10-Q 1 l10116ae10vq.txt HMI INDUSTRIES ================================================================================ SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 ------------------------ FORM 10-Q (Mark One) [ X ] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934. For the quarterly period ended March 31, 2004 OR [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934. For the transition period from _______________ to _______________ Commission File Number 2-30905 HMI INDUSTRIES INC. (Exact name of Registrant as Specified in Its Charter)

~~(UNAUDITED)~~DELAWARE ~~JUNE 30, September 30, 2003 2002~~ 36-~~----------~~1202810 ------------- ASSETS CURRENT ASSETS: Cash and cash equivalents $ 776,451 $ 481,395 Trade accounts receivable (net of allowance of $224,743 and $482,118) 2,682,024 2,006,667 Inventories: Finished goods 2,200,370 2,076,052 Work-in-~~progress, raw material and supplies 2,682,397 2,112,656 Deferred income taxes 1,460,812 1,476,182 Prepaid expenses 465,108 291,690 Other current assets 90,826 53,657~~ ----------- ------------- ~~Total current assets 10,357,988 8,498,299~~ ----------- ------------- ~~PROPERTY, PLANT AND EQUIPMENT, NET 3,912,985 4,310,070~~ ----------- ------------- ~~OTHER ASSETS: Cost in excess of net assets of acquired businesses (net of amortization of $~~-0- ~~and $3,738,649)~~ - ~~5,450,860 Deferred income taxes 2,535,124 2,550,427 Trademarks (net of amortization of $193,128 and $161,556) 387,252 375,272 Other 155,267 270,833~~ ----------- ----~~---------~~ ~~Total~~(State ~~other~~or ~~assets~~Other ~~3,077,643~~Jurisdiction ~~8,647,392 ----------- ------------- Total assets $17,348,616 $ 21,455,761 =========== ============= LIABILITIES AND STOCKHOLDERS' EQUITY CURRENT LIABILITIES: Line~~ of ~~credit~~Incorporation $or ~~1,391,000~~Organization) $(IRS ~~1,392,000~~Employer ~~Trade~~Identification ~~accounts~~No.) ~~payable~~Genesis 2Building,~~653,594~~ ~~1,956,677~~6000 ~~Income~~Lombardo ~~taxes payable 492~~Center,~~343~~ ~~505,532~~Suite ~~Accrued expenses and other liabilities 3~~500,~~131,826~~ ~~2,394,881~~Seven ~~Long-term debt due within one year 67~~Hills,~~028~~ ~~301,894~~Ohio 44131 ----------- ------------- ~~Total current liabilities 7,735,791 6,550,984~~ ----------- ------------- ~~LONG~~-~~TERM LIABILITIES: Long~~-~~term debt (less amounts due within one year) 16,386 32,726~~ ----------- ------------- ~~Total long~~-~~term liabilities 16,386 32,726~~ ----------- ------------- ~~CONTINGENCIES:~~ - - ~~STOCKHOLDERS' EQUITY: Preferred stock, $5 par value; authorized, 300,000 shares; issued, none~~ - --- ~~Common~~(Address ~~stock, $1 par value; authorized, 10,000,000 shares; issued and outstanding, 6,745,609 and 6,745,609 shares 6,745,609 6,745,609 Capital in excess~~ of ~~par~~Principal ~~value~~Executive ~~8,231,311 8,231,311 Unearned compensation, net - (2,728~~Offices) ~~Retained earnings~~ (~~5,380,481)~~Zip ~~801,459 Accumulated other comprehensive loss - (903,600~~Code) ~~----------- ------------- Total stockholders' equity 9,596,439 14,872,051 ----------- ------------- Total liabilities and stockholders' equity $17,348,616 $ 21,455,761 =========== =============~~

Registrant's Telephone Number, Including Area Code: (216) 986-8008 -------------------------------------------------------------------- Former Name, Former Address and Former Fiscal Year, if Changed Since Last Report Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past ninety (90) days. Yes [ ] No [X] Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12B-2 of the Exchange Act). Yes [ ] No [X] APPLICABLE ONLY TO CORPORATE ISSUERS: Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date. Class Outstanding at September 30,2004 ------------------------------------ -------------------------------- Common stock, $1 par value per share 6,745,609 ================================================================================

~~For~~PART ~~the~~I. ~~three~~FINANCIAL ~~months~~INFORMATION................................................................................... ~~ended~~3 ~~June~~ITEM ~~30,~~1. ~~For~~FINANCIAL ~~the~~STATEMENTS.................................................................................. ~~nine~~3 ~~months~~Consolidated ~~ended~~Condensed ~~June~~Balance ~~30,~~Sheets...................................................................... ~~2003~~3 ~~2002~~Consolidated ~~2003~~Condensed ~~2002~~Statements ~~------------------------------------------------------------------------~~of ~~REVENUES:~~Operations............................................................ ~~Net~~4 ~~product~~Consolidated ~~sales~~Condensed $Statements ~~8,872,525 $ 9,306,956 $ 26,994,286 $ 29,275,300 ----------- ------------ ------------ ------------ OPERATING COSTS AND EXPENSES: Cost~~ of ~~products~~Cash ~~sold~~Flow............................................................. 5~~,256,145~~ ~~5,444,621~~Notes ~~16,090,735~~to ~~16,415,191~~Consolidated ~~Selling,~~Condensed ~~general~~Financial ~~and~~Statements ~~administrative~~(unaudited)........................................... ~~expenses~~6 ~~3,538,010~~ITEM ~~3,512,708~~2. ~~10,742,458~~MANAGEMENT'S ~~11,996,221~~DISCUSSION ~~Loss~~AND onANALYSIS ~~liquidation~~OF ofFINANCIAL ~~foreign~~CONDITION ~~subsidiary~~AND -RESULTS -OF ~~904,169~~OPERATIONS ~~- Interest expense 12,099 22,023 32,805 64,474 Other~~ (~~income)~~DOLLARS ~~expense,~~IN ~~net (26,443~~THOUSANDS)....................................................................................................... ~~61,542~~16 ~~(86,724)~~Critical ~~189,737~~Accounting ~~-----------~~Policies............................................................................... ~~------------~~16 ~~------------~~Results ~~------------~~of ~~Total~~Operations...................................................................................... ~~operating~~16 ~~costs~~Liquidity and ~~expenses~~Capital ~~8,779,811~~Resources............................................................................ ~~9,040,894~~18 ~~27,683,443~~Cautionary ~~28,665,623~~Statement ~~-----------~~for ~~------------~~"Safe ~~------------~~Harbor" ~~------------~~Purposes ~~Income~~Under ~~(loss)~~the ~~before~~Private ~~income~~Securities ~~taxes~~Litigation ~~and~~Reform ~~cumulative~~Act ~~effect~~ of ~~accounting~~1995....................................................................................................... ~~change~~20 ~~92,714~~ITEM ~~266,062~~3. ~~(689,157)~~QUANTITATIVE ~~609,677~~AND ~~Provision~~QUALITATIVE ~~(benefit)~~DISCLOSURES ~~for~~ABOUT ~~income~~MARKET ~~taxes~~RISK........................................... ~~18,806~~21 ~~108,796~~ITEM ~~41,923~~4. ~~278,163~~CONTROLS ~~-----------~~AND ~~------------~~PROCEDURES.............................................................................. ~~------------~~21 ~~------------ Income~~ (~~loss~~A) ~~before~~Evaluation ~~cumulative effect~~ of ~~accounting~~Disclosure ~~change~~Controls ~~73,908~~and ~~157,266~~Procedures....................................................... 21 (~~731,080~~B) ~~331,514~~Changes ~~Cumulative~~in ~~effect~~Internal ofControls........................................................................... ~~accounting~~21 ~~change~~PART -II. -OTHER ~~5,450,860~~INFORMATION...................................................................................... -21 ~~-----------~~ITEM ~~------------~~1. ~~------------~~LEGAL ~~------------~~PROCEEDINGS.................................................................................... ~~NET~~21 ~~INCOME~~ITEM ~~(LOSS)~~2. $CHANGES ~~73,908~~IN $SECURITIES ~~157,266~~AND $USE ~~(6,181,940) $ 331,514 =========== ============ ============ ============ WEIGHTED AVERAGE NUMBER~~ OF ~~SHARES~~PROCEEDS............................................................ ~~OUTSTANDING:~~22 ~~Basic~~ITEM ~~and~~3. ~~diluted~~DEFAULTS ~~6,745,647~~UPON ~~6,729,860~~SENIOR ~~6,743,425~~SECURITIES...................................................................... ~~6,710,756~~22 ~~===========~~ITEM ~~============~~4. ~~============~~SUBMISSION ~~============~~OF ~~BASIC~~MATTERS ~~AND~~TO ~~DILUTED~~A ~~PER~~VOTE ~~SHARE~~ OF ~~COMMON~~SECURITY ~~STOCK:~~HOLDERS.................................................. ~~Income~~22 ~~(loss)~~ITEM ~~before cumulative effect of accounting change $ 0~~5.01 $OTHER 0INFORMATION.~~02 $ (0~~.~~11) $ 0~~.05................................................................................. ~~Cumulative~~22 ~~effect~~ITEM of6. ~~accounting~~EXHIBITS ~~change~~AND $REPORTS -ON $FORM 8-K..................................................................... $22 (~~0.81~~a) $Index -to ~~-----------~~Exhibits...................................................................................... ~~------------~~22 ~~------------ ------------ NET INCOME~~ (~~LOSS~~b) $Reports ~~0.01~~on $Form 08-K.~~02 $ (0~~.~~92)~~.................................................................................. $23 0SIGNATURES.05................................................................................................... ~~=========== ============ ============ ============~~23

