SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
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FORM 10-K
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE FISCAL YEAR ENDED DECEMBER 31, 1997 COMMISSION FILE NUMBER 1-7909
Empire of Carolina, Inc.
(Exact name of registrant as specified in its charter)
DELAWARE 13-2999480
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
5150 LINTON BOULEVARD, DELRAY BEACH, FLORIDA 33484
(Address of principal executive offices) (Zip Code)
(561) 498-4000
(Registrant's telephone number, including area code)
Securities registered pursuant to Section 12(b)
of the Act:
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<TABLE>
<CAPTION>
<S> <C>
Name of each exchange
Title of each class: on which registered:
Common Stock, par value $.10 per share (including the American Stock Exchange
associated Preferred Stock Purchase Rights)
</TABLE>
SECURITIES REGISTERED PURSUANT TO SECTION 12(G) OF THE ACT:
None.
Indicate by check mark whether the Registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes [X] No [ ]
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of the registrant's knowledge, in the proxy statements incorporated by
reference in Part III of this Form 10-K or any amendment to this Form 10-K.
[ ]
The aggregate market value of the voting stock held by non-affiliates of the
Registrant, as of March 13, 1998, was $11,945,000 (assuming solely for the
purpose of this calculation that all directors and officers of the Registrant
are "affiliates").
The number of shares outstanding of the Registrant's Common Stock, par value
$.10 per share, as of March 13, 1998, was 7,855,000.
Documents Incorporated by Reference: None
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PART I
ITEM 1. BUSINESS.
GENERAL
Empire of Carolina, Inc., a Delaware corporation and its subsidiaries ("Empire"
or the "Company") design, manufacture and market a broad variety of toys and
plastic decorative holiday products, including Big Wheel(R) ride-on products,
outdooR activities and games such as Snow Works(TM) winter sleds and Water
Works(TM) water slides and pools (including Crocodile MILE(R) water slides),
Buddy L(R) vehicles, Real Bugs(TM), Grand Champions(R) collectible horses and
holiday products featuring pLASTic decorative holiday display items.
Empire, whose predecessor entity was organized in 1939, has been a toy
manufacturer for approximately 45 years. The Company's business experienced
significant change in 1993 when substantial non-toy operations were sold.
Following the divestitures of non-toy businesses, Empire's operations were
focused on its toy business, including the Big Wheel(R) non-powered ride-on
product line which has been sold throughout the United States since 1970, and
its plastic decorative holiday products business. Since mid-1994 the Company has
undergone changes of management, established a new business strategy, and
effected two acquisitions which added established core toy product lines to the
Company's business.
In the third quarter of 1994, an investor group led by Steven Geller, the
current Chief Executive Officer of the Company, acquired control of Empire as a
base from which to build a diversified toy and plastic products manufacturing
company. In October 1994, Empire acquired Marchon, Inc. ("Marchon") a toy
designer, marketer and manufacturer. Marchon's core toy products included Grand
Champions(R) collectible horses and Crocodile Mile(R) water slides. Marchon had
substantIAL experience at sourcing toy products in the Far East. In July 1995,
Empire acquired substantially all of the toy business assets and certain related
liabilities of Buddy L Inc. and its Hong Kong subsidiary ("Buddy L"), one of the
oldest toy brands in the United States whose core toy products included plastic
toy cars, trucks and other vehicles.
In June 1996, the Company completed a secondary offering of 3,123,908 shares of
Common Stock, at a price per share of $12.00. The gross proceeds to the Company
were $15,624,000.
The Company's 1996 operating results were negatively impacted by serious
difficulties encountered at its Tarboro, NC plant. Increased seasonal demand in
the face of transfers of production from former Buddy L facilities; delays in
the startup of new or transferred production equipment; increased cost of
outsourced production; difficulties created by the influx of Buddy L product and
the training of new employees all led to the loss of production efficiency,
product damage, and missed shipping deadlines which contributed to the Company's
1996 nonrecurring charges and net loss.
In 1997, in response to the Company's financial needs, the Company issued a
total of 2,100,000 shares of Series A preferred stock and 10,000,000 warrants in
a private offering to certain accredited investors (as defined in Rule 501 under
the Securities Act of 1933, as amended). The Series A preferred stock bears no
dividend and is convertible into common stock at an initial conversion price of
$1.25 per share of stated value (convertible into 16,800,000 shares of common
stock). Each warrant has a six-year term and entitles the holder thereof to
purchase one share of common stock at an initial exercise price of $1.375 per
share. The gross proceeds from the sale of such securities was $21 million from
which the Company received net proceeds of $18.7 million. Concurrent with this
offering, the Company's 9% convertible debentures in the original amount of $15
million were exchanged for newly issued shares of Series C convertible preferred
stock (convertible into 7,500,000 shares of common stock). The Series C has no
voting rights, except as required by law. In connection with this private
offering, Charles S. Holmes was elected to replace Steven Geller as Chairman of
the Board, and the Series A preferred stock received the right to designate two
directors and to vote on all matters presented to the stockholders on an as if
converted basis.
On September 25, 1997, the Company held its annual meeting, and the stockholders
voted to approve: (1) an amendment to the Company's Charter to increase the
number of authorized shares of common stock from 30 million
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to 60 million in part to assure that the Company has available authorized shares
of common stock to issue upon the conversion of preferred stock and the exercise
of warrants and stock options to acquire common stock; (2) that James Pinto
serve as one of the two directors to be selected by the Series A preferred
stockholders; (3) an amendment to its Charter to provide that its Board of
Directors shall be comprised of a maximum of eight directors, as shall be
determined by the Board of Directors from time to time.
The Company's net sales were $99.5 million, $148.9 million and $153.7 million,
respectively, for the years ended December 31, 1997, 1996 and 1995. In 1997, the
loss before interest and taxes and net loss were $13.7 million and $20.8
million, respectively. In 1996, the Company incurred a loss before interest and
taxes of $47.3 million, which included nonrecurring and special charges of $21.0
million, yielding a net loss after interest and taxes of $46.2 million. For
fiscal 1995, the loss before interest and taxes was $1.9 million, which included
$7.6 million of special charges, yielding a net loss of $4.5 million.
The Company's executive offices are located at 5150 Linton Boulevard, Delray
Beach, Florida 33484, telephone (561) 498-4000.
RECENT DEVELOPMENTS
The Company had positive operating cash flows during 1997 of $29,861,000, while
also reducing accounts payable and other liabilities by $18,318,000. Net
borrowings under bank lines were reduced by $42,614,000 from the December 31,
1996 level. These results were accomplished by converting accounts receivable
and inventory into cash, as well as the receipt of an income tax refund during
1997 of $15,600,000. Margins have improved slightly from 1996 and manufacturing
costs have been reduced. Factory operations have improved significantly since
1996, with a higher percentage of on time deliveries and a lower overhead
structure.
The net loss for 1997 was $21,130,000 as compared with a net loss of $46,201,000
for 1996. The Company's borrowing base has been reduced for several reasons: the
exiting of unprofitable product lines, the elimination of unutilized assets, and
the changing of manufacturing processes to reduce work in process inventory
levels. Despite the improvements made during 1997, the Company continues to
operate under tight cash constraints as it endeavors to pay down outstanding
liabilities remaining from 1996, as well as operate under the reduced credit
availability of its lending arrangements due to the reduction of its borrowing
base. Effective March 30, 1998, the bank lenders under the Company's secured
credit facility have agreed to certain amendments to the facility which provide
additional availability during the Company's peak production periods, but which
require that such additional funds be repaid by year end. See "Management's
Discussion and Analysis of Financial Condition and Results of Operations" and
notes to consolidated financial statements.
On February 11, 1998, the Company signed a letter of intent to acquire all of
the stock of Apple Sports, Inc. and Apple Golf Shoes, Inc. (the "Apple
Companies"), manufacturers and distributors of golf equipment sold under license
from Wilson Sporting Goods Co. for 5 million shares of the Company's common
stock.. The Apple Companies are located in Ronkonkoma, New York and they have
manufactured and distributed Wilson(R) and Staff(R) golf shoes and other
Wilson(R) accessories SINCe 1986. In 1997, the Apple Companies had revenues in
excess of $24 million.
The proposed transaction is subject to a number of conditions, including
satisfactory completion of due diligence, the negotiation and execution of a
definitive agreement, and the approval by the Company's shareholders. The
Company can give no assurance that the proposed transaction will be consummated,
or, if consummated, that it will be on the terms and conditions described above.
In December 1997, the Company filed a registration statement on Form S-3 under
the Securities Act of 1933 (the "Registration") on behalf of the purchasers of
the Series A preferred
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stock and warrants. In connection with this registration, the Company filed
listing applications with the American Stock Exchange for the Series A preferred
stock, the warrants, and the common stock underlying these securities. The
Registration has not yet been declared effective and the Company has not yet
obtained final approval of the listing applications.
INDUSTRY
THE TOY INDUSTRY
According to the Toy Manufacturers of America, Inc. ("TMA"), an industry trade
group, total domestic shipments of toys, excluding video games and accessories,
were approximately $15.2 billion in 1997. According to the TMA, the United
States is the world's largest toy market, followed by Japan and Western Europe.
The Company competes with several larger toy companies, such as Mattel, Inc.
("Mattel") and Hasbro, Inc. ("Hasbro"), and many smaller companies in the design
and development of new toys, the procurement of licenses, the improvement and
expansion of previously introduced products and product lines and the marketing
and distribution of toy products.
Many factors influence the success of a given toy or product line including
product design, play value, pricing, marketing, in-store exposure and product
availability. While the success of some toy categories vary, other categories
generally perform well from year to year. The perennial best sellers, which form
the backbone of the toy business, are referred to as "core" or "staple" toys.
Products with relatively short life cycles are referred to as "fad" or
"promotional" items. Along with providing opportunities for fun and learning,
toys traditionally mirror scientific progress, changes in social attitudes and
topical customs and values from the adult world. Many of the toys which garner
the most attention reflect the latest technological advances, incorporate
characters made popular in other mediums or are innovative extensions of core
products.
