<PAGE> 1
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE
ACT OF 1934.
For the quarterly period ended July 1, 2000.
[ ] 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: [X] NO:
As of August 11, 2000, the aggregate market value of the voting equity held
by non-affiliates of the Registrant was none.
As of August 11, 2000, 608,000 shares of Common Stock , 43,700 shares of
Series A Preferred Stock and 27,500 shares of Series B Preferred Stock of the
Registrant were issued and outstanding.
<PAGE> 2
AAI.FOSTERGRANT, INC. AND SUBSIDIARIES
QUARTERLY REPORT
TABLE OF CONTENTS
PAGE
PART I. - FINANCIAL INFORMATION
ITEM 1. CONSOLIDATED CONDENSED FINANCIAL STATEMENTS
Consolidated Condensed Balance Sheets as of
January 1, 2000 and July 1, 2000 3
Consolidated Condensed Statements of Operations
for the three and six months ended July 3, 1999
and July 1, 2000 4
Consolidated Condensed Statements of Cash Flows for
the six months ended July 3, 1999 and July 1, 2000 5
Notes to Consolidated Condensed Financial Statements 6-16
ITEM 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations 17-22
ITEM 3. Quantitative and Qualitative Disclosures About Market Risk 22
PART II - OTHER INFORMATION
ITEM 1. Legal Proceedings 23
ITEM 2. Changes in Securities and Use of Proceeds 23
ITEM 3. Defaults Upon Senior Securities 23
ITEM 4. Submission of Matters to a Vote of Security Holders 23
ITEM 5. Other Information 23
ITEM 6. Exhibits and reports on Form 8-K 24
SIGNATURES 25
2
<PAGE> 3
AAI.FOSTERGRANT, INC. AND SUBSIDIARIES
CONSOLIDATED CONDENSED BALANCE SHEETS
(In thousands, except share and per share data)
<TABLE>
<CAPTION>
ASSETS JANUARY 1, JULY 1,
2000 2000
---------- ---------
<S> <C> <C>
CURRENT ASSETS:
Cash and cash equivalents $ 2,289 $ 1,785
Accounts receivable less reserves of approximately
$12,804 and $10,643 22,231 28,778
Inventories 33,025 38,070
Prepaid expenses and other current assets 794 425
Deferred tax assets 3,743 2,500
--------- ---------
Total current assets 62,082 71,558
--------- ---------
Property, plant and equipment, net 19,392 20,450
Intangible assets 13,486 13,158
Other assets 7,588 7,128
Deferred tax assets 5,319 3,529
--------- ---------
Total assets $ 107,867 $ 115,823
========= =========
LIABILITIES AND SHAREHOLDERS' DEFICIT
CURRENT LIABILITIES:
Borrowings under revolving note payable $ 11,000 $ 19,564
Redeemable preferred stock of a subsidiary 1,000 --
Current maturities of long-term obligations 902 673
Deferred compensation - current portion 10 11
Accounts payable 16,414 22,671
Accrued expenses 23,253 22,479
Accrued income taxes 2,104 2,250
--------- ---------
Total current liabilities 54,683 67,648
--------- ---------
10 3/4% series B senior notes due 2006 75,000 64,250
Long-term obligations - less current maturities 420 3,501
Deferred compensation - less current portion 1,662 1,423
Series A redeemable convertible Preferred stock, $.01 par value --
Authorized -- 200,000 shares
Designated, issued and outstanding -- 43,700 shares stated at
redemption value 31,864 33,452
Series B redeemable Preferred stock, $.01 par value --
Authorized -- 75,000 shares
Designated, issued and outstanding - 27,500 shares stated at redemption value -- 367
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 (122) (663)
Accumulated deficit (55,916) (54,431)
--------- ---------
Total shareholders' deficit (55,762) (54,818)
--------- ---------
Total liabilities and shareholders' deficit $ 107,867 $ 115,823
========= =========
</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 share and per share data)
<TABLE>
<CAPTION>
THREE MONTHS ENDED SIX MONTHS ENDED
---------------------- ----------------------
JULY 3, JULY 1, JULY 3, JULY 1,
1999 2000 1999 2000
--------- --------- --------- ---------
<S> <C> <C> <C> <C>
NET SALES $ 45,616 $ 45,707 $ 87,097 $ 88,235
COST OF GOODS SOLD 26,757 25,529 50,745 49,111
--------- --------- --------- ---------
Gross profit 18,859 20,178 36,352 39,124
OPERATING EXPENSES:
Selling 13,267 12,062 24,796 23,505
General and administrative 4,571 4,539 9,038 9,129
Restructuring charge -- -- -- 2,500
--------- --------- --------- ---------
Income from operations 1,021 3,577 2,518 3,990
Interest expense (2,679) (2,851) (5,021) (5,448)
Other (expense) income, net (152) 94 (17) 145
--------- --------- --------- ---------
(Loss) income before income tax expense (1,810) 820 (2,520) (1,313)
Income tax expense -- 43 -- 43
--------- --------- --------- ---------
Net (loss) income before extraordinary items (1,810) 777 (2,520) (1,356)
Extraordinary gain, net of $3.2 million in taxes -- 4,429 -- 4,429
--------- --------- --------- ---------
Net (loss) income before dividends and accretion on preferred stock (1,810) 5,206 (2,520) 3,073
Dividends and accretion on preferred stock 737 801 1,455 1,588
--------- --------- --------- ---------
Net (loss) income applicable to common shareholders $ (2,547) $ 4,405 $ (3,975) $ 1,485
========= ========= ========= =========
</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>
SIX MONTHS ENDED
---------------------
JULY 3, JULY 1,
1999 2000
--------- --------
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net (loss) income before dividends and accretion on preferred stock $ (2,520) $ 3,073
Adjustments to reconcile net loss to net cash used in operating
activities-
Depreciation and amortization 5,878 6,039
Extraordinary gain on early extinguishment of debt -- (4,429)
Amortization of interest costs related to debt 360 272
Equity in earnings of investments in affiliates (84) --
Minority interest in income of consolidated subsidiary 42 --
Cumulative foreign currency translation adjustment 42 --
Changes in assets and liabilities, net of acquisitions -
Accounts receivable (13,025) (6,704)
Inventories 2,051 (5,164)
Prepaid expenses and other current assets 218 212
Deferred costs (106) (230)
Accounts payable 2,563 6,116
Accrued expenses (5,311) (792)
Accrued income taxes (21) 26
-------- --------
Net cash used in operating activities (9,913) (1,581)
-------- --------
CASH FLOWS FROM INVESTING ACTIVITIES
Purchases of property, plant and equipment (4,892) (5,534)
Increase in other assets (237) (179)
-------- --------
Net cash used in investing activities (5,129) (5,713)
-------- --------
CASH FLOWS FROM FINANCING ACTIVITIES:
Net borrowings under revolving note payable 14,728 8,564
Proceeds from issuance of long-term debt -- 2,750
Repurchase of 10 3/4% Series B Senior Notes due 2006 -- (2,750)
Payments on long term obligations and deferred compensation (336) (677)
Redemption of Preferred Stock of a subsidiary -- (1,000)
-------- --------
Net cash provided by financing activities 14,392 6,887
-------- --------
Effect of exchange rate changes on cash and cash equivelents -- (97)
NET DECREASE IN CASH AND CASH EQUIVALENTS (650) (504)
CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD 2,207 2,289
-------- --------
CASH AND CASH EQUIVALENTS, END OF PERIOD $ 1,557 $ 1,785
======== ========
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Cash paid during the period for-
Interest $ 4,532 $ 5,355
======== ========
Income taxes $ 6 $ 40
======== ========
SUPPLEMENTAL DISCLOSURE OF NON-CASH ACTIVITIES:
Acquisition of equipment under capital lease obligations $ -- $ 557
======== ========
Issuance of Series B Preferred Stock in connection with debt
repurchase $ -- 367
======== ========
</TABLE>
The accompanying notes are an integral part of these consolidated condensed
financial statements.
