SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
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FORM 10-Q
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 1998
Commission File No. 0-23629
Happy Kids Inc.
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(Exact Name of Registrant as Specified in Its Charter)
New York 13-3473638
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(State or Other Jurisdiction of (I.R.S. Employer Identification No.)
Incorporation or Organization)
100 West 33rd Street, Suite 1100, New York, New York 10001
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(Address of Principal Executive Offices) (Zip Code)
(212) 695-1151
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(Registrant's Telephone Number,
Including Area Code)
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 the number of shares outstanding of each of the Registrant's
classes of common stock, as of October 31, 1998:
Class Number of Shares
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Common Stock, $.01 par value 10,280,000
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HAPPY KIDS INC. AND SUBSIDIARIES
TABLE OF CONTENTS
Page
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PART I. CONDENSED CONSOLIDATED FINANCIAL INFORMATION................... 1
Item 1. Condensed Consolidated Financial Statements............... 1
Condensed Consolidated Balance Sheets as of September
30, 1998 (unaudited) and December 31, 1997.............. 2
Condensed Consolidated Statements of Income for the
Three and Nine Months Ended September 30, 1998 and
1997 (audited with respect to the nine months ended
September 30, 1997)..................................... 3
Condensed Consolidated Statements of Cash Flows for the
Nine Months Ended September 30, 1998 (unaudited) and
1997.................................................... 4
Notes to Condensed Consolidated Financial Statements...... 5
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations..................... 10
Results of Operations..................................... 11
Liquidity and Capital Resources........................... 13
Backlog................................................... 14
Management Information Systems............................ 15
European Monetary Union................................... 16
Effect of Recently Issued Accounting Standards............ 16
PART II. OTHER INFORMATION.............................................. 17
Item 6. Exhibits and Reports on Form 8-K.......................... 17
SIGNATURES.............................................................. 18
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PART I. CONDENSED CONSOLIDATED FINANCIAL INFORMATION
----------------------------------------------------
Item 1. Condensed Consolidated Financial Statements
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<CAPTION>
HAPPY KIDS INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(in thousands, except per share amounts)
September 30, December 31,
1998 1997
------------ -------------
(unaudited)
ASSETS
<S> <C> <C>
CURRENT ASSETS
Cash ...................................................... $ 357 $ 374
Due from factor ........................................... 25,111 24,232
Accounts receivable - trade (net of allowance of
$513 at September 30, 1998 and December 31, 1997) ...... 636 316
Inventories ............................................... 21,331 16,316
Due from shareholders ..................................... -- 347
Other current assets ...................................... 4,352 1,139
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Total current assets ................................... 51,787 42,724
FIXED ASSETS - NET ........................................... 1,501 1,476
OTHER ASSETS ................................................. 547 752
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Total assets ........................................... $53,835 $44,952
======= =======
LIABILITIES AND SHAREHOLDERS' EQUITY
CURRENT LIABILITIES
Due to bank ............................................... $ 8,315 $24,863
Current portion - capital lease obligations ............... 37 49
Accounts payable and accrued liabilities .................. 10,067 11,393
Due to shareholders ....................................... 314 --
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Total current liabilities .............................. 18,733 36,305
DEFERRED RENT PAYABLE ........................................ 524 584
CAPITAL LEASE OBLIGATIONS .................................... -- 19
DUE TO SHAREHOLDERS .......................................... 5,405 1,400
COMMITMENTS
SHAREHOLDERS' EQUITY:
Preferred stock - 5,000 shares authorized, $.01
par value; no shares issued and outstanding ............ -- --
Common stock - 30,000 shares authorized, $.01 par
value; 10,280 and 7,750 shares issued and
outstanding at September 30, 1998 and December
31, 1997, respectively ................................. 103 78
Additional paid-in capital ................................ 23,263 1,119
Retained earnings ......................................... 5,807 5,447
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Total shareholders' equity ............................. 29,173 6,644
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Total liabilities and shareholders' equity ............. $53,835 $44,952
======= =======
The accompanying notes are an integral part of these statements.
