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 June 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:
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Indicate the number of shares outstanding of each of the Registrant's
classes of common stock, as of July 31, 1998:
Class Number of Shares
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Common Stock, $.01 par value 10,280,000
*Registrant became subject to the filing requirements of the Securities Exchange
Act of 1934 on April 2, 1998, when its Registration Statements on Form S-1 and
Form 8-A were declared effective by the Commission. 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 were issued and sold by
the Company. On April 23, 1998, the Company issued and sold an additional
330,000 shares of its Common Stock at the Initial Public Offering price of
$10.00 per share upon the consummation of the exercise of the underwriters'
over-allotment option granted by the Company in connection with its Initial
Public Offering.
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HAPPY KIDS INC. AND SUBSIDIARIES
TABLE OF CONTENTS
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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 June 30,
1998 (unaudited) and December 31,1997................ 2
Condensed Consolidated Statements of Income for the
Three and Six Months Ended June 30, 1998 and 1997
(unaudited).......................................... 3
Condensed Consolidated Statements of Cash Flows for
the Six Months Ended June 30, 1998 and 1997
(unaudited).......................................... 4
Notes to Condensed Consolidated Financial Statements
(unaudited).......................................... 5
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations................. 9
Results of Operations................................. 10
Liquidity and Capital Resources....................... 12
Backlog............................................... 13
Management Information Systems........................ 14
Effect of Recently Issued Accounting Standards........ 14
PART II. OTHER INFORMATION.............................................. 15
Item 2. Changes in Securities and Use of Proceeds............. 15
Item 5. Other Information..................................... 16
Item 6. Exhibits and Reports on Form 8-K...................... 16
SIGNATURES.............................................................. 17
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PART I. CONDENSED CONSOLIDATED FINANCIAL INFORMATION
ITEM 1. CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
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HAPPY KIDS INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(in thousands, except per share amounts)
June 30, December 31,
1998 1997
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ASSETS (unaudited)
<S> <C> <C>
CURRENT ASSETS
Cash ........................................................ $ 388 $ 374
Due from factor ............................................. 19,445 24,232
Accounts receivable - trade (net of allowance of $513
at June 30, 1998 and December 31, 1997).................... 146 316
Inventories ................................................. 21,873 16,316
Due from shareholders ....................................... -- 347
Prepaid royalties ........................................... 2,614 147
Other current assets ........................................ 2,706 992
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Total current assets .............................. 47,172 42,724
FIXED ASSETS - NET .............................................. 1,373 1,476
OTHER ASSETS .................................................... 545 752
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Total assets ...................................... $ 49,090 $ 44,952
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LIABILITIES AND SHAREHOLDERS' EQUITY
CURRENT LIABILITIES
Due to bank ................................................. $ 3,780 $ 24,863
Current portion - capital lease obligations ................. 44 49
Accounts payable and accrued liabilities .................... 13,032 11,393
Due to shareholders ......................................... 314 --
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Total current liabilities ......................... $ 17,170 $ 36,305
DEFERRED RENT PAYABLE ........................................... 544 584
CAPITAL LEASE OBLIGATIONS ....................................... -- 19
DUE TO SHAREHOLDERS ............................................. 5,574 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 June 30, 1998 and December 31, 1997, respectively .... 103 78
Additional paid-in capital .................................. 23,263 1,119
Retained earnings ........................................... 2,436 5,447
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Total shareholders' equity ....................... 25,802 6,644
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Total liabilities and shareholders' equity ....... $ 49,090 $ 44,952
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The accompanying notes are an integral part of these statements.