5
<PAGE> 6
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"
or "AAi") for the year ended January 1, 2000 as reported in the Company's 10-K
filed with the SEC on March 31, 2000. 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 January 1, 2000 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 July 1, 2000 may not be indicative of the results that may be
expected for the year ending December 30, 2000, or for any other future period.
(b) Revenue Recognition
The Company recognizes revenue from product sales, net of estimated agreed
upon future allowances and anticipated returns and discounts, taking into
account historical experience, upon shipment to the customer.
(c) Inventories
Inventories are stated at the lower of cost (first-in, first-out) or market
and consist of the following at January 1, 2000 and July 1, 2000 (in thousands):
JANUARY 1, JULY 1,
2000 2000
---------- --------
Finished goods.............................. $29,695 $ 35,287
Work-in-process and raw materials........... 3,330 2,783
------- --------
$33,025 $ 38,070
======= ========
(d) 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 may also receive the previous
vendor's merchandise from the customer in connection with 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 through various liquidation
channels. Except as provided below, the excess costs over the fair market value
of the inventory received is charged to selling expense when incurred. The
Company expensed customer acquisition costs of approximately $225,000 and
$372,000 for the three and six months ended July 1, 2000 and $199,000 and
$284,000 for the three and six months ended July 3, 1999.
The excess costs over the fair market value of the inventory received is
capitalized as deferred costs and amortized over the agreement period if the
Company enters into a minimum purchase agreement with the customer from which
the estimated gross profits from future minimum sales during the term of the
agreement are sufficient to recover the amount of the deferred costs. During the
three and six months ended July 3, 1999 the Company capitalized approximately
$45,000 and $106,000 of these costs. The Company capitalized costs of
approximately $230,000 during the three and six months ended July 1, 2000.
Amortization expense related to these costs as well as previously capitalized
costs was approximately $300,000 and $596,000 for the three and six months ended
July 3, 1999 and $339,000 and $659,000 for the three and six months ended July
1, 2000.
6
<PAGE> 7
Note 2 - 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 $71.3 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 certain subordinated promissory notes to shareholders,
net of amounts due the Company from certain of these shareholders. The Company
incurred issuance costs of approximately $3.7 million in relation to the Notes.
These costs are being amortized over the life of the Notes and are included in
other assets in the accompanying consolidated balance sheets. In December 1998
the Notes were exchanged for 10 3/4% Series B Notes due 2006 registered with the
SEC. Interest on the Series B Notes is payable semiannually on January 15 and
July 15.
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 obligations 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 joint and several basis, by each of the
Company's current and future Domestic Subsidiaries (as defined) (the
Guarantors). The Indenture under which the Notes were issued (the Indenture)
imposes certain 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 shareholders and affiliates, sell assets and engage in
mergers and consolidations. At July 1, 2000 management believes the Company was
in compliance with these covenants.
The Notes are redeemable at the option of the Company, in whole or in part,
on or after July 15, 2002 at various redemption prices, declining from 105.375%
of the principal amount to par on and after July 15, 2004. In addition, on or
prior to July 15, 2001, the Company may use the net cash proceeds of one or more
equity offerings to redeem up to 35% of the aggregate principal amount of the
Notes originally issued at a redemption price of 110.750% of the principal
amount thereof plus accrued interest to the date of redemption. Upon a change of
control, each Note holder has the right to require the Company to repurchase
such holder's Notes at a purchase price of 101% of the principal amount plus
accrued interest.
In June 2000, the Company repurchased $10.75 million face value of the
Notes for a purchase price of $2.75 million. The purchase price was financed
utilizing a term loan under its existing Senior Credit Facility. The term loan
is secured by a mortgage on its Smithfield, RI facility and guaranteed by
certain preferred shareholders. The term loan is being amortized over 60 months
commencing April 1, 2001, with the principal balance due at the expiration of
the Senior Credit Facility on July 31, 2003. As a result of this transaction,
the Company recognized a $4.4 million extraordinary gain, net of $3.2 million in
taxes. These purchases resulted from inquiries from holders of the Notes. The
Company does not solicit offers to tender Notes for repurchase, but may, from
time to time, consider requests to repurchase Notes, subject to the availability
of appropriate financing.
In conjunction with this guarantee, 27,500 shares of Series B preferred
stock were issued. The holders of Series B preferred stock are entitled to
receive, prior and in preference to distribution of any assets of the Company
with respect to any other series of preferred stock, common stock or other
capital stock of the Company an amount per share equal to the sum of $6.67
multiplied by the number of six month periods, and fractions thereof, in the
period during which the guarantee was outstanding. The Company has calculated
the value of the Series B preferred stock to be $367,000 based on the assumption
that the guarantee will be outstanding for one year. This amount is being
amortized over the one year period as interest expense. If the guarantee is
outstanding for a period beyond twelve months, the Company will assign
additional value to the stock and amortize the related costs over the additional
period of the guarantee.
Note 3 - Earnings Per Share
During the quarter ended July 1, 2000, the Company decided to eliminate its
earning per share disclosure. This decision was based on several factors
including the Company does not have common stock or potential common stock that
is traded in a public market, as required by SFAS No. 128, "Earnings Per Share",
and the Company's common stock does not have a readily ascertainable fair market
value.
Note 4 - Comprehensive Income (Loss)
Comprehensive income for the three and six months ended July 1, 2000 was
$4.7 million and $2.4 million, respectively, as compared to comprehensive loss
for the three and six months ended July 3, 1999 of $1.6 million and $2.5
million, respectively. Differences between comprehensive income (loss) and
income (loss) before dividends and accretion on preferred stock for each period
represents the foreign currency translation adjustment for each period.
7
<PAGE> 8
Note 5 - Restructuring Charge
In March 2000, the Company recorded a restructuring charge of $2.5 million
related to the termination of three executives. The charge consists of an
accrual of severance payments due to three executives for a two-year period. The
severance will be paid through fiscal 2002. Through July 1, 2000 severance
benefits of approximately $39,000 were paid to one of the three executives.
