -- 40,438 -- -- -- -- -- -- -- 1,332 -- 195 5,238 5,433 -- 5,433 - ----------------------------------------------------------------------------------------------------- 78,918 138,678 5,238 222,834 -- 340,284 10,884 17,450 28,334 -- 40,460 -- 83,368 (83,368) -- -- -- 38,021 -- 38,021 -- 159,675 2,124 550 595 3,269 3,269 2,852 13 -- 2,865 -- 9,844 - ----------------------------------------------------------------------------------------------------- $ 132,799 $ 240,059 $ (77,535) $ 295,323 $ -- $ 553,532 - ----------------------------------------------------------------------------------------------------- $ 21,130 $ 387 $ -- 21,517 $ -- $ 32,518 3,501 76,163 -- 79,664 -- 91,308 14,875 3,661 -- 18,536 -- 28,081 -- -- -- -- 5,028 52 (70) -- (18) -- 702 - ----------------------------------------------------------------------------------------------------- 39,558 80,141 -- 119,699 -- 157,637 -- 1,858 3,022 4,880 16,271 -- -- -- -- -- 61,531 -- -- -- -- -- 116,407 -- -- -- -- -- 8,922 17,900 -- -- 17,900 -- 117,908 12,257 -- -- 12,257 -- 15,668 - ----------------------------------------------------------------------------------------------------- 69,715 81,999 3,022 154,736 -- 494,344 -- -- -- -- 40,000 63,084 158,060 (80,557) 140,587 -- 19,188 - ----------------------------------------------------------------------------------------------------- $ 132,799 $ 240,059 $ (77,535) $ 295,323 $ -- $ 553,532 - -----------------------------------------------------------------------------------------------------
F-43 CONSOLIDATING BALANCE SHEET AS OF JULY 2, 2005 (IN THOUSANDS)
GUARANTOR PARENT SUBSIDIARIES ELIMINATIONS TOTAL - ----------------------------------------------------------------------------------------------------- ASSETS Current Assets: Cash $ -- $ 127 $ -- $ 127 Compensating balances on deposit -- -- -- -- Accounts receivable, net of allowances 394 87,339 -- 87,733 Inventories 2,761 141,573 (22,873) 121,461 Assets held for sale -- 998 -- 998 Prepaid expenses and other current assets 4,431 2,699 -- 7,130 Intercompany 98,194 (62,146) (240) 35,808 Deferred income taxes (3,942) 5,344 -- 1,402 Current assets of discontinued operations -- -- -- -- - ----------------------------------------------------------------------------------------------------- Total current assets 101,838 175,934 (23,113) 254,659 Property, Plant and Equipment, Net of Accumulated Depreciation 7,075 10,538 -- 17,613 Investments in Subsidiaries 362,149 53,699 (415,848) -- Trade names 133,316 10,313 -- 143,629 Non-current deferred tax asset 5,455 -- 45,618 51,073 Other Assets, net 8,224 834 -- 9,058 Non-current assets of discontinued operations -- -- -- -- - ----------------------------------------------------------------------------------------------------- Total Assets $618,057 $ 251,318 $ (393,343) $476,032 - ----------------------------------------------------------------------------------------------------- LIABILITIES AND STOCKHOLDERS' EQUITY Current Liabilities: Revolving line of credit and other current debt $ -- $ 47,748 $ -- $ 47,748 Senior subordinated notes -- current 45,990 -- -- 45,990 Accounts payable 2,934 5,349 (68) 8,215 Accrued expenses 5,975 6,812 -- 12,787 Accrued interest 11,535 2,054 -- 13,589 Income taxes payable 3,936 -- -- 3,936 Current liabilities of discontinued operations -- -- -- -- - ----------------------------------------------------------------------------------------------------- Total current liabilities 70,370 61,963 (68) 132,265 Non-current Deferred tax liability (42,985) (2,633) 45,618 -- Senior subordinated notes due 2005 79,010 -- -- 79,010 Senior subordinated notes due 2008, including an adjustment of $7,082 to the carrying value related to interest rate swap agreements 156,387 -- -- 156,387 Term loan and other notes payable -- 100,050 -- 100,050 Other long term liabilities 1,995 3,588 -- 5,583 Non-current liabilities of discontinued operations 5,455 -- -- 5,455 - ----------------------------------------------------------------------------------------------------- Total liabilities 270,232 162,968 45,550 478,750 Minority Interest -- -- -- -- Convertible Preferred Stock 40,000 -- -- 40,000 Stockholders' Equity 307,825 88,350 (438,893) (42,718) - ----------------------------------------------------------------------------------------------------- Total Liabilities and Stockholders' Equity $618,057 $ 251,318 $ (393,343) $476,032 - -----------------------------------------------------------------------------------------------------
F-44
FOREIGN BORROWERS AND GUARANTOR OTHER TOTAL OTHER CONSOLIDATED CONSOLIDATED SUBSIDIARIES SUBSIDIARIES ELIMINATIONS SUBSIDIARIES ELIMINATIONS TOTALS - ------------------------------------------------------------------------------------------------ $ 2,019 $ 12,711 $ -- $ 14,730 $ -- $ 14,857 -- 34,355 -- 34,355 34,355 28,166 24,280 -- 52,446 -- 140,179 54,386 19,218 -- 73,604 -- 195,065 -- -- -- -- 998 2,525 6,393 -- 8,918 -- 16,048 (8,306) (27,502) -- (35,808) -- -- 4,312 (190) -- 4,122 5,524 -- 101,927 -- 101,927 101,927 - ------------------------------------------------------------------------------------------------ 83,102 171,192 -- 254,294 -- 508,953 11,328 21,286 -- 32,614 -- 50,227 16,135 79,742 (95,877) -- -- -- 36,412 -- -- 36,412 -- 180,041 3,150 507 -- 3,657 54,730 -- 2,497 -- 2,497 -- 11,555 7,737 -- 7,737 -- 7,737 - ------------------------------------------------------------------------------------------------ $ 150,127 $ 282,961 $ (95,877) $ 337,211 $ -- $ 813,243 - ------------------------------------------------------------------------------------------------ $ 21,886 $ 1,096 $ -- $ 22,982 $ -- $ 70,730 -- -- -- -- 45,990 8,434 69,605 -- 78,039 -- 86,254 17,292 4,723 -- 22,015 -- 34,802 -- -- -- -- 13,589 771 (332) -- 439 -- 4,375 -- 47,331 -- 47,331 -- 47,331 - ------------------------------------------------------------------------------------------------ 48,383 122,423 -- 170,806 -- 303,071 -- 3,334 -- 3,334 3,334 -- -- -- -- -- 79,010 -- -- -- -- -- 156,387 -- -- -- -- -- 100,050 14,688 12 -- 14,700 -- 20,283 -- 1,462 -- 1,462 -- 6,917 - ------------------------------------------------------------------------------------------------ 63,071 127,231 -- 190,302 -- 669,052 -- 24,263 24,263 -- 24,263 -- -- -- -- 40,000 87,056 131,467 (95,877) 122,646 -- 79,928 - ------------------------------------------------------------------------------------------------ $ 150,127 $ 282,961 $ (95,877) $ 337,211 $ -- $ 813,243 - ------------------------------------------------------------------------------------------------
F-45 CONSOLIDATING STATEMENT OF OPERATIONS FOR THE YEAR ENDED JULY 1, 2006 (IN THOUSANDS)
GUARANTOR PARENT SUBSIDIARIES ELIMINATIONS TOTAL - ------------------------------------------------------------------------------------------------------ Net Sales $157,838 $ 463,356 $ (249,633) $371,561 Cost of Goods Sold 125,731 403,120 (258,382) 270,469 Distribution Expenses -- 25,525 -- 25,525 - ------------------------------------------------------------------------------------------------------ Gross Profit 32,107 34,711 8,749 75,567 Selling, General and Administrative expenses 37,685 53,331 -- 91,016 Impairment loss on intangible assets 21,750 217 -- 21,967 Restructuring costs 37 281 -- 318 - ------------------------------------------------------------------------------------------------------ Operating (loss) Income (27,365) (19,118) 8,749 (37,734) Interest Expense, Net (7,535) 21,958 -- 14,423 Gain on early extinguishment of debt (21,721) -- -- (21,721) (Income) Loss from Subsidiaries 8,215 (52) (8,163) -- - ------------------------------------------------------------------------------------------------------ (Loss) Income Before Income Taxes (6,324) (41,024) 16,912 (30,436) Income Tax Expense (Benefit) 36,882 -- -- 36,882 - ------------------------------------------------------------------------------------------------------ Net (Loss) Income from Continuing Operations (43,206) (41,024) 16,912 (67,318) Income from Discontinued Operations, Net of tax -- -- -- -- Gain on Sale of Discontinued Operations, Net of tax (16,807) -- -- (16,807) - ------------------------------------------------------------------------------------------------------ Net (Loss) Income $(60,013) $ (41,024) $ 16,912 $(84,125) - ------------------------------------------------------------------------------------------------------
