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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K/A
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[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934.
For the fiscal year ended December 31, 1998
[ ] 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 0-21335
GARGOYLES, INC.
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(Exact name of registrant as specified in its charter)
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Washington 91-1247269
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(State of Incorporation) (I.R.S. Employer
Identification Number)
5866 South 194th Street
Kent, Washington 98032
(253) 796-2752
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(Address and telephone number of registrant's principal executive offices)
Securities Registered Pursuant to Section 12(b) of the Act:
None
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Securities registered pursuant to Section 12(g) of the Act:
Common Stock, no 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 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes [X] No [ ]
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to
the best of registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. [X]
As of March 22, 1999, 7,822,191 shares of the registrant's common stock,
no par value, were outstanding. The aggregate market value of the common stock
held by non-affiliates or the registrant on that date was $1,046,922, computed
at the closing price on that date.
The information called for by Part III is incorporated by reference to the
definitive Proxy Statement for the Annual Meeting of Shareholders of the
Company to be held in June, 1999.
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INDEX
Page
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PART I
Item 1. Business....................................................... 1
Item 2. Properties...................................................... 14
Item 3. Legal Proceedings............................................... 14
Item 4. Submission of Matters to a Vote of Security Holders............. 15
PART II
Item 5. Market for Registrant's Common Stock and Related
Shareholder Matters............................................. 15
Item 6. Selected Financial Data......................................... 16
Item 7. Management's Discussion and Analysis of Financial Condition
and Results of Operations....................................... 18
Item 8. Financial Statements and Supplementary Data..................... 27
Item 9. Changes and Disagreements with Accountants on Accounting
and Financial Disclosures....................................... 52
PART III
Item 10. Directors and Executive Officers of the Registrant.............. 52
Item 11. Executive Compensation.......................................... 54
Item 12. Security Ownership of Certain Beneficial Owners and Management.. 54
Item 13. Certain Relationships and Related Transactions.................. 54
PART IV
Item 14. Exhibits, Financial Statements and Reports on Form 8-K.......... 54
<PAGE>
PART I
ITEM 1. BUSINESS
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FORWARD-LOOKING STATEMENTS
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Certain statements within the following description of the business of
Gargoyles, Inc. ("Gargoyles" or the "Company") and elsewhere in this Form 10-K
constitute "forward-looking statements" within the meaning of the Private
Securities Litigation Reform Act of 1995. Certain of the forward-looking
statements contained in this Report are identified with cross references to
this section and/or to specific risks identified under "Business -- Risk
Factors." Forward-looking statements included in this report or otherwise
presented by management from time to time involve known and unknown risks,
uncertainties and other factors that may cause the actual results, performance
or achievements of the Company or industry results, to differ materially from
the anticipated results, performance or achievement expressed or implied by
such forward-looking statements. Such factors include, but are not limited to
factors involving business cycles and health of the world and national
economies and developments involving consumer products in general and the
sunglass industry in particular, as well as the other risks and uncertainties
described under "Business -- Risk Factors" in Part I of this Annual Report on
Form 10-K. Forward-looking statements reflect management's views, estimates
and opinions at the date on which the statements are made. The Company
undertakes no obligation to update forward-looking statements to reflect
changes in circumstances or changes in the views, estimates or opinions of
management that occur after the statements are made. Because of the inherent
uncertainty of forward-looking statements and because circumstances or
management's views, estimates and opinions may change, investors are cautioned
not to place undue reliance on forward-looking statements.
THE COMPANY
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The Company designs, assembles, markets and distributes a broad range of
sunglasses and eyewear products. The Company competes primarily in the premium
sunglass markets by offering a diverse line of products marketed under a number
of brands owned by the Company or licensed from third parties. The Company's
principal brands include Gargoyles Performance Eyewear, Gargoyles Protective
Eyewear, Hobie Polarized Sunglasses, Stussy EyeGear, Anarchy Eyewear, Angel
Eyewear, Tomichi Studio and Private Eyes.
The Company operates both directly and through three wholly-owned
subsidiaries: H.S.C., Inc., a Washington corporation ("Hobie"), Sungold
Eyewear, Inc., a Washington corporation ("Sungold"), and Private Eyes Sunglass
Corporation, also a Washington corporation ("Private Eyes"). During 1997 and
the first eight months of 1998, the Company's Timberland Eyewear business was
operated through its majority-owned subsidiary, the kindling company, a
California corporation ("Kindling"). Substantially all of the assets of
Kindling were sold effective September 1, 1998.
Gargoyles was incorporated under the laws of the state of Washington in
1983. References to Gargoyles and the Company in this report include the
Company and its subsidiaries. The Company succeeded to the sunglass business
of Conquest Sports, Inc., a Washington corporation f/k/a Pro-tec, Inc.
("Conquest"), an affiliated sports products company that transferred its
sunglass business to the Company upon the Company's formation in 1983, and
references to Gargoyles and the Company herein include the sunglass business of
Conquest prior to 1983. For a discussion of other transactions involving the
Company and Conquest see "Management's Discussion and Analysis of Financial
Condition and Results of Operations." Antone Manufacturing, Inc. ("Antone"),
an affiliated S corporation that provided assembly operations for Gargoyles,
was merged into the Company in March 1995, and reference to Gargoyles and the
Company herein include the combined operations of the Company and Antone.
The Company's principal executive offices are located at 5866 South 194th
Street, Kent, Washington 98032, and its telephone number at that location is
(253) 796-2752.
OVERVIEW
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The Company was founded in 1983 by Dennis Burns (the "Founder") to develop
a high-performance sunglass using the Company's patented dual-lens toric curve
technology. This toric curve technology continues today to be the foundation
for the Company's Gargoyles Performance Eyewear and Gargoyles Protective
Eyewear brand sunglasses. The Company remained a single-brand company, selling
only Gargoyles branded products until its purchase of the Hobie business in
1996 and its purchase of the Sungold and Private Eyes businesses in 1997.
In 1995, the Founder sold 75% of his stock in the Company to an investor
group led by Trillium Corporation ("Trillium") and certain members of the
Company's former management. This investment group took the Company public in
late September 1996, raising more than $27 million of net proceeds for the
Company, $19 million of which was used to repay debt.
In 1996 and 1997 the Company pursued an aggressive acquisition and
expansion strategy, and between February 1996 and May 1997 the Company acquired
the Hobie Polarized Sunglasses business, entered into a licensing arrangement
with The Timberland Company to develop a line of Timberland brand eyewear,
opened an international sales and marketing office in London, entered into a
licensing arrangement with Golden Bear Golf to develop a line of Jack Nicklaus
signature style golf sunglasses; purchased Sungold which sells Stussy, Anarchy
and Angel brand sunglasses, and purchased Private Eyes which sold Ellen Tracy
and Emmanuelle Khanh brand sunglasses and a line of eyewear accessories under
its Private Eyes brand.
The Company used short-term borrowings to finance its acquisitions and
expansion which, together with the Company's increase in operating expenses in
anticipation of 1997 growth and the deterioration of results of operations in
late 1997, resulted in a shortage of cash in late 1997. At December 31,1996,
the Company had more than $4 million in cash, working capital of $15.6 million
and no long-term or secured debt. At December 31, 1997, the Company had less
than $1 million in cash, more than $29 million of indebtedness to its primary
lender, U.S. Bank (the "Bank") and was unable to make a $2.75 million scheduled
principal payment on its credit facility with the Bank.
In early 1998, the Company's board of directors hired a turn-around team
led by Leo Rosenberger, the Company's Chief Executive Officer and Chief
Financial Officer, to restructure the Company. In January, the Company's
credit facility with the Bank was amended to defer principal payments and to
provide the Company with funds to begin its restructuring. Several changes in
its executive management were made. The Company's former Chairman of the
Board, President and Chief Executive Officer, Chief Operating Officer, Chief
Financial Officer, and Senior Vice President of Sales all resigned from the
Company.
The turn-around team spent significant time and effort in 1998 examining
the Company's operations, and reviewing and investigating the causes and
results of the Company's 1997 financial performance. Although current
management was not present at the time, in hindsight it appears that the
Company's 1997 operating results were primarily the result of industry trends
and former management's focus, almost exclusively, on top-line performance.
This top-line focus resulted in (1) an aggressive acquisition strategy with no
effective integration of the acquired businesses or product lines into the
Company, (2) an aggressive sales and marketing program which included large
expenditures on national advertising and athlete endorsements without a fully
integrated plan to leverage such expenditures, (3) an aggressive build-up of
inventory to fill anticipated orders which failed to materialize, (4)
acquisition of additional leased facilities and infrastructure to support
anticipated growth which did not materialize, (5) an over-emphasis on the
perceived needs of key customers, such as Sunglass Hut, which led to the
development of more fashion-oriented product designs, (6) the neglect of the
Company's product lines, namely its Gargoyles line, which historically had sold
in more non-traditional sales channels, and (7) a rush to ship product
resulting in deterioration of product quality in the Gargoyles and Hobie
brands.
The Company's current management has taken a number of steps to address
the causes and results of the Company's 1997 financial performance, including
working to restructure and solidify relationships with the Bank and the
Company's key suppliers, reducing expenses to levels that can be sustained by
operations, discontinuing unprofitable operations, refocusing the Company's
brands and its sales and marketing efforts, improving the quality of the
Company's products and restructuring its operations, improving processes and
systems to make it easier for the Company and its customers to do business with
each other, and renegotiating contracts and facilities leases to dramatically
reduce the Company's contingent liabilities.
As part of the restructure process, in 1998 the Company discontinued
unprofitable operations and disposed of assets related to those operations.
The Company's former majority-owned subsidiary, the kindling company
("Kindling"), designed and distributed Timberland brand sunglasses and
ophthalmic frames under a license agreement with The Timberland Company.
Kindling introduced its sunglass line in early 1997 and its ophthalmic line in
early 1998. Approximately 5.2 percent of the Company's operating losses in
1997 and 10% of the Company's operating losses in 1998 were attributable to
Kindling's operations. Effective September 1, 1998, Kindling sold
substantially all of its assets to Adventure Optics, LLC. a limited liability
company majority owned by REM Optical Company, Inc., The Timberland Company and
former Kindling President, Douglas W. Lauer. The Company received a portion of
the sale proceeds in partial payment of an intercompany loan from Gargoyles to
Kindling.
In late 1996 the Company had opened a sales and marketing office in London
to manage its European sales efforts. Sales generated by the London office
totaled $1.2 million in 1997 and $817,000 for the first nine months of 1998.
Costs associated with the Company's European operations totaled $2.4 million in
1997 and $1.1 million in 1998. Effective July 31, 1998, the Company closed its
London office.
In May 1997, the Company purchased substantially all the assets of Private
Eyes, which designed and distributed Ellen Tracy Eyewear under a license
agreement with Ellen Tracy, Inc. The Company's Ellen Tracy Eyewear business
was unable to support the minimum royalty and advertising obligations under the
license agreement. On September 8, 1998, the Company and Ellen Tracy, Inc.
mutually agreed to terminate the license.
In January 1997, the Company entered into a license agreement with Golden
Bear Golf, Inc. to design, develop and distribute a line of Jack Nicklaus brand
golf sunglasses. Interest in the golf product line had been insufficient to
support the Company's minimum payment obligations under the license agreement,
and in January 1999, the Company reached an agreement with Golden Bear Golf,
Inc. to terminate the license agreement.
Gargoyles, Inc. became a publicly traded company in 1996. In July 1998,
the Company received notice from Nasdaq that a Nasdaq Listing Qualifications
Panel had determined to delist the Company's common stock from the Nasdaq
National Market for failure to meet Nasdaq's listing requirement with respect
to net tangible assets. The Company's failure to meet Nasdaq's net tangible
asset listing requirement was largely the result of the Company's use of its
working capital to acquire the assets of Sungold and Private Eyes, which
included substantial amounts of intangible assets related to license
agreements, trademarks and goodwill. The Company's common stock continues to
be quoted on the OTC Bulletin Board under the symbol GOYL.
INDUSTRY OVERVIEW
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According to the Sunglass Association of America, total retail sunglass
sales in the US Plano Primary sunglass market grew approximately 8.0% annually
from $1.4 billion in 1989 to $2.6 billion in 1997. The industry is divided
into two principal segments: the under $30 market and the over $30 premium
market. The premium sunglass market, in which the Company competes, showed an
increase of approximately 8.6% annually from $824 million in 1989 to $1.6
billion in 1997. The Company believes that the key factors driving this growth
in the premium sunglass market include increased consumer awareness of the need
for quality eye protection in response to heightened health concerns, increased
demand for technologically advanced, yet stylish products, growing brand
awareness among eyewear consumers, continuous product replacement, and the
growth of Sunglass Hut International, which accounts for approximately 36% of
industry sales.
The average retail price per unit for premium sunglasses at the higher end
retailers was $62.80 in 1997 compared to $59.70 in 1996, a 5% price increase.
The Company believes, however, that this trend will begin to reverse in the
near future with consumers demanding more value for a lower price.
Management believes that misperceptions regarding the dynamics of the
premium sunglass industry in 1995 and 1996 greatly influenced industry results
in 1997 and 1998. Management believes that industry consolidation was
perceived as industry growth, and sunglass manufacturers, including the
Company, used industry sell-in statistics to project sell-through volumes and
overestimated 1997 and 1998 top-line growth. As a consequence, retail inventory
levels in 1996 far exceeded needs, and retailers began a program which has been
described as "reverse distribution" and returned millions of dollars of product
to its vendors in 1997 and 1998. The Company processed $10 million and $4.2
million in returns from customers in 1997 and 1998, respectively. Management
believes that as a result of overproduction of product manufactured by the
Company and others during 1996 and 1997, significant amounts of unsold product
remained in the market at the beginning of the year and affected the Company's
1998 sales and also could affect the Company's sales in 1999.
The Company believes that Oakley and Bausch & Lomb comprised approximately
50% of the domestic premium sunglass market in 1998, with several companies,
including the Company, having smaller market shares. The remainder of the
industry is highly fragmented and comprised of numerous smaller companies.
In addition, the Company believes that as the consumer population ages,
the demand for ophthalmic and prescription sunglass products will increase.
Baby Boomers (persons born between 1946 and 1964) represent one of the largest
sunwear consumer groups. Not only do they have the greatest disposable income,
but they have grown up with sunglasses as an integral part of their lives, and
many are now seeking prescription sunwear. According to the Jobson Optical
Group Data Base, approximately 159 million people in the United States
currently require some form of vision correction, and 98.7 million people
purchased prescription eyewear or contact lenses in 1997.
BUSINESS STRATEGIES
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The Company's objective is to be one of the premier designers,
manufacturers and marketers of sunglasses and eyewear. To achieve this goal,
the Company has developed and is implementing business strategies to capitalize
on growth opportunities within the premium sunglass and ophthalmic markets.
Key elements of the Company's business strategies are as follows:
Offer quality products using latest technologies.
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The Company continuously strives to differentiate its products from those
of its competitors through introductions of quality products using the latest
technologies. The sophisticated geometry of the Company's Gargoyles brand
patented dual lens toric curve design permits the Company to offer consumers an
extreme wraparound sunglass design with wide coverage without sacrificing
overall optical clarity or introducing distortion. In addition, the primary
lens material for Gargoyles products is polycarbonate, which provides
protection from damaging ultraviolet light, is significantly stronger than
safety glass, yet is lightweight. The patented interchangeable lens design of
the Gargoyles brand Legends products allows the consumer to adopt multiple
styles and functions through the use of different lenses in the same frame.
The polarized lens technology of the Hobie Polarized Sunglasses and Hobie's
proprietary copper lenses provide consumers with products which are designed to
eliminate glare more effectively than regular sunglasses. See " --Risk Factors
- -- Dependence on New Product Introductions."
Focus distribution network and expand customer base.
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In 1998, the Company restructured its sales and distribution efforts by
implementing a focused, channel distribution strategy. In 1998 the Company
reduced the number of its direct field sales personnel, closed its London sales
office and terminated its European sales force, restructured its sales
management, and established a sales strategy for each channel using a
combination of direct sales personnel, manufacturers' representatives, and/or
distributors as appropriate for the channel. To maintain distribution in the
department store channel after the Company discontinued its Ellen Tracy
sunglass business, the Company launched it's own women's fashion brand under
the name Tomichi Studio. Initially, the Company's sales efforts will be
focused in those channels where the Company's brands can have an immediate
impact and can have a significant presence.
Use non-traditional distribution channels.
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The premium sunglass industry has traditionally been perceived as a
fashion accessories business with a primary channel of distribution through
sunglass specialty retailers. While the Company's sunglass products do include
fashion brands that sell well in this traditional channel, the Company also
markets sport/function brands which sell primarily through other more non-
traditional channels. The Company believes that its ability to provide
products appealing to customers in multiple distribution channels provides the
Company with a distinct competitive advantage.
Develop brands and brand name recognition.
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The Company seeks to heighten awareness of its brands and to promote
consumer awareness of the brands in connection with high-quality sunglasses and
eyewear products. To strengthen the image of its brands, the Company has
implemented marketing strategies focused on enhancing the retail presentation
of all of its products. The Company's strategy is exemplified by recent
efforts with its oldest brand, Gargoyles Performance Eyewear, and its newest
brand, Tomichi Studio.
The first Gargoyles Performance Eyewear product was sold in 1983 and
gained early recognition from consumers who appreciate high performance and
function from their sunglass products. Placement of the Gargoyles Classic
styles on actors such as Arnold Schwarzenegger in the film The Terminator and
Clint Eastwood in Sudden Impact helped establish the tough, performance
characteristics of Gargoyles products and have been central to Gargoyles
product positioning. The Gargoyles brand also has had a strong following in
NASCAR, and NASCAR champion Dale Earnhardt has been an endorser of Gargoyles
branded products for many years. The Company's early brand positioning and
alliance with Earnhardt and NASCAR has recently been reestablished. In October
1998, the Company entered into three-year endorsement contracts with NASCAR
drivers, Dale Earnhardt, Dale Earnhardt, Jr., Ron Hornaday and Steve Park who
will represent the Company as "Team Gargoyles." According to studies published
by Performance Research, NASCAR and other motor sporting events is the fastest
growing segment in the sports industry, creating the potential for growth in
the Gargoyles brand.
Department store buyers and women's fashion consumers have become
increasingly frustrated with the low margins and high prices associated with
designer-branded product, as exemplified by the recent failures of some of the
top fashion houses in the United States. The fashion consumer is becoming more
value conscious and more socially aware. The Company's recently launched
Tomichi Studio brand is on the vanguard of these two trends. In November 1998,
the Company's Private Eyes subsidiary launched a women's fashion sunglass line
to be marketed to department stores under the Company's Tomichi Studio brand.
Two percent of net sales of the Tomichi Studio products will be donated to the
Susan G. Komen Foundation, a charitable foundation devoted exclusively to
raising money for breast cancer research. At present, Tomichi Studio is the
only sunglass brand which is marketed in partnership with a charitable
organization, giving the Company a distinctive advantage over its competitors
in the department store channel. In addition, since the Tomichi Studio name is
owned by the Company, the Company pays no royalties to license a designer name
and can offer higher margins to its department-store customers while
maintaining lower retail prices for the consumer.
Develop an Infrastructure to Manage Multiple Brands and Changes in Those
Brands.
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In 1998, the Company has been working to restructure its business to
integrate the businesses acquired in 1996 and 1997 and to create an
infrastructure that allows the Company to effectively and efficiently manage
the business of multiple brands. Management believes that the long-term
success of the Company depends upon the Company's ability to manage multiple
brands, including from time to time developing new brands, integrating acquired
brands, managing the demands of maturing brands, and discontinuing brands that
are no longer profitable. To that end, the Company has worked in 1998 to
restructure its systems and operating processes, its sales and marketing
efforts, and its customer service departments to facilitate this multiple-brand
management strategy.
Leverage Product Production and Production Planning.
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In the past, the Company depended on multiple vendors in geographically
diverse areas to perform its molding, hard-coating, mirroring and cutting
processes for its Gargoyles brand lenses. Beginning in 1997, the Company began
working with a more limited number of vendors in the United States who
expressed an interest in developing the expertise to manufacture the toric
curved lenses used in the Company's Gargoyles products. Consolidating
manufacturing processes for the Gargoyles product with fewer vendors has
resulted in higher product margins due to lower shipping costs between vendors
and lower costs related to damaged or lost goods. In addition, several of the
Company's European and Asian vendors provide products for a number of the
Company's brands. The Company is currently working with these vendors in an
effort to consolidate production of more products with fewer vendors, thereby
strengthening the Company's relationship with its remaining vendors and making
the Company a more significant customer of those vendors while providing the
Company with greater flexibility in product production scheduling. In 1998,
the Company has restructured and improved its production planning processes.
Improved production planning also has resulted in higher product margins as a
result of lower labor costs related to the assembly of the Company's Gargoyles
and Hobie brand products, and to less inventory of slower-moving goods which
are eventually sold at prices below the Company's list price.
PRODUCTS
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Gargoyles Performance Eyewear Brand Sunglasses
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Gargoyles Performance Eyewear is positioned as premium performance eyewear
for men and women. Gargoyles products combine proprietary optical technology
and polycarbonate lenses with technical mirroring and coating processes and
durable, contemporary frames to satisfy the demand of consumers with active
outdoor lifestyles. In 1998 the Company discontinued several purely fashion
products and preserved those styles targeted to a specific perceived need of
the Gargoyles core consumer. Suggested retail prices for the 13 styles in the
Gargoyles Performance Eyewear collection range from $80 to $175. In 1999,
Gargoyles has introduced its American Lifestyle Collection. This collection is
comprised of 12 styles with the same high-performance features of other
Gargoyles products with eight-base, distortion-free, polycarbonate lenses.
Suggested retail prices for styles in the American Lifestyle Collection range
from $50 to $80.
Gargoyles Protective Eyewear.
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Gargoyles also offers a line of protective eyewear under its Gargoyles
Protective Eyewear collection. There are two styles in the Gargoyles
Protective Eyewear line, both of which are clear, polycarbonate versions of
Gargoyles' Classic style, and a slightly smaller version of the Classic known
as the `85's. In 1997, Gargoyles introduced a line of Gargoyles Protective
Safety Eyewear which includes styles which pass ANSI Z87.1 standards, and are,
therefore, approved for use in industrial applications. Gargoyles Protective
Eyewear also offers a line of accessories including side shields and Rx
inserts, for consumers who require prescription eyewear. All protective
eyewear styles have toric curved lenses. Suggested retail prices for styles in
the Gargoyles Protective Eyewear and Gargoyles Protective Safety Eyewear
collections range from $80 to $135.
Hobie Polarized Sunglasses Brand Sunglasses
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The Company's Hobie Polarized brand sunglasses are designed and assembled
by the Company's subsidiary, Hobie, under a license agreement with Hobie
Designs, Inc. All of the Company's Hobie brand sunglasses are positioned as
premium sunglasses for men and women, and all styles have polarized lenses.
Polarized lenses are designed to eliminate glare more effectively than regular
lenses. The Hobie brand traditionally has had a strong following with
consumers active in water sports who seek to eliminate glare from the water.
Hobie has expanded its product offerings to bring all the benefits of polarized
sunglasses to a broader audience, and the outdoor enthusiast now can have both
style and function. In addition, in response to the needs of aging consumers
with active outdoor lifestyles, almost all Hobie Polarized styles are available
with prescription polarized lenses. Hobie Polarized Sunglasses offers 38
styles at suggested retail prices ranging from $70 to $195.
Stussy Eyegear Brand Sunglasses
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Stussy Eyegear is designed and distributed by Sungold under a license
agreement with Stussy, Inc. The roots of the design of the Stussy Eyegear
products are in the surfer beaches of Laguna Beach, California with the edge of
the urban street. This image was first exemplified by Shawn Stussy in his
Stussy clothing line. Stussy Eyegear is designed for the young consumer aged
18 to 35 who lives a "cool" lifestyle. Stussy Eyegear offers 23 styles at
suggested retail prices ranging from $60 to $90.
Anarchy and Angel Eyewear Brand Sunglasses
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Anarchy and Angel Eyewear are brands owned and developed by Sungold and
were introduced by the Company in April 1997 following the purchase of Sungold.
Anarchy and Angel Eyewear are designed for the young consumer aged 14 to 24.
Anarchy Eyewear are designed for young men who want to escape from the norm.
Anarchy Eyewear is marketed as "a revolution against conformity; what to wear
to have attitude." Angel Eyewear is marketed as "divine power for girls who
want big air, not big hair; girls who would rather board than be bored."
Anarchy Eyewear offers 10 styles at suggested retail prices ranging from $45 to
$65. Angel Eyewear offers 6 styles at retail prices ranging from $45 to $65.