2 PART I. FINANCIAL INFORMATION ITEM 1. FINANCIAL STATEMENTS CONSOLIDATED CONDENSED BALANCE SHEETS Dollars and shares in thousands, except par values

~~For~~(UNAUDITED) ~~the~~SEPTEMBER ~~nine~~30, ~~months~~MARCH ~~ended June 30~~31, 2003 ~~2002~~2004 RESTATED ----------- -----------~~------------~~ ~~CASH~~ASSETS ~~FLOWS~~CURRENT ~~FROM OPERATING ACTIVITIES~~ASSETS: ~~Net~~Cash ~~(loss)~~and ~~income~~cash ~~$(6,181,940)~~equivalents $ ~~331~~1,~~514~~433 ~~ADJUSTMENTS~~$ TO948 ~~RECONCILE~~Trade ~~NET~~accounts ~~INCOME~~receivable TO(net ~~NET~~of ~~CASH~~allowance ~~PROVIDED~~of BY$162 ~~OPERATING~~and ~~ACTIVITIES:~~$194) ~~Cumulative~~2,553 ~~effect~~1,892 ofInventories: ~~accounting~~Finished ~~change~~goods 52,~~450~~731 2,~~860~~555 Work-in-progress, ~~Loss~~raw onmaterial ~~liquidation~~and ofsupplies ~~foreign~~2,122 ~~subsidiary 904~~2,~~169~~153 -Prepaid ~~Depreciation~~expenses ~~and~~171 ~~amortization~~397 ~~563,863~~Other ~~663,209~~current ~~Provision~~assets ~~for~~136 ~~loss~~152 on--------- ~~disposal~~-------- ofTotal current assets -9,146 178,~~000~~097 ~~Common/treasury~~--------- ~~shares~~-------- ~~issued~~PROPERTY, ~~net~~PLANT ofAND ~~unearned~~EQUIPMENT, ~~compensation~~NET -1,897 412,~~841~~178 ~~Provision~~--------- ~~for~~-------- ~~losses~~OTHER onASSETS: ~~receivables~~Trademarks -(net ~~27,526~~of ~~Unearned~~amortization ~~compensation~~of ~~2,728~~$214 -and ~~Deferred~~$202) ~~income~~232 ~~taxes~~272 ~~30,673~~Other ~~239,904~~- ~~CHANGES~~121 IN--------- ~~OPERATING~~-------- ~~ASSETS~~Total ~~AND~~other ~~LIABILITIES:~~assets ~~Increase~~232 in393 ~~receivables~~--------- ~~(675,357)~~-------- ~~(564,436)~~Total ~~Increase~~assets in$ ~~inventories (694~~11,~~059)~~275 ~~(867~~$ 10,~~215)~~668 ~~Increase~~========= in======== ~~prepaid~~LIABILITIES ~~expenses~~AND ~~(173,418)~~STOCKHOLDERS' ~~(151,796)~~DEFICIT ~~(Increase)~~CURRENT ~~decrease~~LIABILITIES: inLine ~~other~~of ~~current~~credit ~~assets~~$ ~~(37,169)~~466 ~~307~~$ 1,~~856~~383 ~~Increase~~Trade in accounts payable ~~696~~2,~~917~~771 12,~~419,832~~143 ~~Increase~~Income intaxes ~~accrued~~payable 504 506 Accrued expenses and other liabilities ~~736~~2,~~945~~529 ~~270~~2,~~051~~399 ~~Decrease~~Distributor inDevelopment ~~income~~Liability ~~taxes~~due ~~payable~~within ~~(13,189)~~one ~~(14,003)~~year ~~Other,~~200 ~~net~~200 ~~71,446~~Long-term ~~(83,033)~~debt due within one year 22 22 ----------- --------~~---~~ ~~Net~~Total ~~cash~~current ~~provided~~liabilities ~~by operating activities 682~~6,~~469~~492 16,~~638,250~~653 ----------- -------- LONG-TERM LIABILITIES: Long--term ~~CASH~~debt ~~FLOWS~~(less ~~FROM~~amounts ~~INVESTING~~due ~~ACTIVITIES:~~within ~~Capital~~one ~~expenditures~~year) - 11 Distributor Development Liability (~~135,207~~less amounts due within one year) ~~(732~~14,~~204)~~495 12,758 ----------- --------~~---~~ ~~Net~~Total ~~cash~~long-term ~~used~~liabilities ~~in investing activities (135~~14,~~207)~~495 ~~(732~~12,~~204)~~769 ----------- -------- CONTINGENCIES: - -- ~~CASH~~STOCKHOLDERS' ~~FLOWS~~DEFICIT: ~~FROM~~Preferred ~~FINANCING~~stock, ~~ACTIVITIES:~~$5 ~~Net~~par ~~repayments~~value; ~~under~~authorized, ~~credit~~300 ~~facility~~shares; (issued, none - - Common stock, $1 par value; authorized,~~000)~~ ~~(390~~10,000) ~~Payment~~shares; ofissued ~~long~~and ~~term~~outstanding, ~~debt~~6,746 ~~(251~~shares 6,~~206)~~746 ~~(522~~6,~~310)~~746 ~~-----------~~Capital ~~-----------~~in ~~Net~~excess ~~cash~~of ~~used~~par invalue ~~financing~~8,231 ~~activities~~8,231 Accumulated deficit (~~252~~24,~~206~~689) (~~912~~23,~~310~~731) ----------- --------~~---~~ ~~Net~~Total ~~increase~~stockholders' deficit (~~decrease~~9,712) ~~in cash and cash equivalents 295,056~~ (68,~~264~~754) ~~Cash and cash equivalents, beginning of period 481,395 6,865~~ ----------- --------~~---~~ ~~Cash~~Total liabilities and ~~cash~~stockholders' ~~equivalents,~~deficit ~~end of period~~ $ ~~776~~11,~~451~~275 $ ~~601~~10,668 =========== ========~~===~~

See notes to consolidated condensed financial statements. 3 CONSOLIDATED CONDENSED STATEMENTS OF OPERATIONS (Unaudited) Dollars and shares in thousands, except per share data