CONSOLIDATING STATEMENT OF OPERATIONS FOR THE YEAR ENDED JULY 2, 2005 (IN THOUSANDS)
GUARANTOR PARENT SUBSIDIARIES ELIMINATIONS TOTAL - ------------------------------------------------------------------------------------------------------ Net Sales $206,641 $ 581,259 $ (338,046) $449,854 Cost of Goods Sold 167,145 501,356 (343,514) 324,987 Distribution Expenses -- 34,855 -- 34,855 - ------------------------------------------------------------------------------------------------------ Gross Profit 39,496 45,048 5,468 90,012 Selling, General and Administrative expenses 51,847 48,854 -- 100,701 Impairment loss on intangible assets 2,953 258 -- 3,211 Restructuring costs 489 526 -- 1,015 - ------------------------------------------------------------------------------------------------------ Operating (loss) Income (15,793) (4,590) 5,468 (14,915) Interest Expense, Net 21,905 21,987 -- 43,892 (Income) Loss from Subsidiaries 30,118 (53) (30,065) -- - ------------------------------------------------------------------------------------------------------ (Loss) Income Before Income Taxes (67,816) (26,524) 35,533 (58,807) Income Tax Benefit (16,069) -- -- (16,069) - ------------------------------------------------------------------------------------------------------ Net (Loss) Income from Continuing Operations (51,747) (26,524) 35,533 (42,738) Income from Discontinued Operations, Net of tax (5,455) -- -- (5,455) - ------------------------------------------------------------------------------------------------------ Net (Loss) Income $(57,202) $ (26,524) $ 35,533 $(48,193) - ------------------------------------------------------------------------------------------------------
F-46
FOREIGN BORROWERS AND GUARANTOR OTHER TOTAL OTHER CONSOLIDATED CONSOLIDATED SUBSIDIARIES SUBSIDIARIES ELIMINATIONS SUBSIDIARIES ELIMINATIONS TOTALS - ------------------------------------------------------------------------------------------------ $ 186,952 $ 200,901 $ -- $ 387,853 $ (123,454) $ 635,960 121,935 172,376 -- 294,311 (117,250) 447,530 13,654 4,900 -- 18,554 -- 44,079 - ------------------------------------------------------------------------------------------------ 51,363 23,625 -- 74,988 (6,204) 144,351 54,616 30,881 1,766 87,263 (6,204) 172,075 -- -- -- -- -- 21,967 549 -- -- 549 -- 867 - ------------------------------------------------------------------------------------------------ (3,802) (7,256) (1,766) (12,824) -- (50,558) 937 (78,886) 83,843 5,894 16,651 36,968 -- -- -- -- -- (21,721) -- -- -- -- -- -- - ------------------------------------------------------------------------------------------------ (4,739) 71,630 (85,609) (18,718) (16,651) (65,805) 3,349 (1,190) (2,812) (653) -- 36,229 - ------------------------------------------------------------------------------------------------ (8,088) 72,820 (82,797) (18,065) (16,651) (102,034) -- 1,735 -- 1,735 -- 1,735 62,753 (13,614) -- 49,139 -- 32,332 - ------------------------------------------------------------------------------------------------ $ 54,665 $ 60,941 $ (82,797) $ 32,809 $ (16,651) $ (67,967) - ------------------------------------------------------------------------------------------------
FOREIGN BORROWERS AND GUARANTOR OTHER TOTAL OTHER CONSOLIDATED CONSOLIDATED SUBSIDIARIES SUBSIDIARIES ELIMINATIONS SUBSIDIARIES ELIMINATIONS TOTALS - ------------------------------------------------------------------------------------------------ $ 217,576 $ 362,186 $ -- $ 579,762 $ (247,880) $ 781,736 132,435 321,681 -- 454,116 (239,520) 539,583 15,021 4,803 -- 19,824 54,679 - ------------------------------------------------------------------------------------------------ 70,120 35,702 -- 105,822 (8,360) 187,474 74,790 40,679 -- 115,469 (8,360) 207,810 -- -- -- -- -- 3,211 -- -- -- -- -- 1,015 - ------------------------------------------------------------------------------------------------ (4,670) (4,977) -- (9,647) -- (24,562) (764) 500 8,075 7,811 -- 51,703 -- -- -- -- -- - ------------------------------------------------------------------------------------------------ (3,906) (5,477) (8,075) (17,458) -- (76,265) (4,964) (1,307) (6,271) -- (22,340) - ------------------------------------------------------------------------------------------------ 1,058 (4,170) (8,075) (11,187) -- (53,925) -- 7,593 -- 7,593 -- 2,138 - ------------------------------------------------------------------------------------------------ $ 1,058 $ 3,423 $ (8,075) $ (3,594) $ -- $ (51,787) - ------------------------------------------------------------------------------------------------
F-47 CONSOLIDATING STATEMENT OF OPERATIONS FOR THE YEAR ENDED JULY 3, 2004 (IN THOUSANDS)
GUARANTOR PARENT SUBSIDIARIES ELIMINATIONS TOTAL - ------------------------------------------------------------------------------------------------------ Net Sales $ 246,937 $ 682,125 $ (386,935) $ 542,127 Cost of Goods Sold 211,464 580,454 (398,270) 393,648 Distribution Expenses -- 45,339 -- 45,339 - ------------------------------------------------------------------------------------------------------ Gross Profit 35,473 56,332 11,335 103,140 Selling, General and Administrative expenses 58,053 109,234 -- 167,287 Impairment loss on intangible assets 5,883 24,791 -- 30,674 Restructuring costs 1,255 543 -- 1,798 - ------------------------------------------------------------------------------------------------------ Operating (loss) Income (29,718) (78,236) 11,335 (96,619) Interest Expense, Net 28,562 5,541 -- 34,103 Loss on early extinguishment of debt 5,049 -- 5,049 (Income) Loss from Subsidiaries 57,938 822 (58,760) -- - ------------------------------------------------------------------------------------------------------ (Loss) Income Before Income Taxes (121,267) (84,599) 70,095 (135,771) Income Tax (Benefit) Expense (13,938) (18,488) -- (32,426) - ------------------------------------------------------------------------------------------------------ Net (Loss) Income from Continuing Operations (107,329) (66,111) 70,095 (103,345) Income from Discontinued Operations, Net of tax -- -- -- -- - ------------------------------------------------------------------------------------------------------ Net (Loss) Income $(107,329) $ (66,111) $ 70,095 $(103,345) - ------------------------------------------------------------------------------------------------------
F-48
FOREIGN BORROWERS AND GUARANTOR OTHER TOTAL OTHER CONSOLIDATED CONSOLIDATED SUBSIDIARIES SUBSIDIARIES ELIMINATIONS SUBSIDIARIES ELIMINATIONS TOTALS - ------------------------------------------------------------------------------------------------ $ 216,796 $ 397,635 $ -- $ 614,431 $ (311,798) $ 844,760 132,078 343,447 -- 475,525 (291,948) 577,225 12,996 4,436 -- 17,432 62,771 - ------------------------------------------------------------------------------------------------ 71,722 49,752 -- 121,474 (19,850) 204,764 59,530 41,507 -- 101,037 (19,850) 248,474 13,108 (2,927) -- 10,181 40,855 -- -- -- -- -- 1,798 - ------------------------------------------------------------------------------------------------ (916) 11,172 -- 10,256 -- (86,363) 565 (563) 5,678 5,680 -- 39,783 -- -- -- -- -- 5,049 -- -- -- -- -- -- - ------------------------------------------------------------------------------------------------ (1,481) 11,735 (5,678) 4,576 -- (131,195) 2,403 2,589 -- 4,992 -- (27,434) - ------------------------------------------------------------------------------------------------ (3,884) 9,146 (5,678) (416) -- (103,761) -- 8,589 -- 8,589 -- 8,589 - ------------------------------------------------------------------------------------------------ $ (3,884) $ 17,735 $ (5,678) $ 8,173 $ -- $ (95,172) - ------------------------------------------------------------------------------------------------
