<PAGE> 1
AAI.FOSTERGRANT, INC. AND SUBSIDIARIES
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
EXCHANGE ACT OF 1934.
For the quarterly period ended October 3, 1998.
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES
EXCHANGE ACT OF 1934.
For the transition period from _______ to _______
Commission File Number 333-61119
AAI.FOSTERGRANT, INC.
------------------------------------------------------
(Exact name of registrant as specified in its charter)
RHODE ISLAND 05-0419304
- ------------------------------- ----------------------
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification Number)
500 GEORGE WASHINGTON HIGHWAY
SMITHFIELD, RI 02917
---------------------------------------------------
(Address of principal executive offices) (Zip code)
(401)231-3800
----------------------------------------------------
(Registrant's telephone number, including area code)
Indicate by checkmark 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: [ ] NO: [X ]
As of December 21, 1998, there were 608,000 shares of the Registrant's
Common Stock, $.01 par value, outstanding.
<PAGE> 2
AAI.FOSTERGRANT, INC. AND SUBSIDIARIES
QUARTERLY REPORT
TABLE OF CONTENTS
<TABLE>
<CAPTION>
PAGE
<S> <C>
PART I. - FINANCIAL INFORMATION
ITEM 1. CONSOLIDATED CONDENSED FINANCIAL STATEMENTS
Consolidated Condensed Balance Sheets as of December 31, 1997
and October 3, 1998 3
Consolidated Condensed Statements of Operations for the three
and nine months ended September 30, 1997 and October 3, 1998 4
Consolidated Condensed Statements of Cash Flows for the nine
months ended September 30, 1997 and October 3, 1998 5
Notes to Consolidated Condensed Financial Statements 7
FINANCIAL STATEMENTS FOR FANTASMA, LLC A MOSTLY-OWNED
SUBSIDIARY OF AAI.FOSTERGRANT, INC
Condensed Balance Sheets as of December 31, 1997 and October 3, 1998 16
Condensed Statements of Operations for the three and nine
months ended September 30, 1997 and October 3, 1998 17
Condensed Statement of Cash Flows for the nine months
ended September 30, 1997 and October 3, 1998 18
Notes to Financial Statements 19
ITEM 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations 21
ITEM 3. Quantitative and Qualitative Disclosures About Market Risk 32
PART II - OTHER INFORMATION
ITEM 1. Legal Proceedings 32
ITEM 2. Changes in Securities and Use of Proceeds 32
ITEM 3. Defaults Upon Senior Securities 32
ITEM 4. Submission of Matters to a Vote of Security Holders 32
ITEM 5. Other Information 32
ITEM 6. Exhibits and reports on Form 8-K 32
SIGNATURES 33
</TABLE>
2
<PAGE> 3
AAI.FOSTERGRANT, INC. AND SUBSIDIARIES
CONSOLIDATED CONDENSED BALANCE SHEETS
(In thousands)
<TABLE>
<CAPTION>
DECEMBER 31, OCTOBER 3,
1997 1998
<S> <C> <C>
ASSETS
CURRENT ASSETS:
Cash and cash equivalents $ 2,779 $ 2,588
Accounts receivable less reserves of approximately
$10,338 and $10,446, in 1997 and 1998, respectively 18,323 33,276
Inventories 32,795 28,337
Prepaid expenses and other current assets 734 996
Deferred tax assets 9,707 10,041
-------- ---------
Total current assets 64,338 75,238
-------- ---------
Property, plant and equipment, net 10,185 20,236
Intangible assets 16,600 21,262
Other assets 2,623 5,730
-------- ---------
Total assets $ 93,746 $ 122,466
======== =========
LIABILITIES AND SHAREHOLDERS' DEFICIT
CURRENT LIABILITIES:
Borrowings under senior credit facility $ 27,598 $ 4,018
Current maturities of long-term obligations 3,361 490
Accounts payable 14,117 11,275
Accrued expenses 11,221 12,599
Accrued income taxes 2,105 2,198
-------- ---------
Total current liabilities 58,402 30,580
-------- ---------
Long-term obligations, less current maturities 9,653 1,786
Deferred tax liabilities 645 645
Subordinated promissory notes payable to shareholders 5,487 --
10 3/4% senior notes -- 75,000
Redeemable preferred stock of a subsidiary 835 888
Preferred stock, $.01 par value --
Authorized -- 200,000 shares Designated, issued and
outstanding -- 43,700 shares of Series A Redeemable
Convertible Preferred Stock, stated at redemption value 26,083 28,139
SHAREHOLDERS' DEFICIT:
Common stock, $.01 par value--
Authorized-- 4,800,000 shares
Issued and outstanding-- 608,000 shares 6 6
Additional paid-in capital 270 270
Accumulated other comprehensive loss (78) (132)
Accumulated deficit (7,557) (14,716)
-------- ---------
Total shareholders' deficit (7,359) (14,572)
-------- ---------
Total liabilities and shareholders' deficit $ 93,746 $ 122,466
======== =========
</TABLE>
The accompanying notes are an integral part of these consolidated condensed
financial statements.
3
<PAGE> 4
AAI.FOSTERGRANT, INC. AND SUBSIDIARIES
CONSOLIDATED CONDENSED STATEMENTS OF OPERATIONS
(In thousands, except per share data)
<TABLE>
<CAPTION>
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, OCTOBER 3, SEPTEMBER 30, OCTOBER 3,
1997 1998 1997 1998
<S> <C> <C> <C> <C>
NET SALES $ 34,213 $ 36,849 $ 110,098 $ 125,480
COST OF GOODS SOLD 17,574 20,449 58,772 67,992
--------- --------- --------- ---------
Gross profit 16,639 16,400 51,326 57,488
OPERATING EXPENSES:
Selling 10,573 12,792 30,728 36,275
General and administrative 4,491 5,823 15,019 18,948
Restructuring charge -- -- -- 2,600
--------- --------- --------- ---------
Income (loss) from operations 1,575 (2,215) 5,579 (335)
--------- --------- --------- ---------
Interest expense (1,017) (2,216) (3,088) (4,854)
Other expense, net (15) (243) (56) (253)
--------- --------- --------- ---------
Income (loss) before income tax
(expense) benefit and dividends
and accretion on preferred stock 543 (4,674) 2,435 (5,442)
--------- --------- --------- ---------
Income tax (expense) benefit (320) -- (1,422) 338
--------- --------- --------- ---------
Net income (loss) before dividends
and accretion on preferred stock 223 (4,674) 1,013 (5,104)
--------- --------- --------- ---------
Dividends and accretion on
Preferred stock 644 699 1,854 2,056
--------- --------- --------- ---------
Net loss applicable to common
shareholders $ (421) $ (5,373) $ (841) $ (7,160)
========= ========= ========= =========
Basic and diluted net loss per share
applicable to common shareholders $ (0.69) $ (8.84) $ (1.38) $ (11.78)
========= ========= ========= =========
Basic and diluted weighted average
shares outstanding 608,000 608,000 608,000 608,000
========= ========= ========= =========
</TABLE>
The accompanying notes are an integral part of these consolidated condensed
financial statements.
4
<PAGE> 5
AAI.FOSTERGRANT, INC. AND SUBSIDIARIES
CONSOLIDATED CONDENSED STATEMENTS OF CASH FLOWS
(In thousands)
<TABLE>
<CAPTION>
NINE MONTHS ENDED
SEPTEMBER 30, OCTOBER 3,
1997 1998
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income (loss) $ 1,013 $ (5,104)
Adjustments to reconcile net income (loss) to net cash
used in operating activities-
Depreciation and amortization 5,880 8,840
Amortization of deferred financing costs -- 78
Equity in earnings of investments in affiliates 126 61
Minority interest in income of consolidated subsidiary 42 53
Cumulative foreign currency translation adjustment (24) (52)
Deferred compensation 214 143
Deferred interest on subordinated promissory notes payable 211 140
Deferred taxes 484 (334)
Changes in assets and liabilities, net of acquisitions -
Accounts receivable (7,740) (11,666)
Inventories 4,966 9,760
Prepaid expenses and other current assets 926 48
Accounts payable (9,634) (7,468)
Accrued expenses (3,124) (25)
Accrued taxes 1,050 (87)
-------- --------
Net cash used in operating activities (5,610) (5,613)
-------- --------
CASH FLOWS FROM INVESTING ACTIVITIES:
Acquisitions, net of cash received (1,835) (9,464)
Purchases of property, plant and equipment (5,769) (16,783)
Advances to officers/shareholders 19 (3,511)
Decrease in investment in affiliates 328 15
Increase in other assets (617) (122)
-------- --------
Net cash used in investing activities (7,874) (29,865)
-------- --------
CASH FLOWS FROM FINANCING ACTIVITIES:
Net borrowings (repayments) under senior credit facility 13,275 (32,258)
Proceeds from term note payable -- 13,222
Payments on term note payable -- (13,222)
Payments on subordinated notes -- (2,132)
Proceeds from 10 3/4% senior notes -- 75,000
Costs related to issuance of 10 3/4% senior notes -- (3,120)
Payments on long term obligations -- (2,203)
-------- --------
Net cash provided by financing activities 13,275 35,287
-------- --------
NET DECREASE IN CASH AND CASH EQUIVALENTS (209) (191)
CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD 1,477 2,779
-------- --------
CASH AND CASH EQUIVALENTS, END OF PERIOD $ 1,268 $ 2,588
======== ========
</TABLE>
The accompanying notes are an integral part of these consolidated condensed
financial statements.
