10-Q 1 e10-q.txt ZARING NATIONAL CORPORATION 10-Q 1 SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-Q (X) QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the Quarterly Period Ended June 30, 2000 or ( ) TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934 Commission File Number 333-22679 ZARING NATIONAL CORPORATION (Exact name of registrant as specified in its charter) OHIO 31-1506058 -------------------------------------------------------------------------------- (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No.) 11300 Cornell Park Drive, Suite 500, Cincinnati, Ohio 45242-1825 -------------------------------------------------------------------------------- (Address of principal executive offices) (Zip Code) 513-489-8849 -------------------------------------------------------------------------------- (Registrant's telephone number, including area code) Securities registered pursuant to Section 12(g) of the Act: Common Shares, without par value (Title of Class) 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 twelve months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to the filing requirements for the past 90 days. YES X NO ----------- ---------- Number of common shares outstanding as of June 30, 2000: 4,591,389 Total Pages: 25 Page 1 2 ZARING NATIONAL CORPORATION INDEX

Page 2 3 \ PART I. FINANCIAL INFORMATION ITEM 1. CONSOLIDATED FINANCIAL STATEMENTS ZARING NATIONAL CORPORATION CONSOLIDATED BALANCE SHEETS ASSETS (DOLLARS IN THOUSANDS)

The accompanying notes are an integral part of these consolidated balance sheets. Page 3 4 ZARING NATIONAL CORPORATION CONSOLIDATED BALANCE SHEETS (CONTINUED) LIABILITIES AND SHAREHOLDERS' EQUITY (DOLLARS IN THOUSANDS)

The accompanying notes are an integral part of these consolidated balance sheets. Page 4 5 ZARING NATIONAL CORPORATION CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED) (DOLLARS IN THOUSANDS, EXCEPT PER SHARE INFORMATION)

The accompanying notes are an integral part of these consolidated financial statements. Page 5 6 ZARING NATIONAL CORPORATION CONSOLIDATED STATEMENT OF SHAREHOLDERS' EQUITY (UNAUDITED) (DOLLARS IN THOUSANDS)

The accompanying notes are an integral part of this consolidated financial statement. Page 6 7 ZARING NATIONAL CORPORATION CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED) (DOLLARS IN THOUSANDS)

Supplemental Schedule of Non-cash Investing and Financing Activities: During the six months ended June 30, 1999, the Company received a note receivable in exchange for the sale of an investment in the HomeMax, Inc. subsidiary (Note 7): Note receivable $ 4,400 Deferred gain (1,775) Minority interest (2,521) Accrued expenses (104)

The accompanying notes are an integral part of these consolidated financial statements. Page 7 8 ZARING NATIONAL CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS JUNE 30, 2000 (UNAUDITED) (DOLLARS IN THOUSANDS, EXCEPT SHARE INFORMATION) (1) Basis of Presentation- --------------------- (a) Operations--Effective in May 1997, Zaring National Corporation (an Ohio corporation) implemented the formation of a holding company structure which results in the accompanying consolidated financial statements including the accounts of Zaring National Corporation and subsidiaries (the Company). The subsidiaries of the Company include the following: Zaring Homes, Inc. and its subsidiaries, Zaring Homes of Indiana, LLC and Zaring Homes Kentucky, LLC; Zaring Holdings, Inc.; HomeMax Operating Properties, LLC; HomeMax, Inc. and its subsidiaries, HomeMax North Carolina, Inc., HomeMax Tennessee, Inc., HomeMax South Carolina, Inc., HomeMax Ohio, Inc., HM Properties, Inc., HomeMax Indiana, LLC and HomeMax Kentucky, LLC; Hearthside Homes, LLC; and Zaring Financial Services, LLC. The principal business of the Company's subsidiary, Zaring Homes, Inc. (Zaring Homes) is the designing, constructing, marketing and selling of single-family homes and the acquisition and development of land for sale as residential building lots in the midwest and southeast United States. Zaring Homes began operations in Cincinnati, Ohio in 1964 and commenced operations in Nashville, Tennessee in 1986. In 1994, operations commenced in Raleigh/Durham, North Carolina and Indianapolis, Indiana. In 1996, operations commenced in Louisville, Kentucky and Charlotte, North Carolina. In November 1996, the Company formed HomeMax, Inc. (HomeMax) for the purpose of entering into the retail distribution of manufactured housing. HomeMax, based in Raleigh, North Carolina, commenced operations in the first quarter of 1997 and currently operates eleven sales villages located in North Carolina and South Carolina. Effective October 1, 1997, the Company, through its then newly formed subsidiary Hearthside Homes, LLC (Hearthside), acquired substantially all of the net operating assets of Legacy, Inc., an Indianapolis based builder of entry level single family homes. The Company also acquired the stock of Legacy Mortgage Corporation. Legacy Mortgage Corporation, doing business as Hearthside Home Mortgage, originated, processed and sold mortgages to third-party investors. In June 1998, the Company's principal shareholder formed First Cincinnati Leasing LLC (Leasing LLC) and First Cincinnati Land LLC (Land LLC) to purchase and leaseback certain model homes and purchase certain undeveloped land, as applicable. In March, 1999 and February, 2000, the Company's principal shareholder formed First Cincinnati Leasing 99, LLC (Leasing 99 LLC) and First Cincinnati Leasing 2000 LLC (Leasing 2000 LLC) to purchase and leaseback certain additional model homes. As a result of, among others, the principal shareholder's control of Leasing LLC, Leasing 99 LLC, Leasing 2000 LLC and Land LLC, the results of each of these entities have been consolidated with the Company's activities subsequent to their formation. The LLCs' initial capitalization and related share of income is included as a component of minority interest in the accompanying consolidated financial statements. In October 1998, the Company increased its ownership of Blue Chip Mortgage Company, LLC (Blue Chip) from 50% to 100%. Accordingly, the financial results of Blue Chip subsequent to September 1998 are consolidated with the Company's activities. Effective April 1, 1999, Blue Chip and Legacy Mortgage Corporation were merged and renamed Zaring Financial Services, LLC (Zaring Page 8 9 Financial Services). Zaring Financial Services processes and sells mortgages to third party lenders. All significant intercompany transactions and balances have been eliminated in consolidation. (b) Operating Initiatives--In 1999, the Company experienced losses in each of its operating segments and was unable to comply with certain terms and conditions of its loan covenants despite revenue growth. Management's plans to improve operating results and cashflow available to fund ongoing operations include initiatives to reduce certain assets, including the discontinuance of the operations of Hearthside (Note 9), reduce certain costs in each of its segments and modify the terms and conditions of its existing credit facilities (Note 4). In conjunction with the Company's asset reduction plans, during the first quarter of 2000, the Company announced that it had hired an investment banker to review various strategic alternatives including the sale of certain or all of its operations. In the event certain of the Company's operations are sold, net proceeds will be utilized to reduce outstanding debt and fund continuing operations. (See also Note (13)) (c) Interim Reporting--The accompanying consolidated financial statements have been prepared in accordance with the rules and regulations of the Securities and Exchange Commission for interim financial information. Since such financial statements do not include all the information and footnotes required by generally accepted accounting principles for complete financial statements, they should be read in conjunction with the consolidated financial statements and related footnotes included in the Form 10-K for the fiscal year ended December 31, 1999 filed with the Securities and Exchange Commission. The financial statements are unaudited, but in the opinion of management, all adjustments (consisting of normal recurring adjustments) considered necessary for a fair presentation of the Company's unaudited consolidated financial statements as of June 30, 2000 have been included. Operating results for the six months ended June 30, 2000, are not necessarily indicative of the results for the entire year. (2) Capitalized Interest- -------------------- Interest is capitalized on land in the process of development, construction of sales villages and residential housing construction costs during the development and construction period. The following table summarizes the activity with respect to capitalized interest:

(3) Accrued Liabilities- ------------------- Accrued liabilities consist of the following as of June 30: 2000 1999 ------- ------- Estimate to complete closed homes $ 2,871 $ 1,825 Incremental warranty provision (Note 8) 1,417 -- Other 6,990 5,933 ------- ------- $11,278 $ 7,758 ======= ======= (4) Notes Payable- ------------- The Company has a syndicated credit facility with PNC Bank acting as agent. This facility consists of a revolving credit facility, including amounts available for letters of credit, as defined in the agreement, and a term loan. Page 9 10 The Company's notes payable consist of the following at June 30, 2000: Revolving Credit Facility, payable to PNC Bank, as agent, $9.2 million available at June 30, 2000, interest rate options of the greater of the Prime Rate or the Federal Funds rate plus 1.0% (borrowings outstanding at June 30, 2000 are at 10.5%), expiring in March 2001 $54,000 ======= Obligation of HomeMax: Manufactured Housing Floor Plan Facility for inventory and display models, payable to Bombardier Capital, Inc., variable interest rates (9.5% at June 30, 2000), subject to repayment upon the earlier of sale or fifteen months from the date of initial borrowing, secured by the inventory, an irrevocable letter of credit from American Homestar and a repurchase agreement with American Homestar in the event of default $10,513 ======= Term Loans, payable to PNC Bank, as agent, borrowings at interest rate options of (a) the greater of the Prime Rate or the Federal Funds rate plus .50% or the (b) Euro-rate plus 1.50% to 2.30%, depending on the Company's leverage ratio (borrowings outstanding at June 30, 2000 are at 10.5%), payable in quarterly installments of $750 through March 2001 $ 3,000 Credit Agreement, payable to the Provident Bank, $15.0 million available for working capital needs of HomeMax and subsidiaries, interest at the Prime Rate plus 1.0%, (10.5% at June 30, 2000), payable in three annual installments of $1.47 million commencing March 15, 2000, entire balance payable at the earlier of September 15, 2002 or 90 days following the sale of the remaining 50% of HomeMax, secured by $8.4 million of promissory notes, prepayment penalty equal to a percentage of the gain, if any, upon the sale of additional interest in HomeMax, as defined per the Credit Agreement, $10.0 million guaranteed by Zaring Homes, Inc 13,530 Other Term Notes, payable to banks, interest at 7.95%, payable in quarterly installments of $437 through March 2001 1,748 Other Term Notes, interest at 7.0% to 12.0%, principal installments of $72 due January 2002, $2,425 due April 2003 and $692 due April 2005, secured by certain land 3,069 Obligations of Leasing LLC, Land LLC and Leasing 99 LLC: Notes payable by Leasing LLC to The Huntington National Bank, permitted borrowings of up to $10.0 million, interest at LIBOR plus 1.75% (8.39% at June 30, 2000) payable monthly, secured by model homes and a personal guarantee, payable upon sale of the models or in annual installments through June 2001 4,084 Notes payable by Leasing 99 LLC to The Huntington National Bank, permitted borrowings of up to $3.0 million, interest at LIBOR plus 1.75% (8.39% at June 30, 2000), payable monthly, secured by model homes, a personal guarantee and a guarantee by Leasing LLC, payable upon sale of the models or in annual installments through March 2002 2,435 Notes payable by Land LLC to the Provident Bank, permitted borrowings of up to $10.0 million, interest at LIBOR plus 2.25% (8.89% at June 30, 2000) payable monthly, secured by land and a personal guarantee, payable in July 2001 7,556 ------- $35,422 =======