Restructure Charge Payments Reserve Balance
Description April 1,2000 Q2 2000 July 1, 2000
----------- ------------------ -------- --------------
Severance benefits $2,500 ($39) $2,461
====== ===== ======
Note 6 - New Accounting Standards
In June 1999, FASB issued SFAS No. 137, "Accounting for Derivative
Instruments and Hedging Activities--Deferral of the Effective Date of FASB No.
133", which defers the effective date of SFAS No. 133 to all fiscal quarters of
all fiscal years beginning after June 15, 2000. SFAS No. 133, Accounting for
Derivative Instruments and Hedging Activities, issued in June 1998, establishes
accounting and reporting standards for derivative instruments, including certain
derivative instruments embedded in other contracts, and hedging activities. It
requires an entity to recognize all derivatives as either assets or liabilities
in the statement of financial position and measure those instruments at fair
value. The Company does not expect adoption of this statement to have a
significant impact on its consolidated financial position or results of
operations.
The Securities and Exchange Commission issued Staff Accounting Bulletin
(SAB) No. 101, "Revenue Recognition", in December 1999. The Company is required
to adopt this new accounting guidance through a cumulative charge to operations,
in accordance with Accounting Principles Board (APB) Opinion No. 20, "Accounting
Changes", no later than the fourth quarter of fiscal 2000. The Company does not
expect adoption of the guidance provided in SAB No. 101 to have a material
impact on future operating results.
In March 2000, the FASB issued Interpretation No. 44, "Accounting for
Certain Transactions Involving Stock Compensation - an Interpretation of APB
Opinion No. 25." The interpretation clarifies the application of APB Opinion No.
25 in certain situations, as defined. The Interpretation is effective July 1,
2000, but covers certain events occurring during the period after December 15,
1998, but before the effective date. To the extent that events covered by this
interpretation occur during the period after December 15, 1998, but before the
effective date, the effects of applying this interpretation would be recognized
on a prospective basis from the effective date. Accordingly, upon initial
application of the final interpretation, (a) no adjustments would be made to the
financial statements for periods before the effective date and (b) no expense
would be recognized for any additional compensation cost measured that is
attributable to periods before the effective date. The Company does not expect
the adoption of this interpretation to have a significant impact on the
accompanying financial statements.
Note 7 - Segment Reporting
The Company has determined it has three reportable segments: mass
merchandisers, chain drug stores/combo stores/supermarkets, and variety stores.
The Company distributes accessories such as, costume jewelry, optical products,
watches, clocks and other accessories.
The Company's reportable segments are strategic business units that sell the
Company's products to distinct distribution channels. They are managed
separately because each business requires different marketing strategies. The
Company's approach is based on the way that management organizes the segments
within the enterprise for making operating decisions and assessing performance.
The accounting policies of the segments are the same as those described in
the summary of significant accounting policies. The Company evaluates
performance based on profit or loss from operations before income taxes not
including nonrecurring gains and losses.
8
<PAGE> 9
<TABLE>
<CAPTION>
CHAIN DRUG
THREE MONTHS STORES/COMBO
ENDED MASS STORES/
JULY 3, 1999 MERCHANDISERS SUPERMARKETS VARIETY OTHER TOTAL
--------------------- ------------- ------------- ------- ------ --------
<S> <C> <C> <C> <C> <C>
Net sales $ 24,527 $11,849 $ 5,312 $3,928 $ 45,616
======== ======= ======= ====== ========
Segment (loss) profit $ (1,235) $ 1,143 $(1,159) $ (407) $ (1,658)
========= ======= ======= ====== ========
</TABLE>
<TABLE>
<CAPTION>
CHAIN DRUG
THREE MONTHS STORES/COMBO
ENDED MASS STORES/
JULY 1, 2000 MERCHANDISERS SUPERMARKETS VARIETY OTHER TOTAL
--------------------- ------------- ------------ -------- ------ --------
<S> <C> <C> <C> <C> <C>
Net sales $ 27,492 $ 10,023 $ 5,447 $2,745 $ 45,707
======== ======== ======== ====== ========
Segment profit $ 467 $ 187 $ 47 $ 24 $ 725
======== ======== ======== ====== ========
</TABLE>
<TABLE>
<CAPTION>
CHAIN DRUG
SIX MONTHS STORES/COMBO
ENDED MASS STORES/
JULY 3, 1999 MERCHANDISERS SUPERMARKETS VARIETY OTHER TOTAL
--------------------- ------------- ------------ -------- ------ --------
<S> <C> <C> <C> <C> <C>
Net sales $ 50,782 $19,722 $10,725 $ 5,868 $ 87,097
======== ======= ======= ======= ========
Segment (loss) profit $ (177) $ 874 $(1,941) $(1,259) $ (2,503)
========= ======= ======= ======= ========
</TABLE>
<TABLE>
<CAPTION>
CHAIN DRUG
SIX MONTHS STORES/COMBO
ENDED MASS STORES/
JULY 1, 2000 MERCHANDISERS SUPERMARKETS VARIETY OTHER TOTAL
--------------------- ------------- ------------ -------- ----- --------
<S> <C> <C> <C> <C> <C>
Net sales $ 51,147 $ 20,066 $ 12,750 $4,272 $ 88,235
======== ======== ======== ====== ========
Segment profit (loss) $ 1,402 $ 910 $ (687) $ (582) $ (1,043)
======== ======== ======== ====== ========
</TABLE>
Revenues from segments below the quantitative thresholds are attributable to
five operating segments of the Company. Those segments include department
stores, armed forces' PX stores, boutique stores, gift shops, bookstores and
catalogues. None of these segments have ever met any of the quantitative
thresholds for determining reportable segments and their combined results are
presented as Other.
Segment profit (loss) differs from the profit (loss) before income tax
expense and dividends and accretion on preferred stock by the amount of other
income, restructure charge and extraordinary items which are not allocated by
segment. The chief operating decision-maker does not review segment assets.
Total assets specifically identifiable with each reportable segment are as
follows:
JANUARY 1, JULY 1,
2000 2000
--------- ---------
Mass merchandisers $ 19,730 $ 28,608
Chain drug stores/combo stores/supermarkets 3,495 9,088
Variety 2,708 4,184
Other 2,454 2,588
Unassigned assets 79,480 71,355
--------- ---------
$ 107,867 $ 115,823
========= =========
9
<PAGE> 10
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 they 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. Prior to September 1, 1999,
the Company held an 80% interest in Fantasma LLC ("Fantasma") and accordingly
Fantasma was included as a mostly owned subsidiary in the supplemental
consolidating financial information for such periods.
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 subsidiary's investment accounts and earnings. The principal
elimination entries eliminate investments in subsidiaries and intercompany
balances and transactions.
Effective January 3, 1999, the assets of the Company's wholly owned
guarantor subsidiaries (other than Fantasma) were transferred to the Company.