5
<PAGE> 6
AAI.FOSTERGRANT, INC. AND SUBSIDIARIES
CONSOLIDATED CONDENSED STATEMENTS OF CASH FLOWS
(In thousands)
<TABLE>
<CAPTION>
NINE MONTHS ENDED
SEPTEMBER 30, OCTOBER 3,
1997 1998
<S> <C> <C>
SUPPLEMENTAL DISCLOSURE OF NON-CASH INVESTING
ACTIVITIES:
Conversion of leasehold improvements to building improvements $ -- $ 1,393
======= ========
Offset of advances to officers/shareholders against
subordinated promissory notes payable to
officers/shareholders $ -- $ 3,495
======= ========
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Cash paid during the period for-
Interest $ 3,005 $ 3,620
======= ========
Taxes $ 44 $ 407
======= ========
SUPPLEMENTAL DISCLOSURE OF CASH FLOWS RELATED
TO ACQUISITIONS:
During the nine months ended September 30, 1997,
the Company acquired Superior, and during the nine
months ended October 3, 1998 the Company acquired
Foster Grant UK and Fantasma as described in Note 2.
These acquisitions are summarized as follows-
Fair value of assets acquired, excluding cash 5,950 15,672
Payments in connection with the acquisitions,
net of cash acquired (1,835) (9,464)
------- --------
Liabilities assumed and notes issued $ 4,115 $ 6,208
======= ========
</TABLE>
The accompanying notes are an integral part of these consolidated condensed
financial statements.
6
<PAGE> 7
AAI.FOSTERGRANT, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS
Note 1 - Significant Accounting Policies
(a) Interim Consolidated Condensed Financial Statements
The accompanying unaudited interim consolidated condensed financial
statements have been prepared in accordance with generally accepted accounting
principles for interim financial information and pursuant to the rules and
regulations of the Securities and Exchange Commission (SEC) for reporting on
Form 10-Q. Accordingly, certain information and footnote disclosure required for
complete financial statements are not included herein. It is recommended that
these financial statements be read in conjunction with the consolidated
financial statements and related notes of AAi.FosterGrant, Inc. (the Company)
for the year ended December 31, 1997 as reported in the Company's S-4
Registration Statement (SEC File No. 333-61119). In the opinion of management,
all adjustments (consisting of normal, recurring adjustments) considered
necessary for a fair presentation of financial position, results of operations
and cash flows at the dates and for the periods presented have been included.
The consolidated condensed balance sheet presented as of December 31, 1997 has
been derived from the consolidated financial statements that have been audited
by the Company's independent public accountants. The results of operations for
the period ended October 3, 1998 may not be indicative of the results that may
be expected for the year ending January 2, 1999, or for any other future period.
(b) Inventories
Inventories are stated at the lower of cost (first-in, first-out) or market
and consist of the following at December 31, 1997 and October 3, 1998 (in
thousands):
<TABLE>
<CAPTION>
December 31, October 3,
1997 1998
<S> <C> <C>
Finished goods............................... $28,229 $22,139
Work-in-process and raw materials............ 4,566 6,198
------- -------
$32,795 $28,337
======= =======
</TABLE>
(c) Customer Acquisition Costs
The Company incurs direct and incremental costs in connection with the
acquisition of certain new customers and new store locations from existing
customers under multi-year agreements. The Company receives the previous
vendor's merchandise from the customer in connection with most of these
agreements. In these situations, the Company values this inventory at fair
market value, representing the lower of cost or net realizable value, and
records that value as inventory. The Company sells this inventory to various
liquidation channels. The excess costs over the fair market value of the
inventory received is charged to selling
7
<PAGE> 8
AAI.FOSTERGRANT, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS
(CONTINUED)
expense when incurred. The Company expensed customer acquisition costs of
approximately $205,000 and $449,000 for the three and nine months ended
September 30, 1997 and $1.2 million and $1.7 million for the three and nine
months ended October 3, 1998.
(d) New Accounting Standards
In July 1997, the Financial Accounting Standards Board (FASB) issued
Statement of Financial Accounting Standards (SFAS) No. 131, Disclosures About
Segments of an Enterprise and Related Information. SFAS No. 131 requires certain
financial and supplementary information to be disclosed on an annual and interim
basis for each reportable segment of an enterprise. SFAS No. 131 is effective
for fiscal years beginning after December 15, 1997. Unless impracticable,
companies would be required to restate prior period information upon adoption.
The Company will adopt this statement in its fiscal year end 1998 financial
statements.
In June 1998, the FASB issued SFAS No. 133, Accounting for Derivative
Instruments and Hedging Activities. This statement established accounting and
reporting standards for derivative instruments, including certain derivative
instruments embedded in other contracts, and for hedging activities. It requires
that entities recognize all derivatives as either assets or liabilities in the
statement of financial position and measure those instruments at fair value.
This statement is effective for all fiscal quarters of fiscal years beginning
after June 15, 1999. The Company does not believe that the adoption of SFAS 133
will have a material impact on its financial statements.
Note 2 - Acquisitions
In June 1998, the Company acquired an 80% interest in Fantasma, LLC
(Fantasma) for approximately $4.1 million in cash. The remaining 20% interest in
Fantasma is held by a previous member of Fantasma. This member and an employee
of Fantasma have options to acquire up to an additional 13% interest if certain
earnings targets for Fantasma are met in 1998, 1999 and 2000. The Company's
acquisition of Fantasma added watches and clocks to its product lines and Disney
and Warner Bros. stores to its customer base.
The acquisition was accounted for using the purchase method; accordingly,
the results of operations of Fantasma from the date of acquisition are included
in the Company's consolidated statements of operations. The purchase price was
allocated based on estimated fair market value of assets and liabilities at the
date of acquisition. In connection with the purchase price allocation, the
Company recorded goodwill of approximately $4.6 million, which is being
amortized ratably over 10 years.
8
<PAGE> 9
AAI.FOSTERGRANT, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS
(CONTINUED)
In March 1998, the Company acquired certain assets and liabilities of
Eyecare Products UK Ltd. (Foster Grant UK), including the Foster Grant trademark
in territories not previously owned, for approximately $5.5 million in cash.
Foster Grant UK is a marketer and distributor of sunglasses and reading glasses
in Europe. The purchase price may be increased by approximately $700,000 in 1998
and 1999 based on Foster Grant UK performance.
The acquisition has been accounted for using the purchase method of
accounting; accordingly, the results of operation of Foster Grant UK from the
date of acquisition are included in the Company's consolidated statements of
operations. The purchase price was allocated based on estimated fair values of
assets and liabilities at the date of acquisition. In connection with the
purchase price allocation, the Company recorded approximately $1.1 million of
intangible assets which are being amortized on a straight-line basis over 20
years.
In July 1997, the Company acquired the assets of Superior Jewelry Company
(Superior), a distributor of costume jewelry to retail drug stores and discount
mass merchandisers in the United States. The Company paid approximately $1.8
million in cash and assumed certain liabilities in the amount of approximately
$4.0 million. The purchase price may be increased by up to an additional $3.0
million based on Superior's annual earnings during 1997 and 1998. Any increase
in purchase price will be recorded as goodwill when paid. Based on 1997
activity, the purchase price increased $0.9 million and is subject to an
additional $2.0 million upward adjustment based on 1998 annual earnings.
The acquisition was accounted for using the purchase method of accounting;
accordingly, the results of operations of Superior from the date of the
acquisition are included in the accompanying consolidated statements of
operations. The purchase price was allocated based on estimated fair values of
assets and liabilities at the date of acquisition. In connection with the
purchase price allocation, the Company recorded goodwill of approximately $3.5
million, adjusted to include the additional purchase price for 1997 activity,
which is being amortized on a straight-line basis over 10 years.
The following unaudited proforma summary information presents the combined
results of operations of the Company, Fantasma, Foster Grant UK and Superior as
if the acquisitions had occurred at the beginning of 1998. This unaudited
proforma financial information is presented for informational purposes only and
may not be indicative of the results of operations as they would have been if
the Company, Fantasma, Foster Grant UK and Superior had been a single entity nor
is it necessarily indicative of the results of operations that may occur in the
future. Anticipated efficiencies from the consolidation of the Company,
Fantasma, Foster Grant UK and Superior have been excluded from the amounts in
the unaudited pro forma summary presented below.
9
<PAGE> 10
AAI.FOSTERGRANT, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS
(CONTINUED)
<TABLE>
<CAPTION>
Nine Months Ended Nine Months Ended
September 30, 1997 October 3, 1998
------------------ -----------------
<S> <C> <C>
Net sales........................................ $132,416 $131,702
Net income (loss) applicable to common
shareholders................................... 137 (7,513)
Basic and diluted net income (loss) per share
applicable to common shareholders.............. 0.23 (12.36)
</TABLE>
Note 3 - Long-Term Obligations
On July 21, 1998, the Company sold $75.0 million of 10 3/4% Senior Series A
Notes due 2006 (the Notes) through a Rule 144A offering. The net proceeds of
approximately $72.0 million received by the Company from the issuance and sale
of the Notes were used to repay outstanding indebtedness under the credit
facility with a bank and the Subordinated Promissory Notes to shareholders, net
of amounts due the Company from certain of these shareholders. On November 16,
1998 the Company's registration statement filed with the SEC to exchange the
Notes for Series B Notes registered with the SEC was declared effective.
Interest on the Notes is payable semiannually on January 15 and July 15,
commencing January 15, 1999. The Notes are general unsecured obligations of the
Company, rank senior in right of payment to all future subordinated indebtedness
of the Company and rank pari passu in right of payment to all existing and
future unsubordinated indebtedness of the Company including the bank credit
facility. Accounts receivable and inventory of the Company and its domestic
subsidiaries secure the bank credit facility. Accordingly, the Company's
obligation under the bank credit facility will effectively rank senior in right
of payment to the Notes to the extent of the assets subject to such security
interest. The Notes are fully and unconditionally guaranteed, on a senior and
joint and several basis, by each of the Company's current and future domestic
subsidiaries (as defined) (the Guarantors).