Moderate-Priced and Private Label Products
- ------------------------------------------
Sungold designs and distributes a line of moderate-priced sunglass
products under the name Union Eyeware which are sold in chain stores and
specialty retailers. Suggested retail prices for moderate-priced products
range from $7 to $20. Sungold also from time to time produces private label
products. Currently, Sungold is producing a line of private label sunglass
products for Champs, Going to the Game, the Gap and Old Navy.
Private Eyes Brand Accessories
- ------------------------------
The Company's subsidiary, Private Eyes, which was acquired in 1997,
designs and distributes eyewear accessories under its Private Eyes brand. The
Private Eyes accessories line includes eyewear cases and chains which complete
the consumer's practical eyewear needs and give Private Eyes' customers a
reasonably priced add-on sale to eyewear purchases. Suggested retail prices
for cases and chains range from $10 to $25.
Tomichi Studio Brand Sunglasses
- -------------------------------
The Company's subsidiary, Private Eyes, introduced a line of women's
fashion sunglasses and reading glasses in November 1998 under the Company's
Tomichi Studio brand name. Tomichi Studio eyewear products are designed for
women between the ages of 28 and 55 and are marketed through department stores,
optical and specialty chain stores. Two percent of net sales of Tomichi Studio
products are donated to the Susan G. Komen Foundation, a charitable foundation
devoted exclusively to raising funds for breast cancer research. Tomichi
Studio offers 18 styles of sunglasses at suggested retail prices ranging from
$45 to $70 and 4 styles of reading glasses at suggested retail prices ranging
from $40 to $45.
PRODUCT DEVELOPMENT
- -------------------
The Company strives to be an innovator in the development of new product
styles. Gargoyles, Hobie, Sungold and Private Eyes all have professionals in
place dedicated to the development of new products for each of their brands.
The Company also from time to time works with outside consultants and with its
vendors' design teams on product development.
The frequency of product introductions and the length of time a style
remains in a particular product line varies with the Company's brands. New
styles of technologically-based products, such as the Gargoyles and Hobie brand
products historically have been introduced once or twice a year and, although
certain styles which do not achieve anticipated levels of consumer acceptance
from time to time will be discontinued, certain top-selling styles have
remained in the product lines for several years. The Classic style has been in
the Gargoyles Performance Eyewear line since 1983 and remains that brand's
number one selling style. Fashion-based products and products marketed to the
younger consumer such as the Company's Tomichi Studio, Stussy and Anarchy and
Angel brand products, are introduced more frequently, and these styles usually
remain in a collection for a much shorter period of time.
MANUFACTURING
- -------------
During 1998, management has worked to simplify its production policies and
procedures and to eliminate redundancies in operations. In addition, the
Company has established relationships with new vendors and located new sources
of supply which will provide the Company with better quality products at lower
prices.
The Company currently sources its frames, lenses and components from a
diverse group of suppliers in the United States, Asia and Europe. Lenses for
Gargoyles toric curve products are molded, hard-coated, and mirrored by two
suppliers in the United States. Frames for Gargoyles products are currently
produced by a network of suppliers in Italy, Japan and the United States.
Assembly of Gargoyles products is performed by the Company's vendors and by the
Company at its Kent, Washington facility. Frames for the Company's Hobie
products are sourced from Europe and Asia, and lenses are sourced from Italy
and Japan. Hobie products are assembled at the Company's facility in Kent,
Washington. The Company's Stussy, Anarchy and Angel products are sourced from
a number of suppliers in Asia and Italy and arrive fully assembled at the
Company's Farmingdale, New York facility where they are inspected and packaged.
The Company's Gargoyles American Lifestyle Collection, Private Eyes and Tomichi
Studio products are sourced from a number of suppliers in Asia, Europe and the
United States and arrive fully assembled at the Company's Kent, Washington
facility where they are inspected and packaged.
The Company's cash-flow problems in 1998 affected its relationships with
its vendors and suppliers, but management has been working diligently to
reestablish and rebuild these relationships. The Company has entered into
promissory notes with most of its key vendors to schedule repayment of past due
trade indebtedness and also has reached agreement with those vendors on terms
for payment of new purchases. Management believes that so long as the Company
can make scheduled payments to vendors, it will be able to obtain sufficient
inventory to fill orders to meet its sales projections in 1999. See " --
Forward-Looking Statements."
For information concerning backlog and backorders, see "Management's
Discussion and Analysis of Financial Condition and Results of Operations-
Backlog and Backorders."
DISTRIBUTION
- ------------
To preserve the integrity of the Company's brand names, the Company
selectively limits its distribution to retailers that market products
consistent with the Company's image and pricing strategy and that provide a
high level of customer service and technical expertise. Individual accounts
are typically selected based on their potential ability to positively represent
the Company's brands and technological benefits, reputation for advertising
prices at or near the manufacturer's suggested retail price, expected ability
to display a wide assortment of the Company's product selections and
demonstrated commitment to merchandising and product knowledge that will
support the brand image of the various Company brands.
In 1998, the Company established a distribution strategy which emphasizes
the distribution channel itself, and focuses the efforts of the marketing and
sales departments on the needs of customers and consumers in a given channel.
The Company sells its products through a variety of channels including the
traditional sunglass specialty, sport specialty, department store and optical
channels. In addition, the Company distributes its products through non-
traditional channels including automotive, military, industrial and medical-
dental channels. In 1999, the Gargoyles brand will focus on increasing its
distribution in the non-traditional channels, and the Hobie brand will focus on
increasing its distribution in optical chain stores. Stussy, Anarchy and Angel
brands will focus on increasing their already strong presence in sunglass
specialty and sport specialty channels.
SALES
- -----
Since its inception, the Company's sales efforts have included use of
manufacturers' representatives, distributors and a direct sales force. Prior
to March 1994, the Company's selling efforts were conducted principally by
manufacturers' representatives who represented multiple companies. In 1994,
the Company began investing in a direct sales force to sell its Gargoyles
Performance Eyewear products. With the acquisition of additional businesses
and product lines in 1996 and 1997, the Company's former sales strategy
involved all direct sales force personnel selling all brands in all channels; a
strategy which proved inefficient and ineffective. This sales strategy has
been changed. Now, the Company's sales efforts are organized by channel, and
the mix of direct sales personnel, manufacturers representatives and
distributors varies by channel. In addition, the sales force is encouraged to
work with customers to help assure that the volume of product sold to customers
will sell through to consumers, thereby strengthening the Company's customer
relationships and avoiding the expense of processing unnecessary returns.
MARKETING AND PROMOTION
- -----------------------
When the Company was a single-brand company offering only Gargoyles
products, marketing of the Gargoyles brand was narrowly focused. Marketing
initiatives included NASCAR endorsements and emphasized the performance
features and functions of the Gargoyles products. With the acquisition of new
product lines the marketing initiatives and brand positioning became less
individualized, especially with respect to the Gargoyles and Hobie brands, and
the brands were positioned more as fashion brands with similar marketing images
and approaches used for both the Gargoyles and Hobie brands. During 1998 the
Company reexamined each of the brands and, as a result, refocused certain
brands, discontinued unprofitable brands, and developed a new brand.
In connection with its sports-performance based brands, the Company uses
endorsements by professional athletes to promote its products and brand image
by highlighting the sports efficacy of various products designs. The Company's
athlete endorsement strategy focuses on selecting athletes who are highly
acclaimed in their respective sports to wear and promote the Company's
sunglasses. Athletes currently under contract to promote the Gargoyles
Performance Eyewear brand include NASCAR champions Dale Earnhardt, Dale
Earnhardt, Jr., Ron Hornaday and Steve Park, who comprise "Team Gargoyles."
Athletes currently under contract to promote the Hobie Polarized Sunglasses
brand include surf legends, Gerry Lopez and Buzzy Kerbox, world champion surfer
Prue Jeffries, and legendary angler Lefty Kreh. Athletes currently under
contract to promote the Anarchy and Angel Eyewear lines include surfing
champions Serena Brooke and Christian Fletcher, and all-around snowboard
champion, Jimmy Halopoff.
CUSTOMER SERVICE
- ----------------
The Company's ultimate objective with respect to customer service is quite
simple: to make it easier for its customers to do business with the Company.
Realignment of the sales and marketing efforts of the Company in 1998 also
affected the Company's customer service department. Certain positions were
eliminated, and certain other positions were dedicated to the support of
individual brands. Most significantly, the Company's customer service
representatives no longer function as passive order takers and complaints
processors. Instead, they have adopted a proactive approach to customer
service, contacting the Company's customers on a regular basis, building
positive customer relationships, and acting as sales representatives covering
smaller accounts not otherwise covered by the Company's sales force.
PRINCIPAL CUSTOMERS
- -------------------
Net sales to the Company's 10 largest customers during the years ended
December 31, 1998, 1997, and 1996 accounted for approximately 33%, 50% and 56%,
respectively. Sunglass Hut, the Company's largest customer, accounted for
approximately 14 %, 21% and 30% of the Company's consolidated net sales for the
same periods. As of December 31, 1998, the Company's Stussy, Anarchy and
Angel brand products are sold in more than 1900 Sunglass Hut locations
throughout the United States. As of March 31, 1999, the Company's Gargoyles
Performance Eyewear brand products will be sold in approximately 250 Sunglass
Hut locations in the United States and should be in approximately 750 locations
by 1999 year end. See " -- Forward-Looking Statements and- Risk Factors -
Dependence on Sunglass Hut."
INTELLECTUAL PROPERTY
- ---------------------
The Company aggressively asserts its rights under patent, trade secret,
unfair competition, trade dress, trademark and copyright laws to protect its
intellectual property, including product designs, proprietary manufacturing
processes and technologies, product research and concepts and recognized
trademarks. These rights are protected through the acquisition of patents and
trademark registrations, the maintenance of trade secrets, the development of
trade dress (the "look and feel" of a product) and, where appropriate,
litigation against those who are, in the Company's opinion, infringing its
rights.
Patents and Trademarks.
-----------------------
As of December 31, 1998, the Company had three U.S. utility patents in
effect relating to eyewear, including patents directed to the dual lens toric
curve technology. As of December 31, 1998, the Company had one utility patent
application pending in the United States.
As part of a structured settlement of a patent infringement case initiated
by the Company against Neoptx, Inc., in May 1997 the Company assigned its
rights in its stick-on lens patent to Neoptx, Inc. in exchange for $300,000 and
a world-wide royalty-free license in the assigned patented technology.
As part of a structured settlement of a patent infringement case initiated
by the Company against Aearo Corporation, in October 1998, the Company granted
to Aearo Corporation a license to continue to make and sell certain infringing
product into certain industrial safety eyewear markets in exchange for a one-
time, lump sum royalty of $1.2 million, which was paid by Aearo upon execution
of the license agreement.
As of December 31, 1998, the Company had registered 35 U.S. trademarks and
27 international trademarks relating primarily to the names Gargoyles and its G
logo, Anarchy and its A logo, and Private Eyes. In addition, the Company has
licensed the right to use the Hobie and Stussy, trademarks for use on eyewear
products pursuant to the terms of agreements with third parties. Due to the
Company's quality control standards and the desire to protect its proprietary
technology and prevent overexposure of its trademarks, the Company has not
licensed its trademarks for use by other parties for the manufacture and sale
of sunglass products. See "- Risk Factors - Uncertain Protection of
Intellectual Property Rights."
While there can be no assurance that the Company's patents or trademarks
protect its proprietary information and technologies, the Company intends to
continue to assert its intellectual property rights against any infringer.
Although the Company's assertion of its rights could result in substantial cost
to, and diversion of effort by, the Company, management believes that
protection of the Company's intellectual property rights is a key component of
the Company's business strategy. See "-- Forward-Looking Statements."
Trade Secrets.
-------------
The Company also relies on unpatented trade secrets for the protection of
certain intellectual property rights. The Company protects its trade secrets
by requiring its employees, consultants and other agents and advisors to
execute confidentiality agreements upon the commencement of employment or other
relationship with the Company. There can be no assurance, however, that these
agreements will provide meaningful protection for the Company's proprietary
information or adequate remedies in the event of unauthorized use or disclosure
of such information. In addition, there can be no assurance that others will
not independently develop substantially equivalent proprietary information and
technologies, or otherwise gain access to the Company's trade secrets or
disclose such technology, or that the Company can meaningfully protect its
rights to unpatented trade secrets. See "- Forward Looking Statements."
COMPETITION
- -----------
The Company competes primarily in the premium segment of the sunglass
market, which is fragmented and highly competitive. The Company competes with
a number of established companies, including Bausch & Lomb, the marketer of the
Ray Ban, Killer Loop, Arnette and Revo brands, and Oakley, which in recent
years together have controlled approximately 50% of the premium market segment,
as well as Luxottica Group S.P.A., Safilo USA Inc. and Bolle America, Inc. In
the polarized sunglass segment, the Company competes against Maui Jim and Costa
del Mar brands, as well as the polarized products sold by other sunglass
manufacturers. The Company also competes in the market for premium protective
eyewear, primarily against Bolle America, Inc., and against lower-priced
products produced by Aearo Corporation, Uvex Safety, Inc. and Titmus Optical,
Inc. Several of these companies in the premium sunglass and protective eyewear
markets have substantially greater resources and better name recognition than
the Company and sell their products through broader and more diverse
distribution channels. The Company could also face competition from new
competitors that also have greater financial and other resources than the
Company.
The premium sunglass market is susceptible to rapid changes in consumer
preferences that could affect acceptance and sales of the Company's products.
The major competitive factors include fashion trends, brand recognition,
methods of distribution and the number and range of products offered. In
addition, to retain and increase its market share, the Company must continue to
be competitive in the areas of quality, performance, technology, intellectual
property protection and customer service. See "-- Forward-Looking Statements"
and "- Risk Factors - Highly Competitive Market."
EMPLOYEES
- ---------
As a result of its restructure efforts in 1998, the Company has reduced
significantly the size of its work force. As of March 31, 1998, the Company
had 292 employees, of which 100 were full-time salaried, 179 were full-time
hourly and 13 were part-time hourly. As of March 31, 1999, the Company had 196
employees, of which 73 were full-time salaried, 114 were full-time hourly and 9
were part-time hourly. The Company is not a party to any labor agreement and
none of its employees is represented by a labor union. The Company considers
its relationship with its employees to be very good , and has never experienced
a work stoppage.
RISK FACTORS
- ------------
Investment in securities of the Company involves a high degree of risk, as
the Company's business, results of operations and financial condition are
subject to many risks and uncertainties, including, without limitation, those
set forth below. The following risk factors, among others, could cause the
Company's actual results to differ materially from those expressed in the
Company's forward-looking statements in this report and presented elsewhere by
management from time to time. See "--Forward-Looking Statements."
Liquidity And Capital Resources; Losses; Going Concern Qualification
--------------------------------------------------------------------
The Company incurred significant operating losses in 1998. The Company
was unable to make a scheduled payment on its bank debt in December 1997, and
at the Company's request, its banking arrangements were restructured in early
1998. The Company also has had difficulty paying suppliers on a timely basis
and has made arrangements with certain suppliers to provide for unsecured
promissory notes and payment schedules for past due amounts and to provide
letters of credit for a portion of the purchase price of future orders.
Certain of the Company's suppliers have filed suit to collect past due payable
amounts. See "Legal Proceedings."
The entire outstanding balance of the Company's bank debt of $31.6 million
at March 31, 1999, is due and payable in full on April 30, 1999. The Company
will be unable to pay the bank debt, absent the Company obtaining additional
financing through the sale of equity or convertible debt securities. In
October 1998, the Company entered into an agreement in principal with a New
York investment bank for a transaction which contemplated a recapitalization of
the Company through the sale of equity and subordinated debt securities and the
restructure and refinancing of the Company's senior credit facility. In this
transaction, it was anticipated that holders of the Company's presently
outstanding common stock would own less than 20% of the outstanding equity of
the Company, on a fully diluted basis, after the recapitalization transaction
was completed. The parties have been unable to agree on the definitive terms
of the recapitalization transaction, and the transaction has not closed. The
Company is actively seeking alternative sources of capital and is exploring
various options designed to maximize shareholder value, including the possible
sale of equity or convertible debt securities and the restructuring of its bank
loans to fund working capital. There can be no assurance, however, that any
financing or other source of funds will be available on a timely bases, on
favorable terms or at all.
In addition, management has worked throughout 1998 and continues to work
to reduce expenses to levels that can be sustained by operations . Failure of
operations or expense reduction efforts to meet the Company's expectations,
unanticipated expenses, loss of continued cooperation of the Company's key
suppliers or the bank, third-party claims, or adverse developments in pending
collection litigation, could result in additional cash requirements that could
be difficult or impossible to satisfy and could require the Company to further
reduce its operating expenditures, to curtail certain operations or to dispose
of operating assets to enable it to continue operations. See "Management's
Discussion and Analysis of Financial Condition and Results of Operations -
Liquidity and Capital Resources."
Potential Inability To Regain Growth
------------------------------------
The Company experienced rapid growth prior to 1997. The Company's losses
in 1997 and 1998 and its liquidity constraints in 1998 have inhibited the
Company's ability to maintain its business strategies to increase its revenues
and to generate profits. The Company's ability to regain its growth momentum
and to generate profits will depend on, among other factors, the Company's
ability to raise needed capital, the continued growth of the premium sunglass
market, the Company's ability to develop and introduce new eyewear products,
and the Company's ability to broaden and increase sales through its domestic
and international sales and distribution channels.
The Company's future success will depend on its ability to regain growth
and to again expand its production and marketing capacities, which will place a
significant strain on the Company's employees and operations. The Company's
aggressive acquisition strategy of 1996 and 1997 placed significant strain on
its administrative and operational resources and increased demands on its
internal systems, procedures and controls. There can be no assurance that the
Company's administrative infrastructure, systems, procedures and controls will
adequately support the Company's operations or that Company management will be
able to achieve the effective integration of the Company's acquisitions or the
execution of the Company's business initiatives necessary to successfully
penetrate the markets for the Company's products. If the Company is unable to
regain its growth effectively and to capture market share, the Company's
business, operating results and financial condition may be materially adversely
affected.
Dependence On Key Personnel
---------------------------
The Company's operations depend to a significant extent on the efforts of
its senior management most of whom have worked together for a relatively short
period of time. Leo Rosenberger, the Company's Chief Executive Officer and
Chief Financial Officer, and Cynthia Pope, the Company's Vice President,
General Counsel and Secretary, joined the Company February 1, 1998. In 1998
there was considerable turnover in management positions below the senior
officer level. The Company is seeking to develop an able, efficient management
team through the proper positioning of existing key employees and the addition
of new management personnel where necessary. The Company's success is highly
dependent on its continuing ability to identify, hire, train, retain and
motivate highly qualified management, product design, marketing, production and
sales personnel. The Company's operations could be adversely affected if, for
any reason, such key personnel do not continue to be active in the Company's
management.
Dependence On New Product Introductions
---------------------------------------
The sustainability of the Company's business and its growth potential will
depend, in part, on its continued ability to develop and introduce innovative
products. Innovative designs are often not successful, and successful product
designs can be displaced by other product designs introduced by competitors
that shift market preferences in their favor. The eyewear industry is subject
to changing consumer preferences, and the Company's sunglasses are likely to be
susceptible to fashion trends. As a result of these and other factors, there
can be no assurance that the Company will successfully maintain or increase its
market share.
Highly Competitive Market
-------------------------
The premium segment of the sunglass market is highly competitive. The
Company competes with a number of established companies, including Bausch &
Lomb, the marketer of the Ray Ban, Killer Loop, Arnette and Revo brands, and
Oakley, which the Company believes together control approximately 50% of the
premium market segment, and with several companies having smaller but
significant market shares. Several of these companies have substantially
greater resources and better name recognition than the Company and sell their
products through broader and more diverse distribution channels. The Company
could also face competition from new competitors, including established branded
consumer products companies that also have greater financial and other
resources than the Company. In addition, as the Company expands
internationally, it will face substantial competition from companies that have
already established their products in international markets and consequently
have significantly more experience in those markets than the Company. The major
competitive factors in the premium sunglass market include fashion trends,
brand recognition, method of distribution and the number and range of products
offered. In addition, to retain and increase its market share, the Company must
continue to be competitive in the areas of quality and performance, technology,
intellectual property protection and customer service. See " - Competition."
Dependence On Sunglass Hut
--------------------------
Sales to Sunglass Hut, a sunglass specialty retail chain (including sales
to Sunsations, which was acquired by Sunglass Hut in July 1995), accounted for
approximately 32%, 30%, 21% and 14% of the Company's net sales for the years
ended December 31, 1995, 1996, 1997 and 1998, respectively. Historically,
Sunglass Hut has contributed significantly to the Company's business and
overall growth. The Company does not have a purchase agreement with Sunglass
Hut, and a substantial decline in purchases of the Company's products by
Sunglass Hut could have a material adverse effect on the Company's business,
prospects, financial condition and operating results. See " -- Principal
Customers."
Reliance On Limited Sources Of Supplies
---------------------------------------
The Company relies on a single source of supply for several of its
products and components, including several of its frames. The effect on the
Company of the loss of any of such sources or of a disruption in their business
will depend primarily on the length of time necessary to find a suitable
alternative source. The loss of a source for a particular product or frame or
any disruption in such source's business or failure by it to meet the Company's
product needs on a timely basis could cause, at a minimum, temporary shortages
in materials and could have a material adverse effect on the Company's
business, prospects, financial condition and operating results. There can be no
assurance that precautions taken by the Company will be adequate or that
alternative sources of supply can be located or developed in a timely manner.
The Company's Classic lens, which is used in manufacturing most of the
other Gargoyles brand products, can be produced only from the Company's molds,
which are operated by the Company's suppliers. If a mold were to become damaged
or unavailable for an extended period, the Company could experience a shortage
of its Classic lens, which could adversely affect the Company's operating
results.
Due to liquidity problems in 1998, the Company has deferred payments owed
to certain key suppliers and made other payment arrangements. See "--Liquidity
and Capital Resources; Losses." The continued ability and willingness of these
suppliers to continue to work with the Company is important to the continued
viability of a number of its brands, and impairment of the Company's
relationships with these suppliers would adversely affect its business.
Uncertain Protection Of Intellectual Property Rights
----------------------------------------------------
The Company relies, in part, on patent, trade secret, unfair competition,
trade dress, trademark and copyright laws to protect its rights to certain
aspects of its products and to protect its competitive position and its rights
to certain aspects of its products. There can be no assurance that any pending
trademark or patent application will result in the issuance of a registered
trademark or patent, that any trademark or patent granted will be effective in
discouraging competition or be held valid if subsequently challenged or that
others will not assert rights in, and ownership of, the patents and other
proprietary rights of the Company. In addition, there can be no assurance that
the actions taken by the Company to protect its proprietary rights will be
adequate to prevent imitation of its products, that the Company's proprietary
information will not become known to competitors, that the Company can
meaningfully protect its rights to unpatented proprietary information or that
others will not independently develop substantially equivalent or better
products that do not infringe on the Company's intellectual property rights.
The Company has in the past been, and is currently, involved in litigation
concerning its proprietary rights. In addition, the laws of certain foreign
countries do not protect proprietary rights to the same extent as do the laws
of the United States. See "- Intellectual Property."
Consistent with the Company's strategy of vigorously defending its
intellectual property rights, the Company devotes substantial resources to the
enforcement of patents issued and trademarks granted to the Company, to the
protection of trade secrets, trade dress or other intellectual property rights
owned by the Company and to the determination of the scope or validity of the
proprietary rights of others that might be asserted against the Company. A
substantial increase in the level of potentially infringing activities by
others could require the Company to increase significantly the resources
devoted to such efforts. In addition, an adverse determination in litigation
could subject the Company to the loss of its rights to a particular patent,
trademark, copyright or trade secret, could require the Company to grant
licenses to third parties, could prevent the Company from manufacturing,
selling or using certain aspects of its products or could subject the Company
to substantial liability, any of which could have a material adverse effect on
the Company's business, prospects, financial condition and operating results.
Seasonality Of Business
-----------------------
The Company's business is affected by economic factors and seasonal
consumer buying patterns. The Company's quarterly results of operations have
fluctuated in the past and may continue to fluctuate as a result of a number of
factors, including seasonal cycles, the timing of new product introductions,
the timing of orders by the Company's customers, the mix of product sales and
the effects of weather conditions on consumer purchases. Historically, the
Company's net sales, in the aggregate, generally have been higher in the period
from March to September. See "Management's Discussion and Analysis of
Financial Condition and Results of Operations - Seasonality."