F-49 CONSOLIDATING STATEMENT OF CASH FLOWS FOR YEAR ENDED JULY 1, 2006 (IN THOUSANDS)
GUARANTOR PARENT SUBSIDIARIES ELIMINATIONS TOTAL - --------------------------------------------------------------------------------------------------------------- CASH FLOWS FROM OPERATING ACTIVITIES: Net loss $(60,013) $ (41,024) $ 16,912 $ (84,125) Adjustments to reconcile net loss to net cash from operating activities: Imputed interest on note payable and other non-cash items (206) -- -- (206) Deferred income tax (benefit) provision 33,628 7,977 -- 41,605 Stock based compensation expense 522 -- -- 522 Depreciation and amortization 3,312 2,339 -- 5,651 Amortization of deferred financing costs 4,370 -- -- 4,370 Bad debt provision -- 1,022 -- 1,022 Gain on sale of discontinued operations 16,807 -- -- 16,807 (Gain) loss on disposal of property and equipment -- (564) -- (564) Inventory valuation adjustment -- 53 -- 53 Impairment loss on intangible assets 21,750 217 -- 21,967 Foreign currency gains and losses -- (59) -- (59) Gain-early settlement of debt (21,721) -- -- (21,721) Equity in income of unconsolidated affiliate/consolidated subsidiaries 8,216 (52) (8,164) -- Minority Interest, net of tax -- -- -- -- Changes in assets and liabilities, net of acquisitions: Accounts receivable (26) 15,144 -- 15,118 Inventories (2,423) 42,110 (8,748) 30,939 Prepaid expenses and other current assets 563 569 -- 1,132 Other non-current assets 91,600 (90,930) -- 670 Accounts payable 4,382 (955) -- 3,427 Income taxes payable (4,547) -- (4,547) Accrued expenses (33,680) 100,178 -- 66,498 - --------------------------------------------------------------------------------------------------------------- NET CASH FROM OPERATING ACTIVITIES 62,534 36,025 -- 98,559 - --------------------------------------------------------------------------------------------------------------- CASH FLOWS FROM INVESTING ACTIVITIES: Capital expenditures (611) (182) -- (793) Proceeds from sale of property and equipment -- 2,031 -- 2,031 Proceeds from sale of tabletop assets -- 14,195 14,195 Proceeds from sale of discontinued operations -- -- -- -- Acquisition of majority interest -- -- -- -- Additional payment for trade names (217) -- (217) Increase in compensating balances on deposit -- -- -- -- - --------------------------------------------------------------------------------------------------------------- NET CASH FROM INVESTING ACTIVITIES (828) 16,044 -- 15,216 - --------------------------------------------------------------------------------------------------------------- CASH FLOWS FROM FINANCING ACTIVITIES: Net proceeds (repayments) from revolving line of credit and other short term debt -- (47,551) -- (47,551) Proceeds from new credit agreement -- -- -- -- Repayment of terminated credit agreement -- -- -- -- Repayment of long-term debt (50,127) (208) (50,335) Costs associated with refinancing (11,753) -- -- (11,753) Intercompany dividend -- -- -- -- Dividend paid -- -- -- -- Common stock issued 175 -- -- 175 - --------------------------------------------------------------------------------------------------------------- NET CASH FROM FINANCING ACTIVITIES (61,705) (47,759) -- (109,464) - --------------------------------------------------------------------------------------------------------------- The effect of exchange rate changes on cash -- -- -- -- - --------------------------------------------------------------------------------------------------------------- Net (decrease)/increase in cash and cash equivalents 1 4,310 -- 4,311 Cash, beginning of year(1), including cash of discontinued operations of $35,934 -- 127 -- 127 - --------------------------------------------------------------------------------------------------------------- Cash, end of year $ 1 $ 4,437 $ -- $ 4,438 - ---------------------------------------------------------------------------------------------------------------
- --------------- (1) Amounts do not reconcile to face of balance sheet. F-50
FOREIGN BORROWERS AND GUARANTOR OTHER TOTAL OTHER CONSOLIDATED CONSOLIDATED SUBSIDIARIES SUBSIDIARIES ELIMINATIONS SUBSIDIARIES ELIMINATIONS TOTALS - ------------------------------------------------------------------------------------------------ $ 54,665 $ 60,941 $ (82,797) $ 32,809 $ (16,651) $ (67,967) -- -- -- 89 -- 89 -- (117) 4,513 (1,956) (2,811) (254) -- 41,351 -- -- -- -- -- 522 1,204 8,621 -- 9,825 -- 15,476 555 -- -- 555 -- 4,925 265 3,391 -- 3,656 -- 4,678 (62,753) 13,614 -- (49,139) -- (32,332) 137 (24) -- 113 -- (451) (838) 992 -- 154 -- 207 -- -- -- -- -- 21,967 (124) -- -- (124) -- (183) -- -- -- -- -- (21,721) -- -- -- -- -- 1,404 -- 1,404 -- 1,404 -- -- -- (602) (8,810) -- (9,412) -- 5,706 7,409 (19,422) -- (12,013) -- 18,926 (386) (3,407) -- (3,793) -- (2,661) (17) 91 1,765 1,839 2,509 (5,636) 15,289 -- 9,653 -- 13,080 (737) 1,905 -- 1,168 -- (3,379) (1,274) (75,114) -- (76,388) -- (9,890) - ------------------------------------------------------------------------------------------------ (3,619) (2,396) (83,843) (89,858) (16,651) (7,950) - ------------------------------------------------------------------------------------------------ (401) (4,708) -- (5,109) -- (5,902) -- 116 -- 116 -- 2,147 -- -- -- -- 14,195 80,935 (10,997) -- 69,938 -- 69,938 -- (4,525) -- (4,525) -- (4,525) -- -- -- -- -- (217) -- (4,867) -- (4,867) -- (4,867) - ------------------------------------------------------------------------------------------------ 80,534 (24,981) -- 55,553 -- 70,769 - ------------------------------------------------------------------------------------------------ 4,647 200 -- 4,847 -- (42,704) 48,870 -- -- 48,870 -- 48,870 (39,675) -- -- (39,675) -- (39,675) -- (140) -- (140) (50,475) (1,884) -- -- (1,884) (13,637) -- (16,651) -- (16,651) 16,651 -- (83,843) -- 83,843 -- -- -- -- -- -- -- -- 175 - ------------------------------------------------------------------------------------------------ (71,885) (16,591) 83,843 (4,633) 16,651 (97,446) - ------------------------------------------------------------------------------------------------ 198 1,741 1,939 -- 1,939 - ------------------------------------------------------------------------------------------------ 5,228 (42,227) -- (36,999) -- (32,688) 2,019 48,645 -- 50,664 -- 50,791 - ------------------------------------------------------------------------------------------------ $ 7,247 $ 6,418 $ -- $ 13,665 $ -- $ 18,103 - ------------------------------------------------------------------------------------------------
F-51 CONSOLIDATING STATEMENT OF CASH FLOWS FOR YEAR ENDED JULY 2, 2005 (IN THOUSANDS)
GUARANTOR PARENT SUBSIDIARIES ELIMINATIONS TOTAL - ---------------------------------------------------------------------------------------------------------- CASH FLOWS FROM OPERATING ACTIVITIES: Net (loss) income $(57,202) $ (26,524) $ 35,533 $(48,193) Adjustments to reconcile net (loss) income to net cash from operating activities: Imputed interest on note payable and other non-cash items (2,254) -- -- (2,254) Deferred income tax (benefit) provision (29,290) 17,720 -- (11,570) Depreciation and amortization 5,523 3,163 -- 8,686 Amortization of deferred financing costs 4,624 -- -- 4,624 Bad debt provision (recovery) provision -- (1,315) -- (1,315) (Gain) loss on disposal of property and equipment -- (91) -- (91) Inventory valuation adjustment -- 1,995 -- 1,995 Impairment loss on intangible assets 2,953 258 -- 3,211 Foreign currency gains and losses -- (32) -- (32) Gain on sale of investment -- -- -- -- Equity in income of unconsolidated affiliate/consolidated subsidiaries 30,118 (53) (30,065) -- Minority Interest, net of tax -- -- -- -- Changes in assets and liabilities, net of acquisitions: Accounts receivable (83) 10,924 -- 10,841 Inventories 2,372 21,621 (5,468) 18,525 Prepaid expenses and other current assets 2,722 (102) -- 2,620 Other non-current assets -- (564) -- (564) Accounts payable 12 3,828 -- 3,840 Income taxes payable 6,272 1,497 -- 7,769 Accrued expenses 38,419 (47,522) -- (9,103) - ---------------------------------------------------------------------------------------------------------- NET CASH FROM OPERATING ACTIVITIES 4,186 (15,197) -- (11,011) - ---------------------------------------------------------------------------------------------------------- CASH FLOWS FROM INVESTING ACTIVITIES: Capital expenditures (779) (610) -- (1,389) Proceeds from sale of property and equipment -- 938 -- 938 Increase in compensating balances on deposit -- -- -- -- - ---------------------------------------------------------------------------------------------------------- NET CASH FROM INVESTING ACTIVITIES (779) 328 -- (451) - ---------------------------------------------------------------------------------------------------------- CASH FLOWS FROM FINANCING ACTIVITIES: Net proceeds (repayments) from revolving line of credit and other short term debt -- 14,897 -- 14,897 Repayment of long-term debt -- (546) -- (546) Distributions to minority shareholders -- -- -- -- Costs associated with refinancing (2,598) -- -- (2,598) Additional payment for trade names (837) (258) -- (1,095) Dividend paid -- -- -- -- Common stock issued 27 -- -- 27 - ---------------------------------------------------------------------------------------------------------- NET CASH FROM FINANCING ACTIVITIES (3,408) 14,093 -- 10,685 - ---------------------------------------------------------------------------------------------------------- The effect of exchange rate changes on cash -- -- -- -- - ---------------------------------------------------------------------------------------------------------- Net increase in cash and cash equivalents (1) (776) -- (777) Cash, beginning of year(1), including cash of discontinued operations of $27,917 1 903 -- 904 - ---------------------------------------------------------------------------------------------------------- Cash, end of year(1), including cash of discontinued operations of $35,934 $ -- $ 127 $ -- $ 127 - ----------------------------------------------------------------------------------------------------------
- --------------- (1) Amounts do not reconcile to face of balance sheet. F-52
FOREIGN BORROWERS AND GUARANTOR OTHER TOTAL OTHER CONSOLIDATED CONSOLIDATED SUBSIDIARIES SUBSIDIARIES ELIMINATIONS SUBSIDIARIES ELIMINATIONS TOTALS - -------------------------------------------------------------------------------------------------- $ 1,058 $ 3,423 $ (8,075) $ (3,594) $ -- $ (51,787) -- 348 -- 348 -- (1,906) (5,357) (1,115) -- (6,472) -- (18,042) 1,192 10,036 -- 11,228 -- 19,914 -- -- -- -- -- 4,624 16 108 -- 124 -- (1,191) 150 160 -- 310 -- 219 1,539 (497) -- 1,042 -- 3,037 -- -- -- -- -- 3,211 -- -- -- -- -- (32) -- (861) -- (861) -- (861) -- -- -- -- -- -- -- 6,389 -- 6,389 -- 6,389 588 770 -- 1,358 -- 12,199 (11,663) 6,097 -- (5,566) -- 12,959 (450) (2,788) -- (3,238) -- (618) -- 253 -- 253 (311) (13,643) (6,072) -- (19,715) -- (15,875) (2,158) (2,019) -- (4,177) -- 3,592 12,431 3,862 -- 16,293 -- 7,190 - -------------------------------------------------------------------------------------------------- (16,297) 18,094 (8,075) (6,278) -- (17,289) - -------------------------------------------------------------------------------------------------- (4,251) (3,631) -- (7,882) -- (9,271) 14,999 1,224 -- 16,223 -- 17,161 -- (355) -- (355) -- (355) - -------------------------------------------------------------------------------------------------- 10,748 (2,762) -- 7,986 -- 7,535 - -------------------------------------------------------------------------------------------------- 11,660 1,229 -- 12,889 -- 27,786 -- (503) -- (503) -- (1,049) -- (2,296) -- (2,296) (2,296) -- -- -- -- -- (2,598) -- -- -- -- -- (1,095) (5,553) (2,522) 8,075 -- -- -- -- -- -- -- -- 27 - -------------------------------------------------------------------------------------------------- 6,107 (4,092) 8,075 10,090 -- 20,775 - -------------------------------------------------------------------------------------------------- (58) (3,389) -- (3,447) -- (3,447) - -------------------------------------------------------------------------------------------------- 500 7,851 -- 8,351 -- 7,574 1,518 40,795 -- 42,313 -- 43,217 - -------------------------------------------------------------------------------------------------- $ 2,018 $ 48,646 $ -- $ 50,664 $ -- $ 50,791 - --------------------------------------------------------------------------------------------------
F-53 CONSOLIDATING STATEMENT OF CASH FLOWS FOR YEAR ENDED JULY 3, 2004 (IN THOUSANDS)
GUARANTOR PARENT SUBSIDIARIES ELIMINATIONS TOTAL - ----------------------------------------------------------------------------------------------------------------- CASH FLOWS FROM OPERATING ACTIVITIES: Net (loss) income $(107,329) $ (66,111) $ 70,095 $(103,345) Adjustments to reconcile net income to net cash from operating activities: Imputed interest on note payable and other non-cash items (2,254) -- -- (2,254) Deferred income tax (benefit) provision (11,712) (18,749) -- (30,461) Depreciation and amortization 6,010 4,050 -- 10,060 Amortization of deferred financing costs 3,501 -- -- 3,501 Bad debt provision -- 2,239 -- 2,239 Loss on disposal of property and equipment 928 1,834 -- 2,762 Inventory valuation adjustment -- 20,532 -- 20,532 Impairment loss on intangible assets 5,883 24,791 -- 30,674 Foreign currency gains and losses -- 678 -- 678 Equity in income of unconsolidated affiliate/consolidated subsidiaries 57,939 821 (58,760) -- Minority Interest, net of tax -- -- -- -- Loss on early extinguishment of debt 4,469 580 -- 5,049 Changes in assets and liabilities, net of acquisitions: Accounts receivable (246) 28,067 -- 27,821 Inventories (3,025) 1,361 (11,335) (12,999) Prepaid expenses and other current assets (1,697) 1,120 -- (577) Decrease (increase) in other non-current assets -- -- -- -- Accounts payable 3,173 (3,609) -- (436) Income taxes payable 24,860 (11,990) -- 12,870 Accrued expenses 47,323 (40,489) -- 6,834 - ----------------------------------------------------------------------------------------------------------------- NET CASH FROM OPERATING ACTIVITIES 27,823 (54,875) -- (27,052) - ----------------------------------------------------------------------------------------------------------------- CASH FLOWS FROM INVESTING ACTIVITIES: Capital expenditures (2,412) (2,437) -- (4,849) Proceeds from sale of property and equipment -- 84 -- 84 Increase in compensating balances on deposit -- -- -- -- - ----------------------------------------------------------------------------------------------------------------- NET CASH FROM INVESTING ACTIVITIES (2,412) (2,353) -- (4,765) - ----------------------------------------------------------------------------------------------------------------- CASH FLOWS FROM FINANCING ACTIVITIES: Net proceeds (repayments) from revolving line of credit and other short term debt -- 50,609 -- 50,609 Repayment of terminated credit agreement -- (105,928) -- (105,928) Proceeds from amended and restated credit agreement -- 105,928 -- 105,928 Repayment of long-term debt -- (869) -- (869) Costs associated with refinancing (3,758) (580) -- (4,338) Additional payment for trade names (21,875) -- -- (21,875) Dividend paid -- -- -- -- Common stock issued 223 -- -- 223 - ----------------------------------------------------------------------------------------------------------------- NET CASH FROM FINANCING ACTIVITIES (25,410) 49,160 -- 23,750 - ----------------------------------------------------------------------------------------------------------------- The effect of exchange rate changes on cash -- -- -- -- - ----------------------------------------------------------------------------------------------------------------- Net increase (decrease) in cash and cash equivalents 1 (8,068) -- (8,067) Cash, beginning of year, including cash of discontinued operations of $4,143 0 8,972 -- 8,972 - ----------------------------------------------------------------------------------------------------------------- Cash, end of year, including cash of discontinued operations of $27,917 $ 1 $ 904 $ -- $ 905 - -----------------------------------------------------------------------------------------------------------------
