SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-K (X) ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE FISCAL YEAR ENDED JUNE 30, 2003 OR ( ) TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 COMMISSION FILE NUMBER 000-26667 CRAFTMADE INTERNATIONAL, INC. (EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER) DELAWARE 75-2057054 (STATE OR OTHER JURISDICTION (I.R.S. EMPLOYER OF INCORPORATION OR ORGANIZATION) IDENTIFICATION NO.) 650 S. ROYAL LANE, SUITE 100 75019 COPPELL, TEXAS (ZIP CODE) (ADDRESS OF PRINCIPAL EXECUTIVE OFFICES) REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE: (972) 393-3800 SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT: NONE SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT: TITLE OF EACH CLASS NAME OF EACH EXCHANGE COMMON STOCK, $0.01 PAR VALUE ON WHICH REGISTERED NASDAQ NATIONAL MARKET SYSTEM 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, 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 OR INFORMATION STATEMENTS INCORPORATED BY REFERENCE IN PART III OF THIS FORM 10-K OR ANY AMENDMENT TO THIS FORM 10-K.____ INDICATE BY CHECK MARK WHETHER THE REGISTRANT IS AN ACCELERATED FILER (AS DEFINED IN RULE 12B-2 OF THE ACT). YES [ ] NO[X] THE AGGREGATE MARKET VALUE OF THE VOTING STOCK HELD BY NONAFFILIATES OF THE REGISTRANT AS OF DECEMBER 31, 2002 WAS $59,020,000 THE NUMBER OF SHARES OUTSTANDING OF THE REGISTRANT'S $.01 PAR VALUE COMMON STOCK AS OF SEPTEMBER 26, 2003 WAS 5,424,628 DOCUMENTS INCORPORATED BY REFERENCE PORTIONS OF THE REGISTRANT'S PROXY STATEMENT PERTAINING TO THE REGISTRANT'S 2003 ANNUAL MEETING OF STOCKHOLDERS ARE INCORPORATED BY REFERENCE INTO PART III OF THIS REPORT. INDEX PART I ...................................................................................................................... 1 Item 1. Business.................................................................................................... 1 Item 2. Properties.................................................................................................. 7 Item 3. Legal Proceedings........................................................................................... 7 Item 4. Submission of Matters to a Vote of Security Holders......................................................... 7 PART II ...................................................................................................................... 8 Item 5. Market for the Registrant's Common Equity and Related Stockholder Matters...................................................................................... 8 Item 6. Selected Financial Data..................................................................................... 9 Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operation....................................................................... 10 Item 7A. Quantitative and Qualitative Disclosures About Market Risk.................................................. 16 Item 8. Financial Statements and Supplementary Data................................................................. 17 Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure...................................................................... 17 Item 9A. Controls and Procedures..................................................................................... 17 PART III ..................................................................................................................... 18 Item 10. Directors and Executive Officers of the Registrant.......................................................... 18 Item 11. Executive Compensation...................................................................................... 18 Item 12. Security Ownership of Certain Beneficial Owners and Management........................................................................................... 18 Item 13. Certain Relationships and Related Transactions.............................................................. 18 Item 14. Principal Accounting Fees and Services ..................................................................... 18 PART IV ...................................................................................................................... 19 Item 15. Exhibits, Financial Statements, Financial Statement Schedule and Reports on Form 8-K......................................................................... 19 Signatures ........................................................................................................... 25 PART I ITEM 1. BUSINESS THE COMPANY Craftmade International, Inc. was incorporated in the state of Texas on July 1985 and reincorporated in the state of Delaware in December 1991 and is organized into two operating segments: Craftmade International, Inc. ("Craftmade") and Trade Source International, Inc. ("TSI"). See Note 15 - Segment Information in the Notes to Consolidated Financial Statements for certain financial information about the Company's two segments. Craftmade, TSI, their wholly-owned subsidiaries, and their equity interest in the 50% owned investees are collectively referred to as the "Company". CRAFTMADE - Craftmade is principally engaged in the design, distribution and marketing of ceiling fans, light kits, outdoor lighting, bath-strip lighting and related accessories to a nationwide network of over 1,600 lighting showrooms and electrical wholesalers specializing in sales to the remodeling, new home construction and replacement markets. Craftmade completed an arrangement with Fanthing Electrical Corp. ("Fanthing"), which is located in Taichung, Taiwan, in August 1986 for the manufacture of ceiling fans designed to Craftmade's specifications. Craftmade's ceiling fan product line consists of over two dozen series of premium priced to lower priced ceiling fans and is distributed under the Craftmade(R) trade name. Craftmade also markets nearly eighty light kit models in various colors for attachment and use with its ceiling fans or other ceiling fans, along with parts and accessories for its ceiling fans and light kits. In addition, nearly two dozen styles of bath-strip lighting and over forty designs of outdoor lighting are marketed under its Accolade(R) trade name. Craftmade purchases substantially all of its light kits from Sunlit Industries ("Sunlit"), in Taipei, Taiwan. The combination of design and functional features which characterize Craftmade ceiling fans have made them, in management's judgment, one of the most reliable, durable, energy efficient and cost effective ceiling fans in the marketplace. Craftmade's national sales organization, which consists of 33 independent sales groups employing approximately 65 sales representatives, markets its products to its distribution network of lighting showrooms and electrical wholesalers. Craftmade also imports and distributes a variety of cables and components for the telephone and communications industries. TSI - TSI is principally engaged in the design, distribution and marketing of outdoor and indoor lighting, selected ceiling fans and various fan accessories to mass merchandisers. TSI's outdoor lighting consists of over one-hundred designs in different decorative finishes. The indoor lighting product line includes ceiling mount lighting fixtures and bath-strip lighting. TSI purchases substantially all of its products from manufacturers located in China. 50% OWNED INVESTEES - The Company has a 50% ownership interest in two entities, Design Trends, LLC ("Design Trends") and Prime/Home Impressions, LLC ("PHI"): DESIGN TRENDS- Design Trends markets indoor lighting, including portable table lamps, floor lamps, chandeliers and wall sconces designed by Patrick Dolan. Substantially all of Design Trends' sales are to mass merchandisers. PHI- PHI markets various fan accessories including decorative pull-chains, replacement switches, blade arms, blades and ceiling medallions. All of PHI's sale are to mass merchandisers. Our Annual Report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and all amendments to these reports will be made available free of charge through the Investor Relations section of our Internet website, HTTP://WWW. CRAFTMADE.COM, or CRAFTMADE.COM, as soon as practicable after such material is electronically filed with, or furnished to, the Securities and Exchange Commission. CRAFTMADE PRODUCTS CEILING FANS - Craftmade's ceiling fan product line consists of over two dozen fan series for sale to the new home construction, remodeling and replacement markets. These series are differentiated on the basis of cost, air movement and appearance. Craftmade's fans are manufactured and assembled in a variety of colors, styles and -1- finishes and can be used either in conjunction with or independent of Craftmade's light kits. Series lines include Early American, Traditional and Modern High-Tech Decor and, depending on the size, finish and other features, range in price from the premium Cameo, Constantina, Crescent and Presidential series to various low-end builder series. Craftmade's fans come in five motor sizes, five blade sizes and over two dozen different decorative finishes. The range of styles and colors gives consumers the ability to select ceiling fans for any style of house, interior decoration or living and working area, including outdoor patios. Ceiling fans accounted for 43%, 42% and 43% of the Company's sales for fiscal years 2003, 2002 and 2001, respectively. LIGHT KITS - Craftmade markets nearly eighty models of light kits, which consist of the glass shades and filters, in various colors which may be utilized with Craftmade's ceiling fans or other ceiling fans. BATH-STRIP LIGHTING - Craftmade markets nearly two dozen series of bath-strip lighting in different lengths and decorative finishes under the Accolade(R) trade name. Craftmade plans to add finishes and series from time to time based on customer demand. OUTDOOR LIGHTING - Craftmade markets over forty designs of outdoor lighting in different decorative finishes under the Accolade(R) trade name. Other outdoor products are also marketed under the TSI Prime brand, or under the retailers' private label. Styles include wall-mount, pendant and post-mount. Craftmade plans to add finishes and designs from time to time based on customer demand. ACCESSORIES - Craftmade also markets a variety of designer and standard wall controls to regulate the speed and intensity of ceiling fans and lighting fixtures and universal down-rods for use with ceiling fans. Accessory sales represented 9%, 11% and 12% of the Company's sales in fiscal years 2003, 2002 and 2001, respectively. TSI PRODUCTS TSI markets over one hundred designs of lighting, including ceiling mount lighting fixtures, bath-strip lighting and outdoor lighting in a variety of decorative finishes, colors and sizes to various mass merchandisers under the TSI Prime brand, as well as the retailers' private label brands. The outdoor lighting is designed for either wall mounting or as a post-mounted fixture. TSI's sales of outdoor lighting represented 16%, 21% and 19% of the Company's sales in fiscal years 2003, 2002, and 2001, respectively. Indoor lighting represented 15%, 12%, and 12%, respectively, of the Company's sales in fiscal years, 2003, 2002, and 2001. 50% OWNED INVESTEES' PRODUCTS DESIGN TRENDS - During fiscal year 2000, the Company began marketing floor and table lamps, chandeliers and wall sconces designed by Patrick Dolan to various mass merchandisers through Design Trends, a 50% owned investee. The program is merchandised in a patented display and packaged in a mix and match system that enables the consumer to customize a lamp base and shade combination. Lampshades are displayed separately on a revolving carousel that economizes space. The smaller packaging of the lamp bases enables the retailer to display a greater number of SKUs in the same amount of space. Selections of lamp bases include large, medium, buffet, small and mini lamps and are offered in a variety of styles and finishes. PHI - PHI markets various fan accessories, including decorative pull-chains, replacement switches, blade arms, blades and ceiling medallions to various mass merchandisers. MANUFACTURING Craftmade's ceiling fans, bath-strip lighting and substantially all of its light kits and certain accessories are produced by Fanthing and Sunlit. Craftmade selected Fanthing in August 1986 to manufacture all of its ceiling fans and certain fan accessories based on the Company's belief that Fanthing has the capability to produce and ship a wide variety of product on a cost effective basis while maintaining excellent quality control in the manufacturing process. In 1989, Craftmade and Fanthing entered into a formal written agreement that is terminable on 180 days prior notice. The written agreement does not obligate Fanthing to produce and sell fans to Craftmade in any specified quantity, nor does it obligate Fanthing to sell products to Craftmade at a fixed price. Fanthing is permitted under the arrangement to manufacture ceiling fans for other distributors provided such -2- ceiling fans are not a replication of Craftmade's series or models. Fanthing also manufactures certain ceiling fan accessories, such as down-rods, which are sold by Craftmade independently of its ceiling fans. Fanthing has provided Craftmade with a $1,000,000 credit facility, pursuant to which Fanthing will manufacture and ship ceiling fans prior to receipt of payment from Craftmade. Accordingly, payment can be deferred until delivery of such products. At present levels, this credit facility is equivalent to approximately three weeks' supply of ceiling fans and represents a supplier commitment that the Company's management believes is unusual for the industry and favorable to the Company. Fanthing is not required to provide this credit facility under its agreement with Craftmade, and Fanthing may discontinue this credit facility at any time. Craftmade places orders with Fanthing in anticipation of normally recurring orders. In the ordinary course of business, orders are filled within 60 days, which includes approximately 20 days for transport. While Craftmade's agreement with Fanthing does not contain provisions relating to adjustments or returns as a result of product defects, Fanthing has historically extended Craftmade full credit for any product returns. Ceiling fans are shipped in container-size lots, generally consisting of 1,600 fan units. Delivery is made in Dallas, Texas upon presentment of documents by Craftmade's designated freight forwarder following payment for such containers at Fanthing's bank in Taiwan. The Company's management believes that Craftmade's relationship with Fanthing and its ability to supply quality ceiling fans at competitive prices have been critical to the success of Craftmade. The Company's management currently believes Craftmade's relationship with Fanthing is excellent and foresees no reason, based on its association to date, for such relationship to deteriorate. If for any reason Fanthing were to discontinue its relationship with Craftmade in the future or should it be unable to continue to supply sufficient amounts of Craftmade products, Craftmade would be required to seek alternative sources of supply. The Company's management currently believes Craftmade could secure alternative sources of supply with minimal business disruption. Craftmade purchases its bath-strip lighting and substantially all of its light kits from Sunlit. Light kit orders are placed independently of ceiling fan orders, but are also received in container-size lots generally consisting of up to 4,500 light kit units under payment and delivery arrangements similar to those for ceiling fans. Craftmade offers a variety of light kits in various finishes and colors, as well as a variety of fixtures designed for ceiling fans. Craftmade also offers a variety of glass selections for the various light fixtures, including blown glass, beveled glass and crystal. Fixtures and glass are shipped from Sunlit in the light kit containers. Craftmade and TSI purchase outdoor lighting from several manufacturers located in Asia. Outdoor lighting orders are received in container-size lots, similar to light kit and ceiling fan orders. Craftmade and TSI offer a wide variety of outdoor lighting styles in various finishes, colors and sizes and are designed for either wall mounting or as post-mounted fixtures. Craftmade's wall controls, timers and switches as well as certain of its ceiling fan blades are manufactured by companies based in the United States. Craftmade offers a variety of custom blade sets in various sizes and finishes, including unfinished oak, ash and other wood grains and in clear, mirror, gold mirror, black, smoke and antique white acrylic. The finished products are packaged and labeled under the Craftmade brand name. TSI purchases most of its ceiling fan accessories from several manufacturers located in Asia, with the exception of ceiling medallions which are purchased from a manufacturer located in the United States. Design Trends purchases its portable lamps and shades from three primary manufacturers located in China. These products are also shipped in containers, either to the Company's facility in Coppell, Texas or directly to the customer. DISTRIBUTION Craftmade's products are marketed through more than 1,600 lighting showrooms and electrical wholesaler locations specializing in sales to the new home construction, remodeling and replacement markets. Its ceiling fans, light kits, outdoor lighting and accessories are distributed through 33 independent sales groups on a national basis. Each sales group is selected to represent Craftmade in a specific market area. The independent sales groups comprise a sales force of approximately 65 sales representatives, who represent Craftmade exclusively in the sale of ceiling fans in return for commissions on such sales. During fiscal years 2003, 2002 and 2001, no single lighting showroom or electrical wholesaler accounted for more than 2% of Craftmade's sales. -3- Sales representatives are carefully selected and continually evaluated in order to promote high-level representation of Craftmade's products. Craftmade employees provide initial field training to new sales representatives covering features, styles, operation and other attributes of Craftmade products to enable representatives to more effectively market Craftmade's products. Additional training, especially for new product series, is provided on a regular basis at semi-annual trade shows held throughout the United States. Management believes it has assembled a highly motivated and effective sales representative organization that has demonstrated a strong commitment to Craftmade and its products. Management further believes that the strength of its sales representative organization is primarily attributable to the quality and competitive pricing of Craftmade's products as well as the ongoing administrative and marketing support that Craftmade provides to its sales representatives. All of TSI's sales are to mass merchandisers with two customers comprising the most significant portion of TSI's and the Company's sales, as follows: Customer A Customer B --------------------------- --------------------------- Percent of Percent of Percent of Percent of Consolidated TSI's Consolidated Fiscal Year TSI's Sales Sales Sales Sales ---------- ----------- ------------ ---------- ------------ 2003 56% 18% 25% 8% 2002 59% 19% 12% 4% 2001 55% 17% 31% 10% The majority of TSI's sales are by direct shipment. The remaining sales are shipped from the Company's Coppell, Texas facility. TSI utilizes an internal sales force to market its products and sales representatives to service specific mass merchandiser locations. 