Toy production is a labor intensive process requiring molding and shaping or
cutting and sewing, coloring, painting or detailing, assembling, inspecting,
packaging and warehousing. Management believes that the substantial majority of
the toys sold in the U.S. are manufactured, either in whole or in part, overseas
where labor rates are comparatively low. The largest foreign producer markets
are China and, to a lesser extent, other countries in the Far East. Most foreign
production is performed by independent contractors which utilize tools, molds
and designs provided by U.S. toy companies and which manufacture products under
exclusive contracts. While foreign manufacturing operations generally have
relatively inexpensive labor costs, such operations require greater lead times
than domestic manufacturing and also result in greater shipping costs,
particularly for larger toys. The design, production and sale of toy products in
the U.S. are subject to various regulations. See "Business -- Regulation."
Toy manufacturers sell their products either directly to retailers or to
wholesalers who carry the product lines of many manufacturers. There are
thousands of retail outlets in the United States which sell toys and games.
These outlets include: small, independent toy stores; large toy specialty
retailers; general merchandise discount chains; department, drug and variety
stores; gift and novelty shops; price clubs and mail order catalogues. Despite
the broad number of toy outlets, retail toy sales have become increasingly
concentrated through a small number of large chains, such as Toys "R" Us, Inc.
("Toys "R" Us"), Wal-Mart Stores, Inc. ("Wal-Mart"), Kmart Corporation ("Kmart")
and Target Stores, Inc., a division of Dayton-Hudson Corp. ("Target"), which
generally feature a large selection of toys, some at discount prices, and seek
to maintain lean inventories to reduce their own inventory risk. This
concentration has tended to favor larger manufacturers which are able to offer
these retail chains broader product offerings, higher levels of advertising and
marketing support, and consistent product support through electronic data
interchange and just-in-time delivery programs. The Company believes that the
leading toy retailers desire to have a greater number of toy suppliers which
offer a variety of quality, branded product lines and which have the financial
strength to support the retailers' product distribution requirements. In
addition, licensing is becoming an increasingly important factor in the toy
industry. The Company intends to pursue licensing opportunities that fit its
business plan.
While toys are sold year round, toy industry retail sales are heavily weighted
toward the fourth quarter when many toys are purchased as holiday gifts. Each
calendar year begins with a major international toy fair held in Hong Kong in
the first week in January. This trade show is expanded and repeated in New York
in the middle of February. During the January/February period, additional toy
fairs are held in London, Paris, Milan, Nuremberg and Valencia. The toy fairs
allow manufacturers to display their current lines and begin the process of
generating
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purchase orders for the important holiday season. Due to the seasonality and
long lead times required for foreign production, retailer buying activity tends
to significantly lead production and shipment.
PRODUCTS
The Company produces and sells over 300 items which are grouped into four
product categories: Ride-ons, Outdoor, Holiday and Girls and Boys Toys.
RIDE-ONS
The Company's ride-on products include pedal-driven, battery operated and
foot-to-floor models. Big Wheel(R), an internationally recognized branded
product, is a three-wheeled, pedal-driven ride-on targeted to appeal to children
seven and under and has been marketed in the United States since 1970. Big
Wheels(R) are manufactured in a variety of sizes and designs.
OUTDOOR
Crocodile Mile(R) water slides, long plastic mats over which water is run, are
targeted to the five years old to teen age groups. Water Works(TM) spring and
summer products include water slides and smaller plastic wading pools targeted
TO toddlers through adult groups and plastic sand boxes targeted to children.
Snow Works(TM) winter products consist OF plastic sleds, toboggans, snowboards
and saucers that come in a variety of styles, sizes and colors. While considered
toys, they are also distributed in the traditional sporting goods market and are
targeted to the toddler to teen age groups. This product category generally
favors domestic production where the Company can take advantage of weather
conditions which stimulate reorder business.
HOLIDAY PRODUCTS
This family of highly decorated plastic products comes in a range of colors,
styles and sizes for three major holidays: Easter, Halloween and Christmas.
These products include Easter baskets and bunnies, Halloween pumpkin baskets,
scarecrows and ghosts, and Christmas nativity scenes, Santa Clauses, snowmen and
outdoor candles. Certain of these products are illuminated. In 1996, the Company
introduced Light Toppers(R) brand Halloween and Christmas decorations, an
innovative new way to decorate walkways and trees.
GIRLS AND BOYS TOYS
GIRLS TOYS. Grand Champions(R) is a branded line of collectible horses and
accessories which includes realisticallY sculpted and detailed horses. The Grand
Champions(R) line has been offered by the Company for ten years, and has grown
through introductions of new breeds, poses, colors, features and packaging. The
Feed N' Nuzzle(TM) collection features realistic stallions, mares and foals that
eat and nuzzle like live horses. Thoroughbred Champions(TM) stallion and mare
collections and Show Champions(TM) dog assortment are new 1998 additions to the
Grand Champions(R) line. Fantasy Fillies is a line of colorful horses, including
Unicorn and Pegasus Fantasy Fillies which have long manes and tails while Star
Prancers have sparkling lights on their manes which can be activated by pulling
on their reins.
BOYS TOYS. Empire's boys toy lines consist of Buddy L(R) vehicles, Buddy L(R)
preschool products and Real Bugs. Buddy L(R) vehicles consist of a wide variety
of plastic and metal cars, trucks, airplanes and helicopters in multiple sizes
featuring electronic voice, lights, sounds and in some models motorization.
During 1997, the Company introduced Record 'N Play(TM), a Buddy L(R) vehicle
category which enables young children to record their own sound effects and
rescue scenarios. New for 1998 are YoYo Balls(R) and YoYo Ball(R) Pets, yoyos
that always come back to you, the latter being covered with plush animal
figures. In the preschool category, the Company recently introduced an
assortment of Big Bruiser(R) Adventure Playsets which combine vehicles pulling
trailers, with drivers and animals. Real Bugs(TM) is a line of toy bugs of
various shapes, sizes and features which contain replaceable simulated blood and
guts fluid and are designed to appeal to young boys.
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MARKETING AND SALES
The Company's products are sold throughout the world, with the United States
representing approximately 93% and 90% of 1997 and 1996 sales, respectively. The
balance is sold primarily in Canada, Western Europe and South America. In the
United States, the Company's products are distributed directly to large
retailers, including independent toy stores, toy specialty retailers, general
merchandise chain stores, department stores, gift and novelty shops and other
retail outlets and, to a lesser extent, to wholesalers who carry the product
lines of many manufacturers. Decorative holiday products are also sold through
home improvement and lawn and garden chains. International sales of the
Company's products are made primarily through distributors and, to a lesser
extent, through direct sales to retailers. An international sales distribution
agreement completed in September 1996 was terminated during the second quarter
of 1997, for which the Company received a $2.4 million settlement upon
termination.
Although the Company sells to over 1,000 accounts, the Company's three largest
customers accounted for an aggregate of approximately 60% of its sales in 1997.
Sales to Toys "R" Us, Wal-Mart and Target accounted for 26%, 21% and 13% of
sales, respectively, in 1997. Sales to Wal-Mart and Toys "R" Us accounted for
25% and 19% of sales, respectively, in 1996. Sales to Toys "R" Us, Wal-Mart and
Kmart accounted for 19%, 15% and 10% of sales, respectively, in 1995. No other
customer accounted for more than 10% of the Company's consolidated sales in
those years. The loss of, or deterioration of the Company's relationship with,
one or more of the Company's largest customers could have a material adverse
effect on the Company's business, financial condition and results of operations.
In general, the Company's major customers review its product lines and product
concepts for the upcoming year at showings beginning in January and February. By
the end of June, the Company has historically received orders or order
indications for a substantial majority of its full year's business. As is
customary, these orders generally may be canceled without penalty at any time
prior to shipment. Historically, the greatest proportion of shipments of
products to retailers occurs during the third and fourth quarters of each year.
The Company markets its products through an in-house sales force of full-time
salaried employees and independent sales organizations that cover most of the
United States. Senior sales management supervises an independent sales network,
with management controlling the largest accounts as house accounts. The Company
maintains sales offices and showrooms in New York City. In addition, the Company
maintains a sales office and showroom in Hong Kong, which also oversees the
sourcing of foreign production.
Historically, the Company's principal mode of advertising has been cooperative
advertising. Starting in 1995, the Company selectively expanded its marketing
budget to include television advertising, which generally focuses on the
promotion of individual products, such as the Grand Champions(R) horses and
Super Crocodile Mile(R), which reinforce and strengthen cORE product lines.
NEW PRODUCT DEVELOPMENT AND LICENSING
Through its product design and development group, the Company regularly
refreshes, redesigns and extends existing product lines and develops new product
lines. Product design and development are principally conducted by a group of
professional designers and engineers employed by the Company. The Company will
also enter into licensing agreements to utilize the name, character or product
of a licensor. The Company generally focuses on a licensing agreement as an
extension of one of its core product categories. Management recognizes the
importance of licensing and continues to conservatively participate in this
marketing strategy. The Company's current licenses include certain rights to
Harley-Davidson(R), Barbie(TM), Chevrolet(R), Chrysler/Jeep(R) and Goodyear(R)
trademarks.
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As a result of limited cash resources available in 1997, the Company reduced the
resources devoted to product design and development. During the year ended
December 31, 1997 the Company spent approximately $1.2 million in connection
with the design and development of products, exclusive of royalty payments, as
compared to approximately $3.2 million during 1996 and approximately $3 million
during 1995. The timing and extent of future research and development
expenditures will depend to a significant extent upon the availability of
capital resources and the Company's business strategy.
Recent efforts have focused the product design group on developing items to be
sourced in the Far East, such as Triple Trixsters(TM) and YoYo Balls(R) which
are intended to improve the Company's profit margins. Before tools, dies and
molds FOR new products are produced, the Company generally prepares mock-ups of
such products for exhibition to its customers. The decision to include a new
product and to build or have built the necessary tools, dies and molds generally
requires preliminary acceptance of the new product by major customers. With
respect to new product introductions, the Company's strategy is to begin
production on a limited basis until a product's initial success has been proven
in the marketplace.
The production schedule is then modified to meet demand.
The Company uses licenses with third parties to permit the Company to
manufacture and market toys based on properties which have developed their own
popular identity, often through exposure in various media such as television
programs, movies and cartoons. The Company focuses on licensing agreements to
extend its core product categories. No license involved more than 5% of the
Company's toy sales in 1997 and 1996.
The Company makes selective use of independent toy designers and developers, who
bring products to the Company and are generally paid a royalty on the net
selling price of any products licensed by the Company. These independent toy
designers may also create different products for other toy companies. Sales of
products developed by outside inventors were approximately 5% and 14% of
consolidated sales in 1997 and 1996, respectively.