F-54
FOREIGN BORROWERS AND GUARANTOR OTHER TOTAL OTHER CONSOLIDATED CONSOLIDATED SUBSIDIARIES SUBSIDIARIES ELIMINATIONS SUBSIDIARIES ELIMINATIONS TOTALS - -------------------------------------------------------------------------------------------------- $ (3,884) $ 17,735 $ (5,678) $ 8,173 $ -- $ (95,172) -- -- -- -- -- (2,254) (522) (301) -- (823) -- (31,284) 781 8,592 -- 9,373 -- 19,433 -- -- -- -- -- 3,501 -- 1,150 -- 1,150 -- 3,389 1,338 1,204 -- 2,542 -- 5,304 -- (340) -- (340) -- 20,192 13,108 (2,927) -- 10,181 -- 40,855 -- -- -- -- -- 678 -- -- -- -- -- -- -- 7,745 -- 7,745 -- 7,745 -- -- -- -- -- 5,049 -- (449) (3,432) -- (3,881) -- 23,940 (8,020) (24,052) -- (32,072) -- (45,071) (653) (3,155) -- (3,808) -- (4,385) -- 180 180 -- 180 13,428 41,856 -- 55,284 -- 54,848 989 3,810 -- 4,799 -- 17,669 (7,860) (527) -- (8,387) -- (1,553) - -------------------------------------------------------------------------------------------------- 8,256 47,538 (5,678) 50,116 -- 23,064 - -------------------------------------------------------------------------------------------------- (13,794) (14,465) -- (28,259) -- (33,108) 957 -- -- 957 -- 1,041 (16,600) -- (16,600) -- (16,600) - -------------------------------------------------------------------------------------------------- (12,837) (31,065) -- (43,902) -- (48,667) - -------------------------------------------------------------------------------------------------- 10,438 -- -- 10,438 -- 61,047 -- -- -- -- -- (105,928) -- -- -- -- -- 105,928 -- -- -- -- -- (869) -- -- -- -- -- (4,338) -- -- -- -- -- (21,875) (5,393) (286) 5,679 -- -- -- -- -- -- -- -- 223 - -------------------------------------------------------------------------------------------------- 5,045 (286) 5,679 10,438 -- 34,188 - -------------------------------------------------------------------------------------------------- 1,054 976 -- 2,030 -- 2,030 - -------------------------------------------------------------------------------------------------- 1,518 17,164 -- 18,682 -- 10,615 -- 23,630 -- 23,630 -- 32,602 - -------------------------------------------------------------------------------------------------- $ 1,518 $ 40,794 $ -- $ 42,312 $ -- $ 43,217 - --------------------------------------------------------------------------------------------------
F-55 22. SUBSEQUENT EVENTS On August 15, 2006, the Company entered into a ninth amendment to, and waiver under, the senior secured credit facility (the "Ninth Amendment"). The Ninth Amendment, among other things: (1) provides for an additional overadvance amount of $26.25 million; (2) eliminates the fixed charge coverage ratio and minimum EBITDA covenants through and including March 2007 and revises such covenants thereafter; (3) adds a monthly cash flow covenant through March 2007; (4) provides that the combined outstanding amount of the existing overadvance of up to $16.2 million plus the additional overadvance of up to $26.25 million must be reduced to a maximum of $23.0 million by the end of March 2007; (5) excludes from EBITDA up to $6 million of losses or sale of excess inventory between August 15, 2006 and December 31, 2006; (6) increases the interest rate by 50 basis points; and (7) extends to September 15, 2006 the date by which the Company must deliver an executed landlord waiver for a warehouse located in Redlands, California. As partial consideration for the Ninth Amendment, the Company issued a warrant to purchase 719,320 shares of common stock of the Company at an exercise price of $2.12 per share. The warrant may be exercised any time before the later of December 31, 2007 and the Stated Termination Date (as defined in the senior secured credit facility). The Company granted registration rights with respect to the shares issuable upon exercise of the warrant. On October 10, 2006, the Company entered into an amendment and restatement to the Europe Facility Agreement, which waives compliance with the fixed charge coverage ratio for the months of April and May 2006 and amends the definition of such covenant thereafter. F-56
EXHIBIT NUMBER DESCRIPTION OF DOCUMENT - ------- ----------------------- 3.1 Second Amended and Restated Certificate of Incorporation of Registrant, as amended. Incorporated by reference to the Registrant's Annual Report on Form 10-K for the fiscal year ended July 3, 2004. 3.2 Certificate of Designation for the Series A Convertible Preferred Stock of the Registrant. Incorporated by reference to the Registrant's Annual Report on Form 10-K for the fiscal year ended July 3, 2004. 3.3 Certificate of Amendment to Second Amended and Restated Certificate of Incorporation. Incorporated by reference to the Registrant's Annual Report on Form 10-K for the fiscal year ended July 3, 2004. 3.4 Certificate of Amendment to Second Amended and Restated Certificate of Incorporation. Incorporated by reference to the Registrant's Annual Report on Form 10-K for the fiscal year ended July 3, 2004. 3.5 Certificate of Designation of Series B Junior Participating Preferred Stock. Incorporated by reference to the Registrant's Annual Report on Form 10-K for the fiscal year ended July 3, 2004. 3.6 Certificate of Designation of Series C Preferred Stock. Incorporated by reference to the Registrant's Current on Form 8-K dated August 26, 2005. 3.7 By-laws of the Registrant. Incorporated by reference to the Registrant's Registration Statement on Form S-1 (Registration No. 33-42097). 4.1 Specimen Certificate for shares of Common Stock, $.01 par value, of the Registrant. Incorporated by reference to the Registrant's Registration Statement on Form S-1 (Registration No. 33-42097). 4.2 Form of Note for Registrant's 10 3/4% Senior Subordinated Notes. Incorporated by reference to the Registrant's Registration Statement on Form S-4 (Registration No. 333-70169). 4.3 Indenture dated December 16,1998 between Norwest Bank National Association, as Issuer, and the Registrant relating to the Registrant's 10 3/4% Senior Subordinated Notes. Incorporated by reference to the Registrant's Registration Statement on Form S-4 (Registration No. 333-70169). 4.4 Indenture, dated as of April 23, 2001, amount Salton, Inc., the Guarantors (as defined therein), and Wells Fargo Bank Minnesota, N.A., as trustee, relating to $250,000,000 in aggregate principal amount and maturity of 12 1/4% Senior Subordinated Notes due 2008. Incorporated by reference to the Quarterly Report on Form 10-Q for the fiscal quarter ended March 31, 2001. 4.5 Form of Note for Registrant's 12 1/4% Senior Subordinated Notes due April 15, 2008. Incorporated by reference to the Quarterly Report on Form 10-Q for the fiscal quarter ended March 31, 2001. 4.6 Rights Agreement dated as of June 28, 2004 between the registrant and UMB Bank, N.A., as Rights Agreement Incorporated by reference to the Registrant's Current Report on Form 8-K dated June 28, 2004. 4.7 Letter to Stockholders relating to the adoption of a stockholder rights plan with attachment. Incorporated by reference to the Registrant's Current on Form 8-K dated June 28, 2004. 4.8 Agreement of Resignation, Appointment and Acceptance dated June 27, 2005 by and among Salton, Inc., Wells Fargo Bank, National Association, successor by merger to Wells Fargo Bank Minnesota, National Association, formerly known as Norwest Bank Minnesota, National Association and SunTrust Bank, a national association. Incorporated by reference to the Registrant's Current on Form 8-K dated June 27, 2005. 4.9 Agreement of Resignation, Appointment and Acceptance dated June 27, 2005 by and among Salton, Inc., Wells Fargo Bank, National Association, successor by merger to Wells Fargo Bank Minnesota, National Association, formerly known as Norwest Bank Minnesota, National Association and SunTrust Bank, a national association. Incorporated by reference to the Registrant's Current on Form 8-K dated June 27, 2005.
