10-K405 1 natc-10k.txt SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-K (MARK ONE) [X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE FISCAL YEAR ENDED DECEMBER 31, 2001 OR [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE TRANSITION PERIOD FROM _______________ TO _______________. COMMISSION FILE NUMBER 333-31931 NORTH ATLANTIC TRADING COMPANY, INC. ------------------------------------ (Exact name of registrant as specified in its charter) DELAWARE 13-3961898 ------------------------------ ------------------ (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No.) 257 PARK AVENUE SOUTH, NEW YORK, NEW YORK 10010-7304 ---------------------------------------------------- (Address of principal executive offices) (Zip Code) Registrant's telephone number, including area code: (212) 253-8185 Securities registered pursuant to Section 12(b) of the Act: None Securities registered pursuant to Section 12(g) of the Act: None Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes [X] No [ ]. Indicate 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 materials or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. [X] As of February 28, 2002, the only class of voting or non-voting common equity issued and outstanding is the Registrant's Voting Common Stock, par value $.01 per share, 100% of which is owned by 43 holders of record, 35 of whom are affiliates or employees of the Registrant. There is no trading market for the Voting Common Stock. As of February 28, 2002, 528,241 shares of the Registrant's Voting Common Stock, par value $.01 per share, and no shares of the Registrant's Non-Voting Common Stock, par value $.01 per share, were outstanding. NY2:\1139832\01\_F$001!.DOC\64980.0003 North Atlantic Trading Company, Inc. 2001 Form 10-K Annual Report TABLE OF CONTENTS
PAGE ---- PART I 3 Item 1. Business..........................................................................................3 -------- Item 2. Properties.......................................................................................13 ---------- Item 3. Legal Proceedings................................................................................14 ----------------- Item 4. Submission of Matters to a Vote of Security Holders..............................................20 --------------------------------------------------- PART II 20 Item 5. Market for Registrant's Common Stock and Related Stockholder Matters.............................20 -------------------------------------------------------------------- Item 6. Selected Financial Data..........................................................................21 ----------------------- Consolidated Selected Financial Data 21 Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations............23 ------------------------------------------------------------------------------------- Item 7A. Quantitative and Qualitative Disclosures about Market Risk.......................................30 ---------------------------------------------------------- Item 8. Financial Statements and Supplementary Data......................................................31 ------------------------------------------- Item 9. Changes in and Disagreements With Accountants on Accounting and Financial Disclosure.............31 ------------------------------------------------------------------------------------ PART III 31 Item 10. Directors and Executive Officers of the Registrant...............................................31 -------------------------------------------------- Name 31 Item 11. Executive Compensation...........................................................................33 ---------------------- STOCK OPTIONS 34 EMPLOYMENT AGREEMENTS 34 Item 12. Security Ownership of Certain Beneficial Owners and Management...................................40 -------------------------------------------------------------- Item 13. Certain Relationships and Related Transactions...................................................43 ---------------------------------------------- PART IV 44 Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K.................................44 ---------------------------------------------------------------- INDEX TO FINANCIAL STATEMENTS..............................................................................44 INDEX TO EXHIBITS 45 SIGNATURES 52
PART I Item 1. Business OVERVIEW North Atlantic Trading Company, Inc. (the "Company") is a holding company, which is organized under the laws of the State of Delaware. The Company has two significant wholly owned subsidiaries: National Tobacco Company, L.P. ("National Tobacco") and North Atlantic Operating Company, Inc. ("NAOC"). National Tobacco is the third largest manufacturer and marketer of loose leaf chewing tobacco in the United States, selling its products under the brand names BEECH-NUT REGULAR, BEECH-NUT Wintergreen, TROPHY, HAVANA BLOSSOM and DURANGO. NAOC is the largest importer and distributor in the United States of premium cigarette papers and related products, which are sold under the ZIG-ZAG brand name pursuant to an exclusive long-term distribution agreement with Bollore, S.A. ("Bollore"). NAOC also contracts for the manufacture of and distributes Make-Your-Own ("MYO") smoking tobaccos and related products under the ZIG-ZAG brand name, pursuant to its trademarks. EVOLUTION OF THE COMPANY The Company was formed in 1997 to facilitate a corporate reorganization and related financing in connection with the simultaneous acquisition of NATC Holdings USA, Inc. ("NATC") and its ZIG-ZAG business (the "Acquisition"). Prior to the Acquisition, National Tobacco and its corporate general partner, National Tobacco Finance Corporation ("NTFC"), were wholly owned subsidiaries of NTC Holding, LLC, a Delaware limited liability company ("LLC"). All of the outstanding interests in LLC, together with certain subordinated debt obligations, were acquired by the Company in connection with the Acquisition. LLC transferred all of its assets to the Company, including the limited and general partnership interests in National Tobacco, and was subsequently dissolved. In 1988, Thomas F. Helms, Jr., Chairman and Chief Executive Officer, and an investor group led by Lehman Brothers, formed National Tobacco to acquire the smokeless tobacco division of Lorillard, which had introduced the popular BEECH-NUT brand in 1897. Together with the management team he assembled in connection with this initial buyout, Mr. Helms participated in two subsequent leveraged buyouts prior to 1997, each of which increased the percentage of management ownership. Upon consummation of the Acquisition, NATC and its operating subsidiary were merged into NAOC. NATC was originally formed by an investor group to acquire certain assets from UST, Inc. now USST, Inc. ("USST") in March 1993, including, among other rights, the exclusive rights to market and distribute ZIG-ZAG premium cigarette papers in the United States, Canada and certain other international markets. In 1938, UST obtained the North American distribution rights for the ZIG-ZAG brands, which had been originally introduced in France in 1869, from Bollore, a major French industrial concern. The Company's principal executive offices are located in New York, New York at 257 Park Avenue South, 7th Floor, New York, New York 10010, and its telephone number is (212) 253-8185. BUSINESS STRATEGY The Company's current business strategy, whether through internal growth or through acquisitions, is (i) to continue to maximize the sales, marketing and distribution synergies of its National Tobacco and NAOC subsidiaries; (ii) to capitalize on the strong brand-name identities and 3 attributes of its products with a focus on product linkages and extensions; and (iii) to increase operating efficiencies of its subsidiaries. INDUSTRY AND MARKETS The Company competes in two distinct markets: (1) the Smokeless Tobacco market and (2) the MYO cigarette market. The Company believes that both the Smokeless Tobacco market, which includes the loose leaf chewing tobacco segment, and the MYO cigarette market, which is comprised of the premium cigarette papers sector and the rapidly emerging MYO smoking tobaccos and related products sector, are each characterized by non-cyclical demand, relative brand loyalty, meaningful barriers to entry, minimal capital expenditure requirements, relatively high profit margins, generally stable wholesale prices and the ability to generate significant and consistent free cash flows. Smokeless Tobacco Smokeless tobacco products, including chewing tobacco, have a long, established tradition of use in the United States dating back to colonial times. Loose leaf chewing tobacco has generally been most popular in the Southeast, Southwest and rural Northeast and North Central regions of the United States. An estimated 7 million Americans are regular users of smokeless tobacco products, according to the Smokeless Tobacco Council. The smokeless tobacco industry is comprised of the five product categories listed below. The Company believes that many consumers of smokeless tobacco regularly use products in more than one of the following categories. In addition to the Company, other major manufacturers and marketers in the smokeless tobacco industry include US Smokeless Tobacco Co., Pinkerton Tobacco Co., Conwood Corporation and Swisher International Group Inc. The Company currently offers only loose leaf chewing tobacco products; whereas, most other competitors offer more than a single smokeless category. o Moist snuff is cured, aged, flavored and finely ground tobacco packaged in round fiber or plastic cans. o Loose leaf chewing tobacco is typically made from air-cured leaf tobacco, using both domestic and imported tobaccos, aged, flavored and packed in foil pouches. o Plug chewing tobacco is made from air-cured leaf tobacco, heavily flavored and pressed into small bricks or blocks. o Twist chewing tobacco is made of dark, air-cured leaf tobacco, which is twisted into strands that are dried and packaged like a dry, pliable rope. o Dry snuff is a powdered tobacco product, which is sometimes flavored and is packaged in a variety of containers. According to information provided by the Smokeless Tobacco Council, manufacturers' sales for the smokeless tobacco industry were $1.10 billion in 1990 and $2.03 billion in 2000, representing a compounded annual growth rate of 5.7%. This increase is primarily related to the increase in manufacturers' sales of moist snuff which have grown from $706 million in 1990 to $1.66 billion in 2000, representing a compounded annual sales growth rate of 8.1% and an increase in volume from 42.5 million pounds in 1990 to 59.9 million pounds in 2000, representing a compounded annual volume growth rate of 3.2%. Manufacturers' sales of other smokeless tobacco products were $334 million in 1990 and $318 4 million in 2000, representing a compounded annual sales rate of decline of 0.4%. During the same period, the volume of such other smokeless tobacco products declined from 66.9 million pounds to 46.5 million pounds, a compounded annual volume rate of decline of 3.3%. Loose leaf chewing tobacco declined from 62 million pounds to 45 million pounds during this period, a compounded annual volume rate of decline of 2.9%. Loose leaf chewing tobacco products are typically sold through the following retail distribution channels: mass merchandisers, convenience stores, discount tobacco stores, food stores, chain and independent drug stores. Discount tobacco retailers are becoming an increasingly important distribution channel for all tobacco products, including loose leaf chewing tobacco, with their volume growing to approximately 20% of all tobacco sales in 2000. Certain retailers purchase loose leaf chewing tobacco direct from manufacturers, although most purchase through wholesale distributors. MYO Cigarettes Although rapidly emerging, the MYO cigarette market remains a minor component of the overall United States cigarette industry. If viewed in total as a part of that industry, sales of MYO smoking tobacco and related products would represent an estimated market share of 1.3% in 2001. In 2001, the United States cigarette industry sold approximately 425 billion cigarettes, which were consumed by approximately 24% of the adult population. The MYO products are typically sold through the following retail distribution channels: convenience stores, mass merchandisers, discount tobacco stores, food stores and chain and independent drug stores. Certain retailers purchase MYO products direct from manufacturers, although most purchase through wholesale distributors. PRODUCTS Currently, the Company manufactures and markets loose leaf chewing tobacco and imports and distributes premium cigarette papers and related products and contract manufactures and markets MYO smoking tobaccos and related products. Loose Leaf Chewing Tobacco Loose leaf chewing tobacco products can be broadly characterized as either full-flavored or mild. According to A.C. Nielsen, in 2001 full-flavored products accounted for approximately 45% of the loose leaf volume and mild flavored products comprised an estimated 55%. Loose leaf chewing tobacco is made from aged, air-cured tobacco, which is processed and flavored and then packaged in foil pouches. The BEECH-NUT brands are available in two flavors: Regular and Wintergreen. BEECH-NUT REGULAR is a full-flavored product, which is ranked second in market share in the full-flavored loose leaf chewing tobacco category, and third overall. BEECH-NUT WINTERGREEN was introduced by Lorillard in 1979 and has the largest market share of any flavored loose leaf brand. National Tobacco introduced its TROPHY brand into the mild product category in 1992. In addition to the BEECH-NUT brands and TROPHY, National Tobacco currently produces a regional brand, HAVANA BLOSSOM, sold primarily in West Virginia, Pennsylvania and Ohio and a value brand, DURANGO, which was introduced in March 1998. Premium Cigarette Papers and MYO Smoking Tobaccos and Related Products Although premium cigarette papers are sold in a variety of different widths and styles, the Company's primary styles are its standard width ZIG-ZAG White, ZIG-ZAG 1 1/4 width French Orange and ZIG-ZAG Kutcorners, which is 5 designed for easier hand-rolling. Other paper products sold under the ZIG-ZAG name are 1 1/2 sized cigarette papers and a ZIG-ZAG waterproof paper that is sold in Canada. MYO smoking tobacco products include ZIG-ZAG Gold Standard and Classic American Blend tobaccos. MYO related products include ZIG-ZAG cigarette tubes and ZIG-ZAG cigarette rolling and injector machines. SALES AND MARKETING Currently through its National Tobacco subsidiary, the Company has an 88 person nationwide sales organization. National Tobacco and NAOC operate under a Sales Representation Agreement, pursuant to which National Tobacco also markets NAOC's products. Historically, NAOC's sales efforts have been focused on wholesalers in the large chain convenience store, drug store and mass merchandising channels without calling on retail outlets; whereas, National Tobacco's sales efforts are focused on both wholesalers and retail merchants in these channels as well as the food store and discount tobacco store channels. Subsequent to the Acquisition, the Company has expanded the sales of its Smokeless Tobacco and MYO products into geographical markets and retail channels where they previously had been underdeveloped. National Tobacco's loose leaf chewing tobacco has historically been distributed through approximately 1,300 wholesale tobacco and food distributors. In 2001, BEECH-NUT REGULAR, TROPHY AND DURANGO represented 59.7%, 24.3% and 10.7%, respectively, of National Tobacco's total sales. At the retail level, National Tobacco's loose leaf chewing tobacco products are promoted through in-store volume and price-discount programs and the use of innovative, high visibility point-of-purchase floor and shelf displays, banners and posters. National Tobacco has not been reliant upon nor does it conduct any advertising in the consumer media. NAOC's premium cigarette papers have historically been distributed through approximately 1,100 wholesale distributors. Sales by NAOC of its ZIG-ZAG White and ZIG-ZAG French Orange premium cigarette papers are the most important products in terms of sales, and they accounted for 72.8% of NAOC's total sales in 2001. The majority of ZIG-ZAG premium cigarette papers promotional activity is at the distributor level and consists of distributor promotions, trade shows and trade advertising. The MYO smoking tobaccos and related products promotional activity is more focused at the retail level with spending on point of sale and space management and at the consumer level with price off promotions, primarily through the use of coupons. The Company's largest customer is The McLane Company, which accounted for approximately 10.1% of its smokeless tobacco and MYO revenues in 2001. The loss of this customer could have a material adverse effect on the results of operations or financial condition of the Company. The Company does not believe that the loss of any other customer would have a material effect on operations of the Company in the intermediate term. TRADEMARKS AND TRADE SECRETS National Tobacco has numerous registered trademarks relating to its loose leaf chewing tobacco products, including the trademarks for its BEECH-NUT and TROPHY products. These trademarks, which are significant to National Tobacco's business, expire periodically and are renewable for additional 20-year terms upon expiration. Flavor formulae relating to National Tobacco's and NAOC's tobacco products, which are key assets of their businesses, are maintained under strict secrecy. The ZIG-ZAG trade name and trademark for premium cigarette papers and related products are owned by Bollore and have been exclusively 6 licensed to NAOC. The ZIG-ZAG trademark with respect to tobacco and related products is owned by NAOC and was obtained as part of the Acquisition. RAW MATERIALS, PRODUCT SUPPLY AND INVENTORY MANAGEMENT Loose Leaf Chewing Tobacco National Tobacco's loose leaf chewing tobacco is produced from air-cured leaf tobacco. National Tobacco utilizes tobaccos grown domestically in Pennsylvania and Wisconsin and imported from many countries, including but not limited to, Argentina, Brazil, Columbia, France, Germany, Indonesia, Italy, Mexico, and the Philippines. Management does not believe that it is dependent on any single country source for tobacco. Pursuant to an agreement with Lancaster Leaf Tobacco Company of Pennsylvania ("Lancaster"), Lancaster, under instructions from National Tobacco, (i) purchases and processes tobacco on an exclusive basis, (ii) stores tobacco inventory purchased on behalf of National Tobacco and (iii) generally maintains a 12- to 24-months supply of National Tobacco's various tobacco types at its facilities. National Tobacco generally maintains a one- to two-months operating supply of tobacco in its Louisville facility. Other than raw tobacco, the ingredients used in National Tobacco's finished loose leaf chewing tobacco products include food grade flavorings, all of which have been approved by the FDA and other federal agencies. National Tobacco is not dependent upon any one supplier for those raw materials or for the supply of its products' packaging. National Tobacco generally maintains a one- to two-months supply of finished products. This supply is primarily maintained at its manufacturing facilities in Louisville, Kentucky. Finished products are also maintained in five bonded public warehouses to facilitate distribution. Premium Cigarette Paper and MYO Smoking Tobaccos and Related Products Pursuant to the Distribution Agreements with Bollore, NAOC must purchase its premium cigarette papers from Bollore, subject to Bollore fulfilling its obligations under these agreements. If Bollore is unable or unwilling to perform its obligations or ceases its cigarette paper manufacturing operation, in each case as set forth in the Distribution Agreements, NAOC may seek third-party suppliers and continue the use of the ZIG-ZAG trademark. Additionally, to maintain a steady supply of product, Bollore is required to maintain in a public warehouse in the United States a two months supply of emergency inventory at Bollore's expense. See "Distribution Agreements" below. NAOC maintains an adequate supply of product in addition to the immediately available, two-month emergency inventory on hand at the expense of Bollore. By its purchasing patterns, NAOC builds inventory outside promotional periods in order to have adequate inventory to meet increased demand during promotional periods. NAOC's inventory is maintained at the Company's manufacturing facility in Louisville, Kentucky and in bonded public warehouses located in Reno, Nevada and Pittsburgh, Pennsylvania. NAOC obtains its MYO smoking tobaccos primarily from international sources and is not dependent on any one type of tobacco for its blend. The MYO related products are purchased in finished form from several suppliers. Management believes adequate inventories are maintained and that its sources of supply are adequate for projected needs. 7 MANUFACTURING National Tobacco manufactures its loose leaf chewing tobacco products and NAOC contracts for the manufacture of its premium cigarette papers, cigarette tubes, rolling and injecting machines and MYO smoking tobaccos. In the case of its MYO smoking tobacco products, NAOC packages these products at its manufacturing facility in Louisville, Kentucky. The Company believes that its production capabilities, quality control procedures, research and development activities and overall facilities and equipment are adequate and are vital to maintaining the high-quality brand image and operating efficiency of its operations. Production and Quality Control The Company's production process utilizes proprietary production processes and techniques, including strict quality control. During the course of each production day, the Company's quality control group periodically tests the quality of the tobacco, casings (flavorings in syrup form), application of casings and packaging. The Company utilizes sophisticated quality control and pilot plant production equipment to test and closely monitor the quality of its products. The quality of the Company's products is largely the result of using high grade tobacco leaf, food-grade flavorings and an ongoing analysis of tobacco cut, flavorings and moisture content. Given the importance of contract manufacturing to the Company, the Company's quality control group also seeks to ensure that established standards are strictly adhered to by the contract manufacturers, especially with regard to the MYO related products. Research and Development The Company has a Research and Development Department that reformulates existing loose leaf and MYO tobaccos products in an effort to maintain a high level of product consistency and to facilitate the use of less costly raw materials without sacrificing product quality. The Company believes that for all of its tobacco products, including MYO, it has been and will continue to be able to develop cost effective blends of tobacco and flavorings that will maintain or reduce overall costs without compromising high product quality. The Research and Development Department is also responsible for new product development, such as the recently introduced Zig-Zag Little Cigars. The Company, primarily through National Tobacco, spent approximately $532,000, $464,000 and $487,000 on its research and development and quality control efforts for the years 1999, 2000 and 2001, respectively. Facilities and Equipment The Louisville, Kentucky plant, which is owned by National Tobacco, was formerly used by Lorillard for the manufacture of cigarettes, little cigars and chewing tobacco. This approximately 600,000 square foot facility occupies a 26 acre urban site near downtown Louisville. The facility's structures occupy approximately one-half of the total acreage. The facilities are in good condition and have received regular maintenance and capital improvement. Approximately two-thirds of the plant is currently utilized, thus, there is substantial excess manufacturing and storage capacity. The existing structures provide ample space to accommodate an expansion of the Company. 8 COMPETITION National Tobacco is the third largest manufacturer and marketer of loose leaf chewing tobacco. The other three principal competitors in the loose leaf chewing tobacco segment, which, together with National Tobacco, generate approximately 95% of this segment's sales, are Pinkerton Tobacco Co., Conwood Corporation and Swisher International Group Inc. Management believes that moist snuff products are used interchangeably with loose leaf products by many consumers and, as a result, USST, Inc., the largest manufacturer of moist snuff (and of all smokeless tobacco products when taken as a whole) is a significant competitor. As indicated above under "Industry and Markets," sales of moist snuff have grown over the past decade while sales of loose leaf have declined over that same period. In addition, the three previously named companies in the loose leaf segment also manufacture and market moist snuff. NAOC is the largest importer and distributor in North America of premium cigarette papers. NAOC's two major competitors for premium cigarette paper sales, which, together with NAOC, generate approximately 95% of such sales, are Republic Tobacco Company and Robert Burton Associates, a wholly-owned subsidiary of Imperial Tobacco Group plc. Competitors in the MYO smoking tobacco and related products area include Lane Ltd., a subsidiary of Brown & Williamson Tobacco Corporation, and Republic Tobacco Company. Many of the Company's competitors are better capitalized than the Company and have greater financial and other resources than those available to the Company. The Company believes that its strong market positions in its principal product lines are due to its high brand recognition and the perceived quality of each of its products, its manufacturing and operating efficiencies, and its sales, marketing and distribution efforts. EMPLOYEES As of February 28, 2002, the Company employed a total of 234 full-time employees. With the exception of 89 manufacturing employees, all other operations are non-union. The manufacturing employees are covered by three collective bargaining agreements. One of these agreements, covering 84 employees, was extended in December 2001 and will expire in December 2004. The other two agreements, covering five employees, are scheduled to expire during 2002 and the Company currently anticipates that they will be renewed. REGULATION The tobacco industry, particularly with respect to cigarettes, has been under public scrutiny for over thirty years. Industry critics include special interest groups, the Surgeon General and many legislators at the state and federal levels. Although the smokeless tobacco companies have recently come under some scrutiny, much of the focus has been directed at the cigarette industry due to its large size relative to the smokeless tobacco industry. Producers of tobacco products are subject to regulation in the United States at federal, state and local levels. Together with changing public attitudes towards tobacco consumption, the constant expansion of regulations, including increases in various taxes, has been a major cause of the overall decline in consumption of tobacco products since the early 1970's. Moreover, the future trend is toward increasing regulation of the tobacco industry. 9 Federal law has recently required states, in order to receive full funding for federal substance abuse block grants, to establish the minimum age of 18 years for the sale of tobacco products together with an appropriate enforcement program. In recent years, a variety of bills relating to tobacco issues has been introduced in the United States Congress, including bills that would (i) prohibit the advertising and promotion of all tobacco products and/or restrict or eliminate the deductibility of such advertising expenses; (ii) increase labeling requirements on tobacco products to include, among other things, additional warnings and lists of additives and toxins; (iii) modify federal preemption of state laws to allow state courts to hold tobacco manufacturers liable under common law or state statutes; (iv) shift regulatory control of tobacco products and advertisements from the FTC to the Food and Drug Administration ("FDA"); (v) increase tobacco excise taxes; and (vi) require tobacco companies to pay for health care costs incurred by the federal government in connection with tobacco related diseases. Hearings have been held on certain of these proposals; however, to date, none of such proposals have been enacted by Congress. Future enactment of such proposals or similar bills, depending upon their content, could have a material adverse effect on the sales, operations or financial condition of the Company. In 1996, Massachusetts enacted a statute, which requires all tobacco companies to disclose information regarding the ingredients and nicotine content of their products, which information will, subject to certain conditions, be made publicly available. The ingredients of National Tobacco's products are considered by the Company to be proprietary and such disclosure could result in the manufacture and sale of imitations, which could have a material adverse effect on its tobacco business. On December 10, 1997, U.S. District Judge O'Toole (D. Mass.) entered a preliminary injunction on behalf of five smokeless tobacco companies (including National Tobacco) against the Attorney General of Massachusetts and the Commissioner of Public Health. The order bars the officials from taking any steps to enforce the ingredient-reporting requirements of the Massachusetts statute pending a trial on the merits. On November 6, 1998, the United States Court of Appeals for the First Circuit affirmed the injunction. The tobacco companies did not seek an injunction against the nicotine reporting requirements of the Massachusetts statute. On September 7, 2000, upon motion, the District Court granted summary judgement in favor of the tobacco plaintiffs, ruling that the Massachusetts disclosure statute violated among other things, the Takings and Commerce Clauses of the U.S. Constitution. In October 2001, the First Circuit Court of Appeals, through a different three-judge panel, in a split opinion, reversed the District Court, thus upholding the statute. The tobacco companies applied for a rehearing by all of the active judges in the circuit. The full Court of Appeals agreed to rehear the case and withdrew the October 2001 majority opinion. Arguments were held on January 7, 2002, and a decision is pending. Regulations issued by the Massachusetts Attorney General affecting point of sale and certain advertising issues with respect to tobacco products which were to become effective August 1, 1999, were delayed until December 31, 1999 to allow for further review. The Attorney General made minor modifications to the regulations. In January 2000, the Federal District Court in Massachusetts upheld the advertising and point-of-sale regulations, rejecting the industry's First Amendment challenge. On July 12, 2000, the First Circuit Court of Appeals affirmed the District Court's opinion. The cigarette company plaintiffs requested that the United States Supreme Court review the case, and a stay of the regulations pending the disposition of that request was granted. On June 26, 2001, the United States Supreme Court reversed the decision, invalidating the point-of-sale advertising regulations, but upholding the regulations requiring tobacco products to be displayed behind the counter. The Massachusetts regulations, among other things, restrict access to tobacco products. Accordingly, there can be no assurance that prohibiting such direct access will not have an adverse effect on sales. 10 While there is no current regulation materially and adversely affecting the sale of premium cigarette papers, there can be no assurance that federal, state or local regulations will not be enacted which will seek to regulate premium cigarette papers. In the event such regulations are enacted, depending upon their parameters, they could have an adverse effect on the business of NAOC and, consequently, the financial condition of the Company. STATE ATTORNEY GENERAL SETTLEMENT AGREEMENTS In November 1998 most of the states, represented by their attorneys general acting through the National Association of Attorneys General, signed two contracts: the Master Settlement Agreement ("MSA") and the Smokeless Tobacco Master Settlement Agreement ("STMSA"). To the best of the Company's knowledge, the signatories to the MSA are 23 cigarette manufacturers and/or distributors and the only signatory to the STMSA is USST, Inc. In the Company's opinion, the fundamental basis for each agreement is the states' consents to withdraw all claims for monetary, equitable and injunctive relief against certain tobacco products manufacturers and others and, in return, the signatories have agreed to certain marketing restrictions and regulations as well as certain payment obligations. Pursuant to the MSA and subsequent states' statutes, a "cigarette manufacturer" (which is defined to also include make-your-own cigarette tobacco) has the option of either becoming a signatory to the MSA or opening, funding and maintaining an escrow account, with subaccounts on behalf of each settling state. The STMSA has no similar provisions. The MSA escrow accounts are governed by states' statutes that expressly give the manufacturers the option of opening, funding and maintaining an escrow account in lieu of becoming a signatory to the MSA. The statutes require companies, who are not signatories to the MSA, to deposit, on an annual basis, into qualified banks escrow funds based on the number of cigarettes or cigarette equivalents, i.e., the pounds of MYO smoking tobacco, sold. The purpose of these statutes is expressly stated to be to eliminate the cost disadvantage the settling manufacturers have as a result of settling. A company that establishes an escrow account is entitled to direct the investment of the escrowed funds and withdraw any appreciation, but cannot withdraw the principal for twenty-five years from the year of each annual deposit, except to withdraw funds deposited pursuant to an individual state's escrow statute to pay a final judgment to that state's plaintiffs in the event of such a final judgment against the company. Either option - becoming a MSA signatory or establishing an escrow account - is permissible. NAOC has chosen to open and fund an MSA escrow account and, as of December 31, 2001, has funded a total of $510,392 into its account. Either entering into one or both settlement agreements or establishing and maintaining an escrow account, as NAOC has chosen, could have a material adverse effect on the Company's financial position, results of operations or cash flows. EXCISE TAXES Tobacco products and premium cigarette papers have long been subject to federal, state and local excise taxes, and such taxes have frequently been increased or proposed to be increased, in some cases significantly, to fund various legislative initiatives. Since 1986, smokeless tobacco (including dry and moist snuff and chewing tobacco) has been subject to federal excise tax. Smokeless tobacco is taxed by weight (in pounds or fractional parts thereof) manufactured or imported. Effective January 1, 2002, the tax on loose leaf chewing tobacco was increased to $0.195 per pound from $0.17 per pound. Effective January 1, 2002, the federal excise tax on premium cigarette paper was increased to $0.0122 from $0.0106 per fifty papers, the tax on cigarette tubes was increased to $0.0244 from $0.0213 per fifty tubes, and the tax on MYO tobacco was increased to $1.0969 from $0.9567 per pound. These more recent 11 increases in the rate of excise taxes are not expected to have an adverse effect on the Company's business, especially when compared to the tax increases of manufactured cigarettes. Future enactment of increases in excise taxes could have a material adverse effect on the Company. The Company is unable to predict the likelihood of passage of future increases in excise taxes. Tobacco products and premium cigarette papers are also subject to certain state and local taxes. The imposition of state and local taxes can have a detrimental impact on sales in that state or locality. Any enactment of new state excise taxes or an increase in existing excise taxes is likely to have an adverse effect on sales in such situations. ENVIRONMENTAL REGULATIONS The Company believes that it is currently in substantial compliance with all material environmental regulations and pollution control laws. DISTRIBUTION AGREEMENTS NAOC is party to three long-term distribution and licensing agreements with Bollore with respect to sales of premium cigarette papers in the United States, Canada and Hong Kong, Singapore, Dubai, Qatar, Oman and Jordan (respectively, the "U.S. Distribution Agreement," the "Canada Distribution Agreement" and the "Other Countries Distribution Agreement," and, collectively, the "Distribution Agreements"). Under the Distribution Agreements, Bollore granted NAOC the exclusive right to purchase premium cigarette papers bearing the ZIG-ZAG brand name from Bollore for resale in the countries noted above. NAOC has the sole right to determine the price and other terms upon which NAOC may resell any products purchased from Bollore, including the right to determine the distributors of such products within the countries noted above. The Distribution Agreements establish the purchase price through 2004, subject to certain adjustments to reflect increases in the U.S. and Canadian Consumer Price Indices and to account for material currency fluctuations. The Distribution Agreements provide that, in order to assure each of the parties commercially reasonable profits in light of inflationary trends and currency translation factors, prior to December 31, 2004 and each fifth-year anniversary of such date, the parties will enter into good faith negotiations to agree on an index and currency adjustment formula to replace the index and formula currently in effect. If the parties are unable to agree, the dispute is to be submitted to binding arbitration. Pursuant to the Distribution Agreements, export duties, insurance and shipping costs are the responsibility of Bollore and import duties and excise taxes are the responsibility of NAOC. Bollore's terms of sale are 45 days after the bill of lading date and its invoices are payable in Euros. The Distribution Agreements reduce catastrophic foreign exchange risk by providing that Bollore will bear certain exchange rate risks at levels fixed through 2004. The catastrophic exchange rate risk allocations set forth in the Distribution Agreements will be renegotiated in 2004 in a similar manner as set forth above, also to be effective January 1, 2005. According to the Distribution Agreements, NAOC must purchase finished premium cigarette paper products from Bollore, subject to Bollore fulfilling its obligations under these agreements. Bollore is required by the agreements to provide NAOC with the quantities and quality of the products that it desires. The Distribution Agreements provide NAOC with certain safeguards to help ensure that NAOC will be able to secure a steady supply of product. Such safeguards include (i) granting NAOC the right to seek third party suppliers with continued use of the ZIG-ZAG trademark if Bollore is unable to perform its obligations or ceases its cigarette paper manufacturing operation, in each case as set forth in 12 the Distribution Agreements, and (ii) maintaining a two month supply of emergency inventory in the United States at Bollore's expense. Under the Distribution Agreements, NAOC has agreed for the term of the Distribution Agreements and for a period of five years after termination of such Distribution Agreements not to engage, directly or indirectly, in the manufacturing, selling, distributing, marketing or otherwise promoting in the countries identified above premium cigarette paper or premium cigarette paper booklets of a competitor without Bollore's consent, except for certain de minimis acquisitions of debt or equity securities of such competitor and certain activities with respect to an alternative supplier used by NAOC as permitted under the Distribution Agreements. Each of the Distribution Agreements was entered into on November 30, 1992. Each of the U.S. Distribution Agreement and the Canada Distribution Agreement was for an initial term of twenty years commencing on the date of such agreement and will be renewed automatically for successive twenty year terms unless sooner terminated in accordance with the provisions of such agreement. The Other Countries Distribution Agreement was for an initial term of ten years commencing on the date of such agreement and will be renewed automatically for successive ten year terms unless sooner terminated in accordance with the provisions of such agreement. Each of the Distribution Agreements permits Bollore to terminate such agreement (i) if certain minimum purchases (which were significantly exceeded in 2001) of premium cigarette paper booklets have not been made by the Company for resale in the jurisdiction covered by such agreement within a calendar year, (ii) if the Company assigns such agreement without the consent of Bollore (other than certain permissible assignments to wholly owned subsidiaries of the Company), (iii) upon a change of control of the NAOC or any parent of NAOC without the consent of Bollore, (iv) upon certain acquisitions of equity securities of NAOC or any parent of NAOC by a competitor of NAOC or certain investments by significant stockholders of the Company in a competitor of NAOC and (v) certain material breaches, including NAOC's agreement not to promote, directly or indirectly, premium cigarette paper or premium cigarette paper booklets of a competitor. Additionally, each of the Canada Distribution Agreement and the Other Countries Distribution Agreement is terminable by either NAOC or Bollore upon the termination of the U.S. Distribution Agreement. Item 2. Properties As of December 31, 2001, the Company operated manufacturing, distribution, office and warehouse space in the United States with a total floor area of approximately 610,351 square feet. Of this footage, approximately 10,351 square feet are leased and approximately 600,000 square feet are owned. To provide a cost-efficient supply of products to its customers, the Company maintains centralized management of manufacturing and nationwide distribution facilities. National Tobacco has one manufacturing and distribution facility located in Louisville, Kentucky and five other public warehouse distribution facilities in locations throughout the United States. NAOC utilizes the facility in Louisville as well as two public warehouse distribution facilities that are located in Pittsburgh, Pennsylvania and Reno, Nevada. The following table describes the principal properties of the Company (other than sales service centers, sales office space or warehouse space) as of December 31, 2001. 