Page 10 11 Obligation of Zaring Financial Services: Revolving line of credit payable to the Provident Bank, permitted borrowings of up to $5.0 million, $1.4 million available at June 30, 2000, interest at the Prime Rate minus 0.25% (9.25% at June 30, 2000), expiring May 2002 $3,594 ====== Subordinated Debt: Subordinated notes payable to Principal Shareholder, interest at the greater of 9 7/8% or the Prime Rate plus 1 5/8% (11 1/8% at June 30, 2000) payable monthly, principal due September, 2002 $5,000 Subordinated note payable to American Homestar Corporation, interest at 6.00% payable quarterly, payable June 15, 2002 unless accelerated as a result of available cash flow of HomeMax, as defined, convertible into an additional 25% equity interest in HomeMax at the discretion of American Homestar 4,000 ------ $9,000 ======

During 1999 and the first quarter of 2000, the Company was unable to comply with certain covenants included in its credit agreements. The banks initially provided a forbearance agreement which extended to April 14, 2000. Concurrent with the expiration of the forbearance agreement, the Company entered into a third amendment to the loan agreements with its banks. The amendment to the syndicated credit facility includes the following modifications: - The maturity date of the facilities was revised to March 31, 2001 - Maximum available borrowings under the revolving credit facility of $72.5 million as of March 31, 2000 were reduced by $5.0 million on July 1, 2000 and will be reduced by an additional $5.0 million on October 1, 2000 - Interest rates were adjusted to prime plus 1% through August 31, 2000, with an increase to prime plus 2% if borrowings under the revolving credit facility exceed $40.0 million on September 1, 2000, an increase to prime plus 3% if revolver borrowings exceed $25.0 million on November 1, 2000 and prime plus 4% if revolver borrowings exceed $5.0 million on January 1, 2000. Default rates, if applicable, will be 3% above the interest rate in effect. - The third amendment revised preexisting provisions which required, among others, that the Company maintain certain minimum levels of tangible net worth and cash flows from operations to certain fixed charges as well as limiting the Company's ratio of debt to equity, all as defined per the terms of the agreement. The amendment also established limitations on the number of market and model homes maintained in inventory, land acquisition and deviations from expected cash flows (as defined). - Waivers for loan violations occurring prior to April 14, 2000. Management is of the opinion that it is probable the Company will not be in compliance with certain of the terms and conditions of certain of its credit agreements at September 30, 2000. Management intends to discuss the potential covenant violations with its lenders and secure waivers or otherwise amend the agreements to enable prospective compliance. In addition, management is of the opinion that its present cash balances, amounts available from its credit agreements, amounts generated from its asset reduction plans and amounts generated from future operations will provide adequate funds for its future operations. As of June 30, 2000, management is uncertain as to whether borrowings under the revolving credit facility will exceed $40.0 million on September 1, 2000. As further discussed in Notes (1) and (13), management has in place certain operating initiatives, including among others, the sale of certain or all of its operations. The reduction of the borrowings outstanding on the revolving credit facility depend on the outcome of the various initiatives. The Company is contingently liable under letters of credit of approximately $6.2 million issued as a result of lot and land acquisition and development activities through June 30, 2000. Page 11 12 (5) Earnings (Loss) Per Common Share- -------------------------------- Basic earnings per share are computed by dividing net income by the weighted average number of common shares outstanding during the period. Diluted earnings per share are computed similar to basic except the denominator is increased to include the number of additional common shares that would have been outstanding if the dilutive potential common shares had been issued. Options to purchase 538,806 and 477,482 shares of common stock at an average exercise price of $7.39 and $9.32 per share were outstanding as of June 30, 2000 and 1999, respectively, but were not included in the computation of earnings per share since the options' exercise prices were greater than the average market price of the common shares at June 30, 1999. In addition, inclusion of any options in the computation of diluted earnings per share would be anti-dilutive in the event of a net loss from continuing operations. Since there are no dilutive securities, basic and diluted earnings (loss) per share are identical; thus a reconciliation of the numerator and denominator is not necessary. (6) Shareholders' Equity- -------------------- The Company is authorized to issue up to 2,000,000 preferred shares of which 1,000,000 are voting. No preferred shares have been issued. (7) HomeMax, Inc. Joint Venture with American Homestar Corporation -------------------------------------------------------------- Effective March 15, 1999, after assignment of certain obligations and other preclosing activities, the Company sold a 25% interest in HomeMax to American Homestar Corporation (American Homestar) for a note receivable of approximately $4.4 million. The note receivable is to be paid in three annual installments commencing March 15, 2000 and accrues interest payable quarterly, at prime. The amended and restated securities purchase agreement includes the following terms: - American Homestar issued a $4.0 million subordinated convertible loan to HomeMax concurrent with the sale. This subordinated loan accrues interest at 6.0%, payable quarterly, while the principal is payable on June 15, 2002 unless accelerated as a result of available cash flow of HomeMax, as defined. The subordinated loan is convertible into an additional 25% of HomeMax at the discretion of American Homestar. - The Company retained a $4.0 million receivable due from HomeMax which accrues interest at 6.0% and is payable quarterly. The $4.0 million of principal is payable on June 15, 2002, unless accelerated as a result of available cash flow of HomeMax, as defined, and the receivable and related interest are eliminated in the accompanying consolidated financial statements. - The Company agreed to pay up to $3.0 million in connection with certain annual lease obligations. During the six months ended June 30, 2000, $801 was expensed under this commitment. - Subsequent to