For the three months ended ~~June~~March 3031, For the ~~nine~~six months ended ~~June~~March 3031, Restated Restated 2004 2003 ~~2002~~2004 2003 ~~2002~~-------- -------- -------- -------- REVENUES: Product sales, less returns and allowances $ 10,775 $ 9,295 $ 19,158 $ 18,121 Distributor development program (653) (1,409) (1,697) (2,228) -------- -------- -------- -------- Net product sales 10,122 7,886 17,461 15,893 -------- ~~Income~~-------- ~~(loss)~~-------- ~~before~~-------- ~~cumulative~~OPERATING ~~effect~~COSTS AND EXPENSES: Cost of ~~accounting~~products ~~change~~sold $6,273 735,~~908~~592 $11,359 ~~157~~10,~~266~~834 $Selling, ~~(731~~general and administrative expenses 3,~~080)~~781 $3,537 ~~331~~7,~~514~~051 ~~Cumulative~~6,871 ~~effect~~Loss on liquidation of ~~accounting~~foreign ~~change~~subsidiary - 905 - 5905 Interest expense 17 6 34 20 Other (income) expense,~~450,860~~ -net (17) (34) (32) (61) -------- -------- -------- -------- Total operating costs and expenses 10,054 10,006 18,412 18,569 -------- -------- -------- -------- ~~NET~~Income ~~INCOME~~ (~~LOSS~~loss) ~~73,908~~before ~~157,266~~income taxes and cumulative effect of accounting change 68 (62,~~181,940~~120) ~~331~~(951) (2,~~514~~676) ~~Goodwill~~Provision ~~amortization~~(benefit) ~~add~~for ~~back,~~income ~~net~~taxes of- ~~tax~~2 -7 ~~61,375~~(5) -------- ~~184,126~~ -------- -------- -------- Income (loss) before cumulative effect of accounting change 68 (2,122) (958) (2,671) Cumulative effect of accounting change - - - 5,451 -------- -------- -------- -------- ~~ADJUSTED~~ NET INCOME (LOSS) $ ~~73,908~~68 $ ~~218~~(2,~~641~~122) $(~~6,181,940~~958) ~~$ 515~~(8,~~640~~122) ========~~===~~ ========~~===~~ ========~~======~~ ========~~===~~ WEIGHTED AVERAGE NUMBER OF SHARES OUTSTANDING: Basic and diluted 6,~~745,647~~746 6,~~729,860~~742 6,~~743,425~~746 6,~~710,756~~742 ========~~===~~ ========~~===~~ ========~~======~~ ========~~===~~ BASIC AND DILUTED PER SHARE OF COMMON STOCK: Income (loss) before cumulative effect of accounting change $ 0.01 $ (0.0231) $ (0.1114) $ (0.0539) Cumulative effect of accounting change $ - $ - $ - $ (0.81) $-------- -------- ~~Goodwill amortization add back, net of tax $~~ -------- ~~$ 0.01 $~~ -------- ~~$ 0.03 =========== =========== ============== =========== ADJUSTED~~ NET INCOME (LOSS) $ 0.01 $ (0.0331) $ (0.9214) $ 0(1.0820) ========~~===~~ ========~~===~~ ========~~======~~ ========~~===~~

See notes to consolidated condensed financial statements. 4 CONSOLIDATED CONDENSED STATEMENTS OF CASH FLOW (Unaudited)

~~Three~~For ~~Months~~the ~~Ended~~six ~~Nine~~months ~~Months~~ended ~~Ended~~March ~~December~~ 31, ~~2002~~Restated ~~June~~Dollars ~~30,~~in thousands 2004 2003 --------------- -------------~~----~~ ~~Income~~CASH ~~(loss)~~FLOWS ~~before~~FROM ~~cumulative~~OPERATING ~~effect~~ACTIVITIES: ofNet ~~accounting~~loss ~~change~~ $ ~~88,920~~(958) $ (~~731~~8,~~080~~122) ADJUSTMENTS TO RECONCILE NET LOSS TO NET CASH PROVIDED BY OPERATING ACTIVITIES: Cumulative effect of accounting change - 5,~~450~~451 Distributor development program 1,~~860~~737 52,~~450~~229 Depreciation and amortization 360 379 Loss on liquidation of foreign subsidiary - 905 Unearned compensation - 2 CHANGES IN OPERATING ASSETS AND LIABILITIES: Increase in receivables (661) (190) Increase in inventories (145) (334) Decrease in prepaid expenses 226 152 Decrease (increase) in other current assets 16 (18) Increase in accounts payable 628 984 Increase in accrued expenses and other liabilities 130 529 Decrease in income taxes payable (2) (24) Other,~~860~~ net 138 83 ------------- ------------- Net cash provided by operating activities 1,469 2,026 ------------- ------------- ~~ADJUSTED~~CASH ~~NET~~FLOWS ~~LOSS~~FROM $INVESTING ACTIVITIES: Capital expenditures (~~5,361,940~~56) $ (~~6,181,940~~127) ~~===============~~------------- ~~===============~~------------- ~~WEIGHTED~~Net ~~AVERAGE~~cash ~~NUMBER~~used OFin ~~SHARES~~investing ~~OUTSTANDING:~~activities ~~Basic~~(56) ~~and~~(127) ~~diluted~~------------- ~~6,742,314~~------------- ~~6,743,425~~CASH ~~===============~~FLOWS ~~===============~~FROM ~~BASIC~~FINANCING ~~AND~~ACTIVITIES: ~~DILUTED~~Net ~~PER~~repayments ~~SHARE~~under OFcredit ~~COMMON~~facility ~~STOCK:~~(917) ~~Income~~ (~~loss~~1,392) ~~before~~Payment ~~cumulative effect~~ of ~~accounting~~long ~~change~~term $debt ~~0.01 $~~ (0.11) ~~Cumulative~~(201) ~~effect~~------------- of------------- ~~accounting~~Net ~~change~~cash $used in financing activities (~~0.81~~928) $ (~~0.81~~1,593) ------------- ------------- Net increase in cash and cash equivalents 485 306 Cash and cash equivalents, beginning of period 948 481 ------------- ------------- ~~ADJUSTED~~Cash ~~NET~~and ~~LOSS~~cash equivalents, end of period $ ~~(0.80)~~1,433 $ ~~(0.92)~~787 =============== ===============

See notes to consolidated condensed financial statements. 5 NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS (UNAUDITED) (DOLLARS IN THOUSANDS, EXCEPT SHARES AND PER SHARE DATA) 1. Summary of Significant Accounting Policies The interim consolidated condensed financial statements included in this report have been prepared, without audit, by HMI Industries Inc. from our consolidated statements and those of our subsidiaries, pursuant to the rules and regulations of the Securities and Exchange Commission. Although we believe that the disclosures are adequate to make the information presented not misleading, certain information and footnote disclosures, including significant accounting policies, normally included in the annual financial statements have been condensed or omitted pursuant to such rules and regulations. In the opinion of our management, the unaudited financial information for the interim periods presented reflects all adjustments (which include only normal, recurring adjustments) necessary for a fair presentation. These consolidated condensed financial statements and related notes should be read in conjunction with the consolidated condensed financial statements and related notes included in our Annual Report on Form 10-K/A for the fiscal year ended September 30, 2003. Operating results for interim periods are not necessarily indicative of operating results for an entire fiscal year. 2. Restatement The accompanying balance sheet as of September 30, 2003, and the accompanying statements of operations and of cash flows for the three and six months ended March 31, 2003 have been restated. The adjustments associated with the restatement related to the following: Accrued Distributor Development Liabilities Pursuant to EITF 01-9, "Accounting for Consideration Given by a Vendor to a Customer", which was issued in 2001, we changed the way we account for the potential one million dollar award associated with our Distributor Development Program, otherwise known as our Edge Success Program ("Program"). Prior to the adoption of EITF 01-9, we utilized the services of an independent actuary who developed a model based on our historical sales and other factors that identified, in aggregate, the probability of distributors reaching the goal (earning 30,000 credits for sales of our product units) thereby triggering our cash payment obligation. We recognized expense and recorded a liability based on that model. The original intentions of the Program were to aid Master Distributors in their retirement/succession plan and promote growth and retention within the new distributor network. Because of these original intentions and the long-term nature of this Program (fifteen years), management did not consider the implications of this pronouncement to the award associated with the Program and therefore EITF 01-9 was not adopted in 2001 as required. Accordingly, we have restated our revenues to properly reflect the accrual for this award as a reduction of revenues, not as a selling and administrative expense. We have determined that for purposes of EITF 01-9 it is not possible to reasonably estimate such a liability. We have therefore accrued such awards assuming a maximum accrual rate whereby we assume each eligible distributor will earn the award. In other words, for each qualifying sale, we have recorded a liability by reducing revenue. Such a liability will only be derecognized (i.e. the accrual eliminated) when (i) the award is paid out or (ii) when a distributor is no longer eligible for the award. For the quarter and six months ended March 31, 2003, this adjustment (i) decreased sales by $1,409 and $2,228, respectively, and (ii) decreased selling, general and administrative expenses by $184 and $334, respectively. 6 Tooling Assets In 2003, we performed an analysis on the potential impairment of certain tooling assets. We concluded from our analysis, which was based upon the held and used model, that the tooling assets were fully impaired and accordingly we recorded an impairment charge of $1,613 as of September 30, 2003. We inadvertently omitted impairment charges of $98 for patents and trademarks relating to these tooling assets and have reflected such additional impairment in the restated 2003 Consolidated Condensed Balance Sheet for the year ended September 30, 2003. Deferred Tax Asset In 2003, we provided a full valuation allowance on our deferred tax assets. As a result of the restatement related to the Distributor Development Program, our recorded income in 2001 changed to a loss and caused a significant cumulative loss for financial statement purposes. Accordingly, we determined that the impairment of our deferred tax assets should be reflected in the second quarter of fiscal 2001, when we first reflected the adoption of EITF 01-9. As a result we reversed the original impairment recorded in fiscal 2003. For the quarter and six months ended March 31, 2003, the adjustments increased the provision for income taxes by $4 and decreased the provision $28, respectively. Summary of Restatement Adjustments The following table summarizes the effects of the restatement adjustments on certain of our previously issued financial statements by type of adjustment and by the affected captions in our Statement of Operations. The various adjustments recorded to prior years as part of the restatement have no effect on our cash flows.