13 Square Owned or Location Principal Use Feet Leased -------- ------------- ---- ------ New York, NY Corporate 10,351 Leased headquarters Louisville, KY Loose leaf 600,000 Owned(1) chewing tobacco manufacturing, R&D, warehousing and distribution Item 3. Legal Proceedings Proposition 65. On March 30, 1998, an action was filed in California State Court, in the City and County of San Francisco, against defendants United States Tobacco Company, Inc., Conwood Company, L.P., Pinkerton Tobacco Company, Inc., National Tobacco, Swisher International Group Inc., Brown & Williamson Tobacco Corporation, Merrill Reese Inc., Lucky Stores Inc., Quick Stop Markets Inc., Raley's, Inc., Save Mart Supermarkets Inc., Save-On Drug Stores Inc., The Southland Corporation, Circle K Stores, Inc., Longs Drug Stores Corporation, Walgreen Co., Safeway, Inc. and DOES 1-500. The plaintiff amended their claim on June 10, 1998 and subsequently served the complaint on National Tobacco. The complaint purported to be brought by the City and County of San Francisco on behalf of the people of the State of California and by the Environmental Law Foundation on behalf of the general public. Plaintiffs claimed that the defendants violated the California Safe Drinking Water and Toxic Enforcement Act of 1986, Health and Safety Code 25249.6 ("Proposition 65") by "knowingly and intentionally" exposing California consumers to carcinogens and reproductive toxins in smokeless tobacco products while failing to provide a "clear and reasonable" warning that smokeless tobacco products contain substances that are "known to the state to cause cancer" and "known to the state to cause reproductive toxicity." Plaintiffs further claimed that the defendants violated California Unfair Competition Act, Business & Professions Code 17200, et seq., by marketing smokeless tobacco to children, and by fraudulently concealing from the public the alleged adverse consequences and addiction allegedly associated with smokeless tobacco products. The complaint sought a preliminary and permanent injunction preventing defendants from selling smokeless tobacco products without a "clear and reasonable" warning, as well as an injunction ordering defendants to undertake a court-approved public information campaign to instruct children that the use of smokeless tobacco products results in exposure to substances known to the State of California to cause cancer and reproductive harm. The plaintiffs also sought an award of statutory penalties and damage for each violation of Proposition 65 and the Unfair Competition Act, disgorgement of profits from the sale of smokeless tobacco products, and attorney's fees and costs. On December 17, 2001 the case was settled. The terms of the settlement were immaterial to National Tobacco's results. ------------------- (1) Encumbered by a mortgage securing all obligations and liabilities under the Senior Secured Facilities. 14 Kentucky and Illinois Complaints. On July 15, 1998, NAOC and National Tobacco filed a complaint against Republic Tobacco, Inc. and its affiliates ("Republic Tobacco") in Federal District Court for the Western District of Kentucky. The complaint was subsequently amended on August 18, 1998 (collectively, the complaint and the amended complaint are referred to herein as the "Kentucky Complaint"). Republic Tobacco imports and sells Roll-Your-Own ("RYO") cigarette papers under the JOB and TOP as well as other brand names. The Kentucky Complaint alleges, inter alia, that Republic Tobacco's use of exclusivity agreements, rebates, incentive programs, buy-backs and other activities related to the sale of premium cigarette papers in the southeastern United States violate federal and state antitrust and unfair competition laws. The Kentucky Complaint also alleges that Republic Tobacco has defaced and directed others to deface NAOC's point of purchase vendor displays for premium cigarette papers by covering up the Zig-Zag brand name and advertising material with advertisements for Republic Tobacco's RYO cigarette paper brands. The Kentucky Complaint alleges that these activities constitute unfair competition under the federal and state law. On June 30, 1998, Republic Tobacco filed a complaint against the Company, NAOC and National Tobacco in the United States District Court of the Northern District of Illinois. Republic Tobacco did not serve this complaint or otherwise notify the Company of its existence until after the filing and service of the Kentucky Complaint. The Company believes that this complaint was filed in anticipation of the filing of the Kentucky Complaint. This complaint was amended by Republic Tobacco on September 16, 1998 (collectively, the complaint and the amended complaint are referred to herein as the "Illinois Complaint"). In the Illinois Complaint, Republic Tobacco seeks declaratory relief that (a) Republic Tobacco's action in defacing the Company's point of purchase display vendors do not violate federal or state laws and (b) that Republic Tobacco's trade practices do not violate federal or state antitrust or unfair competition laws. In addition, the Illinois Complaint alleges that certain actions taken by the Company to inform its customers of its claims against Republic Tobacco constitute tortuous interference with customer relationships, false advertising, violations of Uniform Deceptive Trade Practices and Consumer Fraud Acts, defamation and unfair competition. In addition, although not included in its original complaint but in its amended complaint, Republic Tobacco alleges that the Company has unlawfully monopolized and attempted to monopolize the market for premium cigarette papers. The Company has counterclaimed alleging that Republic Tobacco's trade practices in the southeastern United States have unlawfully restricted North Atlantic Operating Company's ability to expand the distribution of Zig-Zag premium cigarette papers in the southeast, where sales have been historically underdeveloped. The Company intends to vigorously pursue its claims set forth in the Kentucky and Illinois Complaints and intends to vigorously defend against the claims asserted in the Illinois Complaint. With respect to the claims set forth in the Illinois Complaint, the Company filed a Motion to Dismiss concerning a substantial portion of the claims against the Company, and believes that the claims against the Company are without merit. On April 9, 1999, the Court in the Illinois case dismissed certain of Republic's claims against the Company, including Republic's monopolization claim. The Court also dismissed the Company's counterclaims with leave to replead those claims. The Company has done so. On September 17, 1999, Republic filed a Second Amended Complaint, which was substantially identical to the original complaint, except that it alleged a series of purportedly monopolistic practices on a regional market basis against the Company. The Company filed a 15 motion to dismiss the allegations for failure to state a claim on which relief could be granted. On December 23, 1999, the Court dismissed the antitrust claims in Republic's Second Amended Complaint. On October 20, 2000 Republic filed a motion to dismiss, stay, or transfer the Kentucky proceeding to the Illinois Court. On December 19, 2000, the Court denied Republic's motion, holding that it was premature. The Court noted also that it had communicated with the Court in Illinois and that it had concluded that Republic may not be entitled to any preference on forum selection, which would ordinarily be given because it was first to file. During 2001, expert discovery was completed. Subsequently, both parties have moved for summary judgment on the others claims. These motions for summary judgment are now pending before the Court. West Virginia Complaints. On October 6, 1998 National Tobacco was served with a summons and complaint in an action in the Circuit Court of Kanawha County, West Virginia, entitled Kelly Allen, et al. v. Philip Morris Incorporated, et al. (Civil Action Nos. 98-C-2401). While National Tobacco was served with a single service and complaint, the caption lists 65 separate plaintiffs, each with an individual case number. On November 13, 1998, National Tobacco was served with a summons and complaint in an action in the Circuit Court of Kanawha County, West Virginia, entitled Billie J. Akers, et al. v. Philip Morris Incorporated et al. (Civil Action Nos. 98-C-2696 to 98-C-2713). While National Tobacco was served with a single summons and complaint, the caption of the complaint lists 18 separate plaintiffs, each with an individual case number. This action was filed by the same plaintiffs' attorney who filed the Allen action and the complaint is identical in most material respects. These two actions were commenced by two separate plaintiffs, "individually and/or as the representatives of the various descendants named herein [who] are residents of the State of West Virginia and/or smoked cigarettes or used other tobacco products, manufactured, promoted, advertised, marked, sold and/or distributed by all defendants." The complaints contain no specific allegations referring to any individual plaintiff. These two actions were brought against major manufacturers of cigarettes, smokeless tobacco products, and certain other organizations. The complaints allege that "plaintiffs and plaintiffs' descendents suffer/had suffered from a form of cancer or vascular disease and other injuries due wholly or in part to defendants' products and/or activities." The complaints further allege that the actions "arise from decades of intentionally wrongful conduct by the defendants who have manufactured, promoted, and sold cigarettes and both smokeless and loose tobacco to the plaintiffs and plaintiffs descendants and millions of Americans while knowing, but denying and concealing that their products cause diseases, including but not limited to esophageal, laryngeal, pharyngeal, mouth and throat cancers and Buerger's Disease." The complaints do not identify which plaintiffs, if any, allege injury as a result of the use of smokeless tobacco. The complaints seek unspecified compensatory damages. The Company intends to vigorously defend against each such complaint. In the Allen case, the plaintiffs have specified the defendant companies for each of the 65 cases. National Tobacco was named in only six of the cases, five of which allege consumption, prior to the formation of National Tobacco, of products bearing the trademarks currently owned by National Tobacco. The remaining case alleges lung cancer as the injury. In subsequent discovery, the remaining plaintiff testified that his only use of Beech-Nut chewing tobacco 16 predated National Tobacco's acquisition of the brand. National Tobacco has been dismissed from the first five cases, and intends to vigorously defend the remaining action. The Akers complaint asserts 24 unspecified counts and seeks referral to the West Virginia Mass Litigation Panel, because the actions allegedly "involve multiple plaintiffs pursuing related claims or actions involving one or more common questions of act or law and the plaintiffs seek damages caused by some "product." Discovery of all tobacco-related (cigarette, cigar and smokeless products) actions in the State of West Virginia, including the Allen and Akers cases, has been referred to a Mass Litigation Panel, and assigned to one judge. On January 11, 2000, the judge assigned the cases issued an order concerning discovery schedules and establishing a trial procedure for the purpose of trying all issues of law and fact common to all defendants. On February 29, 2000, West Virginia plaintiffs' counsel, pursuant to the court's order, identified all individual plaintiffs and the defendants against whom they had claims. No individual plaintiff in the Akers cases alleged use of a product manufactured by National Tobacco, although National Tobacco remains a defendant in those actions. In subsequent discovery, one Akers plaintiff alleged use of a National Tobacco product. However, that plaintiff alleges that he has lung cancer. On September 14, 2000, National Tobacco was served with a Summons and Consolidated Complaint filed in Circuit Court of Ohio County, West Virginia, entitled Linda Adams, et al. v. Philip Morris Inc., et al. (Civil Action Nos. 00-C-373 to 00-C-911). While National Tobacco was served with a single Summons and Consolidated Complaint, the caption of the Consolidated Complaint lists 539 separate plaintiffs, each with an individual case number. Only one of these plaintiffs alleged use of a product currently manufactured by National Tobacco. The time period during which this plaintiff allegedly used the product has not yet been specified. Thus, it is not yet known whether National Tobacco is a proper defendant in this case. On September 19, 2000, National Tobacco was served with a Summons and Consolidated Complaint filed in Circuit Court of Ohio County, West Virginia, entitled Ronald Accord, et al. v. Philip Morris Inc., et al. (Civil Action Nos. 00-C-923 to 00-C-1483). While National Tobacco was served with a single Summons and Consolidated Complaint, the caption of the Consolidated Complaint lists 561 separate plaintiffs, each with an individual case number. A total of five of these plaintiffs allege use of a product currently manufactured by National Tobacco. One of these plaintiffs does not specify the time period during which the product was allegedly used, and one alleges use that covers, in part, a period when National Tobacco did not manufacture the product. Of the remaining three, one alleges consumption of a competitor's chewing tobacco from 1966 to 2000 and National Tobacco's Beech-Nut chewing tobacco from 1998 to 2000; another alleges a twenty-four year smoking history ending in 1995 and consumption of Beech-Nut chewing tobacco from 1990 to 1995; and the last alleges a thirty-five year smoking history ending in 2000, and consumption of National Tobacco's Durango Ice chewing tobacco from 1990 to 2000 (although Durango Ice did not come onto the market until 1999). In November 2001, National Tobacco was served with four separate summonses and complaints in actions filed in the Circuit Court of Ohio County, West Virginia. The actions entitled Donald Nice v. Philip Morris Incorporated, et al., (Civil Action No. 01-C-479), Korene S. Lantz v. Philip Morris Incorporated, et al., (Civil Action No. 01-C-480), Ralph A. Prochaska, et al. v. Philip Morris, Inc., et al., (Civil Action No. 01-C-481), and Franklin Scott, et al. v. Philip Morris, Inc., et al., (Civil Action No. 01-C-482). Allege that the individual plaintiffs suffer from various diseases including emphysema, heart disease, lung cancer, arterial blockage, and "addiction" to nicotine, allegedly resulting from the use of various tobacco products, none of which is or has ever been manufactured by National Tobacco. The Plaintiffs in these four actions also 17 allege a conspiracy among "the Tobacco Defendants...to mislead, deceive and confuse the government, the public, and West Virginia Plaintiffs, concerning the harmful effects of their products on the health of individuals, that nicotine is the active addictive component in manufactured tobacco products, and that defendants artificially, intentionally and scientifically manipulate nicotine delivery in manufactured tobacco products to ensure that users remain addicted. . . ." These actions were brought against major manufacturers of cigarettes, smokeless tobacco products (including National Tobacco) and other tobacco products, and certain other organizations. The four complaints assert counts alleging negligence and negligent misrepresentation, strict liability/failure to warn prior to 1970 and strict liability/design defect of unreasonably dangerous product, false representation, deceit, fraudulent concealment, civil conspiracy, breach of express and implied warranty, punitive damages, violations of the West Virginia general consumer protection and antitrust acts and loss of consortium. The complaints seek unspecified compensatory and punitive damages. These four actions have also been consolidated with the cases pending before the West Virginia Mass Litigation Panel. National Tobacco intends to vigorously defend these actions. Trial of these matters was planned in two phases. In the initial phase, a trial was to be held to determine whether tobacco products, including all forms of smokeless tobacco, cigarettes, cigars and pipe and roll-your-own tobacco, can cause certain specified diseases or conditions. In the second phase, individual plaintiffs would attempt to prove that they were in fact injured by tobacco products. Fact and expert discovery in these cases has closed, however, in the cigarette cases the Court has allowed additional discovery. The trial of the smokeless tobacco cases has been postponed indefinitely. The manufacturers of smokeless tobacco products (as well as the manufacturers of cigarettes) moved to sever the claims against the smokeless tobacco manufacturer defendants from the claims against the cigarette manufacturer defendants. That motion was granted, thus, the trial date on the smokeless tobacco claims has now been postponed indefinitely. Minnesota Complaint. On September 24, 1999, National Tobacco was served with a complaint in a case entitled Tuttle v. Lorillard Tobacco Company, et al. (Case No. C2-99-7105), brought in Minnesota. The other manufacturing defendants are Lorillard and The Pinkerton Tobacco Company. The Complaint alleges that plaintiff's decedent was injured as a result of using National Tobacco's (and, prior to the formation of National Tobacco, Lorillard's) Beech-Nut brand and Pinkerton's Red Man brand of loose-leaf chewing tobacco. Plaintiff asserts theories of liability, breach of warranty, fraud, and variations on fraud and misrepresentation. The case has been removed to federal court. Motions to dismiss were filed on all counts except for negligence and, on September 28, 2000, the Court granted all of National Tobacco's motions. The sole cause of action remaining is for negligence. The Court, however, granted leave to the plaintiff to replead within sixty days those alleged causes of action based on alleged fraud. On December 18, 2000, the Plaintiff filed an amended complaint reasserting fraud claims. On January 19, 2001, defendants again moved to dismiss the fraud claims. On July 5, 2001, the Court dismissed one of plaintiff's statutory fraud counts, but held that the remaining fraud courts were adequately pleaded. Discovery is continuing as to the remaining claims. The Court has ordered that the case be ready for trial in February 2003. Although the Company believes that it has good defenses to the above actions in West Virginia and Minnesota and it intends to vigorously defend each such action, no assurances can be given that it will prevail. If any of the plaintiffs were to prevail, the results could have a materially adverse effect on the Company's financial position, results of operations and cash flows. 18 Texas Infringing Products Litigation. In Bollore, S.A. v. Import Warehouse, Inc., Civ. No. 3-99-CV-1196-R (N.D. Texas), Bollore, the Company's Licensor of Zig-Zag brand cigarette papers, obtained a sealed order allowing it to conduct a seizure of infringing and counterfeit Zig-Zag products in the United States. On June 7, 1999, seizures of products occurred in Michigan and Texas. Subsequently, all named defendants have been enjoined from buying and selling such infringing or counterfeit goods. Bollore and the Company have negotiated settlements with one group of defendants, including Import Warehouse Inc. and its owner/operator Ravi Bhatia. Those settlements included a consent injunction against distribution of infringing or counterfeit goods. Management believes that successful prosecution of this litigation, either by settlement or otherwise, will have a favorable impact on its future premium cigarette paper business. On May 18, 2001, the Company, in conjunction with Bollore, conducted raids on the businesses and homes of certain defendants previously enjoined from selling infringing or counterfeit Zig-Zag(R) brand products in the Bollore S.A. v. Import Warehouse litigation. Evidence was uncovered that showed that these defendants and certain other individuals were key participants in importing and distributing the counterfeit Zig-Zag(R) cigarette papers. After a two day hearing in the U.S. District Court for the Northern District of Texas, on May 30, 2001, the Court held the previously enjoined defendants in contempt of court. On October 12, 2001, Bollore filed proposed findings of fact and conclusions of law at the request of the Court. On November 16, 2001, the Court issued its written Order of Contempt, inter alia, estimating a damage amount to be in excess of $11 million, and referring the matter to the United States Attorney with a recommendation that criminal charges for counterfeiting, criminal contempt and perjury be brought. The Court later directed the parties to submit specific damages evidence. On January 17, 2002, the Company filed its damages submission, calculating damages to be approximately $14.5 million. That application is currently pending. On December 5, 2001, the contemptuous defendants filed an appeal of the Contempt Order, claiming that the 1999 injunction entered on the record was technically invalid and that the factual record does not support the finding of contempt. The Company and Bollore on February 22, 2002 filed a motion with the appellate court urging that the Court dismiss the appeal as premature. That motion is pending. If the Court denies that motion, the plaintiffs intend to defend the Contempt Order vigorously. On February 5, 2002, the District Court in the Bollore case granted Bollore's motion to amend the Complaint to add the Company and NAOC as plaintiffs. Pursuant to the U.S. Distribution Agreement and a related agreement between the parties, any collections on the judgments issued in the Bollore v. Import Warehouse case are to be divided evenly between Bollore and the Company after the payment of all expenses. A full trial on the merits has been scheduled for April 1, 2002. On February 7, 2002, Bollore, NAOC and the Company filed a motion with the District Court in the Texas action seeking to hold Ravi Bhatia and Import Warehouse Inc. in contempt of court for violating the terms of the consent order and injunction entered against those defendants. The Company alleges that Mr. Bhatia and Import Warehouse sold counterfeit goods to at least three different companies over an extended period of time. The hearing date for that contempt order has not been set. California Infringing Products Litigation. On March 23, 2001, the Company participated as co-plaintiff with Bollore, S.A. and North Atlantic Operating Company, Inc. ("NAOC"), its subsidiary, in an action entitled Bollore, S.A. v. A&A Smart Shopping (Case No. CV 01-02766 FMC (MANx)), filed in the United States District Court for the Central District of California. The plaintiffs alleged that nine distributors in California were selling counterfeit Zig-Zag(R) brand cigarette papers. As part of that action, the plaintiffs sought 19 and obtained temporary restraining orders prohibiting the sale of such counterfeit products on March 27, 2001. The plaintiffs also obtained a seizure order and, on April 3, 2001, executed it against seven of the distributors. All seven were found to be in possession of counterfeit products. On April 10, 2001, the court granted a preliminary injunction against all of the defendants, barring the sale of counterfeit or infringing Zig-Zag(R) brand products, and requiring the defendants to effect a recall of counterfeit products from the market. Trial is currently scheduled for June 18, 2002. Any collections of judgments in this case are to be divided evenly between Bollore and NAOC. On May 22, 2001, the Company participated as co-plaintiff with Bollore, S.A. and North Atlantic Operating Company, Inc. in an action entitled Bollore, S.A. v. Buy-Rite Wholesale (Case No. CV 01-4570 FMC (MAN)), filed in the United States District Court for the Central District of California. The plaintiffs alleged that seven distributors and retailers in California were selling counterfeit Zig-Zag(R) brand cigarette papers. As part of that action, the plaintiffs sought and obtained temporary restraining orders prohibiting the sale of such counterfeit products on May 22, 2001. The plaintiffs also obtained a seizure order and, on May 31, 2001, executed it on six of the defendants. Of the six, four were found to be in possession of counterfeit products, and a fifth was in possession of infringing foreign products. Nonetheless, on June 7, 2001, the Court declined to issue a preliminary injunction against the continuing sale of counterfeit or infringing goods. Plaintiffs applied to the court for reconsideration as to all defendants. On August 3, 2001 the court again declined to issue a preliminary injunction, without prejudice to filing a more detailed motion. Trial of this matter is currently scheduled for July 23, 2002. Discovery is continuing in all of the above cases and the Company intends to vigorously pursue the defendants for damages. Management believes that the successful prosecution of this litigation, whether by settlement or otherwise, would have a favorable impact on its premium cigarette paper business, which has been adversely affected by this counterfeiting activity. In addition to the above described legal proceedings, the Company is subject to other litigation in the ordinary course of its business. The Company does not consider any of these other proceedings to be material. For a description of regulatory matters and related industry litigation in which the Company is a party, see Part I, Item 1. "Business--Regulation." Item 4. Submission of Matters to a Vote of Security Holders None. PART II Item 5. Market for Registrant's Common Stock and Related Stockholder Matters There is no trading market for the Company's voting common stock, par value $.01 per share (the "Common Stock"), and, as of February 28, 2001, such stock was held by 43 stockholders of record, 35 of whom are affiliates or employees of the Company. There have been no dividends declared on the Common Stock. The current policy of the Company's Board of Directors is to retain any future earnings to provide funds for the operation and expansion of the Company's business; however, the Board of Directors will review the dividend policy periodically to determine whether the declaration of dividends is appropriate. In addition, the payment of dividends by the Company is subject to certain restrictions contained in (i) the Company's senior secured credit facility and 20 (ii) the indenture and certificate of designation, respectively, with regard to the Company's outstanding senior notes and preferred stock. Item 6. Selected Financial Data The following table sets forth the consolidated selected statements of operations, balance sheet and other data for the Company for the periods indicated. The selected data is derived from the audited consolidated financial statements of the Company for such years. As described in the consolidated financial statements, the Company completed an acquisition of NATC and a recapitalization of the Company on June 25, 1997. As such, the selected data of the Company is not comparable in certain respects due to the purchase accounting effect of this acquisition and recapitalization. This selected data should be read in conjunction with, and is qualified by reference to, the consolidated financial statements of the Company, and the related notes thereto, and Management's Discussion and Analysis of Financial Condition and Results of Operations included elsewhere in this Form 10-K. CONSOLIDATED SELECTED FINANCIAL DATA (Amounts in thousands, except per share amounts)
Year Ended December 31, ------------------------------------------------------------------------------ 2001 2000 1999 1998 1997(1) --------------- --------------- ---------------- -------------- -------------- STATEMENT OF OPERATIONS DATA: Net Sales.......................................... $ 93,748 $ 93,145 $ 94,461 $ 93,081 $ 84,430 Income (loss) before extraordinary loss and cumulative effect of change in accounting principle (net of preferred stock dividends of $6,745 in 2001, $6,005 in 2000, $5,361 in 1999, $4,751 in 1998 and $2,268 in 1997) applicable to common shares.................... (8,109) (8,104) (3,766) (3,744) 5,146 Net income (loss) applicable to common shares(2)...................................... (8,109) (9,205) (3,766) (3,744) (1,975) Basic earnings per common share: Income (loss).................................. ($15.35) ($15.35) ($7.13) ($7.09) $9.75 Extraordinary loss............................. -- (1.61) -- -- (13.48) Cumulative effect of change in accounting Principle..................................... -- (.47) -- -- -- ---------- ---------- ----------- ---------- ---------- Net loss applicable to common shares ($15.35) ($17.43) ($7.13) ($7.09) ($3.73) ========== ========== =========== ========== ========== Diluted earnings per common share: Income (loss).................................. ($15.35) ($15.35) ($7.13) ($7.09) $8.43 Extraordinary loss............................. -- (1.61) -- -- (11.66) Cumulative effect of change in accounting principle..................................... -- (.47) -- -- -- ---------- ---------- ----------- ---------- ---------- Net loss applicable to common shares........... ($15.35) ($17.43) ($7.13) ($7.09) ($3.23) ========== ========== =========== ========== ========== BALANCE SHEET DATA (AT END OF PERIOD): Total assets....................................... $214,734 $227,757 $243,603 $260,307 $273,083 ========== ========== =========== ========== ========== Total debt, including current maturities......................................... $167,500 $180,000 $195,864 $215,586 $230,000 ========== ========== =========== ========== ========== Mandatorily redeemable preferred stock.............................................. $ 57,443 $ 50,698 $ 44,693 $ 39,332 $ 34,581 ========== ========== =========== ========== ========== OTHER DATA: Adjusted EBITDA(3)................................. $ 33,033 $ 33,182 $ 37,688 $ 38,503 $ 32,668 ========== ========== =========== ========== ==========
21 (1) The selected data for the year ended December 31, 1997 includes the results of operations of NAOC since its acquisition on June 25, 1997. (2) Net income (loss) attributable to common shares for the year ended December 31, 2000 includes an extraordinary loss of $850 (net of income tax benefit of $521) related to the write-off of deferred financing costs upon the refinancing of the Company's term loan and a cumulative effect of change in accounting principle of $251 (net of income tax benefit of $153) as a result of the adoption of Staff Accounting Bulletin No. 101, "Revenue Recognition in Financial Statements". Net income (loss) attributable to common shares for the year ended December 31, 1997 includes an extraordinary loss of $7,121 (net of income tax benefit of $4,365) related to the write-off of debt discounts and deferred financing costs upon the occurrence of the recapitalization of the Company on June 25, 1997. Income (loss) from continuing operations and net income (loss) applicable to common shares for the periods prior to June 25, 1997 does not include income tax expense because the Company and the Predecessor were a limited liability company and a partnership, respectively, prior to June 25, 1997, and did not incur any federal or state income taxes for such periods. (3) Adjusted EBITDA represents net income plus interest, taxes, depreciation, amortization and certain non-cash charges and expenses. Adjusted EBITDA is presented because management believes that Adjusted EBITDA is useful as an indicator of the Company's historical cash flow available to service its debt. Adjusted EBITDA should not be considered as an alternative to, or more meaningful than, net income (loss) (as determined in accordance with generally accepted accounting principles (GAAP)) as a measure of the Company's operating results or cash flows (as determined in accordance with GAAP) as a measure of the Company's liquidity. Following is a reconciliation of Net Income (Loss) to Adjusted EBITDA:
Year Ended December 31, ----------------------------------------------------------------------------- 2001 2000 1999 1998 1997 -------------- -------------- ---------------- -------------- --------------- Net income (loss) ...................... $ (1,364) $ (3,200) $ 1,595 $ 1,007 $ 293 Interest expense, net................ 19,742 22,261 23,488 24,927 18,361 Income tax expense................... 2,043 1,529 3,813 3,213 852 Depreciation......................... 637 1,067 1,923 1,687 1,619 Amortization......................... 5,490 5,490 5,490 5,490 3,213 Other (income) expense............... 2,642 1,801 (16) (46) (34) Unfunded pension obligation.......... 513 201 594 -- -- LIFO adjustment...................... 2,682 2,434 174 904 (129) Stock option compensation expense.... 33 33 70 819 900 Postretirement expense............... 615 465 557 502 472 Cumulative effective of accounting change............................ -- 251 -- -- -- Extraordinary loss, net of income tax benefit....................... -- 850 -- -- 7,121 ----------- ----------- -------- -------- -------- Adjusted EBITDA......................... $ 33,033 $ 33,182 $ 37,688 $ 38,503 $ 32,668 =========== =========== ======== ======== ========
22 Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations RESULTS OF OPERATIONS The table and discussion set forth below relates to the consolidated results of operations and financial condition of the Company for the years ended December 31, 2001, 2000 and 1999.