MANUFACTURING
The Company has substantial domestic manufacturing and international sourcing
capabilities. Approximately 64% and 72% of the Company's consolidated net sales
in 1997 and 1996, respectively, were attributable to products manufactured in
the United States. In contrast, the products of many toy companies are
principally manufactured by third parties in the Far East. The Company also has
considerable experience in sourcing products through the Far East, which has
enabled the Company to develop extensive contacts and expertise in dealing with
foreign sources of production. The Company evaluates a number of factors when
determining whether to manufacture domestically or source through the Far East,
including the available lead time and shipping and labor costs.
DOMESTIC
The Company believes that its 1.2 million square foot manufacturing facility in
Tarboro, North Carolina is one of the largest plastic toy manufacturing
facilities in the United States, and offers a broad array of manufacturing
capabilities, including extrusion, vacuum, blow and injection plastic molding
processes, as well as assembly, sealing and warehousing operations. The Company
has concentrated production of its domestically manufactured products in the
Tarboro facility.
In February 1997, the Company terminated its month-to-month lease on a factory
and warehouse facility located in Gloversville, New York where some of the Buddy
L(R) products were manufactured. The Company had previously decided not tO
acquire the Gloversville facility in connection with the Buddy L acquisition and
to integrate certain Buddy L production equipment into the Tarboro facility.
Throughout 1997, management implemented cost-cutting measures which
significantly reduced factory overhead. Management believes these steps will
yield additional manufacturing efficiencies and cost savings. Additional cost
cutting measures will be pursued through 1998.
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The Company bases its production schedules on customer orders, historical
trends, the results of market research and current market information. The
actual shipments of products ordered and the order cancellation rate are
affected by consumer acceptance of the product line, the strengths of competing
products, marketing strategies of retailers and overall economic conditions.
Unexpected changes in these factors can result in a lack of product availability
or excess inventory in a particular product line. Accordingly, the Company
closely monitors market activity and adjusts production schedules accordingly.
The Company manufactures its products chiefly from plastic resins. The Company
purchases certain plastic and non-plastic component parts and accessories from
various sources, including several located in Asia. Products are molded,
assembled, painted, decorated and packaged at the Company's facilities and
stored there for shipment.
FOREIGN
The Company sources products from various manufacturers in the Far East through
its facilities in Hong Kong. Approximately 40 manufacturers are utilized for
this purpose, with over 85% of this production taking place in China. The
Company owns most of the tooling used in manufacturing its toys. Items sourced
by the Company in the Far East generally are sold under letters of credit to
U.S. and international customers. However, approximately 28% and 37% of the
Company's foreign production (based on cost) during the years ended December 31,
1997 and 1996, respectively, was sold in inter-company transactions to Empire in
the United States for inclusion in products assembled in the U. S. or for direct
sales to U.S. customers.
Approximately 36% and 28% of the Company's net sales in the years ended December
31, 1997 and 1996, respectively, were attributable to products manufactured for
the Company by unaffiliated parties in the Far East, substantially all of whom
are located in the People's Republic of China ("China"). The Company has not
entered into long-term contracts with any of these manufacturers. Accordingly,
the Company expects to continue to be dependent upon these sources for timely
production and quality workmanship. Given the seasonal nature of the Company's
business, any delay or quality control problems of such manufacturers, delay in
product deliveries, delay in locating or providing new tooling to acceptable
substitutes, or delay in increasing the production of alternative manufacturers
could have a material adverse effect on the Company's business, financial
condition and results of operations. In addition, foreign operations are subject
to a number of risks, including transportation delays and interruptions,
political and economic disruptions, labor strikes, the imposition of tariffs and
import and export controls, changes in governmental policies, and fluctuations
in currency exchange rates, the occurrence of any of which could have a material
adverse effect on the Company's business, financial condition and results of
operations. Many countries in the Asia Pacific region have recently experienced
severe currency devaluations, credit shortages, high interest rates and other
economic difficulties. Changes in Chinese labor market conditions in recent
years have made it more difficult for Hong Kong based manufacturers, and in
particular toy manufacturers, to obtain the work force necessary to meet
aggressive seasonal production schedules. The Company is working with its
manufacturers to ensure timely delivery of the Company's product. However, there
can be no assurance that such manufacturers will be able to meet the Company's
production schedules.
The Company's foreign sourcing and contract manufacturing management
office is located in Hong Kong, until recently a British Crown Colony.
Consequently, the Company may be materially adversely affected by factors
affecting Hong Kong's political situation and its economy or its international
political and economic relations. On July 1, 1997, China assumed sovereignty
over Hong Kong. There can be no assurance that China will continue to grant or
renew or recognize existing licenses, or will continue to abide by the
previously established policies, rules and regulations currently in effect.
There can be no assurance as to the continued stability of political, economic,
or commercial conditions in Hong Kong or that the Company's financial condition
and results of operations will not be materially and adversely affected as a
consequence of these events. In the event of any disruption or other political
or economic change in Hong Kong or China affecting the Company's business, the
Company may be required to seek alternate manufacturing sources. The Company
currently does not have in place plans or arrangements for securing alternate
manufacturing sources in the event that its present relationships with
manufacturers prove impracticable to maintain, and there can be no assurance
that there would be sufficient alternative facilities to meet the increased
demand for production that would likely result from a disruption of
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manufacturing operations in China. Furthermore, such a shift to alternate
facilities would likely result in increased manufacturing costs and could
subject the Company's products to increased duties, tariffs or other
restrictions.
China currently enjoys "most favored nation" ("MFN") status under
United States tariff laws, which provides the most favorable category of United
States import duties. There has been, and continues to be, opposition to the
extension of MFN status for China. The loss of MFN status for China would result
in a substantial increase in the import duty of toy products (which vary
depending on product category, and currently include duties of up to 70% for
non-MFN countries) manufactured in China which would result in increased costs
for the Company. Although the Company would attempt to mitigate this increased
cost by shifting its productions to other countries and/or increasing prices,
there can be no assurance that the Company would be able to do so or be
successful in doing so in a timely manner.
The inability to obtain its products from foreign manufacturers because of trade
restrictions, economic conditions in the Far East, work stoppages or otherwise,
or a material rise in tariffs, could have a material adverse effect upon the
Company's business, financial condition and results of operations.
RAW MATERIALS
The basic raw materials used by the Company are petrochemical resin derivatives
such as high density polyethylene and high impact polystyrene. Petrochemical
plastic resin derivatives are the single largest raw material component in cost
of goods sold. Costs of petrochemical derivatives are affected by demand and
supply as well as the value of the United States dollar in relation to foreign
currencies, and have been subject to volatility in recent years. There can be no
assurance as to the timing or extent to which the Company will be able to pass
on any raw material price increases to its customers. Due to the time lag
between the purchase of raw materials and the sale of finished goods, results of
operations may be only partially affected in the period in which such prices
change. The Company does not enter into any hedging or similar transactions with
respect to its raw materials.
In 1997, the Company obtained approximately 77% of its petrochemical derivatives
from three major domestic chemical companies (54% from two in 1996) and the
balance from several other sources. The Company generally does not have
long-term supply contracts. The Company believes that an adequate supply of
petrochemical derivatives is available from existing and alternate suppliers.
There can be no assurance, however, that there will not be disruptions in the
availability of such supply. The other materials necessary to the various
aspects of the Company's business are generally available in the marketplace
from numerous suppliers.
COMPETITION
The toy industry is highly competitive, with competition based primarily on
product design, promotion, price, quality and play value. In recent years, the
toy industry has experienced rapid consolidation driven, in part, by the ability
of manufacturers to offer a range of products across a broader variety of
categories. The Company competes with several larger toy companies, such as
Mattel and Hasbro and many smaller companies in the design and development of
new toys, the procurement of licenses, the improvement and expansion of
previously introduced products and product lines and the marketing and
distribution of its products. The introduction of new products and product lines
by the Company makes its operations susceptible to the risks associated with new
products, such as production, distribution and quality control problems and the
need to gain customer acceptance.
The sale of holiday products is also competitive. The primary competitive
factors in the sale of holiday products are price, design and product quality.
The decorative holiday products industry is generally highly fragmented with no
dominant market leader. However, the Company believes that it has a leading
market position in several of the product categories in which it participates
and the Company is not aware of any other major manufacturer with a significant
market share in most of the product categories in which the Company
participates.
8
<PAGE>
REGULATION
The Company's toys are subject to the provisions of the Consumer Product Safety
Act, the Federal Hazardous Substances Act (including the Federal Child
Protection and Toy Safety Act of 1969) and the Flammable Fabrics Act, and the
regulations promulgated thereunder. The Consumer Product Safety Act and the
Federal Hazardous Substances Act enable the Consumer Product Safety Commission
("CPSC") to exclude from the market consumer products that fail to comply with
applicable product safety regulations or otherwise create a substantial risk of
injury, and articles that contain excessive amounts of a banned hazardous
substance. The Flammable Fabrics Act enables the CPSC to regulate and enforce
flammability standards for fabrics used in consumer products.
The Company may be required to give public notice of any hazardous or defective
products and to repair, replace or repurchase any such products previously sold.
The Company is also required to report to the CPSC any information which
reasonably supports the conclusion that any of its products may be defective or
entail a substantial risk of injury to the public. In addition, the Company is
subject to various state, local and foreign laws designed to protect children
from hazardous or potentially hazardous products. If any of the Company's
products materially contributing to its dollar volume of sales were found to be
hazardous to the public health and safety or to contain a defect which created a
risk of injury to the public, the cost to repair, replace or repurchase such
products could have a material adverse effect on the Company's business,
financial condition and results of operations.
The Company maintains a quality control program to comply with the various
federal, state, local and international product safety requirements, as well as
to maintain appropriate quality and reliability standards of its products.
The Company uses paint and other raw materials classified as hazardous
substances and generates waste in the manufacture of its products. The Company
is subject to federal and state regulations in the emission, storage and
disposal of such materials.
TRADEMARKS AND PATENTS
The Company believes that selective use of patent, copyright and trademark
protection is significant in protecting the Company's rights in its products and
establishing product recognition. The Company has approximately 100 registered
trademarks in the U.S., including Big Wheel(R), Crocodile Mile(R), Grand
Champions(R), and Buddy L(R), and owns approximately 30 U.S. patents, including
several relating to features of its Crocodile Mile(R) water slides. Other U.S.
trademark and patenT applications are pending. The Company has also sought and
obtained trademark protection with respect to certain of its product lines in
selected countries outside of the United States in which such products are sold.