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<TABLE>
<CAPTION>
HAPPY KIDS INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
(in thousands, except per share amounts)
For the Three Months For the Nine Months
Ended September 30, Ended September 30,
-------------------- --------------------
1998 1997 1998 1997
--------- --------- --------- ---------
(unaudited) (unaudited) (unaudited)
<S> <C> <C> <C> <C>
Net sales ............................... $ 46,993 $ 37,771 $ 114,721 $ 77,328
Cost of goods sold ...................... 34,750 28,359 85,302 57,908
--------- --------- --------- ---------
Gross profit ........................ 12,243 9,412 29,419 19,420
--------- --------- --------- ---------
Operating expenses:
Selling, design and shipping ........ 3,648 2,832 9,653 7,552
General and administrative .......... 2,310 2,570 6,886 6,281
--------- --------- --------- ---------
Total operating expenses ...... 5,958 5,402 16,539 13,833
--------- --------- --------- ---------
Operating earnings ............ 6,285 4,010 12,880 5,587
--------- --------- --------- ---------
Interest expense, net ................... 472 1,154 1,790 2,522
--------- --------- --------- ---------
Income before income taxes ............. 5,813 2,856 11,090 3,065
Provision for income taxes:
Income taxes ....................... 2,442 352 3,838 373
Deferred tax benefit ............... -- -- (1,024) --
--------- --------- --------- ---------
Total income taxes ............ 2,442 352 2,814 373
--------- --------- --------- ---------
Net income .................... $ 3,371 $ 2,504 $ 8,276 $ 2,692
========= ========= ========= =========
Basic income
per common share .................... $ 0.33 $ 0.32 $ 0.88 $ 0.35
========= ========= ========= =========
Weighted average common
shares outstanding .................. 10,280 7,750 9,406 7,750
========= ========= ========= =========
Diluted income
per common share .................... $ 0.33 $ 0.32 $ 0.88 $ 0.35
========= ========= ========= =========
Weighted average common
shares outstanding .................. 10,284 7,750 9,419 7,750
========= ========= ========= =========
Pro forma data (unaudited):
Historical income before
provision for income taxes .... $ 5,813 $ 2,856 $ 11,090 $ 3,065
Income taxes ........................ 2,442 1,199 4,658 1,287
--------- --------- --------- ---------
Net income .................... $ 3,371 $ 1,657 $ 6,432 $ 1,778
========= ========= ========= =========
Pro forma basic income per share ........ $ 0.33 $ 0.21 $ 0.68 $ 0.23
========= ========= ========= =========
Pro forma weighted average
common shares outstanding ........... 10,280 7,750 9,406 7,750
========= ========= ========= =========
Pro forma diluted income per share ...... $ 0.33 $ 0.21 $ 0.68 $ 0.23
========= ========= ========= =========
Pro forma weighted average
common shares outstanding ........... 10,284 7,750 9,419 7,750
========= ========= ========= =========
The accompanying notes are an integral part of these statements.
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<TABLE>
<CAPTION>
HAPPY KIDS INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
For the Nine Months
Ended September 30,
-----------------------
1998 1997
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(unaudited)
<S> <C> <C>
Cash flows from operating activities:
Net income ......................................... $ 8,276 $ 2,692
Adjustments to reconcile net income
to net cash provided by operating activities:
Depreciation and amortization ................... 226 260
Deferred taxes .................................. (1,024) 99
Provision for losses on accounts receivable ..... 45 355
Changes in operating assets and liabilities:
Accounts receivable ............................. (365) 131
Due from factor ................................. (879) (8,207)
Inventories ..................................... (5,015) 872
Other current assets ............................ (2,116) 536
Other assets .................................... (30) 12
Accounts payable and accrued expenses ........... (1,386) (1,558)
Due from shareholders ........................... 347 463
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Net cash used in operating activities .............. (1,921) (4,345)
-------- --------
Cash flows from investing activities:
Acquisition of fixed assets ..................... (251) (60)
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Cash flows from financing activities:
Net borrowings under line of credit ............. (16,548) 7,560
Payments on capital lease ....................... (31) (43)
Borrowings from shareholders .................... (169) (160)
Dividends paid .................................. (3,428) (3,007)
Issuance of common stock ........................ 22,331 --
-------- --------
Net cash provided by financing activities .......... 2,155 4,350
-------- --------
Net decrease in cash ............................... (17) (55)
Cash at beginning of year .......................... 374 674
-------- --------
Cash at end of period .............................. $ 357 $ 619
======== ========
The accompanying notes are an integral part of these statements.
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HAPPY KIDS INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Information relating to September 30, 1998 is unaudited)
Note 1 -- Basis of Presentation:
The information presented for the nine-month period ended September 30,
1998 and for the three-month periods ended September 30, 1998 and 1997 are
unaudited. The information presented for the nine-month period ended September
30, 1997 is audited. In the opinion of the Happy Kids Inc.'s (the "Company")
management, the accompanying unaudited condensed consolidated financial
statements contain all adjustments (consisting only of normal recurring
adjustments) which the Company considers necessary for the fair presentation of
the Company's financial position as of September 30, 1998 and the results of its
operations for the three-month and nine-month periods ended September 30, 1998
and 1997 and its cash flows for the nine- month periods ended September 30, 1998
and 1997. The financial statements included herein have been prepared in
accordance with generally accepted accounting principles and the instructions to
Form 10-Q and Rule 10-01 of Regulation S-X. Accordingly, certain information and
footnote disclosures normally included in financial statements prepared in
accordance with generally accepted accounting principles have been condensed or
omitted. These financial statements should be read in conjunction with the
Company's audited financial statements for the year ended December 31, 1997,
which were included as part of the Company's Registration Statement on Form S-1
(Registration No. 333-44267) (the "Registration Statement"), as declared
effective by the Securities and Exchange Commission (the "SEC") on April 2,
1998.