Possible Business Disruption From Computer Application Failure At
Year 2000
-----------------------------------------------------------------
Because the real-time clocks in many existing computer chips do not
properly recognize a year that begins with "20" rather than "19," many computer
applications based upon those chips could fail or create erroneous results at
and after midnight on December 31, 1999. Because many of these chips are
embedded in existing items of equipment and are non-programmable, components or
all of the equipment must be replaced to obviate these failures or erroneous
results. To the extent that faulty chips are not replaced in critical
components of equipment, heat, power, telephone and other services to the
Company, as well as the Company's own computers, could fail, causing disruption
to the Company's business. To the extent that the Company's vendors and
customers may have operational problems arising from these types of failures
and errors associated with the Year 2000, the Company could be adversely
impacted. See "Management's Discussion and Analysis of Financial Condition and
Results of Operations -- Year 2000."
ITEM 2. PROPERTIES
- --------------------
With the acquisitions of Sungold and Private Eyes in 1997, the Company
acquired various leased operating facilities and showrooms. In the same year,
executing on a plan to consolidate its operations to one facility, the Company
leased an approximately 93,000 square foot facility in Lynnwood, Washington
which was anticipated to be its primary assembly, warehousing and shipping
facilities and for use as its corporate headquarters. As part of the
restructure process, the Company negotiated lease terminations and vacated many
of these facilities, including the Lynnwood facility, and relocated the
Company's operations in Washington state to its original corporate headquarters
in Kent, Washington and to a new 20,000 sq. ft. leased facility located nearby
in Kent, Washington. Sungold continues to operate from its facility in
Farmingdale, New York. The following table sets forth the leases to which the
Company was a party as of January 1, 1998 and the current status of each lease.
<TABLE>
<CAPTION>
Location Sq. Ft. Corporate Function Status
- --------------- ------- --------------------------- -----------------
<S> <C> <C> <C>
Lynnwood, WA 93,000 New corporate headquarters; Lease terminated,
assembly; warehousing facility vacated
and shipping
Kent, WA 26,000 Current headquarters No change
Kent, WA 24,000 Formerly shipping and Lease terminated,
warehousing facility vacated
Farmingdale, NY 26,000 Sungold operations No change
Norwell, MA 16,000 Formerly Private Eyes Lease terminated
operations facility vacated
Kent, WA 15,000 Vacant office space Lease terminated,
facility vacated
New York, NY 3,500 Private Eyes showroom No change
London 3,000 International sales and
marketing office Sublet
San Ramon, CA 1,500 Kindling office Lease terminated,
facility vacated
Dallas, TX N/A Private Eyes showroom Lease terminated,
facility vacated
</TABLE>
As a result of the restructure of the Company's leased facilities, to date the
Company has reduced its minimum future lease payments under such leases by more
than $7.2 million. Management believes that the Company's current facilities
will be sufficient to meet the Company's operating needs for the foreseeable
future. See "Business -- Forward Looking Statements."
ITEM 3. LEGAL PROCEEDINGS
- ---------------------------
On November 22, 1996, the Company filed an action in the United States
District Court for the District of Massachusetts, under Case No. 996-12344RCL,
against Aearo Corporation, a Delaware corporation, alleging infringement of the
Company's toric curve lens utility patent. On May 19, 1998 the Court ruled in
favor of the Company and found that product manufactured by Aearo Corporation
infringes the Company's toric curve patent. Following the Court's ruling, the
only significant issues left for trial included the extent of damages to be
awarded to the Company resulting from Aearo's patent infringement and whether
the Company's patent was validly issued. On October 20, 1998 the Company
reached a settlement agreement with Aearo Corporation. Under the terms of the
settlement, all claims by and against the parties were fully released and the
Company granted to Aearo Corporation a license to continue to make and sell
certain infringing product into certain markets in exchange for a one-time,
lump sum royalty of $1.2 million, which was paid by Aearo upon execution of the
license agreement.
On November 18, December 4 and December 9, 1998 the State of Washington
Department of Revenue assessed the Company, in the aggregate, $475,830 plus
interest in business and occupation taxes and use taxes allegedly due and
payable related to the Company's operations during various periods between
January 1, 1993 and June 30, 1997. At issue in this matter is the Company's
status as a "manufacturer" or "wholesaler" as such terms are defined by the
state of Washington's business and occupation and use tax statutes. The Company
has retained counsel in this matter and intends to appeal and to vigorously
defend the Department's assessment.
On May 11, 1998, Morris Rosenbloom & Co., Inc. filed an action against the
Company in the Supreme Court of the State of New York for Wayne County, under
Index No. 44010. In the lawsuit, plaintiff alleges breach of contract due to
the Company's failure to accept a return of sunglasses under the terms of a
Repurchase Agreement between Morris Rosenbloom and the Company. Plaintiff
claims damages from the Company in excess of $500,000. The Company has
retained counsel to represent it in this matter and intends to defend
vigorously the plaintiff's claims. The Company believes that the ultimate
resolution of this matter will not have a material adverse effect on its
results of operations or financial position. See " Business -- Forward-Looking
Statements."
Due to the Company's cash constraints during 1998, the Company has had
difficulty paying its creditors on a timely basis. The Company has made
arrangement with several of its creditors, including executing promissory notes
and entering into payment schedules, for the repayment of past due amounts.
Certain other creditors have made demands, or have threatened, or have filed
suit to collect past due amounts which have arisen from time to time in the
ordinary course of the Company's business. Claims of approximately $500,000 in
the aggregate are currently pending against the Company for the collection of
past due amounts. No single collection claim is material, but in the unlikely
event all claim amounts should become payable at one time and not scheduled
over a period of time, it would be difficult or impossible for the Company to
make the payment, and the immediate payment of all the claims would have a
material adverse effect on the Company's results of operations or financial
position. See "Business - Forward-Looking Statements"
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
- -------------------------------------------------------------
The Company did not submit any matter to a vote of its security holders
during the fourth quarter of its fiscal year ended December 31, 1998.
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON STOCK AND RELATED SHAREHOLDER MATTERS
- ------------------------------------------------------------------------------
The Company effected its initial public offering of Common Stock on
September 27, 1996, at a price to the public of $16.00 per share. Between
September 27, 1996 and July 13, 1998 the Company's Common Stock traded on the
Nasdaq National Market. In July, 1998, the Company received notice from Nasdaq
that a Nasdaq Listing Qualifications Panel had determined to delist the
Company's common stock from the Nasdaq National Market for failure to meet
Nasdaq's listing requirement with respect to net tangible assets. Delisting
was effective as of the close of business July 13, 1998. Since that time, the
Company's Common Stock has continued to be quoted on the OTC Bulletin Board.
The table below shows for the fiscal quarters indicated the reported high and
low last sale prices of the Company's Common Stock, as reported on the Nasdaq
National Market System and as quoted on the OTC Bulletin Board.
<TABLE>
<CAPTION>
1996 High Low
---------------------------- ------- ------
<S> <C> <C> <C>
Third quarter (from
September 27, 1996) $23.50 $19.75
Fourth quarter $21.25 $ 8.00
1997 High Low
---------------------------- ------- ------
First quarter $10.00 $ 6.75
Second quarter $ 9.38 $ 7.19
Third quarter $ 8.00 $ 5.88
Fourth quarter $ 6.13 $ 3.13
1998 High Low
---------------------------- ------- ------
First quarter $ 4.50 $ 2.63
Second quarter $ 3.50 $ 1.00
Third quarter $ 1.63 $ 0.13
Fourth quarter $ 0.63 $ 0.15
</TABLE>
As of March 22, 1999, there were 127 record holders of Common Stock,
although the Company believes that the number of beneficial owners of its
Common Stock is much higher. On March 22, 1999, the Company's Common Stock
traded at a high of $0.28 and a low of $0.28.
The Company anticipates that for the foreseeable future, all earnings, if
any, will be retained for the operation and expansion of its business and that
it will not pay cash dividends. The payment of dividends, if any, in the
future will be at the discretion of the Board of Directors and will depend
upon, among other things, future earnings, capital requirements, restrictions
in future financing agreements, the general financial condition of the Company
and general business conditions. In addition, the Company's current credit
facility with the Bank prohibits the payment of dividends.
ITEM 6. SELECTED FINANCIAL DATA
- ---------------------------------
The following selected financial data as of December 31, 1998, and for the
year ended December 31, 1998 is derived from the consolidated financial
statements of Gargoyles, Inc., which were audited by BDO Seidman, LLP,
independent auditors. The following selected financial data as of December 31,
1997, 1996 and 1995 and November 30, 1994 and for the years ended December 31,
1997, 1996 and 1995 and November 30, 1994 are derived from the consolidated
financial statements of Gargoyles, Inc., which were audited by Ernst & Young
LLP, independent auditors. This data should be read in conjunction with the
Company's consolidated financial statements and the related notes thereto, and
"Management's Discussion and Analysis of Financial Condition and Results of
Operations" included elsewhere in this Report. Certain reclassifications have
been made to the prior years' financial statements to conform to the current
year presentation.
<TABLE>
<CAPTION>
FISCAL YEAR ENDED
------------------------------------------------------------------
December 31 November 30
--------------------------------------------------- ------------
1998 1997 (1) 1996 (1) 1995 1994
---------- --------- --------- -------- ------------
(in thousands, except per share data)
<S> <C> <C> <C> <C> <C>
Net sales
Gargoyles $ 9,019 $ 12,975 $26,994 $17,896 $11,083
Hobie 5,768 9,562 6,100 - -
Kindling 1,346 2,964 - - -
Sungold 16,927 10,992 - - -
Private Eyes 3,546 4,504 - - -
--------- -------- ------- ------- -------
Total Net Sales 36,606 40,997 33,094 17,896 11,083
Cost of sales 16,225 18,797 14,231 7,017 4,265
--------- -------- ------- ------- -------
Gross profit 20,381 22,200 18,863 10,879 6,818
--------- -------- ------- ------- -------
License income 966 526 480 480 -
Sales and marketing, general and
Administrative, shipping and ware-
housing, product development, and
stock compensation expenses 24,488 30,572 19,983 10,482 6,315
Provision for doubtful accounts 2,630 1,330 166 67 18
Interest expense 3,337 1,974 1,988 1,043 176
Loss on disposition of assets
and related 11,008 - - - -
Other 1,497 3,232 - 2,064 10
--------- -------- ------- ------- -------
Total expenses 42,960 37,108 22,137 13,656 6,519
--------- -------- ------- ------- -------
Net income (loss) $(21,613) $(14,382) $(2,794) $(2,297) $ 299
========= ======== ======= ======= =======
Pro forma net income (loss) $(2,343) $ 179
======= =======
Basic and diluted net loss
per share (2) $ (2.77) $ (1.94) $ (0.47)
========= ======== =======
Pro forma basic and diluted
net income (loss) per share (2) $ (0.43) $ 0.03
======= =======
Weighted average shares used
in computing basic and diluted
net income (loss) per share
and pro forma basic and diluted
net income (loss) per share (2) 7,813 7,428 5,946 5,450 5,450
========= ======== ======= ======= =======
BALANCE SHEET DATA (END OF PERIOD):
Working capital (deficit) $(28,545) $11,392 $15,600 $ (2,692) $ (146)
Total assets 28,008 50,614 27,678 11,476 6,673
Current liabilities, less
current maturities of long
term debt 13,053 14,876 5,728 10,563 5,408
Long-term debt, including
current maturities 28,526 29,160 - 7,367 489
Shareholder's equity (deficit) (14,172) 6,577 20,903 (7,204) 776
- --------------------------
(1) The selected financial data's comparability is affected by the Company's
acquisitions during 1997 and 1996.
(2) Prior year amounts have been restated to comply with Statements of
Accounting Standards No. 128 "Earnings Per Share" and SEC Staff Accounting
Bulletin No. 98. See Note 1 to the Company's Consolidated Financial
Statements.
</TABLE>
SELECTED QUARTERLY FINANCIAL DATA (UNAUDITED)
- ---------------------------------------------
The following table sets forth summary financial data for the Company by
quarter for the years ended December 31, 1998 and 1997, respectively. Certain
reclassifications have been made to the prior years' financial statements to
conform to the current year presentation.
<TABLE>
<CAPTION>
Quarter
------------------------------------------------------------
Year Ended First Second Third(1) Fourth(2)
- ----------------- ------------- ------------ -------------- ---------------
<S> <C> <C> <C> <C>
December 31, 1998
Net revenue $ 11,478,519 $13,175,741 $ 9,062,934 $ 2,889,144
Gross profit 6,364,641 7,676,616 5,360,177 979,354
Net loss (1,542,174) (212,110) (12,043,185) (7,816,017)
Loss per share (0.20) (0.03) (1.54) (1.00)
December 31, 1997
Net revenue $ 8,198,266 $15,866,299 $ 11,067,507 $ 5,865,055
Gross profit 4,999,887 9,704,969 6,497,124 998,526
Net income (loss) 425,533 1,112,798 (1,636,258) (14,283,874)
Loss per share 0.06 0.14 (0.22) (1.92)
- -------------------------
(1) The third quarter of 1998 included charges relating to write down of
assets related to the termination of the Ellen Tracy license agreement and
related Ellen Tracy Eyewear business, a charge to earnings resulting from
the sale of the assets of Kindling and the termination of the Timberland
license agreement and related Timberland Eyewear business, and charges in
connection with the closing of the Company's London office. See
"Management's Discussion and Analysis of Financial Conditions and Results
of Operations -- Overview" and Note 17 of Notes to Consolidated Financial
Statements.
(2) The fourth quarters of 1997 and 1998 included charges relating to lease or
license terminations, asset write-offs, and increases in sales,
receivables and inventory reserves. See "Management's Discussion and
Analysis of Financial Conditions and Results of Operations -- Overview"
and Note 17 of Notes to Consolidated Financial Statements.
</TABLE>
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
- -------------------------------------------------------------------------
OVERVIEW
- --------
The Company designs, assembles, markets and distributes a broad range of
sunglasses and eyewear products. The Company competes primarily in the premium
sunglass markets by offering a diverse line of products marketed under a number
of brands owned by the Company or licensed from third parties. The Company was
founded in 1983 by Dennis Burns (the "Founder") to develop a high-performance
sunglass using the Company's patented dual-lens toric curve technology. This
toric curve technology continues today to be the foundation for the Company's
Gargoyles Performance Eyewear and Gargoyles Protective Eyewear brand
sunglasses. The Company remained a single-brand company, selling only
Gargoyles branded products until its purchase of the Hobie business in 1996 and
its purchase of the Sungold and Private Eyes businesses in 1997.
In a March 22, 1995 recapitalization (the "Recapitalization"), an investor
group (the "Investors") led by Trillium Corporation ("Trillium") acquired a
controlling interest in the Company. In the Recapitalization, the Company (1)
borrowed $6.0 million pursuant to a bank loan guaranteed by Trillium; (2) sold
approximately 3.3 million shares of its Common Stock to the Investors in
exchange for $5.4 million, of which $900,000 was paid in cash and $4.5 million
was paid in the form of a promissory note from Trillium; and (3) redeemed
approximately 3.3 million shares of Common Stock from the Founder for $10.9
million, of which $6.4 million was paid in cash and $4.5 million was paid in
the form of a promissory note to the Founder. In January 1996, the obligations
evidenced by the Company's note to the Founder and Trillium's note to the
Company were satisfied in full. In connection with the Recapitalization, the
Company recorded a charge of $574,000 relating to severance, legal and other
costs and recorded noncash deferred compensation of $400,000 related to the
amendment of an option agreement, which was amortized over the vesting period.
Conquest Asset Sale and Liquidation
-----------------------------------
Prior to the Recapitalization, both the Company and Conquest were majority-
owned by the Founder. Conquest's core business has been the design,
manufacture, distribution and sale of sports helmets. At the time of the
Recapitalization, shares of Conquest's common stock were sold by the Founder to
substantially the same investor group that purchased Common Stock in the
Recapitalization. The Company has advanced funds to Conquest and has
guaranteed certain liabilities of Conquest. Management concluded it was likely
that Conquest will be unable to meet its obligations and, therefore, the
Company recorded a provision in the fourth quarter of 1995 of $1.6 million
representing the write-off of the Company's receivable from Conquest and a
reserve for other potential payments of Conquest liabilities, including certain
Conquest indebtedness which Gargoyles has guaranteed. In June 1996, Conquest
sold certain of its assets for a purchase price of approximately $600,000 plus
the assumption of certain liabilities. At December 31, 1998, Conquest had
approximately $195,000 outstanding on a loan with a bank which is secured by a
note receivable from the purchase of certain Conquest assets and guaranteed by
the Company. Management has concluded that it is unlikely the note receivable
will be collected by Conquest, and Conquest will be unable to pay its loan with
the bank. The Company anticipates that it will be required to pay the
guaranteed amount of $195,000.
On October 2, 1996, the Company concluded its initial public offering in
which 1,954,465 new shares of common stock were issued at a price of $16 per
share. The initial public offering raised $27 million in net proceeds for the
Company. A portion of these net proceeds were used to repay $19 million of
debt in early October. A nonrecurring $300,000 bonus to an executive officer,
in connection with an employment agreement, to be paid upon the closing of the
Offering, was expensed concurrently with the closing of the Offering. In
addition, unamortized loan fees, which were $205,000, associated with debt to
be retired with a portion of the net proceeds of the Offering, were expensed
concurrently with the repayment of the debt immediately after the Offering.
In 1996 and 1997, the Company pursued an aggressive acquisition and
development strategy designed to broaden its product offerings and customer
base and to expand its distribution network. In 1998, certain of these
ventures were sold or discontinued.
Hobie Acquisition
-----------------
In February 1996, the Company acquired the Hobie sunglass business for
$3.9 million. Hobie manufactures polarized sunglasses under the Hobie brand
name pursuant to a long-term license agreement from Hobie Designs, Inc. In
addition, as consideration for certain noncompetition covenants, the Company
agreed to pay an aggregate of $200,000 in 12 monthly installments and issued an
aggregate of 14,540 shares of its Common Stock to two of Hobie's former
shareholders. The Company also paid consulting service fees of $300,000 to
these two shareholders, based upon the achievement by Hobie of certain sales
objectives in 1996 and 1997. The Hobie Acquisition was funded by proceeds of a
bank loan, which Trillium guaranteed. The Hobie Acquisition loan was repaid
with net proceeds of the Offering. Hobie was acquired by the Company on
February 13, 1996 and was accounted for as a purchase. Results of Hobie are
therefore included in the Company's consolidated financial statements for the
year ended December 31, 1996 only for the period from February 14, 1996 to
December 31, 1996.
Timberland Transaction
----------------------
W. Lauer, former president of Revo, a subsidiary of Bausch & Lomb, and The
Timberland Company, formed Kindling, a majority-owned subsidiary of the
Company, to design, develop, manufacture and distribute sunglasses and
ophthalmic frames under the Timberland brand name. Concurrently with Kindling's
formation, the Company and Kindling, jointly and severally, acquired an
exclusive, worldwide (except for Benelux, Cyprus, Israel and Scandinavia)
license from Timberland to use the Timberland and tree logo trademarks on
sunglasses, eyewear accessories and ophthalmic frames. The Company contributed
$1.2 million for its 70% interest in Kindling.
Effective September 1, 1998, Kindling sold substantially all of its assets
to Adventure Optics, LLC, a limited liability company majority owned by REM
Optical Company, Inc. and by The Timberland Company and Douglas W. Lauer. The
total purchase price for the assets was $1,008,000 payable in cash and the
assumption of certain liabilities. The Company received $358,000 of the
proceeds from the sale in partial payment of an intercompany loan from
Gargoyles to Kindling. As part of the sale transaction, the license agreement
with The Timberland Company was terminated. $255,000 of the proceeds from the
asset sale were paid to Timberland as a license termination fee. The Company
recorded a charge to earnings of $1,618,000 as a result of the sale of
Kindling's assets and the termination of the Timberland license agreement.
Sungold Transaction
-------------------
In April 1997, the Company acquired Sungold's eyewear business for $10.97
million. In addition, the Company agreed to pay additional amounts equal to
between 2.5% and 7.5% of Sungold's net sales in excess of $7 million in each of
calendar years 1997, 1998 and 1999. In 1998, the additional payment related to
Sungold's 1997 sales totaled $597,447, and as of December 31, 1998, the Company
has accrued $700,000 for the additional payment related to Sungold's 1998 sales
which is payable in 1999. Sungold produces sunglasses under its Anarchy and
Angel brand names and under the Stussy brand name pursuant to the terms of a
license agreement with Stussy, Inc. Sungold also produces a moderate-priced
sunglass line and certain private-label products The license agreement with
Stussy expires on April 30, 2002 with two, five-year options to renew, assuming
certain conditions are met. The Sungold acquisition was funded by working
capital and the proceeds of a bank loan.
Private Eyes Transaction
------------------------
In May 1997, the Company acquired Private Eyes' eyewear business for $8.0
million, after giving affect to a post-closing adjustment. In addition, the
Company agreed to pay up to an additional $2 million, subject to certain net
sales goals to be achieved in 1997, 1998 and 1999. Private Eyes did not meet
the net sales goals for 1997 or 1998. At the time of the acquisition, Private
Eyes manufactured ophthalmic frames, readers and accessories under its Private
Eyes brand and sunglasses, ophthalmic frames, readers and accessories under the
Ellen Tracy Eyewear brand pursuant to a license agreement with Ellen Tracy,
Inc. The Private Eyes acquisition was funded by working capital and the
proceeds of a bank loan.
The Company's Ellen Tracy Eyewear business was unable to support the
minimum royalty and advertising obligations under the Ellen Tracy license
agreement. On September 8, 1998, the Company and Ellen Tracy, Inc. mutually
agreed to terminate the license. As a result of the license termination, the
Company recorded a non-cash charge to earnings of $8.9 million consisting of
(1) a write-down of identifiable intangibles of $1,040,000, (2) impairment of
long-lived assets (goodwill) based on the expected undiscounted cash flows of
the Private Eyes division without the Ellen Tracy sales (which were 75% and 84%
of the total Private Eyes sales in 1998 and 1997, respectively) in the amount
of $7,164,000, and (3) write-off of deferred marketing costs and estimated
sales returns and doubtful accounts associated with the termination of the
Ellen Tracy license in the amount of $704,000.
The London Office
-----------------
In late 1996 the Company opened a sales and marketing office in London to
manage its European sales efforts. The Company's London office was responsible
for approximately 2.9 percent and 2.2 percent of the Company's sales in 1997
and 1998, respectively. A significant portion of the Company's European sales
were comprised of Timberland branded products. Costs associated with the
Company's European operations totaled $2.4 million and $1.1 million in 1997 and
1998, respectively. The Company closed its London office July 31, 1998. As a
result of the London office closing, the Company recorded a charge to earnings
of $476,000 consisting principally of the non-cash write-off of start-up costs
of $279,000 and severance and other closing costs.
License to Aearo Corporation
----------------------------
On October 20, 1998, as part of a structured settlement of the Company's
patent infringement case against Aearo Corporation, the Company granted to
Aearo a license to use the Company's toric-curve patented technology to make
and sell certain otherwise infringing product into certain industrial safety
markets in exchange for a one-time, lump sum royalty payment of $1.2 million.
After deducting expenses associated with the license agreement and allocating a
portion of the royalty payment for periods prior to the settlement date, the
$600,000 balance was recorded as deferred license income and is being amortized
over the three-year estimated remaining economic life of the license.
Golden Bear Golf Agreement
--------------------------
In January 1997, the Company entered into a license agreement with Golden
Bear Golf, Inc. to design, develop and distribute a line of Jack Nicklaus brand
golf sunglasses. Interest in the golf product line had been insufficient to
support the Company's minimum payment obligations under the license agreement,
and in January 1999, the Company reached an agreement with Golden Bear Golf,
Inc. to terminate the license agreement. As a result of the termination of the
Golden Bear Golf Agreement, the Company recognized expense in 1998 of $124,000
and was released from $562,500 of future minimum payments under the license
agreement.
YEAR ENDED DECEMBER 31, 1998 COMPARED TO YEAR ENDED DECEMBER 31, 1997
- ---------------------------------------------------------------------
Net sales
---------
Net sales decreased $4.4 million or 10.7% to 36.6 million for the year
ended December 31, 1998 from $41.0 million for the year ended December 31,
1997. This decrease was primarily the result of lost sales resulting from the
Company's inability to pay for inventory to fill orders, disposition of the
Timberland Eyewear operation, and termination of the Ellen Tracy license
agreement, which were partially offset by increased sales from the Company's
Sungold subsidiary which was acquired in April 1997. Net sales include twelve
months of sales for Sungold in the 1998 period as compared to nine months of
sales in the 1997 period. The Company's net sales also continue to be affected
by returns from Sunglass Hut, the Company's largest customer. Returns from
Sunglass Hut were approximately $1.6 million in 1998 compared to $5.0 million
in 1997. The Company's sales to Sunglass Hut were approximately 14% of net
sales for the year ended December 31, 1998 compared with 21% for the year ended
December 31, 1997.