the sale, model home inventory was replaced with the inventory of American Homestar. Costs of replacement was provided by the Company and American Homestar. - Subsequent to the sale, the Company and American Homestar each agreed to provide up to $50 per quarter for the four quarters subsequent to March 15, 1999 to support advertising and promotional initiatives. - American Homestar agreed to provide certain management and consulting services for up to three years for compensation of at least $0.5 million plus an additional fee of up to $0.75 million based upon quarterly losses during the first four quarters following closing. During the six months ended June 30, 2000, $285 was expensed under this agreement. Beginning April 1, 2000, the Company is committed to pay $1,000 per month to American Homestar for such services through March 15, 2002. Page 12 13 - American Homestar and the Company each agreed to provide working capital loans of up to $0.5 million to HomeMax which will accrue interest at prime. During the six months ended June 30, 2000, the Company and American Homestar each provided additional financing of $250. - The Company has the option to sell and American Homestar has the option to buy 50% of HomeMax within three years at a defined price. - The Company received an option, which expires on March 15, 2004, to purchase up to 150,000 shares of common stock of American Homestar with an exercise price of $18.00 per share. The accompanying financial statements include the results of HomeMax for all applicable periods. Losses for the period subsequent to the transaction allocable to American Homestar are included as a component of minority interest in loss of consolidated entities in the consolidated statements of operations. Similarly, American Homestar's investment net of allocable losses is included as a component of minority interest (approximately $322 as of June 30, 2000) in the accompanying balance sheets. The gain resulting from the Company's sale of a 25% interest in HomeMax to American Homestar ($1,775) has been deferred until, among other factors, American Homestar converts its subordinated note into an additional 25% equity interest in HomeMax. (8) Litigation- ---------- During 1999, the Company became aware of certain moisture and mold related issues in certain of its luxury site-built home communities in Mason, Ohio. The Company has vigorously pursued various remediation initiatives in an effort to address the various homeowner concerns. As of December 31, 1999 and through June 30, 2000, the Company estimated the cost of remediation could approximate $3.8 million. Certain of the costs associated with the remediation efforts are subject to recovery through the Company's insurance. To date, the Company's primary carrier has accepted certain coverage, however, the excess insurance carrier has to date denied coverage. The Company continues to vigorously pursue its rights under its insurance policies. In the opinion of management and legal counsel it is remote that insurance recoveries will be less than $1.0 million. Adjustments to the estimated costs of remediation as well as the related minimum insurance recoveries will be recorded in the periods in which the facts and circumstances which warrant such adjustments become known. Through June 30, 2000, the Company incurred approximately $2.4 million related to the remediation efforts. As of June 30, 2000, the Company had contractual remediation costs of approximately $3.0 million with certain homeowners in the communities. In March 2000, a purported class action suit was filed by a homeowner which claimed compensatory damages of more than $25,000, treble and punitive damages and other costs. The Company intends to vigorously defend this matter. However, given the preliminary nature of the case, the uncertainty relative to the potential costs of remediation and the uncertainties relative to the scope of insurance coverage available, the Company is currently uncertain as to the magnitude of the potential uninsured liability associated with the case. Accordingly, adjustments to the estimated costs of remediation as well as the related minimum insurance recoveries will be recorded in the periods in which the facts and circumstances which warrant such adjustments become known. (9) Discontinued Operations- ----------------------- On December 13, 1999, the Board of Directors approved plans to discontinue the affairs of Hearthside. Accordingly, in 1999 the Company recorded a provision of $1.75 million as the estimate of the cost of discontinuing the Hearthside operations. As of June 30, 2000, $467,000 of this amount is unused. The net losses associated with the operations of Hearthside for the three months and six months ended June 30, 1999 are included in the accompanying consolidated statements of operations as discontinued Page 13 14 operations. In addition, net assets of Hearthside are separately stated in the accompanying balance sheets. The results of the discontinued Hearthside segment reflect an allocation of interest expense based on assets deployed. Summary financial information of Hearthside is as follows:

AS OF JUNE 30, ----------------------- 2000 1999 -------- -------- Land and home inventories $ 292 $ 13,152 Other assets 1,002 514 Liabilities (1,841) (2,613) -------- -------- Net assets of discontinued operations $ (547) $ 11,053 ======== ======== The disposal of Hearthside assets through an orderly sales process is expected to be completed no later than December 13, 2000. (10) New Pronouncements- ------------------ In June 1998, the FASB issued Statement of Financial Accounting Standards No. 133, "Accounting for Derivative Instruments and Hedging Activities" (SFAS 133). This statement established accounting and reporting standards requiring that every derivative instrument (including certain derivative instruments imbedded in other contracts) be recorded on the balance sheet as either an asset or liability measured at its fair value. This statement requires that changes in the derivative's fair value be recognized currently in earnings unless specific hedge accounting criteria are met. SFAS 133 is effective for fiscal years beginning after June 15, 2000. Upon adoption of this statement, the Company anticipates no impact on its reported consolidated financial position, results of operations, cash flows or related disclosures. (11) Reclassifications- ----------------- Certain amounts in the consolidated interim financial statements for 1999 have been reclassified to conform to the 2000 presentation. (12) Segment Information- --------------------- The following tables set forth, for the periods indicated, certain segment information regarding the Company's operations.