Results for the interim period are not necessarily indicative of results
that may be expected for the entire year.
The Company was incorporated in 1988 in New York under the name O'Boy Inc.
and changed its name to Happy Kids Inc. in December 1997. Historically, the
Company operated as separate business entities, with the first of such entities
commencing operations in 1979, all under the common ownership of the Company's
then-current shareholders. Immediately prior to the effectiveness of the
Company's initial public offering (the "Initial Public Offering"), as described
in Note 2, all of such separate entities became wholly-owned subsidiaries of the
Company (the "Reorganization"). The Company issued 4,262,500 additional shares
of common stock, to its then-current shareholders, in exchange for their
ownership in these separate business entities. All share and per share amounts
throughout this Form 10-Q have been restated to retroactively reflect the
Reorganization.
The accompanying condensed consolidated financial statements include the
consolidated accounts of the Company and its wholly owned subsidiaries to
reflect the Reorganization as stated above. All significant intercompany
accounts and transactions have been eliminated in consolidation.
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HAPPY KIDS INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Information relating to September 30, 1998 is unaudited)
Note 2 -- Initial Public Offering:
On April 8, 1998, the Company consummated its Initial Public Offering of
2,200,000 shares of its Common Stock at a price of $10.00 per share, all of
which shares were issued and sold by the Company. On April 23, 1998, the Company
consummated the exercise of the underwriters' over-allotment option granted by
the Company to the underwriters in connection with the Initial Public Offering.
As a result, the Company issued and sold an additional 330,000 shares of the
Company's Common Stock at the Initial Public Offering price of $10.00 per share.
The net proceeds to the Company from such sales were approximately $22.3
million.
Of the total net proceeds received by the Company upon the consummation of
its Initial Public Offering and the exercise of the over-allotment option, $2.0
million was distributed to certain shareholders of the Company in connection
with the payment of a portion of the S Corporation distribution made by the
Company in connection with the Reorganization (the "S Corporation Distribution")
and the remaining amount was utilized to pay down a portion of the outstanding
balance under the Company's bank credit facility (the "Line of Credit"). See
"Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations -- Liquidity and Capital Resources."
Note 3 -- Income Taxes:
Prior to the completion of the Initial Public Offering, the Company had
elected to be treated as an S Corporation for Federal income tax reporting
purposes. An S Corporation is generally treated like a partnership and is exempt
from Federal income taxes, with certain exceptions, and shareholders report
their pro rata share of corporate taxable income or loss on their individual tax
returns. A provision for state income taxes was made for those states not
recognizing the Company's S Corporation status. The Company's S Corporation
status terminated on the day prior to the effectiveness of the Company's Initial
Public Offering described in Note 2.
Prior to the termination of the Company's S Corporation status, the
Company declared the S Corporation Distribution to the shareholders of record of
the Company on such date. Such shareholders consisted solely of Jack Benun, the
Company's Chairman of the Board, President and Chief Executive Officer, Mark
Benun, the Company's Executive Vice President and Secretary and Isaac Levy, its
Senior Vice President. Such distribution (totaling $7.6 million) represented
substantially all of the Company's remaining undistributed S Corporation
earnings as of the date of termination of S Corporation status, and is evidenced
by four-year 5.7% promissory notes issued to such shareholders in connection
with the Reorganization. Of the total S Corporation Distribution, $2.0 million
of the net proceeds from the Company's Initial Public Offering was used to make
a partial payment of amounts due under the related promissory notes. The balance
of the S Corporation Distribution will be paid in accordance with the terms and
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HAPPY KIDS INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Information relating to September 30, 1998 is unaudited)
provisions of such promissory notes and provides for the timely distribution of
amounts necessary to pay personal income taxes of such shareholders due on
amounts earned by the Company for the period January 1, 1998 through the
termination of such S Corporation status, currently estimated to be $314,000 as
of September 30, 1998.
Subsequent to the termination of the Company's S Corporation status, the
Company uses the liability method for both Federal and state income tax
purposes. The effect of such change was reflected in net income for the second
quarter of 1998 when such termination occurred and resulted in an increase in
deferred tax assets and earnings of approximately $1.0 million.
The pro forma provision for income taxes represents the income tax
provision that would have been reported had the Company been subject to Federal
and additional state and local income taxes as a C Corporation for all periods
presented.