50% OWNED INVESTEES Substantially all of Design Trends' sales are to mass merchandisers with one customer comprising the most significant portion its sales, as follows: Customer A ---------------------------------------------------- Fiscal Year Percent of Design Trends' Sales 2003 87% 2002 85% 2001 79% The majority of Design Trends' sales are by direct shipment. The remaining sales are shipped from the Company's Coppell, Texas facility. Design Trends utilizes an internal sales force to market its products and sales representatives to service specific mass merchandiser locations. MARKETING Craftmade relies primarily on the reputation of its ceiling fans, outdoor lighting and light kits for high quality and competitive prices and the efforts of its sales representative organization in order to promote the sales of its products. The principal markets for Craftmade's products are the new home construction, remodeling and replacement markets. Craftmade utilizes advertising in home lighting magazines, particularly in special editions devoted to ceiling fans and lighting fixtures, and broadly distributes its product catalog. Craftmade also promotes its ceiling fans and light kits at semi-annual trade shows in Dallas (in January and June) and maintains a showroom at the Dallas Trade Mart. Craftmade provides warranties ranging from 10 years to lifetime on the fan motor of its ceiling fans, and includes a one year limited warranty against defects in workmanship and materials to cover the entire ceiling fan. Craftmade also provides a limited lifetime warranty on its higher-end series of fans. The Company's management believes these warranties are highly attractive to both dealers and consumers. TSI relies primarily on the reputation of its products and the relationship it has with its mass merchandiser customers with respect to its sales. TSI participates in advertising programs and special promotions performed by its customers. TSI also promotes its product line at semi-annual trade shows in Dallas (in January and June) and utilizes Craftmade's showroom at the Dallas Trade Mart. -4- With respect to its sales, Design Trends relies on the reputation of its products and the relationship it has with its mass merchandiser customers, as well as its patented display system. Design Trends also participates in advertising programs and special promotions performed by its customers The Company has a 48-hour product shipment policy. In order to meet these policy delivery requirements and to ensure that it has sufficient goods on hand from its overseas suppliers, the Company maintains a significant level of inventory. See "Management's Discussion and Analysis of Financial Condition and Results of Operations-Liquidity and Capital Resources." For information concerning revenues of the Company attributable to foreign and domestic customers, along with information concerning foreign and domestic long-lived assets of the Company, see Note 15 - Segment Information in the Notes to Consolidated Financial Statements. PRODUCT EXPANSION Craftmade continually expands its ceiling fan product line, providing proprietary products to its customer base in order to meet current and anticipated demands for unique, innovative products. During fiscal year 2003, Craftmade introduced three new series of fans: Twin Air, Log Cabin and American Tradition. The Company also added a new custom finish, Oiled Bronze. SEASONALITY The Company's product sales, particularly ceiling fans, are somewhat seasonal with sales in the warmer first and fourth quarters being historically higher than in the two other fiscal quarters. BACKLOG Backlog is not material to the Company's operations as substantially all of the Company's products are shipped to customers within 48 hours following receipt of orders. COMPETITION The ceiling fan and lighting fixture market is highly competitive at all levels of operation. Some of the major companies in the ceiling fan industry include Casablanca, Hunter, Monte Carlo, Quorum, Emerson Electric and Taconi. A number of other well-established companies are also currently engaged in activities that compete directly with Craftmade. Some of Craftmade's competitors are better established, have longer operating histories, substantially greater financial resources or greater name recognition than Craftmade. However, the Company's management believes that the quality of Craftmade's products, the strength of its marketing organization and the growing recognition of the Craftmade name will enable Craftmade to compete successfully in these highly competitive markets. The mass merchandiser market is also highly competitive. TSI and Design Trends have numerous competitors, which are located both within the United States and outside of the country, particularly in Asia. Some of the major companies in the lighting fixture industry include Designer's Fountain, Murray Feiss and Minka. In addition, mass merchandisers themselves will, at times, compete directly against TSI and Design Trends by purchasing private label products from TSI's vendors. However, the Company's management believes that TSI has positioned itself with its customers in a manner that reduces some of the risks involved of competing in the mass merchandiser market, primarily by offering unique display systems and packaging that the company management believes other companies do not offer. INDEPENDENT SAFETY TESTING All of the ceiling fans, outdoor lighting, light kits and lamps sold by the Company in the United States are tested by Underwriter's Laboratories (UL), which is an independent non-profit corporation which tests certain products, including ceiling fans and lighting fixtures, for public safety. Under its agreement with UL, the Company voluntarily submits its products to UL, and UL tests the products for safety. If the product is acceptable, UL issues a listing report that provides a technical description of the product. UL provides the manufacturers with procedures to follow in manufacturing the products. Electrical products that are manufactured in accordance with the designated procedures display the UL listing mark, which is generally recognized by consumers as an indication of a safe -5- product and which is often required by various governmental authorities to comply with local codes and ordinances. The contract between the Company and UL provides for automatic renewal unless either party cancels as a result of default or gives applicable prior notice. PRODUCT LIABILITY The Company is engaged in businesses that could expose it to possible claims for injury resulting from the failure of its products sold. While no material claims have been made against the Company since its inception and the Company maintains product liability insurance, there can be no assurance that claims will not arise in the future or that the coverage of such policy will be sufficient to pay such claims. PATENTS AND TRADEMARKS The Company has patented certain of its product designs and the functional features of some of its products, including a patent on its Cathedral Ceiling Adapter and the Carousel light kit. The expiration dates of Craftmade's patents (excluding pending applications) currently range from 2008 to 2014. In addition, Fanthing holds certain Taiwanese patents covering specific technology employed in Craftmade ceiling fans, but the Company's management does not believe that such patents are material to the production of Craftmade products. From time to time, the Company also enters into license agreements with various designers of the Company's products, including license agreements concerning licenses on patents for eight series of fans and certain other license agreements entered into in the ordinary course of its business. The Company has registered the trademarks Craftmade (R), Accolade (R) and Durocraft (R), along with the product names of certain of its designs, with the United States Patent and Trademark Office. Design Trends merchandises its portable lamp program in a patented display system that makes more efficient use of the retailer's space than conventional lighting displays. The Company's management believes that the display patent is material to Design Trends business. EMPLOYEES As of August 31, 2003, the Company employed a total of 131 full time employees, including five executive officers, (two of whom are TSI officers), 19 managers, 22 clerical and administrative personnel, 26 marketing personnel; 48 warehouse personnel and 11 Design Trends/shipping/production personnel. The Company's employees are not covered by any collective bargaining agreements, and the Company believes its employee relations are satisfactory. -6- ITEM 2. PROPERTIES The Company's headquarters are located in Coppell, Texas. The facility consists of approximately 378,000 square feet of general office and warehouse space, which is owned by the Company and is used by both Craftmade and TSI. The Company's management believes that this Company-owned facility will be sufficient for its purposes for the foreseeable future. See Note 5 - Note Payable in the Notes to Consolidated Financial Statements for a discussion of the Company's term loan used to finance the Company's acquisition of this facility. The Company also leases permanent display facilities at the Dallas Trade Mart, which are used by both Craftmade and TSI. The lease provides for monthly rental payments of $6,372 per month from July 1, 2002 through April 30, 2003, and $6,632 per month from May 1, 2003 through April 30, 2004 with three percent annual increases thereafter. The lease expires April 30, 2007. TSI leases office space from an affiliate of TSI in El Dorado Hills, California. This lease is for $7,500 per month on a month-to-month basis. ITEM 3. LEGAL PROCEEDINGS The Company is currently not a party to any material legal or administrative proceedings. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS. No matters were submitted to a vote of stockholders during the fourth quarter of fiscal year 2003. -7- PART II ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS The initial public offering price of the Company's common stock in April 1990 was $1.55 per share, adjusted for the Company's three-for-two stock splits effective October 30, 1998 and October 31, 1997. The common stock trades on Nasdaq National Market System under the symbol CRFT. The following table sets forth, for the periods indicated, the high and low bid information per share of common stock on the Nasdaq National Market System, as reported by Nasdaq. Dividends High Low per share ------ ------ --------- Fiscal Year Ended June 30, 2002: First Quarter ................................. $14.65 $ 9.10 $ .07 Second Quarter ................................ 16.89 11.08 .07 Third Quarter ................................. 17.84 12.80 .07 Fourth Quarter ................................ 19.05 12.39 .07 Fiscal Year Ended June 30, 2003: First Quarter ................................. $15.50 12.21 $ .07 Second Quarter ................................ 17.60 11.62 .07 Third Quarter ................................. 17.10 13.70 .07 Fourth Quarter ................................ 18.35 14.25 .07 Fiscal Year Ending June 30, 2004: First Quarter (Through September 19, 2003) .... $22.99 $17.32 Computershare Investor Services, Two North Lasalle Street, Chicago IL 60602, is the transfer agent and registrar for the Company's common stock. HOLDERS On August 31, 2003, there were 102 holders of record of the Company's common stock. -8- ITEM 6. SELECTED FINANCIAL DATA The selected financial data in the tables below are for the five fiscal years ended June 30. The data should be read in conjunction with Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations, and the consolidated financial statements included herein. For the years ended ------------------------------------- (In thousands, except per share data) June 30, June 30, June 30, June 30, June 30, 2003 2002 2001 2000 1999 ------- --------- ------- --------- ------- Selected Operating Results: Net sales $71,817 $73,509 $71,107 $75,098 $75,656 Gross profit 23,448 23,328 22,380 22,028 23,424 Equity in earnings of 50% owned investees 4,241 2,622 2,038 1,151 949 Net income 6,846 6,160 4,687 4,280 5,689 Basic earnings per common share 1.24 1.04 $ 0.79 $ 0.63 $ 0.76 Diluted earnings per common share 1.23 1.03 $ 0.79 $ 0.63 $ 0.76 Cash dividends declared per common share $ 0.28 $ 0.28 $ 0.25 $ 0.10 $ 0.08 Basic common shares outstanding 5,512 5,937 5,933 6,781 7,523 Diluted common shares outstanding 5,568 6,001 5,942 6,781 7,535 Summary Balance Sheet: Current assets 25,684 $27,539 $36,868 $31,718 $25,585 Current liabilities 17,983 16,122 26,262 20,905 16,052 Long-term debt 4,322 5,746 8,076 8,588 4,677 Total assets 43,340 44,492 52,361 46,540 44,178 Stockholders' equity 20,538 22,624 17,782 16,959 23,363 Book value per common share $ 3.73 $ 3.81 $ 3.02 $ 2.74 $ 3.16 -9- ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATION. CAUTIONARY STATEMENT With the exception of historical information, the matters discussed in this Item 7 and elsewhere in this Annual Report on Form 10-K contain forward-looking statements. There are certain important factors which could cause results to differ materially from those anticipated by these forward-looking statements. Some of the important factors which would cause actual results to differ materially from those in the forward-looking statements include, among other things, the success of the Design Trends portable lamp program, changes in anticipated levels of sales, whether due to future national or regional economic and competitive conditions, changes in relationships with customers, TSI's dependence on select mass merchandisers, customer acceptance of existing and new products, pricing pressures due to excess capacity, cost increases, exchange rate fluctuations in the U.S. and Taiwanese dollar, changes in tax or interest rates, unfavorable economic and political developments in Asia, the location of the Company's primary vendors, declining conditions in the home construction industry, inability to realize deferred tax assets, and other uncertainties, all of which are difficult to predict and many of which are beyond the control of the Company. Critical Accounting Policies The Company's management's discussion and analysis of its financial condition and results of operations following are based upon the Company's consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States. The preparation of these financial statements requires the Company's management to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities. The Company's estimates are based on historical experience and various other factors that are believed to be reasonable under the circumstances, the results of which form the basis for the Company's conclusions. The Company continually evaluates the information used to make these estimates as its business and the economic environment changes. The Company's management believes that the estimates, assumptions and judgments involved in the accounting policies described below have the greatest potential impact on its financial statements, so the Company considers these to be its critical accounting policies. Revenue Recognition The Company recognizes revenue when title transfers and the risks and rewards of ownership have passed to the customer, based on the terms of sale. Title generally transfers upon shipment of goods from our warehouse. In some instances, the Company ships product directly from our supplier to the customer. In these cases, the Company recognizes revenue when the product is accepted by the customer's representative. The Company does not have an obligation or policy of replacing, at no cost, customer products damaged or lost in transit. As part of its revenue recognition policy, the Company records estimated incentives payable to its customers at a future date as a reduction of revenue at the time the revenues are recorded. The Company bases its estimates on contractual terms of the programs and estimated or actual sales to individual customers. Actual incentives in any future period are inherently uncertain and, thus, may differ from its estimates. If actual or expected incentives were significantly greater than the reserves the Company had established, the Company would record a reduction to net revenues in the period in which the Company made such determination. In addition to various incentive programs, from time to time the Company is required to provide mark down funds to certain of it mass retail customers to assist them in clearing slow-moving inventory. These markdown funds are recorded as a reduction of revenue in the period in which they are incurred. Allowance for Doubtful Accounts The Company maintains an allowance for trade accounts receivable for which collection on specific customer accounts is doubtful. In determining collectibility, the Company's management reviews available customer financial statement information, credit rating reports as well as other external documents and public filings. When it is deemed probable that a specific customer account is uncollectible, that balance is included in the reserve calculation. Actual results could differ from these estimates. -10- Inventories Inventories are the Company's largest asset class. The Company's inventories are primarily comprised of finished goods and are recorded at the lower of cost or market using the average cost method. The Company provides estimated inventory allowances for excess, slow-moving and obsolete inventory as well as inventory whose carrying value is in excess of net realizable value. These reserves are based on current assessments about future demands, market conditions and related management initiatives. If market conditions and actual demands are less favorable than those projected by management, additional inventory write-downs may be required. The Company is required to assess the carrying values of goodwill annually or when circumstances dictate that the carrying value might be impaired. The method for determining if impairment has occurred requires estimates of future cash flows and the Company's weighted average cost of capital. In the event that an impairment is determined to have occurred, the Company will reduce the carrying value of the asset in that period. RESULTS OF OPERATIONS Fiscal year ended June 30, 2003 compared to fiscal year ended June 30, 2002. Net Sales - Net sales decreased $1,692,000 to $71,817,000 for the year ended June 30, 2003 from $73,509,000 for the year ended June 30, 2002. Sales of the Craftmade division decreased 1.3% or $643,000, to $49,155,000 from $49,798,000 for the year ended June 30, 2002. The decrease in sales of the Craftmade division was primarily due to lower unit sales and lower prices on certain discontinued models of fans that were replaced by new models that were introduced in the January lighting market. Management expects the showroom division to generate positive sales growth in fiscal 2004 as a result of new product introductions and fewer close-out sales. Sales of the TSI division decreased 4.4%, or $1,049,000, to $22,662,000 for the year ended June 30,2003 from $23,711,000 for the year ended June 30, 2002. The decline in sales of the TSI division was attributable to a decline in direct shipment sales of outdoor lighting