Three Months Ended ~~Nine~~Six Months Ended ~~-----------------------~~Summary ~~------------------------~~of ~~June~~Restatement ~~30,~~Adjustments ~~June~~by ~~30,~~Type ~~June~~March 3031, ~~June~~2003 30March 31, 2003 ~~2002 2003 2002~~ ---------- ---------- --------- --------- ~~Balance~~(Increase) atdecrease ~~beginning~~to ofnet ~~period~~loss- $DISTRIBUTOR ~~181,200~~DEVELOPMENT $LIABILITIES: ~~198,500~~Revenues $ ~~190~~(1,~~500~~409) $ ~~299~~(2,~~400~~228) ~~Charges~~Selling, togeneral ~~expense~~and ~~36,300~~administrative ~~27,100~~expenses 184~~,800~~ ~~16,300~~334 ~~Usage~~DEFERRED ~~(35,500)~~TAX ~~(34,000)~~ADJUSTMENT ~~(193,300)~~Provision for income taxes (~~124,100~~4) ~~----------~~28 ---------- --------- ~~---------~~Total ~~Balance~~effect ~~at end~~ of ~~period~~restatement $on ~~182,000~~net $loss ~~191,600~~ $ ~~182~~(1,~~000~~229) $ ~~191~~(1,~~600~~866) ========== =========~~= ========= =========~~

7 Summary of Restated Financial Data The following tables present a summary of our balance sheet, statements of operations and of cash flows as previously reported, and as restated as a result of the restatement adjustments summarized above. CONSOLIDATED CONDENSED BALANCE SHEETS Dollars and shares in thousands, except par values

~~For~~Previously ~~the~~RESTATED ~~three~~Reported ~~months~~SEPTEMBER ~~ended~~30, ~~June~~September 30, ~~For~~2003 ~~the~~2003 ~~nine~~------------- ~~months~~------------- ~~ended~~ASSETS ~~June~~CURRENT 30ASSETS: Cash and cash equivalents $ 948 $ 948 Trade accounts receivable (net of allowance of $172) 1,892 ~~2003~~1,892 ~~2002~~Inventories: ~~2003~~Finished ~~2002~~goods 2,555 2,555 Work-in-progress, raw material and supplies 2,153 2,153 Prepaid expenses 397 397 Other current assets 152 152 ------------- ------------- Total current assets 8,097 8,097 ------------- ------------- PROPERTY, PLANT AND EQUIPMENT, NET 2,178 2,178 ------------- ------------- ~~Net~~OTHER ~~income~~ASSETS: Trademarks (~~loss~~net of amortization of $202), as272 ~~reported~~370 Other 121 121 ------------- ------------- Total other assets 393 491 ------------- ------------- Total assets $ 7310,~~908~~668 $ ~~157~~10,~~266~~766 $============= ============= LIABILITIES AND STOCKHOLDERS' (~~6,181,940~~DEFICIT) EQUITY CURRENT LIABILITIES: Line of credit $ ~~331~~1,~~514~~383 ~~Add:~~$ ~~Stock-based~~1,383 ~~employee~~Trade ~~compensation~~accounts ~~expense~~payable ~~included~~2,143 in2,143 ~~reported~~Income ~~net~~taxes ~~income~~payable 506 506 Accrued expenses and other liabilities 2,399 ~~net~~3,445 ofDistributor ~~related~~Development ~~tax~~Liability ~~effects~~due -within -one year 200 - Long-term debt due within one year 22 22 ------------- ----------- -- Total current liabilities 6,653 7,499 ---------- --- ------------- ~~Deduct~~LONG-TERM LIABILITIES: ~~Total stock~~Long-~~based~~term ~~employee~~debt ~~compensation~~(less ~~expense~~amounts ~~determined~~due ~~under~~within ~~fair~~one ~~value~~year) ~~based~~11 ~~method~~11 ~~for~~Distributor ~~all~~Development ~~awards,~~Liability ~~net~~(less ofamounts ~~related~~due ~~tax~~within ~~effects~~one ~~23,309~~year) 2312,~~217~~758 ~~69,834~~- ~~69,487~~ ------------- ----------- -- Total long-term liabilities 12,769 11 --------- ---- ------------- ~~PRO~~CONTINGENCIES: ~~FORMA~~- ~~NET~~- ~~INCOME~~STOCKHOLDERS' (~~LOSS~~DEFICIT) $EQUITY: 50Preferred stock,~~599~~ $5 ~~134~~par value; authorized,~~049~~ $300 (6shares; issued,~~251~~ none - - Common stock,~~774)~~ $1 ~~262~~par value; authorized,~~027~~ ~~===========~~10,000 ~~===========~~shares; ~~============~~issued ~~================~~and ~~BASIC~~outstanding, ~~AND~~6,746 ~~DILUTED~~shares ~~PER~~6,746 ~~SHARE~~6,746 OFCapital ~~COMMON~~in ~~STOCK:~~excess Asof ~~reported~~par $value ~~0.01~~8,231 $8,231 ~~0.02~~Accumulated $deficit (~~0.92~~23,731) $(11,721) ~~0.05~~------------- ~~Proforma~~------------- $Total ~~0.01~~stockholders' $(deficit) ~~0.02~~equity $(8,754) 3,256 ------------- ------------- Total liabilities and stockholders' (~~0.93~~deficit) equity $ ~~0.04~~10,668 $ 10,766 ============= =============

8 CONSOLIDATED CONDENSED STATEMENTS OF OPERATIONS (Unaudited) For the three months ended December

FOR ~~WITHHELD~~THE THREE MONTHS ENDED FOR THE SIX MONTHS ENDED MARCH 31, 2003 MARCH 31, 2003 ---------------------------- ---------------------------- ~~Robert~~Dollars ~~Breadner~~and 4shares in thousands,~~290,728~~ except per share data RESTATED Previously RESTATED Previously Reported Reported ------------ ~~Thomas~~------------ ~~Davidson~~------------ 4------------ REVENUES: Product sales,~~290~~ less returns and allowances 9,~~728~~295 9,295 18,121 18,121 Distributor development program (1,409) - ~~Kirk~~(2,228) ~~Foley~~- 4------------ ------------ ------------ ------------ Net product sales $ 7,~~287~~886 $ 9,~~726~~295 3$ 15,~~002~~893 ~~Eric~~$ ~~Foley~~18,121 4------------ ------------ ------------ ------------ OPERATING COSTS AND EXPENSES: Cost of products sold 5,~~287~~592 5,~~676~~592 10,834 10,834 Selling, general and administrative expenses 3,~~052~~537 ~~James~~3,721 ~~Malone~~6,871 47,~~290~~205 Loss on impairment of asset - - - - Loss on liquidation of subsidiary 905 905 905 905 Interest expense 6 6 20 20 Other (income) expense,~~728~~ net (34) (34) (61) (61) ------------ ~~John~~------------ ~~Pryor~~------------ 4------------ Total operating costs and expenses 10,~~290~~006 10,~~728~~090 18,569 18,903 ------------ ~~Murray~~------------ ~~Walker~~------------ 4------------ (Loss) income before income taxes and cumulative effect of accounting change (2,~~290~~120) (895) (2,~~728~~676) (782) Provision (benefit) for income taxes 2 (2) (5) 23 ------------ ~~Ivan~~------------ ~~Winfield~~------------ 4------------ (Loss) income before cumulative effect of accounting change (2,~~290~~122) (893) (2,~~728~~671) (805) Cumulative effect of accounting change - 5,451 5,451 ------------ ------------ ------------ ------------ NET (LOSS ) INCOME $ (2,122) $ (893) $ (8,122) $ (6,256) ============ ============ ============ ============ Weighted average number of shares outstanding: Basic and diluted 6,742 6,742 6,742 6,742 ============ ============ ============ ============ BASIC AND DILUTED PER SHARE OF COMMON STOCK (NOTE 1): (Loss) income before cumulative effect of accounting change $ (0.31) $ (0.13) $ (0.39) $ (0.12) Cumulative effect of accounting change $ - $ - $ (0.81) $ (0.81) ------------ ------------ ------------ ------------ NET (LOSS ) INCOME $ (0.31) $ (0.13) $ (1.20) $ (0.93) ============ ============ ============ ============