Page 14 15

Other pertinent information regarding the Company's segment operations are as follows:

* Management excludes cash and cash equivalents from assessing a segment's operating performance. (13) Subsequent Event- ---------------- On August 17, 2000 the Company announced it will negotiate exclusively with The Drees Company (Drees) through September 30, 2000 and its intention to merge with Drees. Per the terms of the proposed transaction Drees will acquire the Raleigh operations from Zaring for approximately $12.0 million on or before September 30, 2000 and, thereafter Drees will acquire the Company in a merger transaction in which the Company's public shareholders will receive cash in an Page 15 16 amount approximating 1.2 x the September 30, 2000 adjusted book value of the Company, as defined. Certain of the Company's shareholders will become shareholders of the combined enterprise upon consummation of the merger transaction. Page 16 17 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS THREE AND SIX MONTHS ENDED JUNE 30, 2000 COMPARED TO JUNE 30, 1999 RESULTS OF OPERATIONS The Company's business and the homebuilding industry are subject to changes in national and local economic conditions, as well as other factors, including employment levels, availability of financing, interest rates, consumer confidence and housing demand. The Company's results of continuing operations for the periods presented include luxury site-built homes, retail distribution manufactured homes and financial services and reflect the cyclical nature of the housing industry. The Company reported consolidated net revenues from continuing operations of $99.1 million for the quarter ended June 30, 2000, compared to $73.4 million for the same quarter in 1999, an increase of 35.1%. The net loss from continuing operations for the quarter was $(786,000) or $(0.17) per share, compared to net income of $329,000 or $0.07 per share for the same quarter of 1999. For the six months ended June 30, 2000, consolidated revenues from continuing operations were $183.6 million, compared to $117.6 million for the same period in 1999, an increase of 56.2%. The net loss from continuing operations for the six months ended June 30, 2000 was $(5.0) million or $(1.09) per share, compared to a net loss of $(1.7 million) or $(0.38) per share for the six months ended June 30, 1999. The following tables set forth, for the periods indicated, certain segment information regarding the Company's operations.

Page 17 18

(1) Revenue from sale is recognized upon the closing of the sale.