The Notes may be redeemed at the option of the Company, in whole or part,
at any time on or after July 15, 2002, at 105.375% of their principle amount
plus accrued interest and Liquidated Damages (as defined), if any, with such
percentage declining ratably to 100% as of July 15, 2004 and thereafter. At any
time on or before July 15, 2001, and subject to certain conditions, the Company
may redeem up to 35% of the aggregate principal amount of Notes at a redemption
price of 110.750% of the principal amount plus accrued interest and Liquidated
Damages, if any, at that redemption date with the proceeds of certain equity
offerings of the Company.
The Indenture under which the Notes were issued contains various
restrictive covenants including limitations on the ability of the Company, and
its subsidiaries to, among other things, incur indebtedness, pay dividends,
prepay subordinated indebtedness, repurchase capital stock, make investments,
create liens, engage in transactions with
10
<PAGE> 11
AAI.FOSTERGRANT, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS
(CONTINUED)
shareholders and affiliates, sell assets and engage in mergers and
consolidations. At October 3, 1998, management believes the Company was in
compliance with these covenants.
Note 4 - Earnings Per Share
In accordance with SFAS No. 128, Earnings Per Share was determined by
dividing net loss by the weighted average common shares outstanding during the
period. Diluted earnings per share were determined by dividing net loss by
diluted weighted average shares outstanding. Diluted weighted average shares
reflect the dilutive effect, if any, of common stock options based on the
treasury stock method.
The calculations of basic and diluted weighted average shares outstanding are as
follows (in thousands):
<TABLE>
<CAPTION>
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, OCTOBER 3, SEPTEMBER 30, OCTOBER 3,
1997 1998 1997 1998
<S> <C> <C> <C> <C>
Basic weighted average common
Shares outstanding 608,000 608,000 608,000 608,000
Weighted average common
Equivalent shares 0 0 0 0
------- ------- ------- -------
Diluted weighted average
Shares outstanding 608,000 608,000 608,000 608,000
======= ======= ======= =======
</TABLE>
Diluted weighted average shares outstanding do not include 14,000 and
12,000 common equivalent shares at September 30, 1997 and October 3, 1998,
respectively, as their effect would be anti-dilutive.
Note 5 - Comprehensive Income
Comprehensive net income for the three months ended September 30, 1997 was
$212,000 as compared to a net loss of $4.6 million for the three months ended
October 3, 1998. For the nine months ended September 30, 1997, comprehensive net
loss was $989,000 as compared to $5.2 million for the nine months ended October
3, 1998. Differences between comprehensive net income (loss) and net income
(loss) before dividends and accretion on preferred stock for each period
represents the foreign currency translation adjustment for each period.
11
<PAGE> 12
AAI.FOSTERGRANT, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS
(CONTINUED)
Note 6 - Restructuring Charge
In April 1998, the Company adopted a formal plan to close its Texas
distribution center. The Company recorded a restructuring charge of $2.6 million
during the quarter ended July 4, 1998 in connection with this plant closing. The
components of this charge, which is included in operating expenses for the nine
months ended October 3, 1998 in the accompanying statement of operations, are as
follows (in thousands):
Severance accrual ........................... $1,084
Write down of assets to be disposed ......... 1,516
------
$2,600
======
The severance accrual represents severance payments due to 40 office and
distribution employees. Through October 3, 1998, six of these 40 employees were
terminated and severance benefits of $250,000 were paid.
Note 7 - Subsequent Events
In November 1998, the Company reached a favorable settlement with a
customer related to the customer not honoring its purchase commitments under a
1997 agreement. As a result of this settlement, the Company received $950,000
for lost revenues. This settlement will be reflected in the Company's statement
of operations during the fourth quarter of 1998.
Note 8 - Supplemental Consolidating Financial Information
The following is summarized consolidating financial information for the
Company, segregating the Company, wholly owned guarantor subsidiaries, mostly
owned guarantor subsidiaries and non-guarantor subsidiaries as they relate to
the Notes. The guarantor subsidiaries, both mostly and wholly owned, are
domestic subsidiaries of the Company and guarantee the Notes on a full,
unconditional and joint and several basis. Separate financial statements of the
wholly owned guarantor subsidiaries have not been included because management
believes that they are not material to investors. Separate financial statements
for the mostly owned subsidiary, Fantasma, in which the Company holds an 80%
interest, follow the supplemental consolidating financial information.
The Company and guarantor subsidiaries account for investments in
subsidiaries on the equity method for the purposes of the consolidating
financial data. Earnings of subsidiaries are therefore reflected in the
Company's and guarantor subsidiary's investment accounts and earnings. The
principal elimination entries eliminate investments in subsidiaries and
intercompany balances and transactions.
12
<PAGE> 13
<TABLE>
<CAPTION>
AAI.FOSTERGRANT, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS
(CONTINUED)
(8) SUPPLEMENTAL CONSOLIDATING FINANCIAL INFORMATION (CONTINUED)
CONSOLIDATING BALANCE SHEETS
DECEMBER 31, 1997
----------------------------------------------------------------------
WHOLLY OWNED NON-GUARANTOR
COMPANY SUBSIDIARIES SUBSIDIARIES ELIMINATIONS CONSOLIDATED
-------- ------------ ------------- ------------ ------------
<S> <C> <C> <C> <C> <C>
(IN THOUSANDS)
ASSETS
Current assets
Cash and cash equivalents $ 2,354 $ 183 $ 242 $ -- $ 2,779
Accounts receivable, net 9,756 7,778 789 -- 18,323
Inventories 18,922 13,547 326 -- 32,795
Prepaid expenses and other current assets 224 233 277 -- 734
Deferred tax asset 4,798 4,908 1 -- 9,707
-------- ------- ------- -------- --------
Total current assets 36,054 26,649 1,635 -- 64,338
Property, plant and equipment, net 3,727 6,421 37 -- 10,185
Other assets 25,394 10,433 460 (17,064) 19,223
-------- ------- ------- -------- --------
Total assets $ 65,175 $43,503 $ 2,132 $(17,064) $ 93,746
======== ======= ======= ======== ========
LIABILITIES AND SHAREHOLDERS' (DEFICIT) EQUITY
Current liabilities
Borrowings under senior credit facility $ 12,883 $14,715 $ -- $ -- $ 27,598
Current maturities of long-term obligations 3,361 -- -- -- 3,361
Accounts payable 5,253 8,060 804 -- 14,117
Accrued expenses 7,651 5,283 392 -- 13,326
Due to (from) affiliate 876 2,313 661 (3,850) --
-------- ------- ------- -------- --------
Total current liabilities 30,024 30,371 1,857 (3,850) 58,402
Long-term obligations, less current maturities 9,653 -- -- -- 9,653
Deferred tax liabilities -- 645 -- -- 645
Subordinated promissory notes payable to
shareholders 5,487 -- -- -- 5,487
10 3/4% senior notes -- -- -- -- --
Redeemable preferred stock of a subsidiary -- -- -- 835 835
Preferred Stock 26,083 835 -- (835) 26,083
Shareholders' (deficit) equity (6,072) 11,652 275 (13,214) (7,359)
-------- ------- ------- -------- --------
Total liabilities and shareholders'
(deficit) equity $ 65,175 $43,503 $ 2,132 $(17,064) $ 93,746
======== ======= ======= ======== ========
</TABLE>
<TABLE>
<CAPTION>
OCTOBER 3, 1998
------------------------------------------------------------------------------------
WHOLLY OWNED MOSTLY OWNED NON-GUARANTOR
COMPANY SUBSIDIARIES SUBSIDIARIES SUBSIDIARIES ELIMINATIONS CONSOLIDATED
--------- ------------ ------------ ------------- ------------ ------------
<S> <C> <C> <C> <C> <C> <C>
ASSETS
Current assets
Cash and cash equivalents $ 420 $ 96 $ 183 $ 1,889 $ -- $ 2,588
Accounts receivable, net 21,279 5,441 2,978 3,578 -- 33,276
Inventories 16,745 5,789 2,019 3,784 -- 28,337
Prepaid expenses and other current assets 378 290 143 185 -- 996
Deferred tax asset 9,458 583 0 -- -- 10,041
--------- ------- ------ -------- -------- ---------
Total current assets 48,280 12,199 5,323 9,436 -- 75,238
Property, plant and equipment, net 11,387 7,493 24 1,332 20,236
Other assets 47,952 10,291 4,499 450 (36,200) 26,992
--------- ------- ------ -------- -------- ---------
Total assets $ 107,619 $29,983 $9,846 $ 11,218 $(36,200) $ 122,466
========= ======= ====== ======== ======== =========
LIABILITIES AND SHAREHOLDERS' (DEFICIT) EQUITY
Current liabilities
Borrowings under senior credit facility $ 4,018 $ -- $ -- $ -- $ -- $ 4,018
Current maturities of long-term obligations 490 -- -- -- -- 490
Accounts payable 5,156 3,253 2 2,864 -- 11,275
Accrued expenses 8,908 4,129 1,026 734 -- 14,797
Due to (from) affiliate -- 8,393 5,153 2,165 (15,711) --
--------- ------- ------ -------- -------- ---------
Total current liabilities 18,572 15,775 6,181 5,763 (15,711) 30,580
Long-term obligations, less current maturities 1,786 -- -- -- -- 1,786
Deferred tax liabilities -- 645 -- -- -- 645
Subordinated promissory notes payable to
shareholders -- -- -- -- -- --
10 3/4% senior notes 75,000 -- -- -- -- 75,000
Redeemable preferred stock of a subsidiary -- -- -- -- 888 888
Preferred Stock 28,139 888 -- -- (888) 28,139
Shareholders' (deficit) equity (15,878) 12,675 3,665 5,455 (20,489) (14,572)
--------- ------- ------ -------- -------- ---------
Total liabilities and shareholders'
(deficit) equity $ 107,619 $29,983 $9,846 $ 11,218 $(36,200) $ 122,466
========= ======= ====== ======== ======== =========
</TABLE>
13
<PAGE> 14
<TABLE>
<CAPTION>
AAI.FOSTERGRANT, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS
(CONTINUED)
(8) SUPPLEMENTAL CONSOLIDATING FINANCIAL INFORMATION (CONTINUED)
CONSOLIDATING STATEMENT OF OPERATIONS
THREE MONTHS ENDED
----------------------------------------------------------------------
SEPTEMBER 31, 1997
----------------------------------------------------------------------
WHOLLY OWNED NON-GUARANTOR
COMPANY SUBSIDIARIES SUBSIDIARIES ELIMINATIONS CONSOLIDATED
-------- ------------ ------------- ------------ ------------
(IN THOUSANDS)
<S> <C> <C> <C> <C> <C>
Net sales $ 21,567 $ 10,983 $ 1,663 $ -- $ 34,213