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EXHIBIT NUMBER DESCRIPTION OF DOCUMENT - ------- ----------------------- 4.10 First Supplement to Indenture dated as of August 26, 2005 between Salton, Inc. and SunTrust Bank, as trustee, with respect to the 10 3/4% Senior Subordinated Notes due 2005. Incorporated by reference to the Registrant's Current on Form 8-K dated August 26, 2005. 4.11 First Supplement to Indenture dated as of August 26, 2005 between the Company and SunTrust Bank, as trustee, with respect to the 12 1/4% Senior Subordinated Notes due 2008. Incorporated by reference to the Registrant's Current on Form 8-K dated August 26, 2005. 10.1* Salton/Maxim Housewares, Inc. Stock Option Plan. Incorporated by reference to the Registrant's Registration Statement on form S-1 (Registration No. 33-42097). 10.2 Form of Sales Representative Agreement generally used by and between the Registrant and its sales representatives. Incorporated by reference to the Registrant's Registration Statement on Form S-1 (Registration No. 33-42097). 10.3* Salton/Maxim Housewares, Inc. 1995 Employee Stock Option Plan. Incorporated by reference to the Registrant's Quarterly Report on Form 10-Q for the fiscal quarter ended December 30, 1995. 10.4* Salton/Maxim Housewares, Inc. Non-Employee Directors Stock Option Plan. Incorporated by reference to the Registrant's Quarterly Report on Form 10-Q for the fiscal quarter ended December 30, 1995. 10.5 Stock Purchase Agreement dated July 15, 1998 by and among the Registrant and Centre Capital Investors III, L.P., Centre Capital Tax-Exempt Investors II, L.P., Centre Capital Offshore Investors, L.P., The State Board of Administration of Florida, Centre Parallel Management Partners, L.P. and Centre Partners Coinvestment, L.P. Incorporated by reference to the Registrant's Current Report on Form 8-K dated July 15, 1998. 10.6 Registration Rights Agreement dated July 15, 1998 by and among the Registrant and Centre Capital Investors II, L.P., Centre Capital Tax-Exempt Investors II, L.P., Centre Capital Offshore Investors II, L.P., The State Board of Administration of Florida, Centre Parallel Management Partners, L.P. and Centre Partners Coinvestment, L.P. Incorporated by reference to the Registrant's Current Report on Form 8-K dated July 28, 1998. 10.7* The Salton, Inc. 1998 Employee Stock Option Plan. Incorporated by reference to the Registrant's Definitive Proxy Statement on Schedule 14A filed on December 2, 1998. 10.8 Agreement effective as of July 1, 1999 between Salton and George Foreman. Incorporated by reference to the Registrant's, Current Report on Form 8-K dated December 9, 1999. 10.9 Agreement effective as July 1, 1999 between Salton and Sam Perlmutter. Incorporated by reference to the Registrant's, Current Report on Form 8-K dated December 9, 1999. 10.10 Agreement effective as of July 1, 1999 between Salton and Michael Srednick Incorporated by reference to the Registrant, Current Report on Form 8-K dated December 9, 1999. 10.11* The Salton, Inc. 1999 Employee Stock Option Plan. Incorporated by reference to the Registrant's Definitive Proxy Statement on Schedule 14A filed December 9, 1999. 10.12* Salton, Inc. 2001 Employee Stock Option Plan. Incorporated by reference to the Registrant's Annual Report on Form 10-K for the fiscal year ended June 30, 2001. 10.13* Salton, Inc. 2002 Stock Option Plan. Incorporated by reference to Quarterly Report on Form 10-Q for the fiscal quarter ended March 30, 2002. 10.14 License agreement between Westinghouse Electric Corporation and Salton, Inc. Incorporated by reference to the Registrant's Annual Report on Form 10-K for the fiscal year ended June 29, 2002 10.15* Employment Agreement effective as of January 1, 2003 between Salton, Inc. and David C. Sabin Incorporated by reference to the Registrant's Current Report on Form 8-K dated October 23, 2002
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EXHIBIT NUMBER DESCRIPTION OF DOCUMENT - ------- ----------------------- 10.16* Employment Agreement effective as of January 1, 2003 between Salton, Inc. and Leonhard Dreimann Incorporated by reference to the Registrant's Current Report on Form 8-K dated October 23, 2002 10.17* Employment Agreement effective as of January 1, 2003 between Salton, Inc. and William B. Rue Incorporated by reference to the Registrant's Current Report on Form 8-K dated October 23, 2002 10.18* Employment Agreement effective as of January 1, 2003 between Salton, Inc. and David M. Mulder Incorporated by reference to the Registrant's Current Report on Form 8-K dated October 23, 2002 10.19 Credit Agreement, dated as of May 9, 2003, among the lenders thereto, Wachovia Bank, National Association, as administrative agent and collateral agent and as a co-agent, Bank of America, N.A., as syndication agent and co-documentation agent and as a co-agent, Banc of America Securities LLC, as co-arranger and co-book runner and Wachovia Securities, Inc, as co-arranger and co-book runner, Bank One, N.A. and Fleet Capital Corporation each as co- documentation agents, Salton, Inc., each of Salton's subsidiaries listed on the signature pages thereto and each of Salton's other subsidiaries listed on the signature pages thereto as guarantors. Incorporated by reference to the Quarterly Report on Form 10-Q for the fiscal quarter ended March 29, 2003. 10.20 Agreement dated as of May 28, 2003, between Salton, Inc. and George Foreman. Incorporated by reference to the Current Report on Form 8-K dated May 29, 2003. 10.21 First Amendment to Credit Agreement dated as of February 4, 2004 by and among Salton, Inc., Toastmaster Inc., Salton Toastmaster Logistics LLC, each of Salton's Subsidiaries that are signatories thereto as Guarantors, the Lenders that are signatories thereto and Wachovia Bank, National Association in its capacity as Administrative Agent for the Lenders. Incorporated by reference to the Registrant's Current Report on Form 8-K, dated February 10, 2004. 10.22 Forbearance Agreement and Amendment dated as May 10, 2004 by and among Salton, Inc., Toastmaster Inc., Salton Toastmaster Logistics LLC, each of Salton's Subsidiaries that are signatories thereto as Guarantors, the Lenders that are signatories thereto and Wachovia Bank, National Association in its capacity as Administrative Agent for the Lenders. Incorporated by reference to the Form 8-K filed on May 11, 2004. 10.23 First Amendment to Forbearance Agreement dated as of June 10, 2004 by and among Salton, Inc., Toastmaster Inc., Salton Toastmaster Logistics LLC, each of Salton's Subsidiaries that are signatories thereto as Guarantors, the Lenders that are signatories thereto and Wachovia Bank, National Association in its capacity as Administrative Agent for the Lenders. Incorporated by reference to the Form 8-K filed on June 10, 2004. 10.24 Amended and Restated Credit Agreement dated as of June 15, 2004 among the financial institutions named therein, Wachovia Bank, as the Agent, and Silver Point Finance, LLC, as the Co-Agent, Syndication Agent, Documentation Agent, Arranger and Book Runner, and Salton, Inc, each of its subsidiaries that are signatories thereto as the Borrowers and each of its other subsidiaries that are signatories thereto as Guarantors. Incorporated by reference to the Form 8-K filed on June 15, 2004. 10.25 Second Amendment to Amended and Restated Credit Agreement dated as of May 11, 2005 by and among the Lenders that are signatories thereto, Wells Fargo Foothill, Inc., as administrative agent and collateral agent for the Lenders, Silver Point Finance, LLC, as the co-agent, syndication agent, documentation agent, arranger and book runner, Salton, Inc., a Delaware corporation, each of its subsidiaries that are signatories thereto as the Borrowers and each of its other subsidiaries that are signatories thereto as Guarantors. Incorporated by reference to the Form 10-Q for the fiscal quarter ended April 2, 2005.
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EXHIBIT NUMBER DESCRIPTION OF DOCUMENT - ------- ----------------------- 10.26 Support Agreement dated July 5, 2005 by and between Salton, Inc. and Angelo, Gordon & Co., L.P. Incorporated by reference to the Registrant's Current Report on Form 8-K dated July 5, 2005. 10.27 Third Amendment to, and Waiver under, Amended and Restated Credit Agreement dated as of July 8, 2005 by and among the Lenders, Wells Fargo Foothill, Inc., as administrative agent and collateral agent for the Lenders, Silver Point Finance, LLC, as co-agent, syndication agent, documentation agent, assigner and book runner, Salton, Inc., each of Salton's Subsidiaries identified on the signature pages thereof as Borrowers and each of Salton's Subsidiaries identified on the signature pages thereof as Guarantors. Incorporated by reference to the Registrant's Current Report on Form 8-K dated July 11, 2005. 10.28 Waiver Under Second Amendment to Amended and Restated Credit Agreement dated as of July 14, 2005 by and among the Lenders, Wells Fargo Foothill, Inc., as administrative agent and collateral agent for the lenders, Silver Point Finance, LLC, as co-agent, syndication agents documentation agent, assigner and book runner, Salton, Inc., each of Salton's Subsidiaries identified on the signature pages thereof as Borrowers and each of Salton's Subsidiaries identified on the signature pages thereof as Guarantors. Incorporated by reference to the Registrant's Current Report on Form 8-K dated July 19, 2005. 10.29 Amendment to Support Agreement dated August 1, 2005 among Salton, Inc. and certain beneficial owners of Salton 10 3/4% Senior Subordinated Notes due 2005 and 12 1/4% Senior Subordinated Notes due 2008. Incorporated by reference to the Registrant's Current Report on Form 8-K dated August 1, 2005. 10.30 Credit Agreement dated as of August 26, 2005 among the financial institutions named therein, as the lenders, The Bank of New York, as the agent, Salton, Inc. and each of its subsidiaries that are signatories thereto, as the borrowers, and each of its other subsidiaries that are signatories thereto, as guarantors. Incorporated by reference to the Registrant's Current on Form 8-K dated August 26, 2005. 10.31 Intercreditor Agreement dated as of August 26, 2005 by and between Silver Point Finance, LLC, Wells Fargo Foothill, Inc. and The Bank of New York. Incorporated by reference to the Registrant's Current on Form 8-K dated August 26, 2005. 10.32 Registration Rights Agreement dated as of August 26, 2005 between Salton, Inc. and Angelo, Gordon & Co., L.P. Incorporated by reference to the Registrant's Current on Form 8-K dated August 26, 2005. 10.33 Sale Agreement between Interactive Capital (Proprietary) Limited, in its own right and on behalf of each member of a consortium, and Salton, Inc., on behalf of Pifco Overseas Limited. Incorporated by reference to the Registrant's Current Report on Form 8-K dated August 29, 2005. 10.34* Amended and Restated Salton, Inc. Flexible Deferral Plan. Incorporated by reference to the Registrant's Current Report on Form 8-K dated September 8, 2005. 10.35 Asset Purchase Agreement dated as of September 15, 2005 among Salton, Inc., SAH Acquisition Corp. and Lifetime Brands, Inc. Incorporation by reference to the Registrant's Current Report on 8-K dated September 19, 2005. 10.36 Waiver and Consent under Amended and Restated Credit Agreement dated as of September 16, 2005 by and among the financial institutions identified on the signature pages thereof (the "Lenders"), Wells Fargo Foothill, Inc., as administrative agent and collateral agent for the Lenders, Silver Point Finance, LLC, as the co-agent, syndication agent, documentation agent, arranger and book runner, Salton, Inc., each of Salton's Subsidiaries identified on the signature pages thereof as Guarantors. Incorporated by reference to the Registrant's Current Report on 8-K dated September 23, 2005.
