Item 2. PROPERTIES
The Company owns its facility in Fridley, Minnesota, near Minneapolis. This facility contains administrative, laboratory, production and warehousing areas. The 438,000 square foot, primarily single story, air conditioned plant is located on a 25 acre site, and includes an approximately 38,000 square foot, two story office center that houses the administrative staff, research laboratories, computer services and the test salon. The Company believes the facility, which was constructed in 1969 and improved during the 1980s at a total cost in excess of $60 million, is well maintained and adequate for its contemplated needs. The Company has excess production capacity, which it intends to utilize for new products and for possible expansion of its contract manufacturing activities.
The Company leases its 6,008 square foot office facility in Mill Valley, California, near San Francisco, from Intertec, a division of Innovative Capital Management, Inc.. The term of the lease is for three years commencing October 1, 1996.
Item 3.
Item 3. LEGAL PROCEEDINGS None.
Item 4.
Item 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS None.
PART II
Item 5.
Item 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
The Company's Common Stock is traded in the NASDAQ National Market under the symbol LMAR. The table below sets forth the range of the high and low sale prices, as reported by the NASDAQ stock market during last year. Previous to March 26, 1997 the Company traded under the symbol EHST.
High Low Second Quarter * $ 8 .250 $ 5.250 Third Quarter 6.000 3.750 Fourth Quarter 4.875 3.125
*Includes only the period May 23, 1996, the first trading date after the Company's initial public offering, to June 30, 1996.
As of March 3, 1997, the number of holders of record of the Company's Common Stock was 377 and the number of holders of record of the Company's Preferred Stock was one. As for the Common Stock, this number does not include beneficial holders where shares are held of record by nominees.
Dividends are payable with respect to the Series A Preferred Stock only to the extent (on an as-converted basis) that dividends are declared payable on the Common Stock. The Series B Preferred Stock is entitled to cumulative cash dividends at the rate of 8.0% per annum, payable quarterly ($400,000 annually).
The Company does not anticipate paying any dividends on its Common Stock in the foreseeable future. The payment of future dividends will depend on the evaluation by the Company's Board of Directors of such factors as it deems relevant at the time. Currently, the Board of Directors believes that all of the Company's earnings, if any, should be retained for the development of the Company's business. In addition, payment of dividends on the Common Stock is prohibited by the terms of the Norwest Credit Agreement and is restricted by the terms of its Preferred Stock.
In January 1996, the Company issued 15,575 shares of Common Stock to 311 employees for services rendered to the Company. The securities were valued at $6.00 per share. These securities were exempt from registration under Rule 701 under the Securities Act of 1933.
In May 1996 in connection with the Company's initial public offering, the Company issued warrants to purchase 182,000 shares of Common Stock to the Representatives of the Underwriters for a nominal amount. Also in May 1996 in connection with certain financial advisory services to be provided to the Company, the Company issued warrants to purchase 39,000 shares of Common Stock to Rodman & Renshaw, Inc. for a nominal amount. These securities were exempt from registration under Section 4(2) of the Securities Act. These warrants are initially exercisable at a price of $9.60 per share of Common Stock for a period of four years, commencing May 1997. The exercise price of the warrants and the number of shares of Common Stock issuable upon exercise thereof are subject to adjustment under certain circumstances. The warrants are redeemable by the Company on prior notice if the price of the Common Stock two years after the closing of the offering exceeds $20.00 for a 60-day period.
In June, 1996, the Company issued 9,900 shares pursuant to the exercise of a stock option. These securities were exempt from registration under Rule 701 under the Securities Act of 1933.
Item 6.
Item 6. SELECTED FINANCIAL DATA
SELECTED FINANCIAL DATA (In thousands, except per share data)
Set forth below is selected financial data with respect to the statements of operations of the Company, for the twelve months ended December 31, 1996, 1995, 1994 and for the period from April 1, 1993 (Inception) to December 31, 1993, and the balance sheet data of the Company at December 31, 1996, 1995, 1994 and 1993. In addition, set forth below is selected financial data with respect to the pro forma statement of operations for the Company for the twelve months ended December 31, 1995. Such data presents the combined results of operations of the Company as if the acquisition of the Personal Care Division was effective as of January 1, 1995. The pro forma combined financial data includes all adjustments which the Company considers necessary for a fair presentation, in accordance with generally accepted accounting principles, of its results of operations for that period. The pro forma combined financial data does not purport to represent what the Company's results of operations would actually have been had the acquisition in fact occurred on the indicated date or to project the Company's results of operations for any future date or period.
In addition, included below is selected financial data with respect to the statements of operations for the Personal Care Division for the period from January 1, 1995 to November 30, 1995 (the effective date of the acquisition for financial reporting purposes) and the years ended December 31, 1994, 1993 and 1992, and the balance sheets of the Personal Care Division at December 31, 1994, 1993 and 1992. Such data were derived from the Personal Care Division financial statements, certain of which are included herein.
Financial Data of the Personal Care Division
(1) Includes the results of operations of the Personal Care Division for the month of December 1995 following its acquisition by the Company.
(2) Includes an $11.0 million write-down of assets required to adjust the carrying value of The Personal Care Division to its net realizable value in connection with Dow's decision to sell the Personal Care Division. Future significant charges are not expected as assets and liabilities were recorded at their estimated fair values at the date of the Company's acquisition of the Personal Care Division.
(3) In accordance with the rules of the Securities and Exchange Commission, all common stock equivalents of the Company issued within one year of its initial public offering have been considered as outstanding since the inception of the Company using the treasury stock method even though they are anti-dilutive in loss periods. Common stock equivalents issued prior to one year of the Company's initial public offering are excluded in loss periods as they are anti-dilutive.
(4) Results of operations of the Personal Care Division following its acquisition by the Company in November 1995 are included in the results of operations of the Company for the year ended December 31, 1995.
Item 7.
Item 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATION
Pro Forma and Historical Results of Operations
The following table sets forth pro forma statements of operations information in dollars and as a percentage of total net sales for each of the two years ended December 31, 1995, and the historical statement of operations information in dollars and as a percentage of total net sales for the year ended December 31, 1996. The pro forma information gives effect to the acquisition of the Personal Care Division as if it had occurred at the beginning of each period. The pro forma information is not necessarily indicative of future results of operations.