(1) New orders represent total new home orders received during the period, net of cancellations. (2) Revenue from a sale is recognized upon the closing of the sale. (3) Backlog includes new orders which have not yet closed. Page 18 19 ZARING HOMES, INC., LUXURY SITE-BUILT HOMES- Net revenues for the three months ended June 30, 2000 were $86.3 million, an increase of 30.3% over the $66.2 million reported in the same period 1999. Zaring Homes delivered 290 homes in the second quarter of 2000, compared to 231 homes in 1999, a 25.5% increase. Net revenues for the six months ended June 30, 2000 were $159.2 million as compared to $105.3 million for the six months ended June 30, 1999, a 51.3% increase. This increase in revenues and homes delivered was primarily due to the continued strength of the luxury housing market in substantially all of the Company's markets. The average selling price of a home was $298,000 and $278,000 for the six months ended June 30, 2000 and 1999 respectively, representing a 7.2% increase from the corresponding period in 1999. The total sales value of backlog was $127.6 million as of June 30, 2000 as compared to $152.1 million as of June 30, 1999, a 16.1% decrease. Gross profit dollars and percentages were $14.1 million and 16.4% in the second quarter of 2000 as compared to $13.7 million and 20.7% in the second quarter of 1999. Gross profit dollars increased in the second quarter of 2000 as compared to the second quarter of 1999 primarily due to the number of homes delivered. Gross profit percentages, however, decreased primarily due to increased subcontractor and other production related costs. Gross profit dollars and percentages were $22.8 million and 14.3% during the first six months of 2000 as compared to $21.0 million and 19.9% during the first six months of 1999. Interest expense increased $1.0 million in the second quarter of 2000 as compared to the second quarter of 1999. As a percentage of net revenues, interest expense increased to 3.4% from 2.8%. This increase in interest expense is due to the increase in interest rates related to the third amendment to the syndicated credit facility which became effective April 14, 2000. Interest expense for the six months ended June 30, 2000 increased $1.4 million from $3.9 million in 1999 to $5.3 million in 2000. As a percentage of net revenues interest expense decreased to 3.4% for the six months ended June 30, 2000 from 3.7% for the same period in 1999. As a percentage of revenues, selling expenses remained flat at 7.4% for the three months ended June 30, 2000 as compared to the same period in 1999. Selling expenses for the quarter ended June 30, 2000 increased $1.5 million as compared to the corresponding period in 1999. This increase is primarily due to increase in the number of homes delivered. Selling expenses for the six months ended June 30, 2000 increased $4.3 million to $12.5 million from $8.2 million. As a percentage of revenues, selling expenses remained at 7.8% for the six months ended June 30, 2000 as compared to the same period of 1999. As a percentage of revenues, general and administrative expenses decreased to 5.0% in the second quarter of 2000 from 5.7% in the second quarter of 1999. General and administrative expenses increased $560,000 or 14.8% in the second quarter of 2000 compared to the second quarter of 1999, due primarily to increases in payroll and office related costs. General and administrative expenses increased $1.2 million or 15.9% in the first six months of 2000 compared to the same period of 1999. As a percentage of revenues, general and administration expenses decreased to 5.3% in the first six months of 2000 compared to 6.9% in 1999. As a percentage of revenues, selling, general and administrative expenses were 12.4% and 13.1% for the three month period ended June 30, 2000 and 1999, respectively, and 13.2% and 14.7% for the six month period ended June 30, 2000 and 1999, respectively. The decrease in this percentage is mainly due to the increase in revenues. As a result of the foregoing, Zaring Homes reported pretax income of $565,000 or 0.7% of net revenues in the second quarter of 2000, a decrease of $2.6 million from pre-tax income of $3.1 million in the same period in 1999. For the six months ended June 30, 2000, Zaring Homes reported a pre-tax loss of $(3.4) million or (2.1)% of net revenues as compared to pre-tax income of $1.5 million or 1.5% of net revenues in the same period of 1999. FINANCIAL SERVICES - The financial services segment reported revenues of $446,000 and $820,000 for the three months and six months ended June 30, 2000, respectively. After deducting $428,000 and $919,000 in expenses associated with the mortgage company operations, the financial services segment reported a pretax loss of $(69,000) and $(234,000) for the three months and six months ended June 30, 2000. In the second quarter of 1999, the financial services segment reported pretax loss of $(25,000) on revenues of $353,000. In the six months ended June 30, Page 19 20 1999, the financial services segment reported pretax income of $31,000 on revenues of $668,000. HOMEMAX, INC., RETAIL DISTRIBUTION MANUFACTURED HOMES- Net revenues for the three months ended June 30, 2000 increased $4.3 million from $5.6 million in the second quarter of 1999 to $9.9 million. HomeMax closed 148 units in the second quarter of 2000, an increase of 45.1% from the 102 units closed in the same period of 1999. Net revenues for the six months ended June 30, 2000 increased $10.0 million or 98.0% from $10.2 million for the first six months of 1999 to $20.2 million for the first six months of 2000. HomeMax closed 314 units during the first six months of 2000, an increase of 75.4% from the 179 units closed in the same period of 1999. The increase is due to the maturity of the sales villages and new management at a majority of the villages. Gross profit was $1.4 million or 14.6% for the three months ended June 30, 2000 as compared to $606,000 or 10.7% for the same period in 1999. Gross profit dollars and percentages were $3.0 million and 14.9% during the first six months of 2000 as compared to $1.3 million and 12.6% during the first six months of 1999. The increase in gross profit dollars is due mainly to the increase in average net revenues per unit. Interest expense was $424,000 or 4.3% of revenues in the second quarter of 2000 compared to $368,000 or 6.5% of revenues in the corresponding quarter of 1999. Interest expense was $819,000 for the first six months of 2000 as compared to $913,000 for the first six months of 1999, a decrease of $94,000 or 10.3%. The decrease in interest expense is primarily attributable to the recapitalization of the operations in conjunction with the joint venture agreement with American Homestar, signed March 15, 1999. The recapitalization resulted in a net reduction in the interest bearing debt of HomeMax. The decrease as a percentage of revenues is due primarily to the increase in revenues and decrease in interest expense. Selling, general and administrative expenses for HomeMax were $2.7 million or 27.3% of revenues for the three months ended June 30, 2000 compared to $2.5 million or 43.6% of revenues for the same period in 1999. Selling expenses were $718,000 or 7.3% of revenues in the second quarter of 2000 compared to $810,000 or 14.4% of revenues in the second quarter of 1999. General and administrative expenses were $2.0 million or 20.0% of revenues in the second quarter of 2000 compared to $1.6 million or 28.4% of revenues in the second quarter of 1999. Selling, general and administrative expenses for the six months ended June 30, 2000 were $5.7 million or 28.1% of revenues as compared to $4.9 