Note 4 -- Due to Shareholders:
In connection with the termination of the Company's S Corporation status,
the Company agreed to distribute an aggregate of $7.6 million to the Company's
pre-Initial Public Offering shareholders, such amounts representing the
Company's total undistributed equity resulting from the S Corporation or limited
liability corporation ("LLC") status of the Company and its related entities
prior to the Reorganization, of which $2.0 million was paid from the proceeds of
the Initial Public Offering. The balance is due pursuant to four-year 5.7% notes
payable to such shareholders. Such notes provide for the timely distribution of
amounts necessary to pay the remaining personal income taxes of such
shareholders or members due on amounts earned by such S Corporations or LLCs for
the period January 1, 1998 through the termination of S Corporation or LLC
status of approximately $314,000. In addition, existing amounts due to
shareholders of $1.4 million are subject to the same terms as the above
promissory notes.
Note 5 -- Pro forma Information:
a. Pro Forma Results of Income and Pro Forma Income Taxes:
Pro Forma adjustments in the statements of income for the three and
nine-month periods ended September 30, 1998 and 1997 reflect provisions for
income taxes based upon pro forma pretax income as if the Company had been
subject to Federal and additional state and local income taxes.
As disclosed in Note 3, the Company has, in the past, elected for certain
of its affiliates to be taxed as S Corporations pursuant to the Internal Revenue
Code. In connection with the Company's Initial Public Offering, the Company
terminated such S elections and partnership status and became subject to Federal
and additional state and local income taxes. The pro forma provision for income
taxes represents the income tax provisions that would have been reported
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HAPPY KIDS INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Information relating to September 30, 1998 is unaudited)
had the Company been subject to Federal and additional state and local income
taxes. The effective pro forma tax rate of the Company differs from the Federal
rate of 34% primarily due to the effects of state and local income taxes.
b. Pro Forma Net Income:
Pro forma net income represents the historical amounts after the pro forma
adjustments discussed above.
Note 6 -- Earnings Per Share:
A reconciliation between basic and diluted earnings per share from
operations is as follows:
Three Months Ended Nine Months Ended
September 30, September 30,
------------------- -------------------
1998 1997 1998 1997
------- ------- ------- -------
(unaudited) (unaudited) (unaudited)
(In thousands except per share amounts)
Net Income ..................... $ 3,371 $ 2,504 $ 8,276 $ 2,692
Basic EPS:
Basic common shares ......... 10,280 7,750 9,406 7,750
======= ======= ======= =======
Basic EPS ................... $ 0.33 $ 0.32 $ 0.88 $ 0.35
======= ======= ======= =======
Diluted EPS:
Basic common shares ......... 10,280 7,750 9,406 7,750
Diluted common shares ....... 4 0 13 0
------- ------- ------- -------
Total diluted shares ........ 10,284 7,750 9,419 7,750
======= ======= ======= =======
Diluted EPS ................. $ 0.33 $ 0.32 $ 0.88 $ 0.35
======= ======= ======= =======
Note 7 -- Reclassification:
Certain prior year amounts have been reclassified to conform to the 1998
presentation.
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HAPPY KIDS INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Information relating to September 30, 1998 is unaudited)
Note 8 - Inventories:
Inventories consist of the following finished goods:
September 30, December 31,
1998 1997
------------- -------------
(in thousands)
Warehouse.................. $ 17,382 $ 8,716
In-transit and overseas.... 4,306 8,010
LIFO valuation allowance.... (357) (410)
--------- ---------
$ 21,331 $ 16,316
========= =========
For the nine months ended September 30, 1998 and 1997, the liquidation of
LIFO inventories decreased the cost of sales and, therefore, increased income
before taxes by $53,000 and $679,000, respectively. For the quarters ended
September 30, 1998 and 1997, there were liquidations of the LIFO reserves of $0
and $428,000, respectively.
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Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations.
General
Happy Kids Inc. is a designer and marketer of custom-designed, licensed
and branded children's apparel. The Company produces high-quality, coordinated
apparel programs, including knit tops, bottoms, overalls, shortalls, coveralls
and swimwear, for newborns, infants, toddlers, boys and girls. The Company's
major licenses currently include Nickelodeon's Rugrats, AND 1 and B.U.M.
Equipment. The Company also designs and delivers private label branded playwear
programs for leading retailers and its major programs currently include Sesame
Street for Kmart and New Legends for Kids R Us.
Prior to and including much of 1995, the Company's operating strategy
primarily focused on developing and marketing its own house brands. The Company
manufactured products for inventory under the Company's brands and often
concentrated on enhancing sales volume rather than focusing on a combination of
sales volume and gross margins. The Company believes that the loss it incurred
in 1995 was primarily attributable to these factors. In 1995, to leverage its
strong customer relationships, the Company initiated its current sales strategy
under which the Company's customers order specific quantities of goods on a
fixed-price basis six to nine months in advance of a selling season. As a
result, for 1997 and for the first nine months of 1998, substantially all of the
Company's playwear was produced upon receipt of customer orders. Also in 1995,
the Company elected to concentrate on developing a diversified portfolio of
popular, established and well-recognized licensed properties and private label
relationships and de-emphasized its reliance on house brands, which have been a
declining component of the Company's net sales in each year since 1995. Since
that time, the Company's strategy has been to work closely with its customers to
design and market high-quality coordinated apparel programs resulting in gross
margins that the Company believes are higher than those typically generated from
sales of non-licensed or non-private label branded playwear.