Year Ended December 31, 1996 (Historical) Compared to Year Ended December 31, 1995 (Pro Forma)
Total net sales of $117.1 million for the year ended December 31, 1996 declined 0.6% compared to pro forma net sales of $117.8 million in 1995. During 1996, the Company experienced sales growth from its new product line Willow Lake(TM), contract manufacturing and its Style(R) product line. These increases were offset by sales decreases in the Perma Soft(R) and Salon Style(R) product lines.
The Company's management implemented a new marketing strategy that included increasing advertising that began in the quarter ended June 30, 1996, intended to stem the decline in Perma Soft(R) sales. In addition to supporting the brand with advertising, the Company is testing new line extensions designed to reverse the decline in sales.
In April 1995, DowBrands discontinued advertising of Salon Style(R) in conjunction with the decision to sell the Personal Care Division. During the next ten months, Salon Style(R) was not supported with any advertising funds. Although the Company reinstituted a marketing campaign which included advertising in the first quarter of 1996, Salon Style(R) continued to lose market share. The Company is developing and expects to implement a new marketing strategy for the Salon Style(R) brand in 1997.
In November 1995, the Company entered into a two-year contract in which DowBrands has agreed to purchase all of its future requirements for certain products. Contract manufacturing sales for 1996 were $30.8 million which included sales to DowBrands of $22.2 million or 18.9% of total net sales.
Gross margin as a percentage of sales was 40.0% for the year ended December 31, 1996, as compared with a pro forma gross margin of 39.4% for the same period in 1995. The increase in gross margin percentage is attributable to the product cost savings which were realized through operating efficiencies and the high gross margin generated from the Willow Lake(TM) product line that began shipping in the fourth quarter of 1996. The gross margin percentage improvements were partially offset by an increase in sales of the lower-margin Style(R) line of products and contract manufacturing, and a decrease in consumer retail purchases of the higher margin Perma Soft(R) and Salon Style(R) product line.
Although investment was necessary in 1996 resulting from the takeover of operations from DowBrands and from the implementation of the Company's turnaround strategy, operating expenses of $45.6 million for the year ended December 31, 1996, were relatively unchanged as compared with pro forma operating expenses of $45.1 million for the same period in 1995.
The $11.0 million write-down of assets by DowBrands in the first quarter of 1995 reflected a further adjustment in the carrying value of the Personal Care Division to its net realizable value in connection with DowBrands decision to sell the Personal Care Division. Future significant charges are not expected as all assets and liabilities were recorded at their estimated fair value at the date of the Company's acquisition of the Personal Care Division.
As a result of the foregoing factors, the operating income for the year ended December 31, 1996, was $1.2 million, as compared with a pro forma operating loss of $9.8 million in the same period in 1995. Excluding the write-down of assets, the pro forma operating income for the year ended December 31, 1995, would have been $1.2 million.
Interest Expense of $1.4 million for the year ended December 31, 1996, declined 10.8% compared to pro forma Interest Expense of $1.6 million in 1995. The decrease was due to the additional cash available for working capital in 1996 as a result of the Company's initial public offering in May 1996.
Other income for the year ended December 31, 1996, was $0.7 million as compared with $0.1 million for the same period in 1995. This increase is attributable to the increase in interest income from the investment of the additional cash available as a result of the Company's initial public offering in the second quarter of 1996, and gain on the sale of equipment.
As a result of the foregoing factors, net income for the year ended December 31, 1996, was $0.6 million, as compared with a pro forma net loss of $11.2 million for the same period in 1995.
Year Ended December 31, 1995 (Pro Forma) Compared to Year Ended December 31, 1994 (Pro Forma)
Total net sales on a pro forma basis of $117.8 million for 1995 declined 2.9% compared to $121.3 million in 1994. Although the Salon Style(R) product line and contract manufacturing experienced sales growth, these increases were more than offset by decreases in the Perma Soft(R) and Style(R) product lines. The decrease in Perma Soft(R) sales in 1995 followed moderate sales increases in 1994 after a heavily funded marketing campaign. As part of that 1994 marketing effort, the Perma Soft(R) product line was reformulated and repackaged which together with the substantial reduction in advertising support in 1995 and a reduction in perm incidence, caused the decline in Perma Soft(R) sales in 1995. Contract manufacturing increased $3.9 million and sales to DowBrands represented 18.2% of pro forma total net sales for 1995 compared to 15.9% in 1994.
Pro forma gross margin for 1995 decreased by $5.1 million as compared with 1994, or 10.0%. Gross margin as a percentage of pro forma total net sales was 39.4% in 1995, as compared with 42.5% in 1994. The decrease in gross margin percentage was due to a change in product sales mix to lower-margin products, as a result of a decrease in consumer retail purchases of the higher margin Perma Soft(R) product line, and increases in lower margin contract manufacturing, as well as a greater emphasis on promotional activities, which resulted in higher product costs. The decrease in gross margins was partially offset by the higher margins provided by Salon Style(R), and a reduction of employee benefit expenses in 1995; of which $874,000 was reflected in pro forma adjustments related to the elimination of postretirement benefits and 401(k) matching contributions, and $160,000 related to a reduction in the Company's vacation benefits. Comparable reductions were not included in the 1994 pro forma gross margins.
Operating expenses on a pro forma basis for 1995 decreased to $45.1 million, or 38.3% of pro forma total net sales, as compared to $54.6 million or 45.0% of pro forma total net sales in 1994. The decrease was principally due to a reduction in marketing expenses in 1995 from 1994 levels, which had been increased in 1994 for the Perma Soft(R) marketing campaign and the introduction of a new product line, Salon Style(R). Operating expenses on a pro forma basis also decreased because of the reduction in 1995 employee benefit expenses as a result of pro forma adjustments made by the Company in the amount of $570,000 related to the elimination of postretirement benefits and 401(k) matching contributions, and $105,000 related to the reduction in the Company's vacation benefits. The pro forma adjustments were made to reflect the Company's decision to eliminate or reduce those benefits. Comparable adjustments are not included in the 1994 pro forma operating expenses.
The $120.1 million write-down of assets by Dow in 1994 was required to adjust the carrying value of the Personal Care Division to its net realizable value in connection with Dow's decision to sell the Personal Care Division. An additional write-down of $11.0 million was recorded in 1995. Future significant charges are not expected as all assets and liabilities were recorded at their estimated fair values at the date of the Company's acquisition of the Personal Care Division.
As a result of the foregoing factors, the pro forma operating loss for 1995 was $9.8 million, compared with the 1994 pro forma operating loss of $123.2 million. Excluding the asset write-downs, pro forma operating income would have been $1.2 million in 1995 and pro forma operating loss would have been $3.1 million in 1994.