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HAPPY KIDS INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
(unaudited)
(in thousands, except per share amounts)
For the Three Months For the Six Months
Ended June 30, Ended June 30,
------------------------ ------------------------
1998 1997 1998 1997
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<S> <C> <C> <C> <C>
Net sales ................................... $ 32,013 $ 14,746 $ 67,728 $ 39,557
Cost of goods sold .......................... 23,468 11,095 50,552 29,549
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Gross profit ............................ 8,545 3,651 17,176 10,008
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Operating expenses:
Selling, design and shipping ............ 3,040 2,280 6,005 4,720
General and administrative .............. 2,472 1,900 4,576 3,711
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Total operating expenses .......... 5,512 4,180 10,581 8,431
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Operating earnings (loss) ......... 3,033 (529) 6,595 1,577
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Interest expense, net ....................... 328 674 1,318 1,368
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Income (loss) before income taxes ........... 2,705 (1,203) 5,277 209
Provision for income taxes:
Income taxes (benefit) ................. 1,136 (122) 1,396 21
Deferred tax benefit ................... (1,024) -- (1,024) --
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Total income taxes ................ 112 (122) 372 21
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Net income (loss) ................. $ 2,593 $ (1,081) $ 4,905 $ 188
========== ========== ========== ==========
Basic income (loss)
per common share ........................ $ 0.25 $ (0.14) $ 0.55 $ 0.02
========== ========== ========== ==========
Weighted average common
shares outstanding ...................... 10,188 7,750 8,976 7,750
========== ========== ========== ==========
Diluted income (loss)
per common share ........................ $ 0.25 $ (0.14) $ 0.55 $ 0.02
========== ========== ========== ==========
Weighted average common
shares outstanding ...................... 10,221 7,750 8,985 7,750
========== ========== ========== ==========
Pro forma data (unaudited) :
Historical income (loss) before
provision for income taxes ........ $ 2,705 $ (1,203) $ 5,277 $ 209
Income taxes (benefit) .................. 1,136 (505) 2,216 88
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Net income (loss) ................. $ 1,569 $ (698) $ 3,061 $ 121
========== ========== ========== ==========
Pro forma basic income (loss) per share ..... $ 0.15 $ (0.09) $ 0.34 $ 0.02
========== ========== ========== ==========
Pro forma weighted average
common shares outstanding ............... 10,188 7,750 8,976 7,750
========== ========== ========== ==========
Pro forma diluted income (loss) per share ... $ 0.15 $ (0.09) $ 0.34 $ 0.02
========== ========== ========== ==========
Pro forma weighted average
common shares outstanding ............... 10,221 7,750 8,985 7,750
========== ========== ========== ==========
The accompanying notes are an integral part of these statements.
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<CAPTION>
HAPPY KIDS INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(unaudited)
(in thousands)
For the Six Months
Ended June 30,
-------------------------
1998 1997
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<S> <C> <C>
Cash flows from operating activities:
Net income ............................................... $ 4,905 $ 188
Adjustments to reconcile net income
to net cash provided by operating activities:
Depreciation and amortization ........................ 114 230
Deferred taxes ....................................... (1,024) --
Changes in operating assets and liabilities:
Accounts receivable .............................. 170 963
Due from factor .................................. 4,787 6,347
Inventories ...................................... (5,557) (6,581)
Prepaid royalties ................................ (2,467) (35)
Other current assets ............................. (617) 656
Other assets ..................................... (28) 457
Accounts payable and accrued liabilities ......... 1,599 (980)
Due from shareholders ............................ 347 72
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Net cash provided by operating activities ................ 2,229 1,317
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Cash flows from investing activities:
Acquisition of fixed assets .............................. (11) (48)
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Cash flows from financing activities:
Net borrowings under line of credit ...................... (21,083) 837
Payments on capital lease ................................ (24) (33)
Borrowings from shareholders ............................. -- (160)
Dividends paid ........................................... (3,428) (2,435)
Issuance of common stock ................................. 22,331 --
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Net cash used in financing activities ............... (2,204) (1,791)
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Net increase (decrease) in cash ...................... 14 (522)
Cash at beginning of year .................................. 374 674
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Cash at end of period ...................................... $ 388 $ 152
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The accompanying notes are an integral part of these statements.
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HAPPY KIDS INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
Note 1 -- Basis of Presentation:
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The information presented for June 30, 1998 and for the three-month and
six-month periods ended June 30, 1998 and 1997 are unaudited, but, 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
June 30, 1998 and the results of its operations and its cash flows for the
three-month and six-month periods ended June 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
(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 was 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 $7.9 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
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
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HAPPY KIDS INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
Company for the period January 1, 1998 through the termination of such S
Corporation status, currently estimated to be $ 314,000 as of June 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 $ 7.9 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:
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a. Pro Forma Results of Income and Pro Forma Income Taxes:
-------------------------------------------------------------
Pro Forma adjustments in the statements of income for the three and
six-month periods ended June 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 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.
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HAPPY KIDS INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
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:
- -----------------------------
The Company has adopted SFAS No. 128, "Earnings Per Share" ("SFAS No.
128") which requires public companies to present basic earnings per share and,
if applicable, diluted earnings per share. In accordance with SFAS No. 128, the
Company has retroactively restated earnings per share. Basic EPS is based on the
weighted average number of common shares outstanding, without consideration of
common stock equivalents. Diluted earnings per share is based on the weighted
average number of common and common equivalent shares outstanding. There were
approximately 33,000 common stock equivalent shares at June 30, 1998 and none at
December 31, 1997.