Year Ended December 31, (000's) ------------------------------------------------------------------------------------ 2001 2000 1999 --------------------------- ------------------------ --------------------------- Net Sales............................... $ 93,748 100.0% $ 93,145 100.0% $ 94,461 100.0% Cost of sales........................... 33,734 36.0 33,689 36.2 32,151 34.0 ------------ ------------- ----------- ----------- ------------ ------------- Gross Profit............................ 60,014 64.0 59,456 63.8 62,310 66.0 Selling, general and administrative expenses.............. 31,461 33.6 30,474 32.7 27,940 29.6 Amortization of goodwill................ 5,490 5.8 5,490 5.9 5,490 5.8 ------------ ------------- ----------- ----------- ------------ ------------- Operating income........................ 23,063 24.6 23,492 25.2 28,880 30.6 Interest expense & financing costs, net. 19,742 21.1 22,261 23.9 23,488 24.9 Other expense (income).................. 2,642 2.8 1,801 1.9 (16) -- ------------ ------------- ----------- ----------- ------------ ------------- Income (loss) from operations before income tax expense............................. 679 0.7 (570) (0.6) 5,408 5.7 Income tax expense...................... 2,043 2.8 1,529 1.6 3,813 4.0 ------------ ------------- ----------- ----------- ------------ ------------- Income (loss) before extraordinary loss and cumulative effect of change in accounting principle............................... (1,364) (1.5) (2,099) (2.2) 1,595 1.7 Extraordinary loss...................... -- -- (850) (0.9) -- -- Cumulative effect of change in accounting principle............................... -- -- (251) (0.3) -- -- ------------ ------------- ----------- ----------- ------------ ------------- Net income (loss)....................... ($1,364) (1.5%) ($3,200) (3.4%) $1,595 1.7% ============ ============= =========== =========== ============ =============
COMPARISON OF YEAR ENDED DECEMBER 31, 2001 TO YEAR ENDED DECEMBER 31, 2000 Net Sales. For the year ended December 31, 2001, net sales were $93.7 million, an increase of $0.6 million or 0.6% from the prior year. Sales of the Smokeless Tobacco segment decreased $0.5 million or 1.3% from the prior year reflecting, in part, a 4.8% volume decrease, which was partially offset by price increases during 2001. Net sales continued to be adversely impacted by competitive pressures, including increased discounting from other loose leaf competitors, from the growth of the moist snuff value brands as well as increased discounting activity from moist snuff manufacturers. Sales of the MYO segment increased $1.1 million or 2.1% from the prior year. This was due primarily to an increase of $2.2 million in sales of the expanded MYO smoking tobacco and related products line, which was partially offset by a planned decrease of $1.0 million in sales to Canada in an effort to balance inventory positions to projected sales levels. For the year, Zig-Zag's Canadian volume at the consumer level increased 6.0%. The Company believes that its U.S. sales of Zig-Zag(R) premium cigarette papers in the MYO segment were materially and adversely affected by the counterfeiting activity that is the subject of the Texas and California Infringing Products Litigations, described above under "Legal Proceedings". The Company believes, based on information submitted as part of the legal process, that net sales of its Zig-Zag(R) premium cigarette papers were reduced by a minimum of $6.5 million. In Management's opinion, this had a material and adverse effect on the Company's sales. Gross Profits. For the year ended December 31, 2001, gross profit increased 0.8% to $60.0 million from $59.5 million for the prior year and the gross profit percentage increased to 64.0% from 63.8%. Gross profit and gross profit percentage of the Smokeless Tobacco segment decreased to $21.6 million or 55.0% of net sales in 2001 from $22.5 million or 56.7% of net sales for the prior year. The increase in the non-cash LIFO inventory adjustment accounted for $0.8 million or 88.9% of the decline. Gross profit of the MYO segment increased 23 4.1% to $38.5 million due to the continued growth in the smoking tobacco and related products area of this segment, in spite of the adverse impact of the counterfeiting activity described above. Gross profit percentage increased from 69.2% of net sales to 70.5% of net sales due to the benefit of a favorable currency strategy and to a decrease in the non-cash LIFO inventory adjustment of $0.6 million. Currency. Currency movements and price increases are the primary adjustment factors for changes in costs of goods sold. Cigarette papers are purchased from Bollore on terms of net 45 days and are payable in Euros. Thus, NAOC bears certain foreign exchange risks for its inventory purchases. To minimize this risk, NAOC utilizes short-term forward currency contracts, through which NAOC secures Euros in order to provide payment for its monthly purchases of inventory. For the year ended December 31, 2001, currency rates were generally favorable due to the strength of the U.S. dollar versus the Euro. Accordingly, the Company was able to benefit economically by utilizing short-term forward currency contracts. In the event that the Euro were to strengthen against the U.S. dollar, the Company will reassess its currency strategy. Selling, General and Administrative Expenses. Selling, general and administrative expenses for the year ended December 31, 2001 increased 3.3% to $31.5 million from the prior year's $30.5 million. This increase was due primarily to marketing and sales incentives to enhance distribution of the expanded MYO product line. Amortization of Goodwill. Amortization of goodwill was unchanged at $5.5 million from the prior year. Interest Expense and Financing Costs. Interest expense and financing costs decreased to $19.7 million in 2001 from $22.3 million for the prior year. This decrease was the result of a lower average term loan balance coupled with a lower average interest rate environment. Other Expense (Income). Other expense increased to $2.6 million in 2001 from $1.8 million for the prior year. Other expense in 2001 represents legal, investigative and related expenses with respect to the Texas and California Infringing Products Litigations involving Zig-Zag(R) premium cigarette papers which are described above under "Legal Proceedings." Income Tax Expense. Income tax expense increased to $2.0 million in 2001 from $1.5 million for the prior year as a result of the increase in taxable income from the prior year. Extraordinary Loss. The Company recorded an extraordinary loss of $0.9 million (net of income tax benefit of $0.5 million) for the year ended December 31, 2000 related to the write-off of deferred financing costs associated with the initial acquisition financing in June 1997 and the subsequent refinancing of the Company's term loan on December 29, 2000. Cumulative Effect of Change in Accounting Principle. The Company recorded a cumulative effect of change in accounting principle of $0.3 million (net of income tax benefit of $0.1 million) for the year ended December 31, 2000, as a result of the adoption of Staff Accounting Bulletin No. 101, "Revenue Recognition in Financial Statements". Net Loss. Due to the factors described above, there was a net loss of $1.4 million for 2001 compared to the prior year's net loss of $3.2 million. 24 COMPARISON OF YEAR ENDED DECEMBER 31, 2000 TO YEAR ENDED DECEMBER 31, 1999 Net Sales. For the year ended December 31, 2000, net sales were $93.1 million, a decrease of $1.3 million or 1.4% from the prior year. Sales of the Smokeless Tobacco segment decreased $6.1 million, or 13.3% from the prior year reflecting, in part, a 16.0% volume decrease, which was partially offset by manufacturers' price increases during 2000. Net sales in 2000 were adversely impacted by a dispute with a substantial customer; an unsuccessful cost savings attempt to change the Smokeless Tobacco segment's Buy 1/Get 1 Free packaging; and reduced market coverage resulting from increased resignations of field sales personnel during the period when certain assets of the Smokeless Tobacco segment were under an agreement to be sold, which agreement was terminated in December 2000. In addition, net sales continues to be adversely impacted by Competitive pressures, including increased discounting, from loose leaf and moist snuff manufacturers. For the Smokeless Tobacco segment, these factors had an estimated aggregate unfavorable impact on net sales of $4.4 million. Sales of the MYO segment increased $4.8 million or 9.8% from the prior year. This increase was due primarily to an increase of $3.4 million in sales of the expanded MYO product line and an increase of $1.5 million in sales to Canada as a result of an increase in sales and inventory levels to avoid out-of-stock situations. Gross Profits. For the year ended December 31, 2000, gross profit decreased 4.6% to $59.5 million from $62.3 million from the prior year and the gross profit percentage declined to 63.8% from 66.0%. Gross profit and gross profit percentage of the Smokeless Tobacco segment decreased to $22.5 million or 56.7% of net sales in 2000 from $28.7 million or 62.6% of net sales for the prior year. The non-cash LIFO inventory adjustment of $2.1 million in 2000 accounted for 34% of the $6.2 million decline. Management believes that the factors discussed above, which adversely impacted net sales by $4.4 million, had an estimated adverse impact on gross profits of $2.8 million. Gross profit and gross profit percentage of the MYO segment increased to $37.0 million or 69.2% of net sales in 2000 from $33.6 million or 69.1% of net sales for the prior year due, in part, to the rapid growth in this segment resulting from increased distribution and new product introductions and, in part, to the strong identity of the Zig-Zag brand. Currency. Currency movements and price increases are the primary adjustment factors for changes in costs of goods sold. Cigarette papers are purchased from Bollore on terms of net 45 days in French francs. Thus, NAOC bears certain foreign exchange risks for its inventory purchases. To hedge this risk, NAOC utilizes short-term forward currency contracts, through which NAOC secures French francs in order to provide payment for its monthly purchases of inventory. In addition, Bollore provides a contractual hedge against significant currency fluctuation in its agreement with NAOC. For the year ended December 31, 2000, currency rates were generally favorable for the Company due to the strength of the U.S. dollar versus the French franc. The Company was able to successfully hedge its currency risk by utilizing short-term forward currency contracts. In the event that the trend of the French franc were to strengthen against the U.S. dollar, the Company would reassess its currency strategy. Selling, General and Administrative Expenses. Selling, general and administrative expenses for the year ended December 31, 2000 increased 9.1% to $30.5 million from the prior year's $28.0 million. This increase was due primarily to increased legal and litigation expenses and marketing and sales incentives, the latter of which was to create enhanced distribution of the expanded MYO product line. Amortization of Goodwill. Amortization of goodwill was unchanged at $5.5 million from the prior year. 25 Interest Expense and Financing Costs. Interest expense and financing costs decreased to $22.3 million in 2000 from $23.5 million for the prior year. This decrease was the result of a lower average term loan balance, despite a higher average interest rate environment. Other Expense (Income). Other expense (income) increased to $1.8 million in 2000. This expense was for legal fees and other costs associated with the proposed sale of the smokeless tobacco segment, which was terminated in December 2000. Income Tax Expense. Income tax expense decreased to $1.5 million in 2000 from $3.8 million for the prior year as a result of the decrease in taxable income from the prior year. Despite a loss from operations, the Company incurred an income tax expense due to the non-deductibility of certain goodwill charges associated with the 1997 acquisition and recapitalization. Extraordinary Loss. The Company recorded an extraordinary loss of $0.9 million (net of income tax benefit of $0.5 million) for the year ended December 31, 2000 related to the write-off of deferred financing costs associated with the initial acquisition financing in June 1997 and the subsequent refinancing of the Company's term loan on December 29, 2000. Cumulative Effect of Change in Accounting Principle. The Company recorded a cumulative effect of change in accounting principle of $0.3 million (net of income tax benefit of $0.1 million) for the year ended December 31, 2000, as a result of the adoption of Staff Accounting Bulletin No. 101, "Revenue Recognition in Financial Statements". Net Income (Loss). Due to the factors described above, there was a net loss of $3.2 million for the year ended December 31, 2000 compared to net income of $1.6 million for the prior year. LIQUIDITY AND CAPITAL REQUIREMENTS Working capital was $24.8 million at December 31, 2001 compared to $28.9 million at December 31, 2000. This decrease was primarily the result of a reduction in inventory of $5.2 million due to the planned reduction of inventory levels at National Tobacco and the non-cash LIFO inventory adjustment of $2.7 million; an increase in receivables of $1.5 million; and a decrease in Deferred Income Taxes of $0.6 million. The Company funds its seasonal working capital requirements through its operating cash flows, and, if needed, bank borrowings. As of December 31, 2001, the Company had an undrawn availability of $9.0 million under its committed $10.0 million revolving credit facility. The Company has a Loan Agreement (the "Loan Agreement") with Bank One, Kentucky, N.A. as Agent (the "Agent"), and the banks named therein which provides for a $25 million term loan and a $10 million revolving line of credit. Borrowings under the Loan Agreement bear interest at variable rates based, at the Company's option, on prime or LIBOR rates. The term loan is payable in eight (8) quarterly installments of $3,125,000 each plus accrued interest, commencing on March 31, 2001. Both the term loan and the revolver mature on December 31, 2002. As part of the revolving line of credit, the lenders agreed to issue up to $10 million of standby letters of credit. The Company's obligations under the Loan Agreement are guaranteed by National Tobacco, NAOC and NTFC. In addition, the Company's obligations are secured by all of the Company's assets and the Company's equity in its subsidiaries. The interest rate on borrowings under the Loan Agreement ranged from 4.62% to 6.05% at December 31, 2001. In addition, the Company must pay a quarterly commitment fee of 0.5% per annum of the unused portion of the revolver. 26 On June 25, 1997, the Company issued $155.0 million of 11% Senior Notes due 2004 (the "Senior Notes"). The Senior Notes mature and are payable on June 15, 2004. The Notes bear interests at 11% per annum, payable semiannually on June 15 and December 15. At the present time, the Company projects that it will not have sufficient funds to effect such repayment in the absence of a refinancing. The Company intends to refinance this debt in advance of its maturity date. The ability to do so will depend, among other things, on the financial performance of the Company and the availability of funds from the capital markets. Although the Company believes it will be able to effect such a refinancing, there can be no assurance that such a refinancing will be obtained. The Loan Agreement and the Senior Notes include cross default provisions and limit the incurrence of additional indebtedness, dividends, transactions with affiliates, asset sales, acquisitions, mergers, prepayments of indebtedness, liens and encumbrances, and other matters. The Loan Agreement also requires the Company to meet a fixed charge coverage test. At December 31, 2001, the Company was in compliance with all provisions of the Loan Agreement and Senior Notes. Following June 15, 2002, dividends on the Company's 12% Senior Payment-in-Kind Preferred Stock (the "Preferred Stock") are payable in cash. The Company's ability to make such dividend payments in cash will depend upon the availability of funds and whether the Company has satisfied the "restricted payments" provision under the Indenture pursuant to which the Senior Notes were issued. At the present time, the Company believes that it will be able to satisfy all conditions with respect to the September 15, 2002 dividend payment, as well as future dividend payments; however, there can be no assurance that the Company's actual performance will satisfy the required conditions stated above. If the Company is unable to satisfy the "restricted payments" provision with respect to the September 15, 2002 dividend payment, or any subsequent dividend payment, dividends on the Preferred Stock will accrue at the rate of 14% per annum (instead of the current 12% per annum rate) until all accrued dividends have been paid. In addition, the holders of the Preferred Stock will have the right to elect two members to the Company's Board of Directors until all accrued dividends have been paid. The tobacco for loose leaf chewing tobacco requires aging of up to two years before being processed into finished products. The Company believes that National Tobacco maintains sufficient tobacco inventories to ensure proper aging as well as an adequate supply based on its historical and projected sales activity. The Company also believes that NAOC maintains adequate inventories based on its historical and projected sales activity and that the supply of such inventory will remain stable for the foreseeable future. The Company believes that any effect of inflation at current levels will be minimal. Historically, the Company has been able to increase prices at a rate equal to or greater than that of inflation and believes that it will continue to be able to do so for the foreseeable future. In addition, the Company has been able to maintain a relatively stable variable cost structure for its smokeless tobacco products due, in part, to its successful procurement and reformulation activities. For 2001, the Company spent $603,000 in capital expenditures. Given its current operation, the Company believes that its annual capital expenditure requirements for 2002 will be in the range of $500,000 - $750,000. Pursuant to the U.S. Distribution Agreement (which is more fully discussed in Item 1), the Company is committed to purchase a minimum of 23,000,000 booklets of premium cigarette papers annually. This level of purchases has been significantly exceeded since the Acquisition and Management believes that the Company will be able to significantly exceed this requirement for the foreseeable future. The agreement has also established the purchase price for Zig-Zag(R) premium cigarette papers through 2004, subject to certain 27 adjustments to reflect increases in the U.S. consumer price index and to account for material currency fluctuations. The Distribution Agreements provide that, in order to assure each of the parties commercially reasonable profits in light of inflationary trends and currency translation factors, prior to December 31, 2004 and each fifth-year anniversary of such date, the parties will enter into good faith negotiations to agree on an index and currency adjustment formula to replace the index and formula currently in effect. If the parties are unable to agree, the dispute is to be submitted to binding arbitration. The following schedule summarizes the Company's contractual cash obligations at December 31, 2001 (in thousands). With regard to the Senior Notes and the Loan Agreement, the schedule shows the principal amounts payable and does not reflect interest payment obligations. With regard to the Preferred Stock, the schedule shows the amount payable upon mandatory redemption and does not reflect dividend payment obligations.
Payments Due By Period ---------------------- Contractual Cash Obligations Total Less than 1 year 1-3 years 4-5 years After 5 years ---------------------------- ----- ---------------- --------- --------- ------------- Senior Notes $155,000 $ - $155,000 $ - - Loan Agreement 12,500 12,500 - - - Preferred Stock 58,051 - - 58,051 - Operating Leases 1,512 817 695 - - ----------- -------------- ------------ --------------- ------------ Total Contractual Cash Obligations $227,063 $ 13,317 $155,695 $ 58,051 $ - =========== ============== ============ ================ ============
Except as described above with respect to the Senior Notes and Preferred Stock, the Company believes that its operating cash flows, together with its revolving credit facility, should be adequate to satisfy its reasonably foreseeable operating capital requirements. This is based, among other things, on the Company's belief that it has significantly reduced the distribution of counterfeit cigarette papers. If such activity were to reoccur, the Company's operating cash flows would likely be adversely and materially affected. Additionally, the financing of any significant future products, business or property acquisitions, and any refinancing of the Senior Notes or Preferred Stock, will depend upon the Company's ability to access the capital markets. CRITICAL ACCOUNTING POLICIES The Company recognizes revenues and the related costs upon the transfer of title and risk of loss to the customer. The Company believes the accounting policies below represent its critical accounting policies due to the estimation process involved in each. See Note 2, in the Audited Consolidated Financial Statements, for a detailed discussion of the Company's accounting policies. Goodwill - The Company amortizes goodwill over the estimated useful lives of its assets. To the extent that the estimated lives need to be shortened, the annual amortization charge may be increased. Further, the realization of the carrying value of the goodwill is dependent upon future expected operating cost flows. If sufficient cash flows are not generated, a write down of goodwill may be required. 28 Taxes - The Company has not provided a valuation allowance to reduce its net deferred income tax assets since the Company is "more likely than not" to be able to realize these benefits before they expire. If the Company should determine that it would not be able to realize all or part of its net deferred income tax assets in the future, an adjustment to the deferred income tax assets would be charged to earnings in the period such determination was made. Contingencies - Note 17 of the Audited Consolidated Financial Statements discusses various litigation matters that impact the Company. No loss or gain contingencies have been recorded for these matters since Management believes that it is not probable that a loss has been incurred or an asset realized. Future events may result in different conclusions, which could materially impact, either positively or negatively, the Company's results of operations or financial position. RECENT ACCOUNTING PRONOUNCEMENTS In July 2001, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards No. 141, "Business Combinations" ("SFAS No. 141"). The Statement addresses financial accounting and reporting for business combinations and supercedes Accounting Principles Board Opinion No. 16 "Business Combinations", and Statement of Financial Accounting Standards No. 38, "Accounting for Pre-acquisition Contingencies of Purchased Enterprises". All business combinations in the scope of SFAS No. 141 are to be accounted for using one method - the purchase method. SFAS No. 141 is effective for all business combinations initiated after June 30, 2001. Also in July 2001, the FASB issued Statement of Financial Accounting Standards No. 142, "Goodwill and Other Intangible Assets" ("SFAS 142"), which establishes the accounting for goodwill and other intangible assets following their recognition. SFAS 142 applies to all goodwill and other intangible assets whether acquired singly, as part of a group, or in a business combination. SFAS 142 provides that goodwill and other intangible assets believed to have indefinite lives should not be amortized but should be tested for impairment annually using a fair-value based approach. In addition, SFAS 142 provides that other intangible assets other than goodwill should be amortized over their useful lives and reviewed for impairment in accordance with Statement of Financial Accounting Standards No. 121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of." SFAS 142 is effective for the Company beginning on January 1, 2002. Upon adoption, the Company will be required to perform a transitional impairment test under SFAS 142 for all goodwill recorded as of January 1, 2002. Any impairment loss recorded as a result of completing the transitional impairment test will be treated as a change in accounting principle. Management has not completed the transitional impairment test and has not determined whether an impairment adjustment will be required upon adoption. Additionally, Management has not yet determined the impact of SFAS 142 on the Company's Amortization expense. The adoption of SFAS 142 would not impact the Company's Adjusted EBITDA, which is Management's performance standard. In October 2001, the FASB issued Statement of Financial Accounting Standards No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets (FAS 144). The Statement addresses financial accounting and reporting for the impairment or disposal of long-lived assets. This Statement supercedes Statement of Financial Accounting Standards No. 121, Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed Of (FAS 121), and the accounting and reporting provisions of Accounting Principles Board Opinion No. 30, Reporting the Results of Operations, Reporting the Effects of Disposal of a Segment of a Business, and Extraordinary, Unusual and Infrequently Occurring Events and Transactions, for the disposal of a segment of a business (as previously defined in that Opinion). This Statement also amends Accounting Research Bulletin No. 51, Consolidated Financial Statements, to eliminate the 29 exception to consolidation for a subsidiary for which control is likely to be temporary. The objectives of FAS 144 are to address significant issues relating to the implementation of FAS 121 and to develop a single accounting model, based on the framework established in FAS 121, for long-lived assets to be disposed of by sale, whether previously held and used or newly acquired. The Company will adopt FAS 144 in the first quarter 2002. Management has not determined the impact of FAS 144 but does not believe that the adoption will have a material effect on the Company's results of operations or financial position. During 2001, the Emerging Issues Task Force issued: EITF No. 00-14, "Accounting for Certain Sales Incentives" addressing the recognition, measurement and statement of earnings classification of certain sales incentives; and EITF No. 00-25, "Vendor Income Statement Characterization of Consideration Paid to a Reseller of the Vendor's Products" addressing the statement of earnings classification of consideration from a vendor to an entity that purchases the vendor's products for resale. The Company will adopt EITF 00-14 and 00-25 in the first quarter of 2002. Management is currently evaluating the impact of EITF 00-14 and 00-25 and expects that their adoption will result in a reclassification of certain expenses from selling, general and administrative expenses to net sales with no impact on the operating income (loss) or net income (loss) for 2002 and future years. Prior year amounts will be reclassified to be consistent with the Company's 2002 presentation. FORWARD-LOOKING STATEMENTS The Company cautions the reader that certain statements contained in the Management's Discussion and Analysis of Financial Condition and Results of Operations section as well as elsewhere in this Form 10-K are "forward-looking statements" within the meaning of the Private Securities Litigation Reform Act of 1995. Forward-looking statements are not guarantees of future performance. They involve risks, uncertainties and other important factors, including the risks discussed below. The Company's actual future results, performance or achievement of results may differ materially from any such results, performance or achievement implied by these statements. Among the factors that could affect the Company's actual results and could cause results to differ from those anticipated in the forward-looking statements contained herein is the Company's ability to implement its business strategy successfully, which may be dependent on business, financial, and other factors beyond the Company's control, including, among others, federal, state and/or local regulations and taxes, competitive pressures, prevailing changes in consumer preferences, consumer acceptance of new product introductions and other marketing initiatives, access to sufficient quantities of raw material or inventory to meet any sudden increase in demand, disruption to historical wholesale ordering patterns, product liability litigation and any disruption in access to capital necessary to achieve the Company's business strategy. The Company cautions the reader not to put undue reliance on any forward-looking statements. In addition, the Company does not have any intention or obligation to update the forward-looking statements in this document. The Company claims the protection of the safe harbor for forward-looking statements contained in Section 21E of the Securities Exchange Act of 1934. Item 7A. Quantitative and Qualitative Disclosures about Market Risk Interest Rate Sensitivity. The Company has exposure to interest rate volatility primarily relating to interest rate changes applicable to term and revolving loans under its senior secured credit facility. The Company's credit facility bears interest at rates which vary with changes in (i) LIBOR or (ii) a rate of interest announced publicly by the Federal Reserve. The Company does not speculate on the future direction of interest rates. As of December 31, 2001, $12.5 million of the Company's debt bore interest at variable rates. The Company believes that the effect, if any, of reasonably possible near-term changes in 30 interest rates on the Company's consolidated financial position, results of operations or cash flows would not be significant. Foreign Currency Sensitivity. NAOC purchases inventory from Bollore on terms of net 45 days which is payable in Euros. Accordingly, exposure exists to potentially adverse movement in foreign currency rates. NAOC uses short-term forward currency contracts to minimize the risk in foreign currency exchange rates. In addition, Bollore provides a contractual hedge against catastrophic currency fluctuation in its agreement with NAOC. NAOC does not use derivative financial instruments for speculative trading purposes, nor does NAOC hedge its foreign currency exposure in a manner that entirely offsets the effects of changes in foreign exchange rates. NAOC regularly reviews its hedging programs and may as part of this review determine at any time to change its hedging policy. As of December 31, 2001, NAOC had no outstanding forward currency contracts. Item 8. Financial Statements and Supplementary Data The Company's Consolidated Financial Statements and Notes to Consolidated Financial Statements, and the report of PricewaterhouseCoopers LLP, independent accountants, with respect thereto, referred to in the Index to Consolidated Financial Statements and Financial Statement Schedules of the Company contained in Item 14(a), appear on pages F-1 through F-35 of this Form 10-K and are incorporated herein by reference thereto. Information required by schedules called for under Regulation S-X is either not applicable or is included in the Consolidated Financial Statements or Notes thereto. Item 9. Changes in and Disagreements With Accountants on Accounting and Financial Disclosure None. PART III Item 10. Directors and Executive Officers of the Registrant BOARD OF DIRECTORS AND EXECUTIVE OFFICERS The following table sets forth the name, position with the Company and age of each member of the Board of Directors and each executive officer of the Company as of the date of this filing. See "Election of Directors." Name Age Position ---- --- -------- Thomas F. Helms, Jr........ 61 Chief Executive Officer, President and Chairman of the Board David I. Brunson........... 