Pro forma interest expense, which was $1.6 million for 1995, compared with $2.4 million in 1994, represents interest on the indebtedness incurred in connection with the Company's acquisition of the Personal Care Division and expected average borrowings during the periods.
As a result of the foregoing factors, the pro forma net loss for 1995 was $11.2 million, compared with the 1994 pro forma net loss of $124.9 million.
Historical Results of Operations
Years Ended December 31, 1996, 1995 and 1994
The Company was in a development stage and had no revenues until it completed the acquisition of the Personal Care Division in November 1995. Operating expenses of $45.6 million were incurred in the year ended December 31, 1996, compared with $3.5 million in the year ended December 31, 1995, and $0.6 million in the year ended December 31, 1994. The higher operating expenses for 1996 reflect the inclusion of the Personal Care Division's operating expenses after its acquisition in late 1995. Prior to the acquisition, the Company's operating expenses were comprised of marketing, administrative and other operating expenses incurred to support the Company's technology development and research activities. The Company's net income for the year ended December 31, 1996 was $0.6 million as compared with a loss of $1.4 million and $0.6 million for the years ended December 31, 1995 and 1994 respectively.
Liquidity and Capital Resources
In 1996, the Company primarily financed its working and other capital requirements from operations, the initial public offering and borrowing under its term loan and revolving credit line with Norwest Business Credit. (See Note 6 to the Financial Statements.)
At December 31, 1996, the Company had $12.1 million in cash and cash equivalents. In May 1996, the Company completed its initial public offering for the sale of 2,600,000 shares of common stock at $8 per share. Net proceeds to the Company from the offering were approximately $18.0 million.
In November 1995, the Company entered into a loan agreement with Norwest Business Credit. The Norwest Credit Agreement is for three years, and provides for a working capital line up to $14.0 million and a term loan of $6.0 million which is amortized over five years with annual principal payments of $1.2 million. The working capital balances and term loan are payable in full in November 1998. The interest rates on these loans are variable and are tied to Norwest Bank's base rate which at December 31, 1996, was 8.5%. The interest rates on the revolver and the term loan are currently 8.75% and 9.0%, respectively. The working capital line and term loan with Norwest are secured by all of the assets of the Company and impose certain operating and financial restrictions such as minimum income requirements, minimum net worth and debt service and leverage ratios.
In June 1996, the Company used $8.0 million of the net proceeds from its initial public offering to pay down a portion of its revolving credit line with Norwest Business Credit, Inc. As of December 31, 1996, the Company had approximately $9.8 million of debt outstanding under its revolving credit line agreement with Norwest.
Upon completion of the Company's initial public offering, its $5.0 million convertible note with DowBrands converted into 763,500 shares of Series B convertible preferred stock, the holders of which are entitled to dividends ($400,000 annually), which will accrue whether or not declared, and will be cumulative to the extent not paid.
Accounts receivable at December 31, 1996, increased $6.0 million from December 31, 1995, principally due to higher sales in December 1996 as compared with December 1995. Inventory increased at December 31, 1996, as compared to 1995 as the Company began building its inventory for the launch of its new Willow Lake(TM) product line.
The Company's launch of Willow Lake(TM) as well as the introduction of other new products in 1997 will be supported by a major marketing campaign including advertising and consumer promotions. The funds required for this marketing campaign are expected to come primarily from working capital and the Company's line of credit facility. The Company also intends to increase this facility during 1997 but no assurance can be made that Norwest will agree to an increase.
Capital expenditures for 1996 were approximately $3.5 million and are anticipated to be $2.9 million for 1997.
At December 31, 1996, the Company had a net operating loss carry forward for federal income tax purposes of approximately $2.8 million which expires at various dates between 2008 and 2111.
Management believes that the Company's cash on hand, anticipated cash flow from operations and the amounts available to the Company under the Norwest Credit Agreement will be sufficient for its working capital, capital expenditures and debt service and preferred stock requirements for at least the next 12 months.
Item 8.
Item 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
PART III
Item 10.
Item 10. DIRECTORS AND OFFICERS OF THE REGISTRANT
Incorporated by reference from the Company's 1997 Proxy Statement in the material captioned "Election of Directors." Information with respect to Executive Officers of the registrant is presented at the end of Part I hereof.
Item 11.
Item 11. EXECUTIVE COMPENSATION
Incorporated by reference from the Company's 1997 Proxy Statement in the material captioned `Compensation of Executive Officers" and "Additional Information Relating to Directors and Officers of the Company."
Item 12.
Item 12. SECURITY OWNERSHIP OF CERTAIN BENFICIAL OWNERS AND MANGEMENT
Incorporated by reference from the Company's 1997 Proxy Statement in the material captioned "Security Ownership of Certain Beneficial Owners and Management."
Item 13.
Item 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Incorporated by reference from the Company's 1997 Proxy Statement in the material captioned "Certain Transactions."
PART IV
Item 14.
Item 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
(a) Financial Statements and Schedules - See index in Item 8. (b) Reports on Form 8-K. Form 8-K dated October 30, 1996 reporting an Item 5 event. No financial statements were filed with the Report. (c) List of Exhibits.
1. SIGNATURES
Pursuant to the requirements of Section 13 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 27, 1997 THE LAMAUR CORPORATION (Registrant)
By: /s/ DON G. HOFF Don G. Hoff, Chairman of the Board and Chief Executive Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been duly signed by the following persons on behalf of the registrant and in the capacities and on the dates indicated.