EMPLOYEES
At January 30, 1998, the Company had approximately 530 employees in the United
States, approximately 85 of whom were salaried, and approximately 40 employees
in Hong Kong and China. If required by the Company's future operations, the
Company believes it could supplement its work force through the recall of hourly
production employees and the hiring of temporary employees. No employees are
covered by a collective bargaining agreement.
OTHER
During 1997, the Company decided to dispose of the steel-walled pool product
line acquired in the Buddy L acquisition. Assets, primarily inventory, machinery
and equipment, with a book value of $3,243,000 were sold, resulting in a loss of
$1,008,000. The Company ceased manufacturing apparel buttons, buckles and
novelty items for use in the garment industry in 1997.
9
<PAGE>
FORWARD-LOOKING INFORMATION MAY PROVE INACCURATE
This Annual Report contains various forward-looking statements and information,
including under the captions "Recent Developments" and "Management's Discussion
and Analysis of Financial Condition and Results of Operations," that are based
on management's beliefs as well as assumptions made by and information currently
available to management, including statements regarding future economic
performance and financial condition, liquidity and capital resources and
management's plans and objectives. When used in this document, the words
"expect," "anticipate," "estimate," "believe," and similar expressions are
intended to identify forward-looking statements. Such statements are subject to
various risks and uncertainties which could cause actual results to vary
materially from those stated. Should one or more of these risks or uncertainties
materialize or should underlying assumptions prove incorrect actual results may
vary materially from those anticipated, estimated, expected or projected. Such
risks and uncertainties include the Company's ability to close the proposed
transaction described above under "Recent Developments," manage inventory
production and costs, to meet potential increases or decreases in demand,
potential adverse customer impact due to delivery delays including effects on
existing and future orders, competitive practices in the toy and decorative
holiday products industries, changing consumer preferences and risks associated
with consumer acceptance of new product introductions, potential increases in
raw material prices, potential delays or production problems associated with
foreign sourcing of production and the impact of pricing policies including
providing discounts and allowances, reliance on key customers, the seasonality
of the Company's business, the ability of the Company to meet existing financial
obligations in the event of adverse industry or other developments, and the
Company's ability to obtain additional capital to fund future commitments and
operations. Certain of these as well as other risks and uncertainties are
described in more detail in the Company's Registration Statement on Form S-1
filed under the Securities Act of 1933, Registration No. 333-4440. The Company
undertakes no obligation to update any such factors or to publicly announce the
result of any revisions to any of the forward-looking statements contained
herein to reflect future events or developments.
ITEM 2. PROPERTIES.
GENERAL CHARACTER
LOCATION AND USE OF PROPERTY
OWNED: (1)
Tarboro, NC 1,200,000 sq. ft. of factory, warehouse and office space
Tarboro, NC 24,000 sq. ft. of warehouse space
LEASED:
New York, NY 29,000 sq. ft. of showroom space (2)
Delray Beach, FL 16,000 sq. ft. office space
Hong Kong 2,600 sq. ft. office space
Hong Kong 1,200 sq. ft. showroom
Hong Kong 1,358 sq. ft. warehouse space
- -------------
(1) The real property owned by the Company is subject to liens in favor of its
senior lenders.
(2) Approximately 18,000 square feet of the location is sub-leased.
In the opinion of management, the Company's various properties used in
operations are generally in good condition and adequate for its business.
10
<PAGE>
ITEM 3. LEGAL PROCEEDINGS.
INTELLECTUAL PROPERTY LITIGATION. George Delaney and Rehkemper I.D., Inc. v.
Marchon, Inc., is an action pending in the Circuit Court of Cook County,
Illinois, which was commenced on December 3, 1990, arising from a business
arrangement between the plaintiffs and Marchon, alleging an interest in one of
Marchon's products. On November 22, 1991, the trial court judge issued an
opinion and dismissed plaintiff's complaint with prejudice. Plaintiffs appealed
and, on September 23, 1993, the Appellate Court reversed the dismissal and
remanded the case for further proceedings. The plaintiffs have filed an amended
complaint against the Company and the case is set for trial in 1998. Although
the Company is vigorously contesting the matters set forth in the complaint, it
is unable at this time to determine the extent of its financial exposure.
ENVIRONMENTAL MATTERS. CLR Corporation ("CLR"), a 75%-owned subsidiary of the
Company, was alleged by the EPA to be responsible for disposal activities of two
former subsidiaries at two Superfund sites, located in Southington, Connecticut
and Bennington, Vermont. CLR is among numerous potentially responsible parties
identified by the EPA in connection with each site. The Company entered into
consent decrees in regard to each of these matters during 1997 and made payments
of $93,000 and $178,000, respectively.
On or about May 28, 1996, a complaint was filed in the United States District
Court for the Middle District of Pennsylvania in a Superfund lawsuit captioned
United States of America v. Keystone Sanitation Company, Inc., et al., and
naming as a third-party defendant, among 178 others, Empire of Carolina, Inc.,
as a successor to or d/b/a or f/d/b/a Isaly Klondike Company. The complaint also
named the Hanover Klondike Company (a predecessor by merger to Isaly Klondike),
Isaly Klondike and Good Humor Corporation (as a successor to Isaly Klondike).
This Superfund suit sought recovery of clean-up costs associated with the
Keystone Sanitation site in Pennsylvania. The Isaly Klondike Company was alleged
to have sent materials to the site. Isaly Klondike and Empire sold certain
assets to an affiliate or subsidiary of Good Humor Corporation in 1993. The
complaint sought relief under CERCLA and its Pennsylvania state equivalent, the
Pennsylvania Hazardous Site Clean-Up Act, claiming that all of the third-party
defendants are liable directly as potentially responsible parties and/or in
contribution for the costs incurred by the third-party plaintiffs in
investigation and cleaning up the Keystone Site. During 1997, the Company
entered into a consent decree with the plaintiffs for a payment of $21,000.
The Company may be subject to various other potential environmental claims by
the EPA and state environmental regulatory authorities with respect to other
sites. Other than the Keystone Sanitation matter, neither the EPA nor any state
environmental regulatory authorities have initiated or threatened litigation
regarding any of these sites to date. It is the Company's policy to accrue
remediation costs when it is probable that such costs will be incurred and when
they can be reasonably estimated. As of December 31, 1997, the Company had
reserves for environmental liabilities of approximately $125,000. Estimates of
costs of future remediation are necessarily imprecise due to, among other
things, the allocation of costs among potentially responsible parties. Although
it is possible that additional environmental liability related to these matters
could result in amounts that could be material to the Company's business,
financial position and results of operations, a reasonably possible range of
such amounts cannot presently be estimated. Based upon the facts presently
known, the large number of other potentially responsible parties and potential
defenses that exist, the Company believes that its share of the costs of
clean-up for its current remediation sites will not, in the aggregate, have a
material adverse impact on its consolidated financial statements.
PRODUCT LIABILITY MATTERS. Due to the nature of its business, the Company at any
particular time is a defendant in a number of product liability lawsuits
involving personal injury allegedly related to the Company's products. Many of
these claims allege damages for injuries suffered from the use of the Company's
products. Typical product liability claims might include allegations of failure
to warn, design defects or defects in the manufacturing process. While the
Company maintains product liability insurance, no assurance can be given that
such insurance will cover all such product liability claims, that an insurer
will seek to deny or limit coverage or that an insurer will be solvent at the
time of any covered loss. Further, there can be no assurance that the Company
will be able to obtain insurance coverage at acceptable levels, costs and
coverages in the future. Successful assertion against the Company of one or a
series of large uninsured claims, or of one or a series of claims exceeding any
insurance coverage, could have a
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<PAGE>
material adverse effect on the Company's business, financial condition and
results of operations. It is also likely that, due to deductible and
self-retention levels under the Company's insurance policies, the assertion in
any given year of a large number of claims against the Company could have a
similar effect on the Company.
TAX MATTERS. On November 13, 1996, the Internal Revenue Service ("IRS") issued
the Company a notice of an asserted income tax deficiency in the amount of $1.3
million. The alleged deficiency relates to the taxable year ended December 31,
1993 and involves the disallowance of deductions for officers' compensation,
country club dues and a state intangible tax paid by Empire on behalf of two
former officers. The Company filed a petition in the U. S. Tax Court on February
7, 1997 asking for a redetermination of the asserted deficiency. On January 26,
1998, the Company and the IRS filed with the Tax Court a Stipulation of Settled
Issues, reducing the proposed deficiency to $4,307. For procedural reasons, a
final judgment cannot be entered in the Tax Court until the IRS completes its
audit of the Company's tax returns for the year ended December 31, 1996.
CERTAIN OTHER MATTERS. Marvin Smollar, a former director of the Company, was the
defendant in a suit filed by the Company in January 1997 which sought to enforce
a certain guarantee by Mr. Smollar of debt owed to the Company by 555 Corporate
Woods Parkway, Inc. Mr. Smollar denied the allegations in the Company's
complaint. On February 24, 1997, Mr. Smollar commenced an action in the Circuit
Court of Palm Beach County, Florida captioned Marvin Smollar v. Empire of
Carolina, Inc. claiming (a) breach of his employment agreement, (b) breach of a
Marchon phantom stock plan agreement and (c) breach of an oral agreement to pay
relocation expenses, and seeking injunctive relief enjoining the Executive
Committee of the Board of Directors from taking certain actions. Mr. Smollar's
claims arose in part from his termination as President and Chief Operating
Officer of the Company in January 1997. The complaint sought unspecified damages
in excess of $1 million in respect of his employment agreement. During January
1998, the Company and Mr. Smollar entered into a settlement agreement resolving
each of these claims in addition to a claim that had been brought by 1431
Kingsland Avenue, L.P., alleging that the Company had breached a lease at 1431
Kingsland Avenue in Pagedale, Missouri.
ROUTINE MATTERS. In addition, the Company is involved from time to time in
routine litigation incidental to its business. Although no assurance can be
given as to the outcome or expense associated with any of these routine
proceedings, the Company believes that none of such proceedings, either
individually or in the aggregate, will have a material adverse effect on the
financial condition of the Company.