Accordingly, the Company now performs all operations previously performed by
these wholly owned guarantor subsidiaries, the results of which are included in
the consolidating financial information for periods ending after such date.
Effective September 1, 1999, the Company acquired 100% of the interests of
Fantasma, which is included as a wholly owned subsidiary in the consolidating
financial information for periods ending after such date.
10
<PAGE> 11
SUPPLEMENTAL CONSOLIDATING FINANCIAL INFORMATION
<TABLE>
<CAPTION>
JANUARY 1, 2000
-------------------------------------------------------------------
WHOLLY
OWNED NON-GUARANTOR
COMPANY SUBSIDIARIES SUBSIDIARIES ELIMINATIONS CONSOLIDATED
-------- ------------ ------------ ------------ ------------
(IN THOUSANDS)
ASSETS
<S> <C> <C> <C> <C> <C>
CONSOLIDATING BALANCE SHEETS
CURRENT ASSETS:
Cash and cash equivalents $ 97 $ 8 $ 2,184 $ -- $ 2,289
Accounts receivable, net 16,303 2,427 3,501 -- 22,231
Inventories 28,743 -- 4,282 -- 33,025
Prepaid expenses and other current
assets 400 41 353 -- 794
Deferred tax assets 3,743 -- -- -- 3,743
-------- ------ ------- -------- --------
Total current assets 49,286 2,476 10,320 -- 62,082
PROPERTY, PLANT AND EQUIPMENT, NET 17,727 14 1,651 -- 19,392
OTHER ASSETS 43,334 -- 1,712 (18,653) 26,393
-------- ------ ------- --------- --------
Total assets $110,347 $2,490 $13,683 $ (18,653) $107,867
======== ====== ======= ========= ========
LIABILITIES AND SHAREHOLDERS' EQUITY (DEFICIT)
CURRENT LIABILITIES:
Borrowings under revolving note
payable $ 11,000 $ -- $ -- $ -- $ 11,000
Redeemable preferred stock of a
subsidiary 1,000 -- -- -- 1,000
Current maturities of long-term
obligations 569 -- 343 -- 912
Accounts payable 15,364 209 841 -- 16,414
Accrued expenses 22,545 1,075 1,798 (61) 25,357
Due (from) to affiliate (590) 5,569 4,940 (9,919) --
--------- ------ ------- --------- --------
Total current liabilities 49,888 6,853 7,922 (9,980) 54,683
10 3/4% SENIOR NOTES 75,000 -- -- -- 75,000
LONG-TERM OBLIGATIONS, LESS CURRENT
MATURITIES 1,878 -- 204 -- 2,082
Preferred stock 31,864 -- 31,864
Shareholders' (deficit) equity (48,283) (4,363) 5,557 (8,673) (55,762)
-------- ------ ------- --------- --------
Total liabilities and shareholders'
(deficit) equity $110,347 $2,409 $13,683 $ (18,653) $107,867
======== ====== ======= ========= ========
</TABLE>
11
<PAGE> 12
SUPPLEMENTAL CONSOLIDATING FINANCIAL INFORMATION
<TABLE>
<CAPTION>
JULY 1, 2000
------------------------------------------------------------------
WHOLLY
OWNED NON-GUARANTOR
COMPANY SUBSIDIARIES SUBSIDIARIES ELIMINATIONS CONSOLIDATED
--------- ------------ ------------- ------------ ------------
(IN THOUSANDS)
ASSETS
<S> <C> <C> <C> <C> <C>
CONSOLIDATING BALANCE SHEETS
CURRENT ASSETS:
Cash and cash equivalents $ 76 $ -- $ 1,709 $ -- $ 1,785
Accounts receivable, net 21,969 783 6,027 -- 28,778
Inventories 34,439 -- 3,630 -- 38,069
Prepaid expenses and other current assets 220 45 159 -- 425
Deferred tax assets 3,743 -- -- -- 3,743
--------- ------ ------- -------- ---------
Total current assets 60,448 828 11,524 -- 72,801
PROPERTY, PLANT AND EQUIPMENT, NET 18,769 10 1,671 -- 20,450
OTHER ASSETS 40,719 -- 1,379 (19,526) 22,572
--------- ------ ------- -------- ---------
TOTAL ASSETS $ 119,936 $ 838 $14,575 $(19,526) $115,823
========= ====== ======= ======== =========
LIABILITIES AND SHAREHOLDERS' EQUITY (DEFICIT)
CURRENT LIABILITIES:
Borrowings under revolving note payable $ 19,564 $ -- $ -- $ -- $ 19,564
Current maturities of long-term
obligations 476 -- 208 -- 684
Accounts payable 20,721 -- 1,951 -- 22,671
Accrued expenses 22,921 693 1,114 -- 24,729
Due to (from) affiliate (985) 6,974 9,538 (15,527) --
---------- ------ ------- -------- --------
Total current liabilities 62,697 7,667 12,811 (15,527) 67,648
10 3/4% SENIOR NOTES 64,250 -- -- -- 64,250
LONG-TERM OBLIGATIONS, LESS
CURRENT MATURITIES 4,669 -- 255 -- 4,924
Preferred stock 33,819 -- -- -- 33,819
Shareholders' (deficit) equity (45,498) (6,829) 1,509 (3,999) (54,818)
--------- ------ ------- -------- --------
Total liabilities and shareholders'
(deficit) equity $ 119,936 $ 838 $14,575 $(19,526) $ 115,823
========= ====== ======= ======== =========
</TABLE>
12
<PAGE> 13
SUPPLEMENTAL CONSOLIDATING FINANCIAL INFORMATION
<TABLE>
<CAPTION>
SIX MONTHS ENDED
---------------------------------------------------------------------
JULY 3, 1999
---------------------------------------------------------------------
MOSTLY OWNED NON-GUARANTOR
COMPANY SUBSIDIARIES SUBSIDIARIES ELIMINATIONS CONSOLIDATED
------- ------------ ------------ ------------ ------------
(IN THOUSANDS)
<S> <C> <C> <C> <C> <C>
CONSOLIDATING STATEMENTS OF OPERATIONS
Net sales $ 71,687 $ 2,844 $ 12,566 $ -- $ 87,097
Cost of goods sold 41,906 3,010 5,829 -- 50,745
-------- -------- -------- -------- --------
Gross profit 29,781 (166) 6,737 -- 36,352
Operating expenses 26,056 2,302 5,476 -- 33,834
Restructuring charge -- -- -- -- --
-------- -------- -------- -------- --------
Income (loss) from operations 3,725 (2,468) 1,261 -- 2,518
Interest expense (4,731) (153) (137) -- (5,021)
Other income (expense), net 421 (24) (498) (1,988) (101)
Equity in earnings (losses) of consolidated
subsidiaries 2,072 -- -- -- 84
-------- -------- -------- -------- --------
Income (loss) before income tax expense
and dividends and accretion and
preferred stock 1,487 (2,645) 626 (1,988) (2,520)
Income tax expense -- -- -- -- --
-------- -------- -------- -------- --------
Net income (loss) before dividends and
accretion on preferred stock 1,487 (2,645) 626 (1,988) (2,520)
Dividends and accretion on preferred stock 1,455 -- -- -- 1,455
-------- -------- -------- -------- --------
Net income (loss) applicable to common
shareholders $ 32 $ (2,645) $ 626 $ (1,988) $ (3,975)
======== ======== ======== ======== ========
</TABLE>
13
<PAGE> 14
SUPPLEMENTAL CONSOLIDATING FINANCIAL INFORMATION
<TABLE>
<CAPTION>
SIX MONTHS ENDED