9 CONSOLIDATED CONDENSED STATEMENTS OF CASH FLOW (Unaudited)

3. Other Intangible Assets Total amortization expense for trademarks and patents was $24 and $21, for the six months ended March 31, 2004, and 2003, respectively. Amortization expense for trademarks and patents is estimated for the remainder of fiscal 2004 and for the next four fiscal years ending September 30, 2005 through 2008, as $15, $15, $14, $11, and $10. 4. Guarantees We have guaranteed repayment to a finance company for certain events of default by some of our Canadian distributors. The finance company purchases the installment sales contracts that the distributors entered into with their customers for the sale of products manufactured by HMI. Our obligation to repurchase any contracts is limited to situations in which the borrower has any valid defense, right of set-off or counterclaim regarding the loan; the loan does not comply with all applicable laws and regulations; or the loan is not a binding obligation of the borrower. For example, we would be required to purchase 10 from the finance company a contract entered into by an end consumer to finance the purchase of our product if the finance company believes that the contract has been improperly obtained. We require the participating Canadian distributors to provide us with cash reserves, which are held as liabilities on our records, in order to provide a fund for the payments of any defaults by the participating Canadian distributors. We had $86 and $46 of cash reserves we had received from Canadian Distributors as of March 31, 2004 and 2003, respectively. These amounts were included in the accrued expenses and other liabilities line item of our Consolidated Condensed Balance Sheets. We expect to hold them for at least a period approximating the term of the finance contracts with the end consumers, which typically have a 36 month term. Although it is not practical for us to estimate future cash payments on possible repurchases; the maximum potential of future payments that we could be required to make under the guarantee is the total contracts outstanding of $628 and $993 at March 31, 2004 and 2003, respectively. However, from the commencement of the contract in July 2002 we have repurchased only one contract approximating $3 under this guarantee. Moreover, we are permitted pursuant to agreements with our Canadian distributors to be reimbursed from the cash reserves referred to above for the costs and expenses incurred in fulfilling our guarantee to the finance company. Warranty We warrant our surface cleaner for a two-year period from the date of purchase and offer a lifetime service benefit for the replacement of the surface cleaner's motor at a price not to exceed $99 (Dollar's not in thousands). On occasion, we also support a five-year optional extended warranty on the portable surface cleaner offered by our U.S. Distributors to the end user as a sales promotion during an in home product demonstration. As an enticement to the end user to buy our product during that demonstration, the five year optional extended warranty is offered to them at no cost; accordingly no revenue for this optional warranty is recognized by HMI. Outside the U.S. we offer a two-year warranty for our high filtration portable surface cleaner. The portable room air cleaner is warranted for renewable one-year periods so long as the main air filter is replaced annually. A five-year warranty is offered for our built-in vacuum system. Our policy is to record a provision for the expected cost of warranty-related claims at the time of the sale and adjust the provision to reflect actual experience quarterly. The amount of warranty liability accrued reflects management's best estimate of the expected future cost of honoring our obligations under the warranty plans. Historically, the cost of fulfilling our warranty obligations has principally involved replacements parts, labor and sometimes travel. Our estimates are based on historical experience, the number of units involved, and the extent of features/components included in product models. Changes in our warranty liability were as follows:

11 5. Earnings Per Share The denominators for calculating our basic and diluted earnings per share were identical for the quarter ended March 31, 2004, as the 1,276 outstanding options were not included in the calculation of diluted shares outstanding as the result would have been anti-dilutive. The exercise prices of these options range from $1.00 to $7.50 per share and they expire between January 4, 2005, and August 29, 2010. All 1,165 stock options outstanding for the quarter ended March 31, 2003, were not included in the computation of diluted EPS because the options' exercise prices were greater than the average market prices of the common stock during the period and, therefore, the effect would be anti-dilutive. 6. Long-term Compensation Plan We record stock-based compensation expense using the intrinsic value method on the date of grant in accordance with Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees," and its related interpretations. Because we establish the exercise price based on the greater of fair market or par value of our stock at the date of grant, the options have no intrinsic value upon grant, and therefore no expense is recorded. Each quarter, we report the potential dilutive impact of stock options in our diluted earnings per share. As allowed by SFAS 148, we have elected to continue to apply the intrinsic value-based method of accounting and have adopted the disclosure requirements of SFAS 123. If we had measured compensation cost for stock options granted under the fair value based method prescribed by SFAS 123, net income would have changed to the pro forma amounts set forth below:

7. Executive Compensation On February 2, 2004, the Board of Directors accepted the resignation and retirement of James R. Malone, Chief Executive Officer, triggering certain benefit payments. Consequently, compensation expense approximating $200 was recorded in the second quarter of fiscal 2004 in accordance with Mr. Malone's provisions of resignation. 8. Commitments and Contingencies Bliss Technologies, Inc. ("Bliss"), the company formed from the 1998 sale of the subsidiary of HMI, filed for bankruptcy in January 2000 in the United States Bankruptcy Court, Eastern District of Michigan. In a separate action filed in 2002, the Official Committee of Unsecured Creditors of Bliss alleges a fraudulent conveyance claim against us asserting that the sale of Bliss in 1998 was a fraudulent transfer insofar as we 12 received more for Bliss than it was worth and that Bliss was insolvent from its inception. Former directors of Bliss, Mark Kirk and Carl Young, are also named as defendants in the action. Claims pending against them allege that in their capacity as Bliss directors they breached fiduciary duties to Bliss creditors. The complaint seeks damages in an unspecified sum. In September 2004 the parties conducted a mediation session with an agreed-upon mediator which did not result in a settlement. Although we may continue to pursue the settlement discussions that began at the mediation we are also continuing to move forward in court with the vigorous defense of the claims against us and the claims against Mr. Kirk and Mr. Young. CONET Industries, Inc., Royal Queen Club International Limited, Chang-whan Chang and Young-so Song ("Plaintiffs") filed a complaint against HMI on or about February 18, 2001, in the Seoul, Korea District Court. It was served by Registered Mail upon HMI at our corporate offices in Seven Hills, Ohio, on or around April 10, 2002. The complaint was filed as a result of lawsuits by us against Mr. Song, a former HMI Distributor in Korea, and Royal Queen Club concerning Mr. Song's CYVAC product. In our lawsuits, we sought and were granted preliminary injunctions against Plaintiffs that prohibited Plaintiffs from manufacturing and selling the old model CYVAC for 311 days and the new model CYVAC for 209 days until the Seoul High Court issued a declaration of suspension of the injunctions. Despite the fact that Plaintiffs had been enjoined by the Courts, Plaintiffs allege that we should compensate them for actual damages for sale discontinuance, supplemental managerial costs, and new mold fabrication costs due to the interruption in the manufacturing and marketing of each product during that period. Plaintiffs also claim that we tortuously interfered with Plaintiffs' business advantages, caused irreparable harm to Plaintiffs' normal business activities, and damaged Plaintiffs' reputation and standing. Chang-whan Chang and Young-so Song allege that they have been critically damaged personally due to the accusations, improper provisional seizure and criminal allegations alleged by us, which they assert resulted in disturbance to business, reputation, and credit. All matters are pending. The Plaintiffs originally alleged damages in excess of U.S. $21,894. After several hearings the court ruled in our favor and against the Plaintiffs on all counts. We were then notified that the Plaintiffs appealed this decision in accordance with Korean law. On August 16, 2004 we were notified by our Korean counsel that the appeal filed by the Plaintiff before the Supreme Court had been dismissed in favor of HMI, effectively terminating the litigation. Claims arising in the ordinary course of business are pending against us. In the third quarter of fiscal 2004 we increased reserves by $500 to provide for any contingent liabilities associated with various litigation and contingent claims. There can be no assurance that an unfavorable outcome in these various litigation and contingent claims would not have a material adverse effect on our consolidated financial position, results of operations, or cash flow. Included in the accompanying Consolidated Condensed Balance Sheets at March 31, 2004, and 2003, were accruals of $15 and $15, respectively, relating to various claims. 9. Debt On February 20, 2004, an amendment of our $3,000 credit facility agreement was executed with our lender. The credit facility expired October 15, 2004. The amended agreement carries the same interest rate and similar covenants as the previous amended loan agreement, with the exception of the interest coverage ratio which was amended to exclude non-cash expenses from the 5.0 to 1.0 ratio, including but not limited to, the impairment of tooling assets and associated inventory, and the tangible net worth covenant in which the minimum amount was reset from $7,400 to $2,400. 13 The cumulative effect of the adjustments on our statement of operations associated with the restatement of our financial statements was a $12,856 reduction in our net earnings over the period from January 1, 2001 through December 31, 2003. Such an earnings reduction caused us to be in default of our $2,400 tangible net worth covenant. In addition we have violated our financial reporting requirements to the bank as the restatement process has delayed any subsequent filings of our public statements with the Securities and Exchange Commission since our first fiscal quarter of 2003. Our credit agreement covenants require that our statements be filed quarterly with the bank within 45 days of the end of each quarter. On October 15, 2004, an amendment of our $3,000 credit facility agreement was executed with our lender. The bank has agreed to extend the maturity date of the loan until December 31, 2004. In addition the bank provided a waiver for the aforementioned covenant and financial reporting violations. The amended agreement carries an interest rate of prime plus one percent and covenants similar to the previous amended loan agreement, with the exception of the tangible net worth covenant which was eliminated through the maturity date of the loan. As of September 30, 2004, there was $962 borrowed on the $3,000 credit facility. 10. Related Party Transactions James R. Malone, our former Chairman and Chief Executive Officer, Darrell Weeter, President of the Company's Americas division, and John Glomb, a Regional Vice President of the Company, each owned 31.67% of the membership interests in a Company called Vision Capital Logistics, LLC ("VCL"). VCL, was a brokerage service provider for sourcing consumer credit, assisting its clients in securing third party financing for its clients' customers to purchase products, including products manufactured by us and sold by our Distributors. VCL charged additional fees to our Distributors for these financing services. VCL's client list also included a number of other "direct sales" companies, including other floor care companies. In securing such financing, VCL guaranteed the legal compliance obligations (but not any payment obligations) of our Distributors to a third party lender. The third party lender paid VCL a participation fee for such financing services, a part of which (twelve percent (12%)) VCL paid to us. During the quarters ended March 31, 2004, and 2003, VCL paid HMI $-0- and $6, respectively in connection with such financing services. Additionally, in certain cases when a Distributor was not able to complete a sale because of the substandard credit status of the retail customer VCL may have provided the Distributor with financing for this sale. In those cases we entered into an arrangement with VCL known as a Swap Program under which VCL purchased the contract of the retail customer from the Distributor and arranged for the financing of the contract at a significant discount. To replace the product sold by our Distributor and for which the Distributor received only a portion of the consumer sale price, VCL purchased a replacement product from us at the same price paid by our Master Distributors and we shipped it to the Distributor to replace the product the Distributor just sold. During the quarters ended March 31, 2004, and 2003, VCL purchased an aggregate of $11 and $6, respectively of our products under the Swap Program. Under the terms of our credit facility in place from time to time, we were prohibited from engaging in certain of the financing activities provided by VCL. In the third quarter of fiscal 2004 we ended our arrangement with VCL. At such time Mr. Weeter and Mr. Glomb sold their membership interests to Mr. Malone. 14 Beginning in June 2000 until January 2003 we sublet to VCL a portion of our office space in Naples, Florida. In February 2003 a new lease was entered into for office space with VCL as the tenant. We began subleasing space from VCL for $3 per month, which amount was based upon an allocation of VCL's total monthly lease payments to the amount of space that we utilized. For the quarters ended March 31, 2004 and 2003 we paid VCL a total of $3 and $8 in lease payments, respectively. The sublease was terminated in February, 2004. Darrell Weeter, an executive officer of the Company, has served for many years as President of FVS, Inc., a distributor of products manufactured by HMI, and which is owned by Mr. Weeter and his wife. For the quarters ended March 31, 2004, and 2003, FVS, Inc. purchased, at Master Distributor pricing, a total of $20 and $21, respectively, in products from us. Mr. Weeter also received amounts due to him under our Career Development Program of $32 and $58 for the three months ended March 31, 2004, and 2003, respectively. The amounts paid were distributor paid overrides ("DPO's") collected by us from distributors that were brought into the Filter Queen business by Mr. Weeter. DPO's are a unit price override charged on top of our standard unit sales price for which we, HMI, act as a pass through, meaning that we collect the DPO from the promoted distributor and disburse it to the promoting distributor upon their request; accordingly these DPO's are not reflected in our income statement as revenue. The total DPO's still owed to Mr. Weeter were $5 and $20 as of March 31, 2004, and September 30, 2003, respectively. This payable to Mr. Weeter was recorded on the other accrued expense and liabilities line item of our Consolidated Condensed Balance Sheets as of March 31, 2004 and September 30, 2003. Derek Hookom, an employee of HMI, is President of Summit Air, a distributor of products manufactured by HMI. For the quarters ended March 31, 2004, and 2003, Summit Air purchased, at Master Distributor pricing, a total of $10, and $86, respectively, in products from us. Mr. Hookom became an employee of HMI on January 1, 2003 and under the terms of his employment agreement; Mr. Hookom remains eligible to receive the Millionaires Club Award associated with the Edge Success Program through sales generated by his personally developed sales network. The Company incurred $52 and $45, respectively, of distributor development program revenue reduction associated with Mr. Hookom's participation in the Program for the quarters ended March 31, 2004 and 2003. Mr. Hookom also received DPO's due to him under our Career Development Program of $36 and $24 for the three months ended March 31, 2004, and 2003, respectively. The amounts paid were distributor paid overrides collected by us