Cost of goods sold 10,667 6,250 657 -- 17,574
-------- -------- ------- ------- ---------
Gross profit 10,900 4,733 1,006 -- 16,639
Selling general and administrative expense 7,130 7,214 720 -- 15,064
-------- -------- ------- ------- ---------
Income (loss) from operations 3,770 (2,481) 286 -- 1,575
Interest expense (594) (400) (23) -- (1,017)
Other (expense) income, net (35) 45 (25) -- (15)
Equity in income of consolidated subsidiaries (2,442) -- -- 2,442 --
-------- -------- ------- ------- ---------
Income (loss) before income tax (expense)
benefit and dividends on accretion on
preferred stock 699 (2,836) 238 2,442 543
Income tax (expense) benefit (512) -- 192 -- (320)
-------- -------- ------- ------- ---------
Net income (loss) before dividends and
accretion on preferred stock 187 (2,836) 430 2,442 223
Dividends and accretion on preferred stock 644 -- -- -- 644
-------- -------- ------- ------- ---------
Net (loss) income applicable to
common shareholders $ (457) $ (2,836) $ 430 $ 2,442 $ (421)
======== ======== ======= ======= =========
</TABLE>
<TABLE>
<CAPTION>
THREE MONTHS ENDED
-------------------------------------------------------------------------------------
OCTOBER 3, 1998
-------------------------------------------------------------------------------------
WHOLLY OWNED MOSTLY OWNED NON-GUARANTOR
COMPANY SUBSIDIARIES SUBSIDIARIES SUBSIDIARIES ELIMINATIONS CONSOLIDATED
--------- ------------ ------------ ------------- ------------ ------------
(IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C>
Net sales $ 26,512 $ 3,630 $ 3,614 $ 3,093 $ -- $ 36,849
Cost of goods sold 18,036 (1,593) 2,448 1,558 -- 20,449
-------- -------- ------- -------- ------- ---------
Gross profit 8,476 5,223 1,166 1,535 -- 16,400
Selling general and administrative expense 6,692 8,581 1,431 1,911 -- 18,615
-------- -------- ------- -------- ------- ---------
Income (loss) from operations 1,784 (3,358) (265) (376) -- (2,215)
Interest expense (2,089) 27 (134) (20) -- (2,216)
Other (expense) income, net (76) 12 -- (179) -- (243)
Equity in income of consolidated subsidiaries (4,201) -- -- -- 4,201 --
-------- -------- ------- -------- ------- ---------
Income (loss) before income tax (expense)
benefit and dividends on accretion on
preferred stock (4,582) (3,319) (399) (575) 4,201 (4,674)
Income tax (expense) benefit -- -- -- -- -- --
-------- -------- ------- -------- ------- ---------
Net income (loss) before dividends and
accretion on preferred stock (4,582) (3,319) (399) (575) 4,201 (4,674)
Dividends and accretion on preferred stock 699 -- -- -- -- 699
-------- -------- ------- -------- ------- ---------
Net (loss) income applicable to
common shareholders $ (5,281) $ (3,319) $ (399) $ (575) $ 4,201 $ (5,373)
======== ======== ======= ======== ======= =========
</TABLE>
<TABLE>
<CAPTION>
CONSOLIDATING STATEMENT OF OPERATIONS
NINE MONTHS ENDED
----------------------------------------------------------------------
SEPTEMBER 31, 1997
----------------------------------------------------------------------
WHOLLY OWNED NON-GUARANTOR
COMPANY SUBSIDIARIES SUBSIDIARIES ELIMINATIONS CONSOLIDATED
-------- ------------ ------------- ------------ ------------
(IN THOUSANDS)
<S> <C> <C> <C> <C> <C>
Net sales $ 51,901 $ 52,918 $ 5,279 $ -- $ 110,098
Cost of goods sold 29,857 26,503 2,412 -- 58,772
-------- -------- ------- ------- ---------
Gross profit 22,044 26,415 2,867 -- 51,326
Selling general and administrative expense 21,543 22,198 2,006 -- 45,747
-------- -------- ------- ------- ---------
Income (loss) from operations 501 4,217 861 -- 5,579
Interest expense (1,699) (1,366) (23) -- (3,088)
Other (expense) income, net (102) 45 1 -- (56)
Equity in income of consolidated subsidiaries 3,657 -- -- (3,657) --
-------- -------- ------- ------- ---------
Income (loss) before income tax (expense)
benefit and dividends on accretion on
preferred stock 2,357 2,896 839 (3,657) 2,435
Income tax (expense) benefit (1,380) -- (42) -- (1,422)
-------- -------- ------- ------- ---------
Net income (loss) before dividends and
accretion on preferred stock 977 2,896 797 (3,657) 1,013
Dividends and accretion on preferred stock 1,854 -- -- -- 1,854
-------- -------- ------- ------- ---------
Net (loss) income applicable to
common shareholders $ (877) $ 2,896 $ 797 $(3,657) $ (841)
======== ======== ======= ======= =========
</TABLE>
<TABLE>
<CAPTION>
NINE MONTHS ENDED
-------------------------------------------------------------------------------------
OCTOBER 3, 1998
-------------------------------------------------------------------------------------
WHOLLY OWNED MOSTLY OWNED NON-GUARANTOR
COMPANY SUBSIDIARIES SUBSIDIARIES SUBSIDIARIES ELIMINATIONS CONSOLIDATED
--------- ------------ ------------ ------------- ------------ ------------
(IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C>
Net sales $ 62,202 $ 46,326 $ 4,116 $ 12,836 $ -- $ 125,480
Cost of goods sold 38,383 20,903 2,749 5,957 -- 67,992
-------- -------- ------- -------- ------- ---------
Gross profit 23,819 25,423 1,367 6,879 -- 57,488
Selling general and administrative expense 30,676 20,124 1,610 5,413 -- 57,823
-------- -------- ------- -------- ------- ---------
Income (loss) from operations (6,857) 5,299 (243) 1,466 -- (335)
Interest expense (4,075) (586) (142) (51) -- (4,854)
Other (expense) income, net (69) 24 -- (208) -- (253)
Equity in income of consolidated subsidiaries 1,403 -- -- -- (1,403) --
-------- -------- ------- -------- ------- ---------
Income (loss) before income tax (expense)
benefit and dividends on accretion on
preferred stock (9,598) 4,737 (385) 1,207 (1,403) (5,442)
Income tax (expense) benefit 4,663 (3,725) -- (600) -- 338
-------- -------- ------- -------- ------- ---------
Net income (loss) before dividends and
accretion on preferred stock (4,935) 1,012 (385) 607 (1,403) (5,104)
Dividends and accretion on preferred stock 2,056 -- -- -- -- 2,056
-------- -------- ------- -------- ------- ---------
Net (loss) income applicable to
common shareholders $ (6,991) $ 1,012 $ (385) $ 607 $(1,403) $ (7,160)
======== ======== ======= ======== ======= =========
</TABLE>
14
<PAGE> 15
<TABLE>
<CAPTION>
AAI.FOSTERGRANT, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS
(CONTINUED)
(8) SUPPLEMENTAL CONSOLIDATING FINANCIAL INFORMATION (CONTINUED)
CONSOLIDATING STATEMENT OF CASH FLOWS
NINE MONTHS ENDED
----------------------------------------------------------------------
SEPTEMBER 30, 1997
----------------------------------------------------------------------
WHOLLY OWNED NON-GUARANTOR
COMPANY SUBSIDIARIES SUBSIDIARIES ELIMINATIONS CONSOLIDATED
--------- ------------ ------------- ------------ ------------
(IN THOUSANDS)
<S> <C> <C> <C> <C> <C>
Cash flows (used in) provided by
operating activities $(11,740) $ 5,943 $ 187 $ -- $ (5,610)
Cash flows from Investing activities:
Purchase of property, plant and equipment (2,191) (3,438) (140) -- (5,769)
Acquisitions, net of cash received (1,835) -- -- -- (1,835)
Advance to affiliates (997) -- -- 997 --
Other investing activities (212) -- (58) -- (270)
-------- ------- ----- ---- --------
Net cash (used in) provided by
investing activities (5,235) (3,438) (198) 997 (7,874)
-------- ------- ----- ---- --------
Cash flows from financing activities:
Net borrowings under senior credit facility 16,975 (3,700) -- -- 13,275
Proceeds from term note payable -- -- -- -- --
Payments on term note payable -- -- -- -- --
Payments on subordinated notes -- -- -- -- --
Proceeds from 10 3/4% senior notes -- -- -- -- --
Costs related to issuance of
10 3/4% senior notes -- -- -- -- --
Payments on long-term obligations -- -- -- -- --
Due to affiliates -- 1,257 (260) (997) --
-------- ------- ----- ---- --------
Net cash provided by (used in)
financing activities 16,975 (2,443) (260) (997) 13,275
-------- ------- ----- ---- --------
Net increase (decrease) in cash -- 62 (271) -- (209)
Cash and cash equivalents, beginning
of period -- 941 536 -- 1,477
-------- ------- ----- ---- --------
Cash and cash equivalents, end of period $ -- $ 1,003 $ 265 $ -- $ 1,268
======== ======= ===== ==== ========
</TABLE>
<TABLE>
<CAPTION>
NINE MONTHS ENDED
-------------------------------------------------------------------------------------
OCTOBER 3, 1998
-------------------------------------------------------------------------------------
WHOLLY OWNED MOSTLY OWNED NON-GUARANTOR
COMPANY SUBSIDIARIES SUBSIDIARIES SUBSIDIARIES ELIMINATIONS CONSOLIDATED
--------- ------------ ------------ ------------ ------------- ------------
(IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C>
Cash flows (used in) provided by
operating activities $(20,150) $ 14,424 $(1,494) $ 1,607 $ -- $ (5,613)
Cash flows from Investing activities:
Purchase of property, plant and equipment (8,671) (5,806) (13) (2,293) -- (16,783)
Acquisitions, net of cash received (9,464) -- -- -- -- (9,464)
Advance to affiliates (10,060) -- -- -- 10,060 --
Other investing activities (379) (60) (22) (3,157) -- (3,618)
-------- -------- ------- ------- ------- --------
Net cash (used in) provided by
investing activities (28,574) (5,866) (35) (5,450) 10,060 (29,865)
-------- -------- ------- ------- ------- --------
Cash flows from financing activities:
Net borrowings under senior credit facility (8,865) (14,715) -- (8,678) -- (32,258)
Proceeds from term note payable 13,222 -- -- -- -- 13,222
Payments on term note payable (13,222) -- -- -- -- (13,222)
Payments on subordinated notes (5,487) -- -- 3,355 -- (2,132)
Proceeds from 10 3/4% senior notes 75,000 -- -- -- -- 75,000
Costs related to issuance of
10 3/4% senior notes (3,120) -- -- -- -- (3,120)
Payments on long-term obligations (10,378) -- -- 8,535 -- (2,203)
Due to affiliates -- 6,057 1,653 2,350 (10,060) --
-------- -------- ------- ------- ------- --------
Net cash provided by (used in)
financing activities 46,790 (8,658) 1,653 5,562 (10,060) 35,287
-------- -------- ------- ------- ------- --------
Net increase (decrease) in cash (1,934) (100) 124 1,719 -- (191)
Cash and cash equivalents, beginning
of period 2,354 183 73 169 -- 2,779
-------- -------- ------- ------- ------- --------
Cash and cash equivalents, end of period $ 420 $ 83 $ 197 $ 1,888 $ -- $ 2,588
======== ======== ======= ======= ======= ========
</TABLE>
15
<PAGE> 16
AAI.FOSTERGRANT, INC. AND SUBSIDIARIES
Fantasma, LLC
(A Mostly Owned Subsidiary of AAi.FosterGrant, Inc.)