51 Executive Vice President--Finance and Administration, Chief Financial Officer, Treasurer, Secretary and Director Jack Africk................ 73 Director Marc S. Cooper............. 40 Director Thomas F. Helms, Jr. Thomas F. Helms, Jr. has been Chief Executive Officer, Chairman of the Board and the sole member of the Administration Committee of the Company since June 1997. On January 1, 1999, Mr. Helms assumed the additional responsibilities of President of the Company. He had previously 31 held the position of President of the Company and its subsidiaries (other than International Flavors and Technology, Inc. ("IFT")) prior to January 1998. He currently serves as Chairman of the Board of each of the Company's corporate subsidiaries. He has been Chief Executive Officer of National Tobacco and NTFC since 1988 and has held the same office with NAOC and IFT since October 1997. Mr. Helms also served as President and Chief Executive Officer of Culbro Corporation's smokeless tobacco division from 1983 until shortly prior to its sale to American Maize-Products Company in March 1986. From 1979 to 1982, Mr. Helms was General Manager of the Etherea Cosmetics and Designer Fragrances Division of Revlon, Inc. Prior to that time, Mr. Helms was employed in marketing and sales positions in various divisions of Revlon Consumer Products Corporation. David I. Brunson. David I. Brunson has been Executive Vice President--Finance and Administration, Chief Financial Officer and a Director of the Company since June 1997 and a member of the Company's Executive Committee since December 1997. He has held the same offices with National Tobacco and NTFC (since April 1997), NAOC (since October and June 1997, respectively) and IFT (since October 1997). In December 1998, Mr. Brunson was also appointed to the offices of Treasurer and Secretary of the Company and Secretary of IFT. In addition, he currently holds the offices of Treasurer and Assistant Secretary with each of the Company's subsidiaries (other than IFT). Mr. Brunson has also served as a member of the Board of the Directors of each of the Company's corporate subsidiaries since October 1997 (or, in the case of NAOC, since June 1997). Prior to joining the Company, from November 1992 until April 1997, he was employed as a Managing Director at Societe Generale and established and was President of Societe Generale Investment Corporation. From July 1979 until November 1992, he was employed at The First National Bank of Chicago, lastly as a Managing Director in the Investment Banking Division. Jack Africk. Jack Africk has been a Director since October 1997 and has been serving as a consultant to the Company since January 1999. From January through December 1998 he served as President and Chief Operating Officer of the Company and each of its subsidiaries (other than IFT). From February to December 1998, Mr. Africk was also a Director of each of the Company's corporate subsidiaries. Beginning in 1996 and until the consummation of the Acquisition, he was Chief Executive Officer of NATC. Prior to that time, from 1993 to 1996, Mr. Africk was a consultant and Director of NATC. Mr. Africk is a former Vice Chairman of UST. From 1979 until 1993, Mr. Africk held various positions with UST, including Vice Chairman and Executive Vice President, as well as positions with subsidiary organizations including President of an international division, and President and Chief Executive Officer of United States Tobacco Company. Mr. Africk also currently serves as Managing Partner of Evolution Partners and as a Director of Tanger Factory Outlets, a NYSE real estate investment trust that owns and operates factory outlet centers, and Crown Central Petroleum, an operator of refineries, gasoline stations and convenience stores. Marc S. Cooper. Marc Cooper has served as a Director of the Company since May 2001. Since May 1999, he has served as a Managing Director of Peter J. Solomon Company in its Mergers and Acquisitions Department. From March 1992 until May 1999, Mr. Cooper founded and served as Vice Chairman of Barington Capital Group, an investment bank. Prior to his tenure with Barington Capital Group, Mr. Cooper spent three years as a partner of Scharf Brothers, a private merchant banking firm. Currently, Mr. Cooper serves as a director of Thinking Tools, Inc. and Precache, Inc. No family relationships exist between any director and executive officer of the Company. 32 ELECTION OF DIRECTORS Pursuant to the terms of an Exchange and Stockholders' Agreement, dated as of June 25, 1997, among the Company and certain of the stockholders of the Company (the "Stockholders' Agreement"), Mr. Helms has the right to vote a number of shares of common stock in respect of the election of directors sufficient to elect all of the directors of the Company unless dividends are not paid in cash to the holders of the Company's Senior Preferred Stock when such dividends are required to be paid in cash, in which event such holders have the right to elect two directors. Each director is to serve until the next annual meeting of shareholders (or written consent in lieu thereof) and until his successor is elected and duly qualified. Item 11. Executive Compensation The following table summarizes the compensation paid by the Company as well as certain other compensation paid or accrued, to the executives listed below for the fiscal years ended December 31, 1999, 2000 and 2001 (each person appearing in the table is referred to as a "Named Executive"):
Summary Compensation Table Annual Compensation ------------------- All Other NAME AND PRINCIPAL POSITION Year Salary ($) Bonus ($) Compensation ($) --------------------------- ---- ---------- --------- ---------------- Thomas F. Helms, Jr. ................................. 2001 $525,000 $400,000 $106,797 (1) Chief Executive Officer and President 2000 525,000 400,000 102,758 (2) 1999 525,000 236,500 48,320 (3) David I. Brunson...................................... 2001 425,000 300,000 78,712 (4) Executive Vice President--Finance and 2000 406,538 200,000 37,174 (5) Administration and Chief Financial Officer 1999 354,231 200,000 18,793 (6) James W. Dobbins...................................... 2001 197,596 25,000 9,242 (7) Senior Vice President--General Counsel 2000 179,327 20,000 6,101 (8) 1999 103,654 25,500 30,670 (9) James M. Murray....................................... 2001 183,481 35,000 10,745 (10) Senior Vice President--Sales & Marketing 2000 164,289 30,000 40,388 (11) 1999 45,769 40,000 24,516 (12) Christopher N. Kounnas................................ 2001 156,000 - 10,826 (13) Senior Vice President--R & D and 2000 156,000 5,000 8,402 (14) Regulatory Compliance.......................... 1999 153,692 - 4,230 (15)
------------------------------- (1) Includes insurance premiums of $41,917 paid by the Company with respect to term life and disability insurance, contributions by the Company of $6,803 to a defined contribution plan, $50,000 as compensation for estate and tax planning activities and $8,077 for miscellaneous payments. (2) Includes insurance premiums of $41,917 paid by the Company with respect to term life and disability insurance, contributions by the Company of $6,803 to a defined contribution plan, $50,000 as compensation for estate and tax planning activities and $4,038 for miscellaneous payments. 33 (3) Includes insurance premiums of $41,917 paid by the Company with respect to term life and disability insurance, and contributions by the Company of $6,403 to a defined contribution plan. (4) Includes insurance premiums of $12,390 paid by the Company with respect to term life and disability insurance, contributions by the Company of $6,803 to a defined contribution plan, $35,000 as compensation for estate and tax planning activities and $24,519 for miscellaneous payments. (5) Includes insurance premiums of $12,390 paid by the Company with respect to term life and disability insurance, contributions by the Company of $6,803 to a defined contribution plan and $17,981 for miscellaneous payments. (6) Includes insurance premiums of $12,390 paid by the Company with respect to term life and disability insurance and contributions by the Company of $6,403 to a defined contribution plan. (7) Includes contributions by the Company of $6,550 to a defined contribution plan and $2,692 for miscellaneous payments. (8) Includes contributions by the Company of $5,380 to a defined contribution plan and $721 for miscellaneous payments. (9) Includes contributions by the Company of $1,616 to a defined contribution plan and $29,054 for relocation expenses. (10) Includes contributions by the Company of $6,803 to a defined contribution plan and $3,942 for miscellaneous payments. (11) Includes contributions by the Company of $6,803 to a defined contribution plan, $687 for miscellaneous payments and $32,898 for relocation expenses. (12) Includes $24,516 for relocation expenses. (13) Includes contributions by the Company of $6,026 to a defined contribution plan and $4,800 for miscellaneous payments. (14) Includes contributions by the Company of $4,802 to a defined contribution plan and $3,600 for miscellaneous payments. (15) Includes contributions by the Company of $4,230 to a defined contribution plan. STOCK OPTIONS The Company did not award any stock options to any of the Named Executives during the last fiscal year. COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION Thomas F. Helms, Jr., Chief Executive Officer and President of the Company, is the sole member of the Company's Administration Committee. In March 2002, a Compensation Committee, consisting of Jack Africk and Marc S. Cooper, was established by the Board of Directors to consider matters relating to the compensation of the Company's executive officers, including bonuses for the year ended December 31, 2001. For information concerning related-party transactions involving Mr. Helms or the members of the Compensation Committee, see Item 13, "Certain Relationship Transactions." COMPENSATION OF DIRECTORS Generally, directors who do not receive compensation as officers or employees of the Company or any of its affiliates will be paid an annual retainer fee of $25,000, plus reasonable out-of-pocket expenses, for their services on the Board and its committees. EMPLOYMENT AGREEMENTS THOMAS F. HELMS JR. Thomas F. Helms, Jr., Chief Executive Officer of the Company, is party to an employment agreement with the Company, dated May 17, 1996 (the "Helms Employment Agreement"), pursuant to which Mr. Helms is currently receiving an annual base salary of $525,000, which is reviewed annually, plus a 34 bonus in accordance with the Company's Executive Plan (as defined). The Helms Employment Agreement provides for a three-year term, renewable annually, and is terminable at will except with respect to severance. In addition, Mr. Helms receives various other benefits, including life insurance and health, hospitalization, disability and pension benefits and other perquisites. The Helms Employment Agreement includes a non-compete provision for a minimum of twelve months following the termination of Mr. Helms's employment as well as for any period during which severance is paid to Mr. Helms. Mr. Helms is entitled to twelve months' severance and a continuation of benefits following a termination of his employment by the Company without cause, except that the bonus received shall be only for the year in which the termination occurred and shall be prorated. DAVID I. BRUNSON David I. Brunson, Executive Vice President--Finance and Administration, Chief Financial Officer, Treasurer and Secretary of the Company, entered into an amended and restated employment agreement with the Company on April 30, 1998 (as so amended and restated, the "Brunson Employment Agreement"). Pursuant to the Brunson Employment Agreement, Mr. Brunson is currently receiving an annual base salary of $425,000, which is reviewed annually, plus a bonus in accordance with the Company's Executive Plan. The Brunson Employment Agreement provides for a term ending on the later of April 30, 2002 or the second anniversary of the date notice of termination is first given, and is terminable at will except with respect to severance. Mr. Brunson received signing and stay bonuses, each in the amount of $300,000, upon the execution of the Brunson Employment Agreement and on February 28, 1999, respectively. In addition, Mr. Brunson receives various other benefits, including life insurance and medical, disability, pension benefits, club memberships, stock options and reimbursements of certain expenses. The Brunson Employment Agreement includes a non-compete provision for a minimum of twelve months following the termination of Mr. Brunson's employment and for any subsequent period during which severance is paid to Mr. Brunson. In the event Mr. Brunson resigns for good reason or is terminated without cause, he is entitled to receive his annual base salary, and a pro rated bonus (based on the highest bonus paid to Mr. Brunson during the preceding two years) for the remainder of the term of employment. Any options or shares of restricted stock granted to Mr. Brunson vest in full as of the date of such termination. In addition, Mr. Brunson would also have the option to require the Company to repurchase at fair market value all or a portion of his shares of the Company's common stock. In the event of his termination within twelve months following the occurrence of a change of control of the Company, Mr. Brunson will receive a lump sum cash payment equal to three times the sum of (a) his current annual base salary and (b) the highest bonus paid to Mr. Brunson pursuant to the Executive Plan during the preceding two years. If Mr. Brunson's employment is terminated for any other reason, he will receive his accrued and unpaid salary and bonus to the date of termination. Pursuant to a non-qualified stock option agreement, Mr. Brunson was granted options to purchase 30,928 shares of Common Stock of the Company. One-third of these options were vested as of the closing of the Acquisition and one-third of these options were vested on each of the first two anniversaries of the date of his employment, April 23, 1997. In connection with the exercise of such options and subject to certain limitations, including a requirement that Mr. Brunson shall not leave, resign or be terminated for cause, the Company has agreed to pay Mr. Brunson an amount equal to the sum of (i) the difference between ordinary income and long-term capital gain tax liability for reportable income resulting from any exercise of the options, plus (ii) a "gross-up" to compensate for the additional ordinary income tax liability resulting from the payment of such amount. 35 RETIREMENT PLAN The table below illustrates the approximate amounts of annual normal retirement benefits payable under the Company's Retirement Plan (as defined herein). 36 Annual Benefits at Retirement with Years of Credited Service(1)
Average Compensation 10 15 20 25 30 35 ------------ ---------- ---------- ---------- ---------- ---------- ---------- $125,000 $ 15,000 $ 22,500 $ 30,000 $ 37,500 $ 45,000 $ 52,500 150,000 18,000 27,000 36,000 45,000 54,000 63,000 175,000 21,000 31,500 42,000 52,500 63,000 73,500 200,000 24,000 36,000 48,000 60,000 72,000 84,000 225,000 27,000 40,500 54,000 67,500 81,000 94,500 250,000 30,000 45,000 60,000 75,000 90,000 105,000 300,000 36,000 54,000 72,000 90,000 108,000 126,000 400,000 48,000 72,000 96,000 120,000 144,000 168,000 450,000 54,000 81,000 108,000 135,000 162,000 189,000 500,000 60,000 90,000 120,000 150,000 180,000 210,000
---------------- (1) Actual amounts paid under the Retirement Plan may be less than the amounts set forth on the table due to IRC limitations. The Company has a noncontributory, defined benefit retirement plan (the "Retirement Plan"), which covers all full-time employees, including officers, upon completing one year of service. A participant in the Retirement Plan becomes fully vested prior to normal retirement at age 65 upon the completion of five years of service. Benefits are also provided under the Retirement Plan in the event of early retirement at or after age 55 and the completion of at least ten years of service (or special early retirement after completion of 30 years of service) and in the event of retirement for disability after completion of five years of service. The amount of the contribution, payment, or accrual with respect to a specified person is not and cannot readily be separately or individually calculated by the actuaries for the Retirement Plan. Benefits under the Retirement Plan are based upon application of a formula to the specified average compensation and years of credited service at normal retirement age. Compensation covered by the Retirement Plan consists of the average annual salary during any five consecutive calendar years in the last ten years of an employee's service, which affords the highest salary, or, if employed for less than five years, the average annual salary for the years employed. The benefits are not subject to any deduction for social security payments. Estimated credited years of service under the Retirement Plan for the Named Executives are as follows: Thomas F. Helms, Jr., 14 years; David I. Brunson, 4 years; James W. Dobbins, 2 years; James M. Murray, 2 years; and Christopher N. Kounnas, 14 years. BONUS PLANS In March 1999, the Compensation Committee of the Company's Board of Directors adopted the 1999 Executive Incentive Plan (the "Executive Plan"), the 1999 Management Bonus Plan (the "Management Plan") and the 1999 Discretionary Bonus Plan (the "Discretionary Plan"). The Executive Plan provides executive members of the Company with the opportunity to receive bonus pay based on the Company's annual EBITDA performance, subject to approval of the Board of Directors. In addition, the Board of Directors can make discretionary bonus payments to one or more participants in the Executive Plan. The Management Plan provides certain members of senior management of the Operating Companies with the opportunity to receive bonus pay based on the Company's annual EBITDA 37 performance as well as the individual performance of participants, subject to approval of Executive Management. If the Company's annual EBITDA performance is not achieved, Executive Management, subject to approval of the Board of Directors, can make discretionary bonus payments. Under the Discretionary Bonus Plan, Executive Management, subject to approval of the Board of Directors, may provide discretionary bonus payments to employees who are not participants in any other bonus plan established by the Company based on individual levels of performance. In addition, the Board of Directors may, from time to time, pay discretionary bonuses outside of the above mentioned plans. 1997 SHARE INCENTIVE PLAN The Board of Directors of the Company has adopted, and the Company's stockholders have approved, the North Atlantic Trading Company, Inc. 1997 Share Incentive Plan (the "Incentive Plan"). The Incentive Plan is intended to provide incentives, which will attract and retain highly competent persons as key employees of the Company and its subsidiaries by providing them opportunities to acquire shares of stock or to receive monetary payments based on the value of such shares pursuant to the Benefits (as defined). Shares Available The Incentive Plan makes available for Benefits an aggregate amount of 61,856 shares of Common Stock (61,760 of which have been granted), subject to certain adjustments. Any shares of Common Stock subject to a stock option or stock appreciation right which for any reason is cancelled or terminated without having been exercised, and subject to limited exceptions, any shares subject to stock awards, performance awards or stock units which are forfeited, any shares subject to performance awards settled in cash or any shares delivered to the Company as part of full payment for the exercise of a stock option or stock appreciation right shall again be available for Benefits under the Incentive Plan. Administration The Incentive Plan provides for administration by a committee (the "Administration Committee") appointed by the Board of Directors from among its members. Currently, the sole member of the Administration Committee is Thomas F. Helms, Jr. The Administration Committee is authorized, subject to the provisions of the Incentive Plan, to establish such rules and regulations as it deems necessary for the proper administration of the Incentive Plan and to make such determinations and interpretations and to take such action in connection with the Incentive Plan and any Benefits granted as it deems necessary or advisable. Thus, among the Administration Committee's powers are the authority to select officers and other key employees of the Company and its subsidiaries to receive Benefits, and determine the form, amount and other terms and conditions of Benefits. The Administration Committee also has the power to modify or waive restrictions on Benefits, to amend Benefits and to grant extensions and accelerations of Benefits. Eligibility for Participation Key employees of the Company or any of its subsidiaries are eligible to participate in the Incentive Plan. The selection of participants from eligible key employees is within the discretion of the Administration Committee. All employees are currently eligible to participate in the Incentive Plan. The Incentive Plan provides for the grant of any or all of the following types of benefits: (1) stock options, including incentive stock options and non-qualified stock options; (2) stock appreciation rights; (3) stock awards, including 38 restricted stock; (4) performance awards; and (5) stock units (collectively, the "Benefits"). Benefits may be granted singly, in combination, or in tandem as determined by the Administration Committee. Stock awards, performance awards and stock units may, as determined by the Administration Committee in its discretion, constitute Performance-Based Awards, as described below. Stock Options Under the Incentive Plan, the Administration Committee may grant awards in the form of options to purchase shares of Common Stock. Options may be either incentive stock options, qualifying for special tax treatment, or non-qualified stock options. The exercise price may be paid in cash or, in the discretion of the Administration Committee, by the delivery of shares of Common Stock of the Company then owned by the participant, by the withholding of shares of Common Stock for which a stock option is exercisable, or by a combination of these methods. In the discretion of the Administration Committee, payment may also be made by delivering a properly executed exercise notice to the Company together with a copy of irrevocable instructions to a broker to deliver promptly to the Company the amount of sale or loan proceeds to pay the exercise price. The Administration Committee may prescribe any other method of paying the exercise price that it determines to be consistent with applicable law and the purpose of the Incentive Plan. In determining which methods a participant may utilize to pay the exercise price, the Administration Committee may consider such factors as it determines are appropriate. Stock Appreciation Rights (SARs) The Incentive Plan authorizes the Administration Committee to grant a SAR either in tandem with a stock option or independent of a stock option. An SAR is a right to receive a payment, in cash or Common Stock, equal to the excess of (x) the fair market value, or other specified valuation (which shall not be greater than the fair market value), of a specified number of shares of Common Stock on the date the right is exercised over (y) the fair market value, or other specified valuation (which shall not be less than fair market value), of such shares of Common Stock on the date the right is granted, all as determined by the Administration Committee. Each SAR shall be subject to such terms and conditions, as the Administration Committee shall impose from time to time. Stock Awards The Incentive Plan authorizes the Administration Committee to grant awards in the form of restricted or unrestricted shares of Common Stock ("Stock Awards"), which includes mandatory stock bonus incentive compensation and which may constitute Performance-Based Awards. Such awards will be subject to such terms, conditions, restrictions, and/or limitations, if any, as the Administration Committee deems appropriate including, but not by way of limitation, restrictions on transferability, continued employment and performance goals established by the Administration Committee over a designated period of time. Performance Awards The Incentive Plan allows for the grant of performance awards, which may take the form of shares of Common Stock or stock units, or any combination thereof and which may constitute Performance-Based Awards. Such awards will be contingent upon the attainment over a period to be determined by the Administration Committee of certain performance goals. The length of the performance period, the performance goals to be achieved and the measure of whether and to what degree such goals have been achieved will be determined by the Administration Committee. Payment of earned performance awards will be made in accordance with terms and conditions prescribed or authorized by the 39 Administration Committee. The participant may elect to defer, or the Administration Committee may require the deferral of, the receipt of performance awards upon such terms, as the Administration Committee deems appropriate. Stock Units The Administration Committee may, in its discretion, grant Stock Units to participants, which may constitute Performance-Based Awards. A "Stock Unit" means a notational account representing one share of Common Stock. The Administration Committee determines the criteria for the vesting of Stock Units and whether a participant granted a Stock Unit should be entitled to Dividend Equivalent rights (as defined in the Incentive Plan). Upon vesting of a Stock Unit, unless the Administration Committee has determined to defer payment with respect to such unit or a participant has elected to defer payment, shares of Common Stock representing the Stock Units will be distributed to the participant unless the Administration Committee, with the consent of the participant, provides for the payment of the Stock Units in cash, or partly in cash and partly in shares of Common Stock, equal to the value of the shares of Common Stock which would otherwise be distributed to the participant. Other Terms of Benefits The Incentive Plan provides that Benefits shall not be transferable other than by will or the laws of descent and distribution. The Administration Committee shall determine the treatment to be afforded to a participant in the event of termination of employment for any reason including death, disability, or retirement. Notwithstanding the foregoing, other than with respect to incentive stock options, the Administration Committee may permit the transferability of an award by a participant to members of the participant's immediate family or trusts for the benefit of such person or family partnerships. Upon the grant of any Benefit under the Incentive Plan, the Administration Committee may, by way of an agreement with the participant, establish such other terms, conditions, restrictions and/or limitations covering the grant of the Benefit as are not inconsistent with the Incentive Plan. No Benefit shall be granted under the Incentive Plan after June 25, 2007. The Board of Directors reserves the right to amend, suspend or terminate the Incentive Plan at any time, subject to the rights of participants with respect to any outstanding Benefits. The Incentive Plan contains provisions for equitable adjustment of Benefits in the event of a merger, consolidation, reorganization, recapitalization, stock dividend, stock split, reverse stock split, split up, spin-off, combination of shares, exchange of shares, dividend in kind or other like change in capital structure or distribution (other than normal cash dividends) to stockholders of the Company. 2001 Share Incentive Plan In October 2001, the Board of Directors of the Company approved the North Atlantic Trading Company, Inc. 2001 Share Incentive Plan (the "2001 Plan"). The 2001 Plan has terms that are substantially identical to the terms of the Share Incentive Plan. The Company has reserved 50,000 shares of Common Stock for benefits under the 2001 Plan. No awards have yet been granted under the 2001 Plan. Item 12. Security Ownership of Certain Beneficial Owners and Management The table below sets forth certain information regarding the beneficial ownership of Common Stock as of March 1, 2002 by (i) each person or entity who beneficially owns five percent or more of the Common Stock, (ii) each Director and Named Executive of the Company and (iii) all Directors and 40 executive officers of the Company as a group. Unless otherwise indicated, each beneficial owner's address is c/o North Atlantic Trading Company, Inc., 257 Park Avenue South, 7th Floor, New York, New York 10010-7304.