to a mass retail customer. Gross Profit - Gross profit increased to 32.6% of sales, or $23,448,000, for the year ended June 30, 2003 compared to 31.7% of sales, or $23,328,000, for the year ended June 30, 2002. The gross margin of the Craftmade division increased to 40.2% of sales for the year ended June 30, 2003 from 39.3% of sales for the year ended June 30, 2002. The improvement in the gross margin of the Craftmade division was due primarily to increased sales of higher margin products. The gross margin of the TSI division improved to 16.2% for the year ended June 30, 2003 compared to 15.7% of sales, for the year ended June 30, 2002. The improvement in the gross margin of TSI was primarily due to a smaller write down of slow moving inventory in the year ended June 30, 2003 compared to the prior year period. The TSI division recorded an inventory write-down of $426,000 and $500,000 in fiscal 2003 and fiscal 2002, respectively. Selling, General and Administrative Expenses - Total selling, general and administrative ("SG&A") expenses of the Company increased $332,000 to $15,307,000, or 21.3% of net sales, for the year ended June 30, 2003 from $14,975,000, or 20.4% of net sales, for the year ended June 30, 2002. Total SG&A expenses of the Craftmade division decreased $168,000 to $11,371,000 or 23.1% of net sales, compared to $11,539,000 or 23.2% of net sales in the previous year. The Craftmade division's SG&A expense as a percentage of sales was relatively unchanged from fiscal 2002 to fiscal 2003. The decline in SG&A expense in total dollars was primarily related to the decline in sales of the Craftmade division from fiscal 2002 to fiscal 2003. Total SG&A expenses of TSI increased $500,000 to $3,936,000 or 17.4% of sales compared to $3,436,000 or 14.5% of net sales, for the year ended June 30, 2002. The increase in TSI's SG&A expenses in dollars as well as a percentage of sales was primarily due to an increase in payroll related expenses. Net Interest Expense - Net interest expense declined $49,000 to $837,000 for the year ended June 30, 2003 from $886,000 for the previous year. This decline was primarily the result of lower interest rates in effect during the period. Equity in Earnings of 50% Owned Investees Before Income Taxes - Income from investees, representing the Company's 50% ownership of PHI and Design Trends, increased $1,619,000 to $4,241,000 for fiscal 2003 from $2,622,000 for fiscal 2002. The increase in income from these investees was due to an increase in sales of Design Trends' portable lamp program which generated $3,404,000 in incremental revenue during the year, as well as a $1,274,000 increase in sales of PHI for fiscal 2003 compared to the previous year. -11- Provision for Income Taxes - The provision for income taxes increased to $4,049,000, or 37.2% of income before taxes for the year ended June 30, 2003 from $3,360,000, or 35.3% of income before taxes for the year ended June 30, 2002 because of higher state income taxes. Fiscal year ended June 30, 2002 compared to fiscal year ended June 30, 2001 Net Sales - Net sales increased $2,402,000 to $73,509,000 for the year ended June 30, 2002 from $71,107,000 for the year ended June 30, 2001. Sales of the Craftmade division increased 2.6% or $1,284,000, to $49,798,000 from $ 48,514,000 for the year ended June 30, 2001. The increase in sales of the Craftmade division was primarily due to an increase in Craftmade's sales of outdoor lighting which generated incremental revenue of $1,070,000 compared to the prior year period. Sales of the TSI division increased 4.9%, or $1,118,000, to $23,711,000 for year ended June 30, 2002 from $22,593,000 for the year ended June 30, 2001. The increase was attributable to additional direct shipment sales of outdoor lighting to a mass retail customer. Gross Profit - Gross profit increased to 31.7% of sales, or $23,328,000, for the year ended June 30, 2002 compared to 31.5% of sales, or $22,380,000, for the year ended June 30, 2001. The gross margin of the Craftmade division increased to 39.3% of sales for the year ended June 30, 2002 from 37.6% of sales for the year ended June 30, 2001. The improvement in the gross margin of the Craftmade division was due primarily to a series of price concessions the Company negotiated with its ceiling fan vendor, which have, in part, been passed on to customers. The improvement in the exchange rate of the U.S. dollar relative to the Taiwanese dollar also had a favorable impact on the gross margin of the showroom division. Gross profit of the TSI division declined to $3,733,000, or 15.7% of sales, for the year ended June 30, 2002 compared to $4,151,000, or 18.4% of TSI's sales, for the year ended June 30, 2001. The decline in the gross margin of TSI was primarily due to an inventory write down of approximately $500,000 that was taken during fiscal 2002 to record discontinued items at their net realizable value. Selling, General and Administrative Expenses - Total selling, general and administrative ("SG&A") expenses of the Company increased $740,000 to $14,975,000, or 20.4% of net sales, for the year ended June 30, 2002 from $14,235,000, or 20.0% of net sales, for the year ended June 30, 2001. Total SG&A expenses of the Craftmade division increased $400,000 to $11,539,000 or 23.2% of net sales, compared to $11,139,000 or 23.0% of Craftmade's net sales, in the previous year. The increase in SG&A expenses of the Craftmade division was primarily related to costs associated with the implementation of the Company's logistics and accounting systems upgrade. Total SG&A expenses of TSI increased $340,000 to $3,436,000 or 14.5% of sales for year ended June 30, 2002 compared to $3,096,000 or 13.7% of net sales, for the year ended June 30, 2001. The increase in TSI's SG&A expenses as a percentage of sales was primarily due to an increase in payroll related SG&A expenses. Net Interest Expense - Net interest expense declined $900,000 to $886,000 for the year ended June 30, 2002 from $1,786,000 for the previous year. This decline was primarily the result of a decrease in the amounts outstanding under the Company's revolving line of credit, combined with lower interest rates in effect during the period. Equity in Earnings of 50% Owned Investees Before Income Taxes - Income from investees, representing the Company's 50% ownership of PHI and Design Trends, increased $584,000 to $2,622,000 for year ended June 30, 2002 from $2,038,000 for the year ended June 30, 2001. The increase in income from these investees was due to an increase in sales of Design Trends' portable lamp program which generated $13,200,000 in incremental revenue during the year. Provision for Income Taxes - The provision for income taxes increased to $3,360,000, or 35.3% of income before taxes for the year ended June 30, 2002 from $2,811,000, or 37.5% of income before taxes for the year ended June 30, 2001. LIQUIDITY AND CAPITAL RESOURCES Fiscal year ended June 30, 2003. The Company's cash increased $2,845,000 from $624,000 at June 30, 2002 to $3,469,000 at June 30, 2003. The Company's operating activities provided cash of $10,342,000 during the year ended June 30, 2003 compared to $13,979,000 during the year ended June 30, 2002. This cash flow was primarily attributable to the Company's net income, a reduction in the Company's accounts receivable, and a reduction in the Company's accounts receivable from Design Trends, its 50% owned investee. -12- Cash used for investing activities of $186,000 was related to additions to property, plant and equipment, primarily for additional racking installed in the Company's warehouse facility. Cash used for financing activities of $7,310,000 was primarily the result of (i) the repurchase of 558,000 shares of the Company's common stock at an aggregate cost of $7,746,000, (ii) principal payments of $1,311,000 on the Company's notes payable and (iii) cash dividends of $1,542,000. These amounts were partially offset by proceeds of $2,966,000 from the Company's line of credit and $323,000 from the exercise of employee stock options. On November 6, 2001, the Company entered into a Credit Agreement with The Frost National Bank ("Frost"), pursuant to which Frost agreed to provide the Company with a $20,000,000 line of credit. The Credit Agreement with Frost replaced the Company's existing $20,000,000 line of credit with J.P. Morgan Chase & Co. ("Chase") and Frost. The terms of the Company's new line of credit with Frost are substantially identical to the Company's preceding line of credit. The Company chose to obtain its line of credit solely from Frost, rather than a syndicate of Frost and Chase, because the Company currently maintains its banking accounts with Frost, and the use of Frost exclusively will permit the Company to facilitate more rapid payments with respect to the line of credit, which the Company believes will result in a reduction of interest expense. The line of credit is due on demand; however, if no demand is made, it is scheduled to mature October 31, 2003. The line of credit is collateralized by inventory, accounts receivable and equipment of the Company. Management is negotiating to renew the Company's line of credit and believe they will be able to complete the negotiations prior to the maturity of its existing line of credit. Management believes that alternative bank financing on acceptable terms would be available should the company not be able to renew its current line of credit. At June 30, 2003, subject to continued compliance with certain covenants and restrictions, the Company had $20,000,000 available on its line of credit, of which $12,000,000 had been utilized. In addition, PHI had $3,000,000 available on its line of credit, on which there was no outstanding balance. The Company's management believes that its current lines of credit, combined with cash flows from operations, are adequate to fund the Company's operations during the next twelve months. At June 30, 2003, $5,131,000 remained outstanding under the note payable for the Company's 378,000 square foot operating facility. The Company's management believes that this facility will be sufficient for its purposes for the foreseeable future. The facility note payable matures on January 1, 2008. As a result of the terms of the Company's note payable on its operating facility, the Company is subject to market risk associated with adverse changes in interest rates. In an effort to reduce this market risk, the Company entered into an interest rate swap agreement (the "Swap Agreement") with Chase during the first quarter of fiscal 2000, which was held by the Company for non-trading purposes. As discussed above, in November 2001, the Company transferred its line of credit from Chase to Frost. In connection with this transfer, the Company and Chase agreed to terminate the Swap Agreement, and Chase paid the Company $61,500 in connection with this termination. Fanthing, Craftmade's ceiling fan manufacturer has provided Craftmade with a $1,000,000 credit facility, pursuant to which it will manufacture and ship ceiling fans prior to receipt of payment from Craftmade. Accordingly, payment can be deferred until delivery of such products. At present levels, such credit facility is equivalent to approximately three weeks' supply of ceiling fans and represents a supplier commitment, which, in the opinion of the Company's management, is unusual for the industry and favorable to the Company. This manufacturer is not required to provide this credit facility under its agreement with Craftmade, and it may discontinue this arrangement at any time. With respect to the Company's 50%-owned investees, PHI had $3,000,000 available on its line of credit, on which there was no outstanding balance. Craftmade is a guarantor on this line of credit. Design Trends utilizes the Company's lines of credits described above. To satisfy anticipated demand for the portable lamp program, Design Trends maintained an inventory level of $3,004,000 at June 30, 2003. This program is primarily with one mass merchandiser customer. Should the terms of the program with this particular mass merchandiser be at a level less than originally anticipated the Company would be required to find other customers for this inventory. There can be no assurances that the alternative sources would generate similar sales levels and profit margins as anticipated with the current mass merchandiser customer. -13- Fiscal year ended June 30, 2002. The Company's cash decreased $99,000 from $723,000 at June 30, 2001 to $624,000 at June 30, 2002. The Company's operating activities provided cash of $13,979,000 during the year ended June 30, 2002 compared to $1,639,000 during the year ended June 30, 2001. This cash flow was primarily attributable to the Company's net income, a reduction in the Company's receivable from Design Trends, its 50% owned investee, and a reduction in TSI's inventory levels. Cash used for investing activities of $696,000 was related to additions to property and equipment, primarily for costs associated with the implementation of the Company's logistics and accounting systems upgrade. Cash used for financing activities of $13,382,000 was primarily the result of (i) the repurchase of 17,000 shares of the Company's common stock at an aggregate cost of $235,000, (ii) principal payments of $2,146,000 on the Company's notes payable, (iii) principal payments or $9,766,000 on the Company's line of credit, and (iv) cash dividends of $1,666,000. These amounts were partially offset by proceeds of $431,000 from the exercise of employee stock options. OFF BALANCE SHEET ARRANGEMENTS Craftmade is a guarantor of PHI's lines of credit. The company has not engaged in any other off balance sheet transactions or agreements. CONTRACTUAL OBLIGATIONS The table below, as well as the information contained in Note 5 - "Note Payable" and Note 12 - "Commitments and Contingencies" to the Company's financial statements, summarizes the Company's various repayment requirements. Payments Due by Period ------------------------------------------------------------------------------------------------------------- CONTRACTUAL OBLIGATIONS TOTAL LESS THAN 1 YEAR 1-3 YEARS 3-5 YEARS MORE THAN 5 YEARS ----------------------- ----- ---------------- --------- --------- ----------------- Long Term Debt Obligations $ 5,131,000 $ 809,000 $1,833,000 $2,489,000 0 Operating Lease Obligations $ 349,000 $ 117,000 $ 168,000 $ 64,000 0 Purchase Obligations $ 6,107,000 $6,107,000 0 0 0 ----------- ---------- ---------- ---------- ---------- Total $11,587,000 $7,033,000 $2,001,000 $2,553,000 At June 30, 2003, the Company has a $20,000,000 line of credit with The Frost National Bank at an interest rate of prime (4.00% at June 30, 2003) less .5%, of which $12,000,000 was outstanding. The line of credit is due on demand; however, if no demand is made, it is scheduled to mature October 31, 2003. At June 30, 2003, PHI had a $3,000,000 line of credit with Wachovia Bank, N.A. at an interest rate equal to the one-month LIBOR plus 2%. At June 30, 2003, the one-month LIBOR rate was equal to 1.30%. There was a zero outstanding balance on the line of credit at June 30, 2003. PHI's Line of Credit is due on demand; however, if no demand is made, it is scheduled to mature October 1, 2004. In addition, PHI has a $500,000 three-year note payable to Wachovia maturing on July 29, 2005, of which $361,000 was outstanding at June 30, 2003. The note bears interest at a rate equal to the Monthly LIBOR Index plus 2.5%. Craftmade is the guarantor on PHI's lines of Credit. -14- EFFECTS OF RECENT ACCOUNTING PRONOUNCEMENTS In July 2002, the FASB issued SFAS No. 146, Accounting for Costs Associated with Exit or Disposal Activities, which has an effective date for exit or disposal activities that are initiated after December 31, 2002. This statement provides that cost associated with an exit or disposal activity must be recognized when the liability is incurred. The adoption of SFAS No. 146 did not have a material impact on the Company's financial statements. In December 2002, the FASB issued SFAS No. 148, Accounting for Stock-Based Compensation - Transition and Disclosure - an Amendment of FAS 123, which is effective for financial statements for fiscal years ending after December 15, 2002. This Statement amends FASB Statement No. 123, Accounting for Stock-Based Compensation, to provide alternative methods of transition for a voluntary change to the fair value based method of accounting for stock-based employee compensation. In addition, this Statement amends the disclosure requirements of Statement 123 to require prominent disclosures in both annual and interim financial statements about the method of accounting for stock-based employee compensation and the effect of the method used on reported results. The disclosure requirements of SFAS No. 148 are included in Note 2 of Notes to Consolidated Financial Statements. In December 2002, the FASB issued Interpretation No. 45 (FIN 45), Guarantor's Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others which has an effective date of December 31, 2002. FIN 45 requires a guarantor to make additional disclosures in its interim and annual financial statements regarding the guarantor's obligations. In addition, FIN 45 requires, under certain circumstances, that a guarantor recognize, at the inception of the guarantee, a liability for the fair value of the obligation undertaken when issuing the guarantee. The impact of the accounting requirements of FIN 45 on the Company's financial statements was not material. In January 2003, the FASB issued Interpretation No. 46 (FIN 46), Consolidation of Variable Interest Entities. This interpretation of Accounting Research Bulletin No. 51, Consolidated Financial Statements, addresses consolidation of variable interest entities. FIN 46 requires certain variable interest entities to be consolidated by the primary beneficiary if the entity does not effectively disperse risks among the parties involved. The provisions of FIN 46 are effective immediately for those variable interest entities created after January 31, 2003. The provisions are effective for the first period beginning after June 15, 2003, for those variable interests held prior to February 1, 2003. The Company has no variable interest entities and accordingly does not believe the adoption of this Interpretation will have a material impact on the Company's financial position or results of operations. In April 2003, the FASB issued SFAS 149, Amendment of Statement 133 on Derivative Instruments and Hedging Activities, which amends SFAS 133 for certain decisions made by the FASB Derivatives Implementation Group. In particular, SFAS 149 (1) clarifies under what circumstances a contract with an initial net investment meets the characteristic of a derivative, (2) clarifies when a derivative contains a financing component, (3) amends the definition of underlying to conform it to language used in FASB interpretation number (FIN) 45, and (4) amends certain other existing pronouncements. SFAS 149 is effective for contracts entered into or modified after June 30, 2003, and for hedging relationships designated after June 30, 2003. In addition, most provisions of SFAS 149 are to be applied prospectively. The effect of adopting this new standard on the Company's financial statements is not expected to be material. In May 2003, the FASB issued SFAS 150, Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity. SFAS 150 clarifies the accounting for certain financial instruments that, under