from distributors that were brought into the Filter Queen business by Mr. Hookom. The total DPO's still owed to Mr. Hookom were $35 and $34 as of March 31, 2004, and September 30, 2003, respectively. This payable to Mr. Hookom was recorded on the other accrued expense and liabilities line item of our Consolidated Condensed Balance Sheets as of March 31, 2004 and September 30, 2003. The above amounts are not considered to be significant to the financial statements as a whole and therefore have not separately identified in the Consolidated Condensed Balance Sheets, Statements of Operations or Statements of Cash Flow. 15 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (DOLLARS IN THOUSANDS) CRITICAL ACCOUNTING POLICIES Our discussion and analysis of our financial condition and results of operations are based upon the consolidated condensed financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America. The preparation of these consolidated condensed financial statements required us to make estimates and judgments that affect the reported amount of assets and liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities at the date of the consolidated condensed financial statements. Actual results may differ from those estimated under different assumptions or conditions. Critical accounting policies are defined as those that are reflective of significant judgment and uncertainties, and potentially may result in materially different outcomes under different assumptions and conditions. For a more complete description of our critical accounting policies please refer to our Annual Report on Form 10-K/A for the fiscal year ended September 30, 2003. RESULTS OF OPERATIONS Product Sales SECOND QUARTER OF FISCAL 2004 COMPARED TO SECOND QUARTER OF FISCAL 2003 Product sales, net of returns and allowances and before distributor development program revenue reduction ("Product Sales") for the quarter ended March 31, 2004, were $10,775. This represents an increase of $1,480 or 15.9% when compared to the prior year product sales of $9,295. The increase in sales was largely attributable to gains in Asia and Europe of $1,414 and $682, respectively, offset by decreased revenues in the Americas of $618. Asian sales increased primarily as a result of shipments to a new customer in Malaysia and improved sales to Japan, Hong Kong and Korea. Increased European sales were largely associated with improved Defender sales to Portugal and Spain, both of which were impacted by these importers marketing our Majestic and Defender product together as a system, similar to how they are marketed in the U.S. The sales decline in the Americas was largely associated with office closings in one sales division. A new divisional director has been assigned to this territory to provide the additional support that has been requested and we are hopeful that we can begin to rebuild this territory. FIRST SIX MONTHS OF FISCAL 2004 COMPARED TO FIRST SIX MONTHS OF FISCAL 2003 Product sales of $19,158 for the six months ended March 31, 2004, were $1,037 or 5.7% higher when compared to the prior year sales of $18,121. The increased sales were largely attributable to increased sales in Asia of $1,956 mostly to a new customer in Malaysia, offset by decreased revenues in the Americas of $757. Distributor Development Program SECOND QUARTER OF FISCAL 2004 COMPARED TO SECOND QUARTER OF FISCAL 2003 The sales reduction associated with the distributor development program for the quarter ended March 31, 2004 was $653 compared to $1,409 for the same quarter of the prior year. The decrease of $756 was driven by termination gains which were largely attributable to one established U.S. distributor who left the business during the quarter. The overall decrease was offset by increased international sales volume. See Note 2 to our Consolidated Condensed Financial Statements for further information on the accounting for this Program. 16 FIRST SIX MONTHS OF FISCAL 2004 COMPARED TO FIRST SIX MONTHS OF FISCAL 2003 The year-to-date sales reduction associated with the distributor development program was $1,697 compared to $2,228 for the same period in the prior year. This decrease of $531 was due to the aforementioned termination gain and decreased sales volume in the Americas when compared to the prior year, offset by increased international sales. Gross Margin, exclusive of distributor development program SECOND QUARTER OF FISCAL 2004 COMPARED TO SECOND QUARTER OF FISCAL 2003 The gross margin exclusive of the impact of the distributor development program revenue reduction ("product gross margin") for the quarter ended March 31, 2004, was $4,502 or 41.8% of sales. This represents an increase in gross margin of $799 when compared to gross margin of $3,703 or 39.8% of sales in 2003 and was largely attributable to the favorable international sales volume discussed above. FIRST SIX MONTHS OF FISCAL 2004 COMPARED TO FIRST SIX MONTHS OF FISCAL 2003 The product gross margin of $7,799 or 40.7% of sales for the six months ended March 31, 2004, was $512 or 7.0% higher when compared to the prior year product gross margin of $7,287 or 40.2% of sales. A favorable sales volume variance of $582 was offset by a variety of individually insignificant plant spending variances. Selling, General, and Administrative ("SG&A") SECOND QUARTER OF FISCAL 2004 COMPARED TO SECOND QUARTER OF FISCAL 2003 SG&A expenses of $3,781 or 37.3% of sales for the quarter ended March 31, 2004, were $244 higher when compared to the same period in fiscal 2003 of $3,537 or 44.8% of sales. This increase was driven by $240 of expenses associated with certain independent professionals who were engaged by a Special Committee of the Board of Directors to review relationships we had with certain affiliates, as well as by the February 2, 2004 resignation and retirement of James R. Malone, the former Chairman and Chief Executive Officer. We recorded $200 of compensation expense in association with Mr. Malone's resignation. This overall increased level of expense was offset by commissions and compensation related expenses associated with the lower sales in the Americas and the decreased level of earnings. FIRST SIX MONTHS OF FISCAL 2004 COMPARED TO FIRST SIX MONTHS OF FISCAL 2003 SG&A expenses of $7,051 or 40.4% of sales for the six months ended March 31, 2004 were $180 higher when compared to the same period in fiscal 2003 of $6,871 or 43.2% of sales. The rationale for the lower expense is consistent with the discussion above. Liquidation of Foreign Subsidiary During the second quarter of fiscal 2003, after reviewing possible future options for our Canadian subsidiary, we chose to liquidate the entity and therefore recorded a loss on disposal of $905 for cumulative translation adjustments associated with this subsidiary. Interest Expense Interest expense was $17 and $34 for the quarter and six months ended March 31, 2004, respectively, compared to $6 and $20 for the same periods in 2003. The increased expense primarily reflects the increased borrowings on our line of credit when compared to the prior year. 17 Other (income) expense, net For the quarter and six months ended March 31, 2004 other expense (income), net, decreased $17 and $29, respectively, and was attributable to a variety of individually insignificant items. Income Taxes The effective tax rate for the quarter and six months ended March 31, 2004 was 0.0% and (0.7%), respectively, compared to effective rates of (0.1%) and 0.2% for the same period in fiscal 2003. The differences from the prior year were associated with state franchise taxes. Cumulative Effect of Accounting Change On October 1, 2002, we adopted SFAS 142. Under SFAS 142, goodwill impairment is deemed to exist if the net book value of a reporting unit exceeds its estimated fair value. During the second quarter of fiscal 2003, we completed our initial impairment test as of October 1, 2002, and recorded a non-cash charge of $5,451 to fully eliminate the carrying value of our goodwill. There was no tax effect related to this item as this charge is a permanent difference for income tax purposes. This amount is reflected, in this Form 10-Q, as a deduction from results of operations for the six months ended March 31, 2003. Inflation and Pricing Product sales and income from continuing operations were not materially impacted by inflation or changing prices. LIQUIDITY AND CAPITAL RESOURCES Operating Activities Cash flows from operating activities provided net cash of $1,469 for the six months ended March 31, 2004, principally due to cash inflows resulting from an increase in accounts payable of $628, decreases in prepaid expenses of $226, as well as net non-cash expenses of $2,097 of which $1,737 is attributable to the new accounting associated with our distributor development program and $360 is related to depreciation and amortization, offset by an increase in receivables of $661 and a net loss of $958. During the last two months of our fiscal year 2003 we re-adjusted our raw material stock levels which led to a reduction in purchases as compared to the previous ten months raw material purchase average. In the first six months of fiscal 2004 we returned to more characteristic purchasing levels thus increasing our overall payable balance for the six months ended March 31, 2004. A more conscientious effort to monitor and improve the working capital balance also impacted the payable balance. Amortization of prepaid risk insurance was the contributing factor to the decrease in prepaid expenses. The increase in the receivables balance is largely attributable to sales volume increases related to several international customers who all receive credit terms to assist with the time delay in shipping products overseas. Investing Activities Capital expenditures of $56 represent the entire net cash used in investing activities for the three months ended March 31, 2004, of which the largest portion relates to engineering testing equipment, and tooling associated with our current product line. 18 Financing Activities Net cash used in financing activities was $928, which included $917 for net repayments under the credit facility and $11 for payment of long-term debt. Our $3,000 credit facility agreement includes various covenants that limit our ability to incur additional indebtedness, restricts paying dividends and limits capital expenditures, and requires we maintain a minimum net worth. As of September 30, 2003, we were not in compliance with our interest coverage ratio, and net worth covenants; however, we obtained a waiver on these covenants which was effective until the February 20, 2004 amendment of the credit facility. We were required to maintain an interest coverage ratio of greater than or equal to 5.0 to 1.0 interest to earnings before interest, taxes, depreciation and amortization ("EBITDA") and a net worth of at least $7,400, calculated quarterly and increasing by 50% of net income annually. On February 20, 2004, an amendment of our credit facility agreement was executed with our lender. The expiration date was extended to October 15, 2004. The amended agreement carried the same interest rate and similar covenants as the previous amended loan agreement, with the exception of the interest coverage ratio which was amended to exclude non-cash expenses from the 5.0 to 1.0 ratio, including