ITEM 4. SUBMISSIONS OF MATTERS TO A VOTE OF SECURITY HOLDERS.
None.
EXECUTIVE OFFICERS
Information concerning the executive officers of the Company, their ages,
position and business experience during the last five years is set forth below:
<TABLE>
<CAPTION>
Name Age Positions(s)
- ------- ---- ------------
<S> <C>
Charles S. Holmes................... 53 Chairman of the Board
Steven E. Geller.................... 57 Chief Executive Officer; Director
Timothy Moran....................... 34 President and ChiefOperating Officer
William H.Craig..................... 41 Executive VicePresident and Chief Financial Officer
J. Artie Rogers..................... 38 Senior Vice President - Finance and Assistant Secretary
Lawrence A. Geller.................. 34 Vice President, General Counsel and Secretary
</TABLE>
CHARLES S. HOLMES has served as a director of the Company since May 1997 and as
Chairman of the Board since June 1997. Since 1991, Mr. Holmes has served as
principal and is the sole stockholder of Asset Management Associates of New
York, Inc. ("Asset Management"), a New York-based firm specializing in
acquisitions of
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<PAGE>
manufacturing businesses. Mr. Holmes founded and was a partner in Asset
Management Associates, a predecessor partnership of Asset management, from 1978
to 1991. Mr. Holmes also is a principal stockholder and serves on the Board of
Directors of NAI Technologies, Inc., a company whose common stock is traded on
the Nasdaq Stock Market. Mr. Holmes is also a principal of HPA Associates, LLC.
See "Market for Registrant's Common Equity and Related Stockholder Matters."
STEVEN E. GELLER has 36 years experience in the toy industry. Mr. Geller has
served as Chief Executive Officer of the Company since September 1994 and Chief
Executive Officer of Empire Industries, Inc. ("EII") since July 1994. He served
as Chairman of the Board of the Company from September 1994 to June 1997 and
Chairman of the Board of EII from July 1994 to June 1997. Prior to joining the
Company, Mr. Geller served as President of Arco Toys, Inc., a wholly owned
subsidiary of Mattel from December 1986 through December 1991 and as a
consultant for Mattel from January 1991 through December 1993. From January 1994
to July 1994, Mr. Geller was self-employed, engaged in structuring, negotiating
and financing the acquisition of the Company. See "Certain Relationships and
Transactions."
TIMOTHY MORAN has served as President and Chief Operating Officer of the Company
since February 1998. He has been President of Apple Sports, Inc., since February
1993. Apple Sports, Inc., is a manufacturer and distributor of licensed golf
products under the Wilson Sporting Goods name.
WILLIAM H. CRAIG has served as Executive Vice President and Chief Financial
Officer since May 1997. Prior to joining the Company, Mr. Craig was President of
Wm. Craig & Co., a financial services firm specializing in workouts and
turnarounds with middle market companies. Formation of his own firm was preceded
by nearly five years with GE Capital, lending and investing in industrial
companies, with a particular emphasis in the plastics industry, including
various cross-selling and co-investing activities with GE Plastics. Before GE
Capital, Mr. Craig was with a merchant bank in Texas, providing expansion and
acquisition capital on a mezzanine or equity basis in middle market companies,
with particular emphasis on manufacturing, plastics, and consumer products. Mr.
Craig's early career was a consultant with the predecessor of Deloitte & Touche
LLP, as well as GMAC.
J. ARTIE ROGERS has 12 years' experience in the toy industry. Mr. Rogers has
served as Senior Vice President-Finance of the Company since December 1994. From
1987 to December 1994, Mr. Rogers served as Vice President - Finance of the
Company. From 1987 to December 1995, Mr. Rogers served as Secretary of the
Company, and has served as Assistant Secretary since December 1995. Prior to
joining the Company in 1986, Mr. Rogers worked for the predecessor of Deloitte &
Touche LLP.
LAWRENCE A. GELLER has served as Vice President and General Counsel since
January 1997 and as Secretary of the Company since December 1995. Mr. Geller
joined the Company in April 1995 as corporate counsel. Prior to joining the
Company, Mr. Geller was engaged in the practice of law with an emphasis on
litigation as a partner with the firm Imhoff & Geller in Norwalk, Connecticut
from 1993 and 1995. During 1991 and 1992, Mr. Geller was an associate with the
law offices of John W. Imhoff, Jr. and from 1989 to 1991 he was an associate
with the law offices of Francis J. Discala, Mr. Geller is the son of Steve
Geller, the Chief Executive Officer and former Chairman of the Company.
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<PAGE>
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS.
COMMON STOCK - The common stock of the Company, par value $.10 per share
("Common Stock"), is listed on the American Stock Exchange under the symbol EMP.
The following table sets forth, for the fiscal quarters indicated, the high and
low sale prices for the Common Stock on the American Stock Exchange.
1997 1996
----------------- ------------
QUARTER HIGH LOW HIGH LOW
- ------- ---- --- ----- ----
1st $4.56 $2.88 $12.25 $6.88
2nd 5.00 .63 15.00 11.88
3rd 3.00 1.75 12.13 3.56
4th 2.50 1.38 6.81 3.75
As of March 20, 1998, the number of holders of record of Common Stock was
approximately 4,015.
SERIES A PREFERRED STOCK AND WARRANTS - On June 17, 1997, pursuant to the
Securities Purchase Agreement dated as of May 5, 1997, as amended by Amendment
No. 1 to the Securities Purchase Agreement, dated as of June 5, 1997, among the
Company, HPA Associates, LLC ("HPA") and EMP Associates LLC ("EMP"), the Company
issued to HPA, EMP and other accredited investors (as defined in Rule 501 under
the Securities Act of 1933, as amended)("Accredited Investors") 1,100,000 shares
of the Company's Series A Preferred stock, $.01 par value per share, and
5,000,000 warrants to purchase shares of the Company's common stock (the
"Principal Investment"). On June 18, 1997, the Company issued to HPA and other
Accredited Investors an additional 500,000 shares of the Series A preferred
stock and an additional 2,500,000 warrants (the "Additional Investment",
together with the Principal Investment, the "Initial Investment"). The investors
in the Initial Investment are collectively referred to herein as the
"Purchasers". The total shares of Series A preferred stock issued to Purchasers
in connection with the foregoing was 1,600,000 and the total number of warrants
issued was 7,500,000.
In early June 1997, notwithstanding the impending closing of the Initial
Investment, the Company determined that it would need additional capital in
order to fully fund its (i) marketing programs, (ii) new product development and
(iii) certain capital improvements, which the Company believed were necessary if
it was to achieve its desired business plan. Accordingly, the Company agreed to
an amendment to the Securities Purchase Agreement pursuant to which, among other
things, the Company agreed to issue and sell to HPA and other private investors
an additional 500,000 shares of Series A preferred stock (initially convertible
into 4 million shares of common stock) and 500,000 warrants to purchase shares
of common stock at an initial exercise price of $1.375 per share, for aggregate
gross consideration of $5,000,000 (the "Further Purchase"). In connection
therewith, the Company agreed to issue to the placement agents and HPA warrants
to purchase an additional 2 million shares of common stock at an initial
exercise price of $1.375 per share.
On October 10, 1997, the Further Purchase was consummated. The proceeds from the
Further Purchase (which after the deduction of the placement agents' commission
and offering expenses of approximately $350,000 were $4.6 million) were used for
working capital purposes, including the repayment of existing trade indebtedness
and short-term bank debt. The balance, if any, was used for general corporate
purposes.
Notwithstanding that the closing price of the Company's common stock on the
American Stock Exchange as of June 6, 1997 (the date of the amendment of the
Securities Purchase Agreement) was $2.3275 per share, the price per Unit of the
Further Purchase was identical to the price per Unit paid by the Purchasers in
connection with the Initial Investment.
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<PAGE>
The Company agreed to make the below market sales as part of the Further
Purchase because of the Company's significant and immediate need for additional
capital. Closing of the Further Purchase was conditioned upon, among other
things, Stockholder approval of the Further Purchase and certain amendments to
the Company's Certificate of Incorporation (the "Charter").
The Company also adopted the First Amendment to its Stockholder Rights Agreement
in order to facilitate the proposed investment by HPA, EMP and their respective
affiliates. On June 12, 1997, the Company and American Stock Transfer & Trust
Company, a New York corporation, as Rights Agent (the "Rights Agent"), adopted
the Second Amendment (the "Second Amendment") to the Rights Agreement dated as
of September 11, 1996 (the "Rights Agreement") between the Company and the
Rights Agent, as amended by the First Amendment thereto dated as of May 5, 1997.
The Second Amendment, among other things, amends the definition of "Acquiring
Person" in Section 1(a) of the Rights Agreement to base the 15% threshold
specified therein on the aggregate number of "Fully-Diluted Common Shares" (as
defined in the Second Amendment) of the Company.
In addition, Smedley Industries, Inc. Liquidating Trust, the successor to Buddy
L, under the Company's agreement to purchase the assets of Buddy L, waived or
released its claim to certain earn out, price protection and registration rights
in exchange for: (i) $100,000 in cash; (ii) 250,000 shares of common stock of
the Company; (iii) a $2.5 million 9% note from the Company's major subsidiary,
and guaranteed by the Company, providing for $625,000 principal payments on the
first four anniversaries of the closing date of the preferred stock Investment
(which note includes certain affirmative and negative covenants which could in
certain circumstances permit the acceleration of payments with respect to such
note); and (iv) certain other benefits, including registration rights.
On August 21, 1997, the Company issued 200,000 warrants with items consistent
with those above to Gerard Klauer Mattison & Co., Inc. ("GKM") in connection
with the Company's settlement of fees owed to GKM for services rendered with
respect to certain financings and sales transactions (the "GKM Warrants").
On January 22, 1998, the holders of the warrants amended the Warrant Agreement
to include (i) 2,500,000 additional warrants issued pursuant to the approval of
"Proposal 3" at the September 25, 1997 annual meeting of stockholders and (ii)
to exchange the 200,000 GKM Warrants for 200,000 Warrants.