previous guidance, issuers could account for as equity. SFAS 150 requires that those instruments be classified as liabilities in statements of financial position. SFAS 150 is effective for interim periods beginning after June 15, 2003. The effect of adopting this new standard on the Company's financial statements is not expected to be material. CHANGES IN INTERNAL CONTROLS There have been no changes in internal controls or in other factors that significantly changed internal controls during the fiscal year ended June 30, 2003. INFLATION Generally, inflation has not had, and the Company does not expect it to have, a material impact upon operating results. However, there can be no assurance that the Company's business will not be affected by inflation in the future. RELATED PARTY TRANSACTIONS TSI leases office space from a director of the Company who is also a senior officer of TSI. This lease is for $7,500 per month on a month-to-month basis. -15- ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK. The information set forth below constitutes a "forward looking statement." See Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations - Cautionary Statement. We are exposed to market risk from changes in interest rates. We have in the past used financial instruments to offset these risks. These financial instruments were not used for trading or speculative purposes. We did not experience any significant changes in market risk for the fiscal year ended June 30, 2002. At June 30, 2003, the Company had a $20,000,000 line of credit (the "Craftmade Line of Credit") with Frost at an interest rate of prime less .5%, of which $12,000,000 was outstanding. At June 30, 2003 the prime rate was equal to 4.00%. The Craftmade Line of Credit is due on demand; however, if not demand is made, it is scheduled to mature October 31, 2003. Management is negotiating to renew the Company's line of credit and believe they will be able to complete the negotiations prior to the maturity of its existing line of credit. Management believes that alternative bank financing on acceptable terms would be available should the company not be able to renew its current line of credit. At June 30, 2002, PHI had a $3,000,000 line of credit (the "PHI Line of Credit") with Wachovia Bank, N.A. at an interest rate of the one-month LIBOR plus 2%, on which there was no outstanding balance. At June 30, 2002 the one-month LIBOR rate was equal to 1.84%. The PHI Line of Credit is due on demand; however, if no demand is made, it is scheduled to mature October 1, 2004. In addition, PHI had a $500,000 three-year note payable with Wachovia maturing on July 29, 2005, of which $361,000 was outstanding at June 30, 2003. The note bears interest at a rate equal to the Monthly LIBOR Index plus 2.5%. Because of the short-term nature of each of the Craftmade Line of Credit and the PHI Line of Credit, the Company is subject to market risk associated with adverse changes in interest rates. A sharp rise in interest rates could materially adversely affect the financial condition and results of operations of the Company. The Company has not entered into any instruments to minimize this market risk of adverse changes in interest rates because the Company believes the cost associated with such instruments would outweigh the benefits that would be obtained from utilizing such instruments. Under the Craftmade Line of Credit, using the June 30, 2003 outstanding balance, for each one-percentage point (1%) incremental increase in the prime rate, the Company's annualized interest expense would increase by approximately $120,000. Consequently, an increase in the prime rate of five percentage points (5%) would result in an estimated annualized increase of interest expense for the Company of approximately $600,000. Under the PHI Note Payable, using the June 30, 2003 outstanding balance , for each one-percentage point (1%) incremental increase in LIBOR, the Company's annualized interest expense would increase by approximately $3,610. Consequently, an increase in LIBOR of five percentage points (5%) would result in an estimated annualized increase of interest expense for the Company of approximately $18,050. We are exposed to market risk from changes in foreign currency exchange rates. The Company currently purchases a substantial amount of ceiling fans and other products of its Craftmade division from Fanthing, a Taiwanese company. The Company's verbal understanding with Fanthing provides that all transactions are to be denominated in U.S. dollars; however, the understanding further provides that, in the event that the value of the U.S. dollar appreciates or depreciates against the Taiwanese dollar by one Taiwanese dollar or more, Fanthing's prices will be accordingly adjusted by 2.5%. As of September 23, 2003, one U.S. dollar equaled $34.09 Taiwanese dollars. A sharp appreciation of the Taiwanese dollar relative to the U.S. dollar could materially adversely affect the financial condition and results of operations of the Company. The Company has not entered into any instruments to minimize this market risk of adverse changes in currency rates because the Company believes the cost associated with such instruments would outweigh the benefits that would be obtained from utilizing such instruments. All other purchases of the Company from foreign vendors are denominated in U.S. dollars and are not subject to adjustment provisions with respect to foreign currency fluctuations. During the fiscal year ended June 30, 2003, the Company purchased approximately $16,111,000 of products from Fanthing. Under the Company's understanding with Fanthing, each $1 incremental appreciation of the Taiwanese dollar would result in an estimated annualized net increase in cost of goods sold of approximately $403,000 based on the Company's purchases during the fiscal year ended June 30, 2003. A $5 incremental appreciation of the Taiwanese dollar would result in an estimated annual increase in cost of goods sold of approximately $2,014,000, based on the Company's purchases during the fiscal year ended June 30, 2003. A $10 incremental appreciation of the Taiwanese dollar would result in an annual increase of approximately $4,028,000, based on the Company's purchases during the fiscal year ended June 30, 2003. These amounts are estimates of the financial impact of an appreciation of the Taiwanese dollar relative to the U.S. dollar and are based on the Company's purchases from Fanthing for the fiscal year ended June 30, 2003. Consequently, these amounts are not necessarily indicative of the effect of such changes with respect to future years. -16- ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA. The financial statements and supplementary data are included under Item 14(a)(1) of this report. ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE Not applicable. ITEM 9A. CONTROLS AND PROCEDURES. The Company's management, including the Company's principal executive officer and principal financial officer, has evaluated the effectiveness of the Company's disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934) as of the end of the period covered by this Annual Report on Form 10-K. Based upon that evaluation, the Company's principal executive officer and principal financial officer have concluded that the disclosure controls and procedures were effective as of the end of the period covered by this Annual Report on Form 10-K. There were no changes in the Company's internal control over financial reporting that occurred during the Company's last fiscal quarter that have materially affected, or are reasonably likely to materially affect, the Company's internal control over financial reporting. -17- PART III ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT The information required by this item is incorporated herein by reference to our proxy statement to be filed with the Securities and Exchange Commission pursuant to Regulation 14A promulgated under the Securities Exchange Act of 1934, as amended (the Proxy Statement). ITEM 11. EXECUTIVE COMPENSATION The information required by this Item is incorporated herein by reference to the Proxy Statement. ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT EQUITY COMPENSATION PLAN INFORMATION The following table sets forth (a) the number of securities to be issued upon exercise of outstanding options, (b) the weighted average of exercise price of such outstanding options, and (c) the number of securities remaining available for future issuance, under the Company's equity compensation plans. All of the Company's equity compensation plans have been approved by security holders of the Company. (a) (b) (c) NUMBER OF SECURITIES TO BE NUMBER OF SECURITIES REMAINING AVAILABLE ISSUED UPON EXERCISE OF WEIGHTED-AVERAGE EXERCISE FOR FUTURE ISSUANCE UNDER EQUITY OUTSTANDING OPTIONS, WARRANTS PRICE OF OUTSTANDING OPTIONS COMPENSATION PLANS (EXCLUDING SECURITIES PLAN CATEGORY AND RIGHTS WARRANTS AND RIGHTS REFLECTED IN COLUMN (a)) ------------- ----------------------------- ---------------------------- ----------------------------------------- 1999 Stock Option Plan 92,500 6.75 100,000 2000 Non-Employee Director Plan 18,000 10.78 57,000 ------- ------- Total 110,500 7.41 157,000 ======= ======= The remaining information required by this Item is incorporated herein by reference to the Proxy Statement. ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS The information required by this Item is incorporated herein by reference to the Proxy Statement. ITEM 14. PRINCIPAL ACCOUNTING FEES AND SERVICES The information required by Item 14 of Form 10-K is not required to be included in this report in accordance with Securities and Exchange Release No. 34-47265A. -18- PART IV ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K. (a) The following documents are filed as a part of this report: 1. Financial Statements - The financial statements listed in the "Index to Consolidated Financial Statements" described at F-1. 2. Financial Statement Schedule - The financial statement schedule listed in the "Index to Consolidated Financial Statements" described at F-1. 3. Exhibits - Refer to (c) below. (b) Reports on Form 8-K On April 24, 2003 the Company furnished a current report on Form 8-K Item 9, and Item 12. to disclose a press release for estimated results for the fiscal year ended June 30, 2003. On April 29, 2003, the Company furnished a current report on Form 8-K Item 9. and Item 12. to disclose an earnings correction to its press release. On May 1, 2003 the Company furnished a current report on Form 8-K Item 9. and Item 12. to disclose a press release describing earnings for fiscal 2003 fourth quarter and year end results. (c) Exhibits 3.1 - Certificate of Incorporation of the Company, filed as Exhibit 3 (a) (2) to the Company's Post Effective Amendment No. 1 to Form S-18 (File No. 33-33594-FW) and incorporated by reference herein. 3.2 - Certificate of Amendment of Certificate of Incorporation of the Company, dated March 24, 1992 and filed as Exhibit 4.2 to the Company's Form S-8 (File No. 333-44337) and incorporated by reference herein. 3.3 - Amended and Restated Bylaws of the Company, filed as Exhibit 3 (b) (2) to the Company's Post Effective Amendment No. 1 to Form S-8 (File No. 33-33594-FW) and incorporated by reference herein. 4.1 - Specimen Common Stock Certificate, filed as Exhibit 4.4 to the Company's Registration Statement on Form S-3 (File No. 333-70823) and incorporated by reference herein. 4.2 - Rights Agreement, dated as of June 23, 1999, between Craftmade International, Inc. and Harris Trust and Savings Bank, as Rights Agent, previously filed as an exhibit to Form 8-K dated July 9, 1999 (File No. 000-26667) and incorporated by reference herein. 10.1 - Earnest Money contract and Design/Build Agreement dated May 8, 1995, between MEPC Quorum Properties II, Inc. and Craftmade International, Inc. (including exhibits), previously filed as an exhibit in Form 10Q for the quarter ended December 31, 1995, and herein incorporated by reference. 10.2 - Assignment of Rents and Leases dated December 21, 1995, between Craftmade International, Inc. and Allianz Life Insurance Company of North America (including exhibits), previously filed as an exhibit in Form 10Q for the quarter ended December 31, 1995, and herein incorporated by reference. 10.3 - Deed of Trust, Mortgage and Security Agreement made by Craftmade International, Inc., dated December 21, 1995, to Patrick M. Arnold, as trustee for the benefit of Allianz Life Insurance Company of North America (including exhibits), previously filed as an exhibit in Form 10Q for the quarter ended December 31, 1995, and herein incorporated by reference. 10.4 - Second Amended and Restated Credit Agreement dated November 14, 1995, among Craftmade International, Inc., Nations Bank of Texas, N.A., as Agent and the Lenders defined therein (including exhibits), previously filed as an exhibit in Form 10Q for the quarter ended December 31, 1995, and herein incorporated by reference. -19- **10.5 - Lease Agreement dated November 30, 1995, between Craftmade International, Inc. and TSI Prime, Inc., previously filed as an exhibit in Form 10Q for the quarter ended December 31, 1995, and herein incorporated by reference. 10.6 - Revolving credit facility with Texas Commerce Bank, previously filed as an exhibit in Form 10K for the year ended June 30, 1996, and herein incorporated by reference. 10.7 - Agreement and Plan of Merger, dated as of July 1, 1998, by and among Craftmade International, Inc., Trade Source International, Inc. a Delaware corporation, Neall and Leslie Humphrey, John DeBlois, the Wiley Family Trust, James Bezzerides, the Bezzco Inc. Employee Retirement Trust and Trade Source International, Inc, a California corporation, filed as Exhibit 2.1 to the Company's Current Report on Form 8-K filed July 15, 1998 (File No. 33-33594-FW) and herein incorporated by reference. 10.8 - Voting Agreement, dated July 1, 1998, by and among James R. Ridings, Neall Humphrey and John DeBlois, filed as Exhibit 2.1 to the Company's Current Report on Form 8-K filed July 15, 1998 (File No. 33-33594-FW) and herein incorporated by reference. 10.9 - Third Amendment to Credit Agreement, dated July 1, 1998, by and among Craftmade International, Inc., a Delaware corporation, Trade Source International, Inc., a Delaware corporation, Chase Bank of Texas, National Association (formerly named Texas Commerce Bank, National Association) and Frost National Bank (formerly named Overton Bank and Trust), filed as Exhibit 2.1 to the Company's Current Report on Form 8-K filed July 15, 1998 (File No. 33-33594-FW) and herein incorporated by reference. 10.10 - Consent to Merger by Chase Bank of Texas, National Association and Frost National Bank, filed as Exhibit 2.1 to the Company's Current Report on Form 8-K filed July 15, 1998 (File No. 33-33594-FW) and herein incorporated by reference. **10.11 - Employment Agreement, dated July 1, 1998, by and among Craftmade International, Inc., Trade Source International, Inc., a Delaware corporation and Neall Humphrey, filed as Exhibit 2.1 to the Company's Current Report on Form 8-K filed July 15, 1998 (File No. 33-33594-FW) and herein incorporated by reference. 10.12 - Employment Agreement, dated July 1, 1998, by and among Craftmade International, Inc., Trade Source International, Inc., a Delaware corporation and Leslie Humphrey, filed as Exhibit 2.1 to the Company's Current Report on Form 8-K filed July 15, 1998 (File No. 33-33594-FW) and herein incorporated by reference. **10.13 - Employment Agreement, dated July 1, 1998, by and among Craftmade International, Inc., Trade Source International, Inc., a Delaware corporation and John DeBlois, filed as Exhibit 2.1 to the Company's Current Report on Form 8-K filed July 15, 1998 (File No. 33-33594-FW) and herein incorporated by reference. 10.14 - Registration Rights Agreement, dated July 1, 1998, by and among Craftmade International, Inc., Neall and Leslie Humphrey and John DeBlois, filed as Exhibit 2.1 to the Company's Current Report on Form 8-K filed July 15, 1998 (File No. 33-33594-FW) and herein incorporated by reference. 10.15 - ISDA Master Agreement and Schedule, dated June 17, 1999, by and among Chase Bank of Texas, National Association, Craftmade International, Inc., Durocraft International, Inc. and Trade Source International, Inc., filed as Exhibit 10.15 to the Company's Quarterly Report on Form 10Q filed November 12, 1999 (File No. 000-26667) and herein incorporated by reference. 10.16 - Confirmation under ISDA Master Agreement, dated July 23, 1999, from Chase Bank of Texas, National Association to Craftmade International, Inc., filed as Exhibit 10.16 to the Company's Quarterly Report on Form 10Q filed November 12, 1999 (File No. 000-26667) and herein incorporated by reference. -20- 10.17 - Fourth Amendment to Credit Agreement, dated April 2, 1999, by and among Craftmade International, Inc., a Delaware corporation, Durocraft International, Inc. a Texas corporation, Trade Source International, a Delaware corporation, Chase Bank of Texas, National Association and Frost National Bank, filed as Exhibit 10.17 to the Company's Quarterly Report on Form 10-Q filed May 15, 2000 (File No. 000-26667) and herein incorporated by reference. 10.18 - Letter Agreement Concerning Fifth Amendment to Credit Agreement, dated August 11, 1999, from Chase Bank of Texas, N.A. and Frost National Bank to Craftmade International, Inc., Durocraft International Inc., Trade Source International, Inc., and C/D/R Incorporated, filed as Exhibit 10.18 to the Company's Quarterly Report on Form 10-Q filed May 15, 2000 (File No. 000-26667) and herein incorporated by reference. 10.19 - Sixth Amendment to Credit Agreement, dated November 12, 1999, by and among Craftmade International, Inc., a Delaware corporation, Durocraft International, Inc., a Texas corporation, Trade Source International, Inc., a Delaware corporation, C/D/R Incorporated, a Delaware corporation, Chase Bank of Texas, National Association and Frost National Bank, filed as Exhibit 10.19 to the Company's Quarterly Report on Form 10-Q filed May 15, 2000 (File No. 000-26667) and herein incorporated by reference. **10.20 - Employment Agreement dated October 25, 1999, between Kathy Oher and Craftmade International, Inc., filed as Exhibit 10.20 to the Company's Annual Report on Form 10-K filed September 26, 2000 (File No. 000-26667) and herein incorporated by reference. 10.21 - Seventh Amendment to Credit Agreement dated May 12, 2000, by and among Craftmade International, Inc., a Delaware corporation, Durocraft International, Inc., a Texas corporation, Trade Source International, Inc., a Delaware corporation, C/D/R Incorporated, a Delaware corporation, Chase Bank of Texas, National Association and Frost National Bank, filed as Exhibit 10.21 to the Company's Annual Report on Form 10-K filed September 26, 2000 (File No. 000-26667) and herein incorporated by reference. **10.22 - Craftmade International, Inc. 1999 Stock Option Plan, filed as Exhibit A to the Company's Proxy Statement on Schedule 14A filed October 4, 2000 (File No. 000-26667) and herein incorporated by reference. **10.23 - Craftmade International, Inc. 2000 Non-Employee Director Stock Plan, filed as Exhibit B to the Company's Proxy Statement on Schedule 14A filed October 4, 2000 (File No. 000-26667) and herein incorporated by reference. 