Condensed Balance Sheets
(In thousands)
<TABLE>
<CAPTION>
DECEMBER 31, OCTOBER 3,
1997 1998
<S> <C> <C>
ASSETS
CURRENT ASSETS:
Cash and cash equivalents $ 238 $ 183
Accounts receivable less reserves of approximately
$402 and $432, in 1997 and 1998, respectively 5,108 2,978
Inventories 1,908 2,019
Prepaid expenses and other current assets 72 143
------ ------
Total current assets 7,326 5,323
------ ------
Property, plant and equipment, net 66 24
Intangible assets 3 4,499
------ ------
Total assets $7,395 $9,846
====== ======
LIABILITIES AND MEMBERS' EQUITY
CURRENT LIABILITIES:
Note payable to member $5,425 $5,153
Accounts payable and accrued liabilities 1,657 1,028
------ ------
Total current liabilities 7,082 6,181
Members' equity 313 3,665
------ ------
Total liabilities and members' equity $7,395 $9,846
====== ======
</TABLE>
The accompanying notes are an integral part of these condensed financial
statements
16
<PAGE> 17
AAI.FOSTERGRANT, INC. AND SUBSIDIARIES
Fantasma, LLC
(A Mostly Owned Subsidiary of AAi.FosterGrant, Inc.)
Condensed Statements of Operations
(In thousands)
<TABLE>
<CAPTION>
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, OCTOBER 3, SEPTEMBER 30, OCTOBER 3,
1997 1998 1997 1998
<S> <C> <C> <C> <C>
NET SALES $ 4,347 $ 3,614 $ 8,441 $ 8,455
COST OF GOODS SOLD 2,897 2,448 6,028 5,624
------- ------- ------- -------
Gross profit 1,450 1,166 2,413 2,831
OPERATING EXPENSES:
Selling 492 826 1,280 1,730
General and administrative 600 605 1,511 1,543
------- ------- ------- -------
Income (loss) from operations 358 (265) (378) (442)
Interest expense (103) (134) (267) (302)
------- ------- ------- -------
Net income (loss) $ 255 $ (399) $ (645) $ (744)
======= ======= ======= =======
</TABLE>
The accompanying notes are an integral part of these condensed financial
statements.
17
<PAGE> 18
AAI.FOSTERGRANT, INC. AND SUBSIDIARIES
Fantasma, LLC
(A Mostly Owned Subsidiary of AAi.FosterGrant, Inc.)
CONDENSED STATEMENTS OF CASH FLOWS
(In thousands)
<TABLE>
<CAPTION>
NINE MONTHS ENDED
SEPTEMBER 30, OCTOBER 3,
1997 1998
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss $ (645) $ (744)
Adjustments to reconcile net loss to net cash
(used in) provided by operating activities-
Depreciation and amortization 5 135
Write-off of property and equipment -- 49
Deferred interest on note payable to member -- 134
Changes in assets and liabilities -
Accounts receivable (165) 2,130
Inventories (754) (111)
Prepaid expenses and other current assets (105) (71)
Accounts payable and accrued expenses 299 (629)
------- -------
Net cash (used in) provided by operating activities (1,365) 893
------- -------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of property and equipment (20) (14)
Decrease in other assets -- 3
------- -------
Net cash used in investing activities (20) (11)
------- -------
CASH FLOWS FROM FINANCING ACTIVITIES:
Borrowing under note payable to member -- 5,019
Advances payable to member 1,196 (1,661)
Repayments of note payable to member -- (3,764)
Member distributions -- (531)
------- -------
Net cash provided by (used in) financing activities 1,196 (937)
------- -------
NET DECREASE IN CASH AND CASH EQUIVALENTS (189) (55)
CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD 189 238
------- -------
CASH AND CASH EQUIVALENTS, END OF PERIOD $ -- $ 183
======= =======
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Cash paid during the period for-
Interest $ 360 $ --
======= =======
Taxes $ -- $ --
======= =======
SUPPLEMENTAL DISCLOSURE OF NONCASH ACTIVITIES
Pushdown of purchase price related to AAi.FosterGrant's
investment In Fantasma, LLC $ -- $ 4,627
======= =======
</TABLE>
The accompanying notes are an integral part of these condensed financial
statements.
18
<PAGE> 19
AAI.FOSTERGRANT, INC. AND SUBSIDIARIES
FANTASMA, LLC
NOTES TO FINANCIAL STATEMENTS
Note 1 - Significant Accounting Policies
(a) Interim Consolidated Condensed Financial Statements
The accompanying unaudited interim consolidated condensed financial
statements have been prepared in accordance with generally accepted accounting
principles for interim financial information and pursuant to the rules and
regulations of the Securities and Exchange Commission for reporting on Form
10-Q. Accordingly, certain information and footnote disclosure required for
complete financial statements are not included herein. It is recommended that
these financial statements be read in conjunction with the consolidated
financial statements and related notes of AAi.FosterGrant, Inc. (the Company)
and Fantasma, LLC (Fantasma) for the year ended December 31, 1997 as reported in
the Company's S-4 Registration Statement (SEC File No. 333-61119) declared
effective on November 16, 1998. In the opinion of management, all adjustments
(consisting of normal, recurring adjustments) considered necessary for a fair
presentation of financial position, results of operations and cash flows at the
dates and for the periods presented have been included. The consolidated
condensed balance sheet presented as of December 31, 1997 has been derived from
the consolidated financial statements that have been audited by the Company's
independent public accountants. The results of operations for the period ended
October 3, 1998 may not be indicative of the results that may be expected for
the year ending January 2, 1999, or for any other future period.
(b) Organization and Business Activity
Fantasma was organized under the laws of the State of Delaware on August
22, 1996 and began business operations on September 1, 1996. Fantasma imports
and wholesales licensed watches, clocks, and other novelties to customers
located throughout the United States, Europe and Japan.
Prior to September 1, 1996, Fantasma operated as a division of Overdrive
Capital Corp. (formerly known as Good Stuff Corp.). Overdrive Capital Corp.
(Overdrive) sold the division's operating assets to Fantasma in exchange for a
two-year, $3,764,366 note. Overdrive maintained a 67% ownership interest in
Fantasma, with a former stockholder of Overdrive holding a 33% ownership
interest.
In June 1998, the Company acquired an 80% interest in Fantasma for
approximately $4.1 million in cash. The remaining 20% interest in Fantasma is
held by a previous member of Fantasma. This member and an employee of Fantasma
have options to acquire up to an additional 13% interest if certain earnings
targets for Fantasma are met in 1998, 1999 and 2000. The operating agreement
under which Fantasma is managed provides the Company with sole voting rights
except on limited matters affecting the admission of members, capital
contributions or the members' respective rights in profits, cash flow and
distributions.
19
<PAGE> 20
AAI.FOSTERGRANT, INC. AND SUBSIDIARIES
FANTASMA, LLC
NOTES TO FINANCIAL STATEMENTS
(CONTINUED)
Accordingly, for financial statement presentation, the acquisition was accounted
for using the purchase method. The purchase price was allocated based on
estimated fair market value of assets and liabilities at the date of
acquisition. In connection with the purchase price allocation, the Company
recorded goodwill of approximately $4.6 million, which is being amortized on a
straight-line basis over 10 years.