Gross profit
------------
Gross profit decreased $1.8 million or 8.1% to $20.4 million for the year
ended December 31, 1998 from $22.2 million for the year ended December 31,
1997. Gross margin increased to 55.7% in 1998 from 54.2% in 1997 primarily due
to an increase in the percentage of total sales from the Company's Sungold
subsidiary which sold products in 1998 at margins generally higher than margins
on other Company products.
License income
--------------
License income was $966,000 and $526,000 for the years ended December 31,
1998 and 1997, respectively. This increase was due to a royalty payment of
$1.2 million from Aearo Corporation as part of a structured settlement of the
Company's patent infringement litigation against Aearo. $600,000 of the Aearo
payment was recorded as deferred license income and is being amortized over the
three-year estimated economic life of the license. See "Legal Proceedings" and
Note 1 to the Consolidated Financial Statements.
Operating expenses
------------------
Operating expenses decreased to $27.1 million for the year ended December
31, 1998 from $32.0 million for the year ended December 31, 1997, primarily as
a result of management's cost savings initiatives, including reducing payroll,
closing unprofitable operations, and eliminating unprofitable license
agreements. As a percentage of net sales, operating expenses decreased to
74.1% in 1998 from 77.8% in 1997.
Sales and marketing expenses decreased $5.0 million or 25.4% from $19.4
million in 1997 to $14.4 million in 1998 primarily as a result of closing the
Company's London office, terminating the Ellen Tracy license, reducing national
advertising expenditures, and reducing the number of NASCAR race sponsorships.
As a percentage of net sales, sales and marketing expenses decreased to 39.5%
in 1998 from 47.2% in 1997.
General and administrative expenses decreased 10.8% from $7.9 million in
1997 to $7.0 million in 1998, primarily as a result of the acquisition of
Private Eyes and Sungold, which were purchased in March and April of 1997.
General and Administrative expenses for 1998 include a full 12 months of
expenses for Private Eyes and Sungold as compared to 10 months of expenses for
Private Eyes and 9 months of expenses for Sungold in 1997. As a percentage of
net sales, general and administrative expenses were 19.2% in each of 1998 and
1997.
Shipping and warehousing expenses increased $293,000 or 14.9% in 1998,
primarily as a result of the acquisition of Sungold and Private Eyes. As a
percentage of net sales, shipping and warehousing expenses increased to 6.2% in
1998 as compared to 4.8% in 1997.
Product development costs decreased $597,000 or 44% in 1998, primarily as
a result of changes in the Company's product development processes and
management's cost savings initiatives. As a percentage of net sales, product
development expenses decreased to 2.1% in 1998 from 3.3% in 1997.
Provision for doubtful accounts increased $1.3 million or 97.7% in 1998,
primarily as a result of write off of receivable balances that are no longer
deemed collectible. As a percentage of net sales, provision for doubtful
accounts increased to 7.2% in 1998 from 3.2% in 1997.
Interest expense was $3.3 million for the year ended December 31, 1998 and
was $2.0 million for the year ended December 31, 1997. The increase in 1998
was due primarily to increased levels of indebtedness and the amortization of
related loan fees. See "--Liquidity and Capital Resources."
Loss on disposition of assets and other related costs of $11 million in
1998 include (1) a non-cash charge of $8.9 million related to the write-down of
goodwill, certain intangible assets, deferred marketing costs and other assets
related to the termination of the Ellen Tracy license agreement and related
Ellen Tracy Eyewear business, see Note 15 to Consolidated Financial Statements,
(2) a charge to earnings of $1.6 million resulting from the sale of the assets
of Kindling and the termination of the related Timberland license, see Note 13
to Consolidated Financial Statements, and (3) costs of $476,000 relating to the
closing of the London office, consisting principally of a non-cash write-off of
start-up costs of $279,000, severance and other closing costs. See Note 17 to
Consolidated Financial Statements.
Severance and relocation expenses of $260,000 in 1998 are comprised of
costs associated with the termination of the lease on the Company's Lynnwood,
Washington facility.
Other expenses of $1.2 in 1998 include a $263,000 reserve against certain
notes receivable and guaranteed loans payable related to a former subsidiary; a
gain of $405,000 related to certain notes receivable from the Company's former
president and CEO, compared to an expense in 1997 of $611,000 to fully reserve
the notes receivable; write-off of obsolete production related costs and assets
for discontinued product lines decreased to $289,000 from $720,000 in 1997;
write-off of trade credits decreased to $211,000 in 1998 from $729,000 in 1997.
Additionally, 1998 other expenses included estimated restructuring compensation
and other related contingencies of $652,000 and other expenses of $227,000,
including termination costs associated with endorsement contracts and other
miscellaneous expenses.
Income tax benefit
------------------
The Company's income tax benefit was zero for the years ended December 31,
1998 and 1997. The Company recorded a 100% valuation allowance against its net
tax assets at December 31, 1998 and 1997.
Net loss
--------
As a result of the items discussed above, the Company's net loss was $21.6
million or $2.77 per share for the year ended December 31, 1998 compared to a
net loss of $14.4 million or $1.94 per share for the year ended December 31,
1997.
YEAR ENDED DECEMBER 31, 1997 COMPARED TO YEAR ENDED DECEMBER 31, 1996
- ---------------------------------------------------------------------
Net sales
---------
Net sales increased to $41.0 million for the year ended December 31, 1997
from $33.1 million for the year ended December 31, 1996. This increase was
primarily the result of (1) increased sales of Hobie brand products through
retail channels other than Sunglass Hut, (2) sales of products from the
Company's Sungold and Private Eyes acquisitions which occurred in the second
quarter of 1997 (3) and sales of Timberland Eyewear, introduced in March, 1997.
Sales from these new brands totaled $18.5 million. These increases were offset
by significantly lower sales of Gargoyles brand products. Sales returns from
Sunglass Hut, the Company's largest customer, were approximately $5.0 million
in 1997 compared to $2.5 million in 1996. The Company's sales of all brands to
Sunglass Hut were approximately 21% of net sales for the year ended December
31, 1997 compared with 30% for the year ended December 31, 1996. Sales to
Sunglass Hut by Sungold, Private Eyes and Timberland were 12.5% of the
Company's total sales to Sunglass Hut in 1997. See "Business -- Risk Factors -
- - Dependence on Sunglass Hut."
Gross profit
------------
Gross profit increased to $22.2 million for the year ended December 31,
1997 from $18.9 million for the year ended December 31, 1996. Gross margin
decreased to 54.2% in 1997 from 57.0% in 1996.
License income
--------------
License income was $526,000 and $480,000 for the year ended December 31,
1997 and 1996, respectively.
Operating expenses
------------------
Operating expenses increased to $32.0 million for the year ended December
31, 1997 from $20.0 million for the year ended December 31, 1996. As a
percentage of net sales, expenses increased to 77.8% in 1997 from 60.9% in
1996, which, in 1996, included stock compensation and IPO bonus of $3.8 million
or 11.6% of net sales.
Sales and marketing expenses increased $9.9 million from $9.5 million in
1996 to $19.4 million in 1997 primarily as a result of the acquisitions of
Sungold and Private Eyes, the launch of the Timberland products, the start-up
of the Company's international sales initiatives and increased marketing
expenditures to support the Company's channel diversification strategy. As a
percentage of net sales, sales and marketing expenses increased to 47.2% in
1997 from 28.6% in 1996.
General and administrative expenses increased from $4.2 million in 1996 to
$7.9 million in 1997, primarily as a result of the Sungold and Private Eyes
acquisitions and to support anticipated growth. As a percentage of net sales,
general and administrative expenses increased to 19.2% in 1997 from 12.8% in
1996.
Shipping and warehousing expenses increased $471,000 in 1997, primarily as
a result of the acquisition of Sungold and Private Eyes. As a percentage of
net sales, shipping and warehousing expenses increased to 4.8% in 1997 as
compared to 4.5% in 1996.
Product development costs increased $411,000 in 1997, primarily as a
result of the acquisitions of Sungold and Private Eyes, expanding the Gargoyles
and Hobie lines and developing new Timberland products. As a percentage of
net sales, product development expenses increased to 3.3% in 1997 from 2.9% in
1996.
Provision for doubtful accounts increased to $1.3 million for the year
ended December 31, 1997 from $166,000 for the year ended December 31, 1996,
primarily as a result of a write-off of doubtful accounts that were no longer
deemed collectable. As a percentage of net sales, provision for doubtful
accounts increased to 3.2% in 1997 from 0.5% in 1996.
Stock compensation and IPO bonus for the year ending December 31, 1996
included a nonrecurring, noncash stock compensation charge of $3.8 million
associated with a non-qualified stock option granted to an officer of the
Company and a nonrecurring compensation charge associated with the Company's
initial public offering.
Severance and relocation expenses of $1.3 million in 1997 include
estimated employee severance payments and benefits of $350,000, estimated lease
obligations and other costs associated with the relocation of its Kent,
Washington and Norwalk, Massachusetts facilities of $704,000 and a write-off of
leasehold improvements associated with the relocated facilities of $202,000.
Interest expense was $2.0 million for the years ended December 31, 1997
and 1996. See " -- Liquidity and Capital Resources."
Other expenses of $2.0 million in 1997 include write-offs of obsolete
production related assets of $720,000, a $611,000 reserve against notes
receivable from the Company's former CEO and $729,000 related to write-offs of
trade credits. All such other expenses were incurred in the fourth quarter.
Income tax benefit
------------------
The Company's income tax benefit was zero for the years ended December 31,
1997 and 1996. The Company recorded a 100% valuation allowance against its net
tax assets at December 31, 1997 and 1996.
Net loss
--------
As a result of the items discussed above, the Company's net loss was $14.4
million or $1.94 per share for the year ended December 31, 1997 compared to a
net loss of $2.8 million or $0.47 per share for the year ended December 31,
1996.
LIQUIDITY AND CAPITAL RESOURCES
- -------------------------------
Historically, the Company has relied primarily on cash from operations and
borrowings to finance its operations. In addition, on October 1, 1996, the
Company concluded its initial public offering in which 1,954,465 new shares of
common stock were issued at a price of $16 per share. The initial public
offering raised $27 million in net proceeds for the Company. A portion of
these net proceeds was used to repay $19 million of debt in early October 1996.
At December 31, 1996, the Company had cash and cash equivalents of $4.4
million, current assets of $21.3 million and current liabilities of $5.7
million. The Company had a credit facility of $15 million, under which no
borrowings were outstanding.
In 1997, the Company used $10.9 million of cash in its operating
activities and $21.8 million of cash in its investing activities, primarily to
fund the acquisitions of Sungold and Private Eyes. Cash provided by the
Company's financing activities, which consisted almost exclusively of bank
borrowings, totaled $29.2 million. As of December 31, 1997, the Company had
cash of $900,000, working capital of $11.4 million and bank borrowings of $29.2
million. The Company had no additional borrowings available under its
revolving loan at December 31, 1997.
Cash used in the Company's operating activities in 1998 totaled $7,000
even though the Company's net loss for 1998 was $21.6 million. Included in the
net loss were (1) non-cash expenses of $15.3 million, consisting of a $10.2
million loss on disposition of assets, primarily related to the sale of
Kindling and the disposition of the Ellen Tracy license, (2) a $2.6 million
provision for doubtful accounts, (3) $2.1 million of depreciation and
amortization, and (4) $0.4 million other non-cash expenses. In addition, from
December 31, 1997 to December 31, 1998, the Company reduced accounts receivable
by $3.6 million, reduced inventories by $3.2 million and increased other
current assets, net of a decrease in accounts payable, accrued expenses and
other current liabilities by $0.4 million., thereby generating cash of $6.4
million. Cash used in the Company's investing activities in 1998, primarily
to fund production and office equipment, totaled $104,000. Cash used in the
Company's financing activities, which consisted almost exclusively of bank
repayments, totaled $634,000. As of December 31, 1998, the Company had unused
sources of liquidity of $656,000 consisting of cash of $194,000 and available
bank borrowings of $462,000.
In January 1998, the Company restructured its credit agreement with the
Bank. The amended credit agreement consists of (1) a revolving loan commitment
of up to $14 million, (2) a term loan of $16.47 million and (3) an equipment
loan of $3.9 million, resulting in an additional approximately $5 million
available to the Company during various periods in 1998. In consideration of
the January amendments to the credit agreement, the Company issued 400,000
shares of the Company's common stock to an affiliate of the Bank and agreed to
file a registration statement related to those shares with the Securities and
Exchange Commission. The shares were valued at the time of issuance based on
the market price of the Company's stock on the date of issuance less an
appropriate discount based on the nature of the underlying stock and its
marketability. The common stock was valued at $862,500 and was recorded as
payment of $200,000 in bank fees that were due December 31, 1997 and $662,500
in debt issuance costs.
The credit agreement was further amended (1) on March 17, 1998 to waive
compliance with certain covenants, (2) on March 31, 1998 to reschedule
principal payments and to revise financial covenants, (3) on April 30, 1998 to
defer the filing of a registration statement with respect to the shares of
Company common stock issued to an affiliate of the Bank, (4) on August 13, 1998
to waive certain financial covenants and to revise certain other financial
covenants, (5) on September 17, 1998, to split the Term Note into two Term
Notes, (6) on November 2, 1998 to waive certain financial covenants and to
revise certain other financial covenants, (7) on December 21, 1998 to defer
filing of a registration statement with respect to the shares of Company common
stock issued to an affiliate of the Bank and to defer certain principal
payments under the Equipment Loans and the Term Loans, and (8) on March 5, 1999
to modify the borrowing base until April 30, 1999 to permit the Company to
borrow $1,750,000 in excess of the amount the Company would otherwise be
permitted to borrow based on collateral requirements as set forth in the credit
agreement. All borrowings under the credit agreement are due and payable on
April 30, 1999. The credit agreement also prohibits the Company from paying
dividends to its shareholders.
During 1998, the Company has had difficulty paying suppliers on a timely
basis, and has made arrangements with certain suppliers to provide for payment
schedules for past due amounts and to provide letters of credit for a portion
of the purchase price of future orders. Certain of the Company's suppliers
have filed suit to collect past due payable amounts. No single collection
claim is material, but in the unlikely event all claim amounts should become
payable at one time and not scheduled over a period of time, it would be
difficult or impossible for the Company to make the payment, and the immediate
payment of all the claims would have a material adverse effect on the Company's
results of operations or financial position. See "Legal Proceedings." The
Company's operations have been constrained by cash shortages, which have
resulted in the reduction of inventory purchases and impairment of the
Company's ability to order sufficient inventory of products to fill orders.
The entire outstanding balance of the Company's bank debt of $31.6 million
is due and payable in full on April 30, 1999. The Company will be unable to
pay the bank debt, absent the Company obtaining additional financing through
the sale of equity or convertible debt securities or additional accommodations
by the bank. In October, 1998, the Company entered into an agreement in
principal with a New York investment bank for a transaction which contemplated
a recapitalization of the Company through the sale of equity and subordinated
debt securities and the restructure and refinancing of the Company's senior
credit facility. The parties have been unable to agree on the definitive terms
of the recapitalization transaction, and the transaction has not closed. The
Company is actively seeking alternative sources of capital and is exploring
various options designed to maximize shareholder value, including the possible
sale of equity or convertible debt securities and the restructuring of its bank
facilities to fund working capital. There can be no assurance, however, that
any financing or other source of funds will be available on a timely basis, on
favorable terms or at all.
In addition, management has worked throughout 1998 and continues to work
to reduce expenses to levels that can be sustained by operations . Failure of
operations or expense reduction efforts to meet the Company's expectations,
unanticipated expenses, loss of continued cooperation of the Company's key
suppliers or the bank, third-party claims, or adverse developments in pending
collection litigation, could result in additional cash requirements that could
be difficult or impossible to satisfy and could require the Company to further
reduce its operating expenditures, to curtail certain operations or to dispose
of operating assets to enable it to continue operations.
NET OPERATING LOSS CARRY-FORWARDS
- ---------------------------------
At December 31, 1998, the Company had net operating loss carry-forwards
for federal tax purposes of $28,400,000 to offset future taxable income. The
Company is actively seeking alternative sources of capital and is exploring
various options designed to maximize shareholder value, including the possible
sale of equity or convertible debt securities and the restructuring of its bank
loans to fund working capital. If a change of ownership occurs as a result of
a recapitalization transaction involving the sale of any of the Company's
securities, there may be significant limitations on the use by the Company of
these net operating loss carry-forwards. After a change in control, if the
Company's operations were profitable, any significant limitation on the
Company's use of its net operating loss carry-forwards would result in an
increase in the Company's tax liability and would reduce its net income and
available cash resources. See Note 8 to Consolidated Financial Statements.
SEASONALITY
- -----------
The Company's net sales generally have been higher in the period from
March to September, the period during which sunglass purchases are highest. As
a result, operating income is typically lower in the first and fourth quarters
as fixed operating costs are spread over lower sales volumes. The Company also
experiences higher accounts receivable during March through September as a
result of higher sales during this period. The Company's quarterly results of
operations have fluctuated in the past and may continue to fluctuate as a
result of a number of factors, including seasonal cycles, the timing of new
product introductions, the timing of orders by the Company's customers, the mix
of product sales and the effects of weather conditions on consumer purchases.
See "Business -- Risk Factors - Seasonality of Business."
BACKLOG AND BACKORDERS
- ----------------------
The Company's backlog (which represents all unshipped orders, regardless
of the scheduled shipping date) was $3,201,116 and $4,239,421, at December 31,
1998 and 1997, respectively.
The Company's backorders (which represent orders for merchandise remaining
unshipped beyond its scheduled shipping date) were at $268,147 and $544,918 on
December 31, 1998 and 1997, respectively.
THE YEAR 2000
- -------------
As the Year 2000 approaches, there are uncertainties concerning whether
computer systems and electronic equipment with date functions will properly
recognize date-sensitive information when the year changes to 2000. Systems
that do not properly recognize such information could generate erroneous data
or fail. Due to the Company's reliance on its management information systems,
failure of these systems for any reasons, including Year 2000 noncompliance,
could affect the Company's operations. Management believes, however, that the
Year 2000 does not pose a significant operational problem for the Company.
The Company has established a Year 2000 contingency plan which is being
addressed by a team of internal staff and outside consultants. The team's
activities are designed to ensure that there is no adverse effect on the
Company's core business operations and that transactions with customers,
suppliers, and financial institutions are fully supported. The Company is well
under way with these efforts, which are scheduled to be completed by September
1999. The Company has completed its assessment of its systems in its Kent,
Washington facilities and in its Farmingdale, New York facility.
The Company has initiated and has substantially completed discussions with
its key vendors and customers to assess whether those parties have appropriate
plans to remediate Year 2000 issues where their systems interface with the
Company's systems or otherwise impact its operations. Management believes that
the Company bears little exposure to risk of Year 2000 non-compliance by third
parties.
The Company has determined that it will need to modify or replace certain
portions of its computer hardware and software and of its telephone and voice-
mail hardware and software so that its computer, telephone and communications
systems will function properly with respect to dates in the year 2000 and
beyond. The Company has also completed the upgrade of its telephone systems,
its voice-mail system in Farmingdale, its backup software, and certain of its
PC software upgrades at a cost of less than $15,000. The Company estimates the
total cost of its system upgrades required for Year 2000 compliance will not
exceed $125,000.
In view of the subtlety of the problem and the unfamiliarity with the
scope of the problems by many in the business community, there can be no
assurance that the Company, or its critical vendors or customers, will not
encounter some form of computer or service failures at or after midnight on
December 31, 1999 which could result in disruption of the Company's business,
perhaps materially so, to the Company's detriment. See "Business -- Risk
Factors -- Possible Business Disruption from Computer Application Failure at
Year 2000."
EFFECT OF RECENTLY ISSUED ACCOUNTING STANDARDS
- ----------------------------------------------
Recent accounting pronouncements having relative applicability to the
Company are described in the Company's consolidated financial statements. The
adoption of the accounting pronouncements is not expected to have a material
impact on the Company's financial position, results of operations, or cash
flow.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
- ----------------------------------------------------
<TABLE>
INDEX TO FINANCIAL STATEMENTS
<CAPTION>
Page
Number
<S> <C>
Report of BDO Seidman, LLP, Independent Auditors...................... 28
Report of Ernst & Young LLP, Independent Auditors..................... 29
Gargoyles, Inc. Consolidated Financial Statements
Consolidated Balance Sheets....................................... 30
Consolidated Statements of Operations............................. 31
Consolidated Statements of Shareholders' Equity................... 32
Consolidated Statements of Cash Flows............................. 33
Notes to Consolidated Financial Statements........................ 34
Schedule II
Consolidated Valuation and Qualifying Accounts.................... 51
</TABLE>
<PAGE>
REPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS
To the Board of Directors and Shareholders
Gargoyles, Inc.
We have audited the accompanying consolidated balance sheet of Gargoyles, Inc.
and subsidiaries ("the Company") as of December 31, 1998, and the related
consolidated statements of operations, shareholders' equity, and cash flows for
the year ended December 31, 1998. Our audit also included the financial
statement schedule listed in the Index at Item 14(a). These financial
statements and schedule are the responsibility of the Company's management.
Our responsibility is to express an opinion on these financial statements and
schedule based on our audit. The financial statements of the Company for the
years ended December 31, 1997 and 1996 were audited by other auditors, whose
report dated April 2, 1998 expressed an unqualified opinion on those
statements.
We conducted our audit in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to
obtain reasonable assurance about whether the financial statements and schedule
are free of material misstatement. An audit includes examining, on a test
basis, evidence supporting the amounts and disclosures in the financial
statements and schedule. An audit also includes assessing the accounting
principles used and significant estimates made by management, as well as
evaluating the overall presentation of the financial statements and schedule.
We believe that our audit provides a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the financial position of Gargoyles, Inc. and
subsidiaries at December 31, 1998, and the related consolidated results of
their operations and their cash flows for the year ended December 31, 1998, in
conformity with generally accepted accounting principles. Also, in our
opinion, the related financial statement schedule presents fairly, in all
material respects, the information set forth therein.
The accompanying financial statements have been prepared assuming the Company
will continue as a going concern. As discussed in Note 1 to the financial
statements, the Company has experienced recurring net operating losses and has
a net worth and working capital deficiency. Further, the Company has been
unable to raise adequate capital to currently fulfill its obligations to its
trade creditors and to satisfy its bank obligations which are due and payable
April 30, 1999. These conditions raise substantial doubt about the Company's
ability to continue as a going concern. Management's plans concerning these
matters are also described in Note 1. The consolidated financial statements do
not include any adjustments that might result from the outcome of this
uncertainly.
BDO Seidman, LLP
Seattle, Washington
April 2, 1999
<PAGE>
REPORT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS
The Board of Directors and Shareholders
Gargoyles, Inc.
We have audited the accompanying consolidated balance sheet of Gargoyles, Inc.
as of December 31, 1997 and the related consolidated statements of operations,
shareholders' equity, and cash flows for the years ended December 31, 1997 and
1996. Our audits also included the financial statement schedule listed in the
index at Item 14(a) relating to the years ended December 31, 1997 and 1996.
These financial statements and schedule are the responsibility of the Company's
management. Our responsibility is to express an opinion on these financial
statements and schedule based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to
obtain reasonable assurance about whether the financial statements are free of
material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements. An audit
also includes assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall financial
statement presentation. We believe that our audits provide a reasonable basis
for our opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the consolidated financial position of
Gargoyles, Inc. at December 31, 1997, and the related consolidated results of
its operations and its cash flows for the years ended December 31, 1997 and
1996, in conformity with generally accepted accounting principles. Also, in
our opinion, the related financial statement schedule, when considered in
relation to the basic financial statements taken as a whole, presents fairly,
in all material respects, the information set forth therein.
Seattle, Washington
April 2, 1998
<PAGE>
<TABLE>
GARGOYLES, INC.