Statements contained or incorporated by reference in this Quarterly Report
on Form 10-Q that are not based on historical facts are "forward-looking
statements" within the meaning of Section 21E of the Securities Exchange Act of
1934, as amended, including, without limitation, statements regarding the
Company's sales strategy, concentration on the development of a diversified
portfolio of licensed properties and private label relationships and gross
margins. Forward-looking statements also may be identified by the use of
forward-looking terminology such as "may", "will", "expect", "estimate",
"anticipate", "continue", or similar terms, variations of such terms or the
negative of those terms. This Form 10-Q contains forward-looking statements that
involve risks and uncertainties, including, but not limited to, those related
to: (i) general economic conditions; (ii) a dependence on license arrangements;
(iii) a dependence on private label relationships; (iv) a dependence on contract
manufacturers; (v) a reliance on key customers; (vi) a dependence on access to
credit facilities; (vii) the risks associated with significant growth; (viii)
competition; (ix) seasonality of sales; (x) cyclicality and trends in the
apparel industry; (xi) import restrictions and other risks associated with
international business; and (xii) risks relating to the Company's Year 2000
compliance and the Year 2000 compliance
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of the Company's contract manufacturers, suppliers, distributors, marketing
partners and certain other parties. The Company's actual results may differ
materially from the results discussed in the forward-looking statements
contained herein.
Results of Operations
Three Months Ended September 30, 1998 Compared to Three Months Ended
September 30, 1997
Net Sales. Net sales increased $9.2 million, or 24.4%, to $47.0 million in
the third quarter of 1998 from $37.8 million in the third quarter of 1997. The
increase in net sales is attributable primarily to increased sales of playwear
of both licensed products and private label programs.
Gross Profit. Gross profit increased by $2.8 million, or 30.0%, to $12.2
million in the third quarter of 1998 from $9.4 million in the third quarter of
1997. The gross profit margin increased to 26.1% in the third quarter of 1998
from 24.9% in the third quarter of 1997. Such increase was due, in part, to
increased sales in certain higher margin licensed products as well as
efficiencies in transportation and handling costs. In addition, the 1997 gross
margin amount includes $428,000 in income due to a decrease in LIFO reserves,
which accounted for .05% of such gross margin, while the 1998 gross margin had
no LIFO reserve adjustment.
Selling, Design and Shipping Expenses. Selling, design and shipping
expenses increased by $816,000, or 28.8%, to $3.6 million in the third quarter
of 1998 from $2.8 million in the third quarter of 1997. This increase is
attributable primarily to higher sales compensation, warehousing and shipping
costs associated with increased sales volumes. In addition, design and
production salaries increased as a result of the Company's expanded product
lines. As a percentage of net sales, selling, design and shipping expenses
increased to 7.8% in the third quarter of 1998 from 7.5% in the third quarter of
1997.
General and Administrative Expenses. General and administrative expenses
decreased $260,000, or 10.1%, to $2.3 million in the third quarter of 1998 from
$2.6 million in the third quarter of 1997. This decrease is primarily the result
of decreased officers' compensation resulting from the reduction in officers'
salaries and bonuses implemented in the first quarter of 1998, offset, somewhat,
by higher factor commissions associated with increased sales volume, as well as
higher professional fees and expenses incurred and related to Year 2000
remediation. As a percentage of net sales, general and administrative expenses
decreased to 4.9% in the third quarter of 1998 from 6.8% in the third quarter of
1997 due to the operating leverage associated with the higher sales.
Interest Expense, net. Interest expense, net, decreased $682,000, or
59.1%, to $472,000 in the third quarter of 1998 from $1.2 million in the third
quarter of 1997. This decrease is a result of the application of a substantial
portion of the proceeds from the Company's Initial Public Offering to the
repayment of the Company's bank debt in the second quarter of 1998. As a
percentage of net sales, interest expense decreased to 1.0% for the third
quarter of 1998, as compared to 3.1% for the third quarter of 1997.
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Income Before Income Taxes. Income before income taxes increased $2.9
million, to $5.8 million in the third quarter of 1998 from $2.9 million in the
third quarter of 1997 due to the reasons described above. As a percentage of net
sales, income before income taxes increased to 12.4% in the third quarter of
1998 from 7.6% in the third quarter of 1997.