---------------------------------------------------------------------
JULY 1, 2000
---------------------------------------------------------------------
WHOLLY OWNED NON-GUARANTOR
COMPANY SUBSIDIARIES SUBSIDIARIES ELIMINATIONS CONSOLIDATED
------- ------------ ------------- ------------ ------------
(IN THOUSANDS)
CONSOLIDATING STATEMENTS OF OPERATIONS
<S> <C> <C> <C> <C> <C>
Net sales $ 73,681 $ 1,396 $ 13,159 $ -- $ 88,235
Cost of goods sold 41,750 1,705 5,656 -- 49,111
-------- -------- -------- -------- --------
Gross profit (loss) 31,931 (309) 7,503 -- 39,124
Operating expenses
26,319 1,176 5,139 -- 32,634
Restructuring charge 2,500 -- -- -- 2,500
-------- -------- -------- -------- --------
Income (loss) from operations 3,111 (1,485) 2,365 -- 3,990
Interest expense (5,144) (30) (274) -- (5,448)
Other income (expense), net 785 38 (678) -- 145
Equity in (losses) earnings of
consolidated subsidiaries (65) -- -- 65 --
-------- -------- -------- -------- --------
(Loss) income before income tax expense
and dividends and accretion on
preferred stock (1,313) (1,477) 1,413 65 (1,313)
Income tax expense 43 1 -- -- (43)
-------- -------- -------- -------- --------
Net (loss) income before extraordinary (1,356) (1,478) 1,413 -- (1,356)
gain
Extraordinary gain, net of tax 4,429 -- -- 65 4,429
-------- -------- -------- -------- --------
Net income (loss) before dividends and
accretion on preferred stock 3,073 (1,478) 1,413 65 3,073
Dividends and accretion on
preferred stock 1,588 -- -- -- 1,588
-------- -------- -------- -------- --------
Net income (loss) applicable to common
shareholders $ 1,485 $ (1,478) $ 1,413 $ 65 $ 1,485
======== ======== ======== ======== ========
</TABLE>
14
<PAGE> 15
SUPPLEMENTAL CONSOLIDATING FINANCIAL INFORMATION
<TABLE>
<CAPTION>
SIX MONTHS ENDED
-----------------------------------------------------------------------
JULY 3,1999
-----------------------------------------------------------------------
MOSTLY OWNED NON-GUARANTOR
COMPANY SUBSIDIARIES SUBSIDIARIES ELIMINATIONS CONSOLIDATED
-------- ------------ ------------- ------------ ------------
(IN THOUSANDS)
CONSOLIDATING STATEMENTS OF CASH FLOWS
<S> <C> <C> <C> <C> <C>
Cash flows from operating activities $ (9,701) $ (75) $ (137) $ -- $ (9,913)
Cash flows from Investing activities:
Purchase of property, plant and equipment (3,863) -- (1,029) -- (4,892)
Advance to affiliates (323) -- -- 328 --
Other investing activities (460) (12) 235 -- (237)
-------- -------- -------- -------- --------
Net cash (used in) provided by investing
activities (4,651) (12) (794) 328 (5,129)
-------- -------- -------- -------- --------
Cash flows from financing activities:
Net borrowings under revolving note payable 14,446 -- 282 -- 14,728
Payments on long-term obligations and
Deferred compensation (196) -- (140) -- (336)
Due to (from) affiliates -- -- 328 (328) --
-------- -------- -------- -------- --------
Net cash provided by (used in)
financing activities 14,250 -- 470 (328) 14,392
-------- -------- -------- -------- --------
Net (decrease) increase in cash (102) (87) (461) -- (650)
Cash and cash equivalents, beginning of period 134 104 1,969 -- 2,207
-------- -------- -------- -------- --------
Cash and cash equivalents, end of period $ 32 $ 17 $ 1,508 $ -- $ 1,557
======== ======== ======== ======== ========
</TABLE>
15
<PAGE> 16
SUPPLEMENTAL CONSOLIDATING FINANCIAL INFORMATION
<TABLE>
<CAPTION>
SIX MONTHS ENDED
-----------------------------------------------------------------------------
JULY 1, 2000
-----------------------------------------------------------------------------
WHOLLY OWNED NON-GUARANTOR
COMPANY SUBSIDIARIES SUBSIDIARIES ELIMINATIONS CONSOLIDATED
--------- ------------- ------------ ------------ ------------
(IN THOUSANDS)
CONSOLIDATING STATEMENTS OF CASH FLOWS
<S> <C> <C> <C> <C> <C>
Cash flows from operating activities $ (1,643) $(1,413) $ 1,475 $ -- $ (1,581)
Cash flows from Investing activities:
Purchase of property, plant and
equipment (4,775) -- (759) -- (5,534)
Advance to affiliates (395) -- -- 395 --
Other investing activities (179) -- -- -- (179)
-------- ------- ------- ------ --------
Net cash (used in) provided by
investing activities (5,349) -- (759) 395 (5,713)
-------- ------- ------- ------ --------
Cash flows from financing activities:
Net borrowings under revolving note
payable 8,564 -- -- -- 8,564
Proceeds from issuance of long-term
debt 2,750 -- -- -- 2,750
Repurchase of 10 3/4% Series B
Senior Notes due 2006 (2,750) -- -- -- (2,750)
Payments on long-term obligations and
deferred compensation (593) -- (84) -- (677)
Redemption of Series A Preferred Stock (1,000) -- -- -- (1,000)
Due to (from) affiliates -- 1,405 (1,010) (395) --
-------- ------- ------- ------ --------
Net cash provided by financing
activities 6,971 1,405 (1,094) (395) 6,887
-------- ------- ------- ------ --------
Net (decrease) in cash (21) (8) (475) -- (504)
Exchange rate effect on cash -- -- (97) -- (97)
Cash and cash equivalents, beginning of
period 97 8 2,184 -- 2,289
-------- ------- ------- ------ --------
Cash and cash equivalents, end of period $ 76 $ -- $1,709 $ -- $ 1,785
======== ======= ======= ====== ========
</TABLE>
16
<PAGE> 17
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 capital expenditure 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. These risks and uncertainties include the substantial
leverage of the Company, customer concentration and consolidation, dependence on
licensed brands, a single site distribution facility, operating in international
economies, unpredictability of discretionary consumer spending, competition,
susceptibility to changing consumer preferences and obtaining full benefits from
the new information system. The following discussion and analysis of financial
condition and results from operations should be read in conjunction with the
Consolidated Financial Statements and related Notes thereto included elsewhere.