CONSOLIDATED BALANCE SHEETS
<CAPTION>
A S S E T S
December 31,
1998 1997
------------- -------------
<S> <C> <C>
Current assets:
Cash and cash equivalents $ 194,314 $ 892,176
Trade receivables, net 2,251,226 10,526,980
Inventories 8,558,276 13,057,024
Other current assets and prepaid expenses 2,031,261 1,792,124
------------ ------------
Total current assets 13,035,077 26,268,304
Property and equipment, net 1,510,333 2,441,133
Intangibles, net 13,004,935 21,232,817
Other assets 457,599 671,411
------------ ------------
Total assets $ 28,007,944 $ 50,613,665
============ ============
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 5,923,196 $ 6,487,131
Accrued expenses and other current
liabilities 7,130,212 8,389,147
Current maturities of long-term debt 28,526,379 -
------------ ------------
Total current liabilities 41,579,787 14,876,278
Long-term debt, net of current maturities - 29,160,554
Deferred License Income 600,000
Shareholders' equity:
Preferred stock - -
Common stock, no par value, authorized shares
-- 40,000,000, issued and outstanding
-- 7,822,191 and 7,437,191, respectively 26,529,282 25,711,782
Accumulated (deficit) (40,735,481) (19,121,995)
Translation adjustment 34,356 (12,954)
------------ ------------
Total shareholders' equity (14,171,843) 6,576,833
------------ ------------
Total liabilities and shareholders' equity $ 28,007,944 $ 50,613,665
============ ============
See accompanying notes to the Consolidated Financial Statements.
</TABLE>
<PAGE>
<TABLE>
GARGOYLES, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
<CAPTION>
Year Ended December 31,
---------------------------------------------
1998 1997 1996
------------ ------------- ------------
<S> <C> <C> <C>
Net sales $ 36,606,338 $ 40,997,127 $ 33,094,398
Cost of sales 16,225,550 18,796,571 14,230,682
------------ ------------- ------------
Gross profit 20,380,788 22,200,556 18,863,716
License income 965,622 526,462 479,609
------------ ------------- ------------
21,346,410 22,727,018 19,343,325
------------ ------------- ------------
Costs and expenses:
Sales and marketing 14,441,482 19,370,213 9,480,986
General and administrative 7,033,120 7,884,281 4,233,136
Shipping and warehousing 2,252,618 1,960,022 1,489,117
Product development 761,041 1,358,420 946,992
Provision for doubtful
accounts 2,629,525 1,329,864 166,150
Stock compensation and
IPO bonus - - 3,833,140
Interest, net 3,336,957 1,974,005 1,987,812
Loss on disposition of
assets and related 11,007,968 - -
Severance and relocation 260,425 1,256,083 -
Other 1,236,760 1,975,931 -
------------ ------------ ------------
Net loss $(21,613,486) $(14,381,801) $ (2,794,008)
============ ============ ============
Basic and diluted net loss
per share $(2.77) $(1.94) $(.47)
============ ============ ============
Weighted average common
shares used in the
calculation of basic and
diluted net loss per share 7,812,890 7,428,055 5,946,360
============ ============ ============
See accompanying notes to the Consolidated Financial Statements.
</TABLE>
<PAGE>
<TABLE>
GARGOYLES, INC.
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
<CAPTION>
Common Stock Deferred
------------------------ Accumulated Compensation
Shares Amount (Deficit) and Other Total
---------- ------------ ------------- ------------ -------------
<S> <C> <C> <C> <C> <C>
Balance at December 31, 1995 5,450,003 $(5,107,430) $ (1,946,186) $ (150,000) $ (7,203,616)
Sale of warrant - 56,000 - - 56,000
Stock issued in connection
with Acquisition 14,540 80,040 - - 80,040
Deferred compensation
related to Amendment of
stock options - 3,378,140 - (3,378,140) -
Stock compensation - - - 3,528,140 3,528,140
Stock issued in Company's
Initial public offering 1,954,465 27,236,826 - - 27,236,826
Net loss for the year ended
December 31, 1996 - - (2,794,008) - (2,794,008)
--------- ----------- ------------ ---------- ------------
Balance at December 31, 1996 7,419,008 25,643,576 (4,740,194) - 20,903,382
Stock options exercised 18,183 68,206 - - 68,206
Translation adjustment - - - (12,954) (12,954)
Net loss for the year ended
December 31, 1997 - - (14,381,801) - (14,381,801)
--------- ----------- ------------ ---------- ------------
Balance at December 31, 1997 7,437,191 25,711,782 (19,121,995) (12,954) 6,576,833
Stock issued in connection
with restructure of
credit agreement 400,000 862,500 - - 862,500
Stock redemption for former CEO (15,000) (45,000) - - (45,000)
Translation adjustment - - - 47,310 47,310
Net loss for the year ended
December 31, 1998 - - (21,613,486) - (21,613,486)
--------- ----------- ------------ ---------- ------------
Balance at December 31, 1998 7,822,191 $26,529,282 $(40,735,481) $ 34,356 $(14,171,843)
========= =========== ============ ========== ============
See accompanying notes to the Consolidated Financial Statements.
</TABLE>
<PAGE>
<TABLE>
GARGOYLES, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
<CAPTION>
Year Ended December 31,
---------------------------------------------
1998 1997 1996
------------- ------------- ------------
<S> <C> <C> <C>
OPERATING ACTIVITIES
- --------------------
Net loss $(21,613,486) $(14,381,801) $(2,794,008)
Adjustments to reconcile
net loss to net cash used
in operating activities:
Stock compensation - - 3,528,140
Depreciation 781,457 1,109,884 571,422
Amortization 1,300,321 817,121 204,360
Deferred income and other 44,000 (360,000) (180,000)
Provision for doubtful
accounts 2,629,525 1,329,864 166,150
Severance, relocation
and other expenses 352,831 2,620,173 (89,802)
Loss on disposition of
assets and related 10,165,276 - -
Changes in assets and
liabilities net of
effects from business
acquisitions and
dispositions:
Trade receivable 3,593,100 151,117 (6,254,920)
Inventories 3,166,398 (4,948,762) 690,152
Other current assets
and other assets (451,484) 422,380 (798,293)
Accounts payable, accrued
expenses and other
current liabilities 25,215 2,294,171 207,957
------------ ----------- ------------
Net cash used in
operating activities (6,847) (10,945,853) (4,748,842)
------------ ----------- ------------
INVESTING ACTIVITIES
- --------------------
Acquisition of property
and equipment (104,150) (1,411,021) (1,407,875)
Business acquisitions:
Purchase of Private Eyes - (8,616,304) -
Purchase of Sungold - (11,732,500) -
Purchase of Hobie - - (3,974,900)
------------ ----------- ------------
Net cash used in
investing activities (104,150) (21,759,825) (5,382,775)
------------ ----------- ------------
FINANCING ACTIVITIES
- --------------------
Proceeds from stock issuance - 68,206 27,236,826
Proceeds from issuance of
long-term debt - 14,870,000 5,240,000
Principal payments on
long-term debt - (185,137) (12,607,145)
Net proceeds (repayment) under
revolving line of credit (634,175) 14,475,691 (5,412,916)
Proceeds from warrant
issuance - - 56,000
------------ ----------- ------------
Net cash provided by (used
in) financing activities (634,175) 29,228,760 14,512,765
------------ ----------- ------------
Effect of foreign
currency translation 47,310 (12,954) -
------------ ----------- ------------
Net increase (decrease) in
cash and cash equivalents (697,862) (3,489,872) 4,381,148
Cash and cash equivalents,
beginning of year 892,176 4,382,048 900
------------ ----------- ------------
Cash and cash equivalents,
end of year $ 194,314 $ 892,176 $ 4,382,048
============ =========== ============
Supplemental Disclosures of
non-cash investing and
financing activities
Common stock issued for
other than cash $ 862,500 $ - $ 80,040
Common stock redemption $ 45,000 $ - $ -
See accompanying notes to the Consolidated Financial Statements.
</TABLE>
<PAGE>
GARGOYLES, INC.
----------------
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR EACH OF THE THREE YEARS IN THE PERIOD ENDED DECEMBER 31, 1998
1. SIGNIFICANT ACCOUNTING POLICIES
- -----------------------------------
Basis of Presentation
- ---------------------
The consolidated financial statements are presented in accordance with
generally accepted accounting principles applicable to a going concern, which
principles contemplate, among other things, realization of assets and payment
of liabilities in the normal course of business. Gargoyles, Inc. ("Gargoyles"
or the "Company") incurred significant operating losses in 1998 and has a net
working-capital deficit of $28.5 million and a tangible net worth deficit of
$27 million at December 31, 1998. The Company was unable to make a scheduled
payment on its bank debt in December 1997, and at the Company's request, its
banking arrangements were restructured in early 1998. The Company also has
had difficulty paying suppliers on a timely basis and has made arrangements
with certain suppliers to provide for unsecured promissory notes and payment
schedules for past due amounts and to provide letters of credit for a portion
of the purchase price of future orders.
The Company is exploring various options designed to maximize shareholder
value, including the possible sale of equity or convertible debt securities and
the restructuring of its bank facilities to fund working capital. The
Company's bank debt is due on April 30, 1999. In addition, management is
seeking to reduce expenses to levels that can be sustained by operations.
However, there can be no assurance that the Company will be successful in its
strategy to reduce costs, in its efforts to raise additional capital or secure
additional debt financing. The consolidated financial statements do not give
effect to adjustments, if any, that may be necessary should the Company be
unable to continue as a going concern and therefore realize its assets and
liquidate its liabilities in other than the normal course of business and at
amounts different from those shown in these consolidated financial statements.
Principal Industry
- ------------------
The Company designs, manufactures and markets a broad range of sunglasses
and eyewear products. The Company's products are sold mainly through sunglass
specialty, sport specialty, department and optical stores. The Company
subcontracts certain of its manufacturing processes. Management believes there
are adequate alternative sources for these services should an existing
subcontractor be unable to perform. Its corporate headquarters and main
warehouse are located in Kent, Washington.
Principles of Consolidation
- ---------------------------
The consolidated financial statements include the accounts of the Company
and its subsidiaries. All significant intercompany balances have been
eliminated in consolidation. Included in the consolidation are H.S.C., Inc.
("Hobie"), Sungold Eyewear, Inc. ("Sungold"), and Private Eyes Sunglass
Corporation ("Private Eyes"), all of which are wholly-owned subsidiaries of the
Company. Also included in periods prior to September 1, 1998 is the kindling
company ("Kindling"), 70% of which is owned by the Company. Effective
September 1, 1998, Kindling disposed of its operations (see Note 13).
Cash and Cash Equivalents
- --------------------------
The Company considers all highly liquid investments with original maturities
of three months or less when purchased to be cash equivalents.
Inventories
- -----------
Inventories are stated at the lower of cost (first-in, first-out method) or
market and consist of direct materials, direct labor, and packaging and freight
charges. Inventories are shown net of reserves established for obsolete or
slow-moving items.
Property and Equipment
- ----------------------
Property and equipment are stated at cost, net of accumulated depreciation
and amortization. Significant additions and improvements are capitalized.
Maintenance and repairs are expensed as incurred. The Company provides for
depreciation and amortization using the straight-line method which recognizes
the cost over the estimated useful lives of the respective assets, ranging from
3 to 7 years, or, as to leasehold improvements, the term of the related lease,
if less than the estimated useful life.
Revenue Recognition
- -------------------
Revenue is recognized when merchandise is shipped to a customer. As
necessary, the Company defers revenue related to contractual obligations with
certain customers. The Company records sales net of volume and cash discounts.
Trade receivables are shown net of an allowance for doubtful accounts of
$920,916 and $820,503 at December 31, 1998 and 1997, respectively.
License Income
- --------------
On October 20, 1998, as part of a structured settlement of the Company's
patent infringement case against Aearo Corporation, the Company granted to
Aearo a license to use the Company's toric-curve patented technology to make
and sell certain otherwise infringing product into certain industrial safety
markets in exchange for a one-time, lump sum royalty payment of $1.2 million.
After deducting expenses associated with the license agreement and allocating a
portion of the royalty payment for periods prior to the settlement date, the
$600,000 balance was recorded as deferred license income and is being amortized
over the three-year estimated remaining economic life of the license.
Warranties
- ----------
The Company's products are covered by a warranty against defects in material
and workmanship. The Company has established a reserve for these anticipated
future warranty costs.
Advertising Expense
- -------------------
The cost of advertising is expensed as incurred. The Company incurred
$1,324,092, $2,858,517 and $380,671 in advertising costs during the years ended
December 31, 1998, 1997 and 1996, respectively.
Income Taxes
- ------------
The Company accounts for income taxes under the liability method, whereby
deferred taxes are provided for the temporary differences between the financial
reporting basis and the tax basis of the Company's assets and liabilities.
These deferred tax assets and liabilities are measured under the provisions of
currently enacted tax laws. To the extent it is considered more likely than
not that all of the Company's deferred tax assets will not be realized, a
valuation allowance is recorded to reduce the deferred tax asset to its net
realizable value.
Concentration of Credit Risk and Financial Instruments
- -------------------------------------------------------
The Company sells its products to local and national companies and
distributors throughout the United States and internationally. Net sales to
the Company's largest customer represented 14%, 21% and 30% of net sales for
the years ended December 31, 1998, 1997 and 1996, respectively. The Company
performs ongoing credit evaluations of its customers and generally does not
require collateral. The Company maintains an allowance for doubtful accounts
at a level which management believes is sufficient to cover potential credit
losses.
The carrying value of financial instruments, which include cash,
receivables, payables and debt, approximates market value at December 31, 1998.
Foreign Currency
- ----------------
The Company translates the assets and liabilities of its London, United
Kingdom operations at rates of exchange in effect at year end. Revenues,
expenses, and cash flows of the operation are translated at the average rates
of exchange during the year. Gains and losses resulting from translation of
the London branch balance sheet are accumulated as a separate component of
shareholders' equity.
Stock-Based Compensation
- ------------------------
The Company grants stock options for a fixed number of shares to employees,
with an exercise price equal or greater than the fair value of the shares at
the time of grant. The Company has elected to apply the disclosure only
provisions of Financial Accounting Standards No. 123, "Accounting for Stock-
Based Compensation" ("Statement No. 123"). Accordingly, the Company accounts
for stock-based compensation using the intrinsic value method prescribed in
Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to
Employees," and related interpretations. Compensation costs for stock options
are measured at the excess, if any, of the fair value of the Company's common
stock at the date of the grant over the stock option price. Pro forma net loss
information has been disclosed in Note 11.
Earnings Per Share
- ------------------
In 1997, the Financial Accounting Standards Board (FASB) issued Statement of
Financial Accounting Standards No. 128, "Earnings per Share" ("Statement No.
128"). Statement No. 128 replaced the calculation of primary and fully diluted
earnings per share with basic and diluted earnings per share. Unlike primary
earnings per share, basic earnings per share excludes the dilutive effects of
options, warrants and convertible securities. Diluted earnings per share is
similar to previously reported fully diluted earnings per share. Earnings per
share amounts for all periods have been presented and, where necessary,
restated to conform to Statement No. 128 requirements and SEC Staff Accounting
Bulletin No. 98. For purposes of calculating diluted earnings per share,
common stock equivalents have not been included as the effect would be
antidilutive.
Impairment of Long-lived Assets
- -------------------------------
In March 1995, the Financial Accounting Standards Board (FASB) issued
Statement of Financial Accounting Standards No. 121, "Accounting for the
Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed Of"
("Statement No. 121"). Management has evaluated the potential permanent
impairment of the net carrying value of certain long-term assets. For each
asset evaluated, the expected undiscounted cash flows have been compared to the
respective asset's net carrying value. Except for those assets written off as
discussed in Note 17, in all cases where evaluation was performed, the expected
undiscounted cash flows exceeded the net carrying value of the assets.
Accordingly, an impairment as defined by Statement No. 121 does not exist and
no loss has been recognized.
Use of Estimates
- ----------------
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the amounts reported in the financial statements and
accompanying notes. Actual results could differ from those estimates.
Reclassification
- ----------------
Certain reclassifications have been made to the prior years' financial
statements to conform to the current year presentation.
2. INVENTORIES
- ---------------
Inventories consist of the following:
<TABLE>
<CAPTION>
December 31,
-------------------------------
1998 1997
----------- ------------
<S> <C> <C>
Materials $ 4,204,151 $ 7,119,328
Finished Goods 4,934,896 7,909,147
Reserves for excess, slow-moving
and obsolete inventories (580,771) (1,971,451)
------------ -------------
Inventories, net $ 8,558,276 $ 13,057,024
============ =============
</TABLE>
3. OTHER CURRENT ASSETS AND PREPAID EXPENSES
- ----------------------------------------------
Other current assets and prepaid expenses consist of the following:
<TABLE>
<CAPTION>
December 31,
-------------------------------
1998 1997
------------ ------------
<S> <C> <C>
Prepaid expenses $ 1,055,675 $ 959,004
Other receivables 33,159 166,245
Income tax refund receivable 160,217 160,217
Deposits 70,125 26,791
Trade credits 100,000 311,049
Note receivable from former CEO 405,610 -
Other 206,475 168,818
------------ ------------
$ 2,031,261 $ 1,792,124
============ ============
</TABLE>
4. PROPERTY AND EQUIPMENT
- ---------------------------
Property and equipment consist of the following:
<TABLE>
<CAPTION>
December 31,
------------------------------
1998 1997
----------- -----------
<S> <C> <C>
Molds and production equipment $ 1,526,227 $ 1,668,557
Office furniture and equipment 1,650,127 1,766,796
Exhibit and marketing equipment 426,496 403,483
Transportation equipment 24,718 24,718
Leasehold improvements 87,562 85,337
------------ ------------
3,715,130 3,948,891
Accumulated depreciation
and amortization (2,204,797) (1,507,758)
------------ ------------
Property and equipment, net $ 1,510,333 $ 2,441,133
=========== ============
</TABLE>
5. INTANGIBLES
- ----------------
Intangible assets primarily result from business acquisitions and consist
of costs in excess of fair value of net assets acquired (which include
trademarks, tradenames and goodwill), licensing and management agreements and
non-compete agreements. These costs are amortized on a straight-line basis
over periods of 2 to 25 years.
<TABLE>
<CAPTION>
December 31,
------------------------------
1998 1997
----------- -----------
<S> <C> <C>
Costs in excess of fair market
value of net assets acquired $11,547,636 $18,289,188
Licensing and management
agreements 2,805,470 3,709,069
Non-compete agreements - 216,000
------------ ------------
14,353,106 22,214,257
Accumulated amortization (1,348,171) (981,440)
------------ ------------
Intangibles, net $13,004,935 $21,232,817
============ ============
</TABLE>
6. ACCRUED EXPENSES AND OTHER CURRENT LIABILITIES
- --------------------------------------------------
Accrued expenses and other current liabilities consist of the following:
<TABLE>
<CAPTION>
December 31,
----------------------------
1998 1997
---------- ----------
<S> <C> <C>
Payroll taxes and benefits $ 794,841 $1,316,688
Acquisition and other obligations 700,000 1,274,829
Relocation and closing costs 166,004 751,362
Interest 208,859 695,452
Marketing royalties and other 515,506 679,767
Deferred income - 556,000
Liability for sales reserve 500,000 1,986,860
Vendor notes payable
(8% interest, unsecured) 2,327,179 -
Other 1,917,823 1,128,189
----------- -----------
$7,130,212 $8,389,147
=========== ===========
</TABLE>
7. DEBT
- --------
Long-term debt consisted of the following:
<TABLE>
<CAPTION>
December 31,
-----------------------------
1998 1997
------------ ------------
<S> <C> <C>
Revolving loan payable to bank, bearing
interest at prime (8.00% and 8.50% at
December 31, 1998 and 1997, respectively),
interest due monthly. $ 8,344,841 $ 14,475,691
Note payable to bank, bearing interest
at prime rate plus 0.75% (8.75% and
9.25% at December 31, 1998 and 1997,
respectively), interest due monthly. 13,000,000 10,970,000
Note payable to bank, bearing interest
at prime rate plus 0.75% (8.75% at
December 31, 1998), interest due monthly. 3,470,000 -
Notes payable to bank, bearing interest
at prime rate plus 0.25%, (8.25% and
8.75% at December 31, 1998 and 1997,
respectively), interest due monthly. 3,467,500 3,467,500
Notes payable to bank, bearing interest
at prime rate plus 0.25%, (8.25% and
8.75% at December 31, 1998 and 1997,
respectively), interest due monthly. 244,038 247,363
----------- -----------
Total long-term debt (all amounts are
due on April 30, 1999) 28,526,379 $29,160,554
=========== ===========
</TABLE>
The Company had approximately $462,000 additional borrowings available
under its revolving loan at December 31, 1998.
The Company had $388,122 outstanding under letters of credit at December
31, 1998.
In January 1996, the Company borrowed $290,000 at 12% per annum from
officers and shareholders. The loans were repaid in full with interest as of
April 1996.
In January 1998, the Company restructured its credit agreement with the
Bank. The amended credit agreement consists of (1) a revolving loan commitment
of up to $14 million, (2) a term loan of $16.47 million and (3) an equipment
loan of $3.9 million, resulting in an additional approximately $5 million
available to the Company during various periods in 1998. In consideration of
the January amendments to the credit agreement, the Company issued 400,000
shares of the Company's common stock to an affiliate of the Bank and agreed to
file a registration statement related to those shares with the Securities and
Exchange Commission. The shares were valued at the time of issuance based on
the market price of the Company's stock on the date of issuance less an
appropriate discount based on the nature of the underlying stock and its
marketability. The common stock was valued at $862,500 and was recorded as
payment of $200,000 in bank fees that were due December 31, 1997 and $662,500
in debt issuance costs.
The credit agreement was further amended (1) on March 17, 1998 to waive
compliance with certain covenants, (2) on March 31, 1998 to reschedule
principal payments and to revise financial covenants, (3) on April 30, 1998 to
defer the filing of a registration statement with respect to the shares of
Company common stock issued to an affiliate of the Bank, (4) on August 13, 1998
to waive certain financial covenants and to revise certain other financial
covenants, (5) on September 17, 1998, to split the Term Note into two Term
Notes, (6) on November 2, 1998 to waive certain financial covenants and to
revise certain other financial covenants, (7) on December 21, 1998 to defer
filing of a registration statement with respect to the shares of Company common
stock issued to an affiliate of the Bank and to defer certain principal
payments under the Equipment Loans and the Term Loans, and (8) on March 5, 1999
to modify the borrowing base until April 30, 1999 to permit the Company to
borrow $1,750,000 in excess of the amount the Company would otherwise be
permitted to borrow based on collateral requirements as set forth in the credit
agreement. All borrowings under the credit agreement are due and payable on
April 30, 1999. Substantially all the assets of the Company are pledged as
collateral for the repayment of borrowings under the revised Credit Agreement.
The credit agreement also prohibits the Company from paying dividends to its
shareholders.
The Company will not be able to repay the bank loans on their April 30,
1999 maturity date, absent the Company obtaining additional financing through
the sale of equity or debt securities or additional accommodations by the bank,
but there can be no assurance that such financing will be available on a timely
basis, on favorable terms or at all.
The Company made interest payments totaling $2,821,715, $1,599,857, and
$1,809,505 during the years ended December 31, 1998, 1997 and 1996,
respectively.
8. INCOME TAXES
- -----------------
The difference between the income tax provision (benefit), all of which is
current, based upon the federal statutory income tax rate and the income tax
provision (benefit) recorded in the financial statements is attributable to the
following:
<TABLE>
<CAPTION>
Year Ended December 31,
--------------------------------------------
1998 1997 1996
------------ ------------ ----------
<S> <C> <C> <C>
Income tax benefit at federal
statutory rate (34%) $(7,348,000) $(4,890,000) $(950,000)
Change in deferred tax
valuation allowance 4,467,200 4,861,000 996,900
Goodwill, amortization and
losses on disposition of
assets 3,081,000
Other (200,200) (29,000) (46,900)
------------ ------------ ----------
$ - $ - $ -
============ ============ ==========
</TABLE>
Deferred income taxes reflect the net tax effects of temporary differences
between the bases of assets and liabilities for financial reporting purposes
and the bases used for income tax return purposes. Significant components of
the Company's deferred tax liabilities and assets are as follows:
<TABLE>
<CAPTION>
December 31,
--------------------------------
1998 1997
------------- -------------
<S> <C> <C>
Deferred tax liabilities:
Tax over book depreciation $ (21,600) $ (52,200)
Amortization of intangibles - (106,000)
Other (3,600) (4,000)
------------ -----------
Total deferred tax liabilities $ (25,200) $ (162,200)
------------ -----------
Deferred tax assets:
Net operating loss carry-forwards 9,666,000 4,092,700
Deferred compensation - -
Sales return allowance 170,000 675,500
Inventory valuation allowance 299,500 820,200
Deferred license income 204,000 189,000
Allowance for doubtful accounts 349,700 485,100
Accrued lease obligations 14,100 205,200
Accrued severance - 119,000
Accrued vacation 68,600 48,200
Warranty reserves 61,200 61,200
Other 158,100 164,900
------------ -----------
Total deferred tax assets 10,991,200 6,861,000
------------ -----------
Net deferred taxes $ 10,966,000 $ 6,698,800
============ ===========
Valuation allowance $(10,966,000) $(6,698,800)
============ ===========
</TABLE>
At December 31, 1998, the Company had net operating loss carry-forwards of
approximately $28,400,000, which expire in 2012. The Company is actively
seeking alternative sources of capital and is exploring various options
designed to maximize shareholder value, including the possible sale of equity
or convertible debt securities and the restructuring of its bank facilities to
fund working capital. If a change of ownership occurs as a result of a
recapitalization transaction involving the sale of any of the Company's
securities and/or a restructure of the Company's bank debt, there may be
significant limitations on the use by the Company of these net operating loss
carry-forwards.