(c) Inventory
Inventories are stated at the lower of cost (first-in, first-out) or market
and consist of finished goods for all years presented. Finished goods inventory
consists of material and overhead.
(d) New Accounting Standards
In July 1997, the FASB issued SFAS No. 131, Disclosures About Segments of
an Enterprise and Related Information. SFAS No. 131 requires certain financial
and supplementary information to be disclosed on an annual and interim basis for
each reportable segment of an enterprise. SFAS No. 131 is effective for fiscal
years beginning after December 15, 1997. Unless impracticable, companies would
be required to restate prior period information upon adoption. Fantasma will
adopt this statement in its fiscal year end 1998 financial statements.
In June 1998, the FASB issued SFAS No. 133, Accounting for Derivative
Instruments and Hedging Activities. This statement establishes accounting and
reporting standards for derivative instruments, including certain derivative
instruments embedded in other contracts, and for hedging activities. It requires
that entities recognize all derivatives as either assets or liabilities in the
statement of financial position and measure those instruments at fair value.
This statement is effective for all fiscal quarters of fiscal years beginning
after June 15, 1999. Fantasma does not believe that the adoption of SFAS No. 133
will have a material impact on its financial statements.
(e) Income Taxes
Fantasma is treated as a partnership for Federal and certain State income
tax purposes, whereby the membership owners are taxed on their proportionate
share of Fantasma's income. As a result, Fantasma has not provided for Federal
income taxes. The provision for income taxes, if any, reflects certain State
taxes that are paid by Fantasma.
(f) Reclassifications
Certain reclassifications have been made to the condensed financial
statements to conform with the Company's presentation.
20
<PAGE> 21
AAI.FOSTERGRANT, INC. AND SUBSIDIARIES
FANTASMA, LLC
NOTES TO FINANCIAL STATEMENTS
(CONTINUED)
Note 2 - Comprehensive Income
Comprehensive net income for the three and nine months ended September 30,
1997 and October 3, 1998 was the same as net income for the three and nine
months then ended.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
The following discussion may contain "forward-looking" statements and are
subject to risks and uncertainties that could cause actual results to differ
significantly from expectations. In particular, statements contained in this
"Management's Discussion and Analysis of Financial Condition and Results of
Operations" section which are not historical facts, including, but not limited
to, statements regarding the anticipated adequacy of cash resources to meet the
Company's working capital and facility construction requirements and statements
regarding the anticipated proportion of revenues to be derived from a limited
number of customers, may constitute forward-looking statements. Although the
Company believes the expectations reflected in such forward-looking statements
are reasonable, it can give no assurance that such expectations will prove to
have been correct. Important factors, which could cause actual results to differ
materially from such expectations, are disclosed under the caption "Risk
Factors" in the Company's Prospectus declared effective on November 16, 1998
contained in its Registration Statement on Form S-4 (SEC File No. 333-61119).
OVERVIEW
The Company is a value-added distributor of optical products, costume
jewelry, watches, clocks and other accessories primarily to mass merchandisers,
variety stores, chain drug stores and supermarkets in North America and the
United Kingdom. As a value-added distributor, the Company provides customized
store displays, merchandising management and a store-level field service force
to replenish and restock displays, reorder product and attend to markdowns and
allowances. Upon shipment to the customer, the Company estimates agreed upon
future allowances, returns and discounts, taking into account historical
experience, and reflects revenue net of these estimates.
When establishing or expanding a customer relationship, the Company
generally enters into multi-year agreements for the supply of specified product
lines to specific customer stores. The agreements typically do not contain
required minimum sales volumes, but may provide for termination penalties equal
to the Company's unamortized cost of product displays provided to the customer.
The Company believes its relationships with retailers are dependent upon its
ability to efficiently utilize allocated floor space to generate satisfactory
returns for its customers. To meet this end, the Company strives to consistently
deliver competitively priced products and service programs that provide
retailers with attractive gross margins and
21
<PAGE> 22
AAI.FOSTERGRANT, INC. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
(CONTINUED)
inventory turnover rates. The Company has historically retained customers from
year to year, although retailers may drop or add product lines supplied by the
Company. Generally, customer loss has been attributable to such customer going
out of business or being acquired by a company which does not carry the
Company's product line or has prior relationships with a competitor of the
Company.
Certain segments of the retail industry, particularly mass merchandisers,
variety stores, drugstores and supermarkets, are experiencing significant
consolidation and in recent years many major retailers have experienced
financial difficulties. These industry wide developments have had and may
continue to have an impact on the Company's results of operations. For example,
net sales were adversely affected in 1997 by the loss of two customers, one as a
result of a merger into a retail chain that does not carry costume jewelry and
the other due to the retailer ceasing operations. In addition, also as a result
of financial pressures, many major retailers have sought to reduce inventory
levels in order to reduce their operating costs which has had a negative effect
on the Company's results of operations.
During the first quarter of 1998, the Company elected to change its fiscal
year end from December 31 to the Saturday closest to December 31. The Company
has also applied this change to its quarterly interim periods during 1998
whereby each interim period will end on the last Saturday of the thirteen-week
period.
Net Sales. The Company offers optical products, costume jewelry, small
synthetic leather goods and other accessories, generally at retail price points
of $20 or less. Net sales of the Company's optical products accounted for
approximately 55.3% and 44.9% of the Company's net sales for the nine months
ended September 30, 1997 and October 3, 1998, respectively; net sales of the
Company's costume jewelry accounted for approximately 39.6% and 36.6% of the
Company's net sales for the nine months ended September 30, 1997 and October 3,
1998 respectively, and the balance represented sales of synthetic leather goods
and other accessories. Optical products generally have slightly higher gross
margins than the Company's other product lines.
Cost of Goods Sold. The Company outsources manufacturing for all of its
products, 75% of which is sourced to manufacturers in Asia through its joint
venture in Hong Kong, with the remainder outsourced to independent domestic
manufacturers. Accordingly, the principal element comprising the Company's cost
of goods sold is the price of manufactured goods purchased through the Company's
joint venture or from independent manufacturers. The Company believes
outsourcing manufacturing allows it to reliably deliver competitively priced
products to the retail market while retaining considerable flexibility in its
cost structure.
22
<PAGE> 23
AAI.FOSTERGRANT, INC. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
(CONTINUED)
Operating Expenses. Operating expenses are comprised primarily of payroll
and occupancy costs related to the Company's selling, general and administrative
activities as well as depreciation and amortization. The Company incurs various
costs in connection with the acquisition of new customers and new stores for
existing customers, principally the cost of new product display fixtures and
costs related to the purchase of the customer's existing inventory. The Company
makes substantial investments in the design, production and installation of
display fixtures in connection with establishing and maintaining customer
relationships. The Company capitalizes the production cost of these display
fixtures as long as it retains ownership of them. These costs are amortized to
selling expenses on a straight-line basis over their estimated useful life,
which is one to three years. If the Company does not retain title to the
displays, the display costs are expensed as shipped.
The Company incurs direct and incremental costs in connection with the
acquisition of certain new customers and new store locations from existing
customers under multi-year agreements. The Company receives the previous
vendor's merchandise from the customer in connection with most of these
agreements. In these situations, the Company values this inventory at its fair
market value, representing the lower of cost or net realizable value, and
records that value as inventory. The Company sells this inventory to its
existing customers. The excess cost over the fair market value of the inventory
received is charged to operating expenses when incurred. These expenses can
cause operating results to fluctuate significantly from quarter to quarter. The
Company expensed customer acquisition costs of approximately $205,000 and
$449,000 for the three and nine months ended September 30, 1997 and $1.2 million
and $1.7 million for the three and nine months ended October 3, 1998. Based on
agreements to date, the Company expects customer acquisition costs to be
approximately $3.0 million in the fourth quarter of fiscal 1998 as compared to
approximately $1.1 million in the fourth quarter of fiscal 1997.
Dividends and Accretion on Preferred Stock. The Company has 43,700 shares
of Series A Redeemable Convertible Preferred Stock (Series A Preferred Stock)
outstanding, of which 34,200 were issued in May 1996 for gross proceeds of $18.0
million, and an additional 9,500 shares were issued for gross proceeds of $5.0
million in connection with the December 1996 acquisition of the businesses of
Foster Grant Group L.P., The Bonneau Company, Opti-Ray, Inc. and Asian Buying
Source, Inc. (collectively, Foster Grant US). Beginning on June 30, 2002, shares
of the Series A Preferred Stock are redeemable at the option of the holder for
an amount equal to the original issue price plus accrued and unpaid dividends
yielding a 10% compounded annual rate of return, provided, however, that the
right to require redemption is suspended as long as any Restrictive Indebtedness
(as defined) is outstanding. Net loss applicable to common shareholders
represents net loss less accretion of original issuance costs and cumulative
dividends due on the Series A Preferred Stock.
23
<PAGE> 24
AAI.FOSTERGRANT, INC. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
(CONTINUED)
Earnings Before Interest, Taxes, Depreciation and Amortization (EBITDA).
Although EBITDA is not a measure of performance calculated in accordance with
Generally Accepted Accounting Principles (GAAP), the Company believes that
EBITDA is accepted as a generally recognized measure of performance in the
distribution industry and provides an indicator of the earnings available to
meet the Company's debt service obligations. EBITDA should not be considered in
isolation or as a substitute for operating income, net income, net cash provided
by operating activities or any other measure for determining The Company's
operating performance or liquidity which is calculated in accordance with GAAP.
EBITDA was $3.5 million, $11.4 million, $900,000 and $8.3 million for the three
and nine months ended September 30, 1997 and October 3, 1998, respectively.
In the second quarter of 1998, the Company adopted a plan to consolidate
distribution operations at its expanded Rhode Island facility and close its
Texas distribution center in the fourth quarter of 1998. The Company expects
this restructuring will generate permanent annual operating expense savings of
approximately $2.8 million commencing in 1999. The Company recorded a $2.6
million charge in the second quarter of 1998 in connection with closure of the
Texas distribution center.