10.24 - Eighth Amendment to Credit Agreement dated February 12, 2001, by and among Craftmade International, Inc., a Delaware corporation, Durocraft International, Inc., a Texas corporation, Trade Source International, Inc., a Delaware corporation, Design Trends, LLC, a Delaware limited liability company, C/D/R Incorporated, a Delaware corporation, The Chase Manhattan Bank and The Frost National Bank, filed as Exhibit 10.24 to the Company's Quarterly Report on Form 10-Q filed May 14, 2001 (File No. 000-26667) and herein incorporated by reference. 10.25 - Ninth Amendment to Credit Agreement dated June 29, 2001, by and among Craftmade International, Inc., a Delaware corporation, Durocraft International, Inc., a Texas corporation, Trade Source International, Inc., a Delaware corporation, Design Trends, LLC, a Delaware limited liability company, C/D/R Incorporated, a Delaware corporation, The Chase Manhattan Bank and The Frost National Bank, filed as Exhibit 10.25 to the Company's Annual Report on Form 10-K filed September 26, 2001 (File No. 000-26667) and herein incorporated by reference. 10.26 - Loan Agreement dated November 6, 2001, by and between Craftmade International, Inc., a Delaware corporation, and The Frost National Bank, a national banking association, filed as Exhibit 10.26 to the Company's quarterly Report on Form 10-Q filed February 14, 2002 (File No. 000-26667) and herein incorporated by reference. -21- 10.27 - Termination Agreement dated November 16, 2001, by and between Craftmade International, Inc., a Delaware corporation, and JP Morgan Chase Bank, filed as Exhibit 10.27 to the Company's Quarterly Report on Form 10-Q filed February 14, 2002 (File No. 000-26667) and herein incorporated by reference. 21 - Subsidiaries of the Registrant. *31.1 - Certification of James R. Ridings, Chairman of the Board, President and Chief Executive Officer of the Company, pursuant to Section 302 of the Sarbanes- Oxley Act of 2002. *31.2 - Certification of Kathleen B. Oher, Vice President and Chief Financial Officer of the Company, pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. *32.1 - Certification of James R. Ridings, Chairman of the Board, President and Chief Executive Officer of the Company, pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. *32.2 - Certification of Kathleen B. Oher, Vice President and Chief Financial Officer of the Company, pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. (d) All other financial statement schedules have been omitted since they are either not required, not applicable or the required information is shown in the financial statements or related notes. *Filed herewith (unless otherwise indicated, exhibits are previously filed). **A management contract or compensatory plan or arrangement required to be filed as an exhibit to this form. -22- 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, on September 29, 2003. CRAFTMADE INTERNATIONAL, INC. By: /s/ James Ridings ------------------------------------- James Ridings, Chairman of the Board, President 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. Signatures Capacity Date ---------- -------- ---- /s/ James Ridings Chairman of the Board, President, September 29, 2003 ------------------------------ Chief Executive Officer and James Ridings Director (Principal Executive Officer) /s/ Clifford Crimmings Vice President Marketing and September 29, 2003 -------------------------- Director Clifford Crimmings /s/ Kathy Oher Chief Financial Officer, Vice September 29, 2003 ---------------------------------- President and Director Kathy Oher (Principal Financial and Accounting Officer) /s/ Neall Humphrey President of Trade Source September 29, 2003 ----------------------------- International, Inc. and Director Neall Humphrey /s/ John DeBlois Executive Vice President of Trade September 29, 2003 -------------------------------- Source International, Inc. John DeBlois and Director /s/ A. Paul Knuckley Director September 29, 2003 ------------------------------ A. Paul Knuckley /s/ Jerry E. Kimmel Director September 29, 2003 ------------------------------- Jerry E. Kimmel /s/ Lary Snodgrass Director September 29, 2003 ------------------------------- Lary Snodgrass -23- INDEX TO FINANCIAL STATEMENTS PAGE ---- CRAFTMADE INTERNATIONAL, INC. CONSOLIDATED FINANCIAL STATEMENTS Report of Independent Auditors F-2 Consolidated Statements of Income F-3 Consolidated Balance Sheets F-4 Consolidated Statements of Cash Flows F-6 Consolidated Statements of Changes in Stockholders' Equity F-8 Notes to Consolidated Financial Statements F-9 Financial Statement Schedule: II - Valuation and qualifying accounts and reserves F-21 All other financial statement schedules have been omitted since they are either not required, not applicable, or the required information is shown in the financial statements or related notes. DESIGN TRENDS, LLC FINANCIAL STATEMENTS Report of Independent Auditors F-22 Statements of Income and Members' Equity F-23 Balance Sheets F-24 Statements of Cash Flows F-26 Notes to Financial Statements F-28 All financial statement schedules have been omitted since they are either not required, not applicable, or the required information is shown in the financial statements or related notes. F-1 REPORT OF INDEPENDENT AUDITORS To the Board of Directors and Stockholders of Craftmade International, Inc. In our opinion, the consolidated financial statements listed in the index appearing under item 15(a)(1) present fairly, in all material respects, the financial position of Craftmade International, Inc. and its subsidiaries (the "Company") at June 30, 2003 and 2002, and the results of their operations and their cash flows for each of the three years in the period ended June 30, 2003 in conformity with accounting principles generally accepted in the United States of America. In addition, in our opinion, the financial statement schedule listed in the index under item 15(a)(2) presents fairly, in all material respects, the information set forth therein when read in conjunction with the related consolidated financial statements. These financial statements and financial statement schedule 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 to the consolidated financial statements, the Company changed its method of accounting for goodwill and other intangibles assets effective July 1, 2001. /s/ PricewaterhouseCoopers LLP Fort Worth, Texas August 8, 2003 F-2 CRAFTMADE INTERNATIONAL, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF INCOME FOR THE YEAR ENDED ------------------------------- June 30, June 30, June 30, 2003 2002 2001 ------- ------- ------- (In thousands except per share data) Net sales $71,817 $73,509 $71,107 Cost of goods sold 48,369 50,181 48,727 ------- ------- ------- Gross profit 23,448 23,328 22,380 ------- ------- ------- Selling, general and administrative expenses 15,307 14,975 14,235 Interest expense, net 837 886 1,786 Depreciation and amortization 650 569 899 ------- ------- ------- Total expenses 16,794 16,430 16,920 ------- ------- ------- Income before equity in earnings of 50% owned investees and income taxes 6,654 6,898 5,460 Equity in earnings of 50% owned investees before income taxes 4,241 2,622 2,038 ------- ------- ------- Income before income taxes 10,895 9,520 7,498 Provision for income taxes 4,049 3,360 2,811 ------- ------- ------- Net income $ 6,846 $ 6,160 $ 4,687 ======= ======= ======= Basic earnings per common share $ 1.24 $ 1.04 $ 0.79 ======= ======= ======= Diluted earnings per common share $ 1.23 $ 1.03 $ 0.79 ======= ======= ======= Cash dividends declared per common share $ 0.28 $ 0.28 $ 0.25 ======= ======= ======= SEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS F-3 CRAFTMADE INTERNATIONAL, INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS ASSETS June 30, June 30, 2003 2002 -------- -------- (In thousands) Current assets: Cash $ 3,469 $ 624 Accounts receivable - net of allowance for doubtful accounts of 11,706 15,077 $150 and $150 respectively Receivables from 50% owned investees 217 2,227 Inventory 9,394 8,570 Deferred income taxes 358 588 Prepaid expenses and other current assets 540 453 -------- -------- Total current assets 25,684 27,539 -------- -------- Property and equipment, net Land 1,535 1,535 Building 7,784 7,784 Office furniture and equipment 3,873 3,694 Leasehold improvements 259 253 -------- -------- 13,451 13,266 Less: accumulated depreciation (4,109) (3,460) -------- -------- Total property and equipment, net 9,342 9,806 -------- -------- Goodwill, net of accumulated amortization of $1,204 and $1,204 respectively 4,735 4,735 Deferred income taxes -- 156 Investment in 50% owned investees 3,567 2,244 Other assets 12 12 -------- -------- Total other assets 8,314 7,147 -------- -------- Total assets $ 43,340 $ 44,492 ======== ======== SEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS F-4 CRAFTMADE INTERNATIONAL, INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS LIABILITIES AND STOCKHOLDERS' EQUITY June 30, June 30, 2003 2002 -------- -------- (In thousands except for share data) Current liabilities: Note payable - current $ 809 $ 696 Revolving lines of credit 12,000 9,034 Accounts payable 2,517 3,067 Commissions payable 247 274 Income taxes payable 484 567 Accrued customer allowances 1,012 1,574 Other accrued liabilities 914 910 -------- -------- Total current liabilities 17,983 16,122 Other non-current liabilities: Note payable - long term 4,322 5,746 Deferred income taxes 497 -- -------- -------- Total liabilities 22,802 21,868 -------- -------- Commitments and contingencies (Note 12) Stockholders' equity: Series A cumulative, convertible callable preferred stock, $1.00 par value, 2,000,000 shares authorized; 32,000 shares issued 32 32 Common stock, $.01 par value, 15,000,000 shares authorized, 9,425,535 and 9,390,535 shares issued, respectively 94 94 Additional paid-in capital 13,584 13,261 Unearned deferred compensation (43) (76) Retained earnings 35,684 30,380 -------- -------- 49,351 43,691 Less: treasury stock, 4,004,477 and 3,446,477 common shares at cost, and 32,000 preferred shares at cost (28,813) (21,067) -------- -------- Total stockholders' equity 20,538 22,624 -------- -------- Total liabilities and stockholders' equity $ 43,340 $ 44,492 ======== ======== SEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS F-5 CRAFTMADE INTERNATIONAL, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS For the years ended June 30, -------------------------------------- 2003 2002 2001 -------- -------- -------- (In thousands) Cash flows from operating activities: Net income $ 6,846 $ 6,160 $ 4,687 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation and amortization 650 569 899 Provision for bad debts 114 187 118 Stock compensation expense 33 32 54 Deferred income taxes 884 (227) (143) Equity in earnings of 50% owned investees (4,241) (2,622) (2,038) Distributions received from 50% owned investees 2,918 1,322 1,160 Change in assets and liabilities providing (using) cash: Accounts receivable 3,257 (1,956) 2,431 Receivables from 50% owned investees 2,010 6,149 (7,544) Inventory (824) 4,080 126 Prepaid expenses and other assets (86) 696 (231) Accounts and commissions payable (577) (1,085) 942 Income taxes payable (84) (4) 709 Accrued liabilities (559) 678 469 -------- -------- -------- Net cash provided by operating activities 10,341 13,979 1,639 -------- -------- -------- Cash flows from investing activities: Additions to property and equipment (186) (696) (761) -------- -------- -------- Net cash used for investing activities (186) (696) (761) -------- -------- -------- Cash flows from financing activities: Principal payments on note payable (1,311) (2,146) (474) Net proceeds from (repayments on) line of credit 2,966 (9,766) 3,200 Treasury stock purchases (7,746) (235) (2,559) Cash dividends (1,542) (1,666) (1,455) Proceeds from exercise of employee stock options 323 431 68 -------- -------- -------- Net cash used for financing activities (7,310) (13,382) (1,220) -------- -------- -------- Net increase(decrease) in cash 2,845 (99) (342) Cash at beginning of year 624 723 1,065 -------- -------- -------- Cash at end of year $ 3,469 $ 624 $ 723 ======== ======== ======== SEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS F-6 CRAFTMADE INTERNATIONAL, INC. AND ITS SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS (CONTINUED) Supplemental disclosures of cash flow information: For the years ended June 30, ------------------------------ 2003 2002 2001 -------- -------- -------- (In thousands) Cash paid during the year for: Interest $ 837 $ 973 $ 1,889 ======== ======== ======== Income taxes $ 3,184 $ 2,926 $ 2,336 ======== ======== ======== SEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS F-7 CRAFTMADE INTERNATIONAL, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS' EQUITY FOR THE YEAR ENDED JUNE 30, 2003 (In thousands) ACCUMULATED SERIES A ADDITIONAL UNEARNED OTHER PREFERRED PAID-IN DEFERRED RETAINED COMPREHENSIVE VOTING COMMON STOCK STOCK CAPITAL COMPENSATION EARNINGS INCOME --------------------- -------- ---------- ------------ -------- ------------- Shares Amount -------- -------- Balance as of June 30, 2000 9,317 $ 93 $ 32 $ 12,453 $ -- $ 22,654 $ -- Comprehensive Income: Net income for the twelve months ended June 30, 2001 -- -- -- -- -- 4,687 -- Income from derivative financial instrument, net of tax of $10 -- -- -- -- -- -- 28 -------- -------- -------- -------- -------- -------- -------- Total comprehensive income -- -- -- -- -- 4,687 28 Stock option grants -- -- -- 162 (162) -- -- Deferred compensation earned -- -- -- -- 54 -- -- Treasury stock purchases -- -- -- -- -- -- -- Exercise of employee stock options 10 -- -- 68 -- -- -- Cash dividends -- -- -- -- -- (1,455) -- -------- -------- -------- -------- -------- -------- -------- Balance as of June 30, 2001 9,327 93 32 12,683 (108) 25,886 28 Comprehensive income: Net income for the twelve months ended June 30, 2002 -- -- -- -- -- 6,160 -- Termination of derivative financial instrument -- -- -- -- -- -- (28) -------- -------- -------- -------- -------- -------- -------- Total comprehensive income 6,160 (28) Deferred compensation earned 32 Treasury stock purchases -- -- -- -- -- -- -- Exercise of employee stock options 64 1 578 -- -- -- Cash dividends -- -- -- -- -- (1,666) -- -------- -------- -------- -------- -------- -------- -------- Balance as of June 30, 2002 9,391 94 32 13,261 (76) 30,380 -- Comprehensive income: Net income for the twelve months ended June 30, 2003 -- -- -- -- -- 6,846 -- -------- -------- -------- -------- -------- -------- -------- Total comprehensive income 6,846 Deferred compensation earned -- -- -- -- 33 -- -- Treasury stock purchases -- -- -- -- -- -- -- Exercise of employee stock options 35 -- -- 323 -- -- -- Cash dividends -- -- -- -- -- (1,542) -- -------- -------- -------- -------- -------- -------- -------- Balance as of June 30, 2003 9,426 $ 94 $ 32 $ 13,584 $ (43) $ 35,684 $ -- ======== ======== ======== ======== ======== ======== ======== TREASURY STOCK --------------------- Shares Amount Total -------- -------- -------- Balance as of June 30, 2000 3,148 $(18,273) $ 16,959 Comprehensive Income: Net income for the twelve months ended June 30, 2001 -- -- 4,687 Income from derivative financial instrument, net of tax of $10 -- -- 28 -------- -------- -------- Total comprehensive income -- -- 4,715 Stock option grants -- -- -- Deferred compensation earned -- -- 54 Treasury stock purchases 313 (2,559) (2,559) Exercise of employee stock options -- -- 68 Cash dividends -- -- (1,455) -------- -------- -------- Balance as of June 30, 2001 3,461 (20,832) 17,782 Comprehensive income: Net income for the twelve months ended June 30, 2002 -- -- 6,160 Termination of derivative financial instrument -- -- (28) -------- -------- -------- Total comprehensive income 6,132 Deferred compensation earned 32 Treasury stock purchases 17 (235) (235) Exercise of employee stock options -- -- 579 Cash dividends -- -- (1,666) -------- -------- -------- Balance as of June 30, 2002 3,478 (21,067) 22,624 Comprehensive income: Net income for the twelve months ended June 30, 2003 -- -- 6,846 -------- -------- -------- Total comprehensive income 6,846 Deferred compensation earned -- -- 33 Treasury stock purchases 558 (7,746) (7,746) Exercise of employee stock options -- -- 323 Cash dividends -- -- (1,542) -------- -------- -------- Balance as of June 30, 2003 4,036 $(28,813) $ 20,538 ======== ======== ======== SEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS F-8 CRAFTMADE INTERNATIONAL, INC. AND ITS SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS NOTE 1 - ORGANIZATION AND NATURE OF THE COMPANY Craftmade International, Inc., a Delaware corporation, is organized into two operating segments: Craftmade International, Inc. ("Craftmade") and Trade Source International, Inc. ("TSI"). Craftmade is principally engaged in the design, distribution and marketing of ceiling fans, light kits, outdoor lighting, bathstrip lighting and related accessories to a nationwide network of lighting showrooms and electrical wholesalers specializing in sales to the remodeling, new home construction and replacement markets. TSI, a wholly-owned subsidiary acquired July 1, 1998, and two 50% owned investees, Prime/Home Impressions, LLC ("PHI") and Design Trends, LLC ("Design Trends"), are principally engaged in the design, distribution and marketing of outdoor and indoor lighting, selected ceiling fans and various fan accessories to mass merchandisers. Craftmade, TSI, their wholly-owned subsidiaries and 50% owned investees are collectively referred to as the "Company". NOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES BASIS OF PRESENTATION - The Company's consolidated financial statements include the accounts of all wholly-owned subsidiaries; 50% owned investees are accounted for using the equity method. All intercompany accounts and transactions have been eliminated. The functional currency of the Company's foreign investees is the United States dollar. CONCENTRATION OF CREDIT RISK - Financial instruments that potentially subject the Company to concentrations of credit risk consist primarily of trade receivables. Substantially all of Craftmade's customers are lighting showrooms; however, credit risk is limited due to the large number of customers and their dispersion across many different geographic locations. As of June 30, 2003, Craftmade had no significant concentration of credit risk. As part of its ongoing control procedures, TSI monitors the creditworthiness of its customers thereby mitigating the effect of any concentration of credit risk. All of TSI's sales are to mass merchandisers with two customers comprising the most significant portion as follows: Customer A Customer B ---------------------------- ---------------------------- Percent of Percent of Fiscal Percent of Consolidated Percent of Consolidated Year TSI's Sales Sales TSI's Sales Sales ------------ ------------ ------------ ------------ ------------ 2003 56% 18% 25% 8% 2002 59% 19% 12% 4% 2001 55% 17% 31% 10% INVENTORIES - Inventories are stated at the lower of cost or market, with cost being determined using the average cost method which approximates the first-in, first-out (FIFO) method. The cost of inventory includes freight-in and duties on imported goods. F-9 PROPERTY AND EQUIPMENT - Property and equipment is recorded at cost. Depreciation is determined using the straight-line method over the estimated useful lives of the property and equipment, as follows: Building 40 years Office furniture, equipment and other 3 to 7 years. Leasehold improvements are amortized over the life of the lease or