No income tax payments were made during the years ended December 31, 1998,
1997 and 1996.
9. COMMITMENTS AND CONTINGENCIES
- ---------------------------------
Lease Agreements
- ----------------
Since 1994, the Company has been leasing its primary operating and office
premises under a non-cancelable operating lease, expiring in March 2000. Terms
of this lease include 4% annual rental payment increases. The owner of these
premises is a current shareholder and the former majority owner of Gargoyles.
Rent expense under this lease totaled $240,972, $231,702 and $222,798 for the
years ended December 31, 1998, 1997 and 1996, respectively.
During 1998, the Company leased additional office and warehouse space
under a non-cancelable lease expiring in August 2000. Terms of this lease
require monthly rental payments of $13,400. In connection with the Company's
1997 acquisition of Sungold, the Company assumed a non-cancelable operating
lease expiring November 2001 for office and warehouse space requiring monthly
payments of approximately $17,000.
In 1998, the Company negotiated releases from and vacated certain of its
operating leases, thereby decreasing its minimum future lease payments under
non-cancelable operating leases. The Company recognized $260,000 of expense in
connection with the termination of these leases. These expenses were included
in severance and relocation expense in the consolidated statements of
operations.
Minimum future lease payments under non-cancelable operating leases as of
December 31, 1998 are as follows:
<TABLE>
<CAPTION>
Year Ending
December 31,
------------
<S> <C> <C>
1999 $ 700,812
2000 518,617
2001 377,153
2002 94,566
2003 7,881
Thereafter 0
----------
$1,699,029
==========
</TABLE>
Endorsement and Licensing Agreements
- ------------------------------------
The Company enters into endorsement contracts from time to time with
certain athletes and others to promote the Company's products. The Company has
also entered into license agreements with the owners of the Hobie and Stussy
brands and into an exclusive distribution agreement for Emmanuelle Khanh
eyewear. The license agreements include royalty payments of 2% to 10% of net
sales, minimum payments based on net sales and annual minimum advertising
expenditures.
In 1998 the Company negotiated terminations of and releases from certain
licensing agreements. Effective September 1, 1998, the Company and The
Timberland Company agreed to terminate the license agreement under which the
Company sold and distributed Timberland Eyewear. As a result of the
termination, the Company was released from $3.4 million minimum future payments
under the Timberland license agreement. To terminate the license, the Company
paid a termination fee of $255,000 to The Timberland Company. On September 8,
1998, the Company and Ellen Tracy, Inc. agreed to terminate the license
agreement under which the Company sold and distributed Ellen Tracy Eyewear. As
a result of the termination, the Company was released from $8.8 million minimum
future payments under the Ellen Tracy license agreement. On January 8, 1999,
the Company and Golden Bear Golf, Inc. agreed to terminate the license under
which the Company was developing Jack Nicklaus golf sunglasses. As a result of
the termination, the Company paid Golden Bear Golf a termination fee and was
released from $562,500 minimum future payments under the Golden Bear Golf
agreement. On February 2, 1999, the Company, Ken Griffey, Jr. and Douglas B.
Hauff, the Company's former president and chief executive officer, entered into
an agreement regarding the termination of the license agreement, and any
amendments thereto, under which the Company used Mr. Griffey's name to market
and sell its Gargoyles Performance Eyewear products. Under the terms of the
February 1999 agreement, Mr. Hauff agreed to assume the obligations of the
Company to Mr. Griffey under the license agreement, and the parties settled
disputes and mutually released claims related to the license agreement. The
assumption of the Company's obligations to Griffey and the release of claims
from Griffey were valued by the Company, in the aggregate, at $200,000.
Minimum annual payments under these agreements are as follows:
<TABLE>
<CAPTION>
Year Ending Endorsement License
December 31, Contracts Agreements
----------- ----------- ------------
<S> <C> <C> <C>
1999 $315,763 $ 344,639
2000 159,700 358,223
2001 112,500 372,344
2002 - 387,024
2003 and thereafter 146,762
-------- ----------
$587,963 $1,608,992
======== ==========
</TABLE>
Litigation
- ----------
On November 18, December 4 and December 9, 1998 the State of Washington
Department of Revenue assessed the Company, in the aggregate, $475,830 plus
interest in business and occupation taxes and use taxes allegedly due and
payable related to the Company's operations during various periods between
January 1, 1993 and June 30, 1997. At issue in this matter is the Company's
status as a "manufacturer" or "wholesaler" as such terms are defined by the
state of Washington's business and occupation and use tax statutes. The Company
has retained counsel in this matter and intends to appeal and to vigorously
defend the Department's assessment.
On May 11, 1998, Morris Rosenbloom & Co., Inc. filed an action against the
Company in the Supreme Court of the State of New York for Wayne County, under
Index No. 44010. In the lawsuit, plaintiff alleges breach of contract due to
the Company's failure to accept a return of sunglasses under the terms of a
Repurchase Agreement between Morris Rosenbloom and the Company. Plaintiff
claims damages from the Company in excess of $500,000. The Company has
retained counsel to represent it in this matter and intends to defend
vigorously the plaintiff's claims. The Company believes that the ultimate
resolution of this matter will not have a material adverse effect on its
results of operations or financial position.
The Company also is a party to various other claims, complaints and legal
actions that have arisen in the ordinary course of business from time to time.
The Company believes that the outcome of all such pending legal proceedings, in
the aggregate, will not have a material adverse effect on its results of
operations or financial position.
10. EMPLOYEE BENEFIT PLAN
- --------------------------
The Company maintains a 401(k) savings plan for all full-time employees
age 21 or older with one year of service. The maximum employee contribution is
15% of the participant's compensation. The Company matches 50% of each dollar
contributed by a participant, with a maximum matching contribution of 3% of a
participant's earnings. The Company's contributions to the plan vest over six
years and totaled $103,372, $91,864 and $72,288 for the years ended December
31, 1998, 1997 and 1996, respectively.
11. SHAREHOLDERS' EQUITY
- -------------------------
Restated Articles of Incorporation
- ----------------------------------
On August 29, 1996, the Company's Board of Directors approved a stock
dividend in the amount of 4.45 shares for every one share of common stock
outstanding, thereby giving effect to a 5.45-to-1 stock split payable on August
29, 1996. On August 28, 1996, the Company filed its Restated Articles of
Incorporation to increase the number of authorized shares to 40,000,000 shares
of common stock and 10,000,000 shares of `blank-check" preferred stock. The
Board of Directors of the Company has the authority to fix and determine the
designations, preferences, limitations and relative rights attributable to such
preferred shares.
Initial Public Offering
- -----------------------
On October 2, 1996, the Company concluded its initial public offering in
which 1,954,465 new shares of common stock were issued at a price of $16 per
share. The initial public offering raised $27 million in net proceeds for the
Company. A portion of these net proceeds were used to repay $19 million of
debt in October, 1996.
Stock Options
- -------------
In March 1995, the Company established the 1995 Stock Incentive
Compensation Plan (the "Plan") that provided for the granting of incentive and
nonqualified options to purchase up to 286,844 shares of common stock. In
September 1996, the Company amended the plan to provide for the granting of
options to purchase up to 817,500 shares of common stock. Generally, options
granted vest over a four-year period. Certain options require acceleration of
vesting if specific operational goals are achieved. Options under this plan
have been granted at prices equal to or greater than the estimated fair value
on the date of grant and expire after ten years. The plan expires in 2005.
Pro forma information regarding net income and earnings per share is
required by Statement No. 123, and has been determined as if the Company had
accounted for its employee stock options under the fair value method of that
Statement. The fair value for these options was estimated at the date of grant
using a Black-Scholes multiple option pricing model with the following weighted
average assumptions for 1998, 1997 and 1996, respectively: risk-free interest
rates of 5.41%, 5.71% and 6.21%, expected volatility range for the Company's
common stock of 2.02%, 29.6% and 38.6%, dividend yield of 0.0% and a weighted
average expected option life of 5 years. The Black-Scholes option valuation
model was developed for use in estimating the fair value of traded options
which have no vesting restrictions and are fully transferable. In addition,
option valuation models require the input of highly subjective assumptions
including the expected stock price volatility. Because the Company's employee
stock options have characteristics significantly different from those traded
options, and because changes in the subjective input assumptions can materially
affect the fair value estimate, in management's opinion, the existing models do
not necessarily provide a reliable single measure of the fair value of its
employee stock options and are not likely to be representative of the effects
on reported net income for future periods.
For purposes of pro forma disclosures, the estimated fair value of the
options is amortized to expense over the options' vesting period. The
Company's pro forma information follows:
<TABLE>
<CAPTION>
Year Ended December 31,
--------------------------------------------
1998 1997 1996
------------ ------------- ------------
<S> <C> <C> <C>
Reported net loss $(21,613,486) $(14,381,801) $(2,794,008)
Pro forma net loss (22,156,766) (14,800,010) (3,056,547)
Reported loss per share (2.77) (1.94) (0.47)
Pro forma loss per share (2.83) (1.99) (0.51)
</TABLE>
The following table summarizes the activity under the Plan.
<TABLE>
<CAPTION>
Weighted Average
Options Option Price Exercise Price
Outstanding per Share Per Share
------------ --------------- -----------------
<S> <C> <C> <C>
Outstanding
December 31, 1995 451,379 $3.48 - $ 5.50 $ 3.68
Granted 44,785 $7.34 - $16.00 $12.59
Outstanding
December 31, 1996 496,164 $3.48 - $16.00 $ 4.48
Granted 205,626 $7.13 - $ 9.38 $ 8.56
Cancelled (67,274) $3.48 - $16.00 $10.16
Exercised (18,183) $3.48 - $ 5.50 $ 3.75
---------
Outstanding
December 31, 1997 616,333 $3.48 - $16.00 $ 5.05
Granted 236,500 $1.72 - $ 2.53 $ 2.30
Cancelled (498,427) $1.72 - $ 9.13 $ 4.88
---------
Outstanding
December 31, 1998 354,406 $1.72 - $16.00 $ 3.46
=========
</TABLE>
The weighted average fair value of options granted using the Black-Sholes
multiple option pricing model is $2.20, $3.60, and $4.89 in 1998, 1997 and
1996, respectively.
The following table summarizes information about stock options outstanding
under the Plan at December 31, 1998.
<TABLE>
<CAPTION>
Options Outstanding Options Exercisable
----------------------------------- ------------------------
Weighted
Weighted Average Weighted
Average Exercise Average
Remaining Price Exercise
Exercise Price Number Contractual Per Number Price
Per Share Outstanding Life Share Exercisable Per Share
- -------------- ------------ ---------- ---------- ------------ ----------
<S> <C> <C> <C> <C> <C>
$1.72 - $ 4.58 273,053 8.31 $2.50 185,054 $2.65
$5.50 - $ 8.00 29,652 7.29 $6.48 21,147 $6.32
$8.63 - $16.00 51,701 8.20 $9.09 42,245 $9.16
------- -------
$1.72 - $16.00 354,406 8.21 $3.46 248,446 $4.07
======= =======
</TABLE>
In January 1996, an outside member of the Company's Board of Directors
purchased a warrant for $56,000. The warrant provides for the issuance of
38,150 shares of common stock at a price of $4.58 per share. The warrant can
be exercised any time prior to December 2005.
Recapitalization
- ----------------
In connection with a change in control of the Company, on March 22, 1995,
the Company sold 3,270,003 shares to a group of new investors, including
certain members of the Company's senior management. Proceeds from the sale
were $5,387,498. On the same date, 3,270,000 previously issued and outstanding
shares were repurchased by the Company from the former majority shareholder for
$10,895,500. The redemption was funded with the proceeds from the stock
issuance and bank financing of $6,000,000. Proceeds in excess of redemption
requirements provided additional working capital. In connection with this
recapitalization, the Company recorded a charge of $573,710 relating primarily
to severance, legal and other costs.
In connection with the recapitalization of Gargoyles, Antone was merged
into Gargoyles. Antone was wholly owned by the former majority owner of
Gargoyles. Antone provided assembly operations for Gargoyles. The merger was
accounted for as a pooling of interests due to common ownership, and financial
statements for all periods prior to the recapitalization have been restated to
reflect the pooling.
Prior to the recapitalization of the Company, the President held an option
to purchase up to 10% of the outstanding shares of Gargoyles stock from the
former majority shareholder. In connection with the recapitalization, the new
shareholders of the Company assumed the option and amended certain provisions
of the option agreement. As a result of the amendments, the Company recorded
deferred compensation of $400,000, equal to the difference between the
estimated fair market value of the stock at the date of the recapitalization
and the option price of $0.91 per share. The amount was being amortized over
the option vesting period.
Also in connection with the recapitalization, the new shareholders granted
the President an additional nonqualified option to purchase 136,250 shares of
common stock owned by the new shareholders at an exercise price of $4.58 per
share. In June 1996, in contemplation of the Company's initial public
offering, the options were further amended to accelerate the vesting and to
extend the expiration date to June 28, 2006. As a result, the remaining
balance of $150,000 from the initial $400,000 deferred compensation was
expensed and Gargoyles recognized an additional nonrecurring, non-cash stock
compensation charge in the second quarter of 1996 of $3.4 million. Total stock
compensation expense related to these agreements of $3.5 million is reflected
as a component of operating expenses for the year ended December 31, 1996.
12. ACQUISITION OF HOBIE
- -------------------------
On February 13, 1996, Gargoyles purchased all of the issued and
outstanding stock of H.S.I., a California corporation d/b/a Hobie Polarized
Sunglasses. Hobie was the manufacturer of Hobie Polarized Sunglasses under an
exclusive license agreement for use of the name Hobie on sunglasses.
The acquisition has been accounted for using the purchase method of
accounting from the date of acquisition. Accordingly, the allocation of the
purchase price of $3,974,900, of which $3,380,014 was paid in cash, has been
based on the fair value of the assets acquired and liabilities assumed.
Included in the purchase price are consulting service fees of $300,000 paid to
two of Hobie's former shareholders. As consideration for certain non-
competition covenants, the Company paid an aggregate of $200,000 in 12 monthly
installments and issued an aggregate of 14,540 shares of its common stock to
two of Hobie's former shareholders. Costs in excess of the fair market value
of assets and liabilities acquired are reflected as intangibles, the most
significant component of which is the Hobie license agreement, which was
amortized over the remaining 27-year license period of the Hobie brand name.
Pro forma information, assuming the acquisition had occurred at the
beginning of the period presented, is as follows:
<TABLE>
<CAPTION>
Year Ended
December 31, 1996
-----------------
<S> <C>
Sales $33,405,000
Gross profit 19,495,000
Net loss (2,951,000)
Net loss per share (0.48)
</TABLE>
13. INVESTMENT IN THE KINDLING COMPANY
- ---------------------------------------
In May 1996, the Company formed Kindling, a majority-owned subsidiary, to
design, develop, manufacture and distribute sunglasses and ophthalmic frames
under the Timberland brand name. The Company contributed $1,200,000 for its
70% interest in Kindling. The Company was also required to contribute an
additional $300,000 to Kindling's capital if Kindling deems such additional
amount necessary and makes a demand prior to January 1, 2000. The Company
further agreed that certain key employees of Kindling may be granted up to an
aggregate of 10% of Kindling's common stock owned by the Company upon
achievement of certain operating objectives. For the year ended December 31,
1996, the Company incurred $299,338 in net operating expenses used to fund
start-up activities of Kindling. Included in the Company's operations were
Kindling's operating losses of approximately $579,000, $477,000 and $299,000
for the periods ended September 1, 1998, December 31, 1997 and 1996,
respectively.
Effective September 1, 1998, Kindling sold substantially all of its assets
to Adventure Optics, LLC, a limited liability company majority owned by REM
Optical Company, Inc. and by The Timberland Company and Douglas W. Lauer. The
total purchase price for the assets was $1,008,000, payable in cash and the
assumption of certain liabilities. The Company received $358,000 of the
proceeds from the sale in partial payment of an intercompany loan from
Gargoyles to Kindling. As part of the sale transaction, the license agreement
with The Timberland Company was terminated. $255,000 of the proceeds from the
asset sale were paid to Timberland as a license termination fee. The Company
recorded a charge to earnings of $1,618,000 as a result of the sale of
Kindling's assets and the termination of the Timberland license agreement.
14. ACQUISITION OF SUNGOLD
- ---------------------------
On April 11, 1997, the Company purchased substantially all the assets and
assumed certain liabilities of Sungold Enterprises, LTD., a New York
corporation ("Sungold"). Sungold manufactured two principal lines of premium
sunglasses, Stussy EyeGear, a young men's fashion brand licensed to Sungold by
Stussy, Inc., a leading designer of streetwear apparel and accessories, and
Anarchy Eyewear, a cutting-edge brand popular with alternative sports
enthusiasts age 15 to 25.
The acquisition was accounted for using the purchase method of accounting.
The total purchase price of $11,700,000 was allocated to the purchased assets
based on the fair value of the assets acquired and liabilities assumed. Costs
in excess of the fair market value of assets acquired and liabilities assumed
are reflected as intangibles and include trademarks, tradenames, non-
competition agreements, license and distribution agreements and goodwill, which
were amortized over various periods not exceeding 25 years. Included in the
agreement are royalty payments due to the seller if certain net sales and gross
margin targets are achieved in each of the years ending December 31, 1997, 1998
and 1999. Such royalty payments are to be made on the first day of April in
the following calendar year and are reflected as adjustments to the purchase
price. The Company paid a royalty payment of $600,000 in 1998 for 1997
operating results and at December 31, 1998 has accrued $700,000 for the royalty
payment due for 1998 operating results.
Pro forma information, assuming the acquisition had occurred at the
beginning of the periods presented, is as follows:
<TABLE>
<CAPTION>
Year Ended
December 31,
----------------------------
1997 1996
------------ ------------
<S> <C> <C> <C>
Sales $45,258,314 $46,498,986
Gross profit 26,376,028 27,338,423
Net loss (13,823,188) (2,640,425)
Net loss per share (1.86) (.44)
</TABLE>
15. ACQUISITION OF PRIVATE EYES
- --------------------------------
On May 14, 1997, the Company purchased substantially all the assets and
assumed certain liabilities of Private Eyes. Private Eyes was the licensee for
Ellen Tracy eyewear, which features a collection of high-quality, high-fashion
women's sunglasses, readers, optical frames and accessories in a variety of
designs ranging from traditional to fashion-forward. Private Eyes was also the
North American distributor for Emmanuelle Khanh Paris Eyewear and a designer
and distributor of its own line of prescription frames and eyewear accessories.
The acquisition was accounted for using the purchase method of accounting.
The total purchase price of $8,000,000 was allocated to the purchased assets
based on the fair value of the assets acquired and liabilities assumed. Costs
in excess of the fair market value of assets acquired and liabilities assumed
are reflected as intangibles. Included in the agreement are contingent
payments due to the seller if certain net sales and gross margin targets are
achieved in each of the years ending December 31, 1997, 1998 and 1999. Such
contingent payments are to be made within 55 days following the calendar year.
Private Eyes did not achieve its goals under the contingent price agreement in
1997 or 1998.
Pro forma information, assuming the acquisition had occurred at the
beginning of the periods presented, is as follows:
<TABLE>
<CAPTION>
Year Ended
December 31,
----------------------------
1997 1996
------------ ------------
<S> <C> <C> <C>
Sales $43,225,564 $41,599,624
Gross profit 25,095,094 23,323,068
Net loss (14,275,353) (2,691,098)
Net loss per share (1.92) (.45)
</TABLE>
The Company's Ellen Tracy Eyewear business was unable to support the
minimum royalty and advertising obligations under the Ellen Tracy license
agreement. On September 8, 1998, the Company and Ellen Tracy, Inc. mutually
agreed to terminate the license. As a result of the license termination, the
Company recorded a charge to earnings of $8.9 million consisting of:
<TABLE>
<S> <C> <C>
Write-down of identifiable intangibles -
Ellen Tracy license $ 1,040,000
Impairment of long-lived assets (goodwill)
based on the expected undiscounted cash flows
of the Private Eyes division without the
Ellen Tracy sales. Ellen Tracy product
sales accounted for 84% and 75% of the total
Private Eyes sales in 1997 and 1998. 7,164,000
Write-off of deferred marketing costs and
estimated sales returns and doubtful accounts
associated with the termination of the
Ellen Tracy license 704,000
-----------
$ 8,908,000
===========
</TABLE>
16. RELATED PARTY TRANSACTIONS
- -------------------------------
Prior to 1996, the Company had advanced funds to Conquest Sports, Inc.
("Conquest," formerly Pro-Tec, Inc.), an affiliate with similar shareholders as
the Company prior to the initial public offering. In addition, the Company
guaranteed certain liabilities of Conquest. Conquest incurred losses in 1995
and Company management concluded that it is likely Conquest will be unable to
meet its obligations. Accordingly, in the fourth quarter of 1995, the Company
recorded a provision related to Conquest in the amount of $1,597,051. At
December 31, 1998, Conquest has approximately $195,000 outstanding on a loan
with a bank which is secured by a note receivable from the purchaser of certain
assets of Conquest and guaranteed by the Company.
On February 24, 1996, adidas America, Inc. ("Adidas") filed a complaint
against the Company and others related to products sold by Adidas to Axcent
Sports, Inc., a related party. Pursuant to an Indemnity Agreement dated
September 26, 1996, a shareholder of the Company and its then President agreed,
jointly and severally, to indemnify and hold harmless the Company from any
losses related to the Adidas litigation. A settlement of the litigation was
reached and the indemnitors paid $200,000 in exchange for a full release of the
Company and all of its affiliates.
On July 24, 1997 the Company advanced funds to its then President and
Chief Executive Officer, Douglas B. Hauff, as evidenced by a promissory note
for $118,000, related to an indemnity obligation resulting from a dispute
between the Company and Adidas. The note was secured by 15,000 shares of the
Company's stock and matured on July 25, 1998. As part of a severance agreement
between the Company and Mr. Hauff, the note was forgiven and the outstanding
principal balance as well as accrued interest thereon was written off as of
December 31,1997. The 15,000 shares of the common stock of the Company
securing the transaction were transferred to the Company.
On April 9, 1997, the Company advanced funds to its then President and
Chief Executive Officer, Douglas B. Hauff, as evidenced by a promissory note in
favor of the Company in original principal amount of $531,299 plus interest at
the rate of 4.75% per annum, relating to an individual income tax payment
resulting from the exercise of a non-qualified stock option. During his
employment with the Company, the Company from time to time had advanced funds
to Mr. Hauff, as evidenced by a second promissory note dated March 11, 1998, in
favor of the Company in original principal amount of $56,307 together with
interest thereon at the rate of 5.75% per annum (the April 1997 note and the
February 1999 note being referred to herein as the "Hauff Notes"). The Hauff
Notes were due on February 15, 1999 and were fully reserved at December 31,
1998. Pursuant to an agreement dated February 2, 1999, Mr. Hauff paid the
Hauff Notes by (1) paying the Company cash in the amount of $185,000, (2)
waiving certain COBRA payments in the amount of $1,330, (3) assigning to the
Company a non-interest bearing promissory note from Trillium Corporation in the
amount of $95,000 payable August 14, 2000 (the "Assigned Note"), (4) executing
and delivering to the Company of a new promissory note in original amount of
$32,500 plus interest at 8% per annum, with a maturity date of August 31, 2001
(the "New Hauff Note"), and (5) assuming certain obligations of the Company to
Ken Griffey, Jr. under a License Agreement dated October 30, 1995 between Mr.
Griffey and the Company which the Company valued at $200,000. The Company has
reserved all but $20,000 of the Assigned Note and New Hauff Note at December
31, 1998.
In 1997 and during first eight months of 1998, the Company provided
shipping and receiving, customer service, accounting, administrative support
and operations management to Kindling at no cost to Kindling.