Note 7 -- Reclassification:
- ---------------------------
Certain prior year amounts have been reclassified to conform to the 1998
presentation.
Note 8 - Inventories:
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Inventories consist of the following finished goods:
June 30, December 31,
1998 1997
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(in thousands)
Warehouse .................... $ 15,658 $ 8,716
In-transit and overseas ...... 6,572 8,010
LIFO valuation allowance ..... (357) (410)
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$ 21,873 $ 16,316
========== ==========
For the six months ended June 30, 1998 and 1997, the liquidation of LIFO
inventories decreased the cost of sales and, therefore, increased income before
taxes by $ 53,000 and $ 251,000, respectively. For the quarters ended June 30,
1998 and 1997 there was no liquidation of the LIFO reserve.
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ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS.
GENERAL
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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 six 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: (i) a dependence
on license arrangements; (ii) a dependence on private label relationships; (iii)
a dependence on contract manufacturers; (iv) a reliance on key customers; (v) a
dependence on access to credit facilities; (vi) the risks associated with
significant growth; (vii) competition; (viii) seasonality of sales; (ix)
cyclicality and trends in the apparel industry; and (x) import restrictions and
other
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risks associated with international business. The Company's actual results may
differ materially from the results discussed in the forward-looking statements
contained herein.
RESULTS OF OPERATIONS
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Three Months Ended June 30, 1998 Compared to Three Months Ended June 30, 1997
- -----------------------------------------------------------------------------
Net Sales. Net sales increased $ 17.3 million, or 117.1%, to $ 32.0
million in the second quarter of 1998 from $14.7 million in the second 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 $ 4.9 million, or 134.0 %, to $
8.5 million in the second quarter of 1998 from $ 3.7 million in the second
quarter of 1997. The gross profit margin increased to 26.7 % in the second
quarter of 1998 from 24.8 % in the second 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.
Selling, Design and Shipping Expenses. Selling, design and shipping
expenses increased by $ 760,000, or 33.3 %, to $3.0 million in the second
quarter of 1998 from $ 2.3 million in the second quarter of 1997. This increase
is attributable primarily to higher sales compensation, warehousing and shipping
costs associated with increased sales volumes. In addition, design salaries
increased as a result of the Company's expanded product lines. As a percentage
of net sales, selling, design and shipping expenses decreased to 9.5 % in the
second quarter of 1998 from 15.5 % in the second quarter of 1997.
General and Administrative Expenses. General and administrative expenses
increased $ 572,000, or 30.1 %, to $ 2.5 million in the second quarter of 1998
from $ 1.9 million in the second quarter 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 and contributions. As a
percentage of net sales, general and administrative expenses decreased to 7.7 %
in the second quarter of 1998 from 12.9 % in the second quarter of 1997 due to
the operating leverage associated with the higher sales.
Interest Expense, net. Interest expense, net decreased $ 346,000, or 51.3
%, to $ 328,000 in the second quarter of 1998 from $674,000 in the second
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 second
quarter of 1998, as compared to 4.6 % for the second quarter of 1997.
Income Before Income Taxes. Income before income taxes increased $ 3.9
million, to $ 2.7 million in the second quarter of 1998 from a loss of $1.2
million in the second quarter of 1997 due to the reasons described above. As a
percentage of net sales, income before income
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taxes increased to 8.5 % in the second quarter of 1998 from (8.2 %) in the
second quarter of 1997.
Six Months Ended June 30, 1998 Compared to Six Months Ended June 30, 1997
- -------------------------------------------------------------------------
Net Sales. Net sales increased $ 28.1 million, or 71.2%, to $67.7 million
in the first six months of 1998 from $ 39.6 million in the first six 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 $ 7.2 million, or 71.6 %, to $
17.2 million in the first six months of 1998 from $ 10.0 million in the first
six months of 1997. The gross profit margin increased to 25.4 % in the first six
months of 1998 from 25.3 % in the first six months of 1997. Such increase was
due to increased sales in certain licensed products. In addition, the 1997 gross
margin amount includes $251,000 in income due to a decrease in LIFO reserves,
which accounted for 0.6 % 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 affect on gross margin for that period.
Selling, Design and Shipping Expenses. Selling, design and shipping
expenses increased by $ 1.3 million, or 27.2 %, to $ 6.0 million in the first
six months of 1998 from $ 4.7 million in the first six 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 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 8.9
% in the first six months of 1998 from 11.9 % in the first six months of 1997.
General and Administrative Expenses. General and administrative expenses
increased $865,000 , or 23.3 %, to $ 4.6 million in the first six months of 1998
from $ 3.7 million in the first six 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 and contributions.