Nine Months Ended September 30, 1998 Compared to Nine Months Ended
September 30, 1997
Net Sales. Net sales increased $37.4 million, or 48.4%, to $114.7 million
in the first nine months of 1998 from $77.3 million in the first nine months of
1997. The increase in net sales is attributable primarily to increased sales of
playwear of both licensed products and private label programs.
Gross Profit. Gross profit increased by $10.0 million, or 51.5%, to $29.4
million in the first nine months of 1998 from $19.4 million in the first nine
months of 1997. The gross profit margin increased to 25.6% in the first nine
months of 1998 from 25.1% in the first nine months of 1997. Such increase was
due to increased sales in certain licensed products. In addition, the 1997 gross
margin amount includes $679,000 in income due to a decrease in LIFO reserves,
which accounted for .04% of such gross margin, while the 1998 gross margin
amount includes $53,000 in income due to a decrease in LIFO reserves, which had
no effect on gross margin for that period.
Selling, Design and Shipping Expenses. Selling, design and shipping
expenses increased by $2.1 million, or 27.8%, to $9.7 million in the first nine
months of 1998 from $7.6 million in the first nine months of 1997. This increase
is attributable primarily to higher sales compensation, warehousing and shipping
costs associated with increased sales volumes. In addition, advertising expenses
increased due to cooperative advertising charges from a licensor associated with
a major licensing program. Also, design and production salaries and sampling
costs increased as a result of the Company's expanded product lines. As a
percentage of net sales, selling, design and shipping expenses decreased to 8.4%
in the first nine months of 1998 from 9.8% in the first nine months of 1997.
General and Administrative Expenses. General and administrative expenses
increased $605,000, or 9.6%, to $6.9 million in the first nine months of 1998
from $6.3 million in the first nine months of 1997. This increase is primarily
the result of higher factor commissions associated with increased sales volume,
as well as higher professional and data processing expenses offset somewhat by
reduced officers' compensation implemented in the first quarter of 1998. As a
percentage of net sales, general and administrative expenses decreased to 6.0%
in the first nine months of 1998 from 8.1% in the first nine months of 1997 due
to the operating leverage associated with the higher sales.
Interest Expense, net. Interest expense, net, decreased $732,000, or
29.0%, to $1.8 million in the first nine months of 1998 from $2.5 million in the
first nine months of 1997. This decrease is a result of the application of a
substantial portion of the proceeds from the Company's Initial Public Offering
to the repayment of the Company's bank debt in the second quarter of 1998. As a
percentage of net sales, interest expense decreased to 1.6% for the first nine
months of 1998, as compared to 3.3% for the first nine months of 1997.
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Income Before Income Taxes. Income before income taxes increased $8.0
million, to $11.1 million in the first nine months of 1998 from $3.1 million in
the first nine months of 1997 due to the reasons described above. As a
percentage of net sales, income before income taxes increased to 9.7% in the
first nine months of 1998 from 4.0% in the first nine months of 1997.
Liquidity and Capital Resources
The Company has financed its cash requirements primarily through
operations and borrowings under its Line of Credit. Historically, the Company's
borrowing requirements have been seasonal, with peak working capital needs
arising during the first and third quarters.
Through the consummation of the Company's Initial Public Offering on April
8, 1998, the Company's Line of Credit permitted borrowings up to $42.0 million
as a revolving credit line to expire on December 31, 1998, subject to annual
renewals (adjusted seasonally to $47.0 million from January 1, 1998 through
April 30, 1998). The Company executed an amendment of its existing Line of
Credit whereby upon effectiveness of the Initial Public Offering and
satisfaction of certain conditions, the Company's Line of Credit was amended to
provide for a discretionary one year revolving Line of Credit, renewable
annually, providing for advances and letter of credit accommodations up to the
lesser of (a) $49.0 million through April 30, 1998, (b) $42.0 million from May
1, 1998 through December 31, 1998, (c) $47.0 million from January 1, 1999
through March 31, 1999, or (d) at all times the sum of (i) up to eighty-five
percent of eligible accounts receivables, plus (ii) up to fifty percent of
finished goods inventory, plus (iii) overadvances approved by the lender. The
maximum amount of revolving credit advances outstanding at any time could not
exceed $35.0 million from January 1, 1998 to April 30, 1998 and $30.0 million
thereafter, and the maximum amount of letters of credit outstanding at any time
may not exceed $35.0 million. The interest rate on amounts borrowed will be the
bank's then prevailing prime rate (8.25% at September 30, 1998). In addition, in
connection with the amendment to the Line of Credit, personal guarantees of
certain of the Company's present shareholders under the Line of Credit
terminated and the collateral pledged by such shareholders were released.