Percent Owned(a) ----------------------------------------- Before Exercise After Exercise Beneficial Owner Number of Shares of Warrants of Warrants ---------------- ---------------- ------------- ------------- Thomas F. Helms, Jr. (b)......................... 477,693 90.4% 80.9% Helms Management Corp. David I. Brunson(c).............................. 279,714 53.0 47.3 Herbert Morris(d)................................ 37,990 7.2 6.4 Flowing Velvet Productions, Inc. 3 Points of View Warwick, New York 10990 Maurice R. Langston(d)........................... 37,038 7.0 6.3 Langston Enterprises, Inc. Alan R. Minsterketter(d)......................... 27,613 5.2 4.7 Alan M. Inc. Jack Africk(e)................................... 21,212 3.9 3.5 DIRECTORS AND EXECUTIVE OFFICERS AS A GROUP (7 PERSONS)....................... 478,911 90.7% 80.9%
---------------------------- (a) The percentages assume, in the column entitled "Before Exercise of Warrants," that none of the outstanding warrants to purchase an aggregate of 63,490 shares at an exercise price of $.01 per share is exercised and, in the column entitled "After Exercise of Warrants," that all of such warrants will be exercised. (b) Helms Management Corp., all of the voting capital stock of which is owned by Mr. Helms and all of the non-voting capital stock of which is owned by a trust established by Mr. Helms for the benefit of his children, owns 271,300 shares of Common Stock, which represents approximately 51.4% of the outstanding shares assuming that none of the outstanding warrants are exercised, or 45.8% of the outstanding shares assuming that all such warrants are exercised. 240,000 shares owned by Helms Management Corp. are subject to a voting trust agreement pursuant to which Mr. Helms and David I. Brunson exercise certain voting powers and which may result in each of them being deemed a beneficial owner of such shares. See "Voting Trust Agreement." Because of Mr. Helms' ability to vote an additional 148,346 shares of Common Stock held by members of the Company's management in respect of the election of the Company's directors pursuant to the Stockholders' Agreement, he may be deemed to be the beneficial owner of such additional shares. See "Stockholders' Agreement." In connection with the transfer of 20,057 shares of Common Stock held by certain stockholders, the transferees of such shares granted Mr. Helms the right to vote such shares with respect to any and all matters submitted to a vote of the stockholders of the Company and, consequently, Mr. Helms may be deemed to be the beneficial owner of such shares. In addition, Mr. Helms may be deemed the beneficial owner of 37,990 shares that are subject to a voting agreement between Helms Management Corp. and Flowing Velvet Productions, Inc. See "Voting Agreement." (c) Includes (i) 2,250 shares of Common Stock owned by Mr. Brunson, (ii) 30,928 shares subject to currently exercisable stock options held by Mr. Brunson and (iii) 240,000 shares owned by Helms Management Corp. that are subject to a voting trust agreement pursuant to which Mr. Brunson exercises certain voting powers and which may result in his being deemed a beneficial owner of such additional shares. See "Voting Trust Agreement." In addition, Mr. Brunson has the right to acquire 6,536 shares currently owned by Helms Management Corp. (d) Reflects shares held by the corporation listed below the name of such natural person. Such natural person owns all of the issued and outstanding shares of capital stock of the corporation listed below the name of such natural person. (e) Includes 6,250 shares of Common Stock held by the Africk Family Foundation, Inc., of which Mr. Africk is the trustee and which may result in his being deemed a beneficial owner of such shares. In addition, 14,962 shares are subject to currently exercisable stock options. 41 STOCKHOLDERS' AGREEMENT The Company and certain stockholders of the Company are parties to the Stockholders' Agreement, setting forth among other things, the manner in which directors of the Company are to be selected. See "Management--Election of Directors." The Stockholders' Agreement also sets forth certain restrictions on the transfer of shares of Common Stock by existing stockholders and on the acquisition by existing stockholders of investments in competitors of Bollore. In addition, the Stockholders' Agreement provides the existing stockholders with certain "tag-along" rights to participate ratably in sales of Common Stock to third parties and requires existing stockholders to participate ratably in certain sales of Common Stock to third parties. Subject to the terms of all applicable debt agreements of the Company and its subsidiaries and to the rights of holders of the Company's preferred stock, the Stockholders' Agreement provides that the Company may maintain insurance on the lives of the members of its management officers and, in the event of the death of any such person, for the mandatory repurchase by the Company of all of such person's Common Stock at the fair market value thereof (which will be determined by an independent investment banking firm if the parties cannot otherwise agree upon such value) to the extent of available insurance proceeds, and the optional repurchase of additional shares of such person's Common Stock at such fair market value to the extent of available cash. Subject to the terms of all applicable debt agreements of the Company and its subsidiaries, and to the rights of holders of the Company's preferred stock, the Company also has the right to repurchase the shares of Common Stock held by members of management if their employment terminates, in the event of certain bankruptcy proceedings relating to such persons or upon an involuntary transfer of their shares by court order or otherwise in each case at the fair market value of such shares. In addition, in connection with the transfer of 20,057 shares of Common Stock pursuant to the Stockholders' Agreement, the transferees of such shares granted Mr. Helms the right to vote such shares with respect to any and all matters submitted to a vote of the stockholders of the Company. VOTING TRUST AGREEMENT Thomas F. Helms, Jr. and David I. Brunson are voting trustees under a Voting Trust Agreement with Helms Management Corp. Helms Management Corp. owns 271,300 shares of Common Stock in the Company, 240,000 of which are subject to the Voting Trust Agreement. Pursuant to the Voting Trust Agreement, the voting trustees have the power to vote the shares subject to the Voting Trust Agreement in connection with the election of directors and any other matters. The holder of the voting trust certificate may remove at any time any of the voting trustees and replace any of them with a successor. As voting trustees under the Voting Trust Agreement, Messrs. Helms and Brunson are entitled to three votes and one vote, respectively. Unless terminated by the certificate holder, the Voting Trust Agreement will terminate on December 17, 2012. VOTING AGREEMENT Helms Management Corp. and Flowing Velvet Products, Inc. ("Flowing Velvet") are parties to a voting agreement, setting forth among other things the agreement by Flowing Velvet to vote in all matters submitted to a vote of Stockholders in such manner as Flowing Velvet may be directed by Thomas F. Helms, Jr., the President of Helms Management Corp. 42 Item 13. Certain Relationships and Related Transactions On March 24, 1998, David I. Brunson, Executive Vice President-Finance and Administration, Chief Financial Officer, Treasurer and Secretary of the Company, purchased 2,250 shares of Common Stock from the Company at a price of $40 per share. As part of the purchase price, Mr. Brunson issued a note to the Company in the aggregate principal amount of $60,000. The note bears interest at 6.5% per annum and has a final maturity on March 31, 2003. On April 26, 1988 and on December 15, 1988, Mr. Thomas F. Helms, Jr., Chief Executive Officer and President of the Company, borrowed $75,000 and $45,000, respectively, in connection with the purchase of a portion of his partnership interest in National Tobacco and executed two separate notes, payable to the Company. On April 14, 1998, Helms Management Corp., a corporation in which Mr. Helms owns all of the voting capital stock and a trust established by Mr.. Helms for the benefit of his children owns all of the non-voting capital stock, issued a promissory note to the Company in the aggregate principal amount of $886,686.30, representing the principal on the notes discussed above, plus an additional loan by the Company in the amount of $766,686.30 to cover certain income tax liabilities of Helms Management Corp. resulting from the conversion of LLC to a "C" corporation in connection with the Acquisition. Upon execution of the $886,686.30 note, the prior notes issued by Mr. Helms were cancelled. The current note bears interest at the rate of 6.5% per annum and has a final maturity on March 31, 2003. On January 4, 1999, Mr. Helms issued a promissory note to the Company, in the principal amount of $150,000, for an additional loan by the Company to cover certain tax liabilities of Helms Management Corp. resulting from the above-mentioned conversion of LLC. This note bears interest at the rate of 6.5% per annum and has a final maturity on December 31, 2003. On April 20, 2001 and on November 12, 2001, additional loans, each in the amount of $150,000, were made to Mr. Helms on the same terms as the existing loans. As of February 28, 2002, the aggregate amount outstanding, including accrued interest, under the above notes was approximately $1,413,000. Kent Helms and Thomas F. Helms, III, sons of Thomas F. Helms, Jr., are employed by the Company as Director eBusiness Development and as Associate Manager-Marketing, respectively. During 2001, Kent Helms received aggregate compensation of $65,000 and Thomas F. Helms, III received aggregate compensation of $66,000 for services in such capacities. Pursuant to a policy adopted by the Board of Directors, their compensation is subject to the approval of, and was approved by, the directors who are not members of Management. Jack Africk, the former President and Chief Operating Officer of the Company, terminated his employment agreement with the Company effective December 31, 1998, but continues to serve as a member of the Company's Board of Directors. In connection with Mr. Africk's resignation from employment, he and the Company entered into a consulting agreement (the "Africk Consulting Agreement") pursuant to which, Mr. Africk provides consulting services to the Company on an as needed basis at the rate of $75,000 per annum. The Africk Consulting Agreement is subject to annual renewals and has been renewed through 2002. For 2001, Mr. Africk received $75,000 pursuant to the terms of the Africk Employment Agreement, and an additional $50,000 for consulting services that exceeded the extent of services contemplated by the Africk Consulting Agreement. Marc S. Cooper is a Managing Director of Peter J. Solomon Company Limited ("PJSC"), an investment banking and financial advisory firm. In June 2001, the Company engaged PJSC to render general financial and strategic advisory services through May 1, 2004. As compensation therefore, the Company agreed to pay PJSC a one time retainer fee consisting of warrants to purchase 3,000 shares of Common Stock at an exercise price of $40.00 per share, which warrants have not yet been issued, and to reimburse PJSC for out-of-pocket expenses incurred in connection with its provision of services. 43 On March 8, 2002, the Board of Directors voted to allow certain employees with outstanding loans from the Company to replace their existing loan obligations, which mature on March 31, 2003, for new loan obligations, to be effective March 31, 2002, with the following terms: 1) an interest rate of 5.0% per annum and 2) a maturity of March 31, 2008. The Named Executives offered this opportunity and the amounts of their loans were: Thomas F. Helms, Jr., $1,413,000; David I. Brunson, $60,000; and Christopher N. Kounnas, $35,000. The substitution has not yet taken place. PART IV Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K (a) 1. Financial Statements: The following consolidated financial statements of North Atlantic Trading Company, Inc. and subsidiaries are filed as part of this Form 10-K and are incorporated by reference in Item 8: INDEX TO FINANCIAL STATEMENTS
NORTH ATLANTIC TRADING COMPANY, INC. PAGE ------------------------------------ ---- AUDITED CONSOLIDATED FINANCIAL STATEMENTS Report of Independent Accountants............................................................................. F-1 Consolidated Balance Sheets as of December 31, 2001 and 2000.................................................. F-2 Consolidated Statements of Operations and Other Comprehensive Income (Loss) for the years ended December 31, 2001, 2000, and 1999.................................................................................... F-3 Consolidated Statements of Cash Flows for the years ended December 31, 2001, 2000, and 1999........................................................... F-4 Consolidated Statements of Changes in Stockholders' Deficit for the years ended December 31, 2001, 2000, and 1999........................................................... F-5 Notes to Consolidated Financial Statements.................................................................... F-6
2. Financial Statement Schedules: All other schedules for which provision is made in the applicable accounting regulation of the Securities and Exchange Commission are not required under the related instructions or are inapplicable and, therefore, have been omitted. 3. See the accompanying Index to Exhibits, which precedes the Exhibits filed with this Form 10-K. 44 INDEX TO EXHIBITS EXHIBIT NUMBER DESCRIPTION ------ ----------- 3.1(a) -- Restated Certificate of Incorporation of North Atlantic Trading Company, Inc., filed February 19, 1998 (incorporated herein by reference to Exhibit 3.1(a)(i) the Registrant's Annual Report on Form 10-K for the fiscal year ended December 31, 1997). 3.1(b) -- Certificate of Incorporation of North Atlantic Operating Company, Inc., filed June 9 1997 (incorporated herein by reference to Exhibit 3.1(b)(i) to the Registrant's Annual Report on Form 10-K for the fiscal year ended December 31, 1997). 3.1(c) -- Certificate of Amendment of Certificate of Incorporation of North Atlantic Operating Company, Inc., filed June 17, 1997 (incorporated herein by reference to Exhibit 3.1(b)(ii) to Amendment No. 1 to Registration Statement (Reg. No. 333-31931) on Form S-4 filed with the Commission on September 3, 1997). 3.1(d) -- Restated Certificate of Incorporation of National Tobacco Finance Corporation, filed April 24, 1996 (incorporated herein by reference to Exhibit 3.1(c) to Amendment No. 1 to Registration Statement (Reg. No. 333-31931) on Form S-4 filed with the Commission on September 3, 1997). 3.1(e) -- Amended and Restated Certificate of Limited Partnership of National Tobacco Company, L.P., filed May 17, 1996 (incorporated herein by reference to Exhibit 3.1(d) to Amendment No. 1 to Registration Statement (Reg. No. 333-31931) on Form S-4 filed with the Commission on September 3, 1997). 3.1(f) -- Certificate of Incorporation of International Flavors and Technology, Inc., filed August 7, 1997 (incorporated herein by reference to Exhibit 3.1(e)(i) to the Registrant's Annual Report on Form 10-K for the fiscal year ended December 31, 1997). 3.1(g) -- Certificate of Amendment of Certificate of Incorporation of International Flavors and Technology, Inc., filed February 19, 1998 (incorporated herein by reference to Exhibit 3.1(e)(ii) to the Registrant's Annual Report on Form 10-K for the fiscal year ended December 31, 1997). 3.2(a) -- Amended and Restated Bylaws of North Atlantic Trading Company, Inc. (incorporated herein by reference to Exhibit 3.2(a) to the Registrant's Quarterly Report on Form 10-Q for the fiscal quarter ended March 31, 1998). 3.2(b) -- Bylaws of North Atlantic Operating Company, Inc. (incorporated herein by reference to Exhibit 3.2(b) to Registration Statement (Reg. No. 333-31931) on Form S-4 filed with the Commission on September 3, 1997). 45 3.2(c) -- Bylaws of National Tobacco Finance Corporation (incorporated herein by reference to Exhibit 3.2(c) to Registration Statement (Reg. No. 333-31931) on Form S-4 filed with the Commission on September 3, 1997). 3.2(d) -- Third Amended and Restated Agreement of Limited Partnership of National Tobacco Company, L.P., effective May 17, 1996 (incorporated herein by reference to Exhibit 3.2(d)(i) to Amendment No. 1 to Registration Statement (Reg. No. 333-31931) on Form S-4 filed with the Commission on September 3, 1997). 3.2 (e) -- Amendment No. 1 to Third Amended and Restated Agreement of Limited Partnership of National Tobacco Company, L.P., effective June 25, 1997 (incorporated herein by reference to Exhibit 3.2(d)(ii) to Amendment No. 1 to Registration Statement (Reg. No. 333-31931) on Form S-4 filed with the Commission on September 3, 1997). 3.2(f) -- Bylaws of International Flavors and Technology, Inc. (incorporated herein by reference to Exhibit 3.2(e) to the Registrant's Annual Report on Form 10-K for the fiscal year ended December 31, 1997). 3.2(g) -- Amendment No. 2 to the Third Amended and Restated Agreement of Limited Partnership of National Tobacco Company, L.P., effective February 10, 2000 (incorporated by reference to Exhibit 3.2 (g) to the Registrant's Annual Report on Form 10-K for the fiscal year ended December 31, 2000). 3.3 -- Certificate of Designation of 12% Senior Exchange Payment-In-Kind Preferred Stock of North Atlantic Trading Company, Inc., filed July 22, 1997 (incorporated herein by reference to Exhibit 3.3(b) to Amendment No. 1 to Registration Statement (Reg. No. 333-31931) on Form S-4 filed with the Commission on September 3, 1997). 4.1 -- Indenture, dated as of June 25, 1997, among North Atlantic Trading Company, Inc., as issuer, National Tobacco Company, L.P., North Atlantic Operating Company, Inc. and National Tobacco Finance Corporation, as guarantors, and United States Trust Company of New York, as trustee (incorporated herein by reference to Exhibit 4.1 to Amendment No. 1 to Registration Statement (Reg. No. 333-31931) on Form S-4 filed with the Commission on September 3, 1997). 4.2 -- First Supplemental Indenture, dated as of February 26, 1998, among North Atlantic Trading Company, Inc., National Tobacco Company, L.P., National Tobacco Finance Corporation, International Flavors and Technology, Inc. and The United States Trust Company of New York (incorporated herein by reference to Exhibit 4.3 to the Registrant's Annual Report on Form 10-K for the fiscal year ended December 31, 1997). 46 9.1 -- Exchange and Stockholders' Agreement, dated as of June 25, 1997, by and between North Atlantic Trading Company, Inc. and those stockholders signatory thereto (incorporated herein by reference to Exhibit 9 to Amendment No. 1 to Registration Statement (Reg. No. 333-31931) on Form S-4 filed with the Commission on September 3, 1997). 9.2 -- Voting Trust Agreement, dated as of December 17, 1997, among Thomas F. Helms, Jr., David I. Brunson and Jeffrey S. Hay, as voting trustees, and Helms Management Corp. (incorporated herein by reference to Exhibit 9.2 to the Registrant's Annual Report on Form 10-K for the fiscal year ended December 31, 1997). 9.3 -- Amendment No. 1 to Voting Trust Agreement, dated as of August 2, 1999, among Thomas F. Helms, Jr. and David I. Brunson, as voting trustees, and Helms Management Corp. (incorporated by reference to Exhibit 9.3 to the Registrant's Annual Report on Form 10-K for the fiscal year ended December 31, 2000). 10.1 -- Third Amended and Restated Purchasing and Processing Agreement, dated as of June 25, 1997, between National Tobacco Company, L.P. and Lancaster Leaf Tobacco Company of Pennsylvania (incorporated herein by reference to Exhibit 10.1 to Amendment No. 1 to Registration Statement (Reg. No. 333-31931) on Form S-4 filed with the Commission on September 3, 1997). 10.2+ -- Amended and Restated Distribution and License Agreement, dated as of November 30, 1992, between Bollore Technologies, S.A. and North Atlantic Trading Company, Inc., a Delaware corporation and predecessor to North Atlantic Operating Company, Inc. [United States] (incorporated herein by reference to Exhibit 10.2 to Amendment No. 2 to Registration Statement (Reg. No. 333-31931) on Form S-4 filed with the Commission on September 3, 1997). 10.3+ -- Amended and Restated Distribution and License Agreement, dated as of November 30, 1992, between Bollore Technologies, S.A. and North Atlantic Trading Company, Inc., a Delaware corporation and predecessor to North Atlantic Operating Company, Inc. [Asia] (incorporated herein by reference to Exhibit 10.3 to Amendment No. 2 to Registration Statement (Reg. No. 333-31931) on Form S-4 filed with the Commission on September 3, 1997). 10.4+ -- Amended and Restated Distribution and License Agreement, dated as of November 30, 1992, between Bollore Technologies, S.A. and North Atlantic Trading Company, Inc., a Delaware corporation and predecessor to North Atlantic Operating Company, Inc. [Canada] (incorporated herein by reference to Exhibit 10.4 to Amendment No. 2 to Registration Statement (Reg. No. 333-31931) on Form S-4 filed with the Commission on September 3, 1997). 47 10.5+ -- Restated Amendment, dated as of June 25, 1997, between Bollore Technologies, S.A. and North Atlantic Operating Company, Inc. (incorporated herein by reference to Exhibit 10.5 to Amendment No. 2 to Registration Statement (Reg. No. 333-31931) on Form S-4 filed with the Commission on September 3, 1997). 10.6 -- Warrant Agreement, dated as of June 25, 1997, between North Atlantic Trading Company, Inc. and United States Trust Company of New York, as warrant agent (incorporated herein by reference to Exhibit 10.12 to Amendment No. 1 to Registration Statement (Reg. No. 333-31931) on Form S-4 filed with the Commission on September 3, 1997). 10.7++ -- 1997 Share Incentive Plan of North Atlantic Trading Company, Inc. (incorporated herein by reference to Exhibit 10.12 to Amendment No. 1 to Registration Statement (Reg. No. 333-31931) on Form S-4 filed with the Commission on September 3, 1997). 10.8++ -- Employment Agreement, dated May 17, 1996, between North Atlantic Trading Company, Inc. and Thomas F. Helms, Jr. (incorporated herein by reference to Exhibit 10.17 to Amendment No. 1 to Registration Statement (Reg. No. 333-31931) on Form S-4 filed with the Commission on September 3, 1997). 10.9 ++ -- Employment Agreement, dated April 14, 1997, between National Tobacco Company, Inc. and David I. Brunson (incorporated herein by reference to Exhibit 10.18(a) to Amendment No. 1 to Registration Statement (Reg. No. 333-31931) on Form S-4 filed with the Commission on September 3, 1997). 10.10++ -- Letter Agreement, dated April 23, 1997, between Thomas F. Helms, Jr. and David I. Brunson (incorporated herein by reference to Exhibit 10.18(b) to Amendment No. 1 to Registration Statement (Reg. No. 333-31931) on Form S-4 filed with the Commission on September 3, 1997). 10.11++ -- Nonqualified Stock Option Agreement, dated as of June 25, 1997, between North Atlantic Trading Company, Inc. and David I. Brunson (incorporated herein by reference to Exhibit 10.18(c) to Amendment No. 1 to Registration Statement (Reg. No. 333-31931) on Form S-4 filed with the Commission on September 3, 1997). 10.12++ -- Amendment No. 1, dated and effective September 2, 1997, to the Nonqualified Stock Option Agreement, dated as of June 25, 1997, between North Atlantic Trading Company, Inc. and David I. Brunson (incorporated herein by reference to Exhibit 10.18(d) to Amendment No. 1 to Registration Statement (Reg. No. 333-31931) on Form S-4 filed with the Commission on September 3, 1997). 10.13++ -- Amendment No. 2, dated as of December 31, 1997, to the Nonqualified Stock Option Agreement, dated as of June 25, 1997, between North Atlantic Trading Company, Inc. and David I. Brunson (incorporated herein by reference to Exhibit 10.18(e) to the Registrant's Annual Report on Form 10-K for the fiscal year ended December 31, 1997). 48 10.14++ -- Consulting Agreement, dated as of June 25, 1997, between North Atlantic Trading Company, Inc. and Jack Africk (incorporated herein by reference to Exhibit 10.20 to Amendment No. 1 to Registration Statement (Reg. No. 333-31931) on Form S-4 filed with the Commission on September 3, 1997). 10.15++ -- National Tobacco Company Management Bonus Program (incorporated herein by reference to Exhibit 10.25 to Amendment No. 1 to Registration Statement (Reg. No. 333-31931) on Form S-4 filed with the Commission on September 3, 1997). 10.16++ -- Amended and Restated Nonqualified Stock Option Agreement dated as of January 12, 1998, between North Atlantic Trading Company, Inc. And Jack Africk (incorporated herein by reference to Exhibit 10.28 to the Registrant's Annual Report on Form 10-K for the fiscal year ended December 31, 1997). 10.17++ -- Assignment and Assumption, dated as of January 1, 1998, between National Tobacco Company, L.P. and North Atlantic Trading Company, Inc. (incorporated herein by reference to Exhibit 10.30 to the Registrant's Annual Report on Form 10-K for the fiscal year ended December 31, 1997). 10.18+ -- Amendment, dated October 27, 1997, to Amended and Restated Distribution and License Agreements, between Bollore and North Atlantic Operating Company, Inc. (incorporated herein by reference to Exhibit 10.31 to the Registrant's Annual Report on Form 10-K for the fiscal year ended December 31, 1997). 10.19 -- Sales Representative Agreement, effective as of January 1, 1998, between National Tobacco Company, L.P. and North Atlantic Operating Company, Inc. (incorporated herein by reference to Exhibit 10.32 to the Registrant's Annual Report on Form 10-K for the fiscal year ended December 31, 1997). 10.20 -- Amendment to Credit Agreement, dated as of June 5, 1998, among North Atlantic Trading Company, Inc., the various lending institutions referenced therein, and National Westminster Bank plc, as Administrative Agent (incorporated herein by reference to Exhibit 10.1 to the Registrant's Quarterly Report on 10-Q for the fiscal quarter ended June 30, 1998). 49 10.21++ -- Amended and Restated Employment Agreement dated as of April 30, 1998, between North Atlantic Trading Company, Inc. and David I. Brunson (incorporated herein by reference to Exhibit 10.2 to the Registrant's Report on 10-Q for the fiscal quarter ended June 30, 1998). 10.22 -- Option Grant Letter, dated April 30, 1998, from Helms Management Corp. to David I. Brunson (incorporated herein by reference to Exhibit 10.5 to the Registrant's Quarterly Report on 10-Q for the fiscal quarter ended June 30, 1998). 10.23 -- Promissory Note, dated April 14, 1998, issued by Helms Management Corp. in favor of North Atlantic Trading Company, Inc. (incorporated herein by reference to Exhibit 10.7 to the Registrant's Quarterly Report on 10-Q for the fiscal quarter ended June 30, 1998). 10.24 -- Amendment, dated as of February 1, 1998, among North Atlantic Trading Company, Inc., the various lending institutions referenced therein and National Westminster Bank plc, as administrative agent (incorporated herein by reference to Exhibit 10.39 to the Registrant's Quarterly Report on 10-Q for the fiscal quarter ended March 31, 1998). 10.25 -- Consent, dated as of March 12, 1998, among North Atlantic Trading Company, Inc., the various lending institutions referenced therein and National Westminster Bank plc, as administrative agent (incorporated herein by reference to Exhibit 10.40 to the Registrant's Quarterly Report on 10-Q for the fiscal quarter ended March 31, 1998). 10.26 -- Subscription Agreement, dated as of March 24, 1998, between North Atlantic Trading Company, Inc. and David I. Brunson (incorporated herein by reference to Exhibit--10.42 to the Registrant's Quarterly Report on 10-Q for the fiscal quarter ended March 31, 1998). 10.27 -- Promissory Note, dated March 24, 1998, issued by David I. Brunson in favor of North Atlantic Trading Company, Inc. (incorporated herein by reference to Exhibit 10.44 to the Registrant's Quarterly Report on 10-Q for the fiscal quarter ended March 31, 1998). 10.28 -- Promissory Note, dated April 14, 1998, issued by Helms Management Corp. in favor of North Atlantic Trading Company, Inc. (incorporated herein by reference to Exhibit 10.7 to the Registrant's Quarterly Report on 10-Q for the fiscal quarter ended June 30, 1998). 10.29++ -- Letter Agreement, dated September 24, 1999, between North Atlantic Trading Company, Inc. and Jack Africk (incorporated by reference to Exhibit 10.34 to the Registrant's Annual Report on Form 10-K for the fiscal year ended December 31, 2000). 10.30++ -- North Atlantic Trading Company, Inc. 1999 Executive Incentive Plan (incorporated by reference to Exhibit 10.35 to the Registrant's Annual Report on Form 10-K for the fiscal year ended December 31, 2000). 10.31++ -- North Atlantic Trading Company, Inc. 1999 Management Bonus Plan (incorporated by reference to Exhibit 10.36 to the Registrant's Annual Report on Form 10-K for the fiscal year ended December 31, 2000). 50 10.32 -- Loan Agreement, dated as of December 29, 2000, by and among North Atlantic Trading Company, Inc., National Tobacco Company, L.P., North Atlantic Operating Company, Inc., National Tobacco Finance Corporation and Bank One, Kentucky N.A., as agent bank and the various lending institutions named therein (incorporated by reference to Exhibit 10.32 to the Registrant's Annual Report on Form 10-K for the fiscal year ended December 31, 2001). 10.33 -- Security Agreement, dated as of December 29, 2000, among North Atlantic Trading Company, Inc., National Tobacco Company, L.P., North Atlantic Operating Company, Inc., National Tobacco Finance Corporation and Bank One Kentucky, N.A., as agent for certain lending institutions (incorporated by reference to Exhibit 10.33 to the Registrant's Annual Report on Form 10-K for the fiscal year ended December 31, 2000). 10.34 -- Guaranty Agreement, dated as of December 29, 2000, among National Tobacco Company, L.P., North Atlantic Operating Company, Inc., National Tobacco Finance Corporation and Bank One, Kentucky, N.A., as agent for certain lending institutions (incorporated by reference to Exhibit 10.34 to the Registrant's Annual Report on Form 10-K for the fiscal year ended December 31, 2000). 10.35 -- Pledge Agreement, dated as of December 29, 2000 among and North Atlantic Trading Company, Inc., National Tobacco Company, L.P., North Atlantic Operating Company, Inc., National Tobacco Finance Corporation and Bank One Kentucky, N.A., as agent for certain lending institutions (incorporated by reference to Exhibit 10.35 to the Registrant's Annual Report on Form 10-K for the fiscal year ended December 31, 2000). 10.36*++ -- 2001 Share Incentive Plan of North Atlantic Trading Company, Inc. 21 -- Subsidiaries of North Atlantic Trading Company, Inc. (incorporated herein by reference to Exhibit 21 to the Registrant's Annual Report on Form 10-K for the fiscal year ended December 31, 1998). * Filed herewith. + Portions of this agreement have been omitted pursuant to Rule 406 under the Securities Act of 1933, as amended, and have been filed confidentially with the Securities and Exchange Commission. ++ Management contracts or compensatory plan or arrangement required to be filed as an exhibit pursuant to Item 14(c) of the rules governing the preparation of this Report. 51 SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. Date: March 29, 2002 NORTH ATLANTIC TRADING COMPANY, INC. By: /s/ Thomas F. Helms, Jr. ------------------------------------- Thomas F. Helms, Jr. Chairman and Chief Executive Officer Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.