As a percentage of net sales, general and administrative expenses decreased to
6.8 % in the first six months of 1998 from 9.4 % in the first six months of 1997
due to the operating leverage associated with the higher sales.
Interest Expense, net. Interest expense, net decreased $ 50,000, or 3.7 %,
to $ 1.3 million in the first six months of 1998 from $ 1.4 million in the first
six months of 1997. This decrease is a result of the application of a
substantial portion of the proceeds from its 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 2.0% for the first six
months of 1998, as compared to 3.5 % for the first six months of 1997.
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Income Before Income Taxes. Income before income taxes increased $ 5.1
million, to $ 5.3 million in the first six months of 1998 from $ 209,000 in the
first six months of 1997 due to the reasons described above. As a percentage of
net sales, income before income taxes increased to 7.8 % in the first six months
of 1998 from 0.1 % in the first six 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 (8.5 % at June 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, and during the quarterly period reported on
herein, the first $5.0 million of borrowings under this Line of Credit bore
interest at the prime rate plus 4.0% (12.5 % at June 30, 1998). The remaining
borrowings bore interest at the prime rate plus 1.0% (9.5% at June 30, 1998).
Additionally, the Company was subject to certain fees associated with the Line
of Credit. The Line of Credit is collaterialized by substantially all of the
assets of the Company. As of June 30, 1998 the Company had $ 3.8 million of
outstanding direct borrowings and $ 18.7 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.
- 12 -
<PAGE>
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 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 was 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 June 30, 1998, the Company's other principal sources of liquidity
included cash of $ 388,000, amounts due from factor of $ 19.4 million and net
accounts receivable of $ 146,000. The Company had working capital of $ 30.0
million and long-term debt of $ 6.1 million as of June 30, 1998.
For the six months ended June 30, 1998, operating activities provided cash
of $ 2.2 million primarily as a result of net income of $4.9 million, a decrease
in amounts due from factor of $ 4.8 million and an increase in accounts payable
and accrued expenses of $ 1.6 million. This was partially offset by an increase
in inventory of $ 5.6 million. Net cash used in financing activities during the
same period was $ 2.2 million consisting primarily of the proceeds of the
Company's Initial Public Offering, offset by reduced net borrowings of $ 21.1
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 were insignificant for the
quarters ended June 30, 1998 and 1997, 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
- 13 -
<PAGE>
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. Many of the Company's orders are received
significantly in advance of scheduled delivery periods. Consequently, the
Company had backlog of $ 107.0 million at June 30, 1998, all of which is
expected to ship prior to March 31, 1999.
MANAGEMENT INFORMATION SYSTEMS
- ------------------------------
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 client's
warehouses, in advance, as to shipments. The Company currently is upgrading its
management information systems, which it expects to complete in 1998, to ensure
proper processing of transactions relating to the year 2000 and beyond. The
Company continues to evaluate appropriate courses of corrective actions,
including replacement of certain systems. The Company does not expect the costs
associated with ensuring year 2000 compliance to have a material effect on its
financial position or results of operations. All costs associated with year 2000
compliance are being funded with cash flow generated from operations and are
being expensed as incurred. Although the Company believes that the information
systems of its major customers and vendors (insofar as they relate to the
Company's business) comply with year 2000 requirements, there can be no
assurance that the year 2000 issue will not affect the information systems of
such customers and vendors as they relate to the Company's business, or that any
such impact on such customers' and vendors' information systems would not have a
material adverse effect on the Company's business, 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.
- 14 -
<PAGE>
PART II. OTHER INFORMATION
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS
CHANGES IN SECURITIES
- ---------------------
On April 1, 1998, the day prior to the effectiveness of the Company's
Initial Public Offering, the Company acquired all of the issued and outstanding
shares of certain related entities of the Company, in exchange for shares of
Common Stock of the Company that have not yet been registered under the
securities laws, from each of Jack Benun, the Company's Chairman of the Board,
President and Chief Executive Officer and Mark Benun, the Company's Executive
Vice President, Secretary and a Director of the Company. Each of Jack Benun and
Mark Benun received 2,131,250 shares of the Company's Common Stock in exchange
for each of their then 50% ownership interests in each of Happy Kids Children's
Apparel, Ltd., Talk of the Town Apparel Corp., O.P. Kids, L.L.C., H.O.T. Kidz,
L.L.C., Hawk Industries, Inc. and J & B 18 Corp.