million or 47.6% of revenues for the same period of 1999. Selling expenses were $1.4 million or 6.9% of revenues for the six months ended June 30, 2000 versus $1.6 million or 15.7% of revenues for the same period of 1999. General and administrative expenses were $4.3 million or 21.2% of revenues for the six months ended June 30, 2000 as compared to $3.3 million or 32.3% of revenues for the first six months of 1999. The increase in selling expenses is primarily due to the increase in closing revenues in 2000 versus 1999. The increase in general and administrative expenses is due to payroll and related costs. The decrease in selling, general and administrative expenses as a percentage of revenue is due mainly to the increase in net revenues. Other income for the three months ended June 30, 2000 includes a gain of $529,000 related to the sale of two unopened sales villages. As a result of the foregoing, HomeMax reported a pretax loss of $(969,000) or (9.8)% of revenues in the second quarter of 2000 compared to a pretax loss of $(1.6) million, (29.3)% of revenues, in the second quarter of 1999. In the six months ended June 30, 2000, HomeMax reported a pretax loss of $(2.5) or (12.5)% of net revenues versus a pretax loss of $(3.8) million or (37.6)% of net revenues for the six months ended June 30, 1999. MAJORITY SHAREHOLDER LLCS - First Cincinnati Leasing LLC, First Cincinnati Leasing 99 LLC, First Cincinnati Leasing 2000 LLC and First Cincinnati Land LLC are reported as "Majority Shareholder LLCs". Leasing LLC and Leasing 99 LLC closed 8 homes during the three months ended June 30, 2000 for $2.5 million versus four home closings for $1.1 million during the three months ended June 30, 1999. Leasing LLC and Leasing 99 LLC closed 11 homes during the six months ended June 30, 2000 for $3.3 million in revenues as compared to five homes closed for $1.4 Page 20 21 million in revenues during the same period of 1999. Interest expense was $329,000 and $664,000 during the three months and six months ended June 30, 2000 as compared to $272,000 and $537,000 during the same periods in 1999. Interest expense represents interest incurred for model home and undeveloped land holdings. Other income, net represents rental income for model homes and land option payments from the Company net of income deferred until land parcels are sold to unrelated third parties. Deferred income of the LLCs approximated $1.6 million at June 30, 2000 as compared to $500,000 at June 30, 1999. CORPORATE- Interest income from subsidiaries represents the allocation of interest cost to the subsidiaries. Corporate general and administrative expenses were $1.1 million for the three month period ended June 30, 2000, as compared to $1.3 million for the three month period ended June 30, 1999. Corporate, general and administrative expenses were $2.5 million and $2.4 million for the six months ended June 30, 2000 and 1999, respectively. The increase in Corporate general and administrative expenses is attributed mainly to increases in payroll and legal and professional costs. INCOME TAXES- The income tax benefit associated with losses reported in the first six months of 2000 and 1999 as a percentage of the loss before taxes and discontinued operations (29.4% and 21.5%, respectively) is primarily due to the losses of HomeMax subsequent to March 15, 1999 not being benefited for financial reporting purposes given these losses are no longer included in the consolidated tax return of the Company. LOSS FROM DISCONTINUED OPERATIONS- On December 13, 1999, the Board of Directors of the Company approved plans to discontinue the affairs of Hearthside. The disposal of Hearthside's assets through an orderly sales process is expected to be completed no later than December 13, 2000. At December 13, 1999 the Company recorded a provision of $1.75 million as the estimate of the cost of discontinuing the Hearthside operations. At June 30, 2000, approximately $467,000 of the estimate remains. Page 21 22 CAPITAL RESOURCES AND LIQUIDITY The Company had cash and equivalents and available borrowings on its revolving credit facility of approximately $6.3 million and $9.2 million, respectively, as of June 30, 2000 as compared to $14.4 million and $7.6 million available as of June 30, 1999. These amounts are available to fund the ongoing operations of the Company. Net cash used in operations during the six months ended June 30, 2000 approximated $1.2 million as compared to $22.1 million during the six months ended June 30, 1999. Net cash used in the first six months of 2000 is primarily attributable to the net loss ($5.0 million), decreases in trade payables, accruals and deposits ($13.1 million), changes in certain assets ($1.5 million) offset by decreases in inventories and receivables ($16.5 million). Net cash provided by investing activities was $948,000 in the first six months of 2000 compared to a use of cash of $865,000 in the same period of 1999. This change is primarily attributable to payment received on the note from American Homestar ($1.5 million) and proceeds of $937,000 from the sale of sales villages and property and equipment offset by property and equipment additions of $1.4 million. Net cash used in financing activities for the six months ended June 30, 2000 was $7.7 million, as compared to net cash provided by financing activities of $26.3 million in the same period in 1999. This use of cash in 2000 was primarily due to net payments on debt of $13.5 million offset by capital contributions of $6.0 million to Leasing 2000 LLC by the Company's Chairman. In the same period in 1999, the Company had net borrowings from debt of $26.4 million. The Company has embarked on an asset reduction plan to provide internally generated funds to be utilized for 2000 operating initiatives. The plan consists of, among others: - Sell the remaining assets of Hearthside and wind up the related operations - Sell and leaseback certain model homes to the Company's Chairman - Reduce the number of market homes per community - Sell certain idle HomeMax sales villages - Defer certain land development initiatives - Sell certain other homebuilding operations - Sell certain or all of its operations During 1999 and the first quarter of 2000, the Company was unable to comply with certain covenants included in its credit agreements. The banks initially provided a forbearance agreement which extended to April 14, 2000. Concurrent with the expiration of the forbearance agreement, the Company negotiated a third amendment to the loan agreements with its banks. The amendment to the syndicated credit facility includes the following modifications: - The maturity date of the facilities was revised to March 31, 2001 - Available borrowings under the revolving credit facility which were $72.5 million as of December 31, 1999 were reduced by $5.0 million on July 1, 2000 and will be reduced by an additional $5.0 million on October 1, 2000 - Interest rates were adjusted to prime plus 1% through August 31, 2000, with an increase to prime plus 2% if borrowings under the revolving credit facility exceed $40.0 million on September 1, 2000, an increase to prime plus 3% if revolver borrowings exceed $25.0 million on November 1, 2000 and prime plus 4% if revolver borrowings exceed $5.0 million on January 1, 2000. Default rates, if applicable, will be 3% above the interest rate in effect. - The third amendment revised preexisting provisions which required, among others, that the Company maintain certain minimum levels of tangible net worth and cash flows from operations to certain fixed charges as well as limiting the Company's ratio of debt to equity, all as defined per the terms of the agreement. The amendment