Signature Title Date
/s/ DON G. HOFF - - ---------------------------- Chairman of the Board and Chief March 27, 1997 Don G. Hoff Executive Officer - - ---------------------------- (Principal Executive Officer)
/s/ JOHN D. HELLMANN - - ------------------------------ Vice President, Chief Financial March 27, 1997 John D. Hellmann Officer - - ------------------------------ (Principal Financial and Accounting Officer)
/s/ DOMINIC J. LaROSA - - --------------------------- President and CEO - Lamaur Division March 27, 1997 Dominic J. LaRosa and Director - - ---------------------------
/s/ HAROLD M. COPPERMAN - - --------------------------- Director March 27, 1997 Harold M. Copperman - - ---------------------------
/s/ GERALD A. EPPNER - - --------------------------- Director March 27, 1997 Gerald A. Eppner - - ----------------------------
/s/ PAUL E. DEAN - - ---------------------------- Director March 27, 1997 Paul E. Dean - - ----------------------------
/s/ PERRY D. HOFF - - ---------------------------- Director March 27, 1997 Perry D. Hoff - - ----------------------------
/s/JOSEPH F. STILEY, III - - ---------------------------- Director March 27, 1997 Joseph F. Stiley, III
INDEPENDENT AUDITORS' REPORT
The Lamaur Corporation:
We have audited the accompanying balance sheets of The Lamaur Corporation, formerly Electronic Hair Styling, Inc., (the "Company"), as of December 31, 1996, and 1995, and the related statements of operations, stockholders' equity and cash flows for each of the three years ended December 31, 1996, 1995 and 1994. 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 in accordance with generally accepted auditing standards. Those standards 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. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, such financial statements present fairly, in all material respects, the financial position of the Company as of December 31, 1996 and 1995, and the results of its operations and its cash flows for each of the three years ended December 31, 1996, 1995 and 1994, in conformity with generally accepted accounting principles.
Deloitte & Touche LLP San Francisco, California March 26, 1997
See notes to financial statements
See notes to financial statements
See notes to financial statements
See notes to financial statements
THE LAMAUR CORPORATION - - --------------------------------------------------------------------------------
NOTES TO FINANCIAL STATEMENTS - - --------------------------------------------------------------------------------
1. ORGANIZATION AND OPERATIONS
Effective March 26, 1997, Electronic Hair Styling, Inc. changed its name to The Lamaur Corporation (the "Company"). The Company, a Delaware corporation, is the successor to Electronic Hair Styling, Inc., which was incorporated in the State of Washington on April 1, 1993 (the "Predecessor"). Effective March 18, 1996, Predecessor merged with and into its wholly-owned subsidiary, the Company. In connection with the merger, the Company issued .660 shares of common stock in exchange for each issued and outstanding share of Predecessor common stock. The accompanying Company financial statements, which are substantially identical to Predecessor's financial statements for periods prior to the merger, give retroactive effect to the merger.
The Company develops, formulates, manufactures and markets personal hair care products, consisting of shampoos, conditioners, hair sprays, permanent wave products and other styling aids, for both consumer and professional hair care markets. The Company is also engaged in the early stages of research and development with respect to a new hair styling concept which is intended to combine electronics and chemicals to create new products designed to color, style and condition hair quickly, without the damaging side effects often experienced with most chemical-based hair styling products. The Company licensed the technology from Intertec Ltd., which is the sole limited partner of Intertec Holdings, L.P., the principal stockholder of the Company (see Note 10). Prior to the acquisition discussed below , the Company was a development stage company.
Effective November 15, 1995, the Company acquired certain assets and liabilities of PCD, the Personal Care Division of DowBrands L.P. ("PCD"). DowBrands L.P. is a limited partnership whose managing partner is DowBrands Inc., a wholly owned subsidiary of The Dow Chemical Company (collectively "DowBrands"). PCD, which was renamed Lamaur after the acquisition, develops, manufactures, and markets hair care products. The acquisition was accounted for as a purchase and did not result in any goodwill. The total purchase price, including related acquisition costs, was $30.2 million consisting of $13.7 million in cash (funded with revolving and term credit facilities, see Note 6), $8.5 million (one million shares) of the Company's Series A convertible preferred stock (see Note 7),a $5.0 million convertible subordinated note (the "DowBrands's Convertible Note," Note 10) and $3.0 million of credits to be issued to DowBrands for future purchases. After giving effect to the conversion of Series A and Series B Preferred Stock (Note 7), DowBrands owns approximately 17% of the Company. The acquisition was accounted for as if it occurred on November 30, 1995, and the Company's financial statements include the results of PCD effective December 1, 1995.
The purchase price was allocated to acquired assets and liabilities based on their estimated fair values as follows:
(In thousands) Accounts receivable.................................. $ 16,458 Inventories.......................................... 11,668 Property, plant and equipment........................ 16,805 Other assets......................................... 35 Accounts payable and accrued expenses................ (14,268) Estimated fair value of assets and liabilities....... 30,698 Total purchase price................................. (30,187) Excess of estimated fair value of assets and liabilities over the purchase price.............................. $ 511 -----------------------------------------------------------
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The excess of the estimated fair value of assets and liabilities over the purchase price was recorded as a reduction of property, plant and equipment.
The following unaudited pro forma summary results of operations for each of the years ended December 31, 1995 and 1994, gives effect to the acquisition of PCD as if it had occurred at the beginning of each period presented. The pro forma results have been prepared for comparative purposes only and do not purport to reflect the results of operations which would have actually occurred had the combination been effective on the dates indicated or which may occur in the future.
December 31, 1995 1994
(In thousands, except per share amounts) - - ------------------ Total net sales $ 117,766 $ 121,277 Net loss $ (11,212) $ (124,856) Net loss per share $ (2.74) $ (30.56)
2. SIGNIFICANT ACCOUNTING POLICIES
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 and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reported period. Actual results could differ from those estimates.
Cash and Cash Equivalent - Certain balances are held in a collateral account with the Company's lender (Note 6). After residing in the account for one day, such balances are applied against the Company's revolving debt. The Company considers all investments with an original maturity of three months or less on their acquisition date to be cash equivalents. These investments consist of A1+/P1 rated commercial paper which at December 31, 1996 were $11,496,000.
Accounts Receivable, net includes an allowance for doubtful accounts.
Receivables from DowBrands represent amounts due under a contract manufacturing agreement with DowBrands (see Note 10) and at December 31, 1995 included a $665,000 refund resulting from an adjustment to the initial purchase price paid to DowBrands, which was received in the first quarter of 1996.
Inventories are stated at the lower of weighted average cost or market.
Property, Plant, and Equipment is recorded at cost and is being depreciated using the straight-line method over the estimated useful lives of the related assets which range from 20 to 50 years for buildings and improvements and 3 to 10 years for machinery and equipment. In 1996, the Company adopted the provisions of Statement of Financial Accounting Standards ("SFAS") No. 121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed of." SFAS No. 121 establishes recognition of impairment losses when a company no longer expects to recover the carrying value of a long-lived asset. The effect of adopting SFAS No. 121 was not material.