During the quarter, upon consummation of the Company's Initial Public
Offering on April 8, 1998, the Company granted stock options to purchase an
aggregate of 80,000 shares of its Common Stock to certain of its non-employee
Directors pursuant to the Company's 1997 Stock Plan. The shares underlying such
options have not yet been registered under the securities laws. All of such
options have an exercise price of $10.00 per share, which was based upon and
equal to the Company's Initial Public Offering price per share of Common Stock.
The Company did not employ an underwriter in connection with the issuance
or sale of the securities described above. The Company claims that the issuance
or sale of the foregoing securities was exempt from registration under either
(i) Section 4(2) of the Securities Act of 1933, as amended (the "Act"), as
transactions not involving any public offering and such securities having been
acquired for investment and not with a view to distribution, or (ii) Rule 701
under the Act as transactions made pursuant to a written compensatory benefit
plan or pursuant to a written contract relating to compensation. Appropriate
legends were affixed to the stock certificates issued in such transactions. All
recipients had adequate access to information about the Company.
USE OF PROCEEDS AND RESTRICTION ON DIVIDENDS
- --------------------------------------------
On April 2, 1998, the SEC declared effective the Company's Registration
Statement on Form S-1 (Registration Statement No. 333-44267), as filed with the
SEC in connection with the Company's Initial Public Offering of Common Stock,
which was co-managed by Ladenburg Thalmann & Co., Inc. and Cruttenden Roth
Incorporated. Pursuant to such Registration Statement, and the Company's
Registration Statement on Form S-1MEF (Registration Statement No. 333-49427),
filed with the SEC on April 3, 1998, which became effective as of such date, the
Company registered and sold an aggregate of 2,530,000 shares of its Common
Stock, including shares underlying the underwriters' over-allotment option, for
a gross aggregate offering price of $25.3 million. In connection with such
offering, the Company incurred total expenses of
- 15 -
<PAGE>
approximately $1.3 million. In addition to such expenses, the Company incurred
underwriting discounts and commissions of approximately $1.8 million. Of the
approximately $19.1 million in net proceeds received by the Company upon
consummation of its Initial Public Offering and the approximately $3.1 million
in net proceeds received by the Company upon consummation of the exercise of the
underwriters' over-allotment option related thereto, an aggregate of $2.0
million was distributed to Jack Benun, the Company's Chairman of the Board,
President and Chief Executive Officer, Mark Benun, the Company's Executive Vice
President, Secretary and a Director and Isaac Levy, the Company's Senior Vice
President and a Director in connection with the payment of the S Corporation
Distribution, and the remaining amount was utilized to pay down the outstanding
balance under the Company's amended Line of Credit. Under such amended Line of
Credit, the Company is obligated to maintain certain financial covenants and is
restricted from paying dividends to its shareholders.
ITEM 5. OTHER INFORMATION.
ELECTION OF INDEPENDENT DIRECTORS
- ---------------------------------
Upon the consummation of the Initial Public Offering on April 8, 1998, the
term of office of two independent Directors, Marvin Azrak and Stephen Kahn,
commenced. Messrs. Azrak and Kahn were also elected to the Company's Audit
Committee and Option Committee, commencing on such date.
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.
- 16 -
<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: August 10 , 1998 By:/s/ Jack Benun
--------------------------------------
Jack Benun
President and Chief Executive Officer
(Principal Executive Officer)
DATE: August 10, 1998 By:/s/ Stuart Bender
--------------------------------------
Stuart Bender
Chief Financial Officer
(Principal Financial and Accounting
Officer)
- 17 -
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
This schedule contains summary financial information extracted from the
unaudited condensed consolidated financial statements as of June 30, 1998 and
June 30, 1997 contained in the Company's Quarterly Report on Form 10-Q for the
period ending June 30, 1998, and is qualified in its entirety by referenced to
such financial statements.
</LEGEND>
<CIK> 0001052262
<NAME> Happy Kids Inc.
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<PERIOD-TYPE> 6-Mos 6-Mos
<FISCAL-YEAR-END> Dec-31-1998 Dec-31-1997
<PERIOD-START> Jan-01-1998 Jan-01-1997
<PERIOD-END> Jun-30-1998 Jun-30-1997
<EXCHANGE-RATE> 1 1
<CASH> 388 0
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<RECEIVABLES> 19,445 0
<ALLOWANCES> 513 0
<INVENTORY> 21,873 0
<CURRENT-ASSETS> 47,172 0
<PP&E> 1,373 0
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<TOTAL-ASSETS> 49,090 0
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<INTEREST-EXPENSE> 1,318 1,368
<INCOME-PRETAX> 5,277 209
<INCOME-TAX> 372 21
<INCOME-CONTINUING> 4,905 188
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<NET-INCOME> 4,905 188
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