OVERVIEW
The Company is a value-added distributor of optical products, costume
jewelry, watches, clocks and other accessories primarily to mass merchandisers,
chain drug stores/combo stores/supermarkets and variety stores 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, which provide
retailers with attractive gross margins and 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 may have an impact on
the Company's results of operations. In addition, 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.
Net Sales. The Company offers optical products, costume jewelry, small
synthetic leather goods, watches, clocks and other accessories, generally at
retail price points of $30 or less. Net sales of the Company's optical products
accounted for approximately 71.5% and 54.9% of the Company's net sales for the
six months ended July 1, 2000 and July 3,1999, respectively. Net sales of the
Company's costume jewelry accounted for approximately 25.4% and 36.7% of the
Company's net sales for the six months ended July 1, 2000 and July 3, 1999,
respectively, and the balance represented sales of synthetic leather goods,
watches, clocks and other accessories.
Cost of Goods Sold. The Company outsources manufacturing for all of its
products, approximately 79.2% 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.
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
17
<PAGE> 18
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 expense on a straight-line basis over the estimated
useful life of these fixtures, which is one to three years. If the Company does
not retain title to the displays, the display costs are expensed as shipped.
During the six months ended July 1, 2000, the Company recognized a $2.5 million
restructuring charge related to the accrual of severance payments due to three
executives, which will be paid over a two-year period.
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 may also receive the previous
vendor's merchandise from the customer in connection with 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 through various liquidation
channels. Except as provided below, the excess costs over the fair market value
of the inventory received is charged to selling expense when incurred. The
Company expensed customer acquisition costs of approximately $199,000 and
$284,000, respectively for the three and six months ended July 1, 2000 and
$225,000 and $372,000, respectively, for the three and six months ended July 3,
1999.
The excess costs over the fair market value of the inventory received is
capitalized as deferred costs and amortized over the agreement period if the
Company enters into a minimum purchase agreement with the customer from which
the estimated gross profits from future minimum sales during the term of the
agreement are sufficient to recover the amount of the deferred costs. During the
three and six months ended July 3, 1999, the Company capitalized approximately
$45,000 and $106,000 of these costs, respectively. The Company capitalized costs
of approximately $230,000 during the three and six months ended July 1, 2000.
Amortization expense related to the costs as well as previously capitalized
costs was approximately $339,000 and $659,000, for the three and six months
ended July 1, 2000, respectively and $300,000 and $596,000, for the three and
six months ended July 3, 1999, respectively.
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 Foster Grant Group
US and related companies. 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 in
the Articles of Incorporation) is outstanding. Net income (loss) applicable to
common shareholders represents net income (loss) less accretion of original
issuance costs and cumulative dividends due on the Series A Preferred Stock.
Extraordinary Gain. In June 2000 the Company repurchased $10.75 million face
value of the Notes for a purchase price of $2.75 million. As a result of this
transaction, the Company recognized a $4.4 million extraordinary gain, net of
$3.2 million in taxes. See further discussion in "Liquidity and Capital
Resources".
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, before the restructuring charge of $2.5 million and the extraordinary
gain of $4.4 million was approximately $6.7 million and $12.7 million for the
three and six months ended July 1, 2000, respectively, as compared to $3.5
million and $8.4 million for the three and six months ended July 3, 1999,
respectively. The year-to-date increase before the restructuring charge and
extraordinary gain of $4.3 million or 51% is principally due to the increase in
operating income. Year-to-date EBITDA, after the restructuring charge and
extraordinary gain was $10.2 million for the six months ended July 1, 2000.
Net income before dividends and accretion on preferred stock, excluding the
restructuring charge and extraordinary gain was $0.8 million and $1.1 million
for the three and six months ended July 1, 2000 as compared to a net loss before
dividends and accretion on preferred stock of $1.8 million and $2.5 million for
the three and six months ended July 3, 1999. Net income before dividends and
accretion on preferred stock, including the restructuring charge and
extraordinary gain was $5.2 million and $3.1 million for the three and six
months ended July 1, 2000.
18
<PAGE> 19
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 SIX MONTHS ENDED
-------------------------- --------------------------
JULY 3, JULY 1, JULY 3, JULY 1,
1999 2000 1999 2000
------- ------- ------- -------
<S> <C> <C> <C> <C>
Net sales 100.0% 100.0% 100.0% 100.0%
Cost of goods sold 58.7 55.9 58.3 55.7
---- ---- ---- ----
Gross profit 41.3 44.1 41.7 44.3
Operating expenses, excluding restructuring charge 39.1 36.3 38.8 37.0
Restructuring charge -- -- -- 2.8
----- ----- ----- -----
Income from operations 2.2 7.8 2.9 4.5
Interest expense (5.9) (6.2) (5.8) (6.2)
Other (expense) income, net (0.3) 0.2 -- 0.2
----- ----- ----- -----
(Loss) income before taxes and dividends and accretion
on preferred stock (4.0) 1.8 (2.9) (1.5)
Income tax expense -- (0.1) -- (0.1)
----- ----- ----- ------
Net (loss) income before extraordinary items,
dividends and accretion on preferred stock (4.0) 1.7 (2.9) (1.6)
Extraordinary gain, Net -- 9.7 -- 5.0
----- ----- ----- -----
Net income (loss) before dividends and accretion on
preferred stock (4.0) 11.4 (2.9) 3.4
Dividend and accretion on preferred stock 1.6 1.8 1.7 1.7
----- ----- ----- -----
Net income (loss) applicable to common shareholders (5.6)% 9.6% (4.6)% 1.7%
===== ===== ===== =====
</TABLE>
THREE MONTHS ENDED JULY 1, 2000 COMPARED TO THREE MONTHS ENDED JULY 3, 1999
Net Sales. Consolidated net sales were $45.7 million for the three months
ended July 1, 2000 as compared to $45.6 million for the three months ended July
3, 1999, an increase of $0.1 million. Sales increased in the Mass Merchandisers
and Variety segments 12.0% and 2.5%, respectively, driven largely by improved
optical sales and partially offset by reductions with a major customer in the
Mass Merchandiser segment. The jewelry reductions were a result of a planned
restructuring in the relationship of a major customer which reduced selling
space and increased competition. These gains were offset by reductions in
Chain Drug/Combo/Supermarkets and other segments due to reductions in jewelry,
along with continued de-emphasis on clocks and watches and small leather goods.
Gross Profit. Gross profit was $20.2 million for the three months ended July
1, 2000 as compared to $18.9 million for the three months ended July 3, 1999.
Gross profit as a percentage of net sales increased to 44.1% for the three
months ended July 1, 2000 from 41.3% for the three months ended July 3, 1999.
The $1.3 million or 7.0% increase is related primarily to the shift of sales
towards optical and the shift within optical to higher margin products along
with lower royalties incurred due to the planned de-emphasis on branded watches,
clocks and other accessory lines.