SIGNATURE TITLE DATE --------- ----- ---- /s/ Thomas F. Helms, Jr. Chairman of the Board March 29, 2002 -------------------------------- and Chief Executive Officer Thomas F. Helms, Jr. (Principal Executive Officer) /s/ David I. Brunson Director, Executive Vice President March 29, 2002 -------------------------------- Finance and Administration, Chief Financial Officer David I. Brunson (Principal Financial and Accounting Officer) /s/ Jack Africk Director March 26, 2002 -------------------------------- Jack Africk /s/ Marc S. Cooper Director March 26, 2002 -------------------------------- Marc S. Cooper
52 NORTH ATLANTIC TRADING COMPANY, INC. AND SUBSIDIARIES REPORT ON AUDITS OF CONSOLIDATED BALANCE SHEETS AS OF DECEMBER 31, 2001 AND 2000 AND THE RELATED CONSOLIDATED STATEMENTS OF OPERATIONS, OTHER COMPREHENSIVE INCOME (LOSS), CASH FLOWS AND CHANGES IN STOCKHOLDERS' DEFICIT FOR THE YEARS ENDED DECEMBER 31, 2001, 2000 AND 1999 C O N T E N T S
PAGES ----- Report of Independent Accountants F-1 Financial Statements: Consolidated Balance Sheets as of December 31, 2001 and 2000 F-2 Consolidated Statements of Operations and Other Comprehensive Income (Loss) for the years ended December 31, 2001, 2000 and 1999 F-3 Consolidated Statements of Cash Flows for the years ended December 31, 2001, 2000 and 1999 F-4 Consolidated Statements of Changes in Stockholders' Deficit for the years ended December 31, 2001, 2000 and 1999 F-5 Notes to Consolidated Financial Statements F-6
REPORT OF INDEPENDENT ACCOUNTANTS To the Board of Directors North Atlantic Trading Company, Inc. In our opinion, the accompanying consolidated balance sheets and the related consolidated statements of operations, other comprehensive income (loss), cash flows, and changes in stockholders' deficit present fairly, in all material respects, the financial position of North Atlantic Trading Company, Inc. and Subsidiaries (the Company) at December 31, 2001 and 2000 and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2001, in conformity with accounting principles generally accepted in the United States of America. These financial statements are the responsibility of the Company's management; our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits of these statements in accordance with auditing standards generally accepted in the United States of America, which require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit 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, and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. As discussed in Note 2 of the Notes to the Consolidated Financial Statements, the Company changed its method of accounting for revenue recognition as a result of the adoption of Staff Accounting Bulletin No. 101, "Revenue Recognition". /s/ PricewaterhouseCoopers LLP New York, New York February 18, 2002 F-1 NORTH ATLANTIC TRADING COMPANY, INC AND SUBSIDIARIES -------------------------------------------------------------------------------- CONSOLIDATED BALANCE SHEETS December 31, 2001 and 2000 (dollars in thousands except share data)
ASSETS 2001 2000 --------------------- -------------------- Current assets: Cash $ 1,130 $ 1,453 Accounts receivable 5,672 4,182 Inventories 43,967 49,172 Income taxes receivable 233 233 Other current assets 1,702 2,070 --------------------- -------------------- Total current assets 52,704 57,110 Property, plant and equipment, net 5,233 5,267 Deferred income taxes 26,644 29,294 Deferred financing costs 4,028 5,360 Goodwill, net 123,557 129,047 Other assets 2,718 1,679 --------------------- -------------------- Total assets $ 214,884 $ 227,757 ===================== ==================== LIABILITIES AND STOCKHOLDERS' DEFICIT Current liabilities: Accounts payable $ 2,614 $ 2,454 Accrued expenses 3,403 3,124 Deferred income taxes 9,542 10,149 Current portion of notes payable and long-term debt 12,500 12,500 --------------------- -------------------- Total current liabilities 28,059 28,227 Notes payable and long-term debt 155,000 167,500 Other long-term liabilities 10,994 9,517 --------------------- -------------------- Total liabilities 194,053 205,244 --------------------- -------------------- Preferred stock, net of unamortized discount of $918 in 2001 and $1,089 in 2000; mandatory redemption value of $58,051 in 2001 and $51,500 in 2000 57,443 50,698 --------------------- -------------------- Stockholders' deficit: Common stock, voting, $.01 par value; authorized shares, 750,000; issued and outstanding shares, 528,241 5 5 Common stock, nonvoting, $.01 par value; authorized shares, 750,000; issued and outstanding shares, -0- Additional paid-in capital 9,144 9,111 Loans to stockholders for stock purchases (187) (184) Accumulated other comprehensive loss (348) - Accumulated deficit (45,226) (37,117) --------------------- -------------------- Total stockholders' deficit (36,612) (28,185) --------------------- -------------------- Total liabilities and stockholders' deficit $ 214,884 $ 227,757 ===================== ====================
The accompanying notes are an integral part of the consolidated financial statements. F-2 NORTH ATLANTIC TRADING COMPANY, INC AND SUBSIDIARIES -------------------------------------------------------------------------------- CONSOLIDATED STATEMENTS OF OPERATIONS for the years ended December 31, 2001, 2000 and 1999 (dollars in thousands except share data)
2001 2000 1999 ------------------- ------------------ ------------------- Net sales $ 93,748 $ 93,145 $ 94,461 Cost of sales 33,734 33,689 32,151 ------------------- ------------------ ------------------- Gross profit 60,014 59,456 62,310 Selling, general and administrative expenses 31,461 30,474 27,940 Amortization of Goodwill 5,490 5,490 5,490 ------------------- ------------------ ------------------- Operating income 23,063 23,492 28,880 Interest expense and financing costs 19,742 22,261 23,488 Other income (expense) (2,642) (1,801) 16 ------------------- ------------------ ------------------- Income (loss) before income tax 679 (570) 5,408 Income tax expense 2,043 1,529 3,813 ------------------- ------------------ ------------------- Income (loss) before extraordinary loss & cumulative effect of change in accounting principle (1,364) (2,099) 1,595 Extraordinary loss, net of income tax benefit of $521 - (850) - ------------------- ------------------ ------------------- Income (loss) before cumulative effect of change in accounting principle (1,364) (2,949) 1,595 Cumulative effect of change in accounting principle, net of income tax benefit of $153 - (251) - ------------------- ------------------ ------------------- Net income (loss) (1,364) (3,200) 1,595 Preferred stock dividends 6,745 6,005 5,361 ------------------- ------------------ ------------------- Net loss applicable to common shares $ (8,109) $ (9,205) $ (3,766) =================== ================== =================== Basic and Diluted earnings per common share: Income (loss) before extraordinary loss & cumulative effect of change in accounting principle $ (2.58) $ (3.98) $ 3.02 Extraordinary loss, net of income tax benefit - (1.61) - Cumulative effect of change in accounting principle, net of income tax benefit - (0.47) - Preferred stock dividends (12.77) (11.37) (10.15) ------------------- ------------------ ------------------- Net loss $ (15.35) $ (17.43) $ (7.13) =================== ================== =================== Weighted average common shares outstanding: Basic and Diluted 528,241 528,241 528,241 CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS) (in thousands) Net income (loss) $ (1,364) $ (3,200) $ 1,595 Other comprehensive income, net of tax benefit: Net change related to cash flow hedges: Cumulative effect of accounting change 28 - - Reclassification to net income (28) - - Minimum pension liability (348) - - ------------------- ------------------ ------------------- Comprehensive income (loss) $ (1,712) $ (3,200) $ 1,595 =================== ================== ===================
The accompanying notes are an integral part of the consolidated financial statements. F-3 NORTH ATLANTIC TRADING COMPANY, INC AND SUBSIDIARIES -------------------------------------------------------------------------------- CONSOLIDATED STATEMENTS OF CASH FLOWS for the years ended December 31, 2001, 2000 and 1999 (dollars in thousands except share data)
2001 2000 1999 ------------------ ------------------- ------------------- Cash flows from operating activities: Net income (loss) $ (1,364) $ (3,200) $ 1,595 Adjustments to reconcile net income (loss) to net cash provided by operating activities: Extraordinary loss - 1,371 - Depreciation 637 1,067 1,923 Amortization of goodwill 5,490 5,490 5,490 Amortization of deferred financing costs 1,332 2,275 2,276 Deferred income taxes 2,043 855 4,034 Change in accrued pension liabilities 513 201 594 Change in accrued postretirement liabilities 615 465 557 Compensation expense 33 33 70 Changes in operating assets and liabilities: Accounts receivable (1,490) 802 502 Inventories 5,205 4,327 4,988 Income tax receivable - (58) (175) Other current assets 368 (382) (414) Other assets (1,039) (396) (267) Accounts payable 160 2,140 (144) Accrued expenses and other 280 (102) (533) ------------------ ------------------- ------------------- Net cash provided by operating activities 12,783 14,888 20,496 ------------------ ------------------- ------------------- Cash flows from investing activities: Capital expenditures, net (603) (456) (770) ------------------ ------------------- ------------------- Net cash used in investing activities (603) (456) (770) ------------------ ------------------- ------------------- Cash flows from financing activities: Payments on senior term loans (12,500) (15,864) (19,721) Net loans to stockholders for stock purchases (3) - 63 ------------------ ------------------- ------------------- Net cash used in financing activities (12,503) (15,864) (19,658) ------------------ ------------------- ------------------- Net increase (decrease) in cash (323) (1,432) 68 Cash, beginning of period 1,453 2,885 2,817 ------------------ ------------------- ------------------- Cash, end of period $ 1,130 $ 1,453 $ 2,885 ================== =================== =================== Supplemental disclosures of cash flow information: Cash paid during the period for interest $ 18,466 $ 20,737 $ 21,563 ================== =================== =================== Cash paid during the period for income taxes - - - ================== =================== ===================
The accompanying notes are an integral part of the consolidated financial statements. F-4 NORTH ATLANTIC TRADING COMPANY, INC AND SUBSIDIARIES -------------------------------------------------------------------------------- CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' DEFICIT for the years ended December 31, 2001, 2000 and 1999 (dollars in thousands)
LOANS TO ACCUMULATED COMMON ADDITIONAL STOCKHOLDERS OTHER TOTAL STOCK, PAID-IN FOR STOCK COMPREHENSIVE ACCUMULATED STOCKHOLDERS' VOTING CAPITAL PURCHASES LOSS DEFICIT DEFICIT ------------ ------------- ------------ -------------- ----------------------------- Beginning balance, January 1, 1999 $ 5 $ 9,020 $ (247) $ - $ (24,146) $ (15,368) Compensation expense - 58 - - - 58 Net loans to stockholders for stock purchases - - 63 - - 63 Preferred stock dividend - - - - (5,361) (5,361) Net income - - - - 1,595 1,595 ------------ ------------- ------------ -------------- ----------------------------- Ending balance, December 31, 1999 5 9,078 (184) - (27,912) (19,013) Compensation expense - 33 - - - 33 Preferred stock dividend - - - (6,005) (5,361) Net loss - - - - (3,200) (3,200) ------------ ------------- ------------ -------------- ----------------------------- Ending balance, December 31, 2000 5 9,111 (184) - (37,117) (28,185) Compensation expense - 33 - - - 33 Net loans to stockholders for stock purchases - - (3) - - (3) Amount related to minimum pension liability - - - (348) - (348) Preferred stock dividend - - - - (6,745) (6,745) Net loss - - - - (1,364) (1,364) ------------ ------------- ------------ -------------- ----------------------------- Ending balance, December 31, 2001 $ 5 $ 9,144 $ (187) $ (348) $ (45,226) $ (36,612) ------------ ------------- ------------ -------------- -----------------------------
The accompanying notes are an integral part of the consolidated financial statements. F-5 NORTH ATLANTIC TRADING COMPANY, INC AND SUBSIDIARIES -------------------------------------------------------------------------------- NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 1. BASIS OF PRESENTATION: North Atlantic Trading Company, Inc. and Subsidiaries (the Company) manufactures and distributes tobacco and related products through its smokeless tobacco and make-your-own operating segments. The smokeless tobacco segment manufactures and distributes smokeless tobacco products under the Beech-Nut, Durango, Trophy and Havana Blossom brand names. The make-your-own segment imports and distributes premium cigarette papers, smoking tobaccos and related products under the Zig-Zag brand name. National Tobacco Company, L.P. (a limited partnership) was formed and acquired the smokeless tobacco division of Lorillard, Inc. in 1988. On April 14, 1992, the general partner and majority owner and certain limited partners sold their partnership interest to a new general partner. Accordingly, the April 1992 transaction was accounted for as the formation of a new entity, National Tobacco Company, L.P. (the Partnership). Certain members of management of the Partnership formed NTC Holding, LLC (the Holding Company), a limited liability company with a finite life expiring December 31, 2100, and caused the Holding Company to form National Tobacco Finance Corporation (the Finance Corporation), a wholly-owned subsidiary of the Holding Company. On May 17, 1996, the Partnership was recapitalized and the Holding Company acquired a 99% limited partnership interest in the Partnership and the Finance Corporation became the sole general partner and owner of the remaining 1% interest of the Partnership. Accordingly, this transaction was accounted for as the formation of a new entity under the purchase method of accounting. On May 19, 1997, certain members of management and holders of membership interests in the Holding Company formed a corporation named North Atlantic Trading Company, Inc. (the Corporation). On June 25, 1997, the Corporation acquired the membership interests in the Holding Company and the Holding Company transferred all of its assets, including its limited partnership interest in the Partnership, all of the capital stock of the Finance Corporation, and its rights to acquire NATC Holdings USA, Inc. (NATC). The Corporation then formed North Atlantic Operating Company, Inc. (NAOC), a Delaware corporation and wholly-owned subsidiary of the Corporation. NAOC then exercised its rights to acquire all of the outstanding capital stock of NATC. NATC and its wholly-owned subsidiary were then merged into NAOC. F-6 NORTH ATLANTIC TRADING COMPANY, INC AND SUBSIDIARIES -------------------------------------------------------------------------------- NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED 1. BASIS OF PRESENTATION, CONTINUED: On February 11, 2000, the Company entered into a definitive Asset Purchase Agreement with Swedish Match North American, Inc. ("Swedish Match"), under which the Company agreed to sell certain smokeless tobacco assets, including its chewing tobacco brands and related formulation, technology and inventory. The transaction was challenged by the Federal Trade Commission ("FTC") as anti-competitive under the antitrust laws. As a result of actions taken by the FTC, on December 22, 2000, the Company and Swedish Match mutually agreed to terminate the Asset Purchase Agreement. Costs related to the sale of $1.8 million, which had previously been deferred, have been recognized in other expenses for the year ended December 31, 2000. 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES: CONSOLIDATION: The consolidated financial statements include the consolidated accounts of the Corporation, the Finance Corporation, the Partnership and NAOC. All inter-company accounts have been eliminated. REVENUE RECOGNITION: The Company recognizes revenues and the related costs upon transfer of title and risk of loss to the customer. In December 1999, the Securities and Exchange Commission ("SEC") issued Staff Accounting Bulletin No. 101, "Revenue Recognition in Financial Statements" ("SAB 101"). The Company adopted SAB 101 effective January 1, 2000, resulting in a cumulative effect adjustment of $251,000 (net of tax benefit of $153,000) as of the date of adoption and a decrease in December 31, 2000 net income of $91,000 (net of tax benefit of $57,000). The change in accounting method would not have had a material effect on the statement of operations for the year ended 1999 if adopted in that year. SHIPPING COSTS: The Company records shipping costs incurred as a component of selling, general and administrative expenses. Shipping costs incurred were $2,560,000, $2,443,000 and $2,561,000 in 2001, 2000, and 1999, respectively. INVENTORIES: Inventories are stated at the lower of cost or market. Cost is determined on the last-in, first-out (LIFO) method. Leaf tobacco is presented in current assets in accordance with standard industry practice, notwithstanding the fact that such tobaccos are carried longer than one year for the purpose of curing. F-7 NORTH ATLANTIC TRADING COMPANY, INC AND SUBSIDIARIES -------------------------------------------------------------------------------- NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES, CONTINUED: FIXED ASSETS: Fixed assets are stated at cost less accumulated depreciation. Depreciation is provided using the straight-line method over the estimated useful lives of the related assets (4 to 7 years for machinery, equipment and furniture, and 25 years for buildings). Expenditures for repairs and maintenance are charged to expense as incurred. The costs of major renewals and betterments are capitalized and depreciated over their estimated useful lives. Upon disposition of fixed assets, the costs and related accumulated depreciation amounts are relieved and any resulting gain or loss is reflected in operations during the period of disposition. GOODWILL: The excess of purchase price over fair value of net assets acquired is amortized using the straight-line method over 40 years and 25 years for the Partnership and NAOC, respectively. The Company periodically reviews the appropriateness of the remaining life of its intangible assets considering whether any event has occurred or condition has developed which may indicate that the remaining life or the amortization method requires adjustment. After reviewing the appropriateness of the remaining life and the pattern of usage of the intangible assets, the Company then assesses the overall recoverability of intangible assets by determining if the unamortized balance can be recovered through undiscounted future operating cash flows. DEFERRED FINANCING COSTS: Deferred financing costs are amortized over the terms of the related debt obligations using the interest method. INCOME TAXES: The Company records the effects of income taxes under the liability method in which deferred income tax assets and liabilities are recognized based on the difference between the financial and tax basis of assets and liabilities using the enacted tax rates in effect for the years in which the differences are expected to reverse. ADVERTISING AND PROMOTION: Advertising and promotion costs are expensed as incurred. FINANCIAL INSTRUMENTS: The Company enters into foreign currency forward contracts to hedge its exposure to changes in foreign currency exchange rates primarily on inventory purchase commitments. The Company adopted Statement of Financial Accounting Standards No. 133 (SFAS 133), "Accounting for Derivative Instruments and Hedging Activities" on January 1, 2001, resulting in a cumulative effect adjustment to increase other comprehensive income by $28,000. Forward contracts that qualify as hedges are adjusted to their fair value through other comprehensive income as determined by market prices on the measurement date. Gains and losses on these contracts are transferred from other comprehensive income into net income as the related inventories are sold. STOCK-BASED COMPENSATION: The Company measures stock compensation costs related to the stock options described in Note 12 on the fair value based method which is the preferred method under the provisions of Statement of Financial Accounting Standards (SFAS) No. 123, "Accounting for Stock-Based Compensation." The fair value based method requires F-8 NORTH ATLANTIC TRADING COMPANY, INC AND SUBSIDIARIES -------------------------------------------------------------------------------- NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES, CONTINUED: compensation cost for stock options to be recognized based on the fair value of stock options granted. COMPUTATION OF NET LOSS PER COMMON SHARE: Basic net loss per common share has been computed by dividing the net loss applicable to common shares by the weighted average number of common shares outstanding during the period. Diluted net loss per share has been computed by dividing the net loss applicable to common shares by the weighted average number of common and common equivalent shares (warrants and stock options), where dilutive, outstanding during the period. RISKS AND UNCERTAINTIES: Smokeless and make-your-own tobacco companies, like other manufacturers and sellers of tobacco products, are subject to regulation at the federal, state and local levels. Such regulations include, among others, labeling requirements, limitations on advertising, and prohibition of sales to minors. The trend in recent years has been toward increased regulation of the tobacco industry. There can be no assurance as to the ultimate content, timing or effect of any regulation of tobacco products by any federal, state or local legislative or regulatory body, nor can there be any assurance that any such legislation or regulation would not have a material adverse effect on the Company's financial position, results of operations or cash flows. The tobacco industry has experienced and is experiencing significant product liability litigation. Most tobacco liability lawsuits have been brought against manufacturers and sellers of cigarettes for injuries allegedly caused by smoking or by exposure to smoke. However, several lawsuits have been brought against manufacturers and sellers of smokeless tobacco for injuries to health allegedly caused by use of smokeless tobacco. Typically, such claims assert that use of smokeless tobacco is addictive and causes oral cancer. As discussed in Note 16, the Partnership was named as a defendant in such a lawsuit. There can be no assurance that the Company will not sustain losses in connection with such lawsuits and that such losses will not have a material adverse effect on the Company's financial position, results of operations or cash flows or that additional lawsuits will not be brought against the Company. Further, in November 1998 most of the states, represented by their attorneys general acting through the National Association of Attorneys General (NAAG), signed two contracts: the Master Settlement Agreement (MSA) and the Smokeless Tobacco Master Settlement Agreement (STMSA). To the best of the Company's knowledge, the signatories to the MSA are 23 cigarette manufacturers and/or distributors and the only signatory to the STMSA is USST, Inc. In the Company's opinion, the fundamental basis for each agreement is the states' consents to withdraw all claims for monetary, equitable and injunctive relief against certain tobacco products manufacturers and others and, in return, the signatories have agreed to certain marketing restrictions and regulations as well as certain payment obligations. F-9 NORTH ATLANTIC TRADING COMPANY, INC AND SUBSIDIARIES -------------------------------------------------------------------------------- NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES, CONTINUED: RISKS AND UNCERTAINTIES, CONTINUED: Pursuant to the MSA and subsequent states' statutes, a "cigarette manufacturer" (which is defined to also include make-your-own cigarette tobacco) has the option of either becoming a signatory to the MSA or opening, funding and maintaining an escrow account, with subaccounts on behalf of each settling state. The STMSA has no similar provisions. The MSA escrow accounts are governed by states' statutes that expressly give the manufacturers the option of opening, funding and maintaining an escrow account in lieu of becoming a signatory to the MSA. The statutes require companies, who are not signatories to the MSA, to deposit, on an annual basis, into qualified banks escrow funds based on the number of cigarettes or cigarette equivalents, i.e., the pounds of MYO tobacco, sold. The purpose of these statutes is expressly stated to be to eliminate the cost disadvantage the settling manufacturers have as a result of settling. Such companies are entitled to direct the investment of the escrowed funds and withdraw any appreciation, but cannot withdraw the principal for twenty-five years from the year of each annual deposit, except to withdraw funds deposited pursuant to an individual state's escrow statute to pay a final judgment to that state's plaintiffs in the event of such a final judgment against the Company. Either option - becoming a MSA signatory or establishing an escrow account - is permissible. NAOC has chosen to open and fund an escrow account. There can be no assurance as to whether entering into one or both settlement agreements or choosing not to do so or establishing and maintaining an escrow account pursuant to the above would have a material adverse effect on the Company's financial position, results of operations or cash flows. Pursuant to the MSA escrow account statutes, the Company is required to deposit such funds for each calendar year into a qualifying escrow account by April 15 of the following year. As of December 31, 2001, the Company has recorded approximately $1,219,000 as an other non-current asset. During 2001, $401,772 was deposited into a qualifying escrow account bringing the total deposit balance to $510,392. As of December 31, 2001 the escrow balance is $527,740 which represents the total deposit balance plus $17,348 interest earned thereon. The remaining amount of approximately $691,000 relates to 2001 and will be deposited by April 15, 2002. The Company is entitled to direct the investment of the escrow funds and is allowed to withdraw any appreciation, but cannot withdraw the principal for twenty-five years from the year of each annual deposit, except to withdraw funds deposited pursuant to an individual state's escrow statute to pay a final judgment to that state's plaintiffs in the event of such a judgment against the Company. USE OF ESTIMATES: The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, disclosure of contingent assets and liabilities as of the dates of the financial statements and the reported amounts of revenues and expenses during the reporting periods. Actual results could differ from those estimates. The F-10 NORTH ATLANTIC TRADING COMPANY, INC AND SUBSIDIARIES -------------------------------------------------------------------------------- NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES, CONTINUED: Company's significant estimates include those affecting the valuation and useful lives of property, plant and equipment and goodwill, assumptions used in determining pension and postretirement benefit obligations, accrued and deferred income taxes and litigation contingencies. CONCENTRATION OF CREDIT RISK: At December 31, 2001 and 2000, the Company had bank deposits in excess of federally insured limits of approximately $2.6 million and $1.8 million, respectively. The Company sells its products to distributors and retail establishments throughout the United States. A single customer accounted for 10.1% and 10.2% of the Company's smokeless tobacco and make-your-own revenues in 2001 and 2000, respectively. The Company performs periodic credit evaluations of its customers and generally does not require collateral on trade receivables. Historically, the Company has not experienced significant credit losses. OTHER INCOME (EXPENSE): Other expense of $2.6 million in 2001 represents legal, investigative and related expenses with respect to the infringement activities involving Zig-Zag premium cigarette papers. Other expense of $1.8 million in 2000 represents legal fees and other costs associated with the proposed sale of the smokeless tobacco segment, which was terminated in December 2000. 3. FAIR VALUE OF FINANCIAL INSTRUMENTS: The following disclosure of the estimated fair value of financial instruments is made in accordance with the requirements of SFAS No. 107, "Disclosure About Fair Value of Financial Instruments," as amended by SFAS No. 126. The estimated fair value amounts have been determined by the Company using the methods and assumptions described below. However, considerable judgment is required to interpret market data to develop estimates of fair value. Accordingly, the estimates presented herein are not necessarily indicative of the amounts the Company could realize in a current market exchange. The use of different market assumptions and/or estimation methodologies may have a material effect on the estimated fair value amounts. CASH AND CASH EQUIVALENTS: Cash and cash equivalents are by definition short-term and the carrying amount is a reasonable estimate of fair value. ACCOUNTS RECEIVABLE: The fair value of accounts receivable approximates their carrying value. NOTES PAYABLE AND LONG-TERM DEBT: The fair value of the notes payable and long-term debt approximates their carrying value. F-11 NORTH ATLANTIC TRADING COMPANY, INC AND SUBSIDIARIES -------------------------------------------------------------------------------- NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED 4. INVENTORIES: The reduction of LIFO inventory quantities decreased net income of the Company by approximately $1.7 million and $1.5 million for the years ended December 31, 2001 and 2000, respectively. The components of inventories at December 31 are as follows (in thousands):
2001 2000 --------------------- -------------------- Raw materials and work in process $ 2,125 $ 2,354 Leaf tobacco 12,404 14,378 Finished goods - loose leaf tobacco 2,431 3,397 Finished goods - MYO products 4,694 4,288 Other 681 441 --------------------- -------------------- 22,335 24,858 LIFO reserve 21,632 24,314 --------------------- -------------------- $ 43,967 $ 49,172 ===================== ==================== The LIFO inventory value is in excess of its current estimated replacement cost by the amount of the LIFO reserve. 5. PROPERTY, PLANT AND EQUIPMENT: Property, plant and equipment at December 31 consists of (in thousands): 2001 2000 --------------------- -------------------- Land $ 654 $ 654 Buildings and improvements 3,745 3,633 Machinery and equipment 6,652 6,246 Furniture and fixtures 2,149 2,064 --------------------- -------------------- 13,200 12,597 Accumulated depreciation (7,967) (7,330) --------------------- -------------------- $ 5,233 $ 5,267 ===================== ====================
F-12 NORTH ATLANTIC TRADING COMPANY, INC AND SUBSIDIARIES -------------------------------------------------------------------------------- NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED 6. GOODWILL: Goodwill at December 31 consists of (in thousands):
2001 2000 --------------------- -------------------- Partnership goodwill, net of accumulated amortization of $4,500 and $3,701 at December 31, 2001 and 2000, respectively $ 27,450 $ 28,249 NAOC goodwill, net of accumulated amortization of $21,175 and $16,484 at December 31, 2001 and 2000, respectively 96,107 100,798 --------------------- -------------------- $ 123,557 $ 129,047 ===================== ==================== 7. OTHER ASSETS: Other assets at December 31, 2001 and 2000 includes loans and accrued interest to the principal shareholder of $1,413 and $1,037, respectively, and amounts related to the MSA escrow account of $1,219 and $487, respectively, as described in Note 2. 8. DEFERRED FINANCING COSTS: Deferred financing costs at December 31 consist of (in thousands): 2001 2000 --------------------- -------------------- Deferred financing costs, net of accumulated amortization of $6,146 and $4,761 at December 31, 2001 and 2000, Respectively $ 4,028 $ 5,360 ===================== ==================== 9. NOTES PAYABLE AND LONG-TERM DEBT: Notes payable and long-term debt at December 31 consists of (in thousands): 2001 2000 --------------------- -------------------- Senior notes $ 155,000 $ 155,000 Term borrowings under loan agreement 12,500 25,000 --------------------- -------------------- 167,500 180,000 Less current portion 12,500 12,500 --------------------- -------------------- $ 155,000 $ 167,500 ===================== ====================
F-13 NORTH ATLANTIC TRADING COMPANY, INC AND SUBSIDIARIES -------------------------------------------------------------------------------- NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED 9. NOTES PAYABLE AND LONG-TERM DEBT, CONTINUED: On June 25, 1997, the Company issued $155.0 million of 11% Senior Notes due 2004 (the Notes). The Notes are unsecured senior obligations of the Company which mature on June 15, 2004. The Notes bear interest at 11% per annum, payable semiannually on June 15 and December 15, to holders of record at the close of business on the June 1 or December 1 immediately preceding the interest payment date. The Notes have no mandatory redemption requirements; however, they are redeemable at the option of the Company at a redemption price of 102.75%, plus accrued interest, on or after June 15, 2002 or 100.0%, plus accrued interest, on or after June 15, 2003 and thereafter. In addition, in the event of a change in control of the Company, as defined, the holders have the right to require the Company to repurchase the Notes at a purchase price of 101.0% plus accrued interest. The Company has a loan agreement (the Loan Agreement) with a bank which provided borrowings of $25.0 million under a term facility and a revolver with available credit of up to $10.0 million. The borrowings under the term facility require quarterly principal payments over the two-year period through the maturity date of December 31, 2002, while the revolver may be repaid and reborrowed as necessary, with any unpaid amounts due and payable upon its termination date of December 31, 2002. Borrowings under the term facility and revolver bear interest per annum at variable rates based on prime or LIBOR rates at the Company's option. The interest rate on borrowings under the term facility ranged from 4.62% to 6.05% at December 31, 2001. In addition, the Company must pay a quarterly commitment fee of 0.5% per annum of the unused portion of the revolver. The Notes and the Loan Agreement include cross default provisions and limit the incurrence of additional indebtedness, dividends, transactions with affiliates, asset sales, acquisitions, mergers, prepayments of indebtedness, liens and encumbrances, and other matters. The Loan Agreement also requires the Company to meet a fixed charge coverage test. At December 31, 2001, the Company was in compliance with all provisions of the Notes and the Loan Agreement. Scheduled maturities (exclusive of future mandatory prepayments, if any) of the Company's notes payable and long-term debt are as follows (in thousands): Through December 31, 2002 $ 12,500 Through December 31, 2003 - Through December 31, 2004 155,000 --------------------- $ 167,500 ===================== F-14 NORTH ATLANTIC TRADING COMPANY, INC AND SUBSIDIARIES -------------------------------------------------------------------------------- NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED 10. INCOME TAXES: The income tax provision for the years ended December 31, 2001, 2000 and 1999 consists of the following components (in thousands):
2001 2000 1999 ---------------------- ---------------------- --------------------- Deferred: Federal $ 1,828 $ 839 $ 3,609 State and local 215 16 204 ---------------------- ---------------------- --------------------- $ 2,043 $ 855 $ 3,813 ====================== ====================== =====================
Deferred tax assets and liabilities at December 31, 2001 and 2000 consist of (in thousands):