Income Tax amounts in the financial statements related to income taxes are calculated using the principles of SFAS No. 109, "Accounting for Income Taxes." Under SFAS 109, prepaid and deferred taxes reflect the impact of temporary differences between the amounts of assets and liabilities recognized for financial reporting purposes and the amounts recognized for tax purposes as well as tax credit carryforwards and loss carryforwards. These deferred taxes are measured by applying currently enacted tax rates. A valuation allowance reduces deferred tax assets as future profits are not yet predictable and utilization of deferred tax assets are not determinable.
Stock Based Compensation - The Company accounts for stock based awards to employees using the intrinsic value method in accordance with Accounting Principles Board Opinion ("APB") No. 25, "Accounting for Stock Issued to Employees" and related Interpretations in accounting for its plans.
Net Income (Loss) Per Share was computed by dividing net income (loss) by the weighted average number of shares of common stock and common stock equivalents, which consist of Series A preferred stock, warrants and options. In accordance with the rules of the Securities and Exchange Commission, common stock equivalents issued within one year of the Company's initial public offering, have been considered as outstanding since the inception of the Company and have been included in the calculation of weighted average common and common equivalent shares outstanding for all periods presented using the treasury stock method, even though they are antidilutive in loss periods. Fully diluted earnings per share has not been presented since the computation would not be dilutive.
Concentration of Credit Risk - The Company sells the majority of its products to large U.S. retailers. Excluding sales to DowBrands, sales to the Company's largest customer was $19.1 million and $1.6 million, in 1996 and 1995, respectively. No other customer accounted for more than 10% of total net sales in 1996. The Company performs ongoing credit evaluations of its customers and generally does not require collateral. The Company maintains reserves for potential credit losses, which have been insignificant.
Fair Value of Financial Instruments - Generally accepted accounting principles require the disclosure of the fair value of certain financial instruments, whether or not recognized in the balance sheet, for which it is practicable to estimate fair value. The Company estimated the fair values presented below using appropriate valuation methodologies and market information available as of year end. Considerable judgment is required to develop estimates of fair value, and the estimates presented aren't necessarily indicative of the amounts that the Company could realize in a current market exchange. The use of different market assumptions or estimation methodologies could have a material effect on the estimated fair values. Additionally, these fair values were estimated at year-end, and current estimates of fair value may differ significantly from the amounts presented.
The following methods and assumptions were used to estimate the fair value of each class of financial instruments:
Accounts Receivable, Accounts Payable and Short-Term Borrowings - The carrying amount of these items approximates fair value.
Debt - To estimate the fair value of debt the Company uses those interest rates that are currently available to it for issuance of debt with similar terms and remaining maturities. At December 31, 1996 and 1995, the carrying value of debt approximated fair value.
Reclassification - Certain reclassifications have been made in the accompanying financial statements in order to conform with the 1996 presentation.
3. ACCOUNTS RECEIVABLE
Accounts Receivable include the following:
December 31, -------------------------------- 1996 1995 -------------------------------- (In thousands) - - ---------------------------------------- Accounts receivable trade.............. $ 17,380 $ 10,030 Non-trade accounts receivable......... 391 767 Allowance for doubtful accounts and returns (557) (492) Total................................... $ 17,214 $ 10,305 - - ------------------------------------------
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Write-offs to accounts receivable were $55,000 and $3,000 for the years ended December 31, 1996, and 1995, respectively. There were no write-offs to accounts receivable for the year ended December 31, 1994.
4. INVENTORIES
Inventories include the following: December 31, --------------------------------------------- 1996 1995 (In thousands) --------------------------------- Finished goods................... $ 7,324 $ 6,393 Work in process.................. 118 480 Raw materials.................... 4,257 4,267 Total............................ $ 11,699 $ 11,140 ----------------------------------
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5. PROPERTY, PLANT AND EQUIPMENT
Property, plant and equipment consist of the following:
December 31, --------------------------------------------- 1996 1995 (In thousands) --------------------------------- Land and land improvements........ $ 1,662 $ 1,662 Buildings and improvements........ 5,253 4,981 Machinery and equipment........... 12,120 9,599 Construction in progress.......... 883 185 Total............................. 19,918 16,427 Less accumulated depreciation..... (1,443) (144) Total............................. $ 18,475 $ 16,283 ----------------------------------
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6. LONG-TERM DEBT
Long-term debt includes the following:
December 31, --------------------------------------------- 1996 1995 (In thousands) ---------------------------------- Revolving loan.................... $ 9,814 $ 8,050 Term loan......................... 4,800 6,000 Obligations under capital leases... 381 - Total............................... 14,995 14,050 Less current portion................ (1,272) (1,200) Long-term portion...................$ 13,723 $ 12,850 ----------------------------------
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In November 1995, the Company obtained from Norwest Business Credit (Norwest) a $20.0 million credit facility. The facility consists of a $14.0 million revolving line of credit and a $6.0 million term loan. Under the terms of the revolving facility, the Company can borrow up to $14.0 million or a lesser amount as determined by the borrowing base (as defined in the loan agreement, comprising a percentage of eligible receivables and inventory). Interest is payable monthly on the revolving line of credit at 8.75% and 9.75% at December 31, 1996 and 1995, respectively. These rates are .5% and 1.25% above Norwest Bank's base rate.
The term loan provided for a single advance of $6.0 million and is payable in monthly installments beginning January 1, 1996, of $100,000, plus interest.. Interest is payable monthly on the term loan at 9.0% and 10.0% at December 31, 1996 and 1995, respectively. These rates are .75 % and 1.50% above Norwest Bank's base rate .
Both credit facilities mature on November 15, 1998. The credit facilities are secured by virtually all assets of the Company. Additionally, the credit facilities prohibit the payment of dividends, restrict the Company's ability to incur additional indebtedness and require the Company to comply with certain financial covenants regarding profitability, minimum net worth, leverage, capital expenditures and cash flow.
The obligations under capital leases are at fixed interest rates ranging from 4.8% to 10.0% and are collateralized by equipment and a letter of credit for $319,000. Machinery and equipment under capital leases were $395,000 (net of $6,000 of accumulated depreciation) as of December 31, 1996. Minimum payments on operating leases obligations are for buildings, autos and office equipment.
Future minimum principal payments on long term debt, capital lease and operating lease obligations are as follows:
The fair value of the Company's long-term debt approximates the carrying amount based on the current rates offered to the Company on similar debt.
7. STOCKHOLDERS' EQUITY
Effective May 22, 1996, the Company completed its initial public offering of 2,600,000 shares of its common stock. Net proceeds to the Company aggregated approximately $18.1 million. As of the closing date of the offering, the $5.0 million convertible note with DowBrands converted into 763,500 shares of Series B preferred stock (see below).