E-4
EXHIBIT NUMBER DESCRIPTION OF DOCUMENT - ------- ----------------------- 10.37 Waiver and Consent under Amended and Restated Credit Agreement dated as of September 22, 2005 by and among the financial institutions on the signature pages thereof (the "Lenders"), Wells Fargo Foothill, Inc., as administrative agent, syndication agent, documentation agent, arranger and book runner, Salton, Inc., each of Salton's Subsidiaries identified on the signature pages thereof as Borrowers and each of Salton's Subsidiaries identified on the signature pages thereof as Guarantors. Incorporated by reference to the Registrant's Current Report on 8-K dated September 19, 2005. 10.38 Fourth Amendment to, and Waiver Under, Amended and Restated Credit Agreement dated as of September 22, 2005 by and among the Lenders, Wells Fargo Foothill, Inc., as administrative agent, and collateral agent for the Lenders, Silver Point Finance, LLC, as co-agent, syndication agent, documentation agent, assigner and book runner, Salton, Inc., each of Salton's Subsidiaries identified on the signature pages thereof as Borrowers and each of Salton's Subsidiaries identified on the signature pages thereof as Guarantors. Incorporated by reference to the Registrant's Current Report on 8-K dated September 23, 2005. 10.39* Form of Stock Option Agreement. Incorporated by reference to the Registrants Annual Report on Form 8-K for the fiscal year ended July 2, 2005. 10.40* Summary of Non-employee Director Compensation. Incorporated by reference to the Registrants Annual Report on Form 8-K for the fiscal year ended July 2, 2005. 10.41 Fifth Amendment to Amended and Restated Credit Agreement dated as of October 7, 2005 by and among the Lenders, Wells Fargo Foothill, Inc., as administrative agent, and collateral agent for the Lenders, Silver Point Finance, LLC, as co-agent, syndication agent, documentation agent, arranger and book runner, Salton, Inc., each of Salton's Subsidiaries identified on the signature pages thereof as Borrowers and each of Salton's Subsidiaries identified on the signature pages thereof as Guarantors. Incorporated by reference to the Registrant's Current Report on Form 8-K dated October 7, 2005. 10.42 Sixth Amendment to Amendment to, and Waiver Under, Amended and Restated Credit Agreement dated as of November 9, 2005 by and among the Lenders, Wells Fargo Foothill, Inc., as administrative agent, and collateral agent for the Lenders, Silver Point Finance, LLC, as co-agent, syndication agent, documentation agent, arranger and book runner, Salton, Inc., each of Salton's Subsidiaries identified on the signature pages thereof as Borrowers and each of Salton's Subsidiaries identified on the signature pages thereof as Guarantors. Incorporated by reference to the Registrant's Current Report on Form 8-K dated November 9, 2005. 10.43 General Release and Separation Agreement dated as of December 5, 2005 by and between David M. Mulder and Salton, Inc. Incorporated by reference to the Registrant's Current Report on Form 8-K dated December 5, 2005. 10.44 Facility Agreement dated as of December 23, 2005 by and among Salton Holdings Limited, Salton Europe Limited, certain affiliates of Salton Holdings Limited, Burdale Financial Limited, as agent and security trustee, and the financial institutions party thereto as lenders. Incorporated by reference to the Registrant's Current Report on Form 8-K dated December 23, 2005. 10.45 Waiver and Consent Under Amended and Restated Credit Agreement dated as of December 20, 2005 by and among the Lenders, Wells Fargo Foothill, Inc., as administrative agent, and collateral agent for the Lenders, Silver Point Finance, LLC,as co-agent, syndication agent, documentation agent, arranger and book runner, Salton, Inc., each of Salton's subsidiaries identified on the signature pages thereof as Borrowers and each of Salton's Subsidiaries identified on the signature pages thereof as Guarantors. Incorporated by reference to the Registrant's Current Report on Form 8-K dated December 23, 2005.
E-5
EXHIBIT NUMBER DESCRIPTION OF DOCUMENT - ------- ----------------------- 10.46 Seventh Amendment to, and Waiver Under, Amended and Restated Credit Agreement dated as of February 8, 2006 by and among the Lenders, Wells Fargo Foothill, Inc., as administrative agent, and collateral agent for the Lenders, Silver Point Finance, LLC, as co-agent, syndication agent, documentation agent, arranger and book runner, Salton, Inc., each of Salton's Subsidiaries identified on the signature pages thereof as Borrowers and each of Salton's Subsidiaries identified on the signature pages thereof as Guarantors. Incorporated by reference to the Registrant's Current Report on Form 8-K dated February 8, 2006. 10.47 Form of Restricted Stock Agreement. Incorporated by reference to the Registrant's Current Report on Form 8-K dated April 26, 2006 10.48 Employment Agreement effective as of December 10, 2005 between Salton, Inc. and William Lutz. Incorporated by reference to the Registrant's Current Report on Form 8-K dated April 26, 2006 10.49 Eighth Amendment to, and Waiver Under, Amended and Restated Credit Agreement dated as of May 10, 2006 by and among the Lenders, Wells Fargo Foothill, Inc., as administrative agent, and collateral agent for the Lenders, Silver Point Finance, LLC, as co-agent, syndication agent, documentation agent, arranger and book runner, Salton, Inc., each of Salton's Subsidiaries identified on the signature pages thereof as Borrowers and each of Salton's Subsidiaries identified on the signature pages thereof as Guarantors. Incorporated by reference to the Registrant's Current Report on Form 8-K dated May 10, 2006. 10.50 Ninth Amendment to, and Waiver Under, Amended and Restated Credit Agreement dated as of August 15, 2006, we entered into a ninth amendment by and among the Lenders, Wells Fargo Foothill, Inc., as administrative agent, and collateral agent for the Lenders, Silver Point Finance, LLC, as co-agent, syndication agent, documentation agent, arranger and book runner, Salton, Inc., each of Salton's Subsidiaries identified on the signature pages thereof as Borrowers and each of Salton's Subsidiaries identified on the signature pages thereof as Guarantors. Incorporated by reference to the Registrant's Current Report on Form 8-K dated August 15, 2006. 10.51 Common Stock Purchase Warrant dated August 15, 2006 issued in favor of SPCP Group, LLC. Incorporated by reference to Registrant's Current Report on Form 8-K dated August 15, 2006. 10.52 Separation Agreement dated as of August 24, 2006 by and between David C. Sabin and Salton, Inc. Incorporated by reference to the Registrant's Current Report on Form 8-K dated August 24, 2006. 10.53 Amendment and Restatement dated as of October 10, 2006 to the Facility Agreement by and among Salton Holdings Limited, Salton Europe Limited, certain affiliates of Salton Holdings Limited, Burdale Financial Limited, as agent and security trustee, and the financial institutions party thereto as lenders. Incorporated by reference to the Registrant's Current Report on Form 8-K dated October 10, 2006. 10.54 Waiver and Consent Under Amended and Restated Credit Agreement dated as October 10, 2006 by and among the Lenders, Wells Fargo Foothill, Inc., as administrative agent, and collateral agent for the Lenders, Silver Point Finance, LLC, as co-agent, syndication agent, documentation agent, arranger and book runner, Salton, Inc., each of Salton's subsidiaries identified on the signature pages thereof as Borrowers and each of Salton's Subsidiaries identified on the signature pages thereof as Guarantors. Incorporated by reference to the Registrant's Current Report on Form 8-K dated October 10, 2006. 12(A) Computation of Ratio of Earnings to Fixed Charges 21.1 Subsidiaries of Salton, Inc. 23.1 Consent of Deloitte & Touche LLP 31.1 Certification by the Chief Executive Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
E-6
EXHIBIT NUMBER DESCRIPTION OF DOCUMENT - ------- ----------------------- 31.2 Certification by the Chief Financial Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 32.1 Certification by the Chief Executive Officer Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 32.2 Certification by the Chief Financial Officer Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
- --------------- * These exhibits are management contracts or compensatory plans or arrangements. E-7 EX-12.(A) 2 c08712exv12wxay.txt COMPUTATION OF RATIO OF EARNINGS TO FIXED CHARGES The following pages contain the Financial Statement Schedules as specified by 12(a) of Part IV of Form 10-K. EXHIBIT 12(a) COMPUTATION OF RATIO OF EARNINGS TO FIXED CHARGES SALTON, INC.