2001 2000 --------------------------------- --------------------------------- ASSETS LIABILITIES ASSETS LIABILITIES --------------------------------- --------------------------------- Inventory $ 9,542 $ 10,149 Property, plant and equipment $ 821 $ 703 Goodwill 13,992 17,031 Accrued pension and postretirement costs 3,839 3,166 NOL carryforward 6,802 7,336 Other 1,190 1,058 --------------------------------- --------------------------------- Deferred income taxes $ 26,644 $ 9,542 $ 29,294 $ 10,149 ================================= =================================
At December 31, 2001, the Company had NOL carryforwards for income tax purposes of $17.9 million which expire in the years beginning in 2012. The Company has determined that at December 31, 2001 its ability to realize future benefits of net deferred tax assets meets the "more likely than not" criteria in SFAS No. 109, "Accounting for Income Taxes"; therefore, no valuation allowance has been recorded. F-15 NORTH ATLANTIC TRADING COMPANY, INC AND SUBSIDIARIES -------------------------------------------------------------------------------- NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED 10. INCOME TAXES, CONTINUED: Reconciliation of the federal statutory rate and the effective income tax rate for the years ended December 31, 2001, 2000 and 1999 is as follows:
2001 2000 1999 ------------------ ------------------ ------------------ Federal statutory rate 35.0% (35.0)% 35.0% tate taxes S 24.3 3.2 5.7 Goodwill amortization 241.8 70.0 30.4 Other (0.7) (1.8) (0.6) ------------------ ------------------ ------------------ Effective income tax rate 300.4% 36.4% 70.5% ================== ================== ==================
11. PENSION AND POSTRETIREMENT BENEFIT PLANS: The Company has defined benefit pension plans covering substantially all of its employees. Benefits for the hourly employees' plan are based on a stated benefit per year of service, reduced by amounts earned in a previous plan. Benefits for salaried employees are based on years of service and the employees' final compensation. The Company sponsors two defined benefit postretirement plans that cover both salaried and hourly employees. One plan provides medical and dental benefits, and the other provides life insurance benefits. The post-retirement health care plan is contributory, with retiree contributions adjusted annually; the life insurance plan is noncontributory. F-16 NORTH ATLANTIC TRADING COMPANY, INC AND SUBSIDIARIES -------------------------------------------------------------------------------- NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED 11. PENSION AND POSTRETIREMENT BENEFIT PLANS, CONTINUED: The following tables provide a reconciliation of the changes in the plans' benefit obligations and fair value of assets over the two-year period ended December 31, 2001, and a statement of the funded status as of December 31 (in thousands):
PENSION BENEFITS POSTRETIREMENT BENEFITS ----------------------------------- ----------------------------------- 2001 2000 2001 2000 ----------------------------------- ----------------------------------- Reconciliation of benefit obligation: Benefit obligation at January 1 $ 10,163 $ 10,110 $ 5,887 $ 5,044 Service cost 558 515 379 320 Interest cost 738 682 435 396 Actuarial loss (gain) 257 (758) 175 314 Benefit paid (436) (386) (181) (187) ----------------------------------- ----------------------------------- Benefit obligation at December 31 $ 11,280 $ 10,163 $ 6,695 $ 5,887 =================================== =================================== Reconciliation of fair value of plan assets: Fair value of plan assets at January 1 $ 8,640 $ 8,648 Actual return on plan assets (510) 270 Employer contributions 35 109 $ 181 187 Benefit paid (436) (387) (181) (187) ----------------------------------- ----------------------------------- Fair value of plan assets at December 31 $ 7,729 $ 8,640 $ - $ - =================================== =================================== Funded status: Funded status at December 31 $ (3,551) $ (1,523) $ (6,695) $ (5,887) Unrecognized prior service cost 8 8 Unrecognized net (gain) loss 194 (1,320) (571) (764) ----------------------------------- ----------------------------------- Net amount recognized $ (3,349) $ (2,835) $ (7,266) $ (6,651) =================================== =================================== The following table provides the amounts recognized in the balance sheets as of December 31 (in thousands): PENSION BENEFITS POSTRETIREMENT BENEFITS ----------------------------------- ---------------------------------- 2001 2000 2001 2000 ----------------------------------- ---------------------------------- Accrued benefit cost $ (3,349)$ (2,835) $ (7,266) $ (6,651) Minimum pension liability (348) - - - Accumulated other comprehensive income 348 - - - ----------------------------------- ---------------------------------- Net amount recognized $ (3,349)$ (2,835) $ (7,266) $ (6,651) =================================== ==================================
F-17 NORTH ATLANTIC TRADING COMPANY, INC AND SUBSIDIARIES -------------------------------------------------------------------------------- NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED 11. PENSION AND POSTRETIREMENT BENEFIT PLANS, CONTINUED: The following table provides the components of net periodic pension and postretirement benefit costs for the plans for the years ended December 31 (in thousands):
PENSION BENEFITS POSTRETIREMENT BENEFITS ----------------------------------------- ----------------------------------------- 2001 2000 1999 2001 2000 1999 ----------------------------------------- ----------------------------------------- Service cost $ 558 $ 515 $ 651 $ 379 $ 320 $ 335 Interest cost 738 682 631 435 396 348 Expected return on plan assets (716) (738) (676) - - - Amortization of gains and losses (31) (149) (12) (18) (64) (5) ----------------------------------------- ----------------------------------------- Net periodic benefit cost $ 549 $ 310 $ 594 $ 796 $ 652 $ 678 ========================================= ========================================= The weighted average assumptions used in the measurement of the Company's benefit obligation are as follows: PENSION BENEFITS POSTRETIREMENT BENEFITS ----------------------------------------- ----------------------------------------- 2001 2000 1999 2001 2000 1999 --------------------------- ------------- --------------------------- ------------- Discount rate 7.25% 7.50% 8.00% 7.25% 7.50% 8.00% Expected return on plan assets 8.50% 8.50% 8.50% - - - Rate of compensation increase 4.00% 4.00% 4.00% - - -
For measurement purposes, the assumed health care cost trend rate for participants under age 65 as of December 31, 2001 and 2000 was 7.5% and 8.0%, respectively, and for participants age 65 and over the rate was 6.5% and 7.0%, respectively. The health care cost trend rate was assumed to decline gradually to 5% for pre-age 65 and for post-age 65 costs over 27 years. Assumed health care cost trend rates have a significant effect on the amounts reported for the postretirement benefit plans. A 1% change in assumed health care cost trend rates would have the following effects (in thousands):
2001 2000 1999 ------------------ ------------------ ----------------- Effect on total of service and interest cost components of net periodic postretirement Cost $ 3 $ 2 $ 2 Effect on the health care component of the accumulated postretirement benefit Obligation 35 32 27
F-18 NORTH ATLANTIC TRADING COMPANY, INC AND SUBSIDIARIES -------------------------------------------------------------------------------- NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED 11. PENSION AND POSTRETIREMENT BENEFIT PLANS, CONTINUED: The Company also sponsors a voluntary retirement savings plan (401(k)). Eligible employees may elect to contribute up to 15% of their annual earnings subject to certain limitations. Through December 31, 1998, the Company matched 50% of each eligible participant's contribution up to 5% of the participant's compensation for the plan year. Beginning January 1, 1999, the Company changed its matching contribution policy. The Company match for the Hourly employee was increased to 66.7% of each eligible participant's contribution up to 6% of compensation for the plan year. The Company match for the Salaried employees was increased to the greater of (1) 66.7% of each eligible participant's contribution up to 6% of compensation, or (2) 100% of the first 3% plus 50% of the next 2% of each eligible participant's contribution. Company matching is subject to a vesting schedule. Additional discretionary matching contributions by the Company are determined annually by the Board of Directors. Company matching contributions to this plan were approximately $0.3 million for each of the years ended December 31, 2001, 2000 and 1999. 12. MANDATORILY REDEEMABLE PREFERRED STOCK: On December 31, 2001 and 2000, the Company had authorized 12 million shares of 12% Senior Payment-In-Kind Preferred Stock (the Preferred Stock) of which 2.32 million shares and 2.06 million shares, respectively, were issued and outstanding. Each share of Preferred Stock has a par value of $0.01 and a liquidation preference of $25, for total liquidation values of approximately $58.1 million and $51.5 million at December 31, 2001 and 2000, respectively. Prior to June 15, 2002, holders of the Preferred Stock are entitled to receive dividends at an annual rate of 12% of the liquidation preference, payable quarterly in cash or by the issuance of additional shares of Preferred Stock having an aggregate liquidation preference equal to the amount of the dividends, at the Company's option. Following June 15, 2002, dividends shall be payable in cash. Such quarterly dividend payments are subject to being able to access and to the availability of the Restricted Payments provision, as defined in the documentation governing the Notes and the Preferred Stock. Preferred stock dividends, including the interest accretion described below, for the years ended December 31, 2001, 2000 and 1999 were $6.7 million, $6.0 million, and $5.4 million, respectively, which were recorded as an increase in the carrying value of the Preferred Stock. On June 25, 1997, the holders of the Preferred Stock were issued warrants, with an original fair value of $1.7 million, to purchase 44,440 shares of common stock of the Company for $0.01 per share, exercisable immediately. The original fair value of these warrants has been recorded in equity, with a corresponding amount recorded as a discount on the carrying value of the Preferred Stock. This discount is being amortized under the interest method over the 10-year term of the Preferred Stock as a part of the annual preferred stock dividend requirement. Amortization of the discount was $0.2 million for each of the years ended December 31, 2001, 2000 and 1999. F-19 NORTH ATLANTIC TRADING COMPANY, INC AND SUBSIDIARIES -------------------------------------------------------------------------------- NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED 12. MANDATORILY REDEEMABLE PREFERRED STOCK, CONTINUED: Prior to June 15, 2000, the Company had the option, subject to certain restrictions, to redeem up to 35% of the Preferred Stock from the net cash proceeds from any one or more public equity offerings of the Company, for 112% of the Liquidation preference plus all accumulated and unpaid dividends. The Preferred Stock is not redeemable from June 16, 2000 to June 15, 2002. The Preferred Stock is then redeemable, at the Company's option, on or after the following dates at the indicated redemption prices (expressed as a percentage of the liquidation preference) plus all accumulated and unpaid dividends: June 15, 2002 - 106%; June 15, 2003 - 104%; June 15, 2004 - 102%; and June 15, 2005 - 100%. The Preferred Stock is mandatorily redeemable on June 15, 2007 at a price equal to the liquidation preference plus all accumulated and unpaid dividends. The Preferred Stock is also redeemable, at the option of the holders, upon a change in control of the Company, as defined, at a price equal to 101% of the liquidation preference plus all accumulated and unpaid dividends. Persons affiliated with the initial purchases of the Preferred Stock were also issued warrants, with an original fair value of $0.7 million, to purchase 19,050 shares of common stock of the Company for $0.01 per share, exercisable immediately. The original fair value of these warrants has been recorded in equity, with a corresponding amount capitalized and included in deferred financing costs. 13. SHARE INCENTIVE PLAN: The Company has a share incentive plan covering certain key employees which provides for the grant of options to purchase common stock of the Company and other stock related benefits. As of December 31, 2001, no benefits other than the stock options described below had been granted. The total number of shares available for granting under the plan is 61,856. Stock option activity is summarized below:
WEIGHTED WEIGHTED AVERAGE AVERAGE INCENTIVE EXERCISE GRANT DATE SHARES PRICE FAIR VALUE ------------------ ------------------ ----------------- Outstanding, December 31, 1999 59,760 $ 18.19 $ 26.51 Granted 2,000 18.19 26.51 Exercised - - - Forfeited - - - ------------------ ------------------ ----------------- Outstanding, December 31, 2000 61,760 18.19 26.51 ------------------ ------------------ ----------------- Granted - - - Exercised - - - Forfeited - - - ------------------ ------------------ ----------------- Outstanding, December 31, 2001 61,760 $ 18.19 $ 26.51 ================== ================== =================
F-20 NORTH ATLANTIC TRADING COMPANY, INC AND SUBSIDIARIES -------------------------------------------------------------------------------- NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED 13. SHARE INCENTIVE PLAN, CONTINUED: Of the stock options outstanding on December 31, 2001, 57,760 were exercisable, with an additional 4,000 becoming exercisable in 2002 through 2004. All stock options expire 15 years from the grant date. The Company estimates that all of the stock options granted will be exercised and that the expected life of all stock options is five years from the date of grant. The weighted average fair value of the options was determined as the difference between the fair value of the common stock on the grant date and the present value of the exercise price over the expected life of five years at a risk free interest rate of 6%, with no assumed dividend yield. A significant percentage of the stock options described above includes a provision under which the Company will reimburse the employee for the difference between their ordinary income tax liability and the liability computed using the capital gains rate in effect upon exercise of the options. The effect of this provision is accounted for as a variable portion of the option plan. The Company has recorded compensation expense related to the options based on the provisions of SFAS No. 123 under which the fixed portion of such expense is determined as the fair value of the options on the date of grant and amortized over the vesting period. The variable portion of the compensation expense is remeasured on each reporting date with the expense amount adjusted for changes in the fair value of the company stock on that date. Compensation expense of $33,000, $33,000 and $70,000 ($20,000, $20,000 and $43,000 net of deferred income tax benefit) has been recognized in the statements of operations for the years ended December 31, 2001, 2000 and 1999, respectively. F-21 NORTH ATLANTIC TRADING COMPANY, INC AND SUBSIDIARIES -------------------------------------------------------------------------------- NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED 14. INCOME (LOSS) PER COMMON SHARE RECONCILIATION (DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS):
FOR THE YEAR ENDED DECEMBER 31, 2001 -------------------------------------------------------------- INCOME SHARES PER SHARE (NUMERATOR) (DENOMIMATOR) AMOUNT -------------------------------------------------------------- Net loss $ (1,364) Less: Preferred stock dividends (6,745) ----------------- Basic and diluted: Net loss available to common stockholders $ (8,109) 528,241 $ (15.35) ============================================================== FOR THE YEAR ENDED DECEMBER 31, 2000 -------------------------------------------------------------- INCOME SHARES PER SHARE (NUMERATOR) (DENOMIMATOR) AMOUNT -------------------------------------------------------------- Net loss before extraordinary loss and cumulative effect of change in accounting principle $ (2,099) Extraordinary loss, net of income tax benefit (850) Cumulative effect of change in accounting principle, net of income tax benefit (251) Less: Preferred stock dividends (6,005) ----------------- Basic and diluted: Net loss available to common stockholders $ (9,205) 528,241 $ (17.43) ============================================================== FOR THE YEAR ENDED DECEMBER 31, 1999 -------------------------------------------------------------- INCOME SHARES PER SHARE (NUMERATOR) (DENOMIMATOR) AMOUNT -------------------------------------------------------------- Net income $ 1,595 Less: Preferred stock dividends (5,361) ----------------- Basic and diluted: Net loss available to common stockholders $ (3,766) 528,241 $ (7.13) ==============================================================
The calculations above are based on the weighted average number of shares of common stock outstanding during the year. Common equivalent shares from stock options of 61,760 and warrants of 63,490 are excluded from the computations as their effect is antidilutive. F-22 NORTH ATLANTIC TRADING COMPANY, INC AND SUBSIDIARIES -------------------------------------------------------------------------------- NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED 15. EXTRAORDINARY LOSS: Upon the refinancing of the Company's term loan on December 29, 2000 as described in Note 8, the Company recorded an extraordinary loss of $0.9 million (net of tax benefit of $0.5 million) for the write-off of related deferred financing costs. 16. FOURTH QUARTER ADJUSTMENT: The fourth quarters of 2001 and 2000 include adjustments to increase the income tax provision by approximately $1,490,000 and $1,140,000, respectively, as a result of the year-end income tax computations. The fourth quarter 2000 also included an adjustment to increase the LIFO expense by approximately $1.5 million, net of income tax of approximately $0.9 million. 17. CONTINGENCIES: PROPOSITION 65. On March 30, 1998, an action was filed in California State Court, in the City and County of San Francisco, against defendants United States Tobacco Company, Inc., Conwood Company, L.P., Pinkerton Tobacco Company, Inc., National Tobacco, Swisher International Group Inc., Brown & Williamson Tobacco Corporation, Merrill Reese Inc., Lucky Stores Inc., Quick Stop Markets Inc., Raley's, Inc., Save Mart Supermarkets Inc., Save-On Drug Stores Inc., The Southland Corporation, Circle K Stores, Inc., Longs Drug Stores Corporation, Walgreen Co., Safeway, Inc. and DOES 1-500. The plaintiff amended their claim on June 10, 1998 and subsequently served the complaint on National Tobacco. The complaint purported to be brought by the City and County of San Francisco on behalf of the people of the State of California and by the Environmental Law Foundation on behalf of the general public. Plaintiffs claimed that the defendants violated the California Safe Drinking Water and Toxic Enforcement Act of 1986, Health and Safety Code 25249.6 ("Proposition 65") by "knowingly and intentionally" exposing California consumers to carcinogens and reproductive toxins in smokeless tobacco products while failing to provide a "clear and reasonable" warning that smokeless tobacco products contain substances that are "known to the state to cause cancer" and "known to the state to cause reproductive toxicity." Plaintiffs further claimed that the defendants violated California Unfair Competition Act, Business & Professions Code 17200, et seq., by marketing smokeless tobacco to children, and by fraudulently concealing from the public the alleged adverse consequences and addiction allegedly associated with smokeless tobacco products. The complaint sought a preliminary and permanent injunction preventing defendants from selling smokeless tobacco products without a "clear and reasonable" warning, as well as an injunction ordering defendants to undertake a court-approved public information campaign to instruct children that the use of smokeless tobacco products results in exposure to substances F-23 NORTH ATLANTIC TRADING COMPANY, INC AND SUBSIDIARIES -------------------------------------------------------------------------------- NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED 17. CONTINGENCIES, CONTINUED: known to the State of California to cause cancer and reproductive harm. The plaintiffs also sought an award of statutory penalties and damage for each violation of Proposition 65 and the Unfair Competition Act, disgorgement of profits from the sale of smokeless tobacco products, and attorney's fees and costs. On December 17, 2001 the case was settled. The terms of the settlement were immaterial to National Tobacco's results. KENTUCKY AND ILLINOIS COMPLAINTS. On July 15, 1998, NAOC and National Tobacco filed a complaint against Republic Tobacco, Inc. and its affiliates ("Republic Tobacco") in Federal District Court for the Western District of Kentucky. The complaint was subsequently amended on August 18, 1998 (collectively, the complaint and the amended complaint are referred to herein as the "Kentucky Complaint"). Republic Tobacco imports and sells Roll-Your-Own ("RYO") cigarette papers under the JOB and TOP as well as other brand names. The Kentucky Complaint alleges, inter alia, that Republic Tobacco's use of exclusivity agreements, rebates, incentive programs, buy-backs and other activities related to the sale of premium cigarette papers in the southeastern United States violate federal and state antitrust and unfair competition laws. The Kentucky Complaint also alleges that Republic Tobacco has defaced and directed others to deface NAOC's point of purchase vendor displays for premium cigarette papers by covering up the Zig-Zag brand name and advertising material with advertisements for Republic Tobacco's RYO cigarette paper brands. The Kentucky Complaint alleges that these activities constitute unfair competition under the federal and state law. On June 30, 1998, Republic Tobacco filed a complaint against the Company, NAOC and National Tobacco in the United States District Court of the Northern District of Illinois. Republic Tobacco did not serve this complaint or otherwise notify the Company of its existence until after the filing and service of the Kentucky Complaint. The Company believes that this complaint was filed in anticipation of the filing of the Kentucky Complaint. This complaint was amended by Republic Tobacco on September 16, 1998 (collectively, the complaint and the amended complaint are referred to herein as the "Illinois Complaint"). In the Illinois Complaint, Republic Tobacco seeks declaratory relief that (a) Republic Tobacco's action in defacing the Company's point of purchase display vendors do not violate federal or state laws and (b) that Republic Tobacco's trade practices do not violate federal or state antitrust or unfair competition laws. In addition, the Illinois Complaint alleges that certain actions taken by the Company to inform its customers of its claims against Republic Tobacco constitute tortuous interference with customer relationships, false advertising, violations of Uniform Deceptive Trade Practices and Consumer Fraud Acts, defamation and unfair competition. In addition, although not included in its original complaint but in its amended complaint, Republic Tobacco alleges that the Company has unlawfully monopolized and attempted to monopolize the market for premium cigarette papers. F-24 NORTH ATLANTIC TRADING COMPANY, INC AND SUBSIDIARIES -------------------------------------------------------------------------------- NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED 17. CONTINGENCIES, CONTINUED: The Company has counterclaimed alleging that Republic Tobacco's trade practices in the southeastern United States have unlawfully restricted North Atlantic Operating Company's ability to expand the distribution of Zig-Zag premium cigarette papers in the southeast, where sales have been historically underdeveloped. The Company intends to vigorously pursue its claims set forth in the Kentucky and Illinois Complaints and intends to vigorously defend against the claims asserted in the Illinois Complaint. With respect to the claims set forth in the Illinois Complaint, the Company filed a Motion to Dismiss concerning a substantial portion of the claims against the Company, and believes that the claims against the Company are without merit. On April 9, 1999, the Court in the Illinois case dismissed certain of Republic's claims against the Company, including Republic's monopolization claim. The Court also dismissed the Company's counterclaims with leave to replead those claims. The Company has done so. On September 17, 1999, Republic filed a Second Amended Complaint, which was substantially identical to the original complaint, except that it alleged a series of purportedly monopolistic practices on a regional market basis against the Company. The Company filed a motion to dismiss the allegations for failure to state a claim on which relief could be granted. On December 23, 1999, the Court dismissed the antitrust claims in Republic's Second Amended Complaint. On October 20, 2000 Republic filed a motion to dismiss, stay, or transfer the Kentucky proceeding to the Illinois Court. On December 19, 2000, the Court denied Republic's motion, holding that it was premature. The Court noted also that it had communicated with the Court in Illinois and that it had concluded that Republic may not be entitled to any preference on forum selection which would ordinarily be given because it was first to file. During 2001, expert discovery was completed. Subsequently, both parties have moved for summary judgment on the others claims. These motions for summary judgment are now pending before the Court. WEST VIRGINIA COMPLAINTS. On October 6, 1998 National Tobacco was served with a summons and complaint in an action in the Circuit Court of Kanawha County, West Virginia, entitled Kelly Allen, et al. v. Philip Morris Incorporated, et al. (Civil Action Nos. 98-C-2401). While National Tobacco was served with a single service and complaint, the caption lists 65 separate plaintiffs, each with an individual case number. On November 13, 1998, National Tobacco was served with a summons and complaint in an action in the Circuit Court of Kanawha County, West Virginia, entitled Billie J. Akers, et al. v. Philip Morris Incorporated et al. (Civil Action Nos. 98-C-2696 to 98-C-2713). While National Tobacco was served with a single summons and complaint, the caption of the complaint lists 18 separate plaintiffs, each with an individual case number. This action was filed by the same F-25 NORTH ATLANTIC TRADING COMPANY, INC AND SUBSIDIARIES -------------------------------------------------------------------------------- NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED 17. CONTINGENCIES, CONTINUED: plaintiffs' attorney who filed the Allen action and the complaint is identical in most material respects. These two actions were commenced by two separate plaintiffs, "individually and/or as the representatives of the various descendants named herein [who] are residents of the State of West Virginia and/or smoked cigarettes or used other tobacco products, manufactured, promoted, advertised, marked, sold and/or distributed by all defendants." The complaints contain no specific allegations referring to any individual plaintiff. These two actions were brought against major manufacturers of cigarettes, smokeless tobacco products, and certain other organizations. The complaints allege that "plaintiffs and plaintiffs' descendents suffer/had suffered from a form of cancer or vascular disease and other injuries due wholly or in part to defendants' products and/or activities." The complaints further allege that the actions "arise from decades of intentionally wrongful conduct by the defendants who have manufactured, promoted, and sold cigarettes and both smokeless and loose tobacco to the plaintiffs and plaintiffs descendants and millions of Americans while knowing, but denying and concealing that their products cause diseases, including but not limited to esophageal, laryngeal, pharyngeal, mouth and throat cancers and Buerger's Disease." The complaints do not identify which plaintiffs, if any, allege injury as a result of the use of smokeless tobacco. The complaints seek unspecified compensatory damages. The Company intends to vigorously defend against each such complaint. In the Allen case, the plaintiffs have specified the defendant companies for each of the 65 cases. National Tobacco was named in only six of the cases, five of which allege consumption, prior to the formation of National Tobacco, of products bearing the trademarks currently owned by National Tobacco. The remaining case alleges lung cancer as the injury. In subsequent discovery, the remaining plaintiff testified that his only use of Beech-Nut chewing tobacco predated National Tobacco's acquisition of the brand. National Tobacco has been dismissed from the first five cases, and intends to vigorously defend the remaining action. The Akers complaint asserts 24 unspecified counts and seeks referral to the West Virginia Mass Litigation Panel, because the actions allegedly "involve multiple plaintiffs pursuing related claims or actions involving one or more common questions of act or law and the plaintiffs seek damages caused by some "product." Discovery of all tobacco-related (cigarette, cigar and smokeless products) actions in the State of West Virginia, including the Allen and Akers cases, has been referred to a Mass Litigation Panel, and assigned to one judge. On January 11, 2000, the judge assigned the cases issued an order concerning discovery schedules and establishing a trial procedure for the purpose of trying all issues of law and fact common to all defendants. On February 29, 2000, West F-26 NORTH ATLANTIC TRADING COMPANY, INC AND SUBSIDIARIES -------------------------------------------------------------------------------- NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED 17. CONTINGENCIES, CONTINUED: Virginia plaintiffs' counsel, pursuant to the court's order, identified all individual plaintiffs and the defendants against whom they had claims. No individual plaintiff in the Akers cases alleged use of a product manufactured by National Tobacco, although National Tobacco remains a defendant in those actions. In subsequent discovery, one Akers plaintiff alleged use of a National Tobacco product. However, that plaintiff alleges that he has lung cancer. On September 14, 2000, National Tobacco was served with a Summons and Consolidated Complaint filed in Circuit Court of Ohio County, West Virginia, entitled Linda Adams, et al. v. Philip Morris Inc., et al. (Civil Action Nos. 00-C-373 to 00-C-911). While National Tobacco was served with a single Summons and Consolidated Complaint, the caption of the Consolidated Complaint lists 539 separate plaintiffs, each with an individual case number. Only one of these plaintiffs alleged use of a product currently manufactured by National Tobacco. The time period during which this plaintiff allegedly used the product has not yet been specified. Thus, it is not yet known whether National Tobacco is a proper defendant in this case. On September 19, 2000, National Tobacco was served with a Summons and Consolidated Complaint filed in Circuit Court of Ohio County, West Virginia, entitled Ronald Accord, et al. v. Philip Morris Inc., et al. (Civil Action Nos. 00-C-923 to 00-C-1483). While National Tobacco was served with a single Summons and Consolidated Complaint, the caption of the Consolidated Complaint lists 561 separate plaintiffs, each with an individual case number. A total of five of these plaintiffs allege use of a product currently manufactured by National Tobacco. One of these plaintiffs does not specify the time period during which the product was allegedly used, and one alleges use that covers, in part, a period when National Tobacco did not manufacture the product. Of the remaining three, one alleges consumption of a competitor's chewing tobacco from 1966 to 2000 and National Tobacco's Beech-Nut chewing tobacco from 1998 to 2000; another alleges a twenty-four year smoking history ending in 1995 and consumption of Beech-Nut chewing tobacco from 1990 to 1995; and the last alleges a thirty-five year smoking history ending in 2000, and consumption of National Tobacco's Durango Ice chewing tobacco from 1990 to 2000 (although Durango Ice did not come onto the market until 1999). In November 2001, National Tobacco was served with four separate summonses and complaints in actions filed in the Circuit Court of Ohio County, West Virginia. The actions entitled Donald Nice v. Philip Morris Incorporated, et al., (Civil Action No. 01-C-479), Korene S. Lantz v. Philip Morris Incorporated, et al., (Civil Action No. 01-C-480), Ralph A. Prochaska, et al. v. Philip Morris, Inc., et al., (Civil Action No. 01-C-481), and Franklin Scott, et al. v. Philip Morris, Inc., et al., (Civil Action No. 01-C-482). Allege that the individual plaintiffs suffer from various diseases including emphysema, heart disease, lung cancer, arterial blockage, and "addiction" to nicotine, allegedly resulting from the use of various tobacco F-27 NORTH ATLANTIC TRADING COMPANY, INC AND SUBSIDIARIES -------------------------------------------------------------------------------- NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED 17. CONTINGENCIES, CONTINUED: products, none of which is or has ever been manufactured by National Tobacco. The Plaintiffs in these four actions also allege a conspiracy among "the Tobacco Defendants ...to mislead, deceive and confuse the government, the public, and West Virginia Plaintiffs, concerning the harmful effects of their products on the health of individuals, that nicotine is the active addictive component in manufactured tobacco products, and that defendants artificially, intentionally and scientifically manipulate nicotine delivery in manufactured tobacco products to ensure that users remain addicted. . . ." These actions were brought against major manufacturers of cigarettes, smokeless tobacco products (including National Tobacco) and other tobacco products, and certain other organizations. The four complaints assert counts alleging negligence and negligent misrepresentation, strict liability/failure to warn prior to 1970 and strict liability/design defect of unreasonably dangerous product, false representation, deceit, fraudulent concealment, civil conspiracy, breach of express and implied warranty, punitive damages, violations of the West Virginia general consumer protection and antitrust acts and loss of consortium. The complaints seek unspecified compensatory and punitive damages. These four actions have also been consolidated with the cases pending before the West Virginia Mass Litigation Panel. National Tobacco intends to vigorously defend these actions. Trial of these matters was planned in two phases. In the initial phase, a trial was to be held to determine whether tobacco products, including all forms of smokeless tobacco, cigarettes, cigars and pipe and roll-your-own tobacco, can cause certain specified diseases or conditions. In the second phase, individual plaintiffs would attempt to prove that they were in fact injured by tobacco products. Fact and expert discovery in these cases has closed, however, in the cigarette cases the Court has allowed additional discovery. The trial of the smokeless tobacco cases has been postponed indefinitely. The manufacturers of smokeless tobacco products (as well as the manufacturers of cigarettes) moved to sever the claims against the smokeless tobacco manufacturer defendants from the claims against the cigarette manufacturer defendants. That motion was granted, thus, the trial date on the smokeless tobacco claims has now been postponed indefinitely. MINNESOTA COMPLAINT. On September 