its useful life, whichever is shorter. Depreciation and amortization expense for the years ended June 30, 2003, 2002 and 2001 approximated $650,000, $569,000 and $503,000, respectively. Maintenance and repairs are charged to expense as incurred; renewals and betterments are charged to appropriate property or equipment accounts. Upon sale or retirement of depreciable assets, the cost and related accumulated depreciation is removed from the accounts, and the resulting gain or loss is included in the results of operations in the period of the sale or retirement. IMPAIRMENT OF LONG-LIVED ASSETS - The Company reviews potential impairments of long-lived assets and certain identifiable Intangibles on an exception basis when there is evidence that events or changes in circumstances have made recovery of an asset's carrying value unlikely. An impairment loss is recognized if the sum of the expected future cash flows, undiscounted and before interest, from the use of the asset is less than the net book value of the asset. Generally, the amount of the impairment loss is measured as the difference between the net book value of the assets and the estimated fair value. GOODWILL - Goodwill relates to Craftmade's acquisition of TSI in fiscal 1999. In accordance with SFAS 142, "Goodwill and Intangible Assets", which was adopted by the Company effective July 2001, goodwill is no longer being amortized. On an annual basis, and when there is reason to suspect that its value has been impaired by comparing its carrying value to its market value, goodwill will be tested for impairment by comparing its carrying value to its fair value. If indicated, an impairment loss will be recorded. Goodwill amortization of $396,000, or $0.07 per share, has been recorded in the accompanying 2001 consolidated statement of income. REVENUE RECOGNITION - The Company recognizes revenue when the customer takes title to the product and the related risks and rewards of ownership of the products have transferred to the customer. The Company records estimated incentives payable to the customer at a future date as a reduction of revenue at the time revenues are recorded. Income and costs from shipping and handling charges paid by the customer are recorded as sales and costs of goods sold, respectively. ADVERTISING COST - The Company's advertising expenditures consist primarily of print advertising programs, and are expensed as incurred or used. Advertising expense for the years ended June 30, 2003, 2002 and 2001, was $1,205,000, $1,326,000 and $1,160,000, respectively. Prepaid advertising costs at June 30, 2002 and 2001 were $219,000 and $226,000, respectively. Prepaid advertising costs will be reflected as an expense during the period used. INCOME TAXES - The Company accounts for income taxes under an asset and liability approach that requires the recognition of deferred tax assets and liabilities for the expected future tax consequences of events that have been recognized in the Company's financial statements or tax returns. In estimating future tax consequences, all expected future events other than enactments of changes in the tax law or rates are considered. Deferred income taxes have been provided on unremitted earnings from foreign investees. The Company reviews its deferred tax assets for ultimate realization and will record a valuation allowance to reduce the deferred tax asset if it is more likely than not that some portion, or all, of these deferred tax assets will not be realized. F-10 The Company's 50% owned investees operate in the form of limited liability corporations for tax purposes and, consequently, do not file federal income tax returns. Instead, the Company's share of their income is reported in the Company's federal tax return. DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES - All derivative instruments are recorded on the balance sheet at fair value. Changes in the fair value of derivatives are recorded each period in current earnings or other comprehensive income, depending on whether a derivative is designated as part of a hedge transaction and, if it is, depending on the type of hedge transaction. For fair-value hedge transactions in which the Company is hedging changes in an asset's, liability's, or firm commitment's fair value, changes in the fair value of the derivative instrument will generally be offset in the income statement by changes in the hedged item's fair value. For cash-flow hedge transactions in which the Company is hedging the variability of cash flows related to a variable-rate asset, liability, or a forecasted transaction, changes in the fair value of the derivative instrument will be reported in other comprehensive income. The gains and losses on the derivative instrument that are reported in other comprehensive income will be reclassified as earnings in the periods in which earnings are impacted by the variability of the cash flows of the hedged item. The ineffective portion of all hedges will be recognized in current-period earnings. At June 30, 2003, the Company did not have any outstanding derivative instruments. STOCK-BASED COMPENSATION - The Company follows the disclosure only provisions of FAS 123, "Accounting for Stock-Based Compensation". However, the Company continues to measure compensation cost for those plans using the intrinsic value based method of accounting as prescribed by Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees". Had compensation cost for the Company's stock option plans been determined based on the fair value of the stock options at grant date, in accordance with the provisions of FAS 123, the Company's net income and earnings per common share would have been adjusted to the pro forma amounts indicated below (in thousands, except per share amounts): Fiscal 2003 Fiscal 2002 Fiscal 2001 ------------ ------------ ------------ Net income, as reported $ 6,846 $ 6,160 $ 4,687 Net income, pro forma $ 6,689 $ 6,021 $ 4,547 Basic earnings per common share, as reported $ 1.23 $ 1.04 $ 0.79 Basic earnings per share $ 1.21 $ 1.01 $ 0.77 Diluted earnings per common share, as reported $ 1.23 $ 1.03 $ 0.79 Diluted earnings per common share, pro forma $ 1.20 $ 1.00 $ 0.77 The fair value of each option grant is calculated on the date of grant using the Black-Scholes option pricing model based upon the following weighted-average assumptions: Fiscal 2003 Fiscal 2002 Fiscal 2001 ------------ ------------ ------------ Expected volatility 50% 50% 58% Risk-free interest rate 3.7% 4.9% 5.8% Expected lives 7 years 7 years 10 years Dividend Yield 1.8% 2.1% 0% The weighted average fair value of options granted during fiscal 2001 with an exercise price less than fair market value on the grant date was $5.00. The weighted average fair value of options granted during fiscal 2003 and 2002 with an exercise equal to fair market value on the grant date was $5.11 and $5.92, respectively. EARNINGS PER COMMON SHARE - Basic earnings per share measures the performance of an entity over the reporting period. Diluted earnings per share measures the performance of an entity over the reporting period while giving effect to all potentially dilutive common shares that were outstanding during the period. The treasury stock method is used to determine the dilutive potential of stock options. Options which, based on their exercise price, would be anti-dilutive are not considered in the treasury stock method calculation. There have been no options excluded from the earnings per share calculations due to their anti-dilutive nature. F-11 SEGMENT INFORMATION - The Company presents two reportable segments, Craftmade and TSI. The Company's reportable segments have been identified utilizing the management approach which designates the internal organization that is used by management for making operating decisions and assessing performance. PERVASIVENESS 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 reporting period. Actual results could differ from those estimates. EFFECTS OF RECENT ACCOUNTING PRONOUNCEMENTS - In July 2002, the FASB issued SFAS No. 146, Accounting for Costs Associated with Exit or Disposal Activities, which has an effective date for exit or disposal activities that are initiated after December 31, 2002. This statement provides that cost associated with an exit or disposal activity must be recognized when the liability is incurred. The adoption of SFAS No. 146 did not have a material impact on the Company's financial statements. In December 2002, the FASB issued SFAS No. 148, Accounting for Stock-Based Compensation - Transition and Disclosure - an Amendment of FAS 123, which is effective for financial statements for fiscal years ending after December 15, 2002. This Statement amends FASB Statement No. 123, Accounting for Stock-Based Compensation, to provide alternative methods of transition for a voluntary change to the fair value based method of accounting for stock-based employee compensation. In addition, this Statement amends the disclosure requirements of Statement 123 to require prominent disclosures in both annual and interim financial statements about the method of accounting for stock-based employee compensation and the effect of the method used on reported results. The disclosure requirements of SFAS No. 148 are included in Note 2 of Notes to Consolidated Financial Statements. In December 2002, the FASB issued Interpretation No. 45 (FIN 45), Guarantor's Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others which has an effective date of December 31, 2002. FIN 45 requires a guarantor to make additional disclosures in its interim and annual financial statements regarding the guarantor's obligations. In addition, FIN 45 requires, under certain circumstances, that a guarantor recognize, at the inception of the guarantee, a liability for the fair value of the obligation undertaken when issuing the guarantee. The impact of the accounting requirements of FIN 45 on the Company's financial statements was not material. In January 2003, the FASB issued Interpretation No. 46 (FIN 46), Consolidation of Variable Interest Entities. This interpretation of Accounting Research Bulletin No. 51, Consolidated Financial Statements, addresses consolidation of variable interest entities. FIN 46 requires certain variable interest entities to be consolidated by the primary beneficiary if the entity does not effectively disperse risks among the parties involved. The provisions of FIN 46 are effective immediately for those variable interest entities created after January 31, 2003. The provisions are effective for the first period beginning after June 15, 2003, for those variable interests held prior to February 1, 2003. The Company has no variable interest entities and accordingly does not believe the adoption of this Interpretation will have a material impact on the Company's financial position, results of operations or cash flows. In April 2003, the FASB issued SFAS 149, Amendment of Statement 133 on Derivative Instruments and Hedging Activities, which amends SFAS 133 for certain decisions made by the FASB Derivatives Implementation Group. In particular, SFAS 149 (1) clarifies under what circumstances a contract with an initial net investment meets the characteristic of a derivative, (2) clarifies when a derivative contains a financing component, (3) amends the definition of underlying to conform it to language used in FASB interpretation number (FIN) 45, and (4) amends certain other existing pronouncements. SFAS 149 is effective for contracts entered into or modified after June 30, 2003, and for hedging relationships designated after June 30, 2003. In addition, most provisions of SFAS 149 are to be applied prospectively. The effect of adopting this new standard on the Company's financial statements is not expected to be material. In May 2003, the FASB issued SFAS 150, Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity. SFAS 150 clarifies the accounting for certain financial instruments that, under previous guidance, issuers could account for as equity. SFAS 150 requires that those instruments be classified as liabilities in statements of financial position. SFAS 150 is effective for interim periods beginning after June 15, 2003. The effect of adopting this new standard on the Company's financial statements is not expected to be material. F-12 NOTE 3 - INVESTMENT IN 50% OWNED INVESTEES Combined summarized financial information for Design Trends and PHI is as follows for the year ended: June 30 June 30 June 30 2003 2002 2001 ------------ ------------ ------------ Net sales $ 37,216,000 $ 32,541,000 $ 21,107,000 Gross profit 11,947,000 8,595,000 6,714,000 Income before income taxes 8,472,000 5,033,000 3,907,000 June 30 June 30 2003 2002 -------------- -------------- Accounts receivable - net $ 4,877,000 $ 6,354,000 Inventories 3,733,000 2,758,000 Total current assets 10,263,000 10,083,000 Total assets 11,894,000 13,277,000 Revolving line of credit -- 1,169,000 Note payable - current 167,000 -- Total current liabilities 6,910,000 9,939,000 Long term debt 194,000 -- Total liabilities 7,104,000 9,939,000 Total partner capital 4,790,000 3,338,000 Substantially all of the 50% owned investees' sales are to mass merchandisers. One customer accounted for 83%, 80%, and 66% of sales in 2003, 2002 and 2001, respectively. At June 30, 2003 and 2002 accounts receivable from this customer totaled $3,215,000 and $5,455,000 respectively. The Company received distributions of $2,918,000, $1,322,000, and $1,160,000, in 2003, 2002 and 2001 respectively, from these two 50% owned investees. The Company's 50% owned investees operate in the form of limited liability corporations and, consequently, do not file federal income tax returns. Instead, the Company's share of their income is reported in the Company's federal tax return. NOTE 4 - REVOLVING LINE OF CREDIT At June 30, 2003, the Company has a $20,000,000 line of credit with a financial institution at an interest rate of prime less .5% (4.25% at June 30, 2003), of which $12,000,000 was outstanding. The line of credit is due on demand; however, if no demand is made, it is scheduled to mature October 31, 2003. This line of credit is collateralized by inventory, accounts receivable and equipment of the Company. Company utilizes borrowings under this line of credit to partially fund its working capital needs as well as the working capital needs of Design Trends. The line of credit contains certain financial covenants, which include tangible net worth, funded debt to EBITDA ratio, capital expenditures and common stock repurchases. The Company has complied with the covenants as of and for the year ended June 30, 2003. Management is negotiating to renew the Company's line of credit and believe they will be able to complete the negotiations prior to the maturity of its existing line of credit. Management believes that alternative bank financing on acceptable terms would be available should the Company not be able to renew its current line of credit. NOTE 5 - NOTE PAYABLE Craftmade has a term loan to finance its home office and warehouse with an original principal balance of $9,200,000. At June 30, 2003 the loan bears interest at 8.302%. The loan is payable in equal monthly installments of principal F-13 and interest of $100,378 with a final balloon payment of $901,045 when the loan matures on January 1, 2008. The loan is collateralized by the building and land. Scheduled maturities of the note payable are as follows (in thousands): Fiscal Year ----------- 2004 $ 809 2005 879 2006 954 2007 1,037 2008 1,452 -------- $ 5,131 ======== NOTE 6 - DERIVATIVE FINANCIAL INSTRUMENTS During fiscal 2000, the Company entered into an interest rate swap agreement, with a maturity of December 29, 2003, to manage its exposure to interest rate movements by effectively converting a portion of its long-term facility debt from fixed to variable rates. The derivative instrument was terminated in November 2001 and the Company received $61,500 in connection with this termination. NOTE 7 - INCOME TAXES Components of the provision for income taxes for the years ended June 30, 2003, 2002 and 2001 consist of the following: 2003 2002 2001 ------------ ------------ ------------ (In thousands) Current expense: Federal $ 2,617 $ 3,300 $ 2,596 State 296 191 147 Foreign 252 96 211 ------------ ------------ ------------ Total current expense $ 3,165 3,587 2,954 Total deferred 884 (227) (143) ------------ ------------ ------------ Provision for income taxes $ 4,049 $ 3,360 $ 2,811 ============ ============ ============ Deferred taxes are provided for temporary differences between the financial reporting basis and the tax basis of the Company's assets and liabilities. The temporary differences that give rise to deferred tax assets and liabilities at June 30, 2003 and 2002 are as follows: 2003 2002 ------------ ------------ (In thousands) Inventories $ 423 $ 689 Accounts receivable reserves 56 56 Accrued customer allowances 185 268 Vacation -- 78 Investment in 50% owned investees 519 374 Other 64 50 ------------ ------------ Total deferred tax assets 1,247 1,515 ------------ ------------ Depreciation and amortization (498) (275) Foreign taxes (888) (496) ------------ ------------ Total deferred tax liabilities (1,386) (771) ------------ ------------ $ (139) $ 744 ============ ============ F-14 The differences between the Company's effective tax rate and the federal statutory rate of 34% for the years ended June 30, 2003, 2002 and 2001 are as follows: 2003 2002 2001 ------------ ------------ ------------ (In thousands) Tax at the statutory corporate rate $ 3,704 $ 3,237 $ 2,550 State income taxes, net of federal benefit 270 170 60 Goodwill amortization -- -- 135 Other 75 (47) 66 ------------ ------------ ------------ Provision for income taxes $ 4,049 $ 3,360 $ 2,811 ============ ============ ============ Effective tax rate 37% 35% 38% ============ ============ ============ NOTE 8 - TRANSACTIONS WITH 50% OWNED INVESTEES There are no sales between the Company and its 50% investees or between the investees, The investees utilize the Company's Coppell, Texas distribution facility and Company personnel in the conduct of their operations. The Company charges Design Trends for facility rent and payroll costs for those full time Company employees when they work directly in Design Trends operations. Facility rent is based on total square footage occupied by Design Trends and payroll costs represent actual costs for those employees. No allocation of indirect personnel costs, including management level personnel, is included in the charge to Design Trends. The Company utilizes borrowings under its line of credit to provide Design Trends with advances for its working capital needs. The Company charges Design Trends interest on these advances at the bank's prime rate plus two percentage points and interest is calculated on the average outstanding monthly balance. PHI reimburses the company $30,000 per month for general, warehouse and administrative expenses. Craftmade's charges to its 50% owned investees are summarized as follows: Year ending 2003 2002 2001 ------------ ------------ ------------ Rent - Design Trends $ 360,000 $ 330,000 $ 225,000 Payroll - Design Trends $ 996,000 $ 700,000 $ 300,000 Interest - Design Trends $ 20,000 $ 421,000 $ 336,000 Administrative - PHI $ 360,000 $ 360,000 $ 360,000 NOTE 9 - STOCKHOLDERS' EQUITY STOCK OPTION PLANS On October 27, 2000, the Company's stockholders approved the 1999 Stock Option Plan ("1999 Plan") and 2000 Non-Employee Director Plan ("Non-Employee