Operating Expenses. Operating expenses were $16.6 million for the three
months ended July 1, 2000 as compared to $17.8 million for the three months
ended July 3, 1999, a decrease of 6.9% or $1.2 million. Decreases occurred
throughout the Company and represent continued attention to expense control.
Interest Expense. Interest expense was $2.9 million for the three months
ended July 1, 2000 as compared to $2.7 million for the three months ended July
3, 1999, an increase of 6.4% or $172,000. This resulted from additional
borrowings under the Company's credit facilities to fund increased purchases of
optical products related to increased shipments as compared to the prior year.
Income Tax. Income tax expense was $43,000 for the three months ended July
1, 2000. No income tax expense or benefit was recorded for the three months
ended July 3, 1999.
Net Income (Loss). As a result of the factors discussed above, net income
before dividends and accretion on preferred stock, excluding the extraordinary
gain was $0.8 million for the three months ended July 1, 2000 as compared to net
loss before dividends and accretion on preferred stock of $1.8 million for the
three months ended July 3, 1999, an increase of $2.6 million in earnings. Net
income before dividends and accretion on preferred stock, after the
extraordinary gain was $5.2 million for the three months ended July 1, 2000. The
extraordinary gain of $4.4 million was recognized as a result of early
extinguishment of debt.
19
<PAGE> 20
Net Loss Applicable to Common Shareholders. Net loss applicable to common
shareholders excluding the extraordinary gain was $24,000 for the three months
ended July 1, 2000 as compared to a loss of $2.5 million for the three months
ended July 3, 1999, a decrease of $2.5 million.
SIX MONTHS ENDED JULY 1, 2000 COMPARED TO SIX MONTHS ENDED JULY 3, 1999
Net Sales. Consolidated net sales were $88.2 million for the six months
ended July 1, 2000 as compared to $87.1 million for the six months ended July 3,
1999, an increase of $1.1 million or 1.3%. The increase in net sales is
primarily attributable to increased optical sales in all retail segments,
partially offset by a decrease in non-optical (which is expected to continue in
the second half).
Gross Profit. Gross profit was $39.1 million for the six months ended July
1, 2000 as compared to $36.4 million for the six months ended July 3, 1999.
Gross profit as a percentage of net sales increased to 44.3% for the six months
ended July 1, 2000 from 41.7% for the six months ended July 3, 1999. The $2.7
million or 7.6% increase is primarily due to the shift in mix to higher margin
optical products and lower royalties expense related to the planned de-emphasis
of branded watches, clocks and other accessories. Also, in 1999, a significant
promotion was conducted with a major customer which resulted in lower than
expected margin.
Operating Expenses. Operating expenses were $32.6 million, before the
restructuring charge of $2.5 million for the six months ended July 1, 2000 as
compared to $33.8 million for the six months ended July 3, 1999, a decrease of
$1.2 million or 3.6%. Decreases occurred throughout the Company and represent
continued attention to expense control.
Interest Expense. Interest expense was $5.4 million for the six months
ended July 1, 2000 as compared to $5.0 million for the six months ended July 3,
1999, an increase of $0.4 million or 8.5%. This resulted from additional
borrowings under the Company's credit facilities to fund operations during 1999
as well as to fund increased purchases of optical products related to increased
shipments as compared to the prior year.
Income Tax. Income tax expense was $43,000 for the six months ended July 1,
2000. No income tax expense or benefit was recorded for the six months ended
July 3, 1999.
Net Income (Loss). As a result of the factors discussed above, net income
before dividends and accretion on preferred stock, excluding the extraordinary
gain of $4.4 million and the restructuring charge of $2.5 million was $1.1
million for the six months ended July 1, 2000 as compared to a net loss before
dividends and accretion on preferred stock of $2.5 million for the six months
ended July 3, 1999, an increase of $3.6 million in earnings. Net income before
dividends and accretion on preferred stock, after the extraordinary gain and the
restructuring charge was $3.1 million for the six months ended July 1, 2000.
Net Income (Loss) Applicable to Common Shareholders. Net loss applicable to
common shareholders excluding the extraordinary gain and the restructuring
charge was $0.4 million for the six months ended July 1, 2000 as compared to
$4.0 million for the six months ended July 3, 1999, a decrease of $3.6 million.
The decrease is attributable to the $3.6 million increase in earnings. Net
income applicable to common shareholders after the extraordinary gain and the
restructuring charge was $1.5 million for the six months ended July 1, 2000.
LIQUIDITY AND CAPITAL RESOURCES
At July 1, 2000, the Company had cash and cash equivalents of $1.8 million
and working capital of $5.2 million as compared to $2.3 million and $7.4
million, respectively, at January 1, 2000. The decline in cash and cash
equivalents is due to the Company's enhanced focus on utilizing worldwide cash
reserves to fund payments on its Senior Credit Facility. The decline in working
capital was driven by an increase in accounts payable due to higher optical
product purchases that carry 60-120 day payment terms.
The Company used $1.6 million of cash in operations during the six months
ended July 1, 2000 compared to a use of $9.9 million during the six months ended
July 3, 1999. The decrease in cash used is principally due to significant
improvements in receivables' days outstanding and the timing of payments in
accrued expenses in the quarter ended July 3, 1999.
The Company used $5.7 million in investing activities during the six months
ended July 1, 2000 compared to a use of $5.1 million during the six months ended
July 3, 1999. These investments were primarily related to the purchase of
display fixtures used in the merchandising of both optical and jewelry products
and represent normal purchases.
The Company generated $6.9 million from financing activities during the six
months ended July 1, 2000 compared to $14.4 million during the six months ended
July 3, 1999. The funds generated from financing activities consisted mainly of
borrowings under the revolving note payable.
20
<PAGE> 21
The Company has 43,700 shares of Series A Preferred Stock that has a
redemption value at July 1, 2000 of $32.7 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. 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 in the Company's Articles of Incorporation) is outstanding. The $75.0
million 10 3/4% Senior Notes due 2006 (the "Notes") constitute Restrictive
Indebtedness. The redemption price of the Series A Preferred Stock is an amount
equal to the 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
FG Preferred Stock, which were redeemable for $1.0 million on February 28, 2000.
The $1.0 million was paid on April 3, 2000. The former holder of the FG
Preferred Stock is entitled to receive an additional payment of between $2.5
million and $3.0 million, depending upon transaction value, in the event of an
initial public offering, merger or similar transaction, or private placement of
securities representing more than 50% of the Company's capital stock, at a
specified valuation.
In June 2000, the Company repurchased $10.75 million face value of the Notes
for a purchase price of $2.75 million. The purchase price was financed utilizing
a term loan under its existing Senior Credit Facility. The term loan is secured
by a mortgage on its Smithfield, RI facility and guaranteed by certain preferred
shareholders. The term loan is being amortized over 60 months commencing April
1, 2001, with the principal balance due at the expiration of the Senior Credit
Facility on July 31, 2003. As a result of this transaction, the Company
recognized a $4.4 million extraordinary gain, net of $3.2 million in taxes.