Prior to such amendment, the first $5.0 million of borrowings under this
Line of Credit bore interest at the prime rate plus 4.0%. The remaining
borrowings bore interest at the prime rate plus 1.0%. Additionally, the Company
was subject to certain fees associated with the Line of Credit. The Line of
Credit is collateralized by substantially all of the assets of the Company. As
of September 30, 1998 the Company had $8.3 million of outstanding direct
borrowings and $16.1 million of contingent liabilities under open letters of
credit.
The Company used approximately $17.1 million of the net proceeds from its
Initial Public Offering consummated on April 8, 1998 and all of the net proceeds
(approximately $3.1 million) received in connection with the exercise of the
underwriters' over-allotment option consummated on April 23, 1998 to reduce the
outstanding balance of direct borrowings under the Line of Credit.
In addition, the Company's lender has sole discretion to make or withhold
advances under the Line of Credit. There can be no assurance that the lender
will continue to lend under the Line
- 13 -
<PAGE>
of Credit. If the lender exercises its discretion to withhold advances, there
would be a material adverse effect on the Company's business, financial
condition and results of operations.
On April 8, 1998, the Company consummated its Initial Public Offering of
2,200,000 shares of its Common Stock at a price of $10.00 per share, all of
which shares were issued and sold by the Company. On April 23, 1998, the Company
consummated the exercise of the underwriters' over-allotment option granted by
the Company to the underwriters in connection with the Initial Public Offering.
As a result, the Company issued and sold an additional 330,000 shares of the
Company's Common Stock at the Initial Public Offering price of $10.00 per share.
The net proceeds to the Company from such sales were approximately $22.3
million.
Of the total net proceeds received by the Company upon the consummation of
its Initial Public Offering and the exercise of the over-allotment option, $2.0
million was distributed to certain shareholders of the Company in connection
with the payment of a portion of the S Corporation distribution and the
remaining amount was utilized to pay down a portion of the outstanding balance
under the Company's Line of Credit.
As of September 30, 1998, the Company's other principal sources of
liquidity included cash of $357,000, amounts due from factor of $25.1 million
and net accounts receivable of $636,000. The Company had working capital of
$33.1 million and long-term debt of $5.9 million as of September 30, 1998.
For the nine months ended September 30, 1998, operating activities used
cash of $1.9 million primarily as a result of a decrease in accounts payable and
accrued expenses of $1.4 million, an increase in amounts due from factor of
$900,000, an increase in inventory of $5.0 million and increased other assets of
$2.1 million, offset by net income of $8.3 million. Net cash provided by
financing activities during the same period was $2.2 million consisting
primarily of the proceeds of the Company's Initial Public Offering, offset by
net borrowings of $16.6 million under the Company's Line of Credit and payments
to shareholders of $3.4 million.
Historically, the Company's business has not required significant capital
expenditures. The Company's capital expenditures for the nine months ended
September 30, 1998 and 1997, were $251,000 and $77,000, respectively. The
Company believes that cash flow expected to be generated from operations,
together with borrowings under its existing Line of Credit, as amended, will be
adequate to satisfy current and planned operations for at least the next 12
months.
Backlog
The Company's customers order specific quantities of goods on a fixed-price
basis six to nine months in advance of a selling season. Such customer orders
are placed in backlog upon their receipt and acceptance by the Company. Customer
orders are generally cancelable on notice to the Company without penalty.
Although the Company has not had significant cancellations in the past, no
assurance can be given that it will not experience a significant level of
cancellations in the future or that its backlog at any point in time will be
converted to sales.
- 14 -
<PAGE>
Many of the Company's orders are received significantly in advance of scheduled
delivery periods. Consequently, the Company had backlog of $105.9 million at
September 30, 1998, all of which it expects to ship over the next six to nine
months.
Management Information Systems
General
The Company believes that advanced information processing is essential to
maintaining its competitive position. The Company participates in the electronic
data interchange program maintained by many of its larger customers, including
J.C. Penney, Kids R Us, Sears, Target and Walmart. This program allows the
Company to receive customer orders, provide advanced shipping notices, monitor
store inventory and track orders on-line from the time such orders are placed
through delivery. The Company is also able to notify certain of its clients'
warehouses, in advance, as to shipments.
Year 2000 Compliance
In 1998, the Company established an oversight committee to review all of
the Company's computer systems and programs, as well as the computer systems of
the third parties upon whose data or functionality the Company relies in any
material respect, and to assess their ability to process transactions in the
Year 2000 and beyond. The Company, through such oversight committee, currently
is upgrading its management information systems, which it expects to complete
during the second quarter of 1999, to ensure proper processing of transactions
relating to Year 2000 and beyond. The Company continues to evaluate appropriate
courses of corrective actions, including replacement of certain systems.