Plan"), previously adopted by the Board of Directors on October 29, 1999 and February 16, 2000, respectively. The 1999 Plan and Non-Employee Plan allow a maximum of 300,000 and 75,000 shares, respectively, of the Company's common stock to be issued. Options granted pursuant to the 1999 Plan will be designated as either Incentive Stock Options ("ISOs") or Non-Qualified Stock Options ("NQSOs"). Options granted pursuant to the Non-Employee Plan will be designated as NQSOs. The F-15 1999 Plan options vest at a rate of 20% on the grant date and 20% for each successive year. The Non-Employee Plan options vest within six months of the date of grant. Options may be exercised at any time once they become vested, but not more than 10 years from the date of grant. A summary of options issued under the above agreements is as follows: CRAFTMADE INTERNATIONAL, INC. STOCK OPTIONS 1999 PLAN NON-EMPLOYEE PLAN ---------------------------------------------------------------------------------------------------------------- WEIGHTED WEIGHTED WEIGHTED WEIGHTED AVERAGE EXERCISE AVERAGE AVERAGE EXERCISE AVERAGE EXERCISE PRICE REMAINING EXERCISE PRICE REMAINING SHARES PRICE RANGE LIFE SHARES PRICE RANGE LIFE ------ -------- -------- --------- ------ -------- -------- --------- Outstanding at June 30, 2000 - $ - - $ - Granted 200,000 6.75 9,000 7.06 Exercised (10,000) 6.75 - - ------- -------- ------- -------- Outstanding at June 30, 2001 190,000 6.75 9,000 7.06 Granted - - 4,500 14.85 Exercised (64,000) 6.75 - - ------- -------- ------- -------- Outstanding at June 30, 2002 126,000 $ 6.75 13,500 $ 9.66 ------- -------- ------- -------- Granted - - 4,500 14.15 Exercised (33,500) 6.75 - - ------- -------- ------- -------- Outstanding at June 30, 2003 92,500 $ 6.75 $ 6.75 7.3 18,000 $ 10.78 $6.56 - $14.85 8.3 ------- -------- -------- --------- ------- -------- -------------- --------- Exercisable at June 30, 2003 12,500 $ 6.75 13,500 $ 9.66 ------- -------- ------- -------- As the exercise price of certain of the option grants noted above was less than fair market value on the date of grant the Company recorded deferred compensation approximating $162,000 in 2001. Deferred compensation expense is recognized in the Company's results of operations as the options vest. TREASURY STOCK PURCHASES During the year ended June 30, 1999, the Company's Board of Directors authorized the Company's management to repurchase up to 2,350,000 shares of the Company's outstanding common stock. At June 30, 2003, the Company had repurchased 2,264,300 shares at an aggregate cost of $23,100,000 of which 558,000 shares at an aggregate cost of $7,746,000 were purchased in fiscal 2003. STOCKHOLDER RIGHTS PLAN On June 23, 1999, the Company declared a dividend of one Preferred Share Purchase Right ("Right") on each outstanding share of the Company's common stock. The dividend distribution was made on July 19, 1999 to stockholders of record on that date. The Rights become exercisable if a person or group acquires 15% or more of the Company's common stock or announces its intent to do so. Each Right will entitle F-16 stockholders to buy one one-thousandth of a share of Series A Preferred Stock, $1.00 par value per share, at an exercise price of $48. When the Rights become exercisable, the holder of each Right (other than the acquiring person or members of such group) is entitled (1) to purchase, at the Right's then current exercise price, a number of the acquiring company's common shares having a market value of twice such price, (2) to purchase, at the Right's then current exercise price, a number of the Company's common shares having a market value of twice such price, or (3) at the option of the Company, to exchange the Rights (other than Rights owned by such person or group), in whole or in part, at an exchange ratio of one-half share of common stock (or one-thousandth of a share of the Series A Preferred Stock) per Right. The Rights may be redeemed for $.001 each by the Company at any time prior to acquisition by a person (or group) of beneficial ownership of 15% or more of the Company's common stock. The Rights will expire on June 23, 2009. NOTE 10 - EARNINGS PER SHARE The following is a reconciliation of the numerator and denominator used in the basic and diluted EPS calculations: For the years ended June 30, ------------------------------------------ 2003 2002 2001 ------------ ------------ ------------ (In thousands, except per share data) Basic and diluted EPS: Numerator: net income $ 6,846 $ 6,160 $ 4,687 ------------ ------------ ------------ Basic denominator: Common shares outstanding 5,512 5,937 5,933 ------------ ------------ ------------ Basic EPS: $ 1.24 $ 1.04 $ .79 ============ ============ ============ Diluted denominator: Common shares outstanding 5,512 5,937 5,933 Options 56 64 9 ------------ ------------ ------------ Total shares 5,568 6,001 5,942 ------------ ------------ ------------ Diluted EPS: $ 1.23 $ 1.03 $ .79 ============ ============ ============ NOTE 11 - DISCLOSURES ABOUT FAIR VALUE OF FINANCIAL INSTRUMENTS The Company's financial instruments include cash, receivables, accounts and commissions payable, accrued liabilities and amounts outstanding under various debt agreements. Management believes the fair values of these instruments approximate the related carrying values as of June 30, 2003 because of their short-term nature, recent renegotiations and/or variable interest rates. NOTE 12 - COMMITMENTS AND CONTINGENCIES As of June 30, 2003, PHI had $3,000,000 available on its line of credit, of which $0 had been utilized. Craftmade is a guarantor on this line of credit. The Company leases various equipment and real estate under non-cancelable operating lease agreements which require future cash payments. The Company incurred rental expense under its operating lease agreements of $353,000, $359,000, and $306,000 for the years ended June 30, 2003, 2002, and 2001, respectively. Future minimum lease payments under noncancelable operating leases as of June 30, 2003 are as follows (in thousands): F-17 Fiscal Year ------------ 2004 $ 117 2005 83 2006 85 2007 64 ------------ $ 349 ============ TSI leases office space from a director of the Company, who is also a senior officer of TSI. This lease is for $7,500 per month on a month-to-month basis. From time to time the Company is involved in certain legal actions and claims arising in the ordinary course of business. It is the opinion of management based on the advice of legal counsel and after consideration of the Company's insurance coverage that currently there is no such litigation or claim that when resolved will have a material effect on the Company's financial position, results of operations or cash flows. NOTE 13 - 401(k) DEFINED CONTRIBUTION PLAN The Company has a qualified 401(k) defined contribution plan which covers substantially all full-time employees who have met certain eligibility requirements. Employees under the age of fifty (50) are allowed to tax defer a maximum of $11,000 of their annual compensation. Employees over the age of fifty (50) are allowed to tax defer a maximum of $12,000 of their annual compensation. The Company will match one-half of the participant's contributions up to 6% of their annual compensation. The Company's matching contribution for the years ended June 30, 2003, 2002, and 2001 aggregated approximately $101,000, $96,000, and $96,000 respectively. NOTE 14 - MAJOR SUPPLIER AND RELATED PARTY On December 7, 1989, Craftmade and its major Supplier (the "Supplier") entered into a written agreement, terminable on 180 days prior notice, pursuant to which the Supplier has agreed to manufacture ceiling fans for Craftmade. The Supplier provides substantially all of Craftmade's ceiling fans and accessories. The Supplier is permitted under the arrangement to manufacture ceiling fans for other distribution provided such ceiling fans are not a replication of the Craftmade series or models. Fans and accessories manufactured and sold to Craftmade by the Supplier account for approximately 66%, 61% and 61% of Craftmade's purchases (35.8%, 37.1% and 31.5% of consolidated purchases) during the years ended June 30, 2003, 2002 and 2001, respectively. F-18 NOTE 15 - SEGMENT INFORMATION The Company operates in two reportable segments, Craftmade and TSI. The accounting policies of the segments are the same as those described in Note 2 - Summary of Significant Accounting Policies. The Company evaluates the performance of its segments and allocates resources to them based on their operating profit and loss and cash flows. The Company is organized on a combination of product type and customer base. The Craftmade segment primarily derives its revenue from home furnishings including ceiling fans, light kits, bathstrip lighting and lamps offered primarily through lighting showrooms, certain major retail chains and catalog houses. The TSI segment derives its revenue from outdoor lighting, portable lamps, indoor lighting and fan accessories marketed solely to mass merchandisers. The following table presents information about the reportable segments (in thousands): CRAFTMADE TSI TOTAL --------- -------- -------- For the year ended June 30, 2003: Net sales to external customers $ 49,155 $ 22,662 $ 71,817 Operating profit 7,836 (345) 7,491 Net interest expense 852 (14) 837 Equity in earnings of 50% owned investees -- 4,241 4,241 Provision for income taxes 2,676 1,373 4,049 Depreciation and amortization 570 80 650 Total assets 21,644 21,696 43,340 For the year ended June 30, 2002: Net sales to external customers $ 49,798 $ 23,711 $ 73,509 Operating profit 7,582 202 7,784 Net interest expense 1,113 (227) 886 Equity in earnings of 50% owned investees -- 2,622 2,622 Provision for income taxes 2,331 1,029 3,360 Depreciation and amortization 474 95 569 Total assets 24,681 19,811 44,492 For the year ended June 30, 2001: Net sales to external customers $ 48,514 $ 22,593 $ 71,107 Operating profit 6,707 539 7,246 Net interest expense 1,951 (165) 1,786 Equity in earnings of 50% owned investees -- (22,654) (22,654) Provision for income taxes 1,675 1,136 2,811 Depreciation and amortization 383 516 899 Total assets 32,397 19,964 52,361 The following is sales information by geographic area for the years ended June 30, 2003, 2002, and 2001 (in thousands) 2003 2002 2001 -------- -------- -------- United States 62,565 69,709 66,997 Hong Kong 9,252 3,800 4,110 ======== ======== ======== 71,817 73,509 71,107 Long-lived assets totalled approximately $9,343,000 and $9,806,000 at June 30, 2003 and 2002, respectively. Approximately $11,000 and $25,000 of the long lived assets at June 30, 2003 and 2002, respectively, are located in Hong Kong. F-19 NOTE 16 - QUARTERLY DATA The Company's product sales, particularly ceiling fans, are somewhat seasonal with sales in the warmer first and fourth quarters being historically higher than in the two other fiscal quarters. The following table contains information derived from unaudited financial statements of the Company. In the opinion of the Company's management, the information includes all adjustments necessary for fair presentation of the results. The results of a particular quarter are not necessarily indicative of the results that might be achieved for a full fiscal year. Fiscal 2003 Fiscal 2002 ------------------------------------------------------------------------------------------------------ First Second Third Fourth First Second Third Fourth Quarter Quarter Quarter Quarter Quarter Quarter Quarter Quarter ------- ------- ------- ------- ------- ------- ------- -------- (In thousands, except per share data) Statements of income data: Net Sales $19,022 $15,961 $17,878 $18,956 $22,267 $15,952 $14,988 $20,302 Gross Profit 6,081 5,207 5,367 6,793 6,645 5,142 4,894 6,646 Operating Profit 2,062 1,448 1,336 2,458 2,753 1,268 993 2,770 Net Income 2,204 1,370 1,356 1,916 1,957 1,120 969 2,113 Basic EPS $ 0.38 $ 0.25 $ 0.25 $ 0.36 $ 0.33 $ 0.19 $ 0.16 $ 0.35 Diluted EPS $ 0.38 $ 0.25 $ 0.25 $ 0.35 $ 0.33 $ 0.19 $ 0.16 $ 0.35 Basic shares outstanding 5,796 5,516 5,384 5,353 5,903 5,931 5,957 5,956 Diluted shares outstanding 5,858 5,574 5,436 5,402 5,974 5,989 6,012 6,027 F-20 CRAFTMADE INTERNATIONAL, INC. AND ITS INVESTEES SCHEDULE II VALUATION AND QUALIFYING ACCOUNTS AND RESERVES Additions --------------- Balance at (1) (2) Balance at beginning of Charged to costs Charged to other Deductions end of Description period and expense accounts (describe) (describe) (a) period ------------------------------------ ---------------- ---------------- -------------------- -------------- ------------ Allowance for doubtful accounts: For the years ended: June 30, 2003 $ 150 $ 114 $ -- $ (114) $ 150 June 30, 2002 $ 150 $ 187 $ -- $ (187) $ 150 June 30, 2001 $ 236 $ 118 $ -- $ (204) $ 150 ------------------------------------ ---------------- ---------------- -------------------- -------------- ------------ (a) Reduction of the allowance for doubtful accounts associated with the write-off of certain uncollectible accounts receivable balances. F-21 REPORT OF INDEPENDENT AUDITORS To the Board of Directors and Stockholders of Design Trends, LLC In our opinion, the financial statements listed in the index appearing under item 15(a)(1) present fairly, in all material respects, the financial position of Design Trends, LLC (a Delaware Limited Liability Corporation) (the "Company") at June 30, 2003, and the results of its operations and its cash flows for the year then ended 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 audit. We conducted our audit 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 audit provide a reasonable basis for our opinion. /s/ PricewaterhouseCoopers LLP Fort Worth, Texas August 8, 2003 F-22 DESIGN TRENDS, LLC STATEMENTS OF INCOME AND MEMBERS' EQUITY FOR THE YEAR ENDED --------------------------------------- June 30, June 30, June 30, 2003 2002 2001 -------- --------- ----------- (Unaudited) (Unaudited) (In thousands) Net sales $ 29,079 $ 25,675 $ 12,433 Cost of goods sold 20,807 19,704 8,947 -------- -------- -------- Gross profit 8,272 5,971 3,486 -------- -------- -------- Selling, general and administrative expenses 2,529 2,166 1,031 Interest expense, net 20 421 336 -------- -------- -------- Total expenses 2,549 2,587 1,367 -------- -------- -------- Income before state income taxes 5,723 3,384 2,119 Provision for state income taxes 133 141 116 -------- -------- -------- Net income $ 5,590 $ 3,243 $ 2,003 Members' equity at beginning of year $ 3,046 $ 2,010 $ 7 Distributions to Members ($ 4,753) ($ 2,207) -- -------- -------- -------- Members' equity at end of year $ 3,883 $ 3,046 $ 2,010 ======== ======== ======== THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE FINANCIAL STATEMENTS F-23 DESIGN TRENDS, LLC BALANCE SHEETS ASSETS June 30, June 30, 2003 2002 -------- -------- (Unaudited) (In thousands) Current assets: Cash $ 816 $ -- Accounts receivable, net of allowance of $0 3,957 5,222 Inventory 3,004 2,180 Deferred income taxes 68 -- Prepaid expenses and other current assets 136 287 ------- ------- Total current assets 7,981 7,689 ------- ------- Display equipment, net of accumulated depreciation of $3,386 and $1,747, respectively 1,535 3,174 ------- ------- Total assets $ 9,516 $10,863 ======= ======= THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE FINANCIAL STATEMENTS F-24 DESIGN TRENDS, LLC BALANCE SHEETS LIABILITIES AND MEMBERS' EQUITY June 30, June 30, 2003 2002 ------- ------- (Unaudited) Current liabilities: Accounts payable $ 1,721 $ 1,757 Commissions payable 36 61 Members' distributions payable 2,016 1,009 Payable to Craftmade 120 1,962 State income taxes payable 100 257 Accrued customer allowances 1,640 2,771 ------- ------- Total current liabilities 5,633 7,817 Commitments and contingencies (Note 5) Members' equity 3,883 3,046 ------- ------- Total liabilities and members' equity $ 9,516 $10,863 ======= ======= THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE FINANCIAL STATEMENTS F-25 DESIGN TRENDS, LLC STATEMENTS OF CASH FLOW For the years ended June 30, --------------------------------- 2003 2002 2001 ------- ------- ------- (Unaudited) (Unaudited) Cash flows from operating activities: Net income $ 5,590 $ 3,243 $ 2,003 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation 1,639 1,562 196 Provision for bad debts (3) 13 -- Deferred income taxes (68) -- -- Change in assets and liabilities providing (using) cash: Accounts receivable 1,268 (409) (4,557) Inventory (824) 2,957 (4,756) Prepaid expenses and other assets 151 (292) 5 Accounts and commissions payable (61) 43 1,725 State income taxes payable (157) 141 115 Payable to Craftmade (1,842) (6,255) 7,606 Accrued customer allowances (1,131) 1,927 837 ------- ------- ------- Net cash provided by operating activities 4,562 2,930 3,172 ------- ------- ------- Cash flows from investing activities: Additions to display equipment -- (2,292) (2,611) ------- ------- ------- Net cash used for investing activities -- (2,292) (2,611) ------- ------- ------- Cash flows from financing activities: Distribution to members (3,746) (1,225) -- ------- ------- ------- Net cash used for financing activities (3,746) (1,225) -- ------- ------- ------- Net increase(decrease) in cash 816 (587) 563 Cash at beginning of year -- 587 24 ------- ------- ------- Cash at end of year $ 816 $ -- $ 587 ======= ======= ======= Non-cash investing and financing activities: Distribution to members declared, not yet paid $ 1,007 $ 982 $ -- THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE FINANCIAL STATEMENTS F-26 DESIGN TRENDS, LLC STATEMENTS OF CASH FLOWS (CONTINUED) Supplemental disclosures of cash flow information: For the years ended June 30, ------------------------------------------ 2003 2002 2001 ------------ ------------ ------------ (Unaudited) (In thousands) Cash paid during the year for: Interest paid to Craftmade $ 20 $ 421 $ 336 ============ ============ ============ State income taxes $ 358 $ 116 $ -- ============ ============ ============ THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE FINANCIAL STATEMENTS. F-27 DESIGN TRENDS, LLC NOTES TO FINANCIAL STATEMENTS NOTE 1 - ORGANIZATION AND NATURE OF THE COMPANY Design Trends, LLC., a Delaware limited liability corporation, is a joint venture between Craftmade International, Inc. ("Craftmade") and Dolan Northwest, LLC. (collectively "Members'"), with each member owning 50% of the entity. Design Trends is principally engaged in designing, sourcing and marketing table lamps, floor lamps, torchiere lamps, chandeliers, bath accessories, wall sconces, and pendant fixtures to mass merchandisers, home centers and home decor retailers. The Company operates in one business segment. NOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES INVENTORIES - Inventories are stated at the lower of cost or market, with cost being determined using the average cost method which approximates the first-in, first-out (FIFO) method. The cost of inventory includes freight-in and duties on imported goods. DISPLAY EQUIPMENT - Display equipment is recorded at cost and is being depreciated on the straight line method over 3 years. Depreciation of display equipment totaling $1,639,000, $1,562,000 and $196,000 in 2003, 2002 and 2001, respectively is reflected as a reduction of net sales. IMPAIRMENT OF LONG-LIVED ASSETS - The Company reviews potential impairments of long-lived assets on an exception basis when there is evidence that events or changes in circumstances have made recovery of an asset's carrying value unlikely. An