also established limitations on the number of market and model homes maintained in inventory, land acquisition and deviations from expected cash flows (as defined). - Waivers for loan violations occurring prior to April 14, 2000. Page 22 23 Management is of the opinion that it is probable the Company will not be in compliance with certain of the terms and conditions of certain of its credit agreements at September 30, 2000. Management intends to discuss the potential covenant violations with its lenders and secure waivers or otherwise amend the agreements to enable prospective compliance. In addition, management is of the opinion that its present cash balances, amounts available from its credit agreements, amounts generated from its asset reduction plans and amounts generated from future operations will provide adequate funds for its future initiatives. As of June 30, 2000, management is uncertain as to whether borrowings under the revolving credit facility will exceed $40.0 million on September 1, 2000. As further discussed in Notes (1) and (13), management has in place certain operating initiatives, including among others, the sale of certain or all of its operations. The reduction of the borrowings outstanding on the revolving credit facility depend on the outcome of the various initiatives. On August 17, 2000 the Company announced it will negotiate exclusively with The Drees Company (Drees) through September 30, 2000 and its intention to merge with Drees. Per the terms of the proposed transaction Drees will acquire the Raleigh operations from Zaring for approximately $12.0 million on or before September 30, 2000 and, thereafter Drees will acquire the Company in a merger transaction in which the Company's public shareholders will receive cash in an amount approximating 1.2 x the September 30, 2000 adjusted book value of the Company, as defined. Certain of the Company's shareholders will become shareholders of the combined enterprise upon consummation of the merger transaction. LOT COMMITMENTS- In the aggregate, as of June 30, 2000, Zaring Homes owned, had the ability to develop or purchase, or had under contract 3,603 lots. At June 30, 2000, Zaring Homes owned approximately 862 lots and undeveloped land, including land owned by Land LLC, which will be developed into approximately 561 lots. Zaring also had under contract, subject to the satisfaction of Zaring's purchase contingencies and exercising of option agreements, 1,433 lots and undeveloped land which, if purchased, would be developed into approximately 347 lots. Of the 1,433 lots under contract, Zaring Homes is committed to 386 lots. PROVISIONS FOR WRITEDOWN TO NET REALIZABLE VALUE- The Company periodically reviews the value of assets held by its reporting segments, including: land, inventories, property and equipment, and intangibles and determines whether any write-downs need to be recorded to reflect declines in value. The estimated net realizable value of real estate inventories and property and equipment represents management's estimate based on present plans and intentions, selling prices in the ordinary course of business and anticipated economic and market conditions. Accordingly, the realization of the value of the Company's real estate inventories, property and equipment and certain intangibles is dependent upon future events and conditions that may cause actual results to differ from amounts presently estimated. INFLATION- Housing demand, in general, is affected adversely by increases in interest rates. If mortgage interest rates, and material and labor costs increase significantly, the Company's revenues, gross profit, and net income could be adversely affected. CAUTIONARY STATEMENTS - Certain statements in this "Management's Discussion and Analysis of Financial Condition and Results of Operations" are "forward looking statements" within the meaning of the Private Securities Litigation Reform Act of 1995. Such statements involve known and unknown risks, uncertainties and other factors that may cause results to differ materially. Such risks, uncertainties and other factors include, but are not limited to, changes in general real estate, general economic and other conditions, fluctuations in interest rates, increases in raw materials and labor costs, levels of competition and other factors described in Zaring National Corporation's Form 10-Q for the quarter ended September 30, 1998. ITEM 3. QUALITATIVE AND QUANTITATIVE DISCLOSURES ABOUT MARKET RISK Page 23 24 There were no material changes in the qualitative and quantitative disclosures about market risk as of June 30, 2000 from that presented in the Company's annual report on Form 10-K for the fiscal year ended December 31, 1999. PART II - OTHER INFORMATION ITEM 1. LEGAL PROCEEDINGS The Company is subject to various claims, lawsuits and administrative proceedings arising in the ordinary course of business with respect to real estate, environmental zoning, and other matters, which seek remedies or damages. The Company believes that any liability that may finally be determined, without consideration of the litigation discussed below, will not have a material effect on its financial position, cash flows, or results of operations. On March 14, 2000, a lawsuit was filed by Felix and Wanda Martinez in the Court of Common Pleas, Hamilton County, Ohio against Zaring National Corporation (the "Company") and its subsidiary, Zaring Homes, Inc., in the form of a purported class action whose members own homes in the "White Blossom" residential development of Zaring Homes in Mason, Ohio. The suit alleges that the home owners have been damaged because of defects in their homes including water and moisture in wall cavities; water damage to wood and other materials used to build the homes; mold and mildew growth inside the homes; excessive humidity; and poor air quality inside the homes. The suit requests compensatory damages of more than $25,000, treble damages, punitive damages, attorney fees, litigation expenses, court costs, interest before and after judgement, and all other available relief. The Company intends to vigorously contest this suit. ITEM 2. CHANGES IN SECURITIES - NONE ITEM 3. DEFAULTS UPON SENIOR SECURITIES - NONE ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS On May 24, 2000, the Company held the Annual Meeting of Shareholders at which the shareholders voted upon the election of six directors for one year terms expiring 2001. The results on these matters were as follows:

At the meeting, the shareholders confirmed the appointment of Arthur Andersen, LLP as independent auditors of the Company for fiscal 2000. There were 4,527,981 votes cast in favor, 3,144 votes cast in opposition and 2,895 abstentions. ITEM 5. OTHER INFORMATION - The Company was notified April 28, 2000 that it failed to maintain the minimum market value of public float for continued listing on the Nasdaq National Market and that it had until July 27, 2000 to regain compliance. The Company submitted an application to transfer to the Nasdaq Small Cap Market and effective August 14, 2000 the Company's shares have been transferred to the Nasdaq Small Cap Market. ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K - NONE Page 24 25 SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. ZARING NATIONAL CORPORATION (Registrant) Date: August 21, 2000 By: /s/Allen G. Zaring III --------------------------- Allen G. Zaring III Chairman of the Board, President and Chief Executive Officer Date: August 21, 2000 By: /s/Ronald G. Gratz ----------------------- Ronald G. Gratz Chief Financial Officer Secretary and Treasurer (Principal Financial and Accounting Officer) Page 25

ZARING NATIONAL CORP 10-Q