Net loss before dividends and accretion on preferred stock for the third
quarter of fiscal 1998 was $4.7 million as compared to net income before
dividends and accretion on preferred stock of $223,000 in the third quarter of
fiscal 1997. Net loss before dividends and accretion on preferred stock for the
nine months ended October 3, 1998 was $5.1 million as compared to net income
before dividends and accretion on preferred stock of $1.0 million for the nine
months ended September 30, 1997.
Excluding the restructuring charge, net loss before dividends and accretion
on preferred stock for the first nine months of fiscal 1998 would have been $2.7
million as compared to net income before dividends and accretion on preferred
stock of $1.0 million in the first nine months of fiscal 1997. Excluding the
restructuring charge, EBITDA would have decreased 4.8% to $10.9 million in the
first nine months of fiscal 1998 as compared to $11.4 million in the first nine
months of fiscal 1997.
24
<PAGE> 25
AAI.FOSTERGRANT, INC. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
(CONTINUED)
RESULTS OF OPERATIONS
The following table sets forth, for the periods indicated, the percentage
relationship to net sales of certain items included in the Company's
Consolidated Condensed Statements of Operations:
<TABLE>
<CAPTION>
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, OCTOBER 3, SEPTEMBER 30, OCTOBER 3,
1997 1998 1997 1998
<S> <C> <C> <C> <C>
Net sales 100.0% 100.0% 100.0% 100.0%
Cost of goods sold 51.4 55.5 53.4 54.2
----- ----- ----- -----
Gross profit 48.6 44.5 46.6 45.8
Operating expenses 44.0 50.5 41.5 44.0
Restructuring charge - - - 2.1
----- ----- ----- -----
Income (loss) from operations 4.6 (6.0) 5.1 (0.3)
Interest expense 3.0 6.0 2.8 3.9
Other expense, net - 0.7 0.1 0.2
----- ----- ----- -----
Income (loss) before taxes and
dividends and accretion on
preferred stock 1.6 (12.7) 2.2 (4.4)
Income tax (expense) benefit (.9) - (1.3) 0.3
----- ----- ----- -----
Net income (loss) befor
dividends and accretion on
preferred stock 0.7 (12.7) 0.9 (4.1)
Dividends and accretion on
preferred stock 1.9 1.9 1.7 1.6
----- ----- ----- -----
Net loss applicable to common
shareholders (1.2)% (14.6)% (0.8)% (5.7)%
===== ===== ===== =====
</TABLE>
THREE MONTHS ENDED OCTOBER 3, 1998 COMPARED TO SEPTEMBER 30, 1997
Net Sales. Consolidated net sales were $36.8 million for the three months
ended October 3, 1998 as compared to $34.2 million for the three months ended
September 30, 1997, an increase of 7.7% or $2.6 million. The increase is
attributable to $3.6 million from sales associated with Fantasma and $1.5
million in international optical sales in the UK. These increases were partially
offset by a $2.5 million decline in sales of optical products of which $2.0
million is attributable to the introduction of optical product in two mass
merchandisers in the third quarter of fiscal year 1997.
25
<PAGE> 26
AAI.FOSTERGRANT, INC. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
(CONTINUED)
Gross Profit. Gross profit was $16.4 million for the three months ended
October 3, 1998 as compared to $16.6 million for the three months ended
September 30, 1997. Gross profit as a percentage of net sales decreased to 44.5%
for the three months ended October 3, 1998 from 48.6% for the three months ended
September 30, 1997. The decrease is primarily due to the lower margin Christmas
boxed goods program representing a higher percentage of total shipments in the
three months ended October 3, 1998 as compared to the three months ended
September 30, 1997.
Operating Expenses. Operating expenses were $18.6 million for the three
months ended October 3, 1998 as compared to $15.1 million for the three months
ended September 30, 1997, an increase of 23.6% or $3.5 million. The increase is
attributable to $2.6 million of operating expenses associated with the acquired
entities, $1.0 million of customer acquisition costs and $800,000 of operating
inefficiencies incurred in operating the Dallas facility subsequent to the
second quarter announcement of the scheduled fourth quarter closure. These
increases were partially offset by reduced service expenses as a result of
merging Foster Grant US's service department with the Company's.
Interest Expense. Interest expense was $2.2 million for the three months
ended October 3, 1998 as compared to $1.0 million for the three months ended
September 30, 1997, an increase of 117.9% or $1.2 million. This resulted from
additional borrowings under the Company's credit facilities to fund acquisitions
and expanded operations.
Income Tax. No income tax benefit was recorded for the three months ended
October 3, 1998 as compared to $320,000 of expense for the three months ended
September 30, 1997.
Net Income (Loss). As a result of the factors discussed above, net loss
before dividends and accretion on preferred stock was $4.7 million for the three
months ended October 3, 1998 as compared to net income before dividends and
accretion on preferred stock of $223,000 for the three months ended September
30, 1997, a decrease of $4.9 million.
Net Loss Applicable to Common Shareholders. Net loss applicable to common
shareholders was $5.4 million for the three months ended October 3, 1998 as
compared to a loss of $421,000 for the three months ended September 30, 1997, an
increase of $5.0 million. The increase was attributable to the $4.9 million
decrease in earnings and an increase of $55,000 in dividends and accretion on
Series A Preferred Stock due to the compounding of accrued dividends.
26
<PAGE> 27
AAI.FOSTERGRANT, INC. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
(CONTINUED)
NINE MONTHS ENDED OCTOBER 3, 1998 COMPARED TO SEPTEMBER 30, 1997
Net Sales. Consolidated net sales were $125.5 million for the nine months
ended October 3, 1998 compared to $110.1 million for the nine months ended
September 30, 1997, an increase of 14.0% or $15.4 million. The increase was
primarily attributable to $6.5 million from Foster Grant UK acquisition; $4.7
million from the Superior acquisition completed in July 1997 and $4.1 million
from the Fantasma acquisition completed in June 1998.
Gross Profit. Gross profit was $57.5 million for the nine months ended
October 3, 1998 as compared to $51.3 million for the nine months ended September
30, 1997, an increase of 12.0% or $6.2 million. The increase was primarily
attributable to $7.9 million contributed by the acquisitions partially offset by
unfavorable product mix. Gross profit as a percentage of net sales decreased to
45.8% for the nine months ended October 3, 1998 from 46.6% for the nine months
ended September 30, 1997. This is primarily due to unfavorable product mix
including the sale of slow moving products as part of the Company's inventory
reduction efforts and lower margin Christmas boxed goods sales representing a
higher percentage of total shipments.
Operating Expenses. Operating expenses were $57.8 million for the nine
months ended October 3, 1998 as compared to $45.7 million for the nine months
ended September 30, 1997, an increase of 26.4% or $12.1 million. Included in
operating expenses for the period ended October 3, 1998 is a restructuring
charge of $2.6 million incurred for the closure of the Dallas office and
distribution facility. The balance of the increased costs is due to operating
expenses associated with acquired entities, customer acquisition costs and
operating inefficiencies incurred subsequent to the announcement of the planned
closure of the Company's Dallas facility. These increases were partially offset
by reduced service expenses as a result of merging Foster Grant US's service
department with the Company's.
Interest Expense. Interest expense was $4.9 million for the nine months
ended October 3, 1998 as compared to $3.1 million for the nine months ended
September 30, 1997, an increase of 57.2% or $1.8 million. This resulted from
additional borrowings under the Company's credit facilities to fund acquisitions
and expanded operations.
Income Tax. Income tax benefit was $338,000 for the nine months ended
October 3, 1998 as compared to income tax expense of $1.4 million for the nine
months ended September 30, 1997.
Net Income (Loss). As a result of the factors discussed above, net loss
before dividends and accretion on preferred stock was $5.1 million for the nine
months ended October 3, 1998 as compared to net income before dividends and
accretion on preferred stock of $1.0 for the nine months ended September 30,
1997, a decrease of $6.1 million.
27
<PAGE> 28
AAI.FOSTERGRANT, INC. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
(CONTINUED)
Net Loss Applicable to Common Shareholders. Net loss applicable to common
shareholders was $7.2 million for the nine months ended October 3, 1998,
compared to a loss of $841,000 for the nine months ended September 30, 1997, an
increase of $6.3 million. The increase was attributable to the $6.1 million
decrease in earnings and a $202,000 increase in dividends and accretion on
Series A Preferred Stock due to the compounding of accrued dividends.
LIQUIDITY AND CAPITAL RESOURCES
At October 3, 1998 the Company had cash and cash equivalents of $2.6
million and working capital of $44.7 million. To date, the Company has funded
its operations through credit facilities, issuance of equity and debt
securities, and cash generated from operations.
The Company used $5.6 million of cash in operations during the nine months
ended October 3, 1998 compared to a use of $5.6 million during the nine months
ended September 30, 1997. Cash used in operating activities remained consistent
however, the decline in operating results and higher accounts receivables were
offset by a decrease in inventory and an increase in non-cash depreciation and
amortization charges.
The Company used $29.9 million in investing activities during the nine
months ended October 3, 1998 compared to a use of $7.9 million during the nine
months ended September 30, 1997. The uses of funds activities during the nine
months ended October 3, 1998 include $6.0 million for the purchase and
continuing expansion of the Company's Smithfield, Rhode Island headquarters,
$8.6 million for display fixtures, $5.5 million to acquire certain assets of
Foster Grant UK and the Foster Grant trademark for the United Kingdom and
Europe, and $4.1 million to acquire an 80% interest in Fantasma.
The Company generated $35.2 million from financing activities during the
nine months ended October 3, 1998 compared to $13.3 million during the nine
months ended September 30, 1997. All of the net proceeds from the sale of $75.0
million of 10 3/4% Senior Notes, received on July 21, 1998, were used to pay
existing debt.