The Company had $600, $62,227 and $86,368 due from employees at December
31, 1998, 1997 and 1996, respectively.
17. LOSS ON DISPOSITION OF ASSETS AND OTHER RELATED COSTS
- ----------------------------------------------------------
The Company recognized net expense of $11 million in the year ended
December 1998, related to the loss on disposition of assets and other related
costs including, (1) a non-cash charge of $8.9 million related to the write-
down of goodwill, certain intangible assets, deferred marketing costs and other
assets related to the termination of the Ellen Tracy License Agreement and
related Ellen Tracy Eyewear business, see Note 15, and (2) a charge to earnings
of $1.6 million resulting from the sale of the assets of Kindling and the
termination of the related Timberland license, see Note 13.
London Office
- -------------
In late 1996 the Company opened a sales and marketing office in London to
manage its European sales efforts. The Company's London office was responsible
for approximately 2.9 percent and 2.2 percent of the Company's sales in 1997
and in 1998, respectively. A significant portion of the Company's European
sales were comprised of Timberland branded products. Costs associated with the
Company's European operations totaled $2.4 million and $1.1 million in 1997 and
1998, respectively. The Company closed its London office July 31, 1998. As a
result of the London office closing, the Company recorded a charge to earnings
of $476,000, consisting principally of the non-cash write-off of start-up costs
of $279,000, severance and other closing costs.
18. SEVERANCE, RELOCATION AND OTHER EXPENSES
- ---------------------------------------------
Severance, relocation and other expenses for the year ended December 31,
1998 totaled $1.5 million compared to $3.3 million in 1997. Estimated lease
obligations and other costs associated with the relocation of its Kent,
Washington and Norwalk, Massachusetts facilities were $260,000 in 1998,
compared to $704,000 in 1997. Estimated employee severance payments and
benefits were $0 in 1998, compared to $350,000 in 1997; write-offs of leasehold
improvements associated with the relocated facilities were also $0 in 1998,
compared to $201,000 in 1997. Also included is $263,000 to establish reserves
against certain notes receivable and guaranteed loans payable related to a
former subsidiary; a gain of $405,000 related to certain notes receivable from
the Company's former president and CEO, compared to an expense in 1997 of
$611,000 to fully reserve the notes receivable; write-off of obsolete
production related costs and assets for discontinued product lines decreased to
$289,000 from $720,000 in 1997; write-off of trade credits decreased to
$211,000 in 1998 from $729,000 in 1997. Additionally, included in 1998
expenses were estimated restructuring compensation and other related
contingencies of $652,000 and other expenses of $227,000 including termination
costs associated with endorsement contracts and other miscellaneous expenses.
<PAGE>
<TABLE>
CONSOLIDATED VALUATION AND QUALIFYING ACCOUNTS
FOR THE YEARS ENDED DECEMBER 31, 1996, 1997 AND 1998
<CAPTION>
Balance at Charged to Balance at
Beginning Costs and End of
of Period Expense Deductions Period
----------- ----------- ------------ -----------
<S> <C> <C> <C> <C>
DOUBTFUL ACCOUNTS
- -----------------
For the year ended December 31, 1996
Allowance for doubtful accounts $ 10,355 $ 269,633 $ (107,388) $ 172,600
========== ========== =========== ==========
For the year ended December 31, 1997
Allowance for doubtful accounts $ 172,600 $1,075,560 $ (427,657) $ 820,503
========== ========== =========== ==========
For the year ended December 31, 1998
Allowance for doubtful accounts $ 820,503 $2,807,390 $(2,706,977) $ 920,916
========== ========== =========== ==========
OBSOLETE, SLOW-MOVING AND EXCESS INVENTORY
- ------------------------------------------
For the year ended December 31, 1996
Inventory Reserve $ 100,000 $ 736,000 $ (454,850) $ 381,150
========== ========== =========== ==========
For the year ended December 31, 1997
Inventory Reserve $ 381,150 $2,539,341 $ (949,040) $1,971,451
========== ========== =========== ==========
For the year ended December 31, 1998
Inventory Reserve $1,971,451 $ 405,657 $(1,796,337) $ 580,771
========== ========== =========== ==========
SALES RETURNS
- --------------
For the year ended December 31, 1996
Sales Return Reserve $ 210,000 $ 568,440 $ (361,717) $ 416,723
========== ========== =========== ==========
For the year ended December 31, 1997
Sales Return Reserve $ 416,723 $3,212,294 $(1,642,157) $1,986,860
========== ========== =========== ==========
For the year ended December 31, 1998
Sales Return Reserve $1,986,860 $2,755,520 $(4,242,380) $ 500,000
========== ========== =========== ==========
</TABLE>
<PAGE>
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURES
- --------------------------------------------------------------------------
On February 23, 1999, the client-auditor relationship between the Company
and its principal accountants, Ernst & Young LLP, ceased. The resignation of
Ernst & Young LLP was effective on February 23, 1999. At a meeting held on
February 22, 1999, the Board of Directors of the Company approved the
engagement of BDO Seidman, LLP as its independent auditors to replace Ernst &
Young LLP who also resigned as auditors of the Company effective February 23,
1999. The Audit Committee of the Board of Directors approved the change on
February 22, 1999.
The audit reports of Ernst & Young LLP on the financial statements of the
Company for the Company's last two fiscal years did not contain an adverse
opinion or disclaimer of opinion, nor was either opinion qualified or modified
as to uncertainty, audit scope, or accounting principles. During registrant's
two most recent fiscal years and the subsequent interim periods preceding such
termination, there have been no disagreements with Ernst & Young LLP on any
matter of accounting principles or practices, financial statement disclosure,
or auditing scope or procedure, which disagreements, if not resolved to the
satisfaction of Ernst & Young LLP, would have caused it to make reference to
the subject matter of the disagreements in connection with its report. There
have occurred no "reportable events" within the meaning of Item 304(a)(1)(v) of
Regulation S-K during registrant's two most recent fiscal years and the
subsequent interim periods preceding such termination.
During the registrant's two most recent fiscal years, and the subsequent
interim period prior to engaging BDO Seidman, LLP, neither the registrant nor
someone on its behalf consulted BDO Seidman, LLP regarding (1) either the
application of accounting principles to a specified transaction, either
completed or proposed; or the type of audit opinion that might be rendered on
the registrant's financial statements, and neither a written report was
provided to registrant nor oral advice provided that BDO Seidman, LLP concluded
was an important factor considered by the registrant in reaching a decision as
to an accounting, auditing or financial reporting issue; or (2) any matter that
was either the subject of a disagreement (as defined in paragraph 304(a)(1)(iv)
of Regulation S-K and the related instructions to this item) or a reportable
event (as described in paragraph 304(a)(1)(v) of Regulation S-K).
<PAGE>
PART III.
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
- -------------------------------------------------------------
The directors and executive officers of the Company, and their ages as of
March 31, 1999, are as follows:
<TABLE>
<CAPTION>
Name Age Position
<S> <C> <C>
Leo Rosenberger 48 Chief Executive Officer, Chief
Financial Officer and Treasurer
Cynthia L. Pope 47 Vice President and General Counsel
and Secretary
Sheldon Goldman 36 President, Sungold
Robert G. Wolfe (1) 42 Chairman of the Board
Timothy C. Potts (1) 50 Director
William D. Ruckelshaus (2) 66 Director
Paul S. Shipman (2) 46 Director
Walter F. Walker (1) 44 Director
- --------------------------
(1) Member of the Audit Committee of the Board of Directors.
(2) Member of the Compensation Committee of the Board of Directors.
</TABLE>
The Company's Board of Directors is comprised of five directors and is
divided into three classes. Each director serves for a three-year term, and
one class will be elected each year by the Company's shareholders. Directors
hold office until their terms expire and their successors are elected and
qualified. Executive officers of the Company are appointed by, and serve at
the direction of, the Board of Directors. There are no family relationships
between any of the directors or executive officers of the Company.
LEO ROSENBERGER, Chief Executive Officer and Chief Financial Officer,
joined the Company in February 1998. From January 1996 to January 1998, Mr.
Rosenberger was President and Chief Financial Officer of Pacific Linen, Inc.
Pacific Linen, Inc. filed a voluntary petition for Chapter 11 bankruptcy in
April 1996 and emerged therefrom in December 1997. In May 1995, Mr.
Rosenberger was appointed by the court as the Chapter 7 Trustee in Bankruptcy
for Waterbed, Inc.. From August 1994 to February 1995 Mr. Rosenberger served
as interim Chief Financial Officer of Jay Jacobs, Inc., a company which filed a
voluntary petition for Chapter 11 bankruptcy protection in May 1994 and emerged
therefrom in November 1995. Mr. Rosenberger was a general partner in a
national accounting and consulting firm and has over twenty years experience as
a turnaround crisis manager and financial restructuring and management
consultant.
CYNTHIA L. POPE joined the Company in February 1998. From July 1995 until
joining the Company, Ms. Pope had a private law practice in Bellingham,
Washington and served as corporate counsel to the Company. From June 1992
until July 1996, Ms. Pope was a partner in the law firm of Brett & Daugert in
Bellingham, Washington. From June 1989 until June 1992 Ms. Pope was an
associate with the law firm of Bogle & Gates in Seattle, Washington. From
January 1985 until June 1989, Ms. Pope was an associate with the law firm of
Ross & Hardies in Chicago, Illinois.
SHELDON GOLDMAN, President of Sungold, joined the Company in April 1997
with the acquisition of Sungold. From 1992 until joining the Company, Mr.
Goldman was President and part owner of Sungold Enterprises, Ltd. From 1985
to 1992 Mr. Goldman was Vice President of Sungold Enterprises, Ltd.
ROBERT G. WOLFE was appointed by the board of directors of the Company in
January 1998 as a Director and as Chairman of the Board of Directors on an
interim basis until the 1998 annual meeting of the Company's shareholders.
Since February 1999, Mr. Wolfe has served as President of GT Group Telecom,
Inc. Mr. Wolfe was Chief Financial Officer of Trillium Corporation from 1996
to December 1998. From 1987 to 1995, Mr. Wolfe was a corporate finance
executive at Goldman Sachs. Mr. Wolfe serves as a director of Trillium
Corporation, GT Group Telecom, Inc., Babylon Entertainment, and RODI Power
Systems, Inc.
TIMOTHY C. POTTS has been a Director of the Company since March 1995.
Mr. Potts has been Senior Vice President--Finance of Trillium since July 1994.
From April 1987 to July 1994, Mr. Potts was the Chief Financial Officer of
Trillium.
WILLIAM D. RUCKELSHAUS has been a Director of the Company since July 1996.
Since March 1996, Mr. Ruckelshaus has been a principal of the Madrona
Investment Group, L.L.C., a private investment firm. Mr. Ruckelshaus is also
Chairman of the Board of Browning-Ferris Industries, Inc., a waste services
company, and from October 1988 to October 1995 was its Chief Executive Officer.
From 1983 to 1985, Mr. Ruckelshaus was Administrator of the Environmental
Protection Agency and from 1979 to 1983, a Senior Vice President of
Weyerhaeuser Co. Mr. Ruckelshaus is also a director of Cummins Engine Co.,
Monsanto Company, Nordstrom, Inc. and Weyerhaeuser Co.
PAUL S. SHIPMAN has been a Director of the Company since June 1996.
Mr. Shipman has been President since September 1981, Chairman of the Board
since November 1992 and Chief Executive Officer since June 1993 of Redhook Ale
Brewery, Incorporated ("Redhook"), a brewer of craft beers.
WALTER F. WALKER has been a Director of the Company since December 1995.
Since September 1994, Mr. Walker has been the President of the Seattle
Supersonics National Basketball Association basketball team, owned by a
subsidiary of Ackerley Communications, Inc. From March to September 1994, he
was President of Walker Capital, Inc., a money management firm. From July 1987
to March 1994, Mr. Walker was a Vice President of Goldman, Sachs & Co., a
registered broker-dealer. From 1976 to 1985, Mr. Walker was a professional
basketball player in the National Basketball Association. Mr. Walker is also a
director of Redhook and Interpoint Corporation.
ITEM 11. EXECUTIVE COMPENSATION
- --------------------------------
Information regarding executive compensation is incorporated by reference
from the Company's 1999 Proxy Statement for its 1999 Annual Meeting of
Shareholders (the "1999 Proxy Statement") under the caption "Executive
Compensation".
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
- ------------------------------------------------------------------------
Information regarding security ownership of certain beneficial owners and
management is incorporated by reference from the 1999 Proxy Statement under the
caption "Beneficial Ownership of Shares".
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
- --------------------------------------------------------
Information regarding certain relationships and related transactions is
incorporated by reference from the 1999 Proxy Statement under the caption
"Certain Transactions".
PART IV.
ITEM 14. EXHIBITS, FINANCIAL STATEMENTS AND REPORTS ON FORM 8-K
- ----------------------------------------------------------------
(A) FINANCIAL STATEMENTS AND FINANCIAL STATEMENT SCHEDULES
See Index to Consolidated Financial Statements on Page 27.
(B) REPORTS ON FORM 8-K
Form 8-K with respect to the sale of assets of the Company's majority-
owned subsidiary, the kindling company, was filed with the Securities and
Exchange Commission on September 8, 1998.
Form 8-K with respect to an agreement in principal with respect to a
proposed transaction for a recapitalization of the Company was filed with
the Securities and Exchange Commission on November 5, 1998.
(C) EXHIBITS
The following exhibits are filed as a part of, or incorporated by
reference into, this report:
<TABLE>
<S> <C>
3.1 (1) Form of Amended and Restated Articles of Incorporation of the
registrant currently in effect.
3.2 (1) Bylaws of the registrant currently in effect.
10.1 (1) Stock Purchase Agreement, dated as of March 14, 1995, among
Gargoyles and certain other parties.
10.2 (1) Nondisclosure, Noncompetition and Indemnity Agreement, dated as
of March 22, 1995, among Gargoyles, Inc., Conquest Sports, Inc.,
Antone Manufacturing, Inc. and the Founder.
10.3 (1) Stock Purchase Agreement, dated as of January 25, 1996, among
Gargoyles, Inc., H.S.C., Inc., Douglas B. Hauff, H.S.I., a
California corporation, dba Hobie Sunglasses and the Sellers
listed therein.
10.4 (1) Industrial Real Estate Lease (Single Tenant Facility), dated
December 16, 1993, between Gargoyles, Inc. and DB&D Partnership.
10.5 (1) Lease Amendment, dated as of March 17, 1995, between Gargoyles,
Inc. and DB&D Partnership.
10.6 (1) + Gargoyles, Inc. Common Stock Purchase Warrant, dated January
1996, between Gargoyles, Inc. and Wally Walker.
10.7 (1) + Form of Indemnity Agreement between Gargoyles, Inc. and each of
its directors.
10.8 (1) + 1995 Stock Incentive Compensation Plan.
10.9 (1) Amended and Restated Agreement Regarding Claim Rights, dated
July 3, 1996, by and between the Founder, Gargoyles, Inc. and
Conquest Sports, Inc.
10.10* (1) Ratification of Settlement Agreement and General Release, dated
April 12, 1995.
10.11* (1) Trademark License Agreement dated as of April 12, 1995.
10.12* (1) License Agreement, effective January 1, 1989, between Hobie
Designs, Inc. and H.S.I.
10.13* (1) License Agreement, dated as of May 31, 1996, among Ixela, Inc.,
Alexi Lalas and Gargoyles, Inc.
10.14 (2) Indemnity Agreement, dated September 26, 1996, by Trillium
Corporation and Douglas B. Hauff in favor of Gargoyles.
10.15 (3) Agreement, dated January 9, 1997, between Gargoyles and
International Speedway Corporation.
10.16 (3) Registration Rights Agreement, dated February 20, 1997, between
Gargoyles and Douglas B. Hauff.
10.17 (3) Registration Rights Agreement, dated February 20, 1997, between
Gargoyles and Trillium Investors II.
10.18 (4) First Amended and Restated Credit Agreement, dated April 7,
1997, between U.S. Bank of Washington, National Association and
Gargoyles, Inc.
10.19 (5) Second Amendment to First Amended and Restated Credit Agreement,
dated July 15, 1997, between U.S. Bank of Washington, National
Association, and Gargoyles, Inc.
10.20 (6) Third Amendment to First Amended and Restated Credit Agreement,
dated January 15, 1998, between U.S. Bank of Washington,
National Association, and Gargoyles, Inc.
10.21 (6) Fourth Amendment to First Amended and Restated Credit Agreement,
dated January 30, 1998, between U.S. Bank of Washington,
National Association, and Gargoyles, Inc.
10.22 (6) Fifth Amendment to First Amended and Restated Credit Agreement,
dated March 17, 1998, between U.S. Bank of Washington, National
Association, and Gargoyles, Inc.
10.23 (6) Promissory Note, dated April 9, 1997, between Douglas B. Hauff
in favor of Gargoyles, Inc.
10.24 (7) Asset Purchase and Sales Agreement, dated as of April 10, 1997,
between Sungold Enterprises, Ltd., Sheldon Goldman, Lionel
Goldman and Lionel Goldman, Trustee of The Lionel Goldman Family
Trust u/a, dated September 30, 1994, and Gargoyles Acquisition
Corporation (n/k/a Sungold Eyewear, Inc.).
10.25 (6) + Employment Agreement, dated as of April 10, 1997, between
Gargoyles Acquisition Corporation (n/k/a Sungold Eyewear, Inc.)
and Sheldon Goldman.
10.26 (6) Royalty Agreement, dated April 10, 1997, between Gargoyles
Acquisition Corporation (n/k/a Sungold Eyewear, Inc.) and
Sungold Enterprises, Ltd.
10.27 (6) Nondisclosure and Noncompetition Agreement dated as of April 10,
1997, between Gargoyles Acquisition Corporation (n/k/a Sungold
Eyewear, Inc.) and Lionel Goldman.
10.28* (6) Amended and Restated License Agreement dated April 10, 1997,
between Stussy, Inc. and Sungold Enterprises, Ltd.
10.29 (8) Asset Purchase and Sale Agreement, dated as of May 5, 1997,
between The Private Eyes Sunglass Corporation, Richard W.
Hammel, Sr., Patricia Lynch, Annette Hammel, Robert Hammel and
Ronald Hammel and Gargoyles Acquisition Corporation II (n/k/a
Private Eyes Sunglass Corporation).
10.30 (6) Contingent Price Agreement, dated as of May 14, 1997, between
Gargoyles Acquisition Corporation II (n/k/a Private Eyes
Sunglass Corporation) and The Private Eyes Sunglass Corporation.
10.31* (6) Exclusive Distributorship Agreement, dated October 25, 1997,
between Cebe International S.A. and Private Eyes Sunglass
Corporation.
10.32 (6) Settlement Agreement, dated as of May 30, 1997, between
Gargoyles, Inc. and Peter G. and Sandra L. LaHaye, LaHaye
Laboratories, Inc. and Neoptx, Inc.
10.33 (6) License Agreement, dated as of June 30, 1997, between Neoptx,
Inc. and Gargoyles, Inc.
10.34 (6) Settlement Agreement and Mutual Release, dated as of July 14,
1997, between Adidas America, Inc., Gargoyles, Inc., Conquest
Sports, Inc., Axcent Sports, Inc., Sports Performance Products,
Inc., Douglas Hauff, and Trillium Corporation.
10.35 (6) + Separation and Release Agreement, dated January 30, 1998,
between Steven R. Kingma and Gargoyles, Inc.
10.36 (6) + Separation and Release Agreement, dated January 30, 1998,
between G. Travis Worth and Gargoyles, Inc.
10.37 (6) + Separation and Release Agreement, dated February 2, 1998,
between David Jobe and Gargoyles, Inc.
10.38 (6) + Separation and Release Agreement, dated March 11, 1998, between
Douglas B. Hauff and Gargoyles, Inc.
10.39 (6) + Mutual General Release and Payment Agreement, dated as of March
2, 1998, between HXPE, Inc., f/k/a/ The Private Eyes Sunglass
Corporation, Richard Hammel, Sr., Patricia Lynch, Gargoyles,
Inc. and Gargoyles Acquisition Corporation II, a/k/a/ Private
Eyes Sunglass Corporation.
10.40 (6) + Employment Agreement, dated as of February 1, 1998, between
Gargoyles, Inc. and Leo Rosenberger.
10.41 (6) Lease Agreement, dated November 27, 1996, between Leonard
Delalio and Robert P. Delalio and Sungold Enterprises Limited.
10.42 (6) $14,000,000 Renewal Revolving Note, dated January 15, 1998, by
Gargoyles, Inc. in favor of U.S. Bank National Association.
10.43 (6) $3,650,000 Renewal Equipment Note, dated January 15, 1998, by
Gargoyles, Inc. in favor of U.S. Bank National Association.
10.44 (6) $250,000 Renewal Equipment Note, dated January 15, 1998, by
Gargoyles, Inc. in favor of U.S. Bank National Association.
10.45 (6) Security Agreement, dated January 15, 1998, between Sungold
Eyewear, Inc. and U.S. Bank National Association.
10.46 (6) Security Agreement, dated January 15, 1998, between Private Eyes
Sunglass Corp. and U.S. Bank National Association.
10.47 *(13) License Agreement dated October 23, 1998, by and between Dale
Earnhardt and Gargoyles, Inc.
10.48 *(13) License Agreement dated October 23, 1998, by and between Dale
Earnhardt, Jr. and Gargoyles, Inc.
10.49 (13) Agreement dated January 8, 1999 between Golden Bear Golf, Inc.
and Gargoyles, Inc.
10.50 (13) Agreement Regarding Hauff Notes dated February 2, 1999 by and
between Gargoyles, Inc. and Douglas B. Hauff.
10.51 (13) Letter Agreement between the Susan G. Komen Breast Cancer
Foundation and the Private Eyes Sunglass Corporation.
10.52 (11) Renewal Term Note I dated September 17, 1998, made by
Gargoyles, Inc. in favor of the U.S. Bank National Association.
10.53 (11) Renewal Term Note II dated September 17, 1998, made by
Gargoyles, Inc. in favor of the U.S. Bank National Association.
10.54 (9) Lease Termination Agreement made as of the 13th day of April
1998, by and between Ronald Gordon, Trustee of A.E.P. Realty
Trust, as Landlord, and Private Eyes Sunglass Corporation, as
Tenant.
10.55 (9) Seventh Amendment to First Amended and Restated Credit Agreement
dated April 30, 1998 by and between U.S. Bank National
Association, successor by merger to U.S. Bank of Washington,
National Association, and Gargoyles, Inc.
10.56 (10) Lease Agreement dated June 8, 1998, by and between South Valley
Associates, as Landlord, and Gargoyles, Inc., as Tenant.
10.57 (10) Eighth Amendment to First Amended and Restated Credit Agreement
dated April 30, 1998 by and between U.S. Bank National
Association, successor by merger to U.S. Bank of Washington,
National Association, and Gargoyles, Inc.
10.58 (11) Ninth Amendment to First Amended and Restated Credit Agreement
dated September 17, 1998, by and between U.S. Bank National
Association, successor by merger to U.S. Bank of Washington
National Association, and Gargoyles, Inc.
10.59 (11) Tenth Amendment to First Amended and Restated Credit Agreement
dated November 2, 1998, by and between U.S. Bank National
Association, successor by merger to U.S. Bank of Washington
National Association, and Gargoyles, Inc.
10.60 (13) Eleventh Amendment to First Amended and Restated Credit
Agreement dated December 21, 1998, by and between U.S. Bank
National Association, successor by merger to U.S. Bank of
Washington National Association, and Gargoyles, Inc.
10.61 (13) Twelfth Amendment to First Amended and Restated Credit Agreement
dated March 5, 1999, by and between U.S. Bank National
Association, successor by merger to U.S. Bank of Washington
National Association, and Gargoyles, Inc.
10.62 (11) License Agreement dated October 20, 1998, between Gargoyles,
Inc. and Aearo Company.
10.63 (11) Termination and Release dated September 8, 1998, by and among
The Timberland Company, Gargoyles, Inc. and the kindling
company.
10.64 (12) Asset Purchase Agreement among Adventure Optics, LLC, the
kindling company, Douglas Lauer and Gargoyles, Inc. dated
September 15, 1998.
10.65 (11) Letter Agreement dated September 8, 1998, between Ellen Tracy,
Inc. and Gargoyles, Inc., on behalf of itself and its wholly-
owned subsidiary, Gargoyles Acquisition Corporation II, now
known as Private Eyes Sunglass Corporation.
10.66 (11) Guaranty dated September 8, 1998, made by Gargoyles, Inc. in
favor of Ellen Tracy, Inc.