24, 1999, National Tobacco was served with a complaint in a case entitled Tuttle v. Lorillard Tobacco Company, et al. (Case No. C2-99-7105), brought in Minnesota. The other manufacturing defendants are Lorillard and The Pinkerton Tobacco Company. The Complaint alleges that plaintiff's decedent was injured as a result of using National Tobacco's (and, prior to the formation of National Tobacco, Lorillard's) Beech-Nut brand and Pinkerton's Red Man brand of loose-leaf chewing tobacco. Plaintiff asserts theories of liability, breach of warranty, fraud, and variations on fraud and misrepresentation. The case has been removed to federal court. Motions to dismiss were filed F-28 NORTH ATLANTIC TRADING COMPANY, INC AND SUBSIDIARIES -------------------------------------------------------------------------------- NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED 17. CONTINGENCIES, CONTINUED: on all counts except for negligence and, on September 28, 2000, the Court granted all of National Tobacco's motions. The sole cause of action remaining is for negligence. The Court, however, granted leave to the plaintiff to replead within sixty days those alleged causes of action based on alleged fraud. On December 18, 2000, the Plaintiff filed an amended complaint reasserting fraud claims. On January 19, 2001, defendants again moved to dismiss the fraud claims. On July 5, 2001, the Court dismissed one of plaintiff's statutory fraud counts, but held that the remaining fraud courts were adequately pleaded. Discovery is continuing as to the remaining claims. The Court has ordered that the case be ready for trial in February 2003. Although the Company believes that it has good defenses to the above actions in West Virginia and Minnesota and it intends to vigorously defend each such action, no assurances can be given that it will prevail. If any of the plaintiffs were to prevail, the results could have a materially adverse effect on the Company's financial position, results of operations and cash flows. TEXAS INFRINGING PRODUCTS LITIGATION. In Bollore, S.A. v. Import Warehouse, Inc., Civ. No. 3-99-CV-1196-R (N.D. Texas), Bollore, the Company's Licensor of Zig-Zag brand cigarette papers, obtained a sealed order allowing it to conduct a seizure of infringing and counterfeit Zig-Zag products in the United States. On June 7, 1999, seizures of products occurred in Michigan and Texas. Subsequently, all named defendants have been enjoined from buying and selling such infringing or counterfeit goods. Bollore and the Company have negotiated settlements with one group of defendants, including Import Warehouse Inc. and its owner/operator Ravi Bhatia. Those settlements included a consent injunction against distribution of infringing or counterfeit goods. Management believes that successful prosecution of this litigation, either by settlement or otherwise, will have a favorable impact on its future premium cigarette paper business. On May 18, 2001, the Company, in conjunction with Bollore, conducted raids on the businesses and homes of certain defendants previously enjoined from selling infringing or counterfeit Zig-Zag(R) brand products in the Bollore S.A. v. Import Warehouse litigation. Evidence was uncovered that showed that these defendants and certain other individuals were key participants in importing and distributing the counterfeit Zig-Zag(R) cigarette papers. After a two day hearing in the U.S. District Court for the Northern District of Texas, on May 30, 2001, the Court held the previously enjoined defendants in contempt of court. On October 12, 2001, Bollore filed proposed findings of fact and conclusions of law at the request of the Court. On November 16, 2001, the Court issued its written Order of Contempt, inter alia, estimating a damage amount to be in excess of $11 million, and referring the matter to the United States Attorney with a recommendation that criminal charges for counterfeiting, criminal contempt and perjury be brought. The Court later directed the parties to submit specific damages evidence. On January 17, 2002, the Company filed its damages submission, calculating damages to be approximately $14.5 million. That application is currently pending. F-29 NORTH ATLANTIC TRADING COMPANY, INC AND SUBSIDIARIES -------------------------------------------------------------------------------- NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED 17. CONTINGENCIES, CONTINUED: On December 5, 2001, the contemptuous defendants filed an appeal of the Contempt Order, claiming that the 1999 injunction entered on the record was technically invalid and that the factual record does not support the finding of contempt. The Company and Bollore on February 22, 2002 filed a motion with the appellate court urging that the Court dismiss the appeal as premature. That motion is pending. If the Court denies that motion, the plaintiffs intend to defend the Contempt Order vigorously. On February 5, 2002, the District Court in the Bollore case granted Bollore's motion to amend the Complaint to add the Company and NAOC as plaintiffs. Pursuant to a separate agreement between the parties, any collections on the judgments issued in the Bollore v. Import Warehouse case are to be divided evenly between Bollore and the Company after the payment of all expenses. A full trial on the merits has been scheduled for April 1, 2002. On February 7, 2002, Bollore, NAOC and the Company filed a motion with the District Court in the Texas action seeking to hold Ravi Bhatia and Import Warehouse Inc. in contempt of court for violating the terms of the consent order and injunction entered against those defendants. The Company alleges that Mr. Bhatia and Import Warehouse sold counterfeit goods to at least three different companies over an extended period of time. The hearing date for that contempt order has not been set. CALIFORNIA INFRINGING PRODUCTS LITIGATION. On March 23, 2001, the Company participated as co-plaintiff with Bollore, S.A. and North Atlantic Operating Company, Inc. ("NAOC"), its subsidiary, in an action entitled Bollore, S.A. v. A&A Smart Shopping (Case No. CV 01-02766 FMC (MANx)), filed in the United States District Court for the Central District of California. The plaintiffs alleged that nine distributors in California were selling counterfeit Zig-Zag(R) brand cigarette papers. As part of that action, the plaintiffs sought and obtained temporary restraining orders prohibiting the sale of such counterfeit products on March 27, 2001. The plaintiffs also obtained a seizure order and, on April 3, 2001, executed it against seven of the distributors. All seven were found to be in possession of counterfeit products. On April 10, 2001, the court granted a preliminary injunction against all of the defendants, barring the sale of counterfeit or infringing Zig-Zag(R) brand products, and requiring the defendants to effect a recall of counterfeit products from the market. Trial is currently scheduled for June 18, 2002. Any collections of judgments in this case are to be divided evenly between Bollore and NAOC. On May 22, 2001, the Company participated as co-plaintiff with Bollore, S.A. and North Atlantic Operating Company, Inc. in an action entitled Bollore, S.A. v. Buy-Rite Wholesale (Case No. CV 01-4570 FMC (MAN)), filed in the United States District Court for the Central District of California. The plaintiffs alleged that seven distributors and retailers in California were selling counterfeit Zig-Zag(R)brand cigarette papers. As part of that action, the plaintiffs F-30 NORTH ATLANTIC TRADING COMPANY, INC AND SUBSIDIARIES -------------------------------------------------------------------------------- NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED 17. CONTINGENCIES, CONTINUED: sought and obtained temporary restraining orders prohibiting the sale of such counterfeit products on May 22, 2001. The plaintiffs also obtained a seizure order and, on May 31, 2001, executed it on six of the defendants. Of the six, four were found to be in possession of counterfeit products, and a fifth was in possession of infringing foreign products. Nonetheless, on June 7, 2001, the Court declined to issue a preliminary injunction against the continuing sale of counterfeit or infringing goods. Plaintiffs applied to the court for reconsideration as to all defendants. On August 3, 2001 the court again declined to issue a preliminary injunction, without prejudice to filing a more detailed motion. Trial of this matter is currently scheduled for July 23, 2002. Discovery is continuing in all of the above cases and the Company intends to vigorously pursue the defendants for damages. Management believes that the successful prosecution of this litigation, whether by settlement or otherwise, would have a favorable impact on its premium cigarette paper business, which has been adversely affected by this counterfeiting activity. No gain contingencies have been recorded for these matters. In addition to the above described legal proceedings, the Company is subject to other litigation in the ordinary course of its business. The Company does not consider any of these other proceedings to be material. For a description of regulatory matters and related industry litigation in which the Company is a party, see Part I, Item 1. "Business--Regulation." 18. PARENT-ONLY FINANCIAL INFORMATION: The Corporation is a holding company with no operations and no assets other than its investments in its subsidiaries, income tax receivables, deferred income tax assets related to the differences between the book and tax basis of its investment in the Partnership, and deferred financing costs related to its debt. All of the Corporation's subsidiaries are wholly-owned and guarantee the debt of the Corporation on a full, unconditional, and joint and several basis. In management's opinion, separate financial statements of the subsidiaries are not meaningful to investors and have not been included in these financial statements. F-31 NORTH ATLANTIC TRADING COMPANY, INC AND SUBSIDIARIES -------------------------------------------------------------------------------- NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED 18. PARENT-ONLY FINANCIAL INFORMATION, CONTINUED: Following is unaudited parent-only summarized financial information of the Corporation (in thousands):
2001 2000 --------------------- -------------------- Noncurrent assets $ 195,462 $ 210,207 Current liabilities 20,164 20,468 Noncurrent liabilities 155,000 167,500 Redeemable preferred stock 57,443 50,698 YEAR ENDED DECEMBER 31, ------------------------------------------ 2001 2000 --------------------- -------------------- Equity in earnings of subsidiaries $ 18,746 $ 19,551 Income loss before extraordinary loss and preferred stock dividends (1,308) (2,305)
19. SEGMENT INFORMATION: In 1998, the Company adopted SFAS No. 131, "Disclosures about Segments of an Enterprise and Related Information." The Company has been historically organized on the basis of product lines which are comprised of two reportable segments. The smokeless tobacco segment manufactures smokeless tobacco products which are distributed primarily through wholesale and food distributors in the United States. The make-your-own segment imports and distributes cigarette papers, tobaccos and related products primarily through wholesale distributors in the United States. The accounting policies of the segments are the same as those described in the "Summary of Significant Accounting Policies." Segment data includes a charge allocating all corporate costs to each operating segment. Elimination and Other includes the assets of the Company not assigned to segments and the elimination of intercompany accounts between segments. The Company evaluates the performance of its segments and allocates resources to them based on earnings before interest, taxes, depreciation, amortization, certain non-cash charges and other income and expenses (Adjusted EBITDA). F-32 NORTH ATLANTIC TRADING COMPANY, INC AND SUBSIDIARIES -------------------------------------------------------------------------------- NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED 19. SEGMENT INFORMATION, CONTINUED: The table below presents financial information about reported segments for 2001, 2000 and 1999 (in thousands):
SMOKELESS ELIMINATIONS 2001 TOBACCO MAKE-YOUR-OWN AND OTHER TOTAL ----------------------------------------- -------------------- ------------------------ ------------------- -------------------- Net sales $ 39,177 $ 54,571 $ - $ 93,748 Adjusted EBITDA 10,542 22,491 33,033 Assets 68,106 236,904 (90,126) 214,884 2000 ----------------------------------------- Net sales 39,733 53,412 - 93,145 Adjusted EBITDA 10,684 22,498 33,182 Assets 73,845 223,732 (69,820) 227,757 1999 ----------------------------------------- Net sales 45,814 48,647 - 94,461 Adjusted EBITDA 14,747 22,941 37,688 Assets 81,482 208,539 (46,418) 243,603
A reconciliation of Adjusted EBITDA to total consolidated operating income for 2001, 2000, and 1999 is as follows (in thousands):
2001 2000 1999 ------------------------------------------------------------ Adjusted EBITDA $ 33,033 $ 33,182 $ 37,688 Depreciation expense (637) (1,067) (1,923) Amortization expense (5,490) (5,490) (5,490) LIFO adjustment (2,682) (2,434) (174) Stock option expense (33) (33) (70) Postretirement/Pension expense (1,128) (666) (1,151) ------------------------------------------------------------ Operating income $ 23,063 $ 23,492 $ 28,880 ============================================================
F-33 NORTH ATLANTIC TRADING COMPANY, INC AND SUBSIDIARIES -------------------------------------------------------------------------------- NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED 20. NEW ACCOUNTING STANDARDS: In July 2001, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards No. 141, "Business Combinations" ("SFAS No. 141"). The Statement addresses financial accounting and reporting for business combinations and supercedes Accounting Principles Board Opinion No. 16 "Business Combinations", and Statement of Financial Accounting Standards No. 38, "Accounting for Pre-acquisition Contingencies of Purchased Enterprises". All business combinations in the scope of SFAS No. 141 are to be accounted for using one method - the purchase method. SFAS No. 141 is effective for all business combinations initiated after June 30, 2001. Also in July 2001, the FASB issued Statement of Financial Accounting Standards No. 142, "Goodwill and Other Intangible Assets" ("SFAS 142"), which establishes the accounting for goodwill and other intangible assets following their recognition. SFAS 142 applies to all goodwill and other intangible assets whether acquired singly, as part of a group, or in a business combination. SFAS 142 provides that goodwill and other intangible assets believed to have indefinite lives should not be amortized but should be tested for impairment annually using a fair-value based approach. In addition, SFAS 142 provides that other intangible assets other than goodwill should be amortized over their useful lives and reviewed for impairment in accordance with Statement of Financial Accounting Standards No. 121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of." SFAS 142 is effective for the Company beginning on January 1, 2002. Upon adoption, the Company will be required to perform a transitional impairment test under SFAS 142 for all goodwill recorded as of January 1, 2002. Any impairment loss recorded as a result of completing the transitional impairment test will be treated as a change in accounting principle. Management has not completed the transitional impairment test and has not determined whether an impairment adjustment will be required upon adoption. Additionally, Management has not yet determined the impact of SFAS 142 on the Company's amortization expense. The adoption of SFAS 142 will not impact the Company's Adjusted EBITDA, which is Management's performance standard. In October 2001, the FASB issued Statement of Financial Accounting Standards No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets (FAS 144). The Statement addresses financial accounting and reporting for the impairment or disposal of long-lived assets. This Statement supercedes Statement of Financial Accounting Standards No. 121, Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed Of (FAS 121), and the accounting and reporting provisions of Accounting Principles Board Opinion No. 30, Reporting the Results of Operations, Reporting the Effects of Disposal of a Segment of a Business, and Extraordinary, Unusual and Infrequently Occurring Events and Transactions, for the disposal of a segment of a business (as previously defined in that Opinion). This Statement also amends Accounting Research Bulletin No. 51, Consolidated Financial Statements, to eliminate the exception to consolidation for a subsidiary for which F-34 NORTH ATLANTIC TRADING COMPANY, INC AND SUBSIDIARIES -------------------------------------------------------------------------------- NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED 20. NEW ACCOUNTING STANDARDS, CONTINUED: control is likely to be temporary. The objectives of FAS 144 are to address significant issues relating to the implementation of FAS 121 and to develop a single accounting model, based on the framework established in FAS 121, for long-lived assets to be disposed of by sale, whether previously held and used or newly acquired. The Company will adopt FAS 144 in the first quarter 2002. Management has not determined the impact of FAS 144 but does not believe that the adoption will have a material effect on the Company's results of operations or financial position. During 2001, the Emerging Issues Task Force issued: EITF No. 00-14, "Accounting for Certain Sales Incentives" addressing the recognition, measurement and statement of earnings classification of certain sales incentives; and EITF No. 00-25, "Vendor Income Statement Characterization of Consideration Paid to a Reseller of the Vendor's Products" addressing the statement of earnings classification of consideration from a vendor to an entity that purchases the vendor's products for resale. The Company will adopt EITF 00-14 and 00-25 in the first quarter of 2002. Management is currently evaluating the impact of EITF 00-14 and 00-25 and expects that their adoption will result in a reclassification of certain expenses from selling, general and administrative expenses to net sales with no impact on the operating income (loss) or net income (loss) for 2002 and future years. Prior year amounts will be reclassified to be consistent with the Company's 2002 presentation. F-35 EXHIBIT INDEX TO NORTH ATLANTIC TRADING COMPANY, INC. ANNUAL REPORT ON FORM 10-K FOR FISCAL YEAR ENDED DECEMBER 31, 2001 EXHIBIT NUMBER DESCRIPTION ------ ----------- 3.1(a) -- Restated Certificate of Incorporation of North Atlantic Trading Company, Inc., filed February 19, 1998 (incorporated herein by reference to Exhibit 3.1(a)(i) the Registrant's Annual Report on Form 10-K for the fiscal year ended December 31, 1997). 3.1(b) -- Certificate of Incorporation of North Atlantic Operating Company, Inc., filed June 9 1997 (incorporated herein by reference to Exhibit 3.1(b)(i) to the Registrant's Annual Report on Form 10-K for the fiscal year ended December 31, 1997). 3.1(c) -- Certificate of Amendment of Certificate of Incorporation of North Atlantic Operating Company, Inc., filed June 17, 1997 (incorporated herein by reference to Exhibit 3.1(b)(ii) to Amendment No. 1 to Registration Statement (Reg. No. 333-31931) on Form S-4 filed with the Commission on September 3, 1997). 3.1(d) -- Restated Certificate of Incorporation of National Tobacco Finance Corporation, filed April 24, 1996 (incorporated herein by reference to Exhibit 3.1(c) to Amendment No. 1 to Registration Statement (Reg. No. 333-31931) on Form S-4 filed with the Commission on September 3, 1997). 3.1(e) -- Amended and Restated Certificate of Limited Partnership of National Tobacco Company, L.P., filed May 17, 1996 (incorporated herein by reference to Exhibit 3.1(d) to Amendment No. 1 to Registration Statement (Reg. No. 333-31931) on Form S-4 filed with the Commission on September 3, 1997). 3.1(f) -- Certificate of Incorporation of International Flavors and Technology, Inc., filed August 7, 1997 (incorporated herein by reference to Exhibit 3.1(e)(i) to the Registrant's Annual Report on Form 10-K for the fiscal year ended December 31, 1997). 3.1(g) -- Certificate of Amendment of Certificate of Incorporation of International Flavors and Technology, Inc., filed February 19, 1998 (incorporated herein by reference to Exhibit 3.1(e)(ii) to the Registrant's Annual Report on Form 10-K for the fiscal year ended December 31, 1997). 3.2(a) -- Amended and Restated Bylaws of North Atlantic Trading Company, Inc. (incorporated herein by reference to Exhibit 3.2(a) to the Registrant's Quarterly Report on Form 10-Q for the fiscal quarter ended March 31, 1998). 3.2(b) -- Bylaws of North Atlantic Operating Company, Inc. (incorporated herein by reference to Exhibit 3.2(b) to Registration Statement (Reg. No. 333-31931) on Form S-4 filed with the Commission on September 3, 1997). 3.2(c) -- Bylaws of National Tobacco Finance Corporation (incorporated herein by reference to Exhibit 3.2(c) to Registration Statement (Reg. No. 333-31931) on Form S-4 filed with the Commission on September 3, 1997). 3.2(d) -- Third Amended and Restated Agreement of Limited Partnership of National Tobacco Company, L.P., effective May 17, 1996 (incorporated herein by reference to Exhibit 3.2(d)(i) to Amendment No. 1 to Registration Statement (Reg. No. 333-31931) on Form S-4 filed with the Commission on September 3, 1997). 3.2 (e) -- Amendment No. 1 to Third Amended and Restated Agreement of Limited Partnership of National Tobacco Company, L.P., effective June 25, 1997 (incorporated herein by reference to Exhibit 3.2(d)(ii) to Amendment No. 1 to Registration Statement (Reg. No. 333-31931) on Form S-4 filed with the Commission on September 3, 1997). 3.2(f) -- Bylaws of International Flavors and Technology, Inc. (incorporated herein by reference to Exhibit 3.2(e) to the Registrant's Annual Report on Form 10-K for the fiscal year ended December 31, 1997). 3.2(g) -- Amendment No. 2 to the Third Amended and Restated Agreement of Limited Partnership of National Tobacco Company, L.P., effective February 10, 2000 (incorporated by reference to Exhibit 3.2 (g) to the Registrant's Annual Report on Form 10-K for the fiscal year ended December 31, 2000). 3.3 -- Certificate of Designation of 12% Senior Exchange Payment-In-Kind Preferred Stock of North Atlantic Trading Company, Inc., filed July 22, 1997 (incorporated herein by reference to Exhibit 3.3(b) to Amendment No. 1 to Registration Statement (Reg. No. 333-31931) on Form S-4 filed with the Commission on September 3, 1997). 4.1 -- Indenture, dated as of June 25, 1997, among North Atlantic Trading Company, Inc., as issuer, National Tobacco Company, L.P., North Atlantic Operating Company, Inc. and National Tobacco Finance Corporation, as guarantors, and United States Trust Company of New York, as trustee (incorporated herein by reference to Exhibit 4.1 to Amendment No. 1 to Registration Statement (Reg. No. 333-31931) on Form S-4 filed with the Commission on September 3, 1997). 4.2 -- First Supplemental Indenture, dated as of February 26, 1998, among North Atlantic Trading Company, Inc., National Tobacco Company, L.P., National Tobacco Finance Corporation, International Flavors and Technology, Inc. and The United States Trust Company of New York (incorporated herein by reference to Exhibit 4.3 to the Registrant's Annual Report on Form 10-K for the fiscal year ended December 31, 1997). 9.1 -- Exchange and Stockholders' Agreement, dated as of June 25, 1997, by and between North Atlantic Trading Company, Inc. and those stockholders signatory thereto (incorporated herein by reference to Exhibit 9 to Amendment No. 1 to Registration Statement (Reg. No. 333-31931) on Form S-4 filed with the Commission on September 3, 1997). 9.2 -- Voting Trust Agreement, dated as of December 17, 1997, among Thomas F. Helms, Jr., David I. Brunson and Jeffrey S. Hay, as voting trustees, and Helms Management Corp. (incorporated herein by reference to Exhibit 9.2 to the Registrant's Annual Report on Form 10-K for the fiscal year ended December 31, 1997). 9.3 -- Amendment No. 1 to Voting Trust Agreement, dated as of August 2, 1999, among Thomas F. Helms, Jr. and David I. Brunson, as voting trustees, and Helms Management Corp. (incorporated by reference to Exhibit 9.3 to the Registrant's Annual Report on Form 10-K for the fiscal year ended December 31, 2000). 10.1 -- Third Amended and Restated Purchasing and Processing Agreement, dated as of June 25, 1997, between National Tobacco Company, L.P. and Lancaster Leaf Tobacco Company of Pennsylvania (incorporated herein by reference to Exhibit 10.1 to Amendment No. 1 to Registration Statement (Reg. No. 333-31931) on Form S-4 filed with the Commission on September 3, 1997). 10.2+ -- Amended and Restated Distribution and License Agreement, dated as of November 30, 1992, between Bollore Technologies, S.A. and North Atlantic Trading Company, Inc., a Delaware corporation and predecessor to North Atlantic Operating Company, Inc. [United States] (incorporated herein by reference to Exhibit 10.2 to Amendment No. 2 to Registration Statement (Reg. No. 333-31931) on Form S-4 filed with the Commission on September 3, 1997). 10.3+ -- Amended and Restated Distribution and License Agreement, dated as of November 30, 1992, between Bollore Technologies, S.A. and North Atlantic Trading Company, Inc., a Delaware corporation and predecessor to North Atlantic Operating Company, Inc. [Asia] (incorporated herein by reference to Exhibit 10.3 to Amendment No. 2 to Registration Statement (Reg. No. 333-31931) on Form S-4 filed with the Commission on September 3, 1997). 10.4+ -- Amended and Restated Distribution and License Agreement, dated as of November 30, 1992, between Bollore Technologies, S.A. and North Atlantic Trading Company, Inc., a Delaware corporation and predecessor to North Atlantic Operating Company, Inc. [Canada] (incorporated herein by reference to Exhibit 10.4 to Amendment No. 2 to Registration Statement (Reg. No. 333-31931) on Form S-4 filed with the Commission on September 3, 1997). 10.5+ -- Restated Amendment, dated as of June 25, 1997, between Bollore Technologies, S.A. and North Atlantic Operating Company, Inc. (incorporated herein by reference to Exhibit 10.5 to Amendment No. 2 to Registration Statement (Reg. No. 333-31931) on Form S-4 filed with the Commission on September 3, 1997). 10.6 -- Warrant Agreement, dated as of June 25, 1997, between North Atlantic Trading Company, Inc. and United States Trust Company of New York, as warrant agent (incorporated herein by reference to Exhibit 10.12 to Amendment No. 1 to Registration Statement (Reg. No. 333-31931) on Form S-4 filed with the Commission on September 3, 1997). 10.7++ -- 1997 Share Incentive Plan of North Atlantic Trading Company, Inc. (incorporated herein by reference to Exhibit 10.12 to Amendment No. 1 to Registration Statement (Reg. No. 333-31931) on Form S-4 filed with the Commission on September 3, 1997). 10.8++ -- Employment Agreement, dated May 17, 1996, between North Atlantic Trading Company, Inc. and Thomas F. Helms, Jr. (incorporated herein by reference to Exhibit 10.17 to Amendment No. 1 to Registration Statement (Reg. No. 333-31931) on Form S-4 filed with the Commission on September 3, 1997). 10.9 ++ -- Employment Agreement, dated April 14, 1997, between National Tobacco Company, Inc. and David I. Brunson (incorporated herein by reference to Exhibit 10.18(a) to Amendment No. 1 to Registration Statement (Reg. No. 333-31931) on Form S-4 filed with the Commission on September 3, 1997). 10.10++ -- Letter Agreement, dated April 23, 1997, between Thomas F. Helms, Jr. and David I. Brunson (incorporated herein by reference to Exhibit 10.18(b) to Amendment No. 1 to Registration Statement (Reg. No. 333-31931) on Form S-4 filed with the Commission on September 3, 1997). 10.11++ -- Nonqualified Stock Option Agreement, dated as of June 25, 1997, between North Atlantic Trading Company, Inc. and David I. Brunson (incorporated herein by reference to Exhibit 10.18(c) to Amendment No. 1 to Registration Statement (Reg. No. 333-31931) on Form S-4 filed with the Commission on September 3, 1997). 10.12++ -- Amendment No. 1, dated and effective September 2, 1997, to the Nonqualified Stock Option Agreement, dated as of June 25, 1997, between North Atlantic Trading Company, Inc. and David I. Brunson (incorporated herein by reference to Exhibit 10.18(d) to Amendment No. 1 to Registration Statement (Reg. No. 333-31931) on Form S-4 filed with the Commission on September 3, 1997). 10.13++ -- Amendment No. 2, dated as of December 31, 1997, to the Nonqualified Stock Option Agreement, dated as of June 25, 1997, between North Atlantic Trading Company, Inc. and David I. Brunson (incorporated herein by reference to Exhibit 10.18(e) to the Registrant's Annual Report on Form 10-K for the fiscal year ended December 31, 1997). 10.14++ -- Consulting Agreement, dated as of June 25, 1997, between North Atlantic Trading Company, Inc. and Jack Africk (incorporated herein by reference to Exhibit 10.20 to Amendment No. 1 to Registration Statement (Reg. No. 333-31931) on Form S-4 filed with the Commission on September 3, 1997). 10.15++ -- National Tobacco Company Management Bonus Program (incorporated herein by reference to Exhibit 10.25 to Amendment No. 1 to Registration Statement (Reg. No. 333-31931) on Form S-4 filed with the Commission on September 3, 1997). 10.16++ -- Amended and Restated Nonqualified Stock Option Agreement dated as of January 12, 1998, between North Atlantic Trading Company, Inc. And Jack Africk (incorporated herein by reference to Exhibit 10.28 to the Registrant's Annual Report on Form 10-K for the fiscal year ended December 31, 1997). 10.17++ -- Assignment and Assumption, dated as of January 1, 1998, between National Tobacco Company, L.P. and North Atlantic Trading Company, Inc. (incorporated herein by reference to Exhibit 10.30 to the Registrant's Annual Report on Form 10-K for the fiscal year ended December 31, 1997). 10.18+ -- Amendment, dated October 27, 1997, to Amended and Restated Distribution and License Agreements, between Bollore and North Atlantic Operating Company, Inc. (incorporated herein by reference to Exhibit 10.31 to the Registrant's Annual Report on Form 10-K for the fiscal year ended December 31, 1997). 10.19 -- Sales Representative Agreement, effective as of January 1, 1998, between National Tobacco Company, L.P. and North Atlantic Operating Company, Inc. (incorporated herein by reference to Exhibit 10.32 to the Registrant's Annual Report on Form 10-K for the fiscal year ended December 31, 1997). 10.20 -- Amendment to Credit Agreement, dated as of June 5, 1998, among North Atlantic Trading Company, Inc., the various lending institutions referenced therein, and National Westminster Bank plc, as Administrative Agent (incorporated herein by reference to Exhibit 10.1 to the Registrant's Quarterly Report on 10-Q for the fiscal quarter ended June 30, 1998). 10.21++ -- Amended and Restated Employment Agreement dated as of April 30, 1998, between North Atlantic Trading Company, Inc. and David I. Brunson (incorporated herein by reference to Exhibit 10.2 to the Registrant's Report on 10-Q for the fiscal quarter ended June 30, 1998). 10.22 -- Option Grant Letter, dated April 30, 1998, from Helms Management Corp. to David I. Brunson (incorporated herein by reference to Exhibit 10.5 to the Registrant's Quarterly Report on 10-Q for the fiscal quarter ended June 30, 1998). 10.23 -- Promissory Note, dated April 14, 1998, issued by Helms Management Corp. in favor of North Atlantic Trading Company, Inc. (incorporated herein by reference to Exhibit 10.7 to the Registrant's Quarterly Report on 10-Q for the fiscal quarter ended June 30, 1998). 10.24 -- Amendment, dated as of February 1, 1998, among North Atlantic Trading Company, Inc., the various lending institutions referenced therein and National Westminster Bank plc, as administrative agent (incorporated herein by reference to Exhibit 10.39 to the Registrant's Quarterly Report on 10-Q for the fiscal quarter ended March 31, 1998). 10.25 -- Consent, dated as of March 12, 1998, among North Atlantic Trading Company, Inc., the various lending institutions referenced therein and National Westminster Bank plc, as administrative agent (incorporated herein by reference to Exhibit 10.40 to the Registrant's Quarterly Report on 10-Q for the fiscal quarter ended March 31, 1998). 10.26 -- Subscription Agreement, dated as of March 24, 1998, between North Atlantic Trading Company, Inc. and David I. Brunson (incorporated herein by reference to Exhibit--10.42 to the Registrant's Quarterly Report on 10-Q for the fiscal quarter ended March 31, 1998). 10.27 -- Promissory Note, dated March 24, 1998, issued by David I. Brunson in favor of North Atlantic Trading Company, Inc. (incorporated herein by reference to Exhibit 10.44 to the Registrant's Quarterly Report on 10-Q for the fiscal quarter ended March 31, 1998). 10.28 -- Promissory Note, dated April 14, 1998, issued by Helms Management Corp. in favor of North Atlantic Trading Company, Inc. (incorporated herein by reference to Exhibit 10.7 to the Registrant's Quarterly Report on 10-Q for the fiscal quarter ended June 30, 1998). 10.29++ -- Letter Agreement, dated September 24, 1999, between North Atlantic Trading Company, Inc. and Jack Africk (incorporated by reference to Exhibit 10.34 to the Registrant's Annual Report on Form 10-K for the fiscal year ended December 31, 2000). 10.30++ -- North Atlantic Trading Company, Inc. 1999 Executive Incentive Plan (incorporated by reference to Exhibit 10.35 to the Registrant's Annual Report on Form 10-K for the fiscal year ended December 31, 2000). 10.31++ -- North Atlantic Trading Company, Inc. 1999 Management Bonus Plan (incorporated by reference to Exhibit 10.36 to the Registrant's Annual Report on Form 10-K for the fiscal year ended December 31, 2000). 10.32 -- Loan Agreement, dated as of December 29, 2000, by and among North Atlantic Trading Company, Inc., National Tobacco Company, L.P., North Atlantic Operating Company, Inc., National Tobacco Finance Corporation and Bank One, Kentucky N.A., as agent bank and the various lending institutions named therein (incorporated by reference to Exhibit 10.32 to the Registrant's Annual Report on Form 10-K for the fiscal year ended December 31, 2001). 10.33 -- Security Agreement, dated as of December 29, 2000, among North Atlantic Trading Company, Inc., National Tobacco Company, L.P., North Atlantic Operating Company, Inc., National Tobacco Finance Corporation and Bank One Kentucky, N.A., as agent for certain lending institutions (incorporated by reference to Exhibit 10.33 to the Registrant's Annual Report on Form 10-K for the fiscal year ended December 31, 2000). 10.34 -- Guaranty Agreement, dated as of December 29, 2000, among National Tobacco Company, L.P., North Atlantic Operating Company, Inc., National Tobacco Finance Corporation and Bank One, Kentucky, N.A., as agent for certain lending institutions (incorporated by reference to Exhibit 10.34 to the Registrant's Annual Report on Form 10-K for the fiscal year ended December 31, 2000). 10.35 -- Pledge Agreement, dated as of December 29, 2000 among and North Atlantic Trading Company, Inc., National Tobacco Company, L.P., North Atlantic Operating Company, Inc., National Tobacco Finance Corporation and Bank One Kentucky, N.A., as agent for certain lending institutions (incorporated by reference to Exhibit 10.35 to the Registrant's Annual Report on Form 10-K for the fiscal year ended December 31, 2000). 10.36*++ -- 2001 Share Incentive Plan of North Atlantic Trading Company, Inc. 21 -- Subsidiaries of North Atlantic Trading Company, Inc. (incorporated herein by reference to Exhibit 21 to the Registrant's Annual Report on Form 10-K for the fiscal year ended December 31, 1998). * Filed herewith. + Portions of this agreement have been omitted pursuant to Rule 406 under the Securities Act of 1933, as amended, and have been filed confidentially with the Securities and Exchange Commission. ++ Management contracts or compensatory plan or arrangement required to be filed as an exhibit pursuant to Item 14(c) of the rules governing the preparation of this Report.