impairment loss is recognized if the sum of the expected future cash flows undiscounted and before interest from the use of the asset is less than the net book value of the asset. Generally, the amount of the impairment loss is measured as the difference between the net book value of the assets and the estimated fair value. REVENUE RECOGNITION - The Company recognizes revenue when the customer takes title to the product and the related risks and rewards of ownership of the products have transferred to the customer. The Company records estimated incentives payable to the customer at a future date as a reduction of revenue at the time revenues are recorded. Income and costs from shipping and handling charges paid by the customer are recorded as sales and costs of goods sold, respectively. ADVERTISING COST - The Company's advertising expenditures consist primarily of print advertising programs, and are expensed as incurred or used. Advertising expense for the years ended June 30, 2003, 2002 and 2001, was $92,000, $26,000 and $25,000, respectively. INCOME TAXES - For federal income tax purposes, the Company is treated as a pass through entity. The Company's Members include their share of the Company's taxable income in their federal income tax returns. As a result, the Company does not provide federal income taxes in its financial statements. The Company accounts for state income taxes under an asset and liability approach that requires the recognition of deferred tax assets and liabilities for the expected future tax consequences of events that have been recognized in the Company's financial statements or tax returns. In estimating future tax consequences, all expected future events other than enactments of changes in the tax law or rates are considered. The Company reviews its deferred tax assets for ultimate realization and will record a valuation allowance to reduce the deferred tax asset if it is more likely than not that some portion, or all, of these deferred tax assets will not be realized. F-28 PERVASIVENESS OF ESTIMATES - The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. Significant items subject to such estimates and assumptions include the carrying amount of property and equipment and valuation allowances for receivables and inventories. Actual results could differ from those estimates. EFFECTS OF RECENT ACCOUNTING PRONOUNCEMENTS - In July 2002, the FASB issued SFAS No. 146, Accounting for Costs Associated with Exit or Disposal Activities, which has an effective date for exit or disposal activities that are initiated after December 31, 2002. This statement provides that cost associated with an exit or disposal activity must be recognized when the liability is incurred. SFAS No. 146 does not currently impact the Company's financial statements. In December 2002, the FASB issued Interpretation No. 45 (FIN 45), Guarantor's Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others. FIN 45 requires a guarantor to make additional disclosures in its interim and annual financial statements regarding the guarantor's obligations. In addition, FIN 45 requires, under certain circumstances, that a guarantor recognize, at the inception of the guarantee, a liability for the fair value of the obligation undertaken when issuing the guarantee. The impact of the accounting requirements of FIN 45 on the Company's financial statements was not material. In January 2003, the FASB issued Interpretation No. 46 (FIN 46), Consolidation of Variable Interest Entities. This interpretation of Accounting Research Bulletin No. 51, Consolidated Financial Statements, addresses consolidation of variable interest entities. FIN 46 requires certain variable interest entities to be consolidated by the primary beneficiary if the entity does not effectively disperse risks among the parties involved. The provisions of FIN 46 are effective immediately for those variable interest entities created after January 31, 2003. The provisions are effective for the first period beginning after June 15, 2003, for those variable interests held prior to February 1, 2003. The Company has no variable interest entities and accordingly does not believe the adoption of this Interpretation will have a material impact on the Company's financial position or results of operations. In April 2003, the FASB issued SFAS 149, Amendment of Statement 133 on Derivative Instruments and Hedging Activities, which amends SFAS 133 for certain decisions made by the FASB Derivatives Implementation Group. In particular, SFAS 149 (1) clarifies under what circumstances a contract with an initial net investment meets the characteristic of a derivative, (2) clarifies when a derivative contains a financing component, (3) amends the definition of underlying to conform it to language used in FASB interpretation number (FIN) 45, and (4) amends certain other existing pronouncements. SFAS 149 is effective for contracts entered into or modified after June 30, 2003, and for hedging relationships designated after June 30, 2003. In addition, most provisions of SFAS 149 are to be applied prospectively. The Company does not expect that the provisions of this statement will have a material impact on the Company's financial statements. In May 2003, the FASB issued SFAS 150, Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity. SFAS 150 improves the accounting for certain financial instruments that, under previous guidance, issuers could account for as equity. SFAS 150 requires that those instruments be classified as liabilities in statements of financial position. SFAS 150 is effective for interim periods beginning after June 15, 2003. The Company does not expect this statement to have a material impact on it's financial statements. NOTE 3 - MAJOR CUSTOMER AND CONCENTRATION OF CREDIT RISK Financial instruments that potentially subject the Company to concentrations of credit risk consist primarily of trade receivables. One mass merchandiser customer accounts for 87%, 85% and 79% of net sales in 2003, 2002 and 2001, respectively. At June 2003 and June 2002, accounts receivable from this customer totaled $2,680,000 and $4,475,000, respectively. As part of its ongoing control procedures, the Company monitors the creditworthiness of its customers thereby mitigating the effect of any concentration of credit risk. F-29 NOTE 4 - INCOME TAXES Components of the provision for state income taxes for the years ended June 30, 2003, 2002 and 2001 consist of the following: 2003 2002 2001 ---------- ----------- ----------- (In thousands) (Unaudited) (Unaudited) Current state expense $ 201 $ 141 $ 116 Deferred state expense (68) -- -- ---------- ---------- ---------- Provision for state income taxes $ 133 $ 141 $ 116 ========== ========== ========== Deferred taxes are provided for temporary differences between the financial reporting basis and the tax basis of the Company's assets and liabilities. These difference primarily relate to inventory and accrued customer allowances. NOTE 5 - RELATED PARTIES AND COMMITMENTS AND CONTINGENCIES There are no sales between the Company and its Members. The Company utilizes Craftmade's Coppell, Texas distribution facility and Craftmade's personnel in the conduct of their operations. The Company pays Craftmade for facility rent and payroll costs for those full time Company employees when they work directly in the Company's operations. Facility rent is based on total square footage occupied by the Company and payroll costs represent actual costs for those employees. No allocation of indirect personnel costs, including Member management level personnel, is charged to the Company. The Company is provided with advances for its working capital needs by Craftmade from borrowings under Craftmade's line of credit. Craftmade charges the Company interest on these advances at the bank's prime rate plus two percentage points and interest is calculated on the average outstanding monthly balance. The Company's payments to Craftmade are summarized as follows: Year ending 2003 2002 2001 ---------- ----------- ----------- (Unaudited) (Unaudited) Rent $ 360,000 $ 330,000 $ 225,000 Payroll $ 996,000 $ 700,000 $ 300,000 Interest $ 20,000 $ 421,000 $ 336,000 F-30 EXHIBIT INDEX Exhibit No. Description -------- ----------- 3.1 - Certificate of Incorporation of the Company, filed as Exhibit 3 (a) (2) to the Company's Post Effective Amendment No. 1 to Form S-18 (File No. 33-33594-FW) and incorporated by reference herein. 3.2 - Certificate of Amendment of Certificate of Incorporation of the Company, dated March 24, 1992 and filed as Exhibit 4.2 to the Company's Form S-8 (File No. 333-44337) and incorporated by reference herein. 3.3 - Amended and Restated Bylaws of the Company, filed as Exhibit 3 (b) (2) to the Company's Post Effective Amendment No. 1 to Form S-8 (File No. 33-33594-FW) and incorporated by reference herein. 4.1 - Specimen Common Stock Certificate, filed as Exhibit 4.4 to the Company's Registration Statement on Form S-3 (File No. 333-70823) and incorporated by reference herein. 4.2 - Rights Agreement, dated as of June 23, 1999, between Craftmade International, Inc. and Harris Trust and Savings Bank, as Rights Agent, previously filed as an exhibit to Form 8-K dated July 9, 1999 (File No. 000-26667) and incorporated by reference herein. 10.1 - Earnest Money contract and Design/Build Agreement dated May 8, 1995, between MEPC Quorum Properties II, Inc. and Craftmade International, Inc. (including exhibits), previously filed as an exhibit in Form 10Q for the quarter ended December 31, 1995, and herein incorporated by reference. 10.2 - Assignment of Rents and Leases dated December 21, 1995, between Craftmade International, Inc. and Allianz Life Insurance Company of North America (including exhibits), previously filed as an exhibit in Form 10Q for the quarter ended December 31, 1995, and herein incorporated by reference. 10.3 - Deed of Trust, Mortgage and Security Agreement made by Craftmade International, Inc., dated December 21, 1995, to Patrick M. Arnold, as trustee for the benefit of Allianz Life Insurance Company of North America (including exhibits), previously filed as an exhibit in Form 10Q for the quarter ended December 31, 1995, and herein incorporated by reference. 10.4 - Second Amended and Restated Credit Agreement dated November 14, 1995, among Craftmade International, Inc., Nations Bank of Texas, N.A., as Agent and the Lenders defined therein (including exhibits), previously filed as an exhibit in Form 10Q for the quarter ended December 31, 1995, and herein incorporated by reference. 10.5 - Lease Agreement dated November 30, 1995, between Craftmade International, Inc. and TSI Prime, Inc., previously filed as an exhibit in Form 10Q for the quarter ended December 31, 1995, and herein incorporated by reference. 10.6 - Revolving credit facility with Texas Commerce Bank, previously filed as an exhibit in Form 10K for the year ended June 30, 1996, and herein incorporated by reference. 10.7 - Agreement and Plan of Merger, dated as of July 1, 1998, by and among Craftmade International, Inc., Trade Source International, Inc. a Delaware corporation, Neall and Leslie Humphrey, John DeBlois, the Wiley Family Trust, James Bezzerides, the Bezzco Inc. Employee Retirement Trust and Trade Source International, Inc, a California corporation, filed as Exhibit 2.1 to the Company's Current Report on Form 8-K filed July 15, 1998 (File No. 33-33594-FW) and herein incorporated by reference. 10.8 - Voting Agreement, dated July 1, 1998, by and among James R. Ridings, Neall Humphrey and John DeBlois, filed as Exhibit 2.1 to the Company's Current Report on Form 8-K filed July 15, 1998 (File No. 33-33594-FW) and herein incorporated by reference. 10.9 - Third Amendment to Credit Agreement, dated July 1, 1998, by and among Craftmade International, Inc., a Delaware corporation, Trade Source International, Inc., a Delaware corporation, Chase Bank of Texas, National Association (formerly named Texas Commerce Bank, National Association) and Frost National Bank (formerly named Overton Bank and Trust), filed as Exhibit 2.1 to the Company's Current Report on Form 8-K filed July 15, 1998 (File No. 33-33594-FW) and herein incorporated by reference. 10.10 - Consent to Merger by Chase Bank of Texas, National Association and Frost National Bank, filed as Exhibit 2.1 to the Company's Current Report on Form 8-K filed July 15, 1998 (File No. 33-33594-FW) and herein incorporated by reference. 10.11 - Employment Agreement, dated July 1, 1998, by and among Craftmade International, Inc., Trade Source International, Inc., a Delaware corporation and Neall Humphrey, filed as Exhibit 2.1 to the Company's Current Report on Form 8-K filed July 15, 1998 (File No. 33-33594-FW) and herein incorporated by reference. 10.12 - Employment Agreement, dated July 1, 1998, by and among Craftmade International, Inc., Trade Source International, Inc., a Delaware corporation and Leslie Humphrey, filed as Exhibit 2.1 to the Company's Current Report on Form 8-K filed July 15, 1998 (File No. 33-33594-FW) and herein incorporated by reference. 10.13 - Employment Agreement, dated July 1, 1998, by and among Craftmade International, Inc., Trade Source International, Inc., a Delaware corporation and John DeBlois, filed as Exhibit 2.1 to the Company's Current Report on Form 8-K filed July 15, 1998 (File No. 33-33594-FW) and herein incorporated by reference. 10.14 - Registration Rights Agreement, dated July 1, 1998, by and among Craftmade International, Inc., Neall and Leslie Humphrey and John DeBlois, filed as Exhibit 2.1 to the Company's Current Report on Form 8-K filed July 15, 1998 (File No. 33-33594-FW) and herein incorporated by reference. 10.15 - ISDA Master Agreement and Schedule, dated June 17, 1999, by and among Chase Bank of Texas, National Association, Craftmade International, Inc., Durocraft International, Inc. and Trade Source International, Inc., filed as Exhibit 10.15 to the Company's Quarterly Report on Form 10Q filed November 12, 1999 (File No. 000-26667) and herein incorporated by reference. 10.16 - Confirmation under ISDA Master Agreement, dated July 23, 1999, from Chase Bank of Texas, National Association to Craftmade International, Inc., filed as Exhibit 10.16 to the Company's Quarterly Report on Form 10Q filed November 12, 1999 (File No. 000-26667) and herein incorporated by reference. 10.17 - Fourth Amendment to Credit Agreement, dated April 2, 1999, by and among Craftmade International, Inc., a Delaware corporation, Durocraft International, Inc. a Texas corporation, Trade Source International, a Delaware corporation, Chase Bank of Texas, National Association and Frost National Bank, filed as Exhibit 10.17 to the Company's Quarterly Report on Form 10-Q filed May 15, 2000 (File No. 000-26667) and herein incorporated by reference. 10.18 - Letter Agreement Concerning Fifth Amendment to Credit Agreement, dated August 11, 1999, from Chase Bank of Texas, N.A. and Frost National Bank to Craftmade International, Inc., Durocraft International Inc., Trade Source International, Inc., and C/D/R Incorporated, filed as Exhibit 10.18 to the Company's Quarterly Report on Form 10-Q filed May 15, 2000 (File No. 000-26667) and herein incorporated by reference. 10.19 - Sixth Amendment to Credit Agreement, dated November 12, 1999, by and among Craftmade International, Inc., a Delaware corporation, Durocraft International, Inc., a Texas corporation, Trade Source International, Inc., a Delaware corporation, C/D/R Incorporated, a Delaware corporation, Chase Bank of Texas, National Association and Frost National Bank, filed as Exhibit 10.19 to the Company's Quarterly Report on Form 10-Q filed May 15, 2000 (File No. 000-26667) and herein incorporated by reference. **10.20 - Employment Agreement dated October 25, 1999, between Kathy Oher and Craftmade International, Inc., filed as Exhibit 10.20 to the Company's Annual Report on Form 10-K filed September 26, 2000 (File No. 000-26667) and herein incorporated by reference. 10.21 - Seventh Amendment to Credit Agreement dated May 12, 2000, by and among Craftmade International, Inc., a Delaware corporation, Durocraft International, Inc., a Texas corporation, Trade Source International, Inc., a Delaware corporation, C/D/R Incorporated, a Delaware corporation, Chase Bank of Texas, National Association and Frost National Bank, filed as Exhibit 10.21 to the Company's Annual Report on Form 10-K filed September 26, 2000 (File No. 000-26667) and herein incorporated by reference. **10.22 - Craftmade International, Inc. 1999 Stock Option Plan, filed as Exhibit A to the Company's Proxy Statement on Schedule 14A filed October 4, 2000 (File No. 000-26667) and herein incorporated by reference. **10.23 - Craftmade International, Inc. 2000 Non-Employee Director Stock Plan, filed as Exhibit B to the Company's Proxy Statement on Schedule 14A filed October 4, 2000 (File No. 000-26667) and herein incorporated by reference. 10.24 - Eighth Amendment to Credit Agreement dated February 12, 2001, by and among Craftmade International, Inc., a Delaware corporation, Durocraft International, Inc., a Texas corporation, Trade Source International, Inc., a Delaware corporation, Design Trends, LLC, a Delaware limited liability company, C/D/R Incorporated, a Delaware corporation, The Chase Manhattan Bank and The Frost National Bank, filed as Exhibit 10.24 to the Company's Quarterly Report on Form 10-Q filed May 14, 2001 (File No. 000-26667) and herein incorporated by reference. 10.25 - Ninth Amendment to Credit Agreement dated June 29, 2001, by and among Craftmade International, Inc., a Delaware corporation, Durocraft International, Inc., a Texas corporation, Trade Source International, Inc., a Delaware corporation, Design Trends, LLC, a Delaware limited liability company, C/D/R Incorporated, a Delaware corporation, The Chase Manhattan Bank and The Frost National Bank, filed as Exhibit 10.25 to the Company's Annual Report on Form 10-K filed September 26, 2001 (File No. 000-26667) and herein incorporated by reference. 10.26 - Loan Agreement dated November 6, 2001, by and between Craftmade International, Inc., a Delaware corporation, and The Frost National Bank, a national banking association, filed as Exhibit 10.26 to the Company's quarterly Report on Form 10-Q filed February 14, 2002 (File No. 000-26667) and herein incorporated by reference. 10.27 - Termination Agreement dated November 16, 2001, by and between Craftmade International, Inc., a Delaware corporation, and JP Morgan Chase Bank, filed as Exhibit 10.27 to the Company's Quarterly Report on Form 10-Q filed February 14, 2002 (File No. 000-26667) and herein incorporated by reference. 21 - Subsidiaries of the Registrant. *31.1 - Certification of James R. Ridings, Chairman of the Board, President and Chief Executive Officer of the Company, pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. *31.2 - Certification of Kathleen B. Oher, Vice President and Chief Financial Officer of the Company, pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. *32.1 - Certification of James R. Ridings, Chairman of the Board, President and Chief Executive Officer of the Company, pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. *32.2 - Certification of Kathleen B. Oher, Vice President and Chief Financial Officer of the Company, pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. *Filed herewith (unless otherwise indicated, exhibits are previously filed). **A management contract or compensatory plan or arrangement required to be filed as an exhibit to this form.