10.67 (14) Amendment to Employment Agreement dated March 31, 1999, by and
between Gargoyles, Inc. and Leo Rosenberger.
21.1 (13) Subsidiaries of the registrant.
23.1 (14) Consent of Ernst & Young LLP, Independent Accountants.
23.2 (14) Consent of BDO Seidman, LLP, Independent Accountants.
27.1 (14) Financial Data Schedule.
- -----------------------
* Confidential Treatment Requested
+ Executive Compensation Plan and Arrangements
(1) Incorporated by reference to the Company's Registration Statement on
Form S-1 (Registration No. 333-07573).
(2) Incorporated by reference to the Company's Quarterly Report on
Form 10-Q for the Quarterly Period Ended September 30, 1996.
(3) Incorporated by reference to the Company's Annual Report on Form 10-K
for the Fiscal Year ended December 31, 1996.
(4) Incorporated by reference to the Company's Quarterly Report on
Form 10-Q for the Quarterly Period Ended March 31, 1997.
(5) Incorporated by reference to the Company's Quarterly Report on
Form 10-Q for the Quarterly Period Ended June 30, 1997.
(6) Incorporated by reference to the Company's Annual Report on Form 10-K
for the Fiscal Year ended December 31, 1997.
(7) Incorporated by reference to the Company's Report on Form 8-K filed
April 28, 1997.
(8) Incorporated by reference to the Company's Report on From 8-K filed
May 29, 1997.
(9) Incorporated by reference to the Company's Quarterly Report on
Form 10-Q for the Quarterly Period Ended March 31, 1998.
(10) Incorporated by reference to the Company's Quarterly Report on
Form 10-Q for the Quarterly Period Ended June 30, 1998.
(11) Incorporated by reference to the Company's Quarterly Report on
Form 10-Q for the Quarterly Period Ended September 30, 1998.
(12) Incorporated by reference to the Company's Report on Form 8-K filed
September 29, 1998.
(13) Incorporated by reference to the Company's Report on From 10-K for the
Fiscal year ended December 31, 1998.
(14) Filed herewith.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange
Act of 1934, the Registrant has duly caused this Report to be signed on its
behalf by the undersigned, thereunto duly authorized, on the 15th day of April,
1999.
GARGOYLES, INC.
/s/ LEO ROSENBERGER
By: ---------------------------
Leo Rosenberger
Chief Executive Officer and Chief Financial Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, this
Report has been signed by the following persons on behalf of the Registrant and
in the capacities indicated below on the 15th day of April, 1999.
Signature Title
/s/ LEO ROSENBERGER Chief Executive Officer and Chief Financial
- -------------------------- Officer (Principle Executive Officer)
Leo Rosenberger
/s/ CHERYL BECKMAN Corporate Comptroller
- -------------------------- (Principle Accounting Officer)
Cheryl Beckman
/s/ ROBERT G. WOLFE Chairman of the Board
- --------------------------
Robert G. Wolfe
/s/ TIMOTHY C. POTTS Director
- --------------------------
Timothy C. Potts
/s/ WILLIAM D. RUCKELSHAUS Director
- --------------------------
William D. Ruckelshaus
/s/ PAUL S. SHIPMAN Director
- --------------------------
Paul S. Shipman
/s/ WALTER F. WALKER Director
- --------------------------
Walter F. Walker
<PAGE>
Exhibit
No. Description
- -------- ----------------------------------------------------------------
3.1 (1) Form of Amended and Restated Articles of Incorporation of the
registrant currently in effect.
3.2 (1) Bylaws of the registrant currently in effect.
10.1 (1) Stock Purchase Agreement, dated as of March 14, 1995, among
Gargoyles and certain other parties.
10.2 (1) Nondisclosure, Noncompetition and Indemnity Agreement, dated as
of March 22, 1995, among Gargoyles, Inc., Conquest Sports, Inc.,
Antone Manufacturing, Inc. and the Founder.
10.3 (1) Stock Purchase Agreement, dated as of January 25, 1996, among
Gargoyles, Inc., H.S.C., Inc., Douglas B. Hauff, H.S.I., a
California corporation, dba Hobie Sunglasses and the Sellers
listed therein.
10.4 (1) Industrial Real Estate Lease (Single Tenant Facility), dated
December 16, 1993, between Gargoyles, Inc. and DB&D Partnership.
10.5 (1) Lease Amendment, dated as of March 17, 1995, between Gargoyles,
Inc. and DB&D Partnership.
10.6 (1) + Gargoyles, Inc. Common Stock Purchase Warrant, dated January
1996, between Gargoyles, Inc. and Wally Walker.
10.7 (1) + Form of Indemnity Agreement between Gargoyles, Inc. and each of
its directors.
10.8 (1) + 1995 Stock Incentive Compensation Plan.
10.9 (1) Amended and Restated Agreement Regarding Claim Rights, dated
July 3, 1996, by and between the Founder, Gargoyles, Inc. and
Conquest Sports, Inc.
10.10* (1) Ratification of Settlement Agreement and General Release, dated
April 12, 1995.
10.11* (1) Trademark License Agreement dated as of April 12, 1995.
10.12* (1) License Agreement, effective January 1, 1989, between Hobie
Designs, Inc. and H.S.I.
10.13* (1) License Agreement, dated as of May 31, 1996, among Ixela, Inc.,
Alexi Lalas and Gargoyles, Inc.
10.14 (2) Indemnity Agreement, dated September 26, 1996, by Trillium
Corporation and Douglas B. Hauff in favor of Gargoyles.
10.15 (3) Agreement, dated January 9, 1997, between Gargoyles and
International Speedway Corporation.
10.16 (3) Registration Rights Agreement, dated February 20, 1997, between
Gargoyles and Douglas B. Hauff.
10.17 (3) Registration Rights Agreement, dated February 20, 1997, between
Gargoyles and Trillium Investors II.
10.18 (4) First Amended and Restated Credit Agreement, dated April 7,
1997, between U.S. Bank of Washington, National Association and
Gargoyles, Inc.
10.19 (5) Second Amendment to First Amended and Restated Credit Agreement,
dated July 15, 1997, between U.S. Bank of Washington, National
Association, and Gargoyles, Inc.
10.20 (6) Third Amendment to First Amended and Restated Credit Agreement,
dated January 15, 1998, between U.S. Bank of Washington,
National Association, and Gargoyles, Inc.
10.21 (6) Fourth Amendment to First Amended and Restated Credit Agreement,
dated January 30, 1998, between U.S. Bank of Washington,
National Association, and Gargoyles, Inc.
10.22 (6) Fifth Amendment to First Amended and Restated Credit Agreement,
dated March 17, 1998, between U.S. Bank of Washington, National
Association, and Gargoyles, Inc.
10.23 (6) Promissory Note, dated April 9, 1997, between Douglas B. Hauff
in favor of Gargoyles, Inc.
10.24 (7) Asset Purchase and Sales Agreement, dated as of April 10, 1997,
between Sungold Enterprises, Ltd., Sheldon Goldman, Lionel
Goldman and Lionel Goldman, Trustee of The Lionel Goldman Family
Trust u/a, dated September 30, 1994, and Gargoyles Acquisition
Corporation (n/k/a Sungold Eyewear, Inc.).
10.25 (6) + Employment Agreement, dated as of April 10, 1997, between
Gargoyles Acquisition Corporation (n/k/a Sungold Eyewear, Inc.)
and Sheldon Goldman.
10.26 (6) Royalty Agreement, dated April 10, 1997, between Gargoyles
Acquisition Corporation (n/k/a Sungold Eyewear, Inc.) and
Sungold Enterprises, Ltd.
10.27 (6) Nondisclosure and Noncompetition Agreement dated as of April 10,
1997, between Gargoyles Acquisition Corporation (n/k/a Sungold
Eyewear, Inc.) and Lionel Goldman.
10.28* (6) Amended and Restated License Agreement dated April 10, 1997,
between Stussy, Inc. and Sungold Enterprises, Ltd.
10.29 (8) Asset Purchase and Sale Agreement, dated as of May 5, 1997,
between The Private Eyes Sunglass Corporation, Richard W.
Hammel, Sr., Patricia Lynch, Annette Hammel, Robert Hammel and
Ronald Hammel and Gargoyles Acquisition Corporation II (n/k/a
Private Eyes Sunglass Corporation).
10.30 (6) Contingent Price Agreement, dated as of May 14, 1997, between
Gargoyles Acquisition Corporation II (n/k/a Private Eyes
Sunglass Corporation) and The Private Eyes Sunglass Corporation.
10.31* (6) Exclusive Distributorship Agreement, dated October 25, 1997,
between Cebe International S.A. and Private Eyes Sunglass
Corporation.
10.32 (6) Settlement Agreement, dated as of May 30, 1997, between
Gargoyles, Inc. and Peter G. and Sandra L. LaHaye, LaHaye
Laboratories, Inc. and Neoptx, Inc.
10.33 (6) License Agreement, dated as of June 30, 1997, between Neoptx,
Inc. and Gargoyles, Inc.
10.34 (6) Settlement Agreement and Mutual Release, dated as of July 14,
1997, between Adidas America, Inc., Gargoyles, Inc., Conquest
Sports, Inc., Axcent Sports, Inc., Sports Performance Products,
Inc., Douglas Hauff, and Trillium Corporation.
10.35 (6) + Separation and Release Agreement, dated January 30, 1998,
between Steven R. Kingma and Gargoyles, Inc.
10.36 (6) + Separation and Release Agreement, dated January 30, 1998,
between G. Travis Worth and Gargoyles, Inc.
10.37 (6) + Separation and Release Agreement, dated February 2, 1998,
between David Jobe and Gargoyles, Inc.
10.38 (6) + Separation and Release Agreement, dated March 11, 1998, between
Douglas B. Hauff and Gargoyles, Inc.
10.39 (6) + Mutual General Release and Payment Agreement, dated as of March
2, 1998, between HXPE, Inc., f/k/a/ The Private Eyes Sunglass
Corporation, Richard Hammel, Sr., Patricia Lynch, Gargoyles,
Inc. and Gargoyles Acquisition Corporation II, a/k/a/ Private
Eyes Sunglass Corporation.
10.40 (6) + Employment Agreement, dated as of February 1, 1998, between
Gargoyles, Inc. and Leo Rosenberger.
10.41 (6) Lease Agreement, dated November 27, 1996, between Leonard
Delalio and Robert P. Delalio and Sungold Enterprises Limited.
10.42 (6) $14,000,000 Renewal Revolving Note, dated January 15, 1998, by
Gargoyles, Inc. in favor of U.S. Bank National Association.
10.43 (6) $3,650,000 Renewal Equipment Note, dated January 15, 1998, by
Gargoyles, Inc. in favor of U.S. Bank National Association.
10.44 (6) $250,000 Renewal Equipment Note, dated January 15, 1998, by
Gargoyles, Inc. in favor of U.S. Bank National Association.
10.45 (6) Security Agreement, dated January 15, 1998, between Sungold
Eyewear, Inc. and U.S. Bank National Association.
10.46 (6) Security Agreement, dated January 15, 1998, between Private Eyes
Sunglass Corp. and U.S. Bank National Association.
10.47 *(13) License Agreement dated October 23, 1998, by and between Dale
Earnhardt and Gargoyles, Inc.
10.48 *(13) License Agreement dated October 23, 1998, by and between Dale
Earnhardt, Jr. and Gargoyles, Inc.
10.49 (13) Agreement dated January 8, 1999 between Golden Bear Golf, Inc.
and Gargoyles, Inc.
10.50 (13) Agreement Regarding Hauff Notes dated February 2, 1999 by and
between Gargoyles, Inc. and Douglas B. Hauff.
10.51 (13) Letter Agreement between the Susan G. Komen Breast Cancer
Foundation and the Private Eyes Sunglass Corporation.
10.52 (11) Renewal Term Note I dated September 17, 1998, made by
Gargoyles, Inc. in favor of the U.S. Bank National Association.
10.53 (11) Renewal Term Note II dated September 17, 1998, made by
Gargoyles, Inc. in favor of the U.S. Bank National Association.
10.54 (9) Lease Termination Agreement made as of the 13th day of April
1998, by and between Ronald Gordon, Trustee of A.E.P. Realty
Trust, as Landlord, and Private Eyes Sunglass Corporation, as
Tenant.
10.55 (9) Seventh Amendment to First Amended and Restated Credit Agreement
dated April 30, 1998 by and between U.S. Bank National
Association, successor by merger to U.S. Bank of Washington,
National Association, and Gargoyles, Inc.
10.56 (10) Lease Agreement dated June 8, 1998, by and between South Valley
Associates, as Landlord, and Gargoyles, Inc., as Tenant.
10.57 (10) Eighth Amendment to First Amended and Restated Credit Agreement
dated April 30, 1998 by and between U.S. Bank National
Association, successor by merger to U.S. Bank of Washington,
National Association, and Gargoyles, Inc.
10.58 (11) Ninth Amendment to First Amended and Restated Credit Agreement
dated September 17, 1998, by and between U.S. Bank National
Association, successor by merger to U.S. Bank of Washington
National Association, and Gargoyles, Inc.
10.59 (11) Tenth Amendment to First Amended and Restated Credit Agreement
dated November 2, 1998, by and between U.S. Bank National
Association, successor by merger to U.S. Bank of Washington
National Association, and Gargoyles, Inc.
10.60 (13) Eleventh Amendment to First Amended and Restated Credit
Agreement dated December 21, 1998, by and between U.S. Bank
National Association, successor by merger to U.S. Bank of
Washington National Association, and Gargoyles, Inc.
10.61 (13) Twelfth Amendment to First Amended and Restated Credit Agreement
dated March 5, 1999, by and between U.S. Bank National
Association, successor by merger to U.S. Bank of Washington
National Association, and Gargoyles, Inc.
10.62 (11) License Agreement dated October 20, 1998, between Gargoyles,
Inc. and Aearo Company.
10.63 (11) Termination and Release dated September 8, 1998, by and among
The Timberland Company, Gargoyles, Inc. and the kindling
company.
10.64 (12) Asset Purchase Agreement among Adventure Optics, LLC, the
kindling company, Douglas Lauer and Gargoyles, Inc. dated
September 15, 1998.
10.65 (11) Letter Agreement dated September 8, 1998, between Ellen Tracy,
Inc. and Gargoyles, Inc., on behalf of itself and its wholly-
owned subsidiary, Gargoyles Acquisition Corporation II, now
known as Private Eyes Sunglass Corporation.
10.66 (11) Guaranty dated September 8, 1998, made by Gargoyles, Inc. in
favor of Ellen Tracy, Inc.
10.67 (14) Amendment to Employment Agreement dated March 31, 1999, by and
between Gargoyles, Inc. and Leo Rosenberger.
21.1 (13) Subsidiaries of the registrant.
23.1 (14) Consent of Ernst & Young LLP, Independent Accountants.
23.2 (14) Consent of BDO Seidman, LLP, Independent Accountants.
27.1 (14) Financial Data Schedule.
- -----------------------
* Confidential Treatment Requested
+ Executive Compensation Plan and Arrangements
(1) Incorporated by reference to the Company's Registration Statement on
Form S-1 (Registration No. 333-07573).
(2) Incorporated by reference to the Company's Quarterly Report on
Form 10-Q for the Quarterly Period Ended September 30, 1996.
(3) Incorporated by reference to the Company's Annual Report on Form 10-K
for the Fiscal Year ended December 31, 1996.
(4) Incorporated by reference to the Company's Quarterly Report on
Form 10-Q for the Quarterly Period Ended March 31, 1997.
(5) Incorporated by reference to the Company's Quarterly Report on
Form 10-Q for the Quarterly Period Ended June 30, 1997.
(6) Incorporated by reference to the Company's Annual Report on Form 10-K
for the Fiscal Year ended December 31, 1997.
(7) Incorporated by reference to the Company's Report on Form 8-K filed
April 28, 1997.
(8) Incorporated by reference to the Company's Report on From 8-K filed
May 29, 1997.
(9) Incorporated by reference to the Company's Quarterly Report on
Form 10-Q for the Quarterly Period Ended March 31, 1998.
(10) Incorporated by reference to the Company's Quarterly Report on
Form 10-Q for the Quarterly Period Ended June 30, 1998.
(11) Incorporated by reference to the Company's Quarterly Report on
Form 10-Q for the Quarterly Period Ended September 30, 1998.
(12) Incorporated by reference to the Company's Report on Form 8-K filed
September 29, 1998.
(13) Incorporated by reference to the Company's Report on From 10-K for the
Fiscal year ended December 31, 1998.
(14) Filed herewith.
</TABLE>
<PAGE>
EXHIBIT 10.67
AMENDMENT TO EMPLOYMENT AGREEMENT
OF
LEO ROSENBERGER
THE AMENDMENT TO EMPLOYMENT AGREEMENT (this "Amendment") is made as of
this 31st day of March 1999 by and between GARGOYLES, INC., a Washington
corporation (the "Company"), and LEO ROSENBERGER ("Employee").
RECITALS
A. The Company and Employee are parties to that certain Employment
Agreement dated as of February 1, 1998 (the "Employment Agreement"); and
B. The Company and Employee desire to amend the Employment Agreement in
accordance with the terms hereof.
AGREEMENT
NOW, THEREFORE, in consideration of the premises and other good and
valuable consideration, the receipt and sufficiency of which are hereby
acknowledged, the parties hereto hereby agree as follows:
1. CHANGE IN CONTROL.
For purposes of this Amendment, a Change in Control shall mean the
earliest date upon which one of the following occurs: (i) the sale or other
disposition of all or substantially all of the assets of the Company, except
pursuant to a proceeding involving a foreclosure and liquidation of the assets,
(ii) the sale or other transfer of voting securities representing a majority of
the votes entitled to be cast for the election of directors of the Company,
(iii) the sale or other transfer of a majority of the value of the equity of
the Company, or (iv) a merger, consolidation, reorganization or other
transaction involving the Company.
2. TERM.
The term of the Employment Agreement set forth in Section 3 of the
Employment Agreement shall continue until the earlier of (i) the date of
occurrence of a Change in Control, (ii) the date upon which Employee ceases to
be the Chief Executive Officer of the Company, or (iii) January 31, 2000; each
of the dates described in (i) through (iii) being referred to herein as the
"Expiration Date." If the term of this Agreement expires due to a Change in
Control or because Employee ceases to be the Chief Executive Officer of the
Company, then Employee agrees to consult with the Company at the request of the
Board of Directors of the Company for a period of up to 90 days after the
Expiration Date (the "Transition Period"). Employee will be paid a consulting
fee of $18,750 per month during the Transition Period. During the Transition
Period, Employee shall help transition the senior management responsibilities
of the Company to other persons, and shall be reasonably available for
discussions with the Board of Directors. The Company may terminate the
Transition Period upon thirty (30) days prior written notice to Employee.
3. 1998 BONUS.
The Company acknowledges that on January 31, 1999 all conditions
precedent to the Company's obligation to pay Employee a bonus of $150,000 as
set forth in Section 5.3 of the Employment Agreement have been satisfied and
such bonus is currently due and payable to Employee.
4. ADDITIONAL BONUS.
4.1 UPON A CHANGE IN CONTROL. Prior to June 1, 1999, upon the
occurrence of a Change in Control or on the date Employee ceases to be the
Chief Executive Officer of the Company, Employee shall have earned a bonus of
$150,000 in cash or other immediately available funds (the "Additional Bonus").
The Additional Bonus shall be paid in two installments, $100,000 of which shall
be paid upon the occurrence of a Change in Control or the date Employee ceases
to be the Chief Executive Officer of the Company, and $50,000 of which shall be
paid 90 days thereafter. If a Change in Control occurs or if Employee ceases
to be the Chief Executive Officer of the Company after June 1, 1999 so that
Employee has received $75,000 of his Additional Bonus on June 1, 1999 in
accordance with Section 4.2 below, then the remaining portion of Employee's
Additional bonus shall be paid in two installments, $50,000 shall be paid upon
the occurrence of a Change in Control or the date Employee ceases to be the
Chief Executive Officer of the Company, and $25,000 of which shall be paid 90
days thereafter.
4.2 WITHOUT A CHANGE IN CONTROL. If the Additional Bonus has not
been paid by June 1, 1999, as a result of a Change in Control or of a change in
Employee's status as Chief Executive Officer of the Company, then Employee's
Additional Bonus shall be due and payable in two equal installments of $75,000.
The first $75,000 shall be due and payable on June 1, 1999, and the second
$75,000 shall be due and payable on the earlier of (i) the date Employee ceases
to be the Chief Executive Officer of the Company, or (ii) January 1, 2000.
5. COMPENSATION AND BENEFITS UPON TERMINATION. Section 6.4 (b) shall be
amended and restated in its entirety as follows:
(b) The Company shall have the right to terminate this Agreement for
any reason at any time prior to January 31, 2000, by delivery of written notice
to Employee of such termination (also a "Termination Date"). If on or before
June 1, 1999, the employment of Employee is terminated by the Company for any
reason other than for Cause, or due to Employee's Death, Disability or
Voluntary Resignation, then the Company shall pay to Employee a termination fee
of $150,000. If the employment of Employee is terminated by the Company
between June 1, 1999 and January 31, 2000 for any reason other than for Cause,
or due to Employee's Death, Disability or Voluntary Resignation, then the
Company shall pay to Employee a termination fee of $75,000.
6. NO OTHER AMENDMENTS. The terms and provisions of this Employment
Agreement are hereby ratified and confirmed and remain in full force and effect
except as amended by this Amendment.
IN WITNESS WHEREOF, the parties hereto have executed this Amendment to
Employment Agreement as of the date first above written.
GARGOYLES, INC.
By /s/ Robert G. Wolfe
--------------------------------------
Robert G. Wolfe, Chairman of the Board
of Directors of Gargoyles, Inc.
/s/ Leo Rosenberger
- -----------------------------------------
LEO ROSENBERGER
2
<PAGE>
Exhibit 23.1
Consent of Ernst & Young LLP, Independent Auditors
We consent to the incorporation by reference in the Registration Statement
(Form S-8 No. 333-1663) pertaining to the 1995 Stock Incentive Compensation
Plan of Gargoyles, Inc. of our report dated April 2, 1998 with respect to the
consolidated financial statements and schedule as of December 31, 1997 and for
the years ended December 31, 1997 and 1996 included in the Annual Report on
Form 10-K for the year ended December 31, 1998.
Seattle, Washington
April 14, 1999
<PAGE>
EXHIBIT 23.2
CONSENT OF BDO SEIDMAN, LLP, INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS
We consent to the incorporation by reference in the Registration Statement
(Form S-8, No. 333-16633) pertaining to the Gargoyles, Inc. 1995 Stock
Incentive Compensation Plan of our report dated April 2, 1999, with respect to
the consolidated financial statements and schedule of Gargoyles, Inc. included
in the Annual Report (Form 10-K) for the year ended December 31, 1998. Our
report contains an explanatory paragraph regarding the Company's ability to
continue as a going concern.
BDO Seidman, LLP
Seattle, Washington
April 15, 1999
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE
CONSOLIDATED BALANCE SHEETS AND CONSOLIDATED STATEMENTS OF OPERATIONS FOUND ON
PAGES 29 AND 30 OF THE COMPANY'S FORM 10-K/A FOR THE YEAR ENDED DECEMBER 31,
1998, AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL
STATEMENTS.
</LEGEND>
<S> <C>
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-START> JAN-01-1998
<PERIOD-END> DEC-31-1998
<CASH> 194,314
<SECURITIES> 0
<RECEIVABLES> 3,172,142
<ALLOWANCES> (920,916)
<INVENTORY> 8,558,276
<CURRENT-ASSETS> 13,035,077
<PP&E> 3,948,891
<DEPRECIATION> (1,507,758)
<TOTAL-ASSETS> 28,007,943
<CURRENT-LIABILITIES> 41,579,787
<BONDS> 0
0
0
<COMMON> 26,529,282
<OTHER-SE> (40,701,125)
<TOTAL-LIABILITY-AND-EQUITY> 28,007,943
<SALES> 36,606,338
<TOTAL-REVENUES> 37,571,960
<CGS> 16,225,550
<TOTAL-COSTS> 27,117,786
<OTHER-EXPENSES> 15,842,110
<LOSS-PROVISION> 2,629,525
<INTEREST-EXPENSE> 3,336,958
<INCOME-PRETAX> (21,613,486)
<INCOME-TAX> 0
<INCOME-CONTINUING> (21,613,486)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (21,613,486)
<EPS-PRIMARY> (2.77)
<EPS-DILUTED> (2.77)
</TABLE>