Although the Company does not expect the costs associated with ensuring Year
2000 compliance to have a material affect on its financial position or results
of operations, if the computer systems used by the Company, or any of its
suppliers or vendors fail or experience significant difficulties related to the
Year 2000, the Company could experience delays in manufacturing, delays in
shipping, an inability to monitor customer orders or to manage inventory, or may
experience related risks that could materially adversely affect the Company's
financial position or its results of operations. The Company has identified and
been in contact with its major customers, its bank and its factor. The reply
from each such entity indicates that each is, or will be, Year 2000 compliant.
The Company has incurred approximately $100,000 of expenses for Year 2000
remediation costs in the nine months ended September 30, 1998 and estimates
future additional expenditures for Year 2000 remediation of approximately
$50,000. All costs associated with Year 2000 compliance are being funded with
cash flow generated from operations and are being expensed as incurred. The
Company has not developed a contingency plan with respect to Year 2000 issues
should they arise.
- 15 -
<PAGE>
European Monetary Union
On January 1, 1999, eleven of the fifteen member countries of the European
Union are scheduled to set fixed conversion rates between their existing legacy
currencies and the euro. At such time, these participating countries have agreed
to adopt the euro as their common legal currency. The eleven participating
countries will issue sovereign debt exclusively in euro and will redenominate
outstanding sovereign debt. The legacy currencies will continue to be used as
legal tender through January 1, 2002, at which point the legacy currencies will
be canceled and euro bills and coins will be used for cash transactions in the
participating countries.
The Company does not denominate its agreements or transactions with
foreign entities in foreign currencies. The Company currently does not believe
that the euro conversion will have a material impact on the Company's financial
condition or results of operations.
Effect of Recently Issued Accounting Standards
SFAS No. 131, "Disclosures about Segments of an Enterprise and Related
Information" ("SFAS No. 131") was issued in June 1997. This statement is
effective for the Company's fiscal year ending December 31, 1998. This statement
changes the way public companies report information about segments of their
business in their annual financial statements and requires them to report
selected segment information in their quarterly reports. Adoption of SFAS No.
131 is not expected to have a material effect on the Company's financial
statement disclosures.
- 16 -
<PAGE>
PART II. OTHER INFORMATION
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits.
27 Financial Data Schedule
(b) Reports on Form 8-K.
No reports on Form 8-K were filed during the quarter for which
this report on Form 10-Q is filed.
- 17 -
<PAGE>
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
Happy Kids Inc.
DATE: November 6, 1998 By: /s/ Jack Benun
---------------------
Jack Benun
President and Chief Executive Officer
(Principal Executive Officer)
DATE: November 6, 1998 By: /s/ Stuart Bender
---------------------
Stuart Bender
Chief Financial Officer
(Principal Financial and Accounting
Officer)
- 18 -
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
This schedule contains summary financial information extracted from the
unaudited condensed consolidated financial statements as of September 30, 1998
(unaudited) and September 30, 1997 contained in the Company's Quarterly Report
on Form 10-Q for the period ending September 30, 1998, and is qualified in its
entirety by reference to such financial statements.
</LEGEND>
<CIK> 0001052262
<NAME> Happy Kids Inc.
<MULTIPLIER> 1,000
<CURRENCY> U.S. Dollars
<S> <C> <C>
<PERIOD-TYPE> 9-Mos 9-Mos
<FISCAL-YEAR-END> DEC-31-1998 DEC-31-1997
<PERIOD-START> JAN-01-1998 JAN-01-1997
<PERIOD-END> SEP-30-1998 SEP-30-1997
<EXCHANGE-RATE> 1 1
<CASH> 357 0
<SECURITIES> 0 0
<RECEIVABLES> 25,747 0
<ALLOWANCES> 513 0
<INVENTORY> 21,331 0
<CURRENT-ASSETS> 51,787 0
<PP&E> 1,501 0
<DEPRECIATION> 0 0
<TOTAL-ASSETS> 53,835 0
<CURRENT-LIABILITIES> 18,733 0
<BONDS> 8,315 0
0 0
0 0
<COMMON> 103 0
<OTHER-SE> 29,070 0
<TOTAL-LIABILITY-AND-EQUITY> 53,835 0
<SALES> 114,721 77,328
<TOTAL-REVENUES> 114,721 77,328
<CGS> 85,302 57,908
<TOTAL-COSTS> 16,539 13,833
<OTHER-EXPENSES> 0 0
<LOSS-PROVISION> 0 0
<INTEREST-EXPENSE> 1,790 2,522
<INCOME-PRETAX> 11,090 3,065
<INCOME-TAX> 2,814 373
<INCOME-CONTINUING> 8,276 2,692
<DISCONTINUED> 0 0
<EXTRAORDINARY> 0 0
<CHANGES> 0 0
<NET-INCOME> 8,276 2,692
<EPS-PRIMARY> 0.88 0.35
<EPS-DILUTED> 0.88 0.35
</TABLE>