but not limited to, the impairment of tooling assets and associated inventory, and the tangible net worth covenant in which the minimum amount was reset to $2,400. The cumulative effect of the adjustments on our statement of operations associated with the restatement of our financial statements was a $12,856 reduction in our net earnings over the period from January 1, 2001 through December 31, 2003. Such an earnings reduction caused us to be in default of our $2,400 tangible net worth covenant. In addition we have violated our financial reporting requirements to the bank as the restatement process has delayed any subsequent filings of our public statements with the Securities and Exchange Commission since our first fiscal quarter of 2003. Our credit agreement covenants require that our statements be filed quarterly with the bank within 45 days of the end of each quarter. On October 15, 2004, an amendment of our $3,000 credit facility agreement was executed with our lender. The bank has agreed to extend the maturity date of the loan until December 31, 2004. In addition the bank provided a waiver for the aforementioned covenant and financial reporting violations. The amended agreement carries an interest rate of prime plus one percent and covenants similar to the previous amended loan agreement, with the exception of the tangible net worth covenant which was eliminated through the maturity date of the loan. We are actively seeking finance sources to replace the credit facility prior to its expiration. If we cannot replace the credit facility prior to December 31, 2004, we currently anticipate that we will have sufficient liquidity to repay the credit facility and cover all our cash needs through March 31, 2005. As of September 30, 2004, there was $962 borrowed on the $3,000 credit facility. Cash Obligations There have been no material changes outside the ordinary course of our business with regards to cash obligations that have not been previously disclosed in our fiscal 2003 Annual Report on Form 10-K. 19 ACCRUED DISTRIBUTOR DEVELOPMENT LIABILITIES We account for a certain Distributor Development Program pursuant to EITF 01-9 "Accounting for Consideration Given by a Vendor to a Customer (Including a Reseller of the Vendor's Products). The accounting associated with this Program requires us to record a liability related to every qualifying sale and only derecognizing such liability (i.e. the accrual is eliminated) when (i) the award is paid out or (ii) when a distributor is no longer eligible for the award. The application of EITF 01-9 requires a $14,695 accrual at March 31, 2004, to reflect the future obligation associated with the Program. This amount was determined by multiplying the percentage of attainment of the 30,000 unit goal for every eligible distributor by the present value of five payments of $200,000, discounted at a risk adjusted interest rate. We have been operating with a distributor network for over seventy years and we implemented the Program in 1997. During those periods we have closely monitored the distributor network and the turnover rate in the network. Based on that accumulated knowledge, we believe that application of EITF 01-9, which requires accruing on each sale as if every distributor involved with the sale was going to earn the $1 million award, results in the recognition of an obligation we believe will be significantly in excess of the payouts from the Program for the foreseeable future. This is due to the assumption inherent in the maximum accrual calculation that every distributor involved with a sale will qualify to earn the award. Our history shows this not to be the case. During the twelve quarters ended September 30, 2003, our turnover rate was, on average, more than 50%. For example, the participants in the Program from the Americas network who left the Program during the twelve months ended September 30, 2003 represented an accrual of over $2,000 and that period was not a period of extraordinary turnover. Because we measure the accrual quarterly, departures may cause quarterly results to vary greatly. In addition, the criteria for derecognizing the accrual for any distributor requires that the distributor has lost eligibility to participate in the Program. We have been funding the actuarially determined present value of total award payouts calculated on an aggregate basis under this program since September 2000 and such fund had a balance of $1,308 as of March 31, 2004. It is our intention to continue to fund the projected stream of cash payouts subject to our cash flow model based on our aggregate actuarial model, which will continue to be updated annually by our independent actuaries based on our experience. These funds are maintained in a short term investment account and recorded as cash and cash equivalents in our Consolidated Condensed Balance Sheets. Please refer to our Annual Report on Form 10-K/A for the fiscal year ended September 30, 2003 for a complete discussion of our accounting associated with this Program. CAUTIONARY STATEMENT FOR "SAFE HARBOR" PURPOSES UNDER THE PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995 This report, including Management's Discussion and Analysis of Financial Condition and Results of Operations contains forward-looking statements within the meaning of the Federal securities laws. As a general matter, forward-looking statements are those focused upon future plans, objectives or performance as opposed to historical items and include statements of anticipated events or trends and expectations and beliefs relating to matters not historical in nature, including by way of example, but not limited to, the statements made in "Product Sales" regarding the hope to rebuild a certain sales territory in the Americas, and "Liquidity" regarding anticipated cash requirements and the adequacy of our current ability to meet those requirements. Such forward-looking statements are subject to uncertainties such as difficulty 20 in protecting our intellectual property rights in a particular foreign jurisdiction; dependency on key personnel and the ability to retain them; recessions in economies where we sell our products; longer payment cycles for and greater difficulties collecting accounts receivable; export controls, tariffs and other trade protection measures; social, economic and political instability; changes in United States and foreign countries laws and policies affecting trade; anticipated sales trends; the ability to attract and retain Distributors and Importers; improved lead generation and recruiting; and the ability to obtain financing for the end consumer through consumer financing companies. Such uncertainties are difficult to predict and could cause our actual results of operation to differ materially from those matters expressed or implied by such forward-looking statements. ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK Our exposure to interest rate risk is related to our borrowings. Fixed rate borrowings may have their fair market value adversely impacted from changes in interest rates. Variable rate borrowings will lead to additional interest expense if interest rates increase. As of March 31, 2004, we had $466 outstanding under our credit facility bearing interest at the prime rate. If interest rates were to increase 50 basis points (0.5%) from the March 31, 2004, rates and assuming no changes in outstanding debt levels from March 31, 2004 levels, we would realize an increase in our annual interest expense of approximately $2. ITEM 4. CONTROLS AND PROCEDURES (A) EVALUATION OF DISCLOSURE CONTROLS AND PROCEDURES We evaluated the design and operation of our disclosure controls and procedures to determine whether they are effective in ensuring that the disclosure of required information is timely and made in accordance with the Exchange Act and the rules and forms of the Securities and Exchange Commission. This evaluation was made under the supervision and with the participation of management, including our principal executive officer and principal financial officer within the 90-day period prior to the filing of this Form 10-Q. The principal executive officer and principal financial officer have concluded, based on their review, that our disclosure controls and procedures, as defined at Exchange Act Rules 13a-14(c) and 15d-14(c), are effective to ensure that information required to be disclosed by us in reports that we file under the Exchange Act is recorded, processed, summarized and reported accurately and within the time periods specified in Securities and Exchange Commission rules and forms. (B) CHANGES IN INTERNAL CONTROLS No significant changes were made to our internal controls or other factors that could significantly affect these controls during the last fiscal quarter of their evaluation referenced in paragraph (A) above. PART II. OTHER INFORMATION ITEM 1. LEGAL PROCEEDINGS See Note 8 for applicable information. ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS Not applicable. ITEM 3. DEFAULTS UPON SENIOR SECURITIES Not applicable. 21 ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS Not applicable. ITEM 5. OTHER INFORMATION Our Common Stock was quoted in the over-the-counter market on the OTC Bulletin Board under the symbol "HMII.OB" until February 19, 2004, the date it was removed. The removal occurred because we were no longer current with regards to our SEC filings, primarily our Form 10-K for the year ended September 30, 2003, and therefore the members of the OTC Bulletin Board could no longer quote our shares. It is now quoted in the Pink Sheets. ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K (A) INDEX TO EXHIBITS 3.1 Certificate of Incorporation~ Incorporated by reference from Annual Report on form 10-K for the year ended September 30, 1995 3.2 Bylaws~ Incorporated by reference from Form 10-Q for the quarter ended June 30, 2003 10.01 Material Contracts~ U.S. Bank N.A. Waiver Letter and Amendment to Revolving Credit Note dated February 20, 2004, , incorporated by reference from Annual Report on Form 10-K for the year ended September 30, 2003 10.02 Material Contracts~ U.S. Bank N.A. Waiver Letter and Amendment to Revolving Credit Note, dated October 15, 2004, incorporated by reference from Form 8-K filed on October 21, 2004 31.1 Rule 13a-14(a)/15d-14(a) Certification~ Certification Pursuant to 15 U.S.C. Section 7241 for Kirk W. Foley, attached 31.2 Rule 13a-14(a)/15d-14(a) Certification~ Certification Pursuant to 15 U.S.C. Section 7241 for Julie A. McGraw, attached 32.1 Section 1350 Certification~ Certification for Kirk W. Foley Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (18 U.S.C. Section 1350), attached 32.2 Section 1350 Certification~ Certification for Julie A. McGraw Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (18 U.S.C. Section 1350), attached 22 (B) REPORTS ON FORM 8-K We filed a report with the SEC on Form 8-K dated February 3, 2004, containing our February 3, 2004, press release to announce the resignation and replacement of our Chairman of the Board. 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. HMI Industries Inc. (Registrant) Date: October 22, 2004 /s/ Julie A. McGraw --------------------------------------- Julie A. McGraw Vice President - Chief Financial Officer 23

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