YEAR ENDED --------------------------------------------------- 2006 2005 2004 2003 2002 - ------------------------------------------------------------------------------------------------------ (THOUSANDS, EXCEPT RATIOS) Fixed Charges Interest and amortization of debt issuance costs on all indebtedness $ 36,968 $ 51,703 $ 39,783 $40,109 $43,357 Add interest element implicit in rentals 2,959 3,296 3,443 3,500 3,040 - ------------------------------------------------------------------------------------------------------ Total fixed charges $ 39,927 $ 54,999 $ 43,226 $43,609 $46,397 (Loss) Income (Loss) Income from continuing operations before income taxes $(65,805) $(76,265) $(131,195) $10,071 $44,541 Add fixed charges 39,927 54,999 43,226 43,609 46,397 - ------------------------------------------------------------------------------------------------------ (Loss) Income from continuing operations before fixed charges and income taxes $(25,878) $(21,266) $ (87,969) $53,680 $90,938 - ------------------------------------------------------------------------------------------------------ Ratio of earnings to fixed charges (0.65) (0.39) (2.04) 1.23 1.96
EX-21.1 3 c08712exv21w1.txt SUBSIDIARIES . . . EXHIBIT 21.1 SUBSIDIARIES OF SALTON, INC.
NAME OF SUBSIDIARY JURISDICTION OF ORGANIZATION - ------------------------------------ ----------------------------- Toastmaster, Inc. Missouri Salton Europe PLC United Kingdom Salton UK United Kingdom Salton/Toastmaster Logistics LLC Delaware Salton Hong Kong Ltd. Hong Kong Salton International CV Netherlands Salton S.a.r.l. Luxembourg Salton Australia Pty Ltd. Australia Icebox LLC Illinois
EX-23.1 4 c08712exv23w1.txt CONSENT OF DELOITTE & TOUCHE LLP CONSENT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM We consent to the incorporation by reference in Registration Statement Nos. 333-72903 and 333-93893 on Form S-8 and Registration Statement No. 333-21692 on Form S-3 of Salton, Inc. of our report dated October 13, 2006 relating to the financial statements of Salton, Inc., appearing in the Annual Report on Form 10-K of Salton, Inc. for the year ended July 1, 2006. /s/Deloitte & Touche LLP Chicago, Illinois October 13, 2006 EX-31.1 5 c08712exv31w1.txt CERTIFICATION OF CEO PURSUANT TO SECTION 302 EXHIBIT 31.1 CERTIFICATION BY THE CHIEF EXECUTIVE OFFICER PURSUANT TO SECTION 302 OF THE SARBANES-OXLEY ACT OF 2002 I, Leonhard Dreimann, certify that: 1. I have reviewed this annual report on Form 10-K of Salton, Inc.; 2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report; 3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report; 4. The registrant's other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have: a) designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared; b) designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles; c) evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and d) disclosed in this report any change in the registrant's internal control over financial reporting that occurred during the registrant's most recent fiscal quarter (the registrant's fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant's internal control over financial reporting; and 5. The registrant's other certifying officers and I have disclosed, based on our most recent evaluation of the internal control over financial reporting, to the registrant's auditors and the audit committee of registrant's board of directors (or persons performing the equivalent functions): a) all significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant's ability to record, process, summarize and report financial information; and b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal control over financial reporting. Date October 16, 2006 By: /s/ LEONHARD DREIMANN ------------------------------------ Leonhard Dreimann Chief Executive Officer EX-31.2 6 c08712exv31w2.txt CERTIFICATION OF CFO PURSUANT TO SECTION 302 EXHIBIT 31.2 CERTIFICATION BY THE CHIEF FINANCIAL OFFICER PURSUANT TO SECTION 302 OF THE SARBANES-OXLEY ACT OF 2002 I, William M. Lutz, also certify that: 1. I have reviewed this annual report on Form 10-K of Salton, Inc.: 2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report; 3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report; 4. The registrant's other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have: a) designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared; b) designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles; c) evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and d) disclosed in this report any change in the registrant's internal control over financial reporting that occurred during the registrant's most recent fiscal quarter (the registrant's fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant's internal control over financial reporting; and 5. The registrant's other certifying officers and I have disclosed, based on our most recent evaluation of the internal control over financial reporting, to the registrant's auditors and the audit committee of registrant's board of directors (or persons performing the equivalent functions): a) all significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant's ability to record, process, summarize and report financial information; and b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal control over financial reporting. Date: October 16, 2006 By: /s/ William M. Lutz ------------------------------ William M. Lutz Chief Financial Officer EX-32.1 7 c08712exv32w1.txt CERTIFICATION OF CEO PURSUANT TO SECTION 906 EXHIBIT 32.1 CERTIFICATION BY THE CHIEF EXECUTIVE OFFICER PURSUANT TO 18 U. S. C. SECTION 1350, AS ADOPTED PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002 Pursuant to 18 U. S. C. Section 1350, I, Leonhard Dreimann, hereby certify that, to the best of my knowledge, the Annual Report of Salton, Inc. on Form 10-K for the fiscal year ended July 1, 2006 (the Report) fully complies with the requirements of Section 13(a) or Section 15(d) of the Securities Exchange Act of 1934, and that the information contained in that Report fairly presents, in all material respects, the financial condition and results of operations of Salton, Inc. By: /s/ Leonhard Dreimann -------------------------- Leonhard Dreimann Chief Executive Officer October 16, 2006 This certification accompanies this Report on Form 10-K pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 and shall not, except to the extent required by such Act, be deemed filed by the Company for purposes of Section 18 of the Securities Exchange Act of 1934, as amended (the Exchange Act). Such certification will not be deemed to be incorporated by reference into any filing under the Securities Act of 1933, as amended, or the Exchange Act, except to the extent that the Company specifically incorporates it by reference. A signed original of this written statement required by Section 906 has been provided to Salton, Inc. and will be retained by Salton, Inc. and furnished to the Securities and Exchange Commission or its staff upon request. EX-32.2 8 c08712exv32w2.txt CERTIFICATION OF CFO PURSUANT TO SECTION 906 EXHIBIT 32.2 CERTIFICATION BY THE CHIEF FINANCIAL OFFICER PURSUANT TO 18 U. S. C. SECTION 1350, AS ADOPTED PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002 Pursuant to 18 U. S. C. Section 1350, I, William M. Lutz, hereby certify that, to the best of my knowledge, the Fiscal yearly Report of Salton, Inc. on Form 10-K for the fiscal year ended July 1, 2006 (the Report) fully complies with the requirements of Section 13(a) or Section 15(d) of the Securities Exchange Act of 1934, and that the information contained in that Report fairly presents, in all material respects, the financial condition and results of operations of Salton, Inc. By: /s/ William M. Lutz -------------------------- William M. Lutz Chief Financial Officer October 16, 2006 This certification accompanies this Report on Form 10-K pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 and shall not, except to the extent required by such Act, be deemed filed by the Company for purposes of Section 18 of the Securities Exchange Act of 1934, as amended (the Exchange Act). Such certification will not be deemed to be incorporated by reference into any filing under the Securities Act of 1933, as amended, or the Exchange Act, except to the extent that the Company specifically incorporates it by reference. A signed original of this written statement required by Section 906 has been provided to Salton, Inc. and will be retained by Salton, Inc. and furnished to the Securities and Exchange Commission or its staff upon request. -----END PRIVACY-ENHANCED MESSAGE-----