Preferred Stock - The Company has authorized 4,000,000 shares of $.01 par value preferred stock, the terms of which are established at the time of issuance by the Board of Directors. In connection with the acquisition described in Note 1, the Company issued one million shares of Series A convertible preferred stock ("Series A Preferred"). The Series A Preferred has a liquidation preference of $10.00 per share or $10.0 million in the aggregate and has dividend and voting rights equal to common stock on an as-converted basis. Each share of Series A Preferred is convertible into .660 shares of common stock at the option of the holder; however, if the trading price of the common equals or exceeds $21.21 per share for a 30-day trading period, the Company may force conversion.
Also in connection with the acquisition, the Company's Board of Directors authorized 763,500 shares of Series B convertible preferred stock ("Series B Preferred") which was issued in May 1996 upon conversion of the $5.0 million DowBrands Convertible Note (Note 1 and Note 10). Series B Preferred bears an 8.0% per annum cumulative dividend, payable quarterly, has a liquidation preference of $6.55 per share or $5.0 million in the aggregate, has dividend and voting rights equal to common stock on an as-converted basis and is redeemable at face value at the option of the Company in $1.0 million increments at any time. Each share of Series B Preferred is convertible into .660 shares of common stock at the option of the holder; however, if the trading price of the common equals or exceeds $21.21 per share for a 30 day trading period, the Company may force conversion.
Equity Incentive Plans - The Company maintains three equity incentive plans for employees, consultants, directors and advisory board members. These plans are the 1996 Stock Incentive Plan, the 1996 Nonqualified Stock Option Plan and the Stock Option Plan for Non-Employee Directors and Advisory Board Members. In connection with Predecessor's merger with the Company (Note 1), all of Predecessor's outstanding stock options were assumed by the Company under the 1996 Stock Incentive Plan or The Stock Option Plan for Non-Employee Directors and Advisory Board Members. Stock options under these plans are issued at an option price not less than market value on date of grant. Total shares authorized under these three plans are 1,250,000, 250,000 and 150,000, respectively. Total shares available for grant under these plans were 18,650, 215,000 and 60,900, respectively, at December 31, 1996. Options granted to directors and advisory board members generally vest one year from the date of grant, and options currently granted to employees and consultants generally vest annually over three years. The 1996 Stock Incentive Plan also provides for the issuance of stock appreciation rights and restricted stock, none of which have been granted as of December 31, 1996.
A summary of changes in common stock options during 1994, 1995, and 1996 is as follows:
During 1996, 340,350 options were canceled at exercise prices ranging from $6.06 to $8.00 per share and reissued at $4.25 per share. The reissued shares are included in the above table.
Options exercisable at December 31, 1996 and 1995, were 526,300 and 476,850, respectively.
The following table summarizes information about the three equity incentive plans at December 31, 1996:
Options Outstanding Options Excercisable - - -------------------------------------------------------- ------------------ Weighted-Average Weighted Remaining Average Weighted Range of Contractual Life Exercise Average Exercise (in years) Price Excercise Prices Number Number Price - - -------------------------------------------------------------------------------- $ 1.52 323,532 8.33 $1.52 316,932 $ 1.52 3.03 234,168 8.55 3.03 159,918 3.03 4.00 - 4.38 754,850 9.08 4.23 49,450 4.25 --------- ----------- 1,312,550 526,300 ========== ===========
The Company applies APB No. 25 "Accounting for Stock Issued to Employees" and related interpretations in accounting for its plans. Accordingly, no compensation cost has been recognized for its stock-based compensation plans. Had compensation cost been determined based on the fair value of the 1996 and 1995 stock option grants consistent with the requirements of SFAS No. 123 "Accounting for Stock-Based Compensation," the Company's net income and earnings per share would have been reduced to the pro forma amounts indicated below:
1996 1995 ---------------- --------------- (In thousands, except per share amounts) Net income (loss) As reported $ 553 $ (1,382) Pro forma $ (142) $ (1,479)
Net income (loss) per share As reported $ .06 $ (.34) Pro forma $ (.03) $ (.36) ============================================
================================================================================ In determining the above pro forma amounts under SFAS 123, the fair value of each option grant is estimated on the date of grant using the Black-Scholes option-pricing model with the following weighted-average assumptions used for grants in 1996 and 1995, respectively: expected volatility of 65% and 0%, risk-free interest rates of 6.4% and 6.4 %, expected lives of 6.5 years and 6.5 years and no expected dividends. The effects of applying SFAS123 in this pro forma disclosure are not indicative of future amounts. SFAS 123 does not apply to awards prior to 1995, and additional awards are anticipated.
Employee Stock Plan - In November 1995, the Company adopted the Employee Stock Plan for the purpose of issuing up to an aggregate of 16,500 shares to former DowBrands employees at no cost to the employee. As of December 31, 1996, 15,575 shares were issued pursuant to this plan.
Noncash Credits- Certain of the Company's employees and consultants have received a portion of their salary or fees, respectively, in the form of non-cash credits which may be applied to 80% of the exercise price of options granted to them. Such credits, $132,000 and $651,000 at December 31, 1996 and 1995, respectively, have been recorded as expense or cost of acquisition and additional paid-in capital as the related salary or consulting fees were earned. The Company ceased issuing any additional noncash credits at December 31, 1996.
Stock Subscription Receivable - In 1995, the Company issued 66,000 shares of common stock for two 6% notes receivable of $50,000 each, due August 1996 and July 2001, respectively, or 30 days after the sale of such common stock, whichever is earlier.
Warrants - In November 1995, the Company borrowed $225,000 from employees and stockholders. The borrowings were repaid in February 1996 with interest at 12% (Note 10). In addition, the lenders received warrants to purchase 74,250 shares of common stock at $3.03 per share. The warrants became exercisable in May 1996 and expire in November 1998.
8. EMPLOYEE BENEFIT PLANS
The Company established an Employee Savings Plan (401K) during 1996 covering substantially all employees. Contributions to this plan are at the discretion of the Board of Directors, subject to certain limitations. No contributions were made by the Company to the plan during the year ending December 31, 1996.
The Company does not provide other post-retirement benefits to its employees.
9. INCOME TAXES
The provision (benefit) for income taxes has been offset by the change in the valuation allowance for the years ended December 31, 1996, 1995 and 1994, because the Company's net operating losses could not be carried back and future profits are not yet predictable and utilization of deferred tax assets are not determinable.