SERIES C PREFERRED STOCK - In connection with the Principal Investment, the
Company's 9% convertible debentures (which had been convertible into 2 million
shares of common stock) issued to affiliates of Weiss, Peck & Greer in the
original principal amount of $15 million were exchanged by the holders thereof
for newly-issued shares of Series C preferred stock of the Company with an
aggregate Stated Value (as defined in the Series C preferred stock Certificate
of Designation) of $15 million. Such holders also released, among other things,
their claims to accrued and unpaid interest, fees and expenses. Each share of
Series C preferred stock is convertible at any time, at the option of the holder
thereof, into fully paid and nonassessable shares of common stock at a rate of
one share of common stock for each $2.00 of Stated Value of Series C preferred
stock (subject to adjustment in certain circumstances). Except as otherwise
expressly provided in the Charter or the By-laws of the Company, the Certificate
of Designation relating to the Series C preferred stock, or as may otherwise be
required by law, the Series C Stockholders, by virtue of their ownership
thereof, have no voting rights.
DIVIDENDS - The Company has not paid any cash dividends since 1990 and does not
anticipate paying cash dividends in the foreseeable future. The Company's
current policy is to retain earnings to provide funds for the operation and
expansion of its business and for the repayment of indebtedness. Any
determination in the future to pay dividends will depend upon the Company's
financial condition, capital requirements, results of operations and other
factors deemed relevant by the Company's Board of Directors, including any
contractual or statutory restrictions on the Company's ability to pay dividends.
The Company's bank facility does not restrict the payment of dividends by the
Company; however, that agreement limits the dividends which Empire Industries,
Inc. ("EII"), the Company's principal operating subsidiary, may pay to the
Company. Under the bank facility, EII may not pay dividends to the Company in
excess of the lesser of $3.6 million or 30% of EII's cumulative net income
(except for certain items specifically permitted for purposes other
15
<PAGE>
than the payment of dividends by the Company, such as the payment of taxes).
Such restrictions could limit the funds available for the payment of dividends
by the Company.
ITEM 6. SELECTED FINANCIAL DATA.
The following selected financial data have been derived from the consolidated
financial statements of the Company for the fiscal years 1997, 1996, 1995, 1994,
and 1993. The selected financial data should be read in conjunction with the
audited consolidated financial statements and notes thereto and with
"Management's Discussion and analysis of Financial Condition and Results of
Operations" included elsewhere herein. All amounts in the tables and notes below
are in thousands, except per share data.
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
1997 1996 1995 (1) 1994 (2) 1993 (3)
-------- --------- -------- -------- --------
STATEMENT OF OPERATIONS DATA:
<S> <C> <C> <C> <C> <C>
Net Sales $ 99,516 $148,908 $153,744 $ 57,964 41,354
Sales distribution settlement 2,400 -- -- -- --
Cost of Sales 87,524 133,464 111,905 40,557 29,733
Nonrecurring inventory charge -- 12,185 -- -- --
Gross Profit 14,392 3,259 41,839 17,407 11,621
Selling and administrative expenses 24,863 41,751 36,183 16,442 15,086
Restructuring and other charges 3,739 8,800 7,550 -- --
Operating income (loss) (14,210) (47,292) (1,894) 965 (3,465)
Interest expense 7,022 11,236 5,996 1,407 2,937
Other income (loss) 102 (5) 514 1,839 5,952
Net income (loss) from continuing operations before income taxes,
extraordinary items and cumulative effect of an accounting
change (21,130) (58,533) (7,376) 1,397 (450)
Income tax expense (benefit) -- (12,332) (2,875) 808 1,066
Net income (loss) from continuing operations before extraordinary
items and cumulative effect of an accounting change (21,130) (46,201) (4,501) 589 (1,516)
Income from discontinued operations, net of tax -- -- -- -- 25,729
Cumulative effect of change in accounting for income taxes -- -- -- -- 114
Net income (loss) (21,130) (46,201) (4,501) 589 24,327
Accretion of noncash preferred stock dividend $(24,645) -- -- -- --
Net income(loss) applicable to common stock $(45,775) $(46,401) $ (4,501) $ 589 $24,327
Weighted average common shares outstanding -- basic and diluted 7,583 6,248 4,681 12,159 14,670
Income (loss) per common share from continuing
operations -- basic and diluted $ (6.04) $ (7.39) $ (.96) $ .05 $ (.10)
BALANCE SHEET DATA (AT PERIOD END):
Working Capital $(10,608) $(30,498) $ 6,837 $ 8,915 $92,871
Total assets 63,576 127,860 140,153 67,956 123,240
Total debt 23,413 80,721 71,106 22,249 9,001
Stockholders' equity 15,453 1,771 30,462 20,577 98,419
</TABLE>
(1) The results of operations for 1995 include the results of operations of
Buddy L since its acquisition on July 7, 1995. See Note 4 of notes to
consolidated financial statements and "Management's Discussion and Analysis
of Financial Condition and Results of Operations."
(2) The results of operations for 1994 included the results of operations of
Marchon since its acquisition on October 13, 1994.
(3) In January 1993, the Company sold the assets used in the business of The
Isaly Klondike Company ("Isaly Klondike") and Popsicle Industries, Inc.
("Popsicle"). These business had been acquired in 1989. As a result of the
sale of these businesses, the results of operations and gains on sale from
Isaly Klondike and Popsicle have been included in income from discontinued
operations.
16
<PAGE>
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS.
The following discussion and analysis of the Company's consolidated results of
operations and consolidated financial position should be read in conjunction
with the Selected Consolidated Financial Data and the Company's consolidated
financial statements, including the notes thereto, appearing elsewhere in this
Annual Report.
GENERAL
The Company designs, manufactures and markets a broad variety of toys and
plastic decorative holiday products. The Company has been involved in the toy
industry for approximately 45 years, and in the 1980's diversified into non-toy
operations such as food products. The Company's business focus shifted entirely
to toys and holiday products in 1993 when substantial non-toy operations were
sold. Since mid-1994, the Company has undergone changes in management and
effected two significant acquisitions which added established core toy product
lines to the Company. The Company concentrates its sales and manufacturing
efforts on items primarily molded from plastic resins. The major product
categories include ride-ons, outdoor activities and holiday products which are
primarily manufactured domestically, and girls and boys toys, which are sourced
through Empire's Hong Kong office.
In October 1994, the Company acquired Marchon, Inc. ("Marchon"), a toy designer,
marketer and manufacturer. Marchon's core toy products included Grand
Champions(R) collectible horses and Crocodile Mile(R) water slides. Marchon had
substantial experience at sourcing toy products in the Far East. In July 1995,
the Company acquired substantially all of the toy product lines of Buddy L Inc.
and its Hong Kong subsidiary (collectively, "Buddy L"), one of the oldest toy
brands in the United States. Buddy L's core toy products included plastic toy
cars, trucks and other vehicles bearing the Buddy L(R) name.
The Company's 1996 operating results were negatively impacted by serious
difficulties encountered at its Tarboro, NC plant. Increased seasonal demand in
the face of transfers of production from former Buddy L facilities; delays in
the startup of new or transferred production equipment; increased cost of
outsourced production; difficulties created by the influx of Buddy L product and
the training of new employees all led to the loss of production efficiency,
product damage, and missed shipping deadlines which contributed to the Company's
1996 nonrecurring charges and net loss.
Management's task for 1997 was well defined: to put the Tarboro facility on a
sound manufacturing base in order to regain the confidence of Empire's customers
and reduce losses on domestic product. A new plant organization, including a new
plant manager, has implemented cost cutting and control measures which have
significantly reduced 1997 factory operating costs, more than commensurate with
reductions in volume, from 1996 levels.
RESULTS OF OPERATIONS
YEAR ENDED DECEMBER 31, 1997 COMPARED TO YEAR ENDED DECEMBER 31, 1996
NET SALES AND NET LOSS. Net sales for the year ended December 31, 1997 decreased
to $99.5 million from $148.9 million for the year ended December 31, 1996. The
net loss for the year ended December 31, 1997 was $21.1 million as compared to a
net loss of $46.2 million for the year ended December 31, 1996. The net loss for
1997 includes a $4.5 million loss related to the (i) impairment of long-lived
assets associated with discontinued product lines of $3.5 million and (ii) a
$1.0 million loss on the sale of the steel-walled pool business. The net loss
for the year ended December 31, 1996 included a decrease in profit margins
resulting from difficulties encountered in the integration of Buddy L; $12.2
million of nonrecurring inventory charges; $8.8 million of restructuring and
other charges; a $5.2 million increase in interest expense; and higher than
normal reserves established for inventory obsolescence and other items.
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Net sales for 1997 decreased by approximately $49.4 million from 1996, primarily
due to lack of customer confidence in Empire's ability to fulfill orders because
of production and delivery problems during 1996, as well as the Company's
financial situation in the early part of the year. Customers dramatically
reduced the number of items taken as well as quantities ordered per item. As a
result, the sales for the domestically produced products declined dramatically.
In addition, the Company decided to reduce the production of battery operated
vehicles during 1997 due to significant production problems during 1996. Battery
operated vehicles sales declined by $16 million during 1997. In addition, 1997
sales of Big Wheelie(R) products decreased by $4.9 million.
The Company's sales in the holiday products category dropped almost $12.5
million. Stiff competition and lack of customer confidence in Empire's ability
to fulfill orders based on the poor performance in 1996 are considered the main
reasons for this decrease.
The consistency of sales in the girls and boys toys category, which are mostly
manufactured in the Far East, showed the relative strength of the Grand
Champions(R) and Buddy L(R) vehicle lines, supported by the newly introduced
Real Bugs(TM) and Record `N Play(TM) toys.
During 1997, the Company received a $2.4 million settlement upon termination of
an international sales distribution agreement.
GROSS PROFIT MARGINS. Gross profit margins, excluding the 1997 sales
distribution settlement and the 1996 nonrecurring charges, were slightly higher
for the year ended December 31, 1997 as compared to the year ended December 31,
1996. The increase was primarily due to production improvements at the Company's
Tarboro, North Carolina manufacturing facility and the increased percentage of
sales of higher margin products manufactured overseas. The effect of these
improvements were adversely impacted by the lower than planned sales volume.
SELLING AND ADMINISTRATIVE ("S&A"). Selling and administrative expenses were
reduced significantly during the year ended December 31, 1997 as compared to the
previous year primarily due to the decreases in the following: executive,
marketing and administrative staff (approximately $4.8 million); the outsourcing
of warehouse management and shipping functions ($3.7 million) and new product
development and customer support ($3.4 million). Total selling and
administrative expenses were 25.0% of sales for 1997 as compared to 28.0% in the
prior year.