The Company has issued 43,700 shares of Series A Preferred Stock, which has
a redemption value at October 3, 1998 of $281 million. Shares of Series A
Preferred Stock are convertible into Common Stock at a rate of 10 for 1,
adjustable for certain dilutive events. Conversion is at the option of the
shareholder, but is automatic upon the consummation of a Qualified Public
Offering (as defined). The holders of Series A Preferred Stock have the right to
require redemption for cash for any unconverted shares, beginning June 30, 2002,
provided, however, that the right to require redemption is suspended as long as
any Restrictive Indebtedness (as defined) is outstanding. The Notes constitute
Restrictive Indebtedness. The redemption price of the Series A Preferred Stock
is an amount equal to the
28
<PAGE> 29
AAI.FOSTERGRANT, INC. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
(CONTINUED)
original issue price, $526.32 per share, plus any accrued and unpaid dividends
yielding a 10% compounded annual rate of return.
In connection with the purchase of Foster Grant US, the Company's
wholly-owned subsidiary, Foster Grant Holdings, Inc. (FG Holdings) issued 100
shares of redeemable nonvoting preferred stock of FG Holdings (the FG Preferred
Stock), which are redeemable on February 28, 2000, or earlier upon the
occurrence of certain specified capital transactions. The redemption price will
range between $1.0 million and $4.0 million depending upon the net sales of
sunglasses, reading glasses and accessories by FG Holdings and the Company, and
upon the total transaction value.
The Company is continually engaged in evaluating potential acquisitions.
The Company expects that funding for future acquisitions may come from a variety
of sources, depending on the size and nature of any such acquisition. Potential
sources of capital include cash generated from operations, borrowings under the
Senior Credit Facility, or other external debt or equity financing. There can be
no assurance that such additional capital sources will be available to the
Company, if at all, on terms that the Company finds acceptable.
The Company has substantial indebtedness and significant debt service
obligations. As of October 3, 1998, the Company had total indebtedness,
including borrowings under the Senior Credit Facility, in the aggregate
principal amount of $81.3 million. The Company had current liabilities of
approximately $30.6 million, which includes $0.3 million in the present value of
minimum lease payments under its capital leases. In addition, the Company has
significant annual obligations that include interest on the Notes of
approximately $8.1 million and minimum payments under its operating leases of
approximately $800,000. The Indenture permits the Company to incur additional
indebtedness, including secured indebtedness, subject to certain limitations.
In addition, the Company has up to $42.0 million available for borrowings
under the Senior Credit Facility. Interest rates on the revolving loans under
the Senior Credit Facility are based, at the Company's option, on the Base Rate
(as defined) or LIBOR plus an applicable margin. The Senior Credit Facility
contains certain restrictions and limitations, including financial covenants
that require the Company to maintain and achieve certain levels of financial
performance and limit the payment of cash dividends and similar restricted
payments.
The Company's ability to make scheduled payments of principal of, or to pay
the interest or Liquidated Damages, if any, on, or to refinance, its
indebtedness (including the Notes), or to fund planned capital expenditures will
depend on its future performance, which, to a certain extent, is subject to
general economic, financial, competitive, legislative, regulatory and other
factors that are beyond its control. Based upon the current level of operations
and anticipated cost savings and revenue growth, the Company believes that cash
flow from operations and available cash, together with available borrowings
under the Senior Credit
29
<PAGE> 30
AAI.FOSTERGRANT, INC. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
(CONTINUED)
Facility, will be adequate to meet the Company's future liquidity needs for at
least the next several years. The Company may, however, need to refinance all or
a portion of the principal of the Notes on or prior to maturity. There can be no
assurance that the Company's business will generate sufficient cash flow from
operations, that anticipated cost savings and revenue growth will be realized or
that future borrowings will be available under the Senior Credit Facility in an
amount sufficient to enable the Company to service its indebtedness, including
the Notes, or to fund its other liquidity needs. In addition, there can be no
assurance that the Company will be able to effect any such refinancing on
commercially reasonable terms or at all.
YEAR 2000
The Company uses several application programs written over many years using
two-digit fields to define the applicable year, rather than four-digit year
fields. Programs that are time sensitive may recognize a date using "00" as the
year 1900 rather than the year 2000. This misinterpretation of the year could
result in an incorrect computation or a computer shutdown.
As a result of the Company's growth, a new information management system is
being implemented, which is expected to be Year 2000 compliant. The Company has
experienced delays in the conversion with the schedule being revised to provide
for full implementation by the summer of 1999. Accordingly, the Company believes
that with the successful conversion to the new software, the Year 2000 issue
will not pose significant operational problems for the Company's systems. The
date on which the Company believes it will complete the conversion is based upon
management's best estimate and there can be no guarantee that this estimate will
be achieved. The Company will evaluate the need for a contingency plan in the
first half of 1999 based on the status of the installation.
Since Year 2000 compliance is being addressed with the implementation of
the Company's new system, the cost of addressing the Year 2000 issue is not
separately identifiable. No material additional costs are anticipated at this
time.
The Company has completed a compliance review of its property, which uses
embedded technology. Although the Company believes that the Year 2000 issue will
not pose a significant problem for any of the Company's systems or property
utilizing embedded technology, there can be no assurance that the Year 2000
issue will not interfere with the function and use of such property.
30
<PAGE> 31
AAI.FOSTERGRANT, INC. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
(CONTINUED)
The Company's major customers and vendors have informed the Company that
they are currently addressing the Year 2000 issue and expect to be Year 2000
compliant by mid-1999. While there can be no guarantee that the systems of other
companies on which the Company's systems rely will be timely converted and will
not have an adverse effect on the Company's systems, the Company does not
believe that its operations are materially vulnerable to the failure of any
vendor or customer to properly address the Year 2000 issue. The Company's
contingency plan in the event other parties are unable to provide Year 2000
compliant electronic data is to revert to paper documentation from these
parties.
The failure to correct a material Year 2000 problem could result in an
interruption in, or failure of, certain normal business activities or
operations. Such failures could materially or adversely affect the Company's
results of operations, liquidity and financial condition. Due to the general
uncertainty inherent in the Year 2000 problem, resulting in part from the
uncertainty of the Year 2000 readiness of third-party suppliers and customers,
the Company is unable to determine at this time whether the consequences of Year
2000 failures will have a material impact on the Company's results of
operations, liquidity or financial condition. The aforementioned steps being
undertaken by the Company are expected to significantly reduce the Company's
level of uncertainty about the Year 2000 problem and, in particular, about the
Year 2000 compliance and readiness of its material suppliers and customers. The
Company believes that, with the implementation of the new system and the other
steps being taken, the possibility of significant interruptions of normal
operations should be reduced.
31
<PAGE> 32
AAI.FOSTERGRANT, INC. AND SUBSIDIARIES
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.
Not applicable.
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
None.
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS
None.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
None.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
By written consent dated August 4, 1998 executed by the holders of 604,200
shares (99.4%) of the Company's Common Stock and 35,530 shares (81.3%) of Series
A Preferred Stock, such shareholders approved an Amendment to the Articles of
Incorporation changing the purpose of the Company.
ITEM 5. OTHER INFORMATION
None.
ITEM 6. Exhibits and reports on Form 8-K
(a) Exhibits
EX-27.1 Financial Data Schedule
(b) Reports on Form 8-K
The registrant filed no reports on form 8-K
during the quarter ended October 3,1998
32
<PAGE> 33
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 hereunto duly authorized.
AAi.FosterGrant, Inc.
(Registrant)
Dated: December 21, 1998 /s/ Gerald F. Cerce
-----------------------------------------------
Gerald F. Cerce
Chairman, President and Chief Executive
Officer (Principal Executive Officer)
Dated: December 21, 1998 /s/ Duane M. Desisto
-----------------------------------------------
Duane M. DeSisto
Treasurer, Assistant Secretary and Chief
Financial Officer (Principal Financial Officer)
Dated: December 21, 1998 /s/ Stephen J. Korotsky
-----------------------------------------------
Stephen J. Korotsky
Controller (Principal Accounting Officer)
33
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE
CONSOLIDATED CONDENSED BALANCE SHEET AS OF OCTOBER 3, 1998 (UNAUDITED) AND THE
CONSOLIDATED CONDENSED STATEMENT OF OPERATIONS FOR THE NINE MONTHS ENDED OCTOBER
3, 1998 (UNAUDITED) AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH
FINANCIAL STATEMENTS CONTAINED IN FORM 10-Q FOR THE NINE MONTHS ENDED
OCTOBER 3, 1998.
</LEGEND>
<CIK> 0001067346
<NAME> AAI.FOSTERGRANT, INC.
<MULTIPLIER> 1,000
<CURRENCY> U.S. DOLLARS
<S> <C>
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> JAN-02-1999
<PERIOD-START> JAN-01-1998
<PERIOD-END> OCT-03-1998
<EXCHANGE-RATE> 1
<CASH> 2,588
<SECURITIES> 0
<RECEIVABLES> 43,791
<ALLOWANCES> 10,446
<INVENTORY> 28,337
<CURRENT-ASSETS> 75,238
<PP&E> 37,785
<DEPRECIATION> 17,549
<TOTAL-ASSETS> 122,466
<CURRENT-LIABILITIES> 30,580
<BONDS> 77,276
29,027
0
<COMMON> 6
<OTHER-SE> (14,578)
<TOTAL-LIABILITY-AND-EQUITY> 122,466
<SALES> 125,480
<TOTAL-REVENUES> 125,480
<CGS> 67,992
<TOTAL-COSTS> 67,992
<OTHER-EXPENSES> 57,823
<LOSS-PROVISION> 444
<INTEREST-EXPENSE> 4,854
<INCOME-PRETAX> (5,442)
<INCOME-TAX> 338
<INCOME-CONTINUING> (5,104)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (7,160)
<EPS-PRIMARY> (11.78)
<EPS-DILUTED> (11.78)
</TABLE>