The actual income tax provision (benefit) attributable to earnings from continuing operations for the years ended December 31, 1996, 1995, and 1994 differed from the amounts computed by applying the U.S. federal tax rate of 34 % to pretax earnings from continuing operations as a result of the following;
The significant components of deferred income taxes as of December 31 are as follows (prior year amounts have been adjusted to reflect changes in current and deferred tax assets and liabilities): ================================================================================
1996 1995 Tax effects of: (In thousands) - - ---------------------------- Current deferred tax assets and liabilities: Accounts Receivable, principally due to reserves. $ 212 $ 187 Inventories, partially due to additional costs inventoried for tax purposes 336 470 Employee benefits 316 29 Other (includes contingencies, other assets and other accruals) (86) 45 ----------- ---------- 778 731 Long-term deferred tax assets and liabilities: License fee 380 380 Noncash credits 297 254 Federal and state operating loss 1,089 758 Property, plant and equipment (768) (96) ----------- ---------- 998 1,296 ----------- ---------- Gross deferred tax assets 1,776 2,027 Valuation allowance (1,776) (2,027) Net deferred taxes $ - $ -
- - -------------------------------------------
Due to the Company's net operating losses, the Company has not paid any income taxes. The Company has accumulated approximately $2.8 million of federal and state operating loss carryforwards (NOLs) at December 31, 1996. These NOLs expire as follows: ================================================================================
(In thousands) 2008.................................................... $ 340 2009.................................................... $ 598 2010.................................................... $ 1,006 2011.................................................... $ 877
10. RELATED PARTY TRANSACTIONS
Related party obligations includes the following:
December 31, 1996 1995 (In thousands)
Promissory note for license rights.... $ 1,000 $ 1,000 DowBrands Convertible Note 8%......... - 5,000 DowBrands purchase credits............ 1,500 3,000 Short-term borrowings................. - 225 ------------ ------------ Total................................. 2,500 9,225 Less current portion.................. (1,500) (1,725) ------------ ------------
Long-term portion..................... $ 1,000 $ 7,500 - - --------------------------------------
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Promissory Note - In May 1993, the Company licensed its proprietary technology from Intertec Ltd., a limited partnership controlled by the Company's Chairman of the Board, pursuant to an exclusive 30-year, nonassignable, license agreement (the "License Agreement"). According to the terms of the License Agreement, the Company is required to pay a $1.0 million license fee, plus royalties, to Intertec Holdings, L.P. as agent for Intertec Ltd. Due to uncertainty regarding recoverability from future operations, the license fee was expensed in 1993. A note for the license fee ("Intertec Note") is payable in four equal annual installments of $250,000 commencing in May 1997. Interest , at 5.5% , is payable in arrears on the date each installment of principal is due. The Company will pay a royalty to Intertec Ltd. equal to (i) 1.0% of the Company's proceeds from any direct sales made by the Company of products, instruments or components using, or derived from, the technology, and (ii) 1.0% of the "revenue base" of the Company's sublicensees. The "revenue base" is the proceeds received by the sub-licensees for their sales of products using the technology. This royalty declines in steps as the revenue base increases, ultimately declining to 0.4% when cumulative sales from all products using the Company's technology reach $10.0 billion. No royalty fees have been paid to date.
Stock Purchase Agreement - In March 1996, the Company and Intertec Holdings, L.P. entered into a stock purchase agreement pursuant to which Intertec Holdings, L.P. agreed to purchase from the Company, and the Company agreed to sell to Intertec Holdings, L.P. shares of common stock at $8.00 per share. The aggregate number of shares of common stock which Intertec Holdings, L.P. is required to purchase is 146,125 shares. Intertec Holdings, L.P. is obligated, subject to there being no event of default under the Company's loan agreements and certain other conditions, to purchase and pay for the shares in four equal installments commencing in May 1997. The deferred purchase price under the stock purchase agreement accrues interest from and after May 1996 at 5.5% per annum, payable with each installment. Intertec Holdings, L.P. may elect to accelerate one or more purchases under the stock purchase agreement on 30 days' prior notice to the Company. The Company may, at any time or from time to time, terminate Intertec Holding, L.P.'s purchase rights with respect to one or more of the installments, on 10 days' prior notice to Intertec Holdings, L.P..
DowBrands Convertible Note 8% - The $5.0 million DowBrands Convertible Note had an interest rate of 8.0% per annum, due quarterly, and was subordinated to any bank borrowings. Upon the completion of the Company's initial public offering, the $5.0 million DowBrands Convertible Note was converted into 763,500 shares of Series B preferred stock (Note 7).
DowBrands Purchase Credits - In connection with the acquisition described in Note 1, DowBrands has agreed to purchase 100% of its requirements for certain DowBrands products from the Company for a period of two years beginning November 16, 1995. In connection with this requirements agreement, DowBrands agreed to accept, as part of the purchase price, $3 million of credits to be applied against future purchases. These credits will be issued to DowBrands through credit memos each quarter in the amount of $375,000 until the credits are fully used. At December 31, 1996 and 1995, $1.5 million of such credits were classified as a current liability. Revenues from this arrangement totaled $22.2 million and $1.6 million for the years ended December 31, 1996 and 1995. Services are priced based on direct material and labor costs incurred plus an agreed-upon profit margin.
Short-term Borrowings - In November 1995, the Company borrowed $225,000 from employees and stockholders. The borrowings were repaid in February 1996 with interest at 12%. The lenders received warrants to purchase 74,250 shares of common stock (Note 7).
Leases - The Company leases its offices and certain office equipment in Mill Valley, California, from Innovative Capital Management, Inc., (ICM) a related party, under a noncancellable lease expiring in September 1999 with monthly rentals of $10,786. The Company's Chairman of the Board and Chief Executive Officer, and his family own 100% of the outstanding stock of ICM. Rental expense was $99,975, $90,156, and $89,428 for 1996, 1995 and 1994, respectively.
Legal Fees - During 1996 and 1995, the Company paid legal fees of approximately $676,000 and $150,000, respectively, to a law firm in which a Director of the Company is a partner. The legal fees related to general services, the acquisition of PCD, and the Company's initial public offering.
11. COMMITMENTS AND CONTINGENCIES
The Company has various purchase and sales commitments and obligations entered into in the ordinary course of business which management does not believe will have a material adverse effect on its financial position or results of operations.