INTEREST EXPENSE Interest expense was $7.0 million for the year ended December
31, 1997 as compared to $11.2 million for the year ended December 31, 1996.
Interest expense was lower due to the infusion of cash into the Company in June
and October 1997 from the preferred stock investments, the conversion of the 9%
senior subordinated debentures to equity and lower loan balances due to lower
accounts receivable and inventory levels. Interest expense during 1996 was
increased by the write off of $2.0 million in deferred financing charges
resulting from amending the Company's lending facilities in December 1996.
INCOME TAXES. For 1997, the Company did not recognize any tax benefits related
to the loss. For 1996, income tax benefits of $12.3 million were recognized as a
result of the ability of the Company to carry net operating losses back to prior
years.
YEAR ENDED DECEMBER 31, 1996 COMPARED TO YEAR ENDED DECEMBER 31, 1995
The results of operations for 1996 reflect the impact of the Buddy L acquisition
for the full year ended December 31, 1996 (which acquisition occurred on July 7,
1995).
NET SALES AND NET INCOME (LOSS). Net sales for the year ended December 31, 1996
decreased to $148.9 million from $153.7 million for the year ended December 31,
1995. Unaudited pro forma net sales (assuming Buddy L had been acquired on
January 1, 1995) for the full year 1995 would have been $187.2 million. Of the
decrease in sales,
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$3.0 million was due to the decrease in holiday product sales. Additionally,
less than 1% and approximately 14% of the Company's sales for the years ended
December 31, 1996 and 1995, respectively, were from products licensed under the
Power Rangers(R) license. The Company de-emphasized production of these products
in 1995 based on its belief that the popularity level of these toys was not
sustainable.
The net loss for the year ended December 31, 1996 was $46.2 million as compared
to a net loss of $4.5 million for the year ended December 31, 1995. The net loss
for the year ended December 31, 1996 is primarily attributable to: a decrease in
profit margins resulting from difficulties encountered in the integration of
Buddy L; $12.2 million of nonrecurring inventory charges; $8.8 million of
restructuring and other charges; a $5.2 million increase in interest expense;
and higher than normal reserves established for inventory obsolescence and other
items.
Toy sales decreased to $119.7 million for 1996 from $121.6 million for 1995. The
decrease was due to missed shipments and order cancellations during the third
and fourth quarters, as a result of the production problems encountered at the
Company's Tarboro facility; and the phase out of Power Rangers(R) and Road
Racing(R) products which had contributed $24.0 million in sales during 1995; and
a generally poor retail season. These reductions were largely offset by the sale
of new products such as Big Wheelie(R) and Fantasy Fillies(R), a full year of
sales of Buddy L toys, and increases in the sale of Crocodile Mile(R) Water
slides and Grand Champions(R) horses.
The Company's sales of holiday products decreased from 1995 to 1996 by $3.0
million or approximately 9% due to decreased sales volume in its Christmas
category. This decrease resulted from order cancellations related to the
production problems encountered at the Tarboro plant.
GROSS PROFIT MARGINS. Gross profit margins were lower for the year ended
December 31, 1996 as compared to the year ended December 31, 1995 due primarily
to the difficulties encountered in the third and fourth quarter associated with
the manufacture of Buddy L products, including the influx of transferred product
and machines which resulted in unfavorable production cost variances at the
Company's Tarboro, North Carolina manufacturing facility.
SELLING AND ADMINISTRATIVE ("S&A"). Selling and administrative expenses were
higher for the year ended December 31, 1996 as compared to the previous year.
Contributing to this increase were a $1.8 million increase in shipping and
premium freight charges caused by late and partial shipments from the Tarboro,
NC plant during the third and fourth quarters, incremental costs of
approximately $1.3 million for staffing of four Strategic Business Units
("SBU's"); duplicate facilities cost of $0.9 million; and $0.6 million
impairment of long-lived assets. Total selling and administrative expenses were
28.0% of sales for 1996 as compared to 23.5% in the prior year.
INTEREST EXPENSE. Interest expense was $11.2 million for the year ended December
31, 1996 as compared to $6.0 million for the year ended December 31, 1995.
Interest expense was higher by approximately $5.2 million due to higher balances
of the Company's revolving credit lines resulting from the losses incurred;
higher inventory and accounts receivable levels; and the write off of $2.0
million in deferred financing charges resulting from amending the Company's
lending facilities in December, 1996.
INCOME TAXES. For 1996, income tax benefits are lower than the federal and state
statutory rates primarily due to the increase in the valuation allowance for
deferred taxes by $9.3 million. See Note 8 to notes to consolidated financial
statements.
SEASONALITY OF SALES
Sales of many products are seasonal in nature. Purchase orders for the Christmas
selling season are typically secured in the months of April, May and June so
that by the end of June, the Company has historically received orders or order
indications for a substantial majority of its full year's toy business. The
Company also offers products sold primarily in the spring and summer months
including Water Works(TM) pools, Crocodile Mile(R) water slides and other items,
which are shipped principally in the first and second quarters of the year and
counter some of this seasonality. In addition, Big Wheel(R) ride-ons, Grand
Champions(R) horses and Buddy L(R) vehicles ship
19
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year-round. Sales of holiday products are heavily concentrated in the Christmas
and Halloween shopping seasons with substantially all shipments occurring the
third and fourth quarters of the year. The Company's production generally is
heaviest in the period from June through September. Typically over 60% of toy
product revenues are generated in the second half of the year with September and
October being the largest shipping months. This was not the case in 1997,
however, due to the overall decline in sales. As a result of the seasonality, a
disproportionate amount of receivables are collected and trade credits are
negotiated in the first calendar quarter of the following year. The Company
expects that its quarterly operating results will vary significantly throughout
the year.
LIQUIDITY AND CAPITAL RESOURCES
Management responded to the circumstances which gave rise to the loss
for fiscal 1996 by, among other things, restructuring its operations,
consolidating its business units, reducing staffing levels, lowering capital
expenditures and rationalizing its product lines. In addition, a new plant
organization, including a new plant manager was put in place. Although these
efforts resulted in reduced cash outflows, the Company, prior to the preferred
stock transaction described below, had insufficient cash resources to fund its
ongoing operations. In addition, these events necessitated the Company's
negotiations with certain trade creditors and of certain amendments to its
senior loan agreement, which included, among other things, a commitment on the
part of the Company to obtain at least $6 million of additional equity
financing.
During 1997, the Company issued a total of 2,100,000 shares of Series A
preferred stock and 10,000,000 warrants. The total gross proceeds from the sale
of such securities was $21 million. Concurrently with this offering, the
Company's 9% convertible debentures were exchanged for newly-issued shares of
Series C convertible preferred stock.
See Note 7 of notes to consolidated financial statements.
The Company used all of the $18,712,000 net proceeds of the $21 million
preferred stock investment for working capital purposes, including the repayment
of some of the existing trade indebtedness and short-term bank debt. During
1997, the Company negotiated extended payouts concerning certain 1996
obligations with trade creditors.
The Company had positive operating cash flows during 1997 of $29,861,000, while
also reducing accounts payable and other liabilities by $18,318,000. Net
borrowings under bank lines were reduced by $42,614,000 from the December 31,
1996 level. These results were accomplished by converting accounts receivable
and inventory into cash, as well as the receipt of an income tax refund during
1997 of $15,600,000. Margins have improved slightly from 1996 and manufacturing
costs have been reduced. Factory operations have improved significantly since
1996, with a higher percentage of on time deliveries and a lower overhead
structure.
The net loss for 1997 was $21,130,000 as compared with a net loss of $46,201,000
for 1996. The Company's borrowing base has been reduced for several reasons: the
exiting of unprofitable product lines, the elimination of unutilized assets, and
the changing of manufacturing processes to reduce work in process inventory
levels. Despite the improvements made during 1997, the Company continues to
operate under tight cash constraints as it endeavors to pay down outstanding
liabilities remaining from 1996, as well as operate under the reduced credit
availability of its lending arrangements due to the reduction of its borrowing
base. On March 30, 1998, the secured bank facility was amended, creating greater
availability to the Company. Maximum borrowings under the facility are capped at
$60 million. Interest on the loan may increase in certain circumstances, by up
to 1/4% from current levels. Monthly principal payments on the long-term portion
of the bank facility have been reduced to $133,000 from $235,000. Covenants will
be structured based on the Company's projected operating results.
The accompanying financial statements have been prepared on a going concern
basis, which contemplates the realization of assets and the satisfaction of
liabilities in the normal course of business. The factors discussed above, among
others, may indicate that the Company will be unable to continue as a going
concern for a reasonable period of time. The financial statements do not include
any adjustments relating to the recoverability and classification of recorded
asset amounts or the amounts and classification of liabilities that might be
necessary should the Company be unable to continue as a going concern. The
Company's ability to continue as a going concern is dependent upon
20
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its ability to generate sufficient cash flow to meet its obligations on a timely
basis, and ultimately to attain profitable operations.
It is anticipated that the Tarboro plant will be further reorganized to increase
operational efficiency, reduce costs and improve gross margins. Rationalization
of the business will be an ongoing process, focused on the elimination of
products or accounts that are not profitable.
A substantial portion of the Company's shipments of its toys produced in the
United States are sold with seasonal dating terms. Payments on sales of the
Company's spring toy product lines produced domestically are generally due June
10th and payments on sales of its fall product are generally due December 10th.
Goods sourced in the Far East are primarily sold under bank letters of credit,
with most payments received within 30 days of shipment or shipped to a west
coast warehouse and sold with domestic credit terms. A substantial portion of
the Company's shipments of holiday products are made on terms that permit
payment more than 90 days after shipment of merchandise. Such shipments are
generally made after June and require payment by December 10 of the year in
which shipment is made.
Due to the seasonality of its revenues, the Company's working capital
requirements fluctuate significantly during the year. The Company's seasonal
financing requirements are highest during the fourth quarter and lowest during
the first quarter.
Marchon Toys, a subsidiary of the Company located in Hong Kong, meets its
working capital needs through two bank credit facilities which are due on
demand. Marchon Toys can borrow up to approximately $2.5 million at interest
rates ranging from 0.5% to 1.75% over the banks' prime rate. The availability of
borrowings is primarily based on Marchon Toys' accounts receivable and inventory
balances, as defined. All of Marchon Toys' assets are collateralized under the
loan agreements.
During the first quarter of 1997, the Company received its 1996 federal
income tax refund of $15.6 million which was applied to general working capital
needs.