These purchases resulted from inquiries from holders of the Notes. The Company
does not solicit offers to tender Notes for repurchase, but may, from time to
time, consider requests to repurchase Notes, subject to the availability of
appropriate financing.
In conjunction with this guarantee, 27,500 shares of Series B preferred
stock were issued. The holders of Series B preferred stock are entitled to
receive, prior and in preference to distribution of any assets of the Company
with respect to any other series of preferred stock, common stock or other
capital stock of the Company an amount per share equal to the sum of $6.67
multiplied by the number of six month periods, and fractions thereof, in the
period during which the guarantee was outstanding. The Company has calculated
the value of the Series B preferred stock to be $367,000 based on the assumption
that the guarantee will be outstanding for one year. This amount is being
amortized over the one year period as interest expense. If the guarantee is
outstanding for a period beyond twelve months, the Company will assign
additional value to the stock and amortize the related costs over the additional
period of the guarantee.
The Company has substantial indebtedness and significant debt service
obligations. As of July 1, 2000, the Company had total indebtedness, including
borrowings under the Senior Credit Facility, in the aggregate principal amount
of $89.4 million. The Company had current liabilities of approximately $67.6
million. In addition, the Company has significant annual obligations that
include interest on the Notes of approximately $6.9 million, minimum royalty
obligations over the next two years of approximately $3.5 million and minimum
payments under its operating leases of approximately $306,000. The Indenture
permits the Company to incur additional indebtedness, including secured
indebtedness, subject to certain limitations.
The Company has up to $12.3 million available for borrowings under the
Senior Credit Facility as of July 1, 2000. 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. On March 24, 2000, the Company entered into a second amendment to the
Senior Credit Facility that modified the financial covenants and waived
non-compliance with the prior covenants. As of July 1, 2000, the Company is in
compliance with the financial covenants, as modified.
The Company's ability to make scheduled payments of principal, or to pay the
interest 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 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.
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<PAGE> 22
SEASONALITY AND QUARTERLY INFORMATION
Significant portions of the Company's business are seasonal. Sunglasses are
shipped primarily during the first half of the year as retailers build inventory
for the spring and summer selling seasons, while costume jewelry and other
accessories are shipped primarily during the second half of the fiscal year as
retailers build inventory for the holiday season. Reading glasses sales are
generally uniform throughout the year. As a result of these shipping trends, the
Company's working capital requirements grow throughout the first half of the
year to fund purchases and accounts receivable. In the second half of the year,
the Company's working capital requirements decrease as accounts receivable are
collected and inventory purchases decline relative to first half needs.
YEAR 2000
Prior to January 1, 2000, many computer experts had predicted widespread
problems related to computer programs' inability to process dates after December
31, 1999. During fiscal 1999, to accommodate the Company's growth, AAi
implemented a new information management system that is Year 2000 compliant. The
Company has not, and does not expect to incur any significant further expenses
related to the Year 2000 issue. The Company anticipates that additional
expenditures will be necessary to achieve the full benefit of its information
system unrelated to the Year 2000 issue, but cannot quantify those costs at this
time. To date, the Company has not experienced any significant operating
problems or product failures as a result of Year 2000 issues with its vendors,
service providers, or customers.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.
The following discussion about the Company's market risk disclosures
includes forward-looking statements. Actual results could differ materially from
those projected in the forward-looking statements. The Company is exposed to
market risk related to changes in interest rates and foreign currency exchange
rates. The Company does not use derivative financial instruments for speculative
or trading purposes.
Interest Rate Risk. The Company is exposed to market risk from changes in
interest rates primarily through its borrowing activities. In addition, the
Company's ability to finance future acquisition transactions may be impacted if
the Company is unable to obtain appropriate financing at acceptable interest
rates.
The Company manages its borrowing exposure to changes in interest rates by
optimizing the use of fixed rate debt with extended maturities. At July 1, 2000,
71% of the carrying values of the Company's long-term debt were at fixed
interest rates.
Foreign Currency Risk. The Company's results of operations are affected by
fluctuations in the value of the U.S. dollar as compared to the value of
currencies in foreign markets primarily related to changes in the British Pound,
the Canadian Dollar, the Mexican Peso, the Euro Dollar and the Hong Kong Dollar.
During the six months ended July 1, 2000, the net impact of foreign currency
changes was not material to the Company's financial condition or results of
operations. The Company manages its exposure to foreign currency exchange risk
by trying to minimize the Company's net investment in its foreign subsidiaries.
The Company generally does not enter into derivative financial instruments to
manage foreign currency exposure.
The Company's operations in Europe are not significant and, therefore, the
Company has not been materially impacted by the introduction of the Euro dollar.
22
<PAGE> 23
AAI. FOSTERGRANT, INC. AND SUBSIDIARIES
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
At the Annual Meeting of Shareholders held May 31, 2000, shareholders
elected the Company's Board of Directors and approved an Amendment to the
Company's Articles of Incorporation authorizing a class of Senior Series B
Preferred Stock.
The vote for the director nominee was:
FOR* WITHHELD
Gerald F. Cerce 921,500 0
Stephen J. Carlotti 921,500 0
Michael Cronin 921,500 0
John H. Flynn, Jr. 921,500 0
Martin E. Franklin 921,500 0
George Graboys 921,500 0
David Jenkins 921,500 0
John R. Ranelli 921,500 0
The vote to approve the Amendment to the Articles of Incorporation authorizing a
class of Senior Series B Preferred Stock was:
FOR* AGAINST ABSTAIN
921,500 0 0
* Includes the holders of Common Stock and Series A Preferred Stock.
Holders of Series A Preferred Stock are entitled to vote based on the
number of shares of Common Stock into which such shares are
convertible, currently 10 to 1.
ITEM 5. OTHER INFORMATION
None
23
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ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
3.1.1(a) Articles of Amendment to Articles of Incorporation filed on
June 9, 2000
10.1.3 Third Amendment to Second Amended and restated Financing and
Security Agreement dated as of June 12, 2000
10.18 Employment Agreement between AAi and Howard Collins dated
March 24, 2000
27.1 Financial Data Schedule
(b) Report on Form 8-K
The registrant filed no reports on form 8-K during the quarter ended
July 1, 2000.
24
<PAGE> 25
AAI. FOSTERGRANT, INC. AND SUBSIDIARIES
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: August 15, 2000 /s/ Gerald F. Cerce
-----------------------------------------
Gerald F. Cerce
Chairman of the Board
Dated: August 15, 2000 /s/ John R. Ranelli
-----------------------------------------
John R. Ranelli
Director, President, and Chief Executive
Officer
(Principal Executive Officer)
Dated: August 15, 2000 /s/ Mark D. Kost
-----------------------------------------
Mark D. Kost
Chief Financial Officer
(Principal Financial Officer)
25