INDEPENDENT AUDITORS' REPORT
The Dow Chemical Company:
We have audited the accompanying statements of operations of PCD, the Personal Care Division of DowBrands L.P., ("PCD"), a limited partnership whose managing partner is DowBrands Inc., a wholly owned subsidiary of The Dow Chemical Company, for the period from January 1, 1995 to November 30, 1995 and for the year ended December 31, 1994, and the related statements of net invested capital and cash flows for the periods then ended. These financial statements are the responsibility of PCD's management. Our responsibility is to express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing standards. Those standards 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. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, such financial statements present fairly, in all material respects, the results of operations of PCD for the period from January 1, 1995 to November 30, 1995, and for the year ended December 31, 1994, and the changes in its net invested capital, and its cash flows for the periods then ended, in conformity with generally accepted accounting principles.
The accompanying financial statements have been prepared from the separate records maintained by PCD and may not be indicative of the conditions that would have existed or the results of operations if PCD had been operated as an unaffiliated company. As discussed in Note 1, Statement of Financial Accounting Standards No. 109 requires that the consolidated amount of current and deferred tax expenses for a group that files a consolidated tax return be allocated among members of the group when those members issue separate financial statements. On the basis that PCD is a division and not a separate subsidiary, current and deferred income taxes have not been provided for in the accompanying financial statements.
DELOITTE & TOUCHE LLP San Francisco, California January 26, 1996
See notes to financial statements.
PCD, THE PERSONAL CARE DIVISION OF DOWBRANDS L.P. STATEMENTS OF NET INVESTED CAPITAL Period From January 1, 1995 to November 30, 1995 and the Year Ended December 31, 1994
Period From January 1, 1995 to November 30, Year Ended December 31, 1995 1994 ------------------------------------ (In thousands)
Net invested capital, beginning of period...................... $ 47,493 $ 169,058 Net loss for the period........ (12,238) (133,488) Net capital invested by (returned to) Dow..................... (3,489) 11,923 ---------- ------------- Net invested capital, end of period $ 31,766 $ 47,493 - - ------------------------------------
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See notes to financial statements.
See notes to financial statements
PCD, THE PERSONAL CARE DIVISION OF DOWBRANDS L.P. NOTES TO FINANCIAL STATEMENTS Period From January 1, 1995 to November 30, 1995 and the Year Ended December 31, 1994
1. ORGANIZATION AND SIGNIFICANT ACCOUNTING POLICIES
Business - PCD, the Personal Care Division of DowBrands L.P., ("PCD") a limited partnership whose managing partner is DowBrands Inc., a wholly owned subsidiary of The Dow Chemical Company (collectively "Dow"), develops, manufactures and markets hair care products.
Effective November 15, 1995, pursuant to an Asset Purchase Agreement, Dow sold substantially all of the assets and liabilities of PCD to Electronic Hair Styling, Inc. (the "Company") for $28.8 million comprised of $12.3 million in cash, a $5.0 million 8.0% subordinated note (convertible into Series B preferred stock), $8.5 million in Series A convertible preferred stock and $3.0 million in credits to be issued to Dow for future purchases. Through its Series A convertible preferred stock holdings, Dow will maintain an approximate 18% ownership interest in the voting equity of the Company. The sale was accounted for as if it occurred on November 30, 1995.
Basis of Presentation - The accompanying financial statements present operations, net invested capital and cash flows of PCD on a historical basis. In 1987, DowBrands L.P. acquired PCD's predecessor for approximately $183 million. As a result of this acquisition, Dow's new accounting basis, determined in accordance with the purchase method of accounting, was "pushed-down" to PCD and, accordingly, the assets and liabilities of PCD were adjusted to reflect their fair values. The excess of Dow's cost of PCD over the estimated fair value of net assets acquired was recorded as goodwill and was being amortized over 40 years. During 1994, in contemplation of Dow's sale of PCD, Dow wrote down its investment in PCD by approximately $120 million. This write-down was applied to PCD's unamortized goodwill of $117 million and to property, plant and equipment of $3 million. In 1995 the proposed buyer withdrew its offer. During 1995, Dow further wrote down its investment in PCD by an additional $11 million, which was recorded as a reduction of property, plant and equipment.
Relationship with Dow - PCD uses certain resources and administrative staff of Dow, including accounting, legal, tax, treasury, data processing, risk management, human resources and corporate relations. PCD is charged a fee for these services at an amount that Dow estimates to be based on actual time or costs incurred. These charges were $1,465,000 in 1994 and $733,500 for the period from January 1, 1995 to November 30, 1995 and are included in operating expenses.
In addition, PCD is charged interest by Dow on an imputed amount of debt required to fund Dow's total capital investment in PCD. Such interest charges were $5,805,000 in 1994 and $1,603,000 for the period from January 1, 1995 to November 30, 1995.
Income Taxes - Statement of Financial Accounting Standards No. 109 requires that the consolidated amount of current and deferred tax expense for a group that files a consolidated tax return be allocated among the members of the group when those members issue separate financial statements. However, management of PCD believes that such requirement applies only to separate financial statements of subsidiaries and since PCD is a division of Dow and not a separate subsidiary, current and deferred income taxes have not been provided for in the accompanying financial statements.
Concentration of Credit Risk - PCD sells the majority of its products to large U.S. retailers. Excluding sales to Dow, sales to PCD's largest customer were $22.3 million in 1994 and $19.7 million for the period from January 1, 1995 to November 30, 1995. No other customer accounted for more than 10% of net sales in any period. PCD performs ongoing credit evaluations of its customers and generally does not require collateral. PCD maintains reserves for potential credit losses, which have been insignificant.
2. RELATED PARTY TRANSACTIONS
PCD provides contract packaging and manufacturing services for Dow. Revenues from this arrangement totaled $19,253,000 in 1994 and $19,783,000 for the period from January 1, 1995 to November 30, 1995. Services are priced based on direct material and labor costs incurred plus an agreed upon profit margin.
3. EMPLOYEE BENEFIT PLANS
Through November 15, 1995, PCD's employees were eligible to participate in Dow's retirement, 401(k) and postretirement health and welfare benefit plans. Contributions to the plans by PCD on behalf of PCD's employees were approximately $1,657,000 in 1994 and $1,432,000 for the period from January 1, 1995 to November 30, 1995.
4. COMMITMENTS AND CONTINGENCIES
PCD has various purchase and sales commitments and obligations entered into in the ordinary course of business which management does not believe will have a material adverse effect on PCD's financial statements.