Capital expenditures, principally for the purchase of tooling for new products
and equipment, were reduced to $900,000 for the year ended December 31, 1997
from $8.3 million for the year ended December 31, 1996.
The Company is subject to various actions and proceedings, including those
relating to intellectual property matters, environmental matters and product
liability matters. See "Legal Proceedings" and Note 11 of notes to consolidated
financial statements.
YEAR 2000 COMPLIANCE
The inability of computers, software and other equipment to recognize and
properly process data fields containing a two digit year is commonly referred to
as the Year 2000 Compliance Issue. As in the case with most companies using
computers, the Company is in the process of addressing the Year 2000 Compliance
Issue.
Due to the operational problems experienced by the Company, the Company did not
commit resources to address the Year 2000 issues until 1998. As a result, the
Company has not quantified the potential cost of Year 2000 Compliance.
The Company will utilize both internal and external resources to reprogram or
replace and test all of its software for Year 2000 compliance. The potential
costs and uncertainties associated with the Year 2000 issue will depend on a
number of factors, including software modification costs, hardware costs, and
the availability and cost of consultants.
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IMPACT OF INFLATION
The primary raw materials used in the manufacture of the Company's domestic toys
and holiday products are petrochemical derivatives, principally polyethylene.
During 1994 the price of polyethylene increased by approximately 80% from the
levels at the end of 1993, with the increases primarily occurring in the third
and fourth quarters of 1994. The Company was unable to pass along a significant
portion of the price increases during 1995. Beginning in late 1995, the price of
polyethylene declined but still remained above historical levels. During 1996
prices again rose by approximately 35%.
Polyethylene prices remained relatively stable during 1997.
Due to the time lag between the purchase of raw materials and the sale of
finished goods, results of operations may be only partially affected in the
period in which such prices change.
BACKLOG
The Company had open orders of $6.6 million and $16.3 million as of December 31,
1997 and December 31, 1996, respectively. Open orders at December 31, 1997 are
significantly lower due to the sale of the steel-walled pool business in the
fourth quarter of 1997. Orders for water slides are also reduced. Pools and
waterslides typically ship in the first and second quarters. End of year order
positions do not yet include orders for fall product lines. The Company believes
that because order patterns in the retail industry vary from time to time, open
orders on any date in a given year are not a meaningful indication of the future
sales.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.
The financial statements and supplementary data to be provided pursuant to this
Item 8 are included under Item 14 of this report.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS OR ACCOUNTING AND
FINANCIAL DISCLOSURE.
None.
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT.
Information required by this item, insofar as it relates to directors, will be
contained under the captions "Election of Directors" in the Company's definitive
Proxy Statement with respect to the Company's Annual Meeting of Stockholders,
and is hereby incorporated by reference thereto. The information relating to
executive officers of the Company is contained in Part I, Item 4 of this report.
ITEM 11. EXECUTIVE COMPENSATION.
The information required by this item will be contained in the Company's
definitive Proxy Statement with respect to the Company's Annual Meeting of
Stockholders, under the caption "Executive Compensation," and is hereby
incorporated by reference thereto.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.
The information required by this item will be contained in the Company's
definitive Proxy Statement with respect to the Company's Annual Meeting of
Stockholders, under the caption "Security Ownership of Certain Beneficial Owners
and Management," and is hereby incorporated by reference thereto.
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ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.
The information required by this item will be contained in the Company's
definitive Proxy Statement with respect to the Company's Annual Meeting of
Stockholders, under the caption "Certain Relationships and Related
Transactions," and is hereby incorporated by reference thereto.
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K.
(a) Documents filed as a part of this Report.
(1) Financial Statements:
<TABLE>
<CAPTION>
<S> <C>
Report of Independent Auditors........................................................................... F-1
Consolidated balance sheets as of December 31, 1997 and 1996............................................. F-2
Consolidated statements of operations for the years ended December 31, 1997, 1996 and 1995............... F-3
Consolidated statements of stockholders' equity for the years ended December 31, 1997, 1996
and 1995................................................................................................. F-4
Consolidated statements of cash flows for the years ended December 31, 1997, 1996 and 1995............... F-5
Notes to consolidated financial statements............................................................... F-7
Supplementary Financial Data............................................................................. F-26
(2) Financial Statement Schedules:
Report of Independent Auditors........................................................................... S-1
Schedule I -- Condensed Financial Information of Registrant.............................................. S-2
</TABLE>
The financial statement schedule should be read in conjunction with the
consolidated financial statements. Financial statement schedules not included in
this Annual Report on Form 10-K have been omitted because they are not
applicable or the required information is shown in the financial statements or
notes thereto.
(3) Exhibits filed as part of this Report:
EXHIBIT NO. DESCRIPTION
2.1 Stock Purchase Agreement dated July 29, 1988, by and among
Clabir, Clabir Corporation (California), HMW Industries, Inc.
and Olin Corporation. (1)
2.2 Agreement and Plan of Merger, dated as of November 14, 1989,
between AmBrit, Inc. ("AmBrit") and Empire of Carolina, Inc.
(the "Company"), including amendment thereto, dated as of
December 4, 1989. (2)
2.3 Agreement and Plan of Merger, dated as of November 14, 1989,
by and among the Company, Clabir Corporation ("Clabir") and
CLR Corporation, including amendment thereto, dated as of
December 4, 1989. (2)
2.4 Sale and Purchase Agreement between the Company and Cargill,
Incorporated, dated September 30, 1992.(3)
2.5 Purchase Agreement among Conopco, Inc., the Company, The
Isaly Klondike Company, Inc., The Isaly Company, Popsicle
Industries, Ltd., Ice Cream Novelties, Inc. and Smith &
O'Flaherty Limited, dated as of January 27, 1993.(4)
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EXHIBIT NO. DESCRIPTION
2.6 Agreement and Plan of Reorganization, dated October 13, 1994,
by and among the Company, Marchon, Inc. ("Marchon") and the
stockholders of Marchon.(5)
2.7 Amended and Restated Asset Purchase Agreement (the "Asset
Purchase Agreement") dated as of May 19, 1995 by and among
the Company, Buddy L Inc., Debtor-in- Possession ("Buddy L")
and Buddy L (Hong Kong) Limited ("BLHK").(6)
2.8 Agreement dated June 2, 1995 amending the Asset Purchase
Agreement, by and among the Company and Buddy L and
acknowledged and agreed to by BLHK.(7)
2.9 Second Amendment dated June 30, 1995 further amending the
Asset Purchase Agreement.(7)
2.10 Third Amendment dated July 7, 1995 further amending the Asset
Purchase Agreement. (7)
2.11 Agreement dated August 31, 1995, among the Company, CLR
Corporation, Clabir Corporation, Olin Corporation and General
Defense Corporation.(8)
3.1 Restated Certificate of Incorporation of the Company.(7)
3.2 First Amendment to Restated Certificate of Incorporation of
the Company.(9)
3.3 Amended and Restated By-Laws of the Company.(10)
3.4 Certificate of Designation of the Series B Junior
Participating Preferred Stock.(11)
3.5 Certificate of Designation Relating to Series A Preferred
Stock.(12)
3.6 Certificate of Designation Relating to Series C Preferred
Stock.(12)
4.1 Form of specimen certificate representing the Company's
Common Stock.(13)
4.2 Excerpts from the Company's amended By-Laws and the Company's
Restated Certificate of Incorporation relating to rights of
holders of the Company's Common Stock.(7)
4.3 Form of 9% Convertible Debentures, issued December 22,
1994.(14)
4.4 Form of Warrant Certificate of purchase common stock of the
Company, issued December 22, 1994.(15)
4.5 Rights Agreement, dated as of September 11, 1996, between
Empire of Carolina, Inc. and American Stock Transfer & Trust
Company as Rights Agent, which includes (i) as Exhibit A
thereto the form of Certificate of Designation of the Series
B Junior Participating Preferred Stock, (ii) as Exhibit B
thereto the form of Right certificate (separate certificates
for the Rights will not be issued until after the
Distribution Date) and (iii) as Exhibit C thereto the Summary
of Stockholder Rights Agreement.(11)
4.6 Warrant Amendment dated May 6, 1997 to Warrant Certificate
issued May 6, 1997 among the Company, HPA Associates, LLC and
EMP Associates LLC.(12)
4.7 Warrant Agreement dated as of June 17, 1997 between the
Company and the holders from time to time of the
warrants.(12)
4.8 Second Amendment dated as of June 12, 1997 to Rights
Agreement, dated as of September 11, 1996 between Empire of
Carolina, Inc. and American Stock Transfer & Trust Company as
Rights Agent.(12)
4.9 Promissory Note from the Company to Smedley Industries, Inc.
Liquidating Trust in the amount of $2,500,000.(12)
4.10 First Amendment dated as of May 5, 1997 to Rights Agreement
of September 11, 1996, between Empire of Carolina, Inc. and
American Stock Transfer and Trust Company as Rights
Agent.(16)
9.1 Voting Agreement, dated September 30, 1994, by and between
Halco Industries, Inc. ("Halco") and Steve Geller.(5)
10.1 Empire Industries, Inc. ("EII") Incentive Plant for 1993.(17)
10.2 Corporate Incentive Plant for 1993.(17)
10.3 Stock Option Agreement, dated July 15, 1994, between Steven
Geller and the Halperin Group.(5)
10.4 Stock Option Agreement, dated July 18, 1994, between the
Company and Steven Geller. (18)
10.5 Stock Option Agreement, dated July 18, 1994, between the
Company and Neil Saul.(18)
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EXHIBIT NO. DESCRIPTION
10.6 Amended and Restated 1994 Stock Option Plan of the
Company.(10)
10.7 Empire of Carolina, Inc. 1996 Outside Directors Stock Option
Plan.(19)
10.8 Empire of Carolina, Inc. 1996 Employee Stock Purchase
Plan.(19)
10.9 Employment Agreement, dated July 15, 1994, by and among the
Company, EII and Steven Geller.(18)
10.10 Employment Agreement, dated July 15, 1994, by and among the
Company, EII and Neil Saul.(18)
10.11 Employment Agreement, dated October 13, 1994, by and among
the Company, EII and Marvin Smollar.(5)
10.12 Settlement and Termination Agreement with Neil Saul.(8)
10.13 Stock Purchase Agreement, dated July 15, 1994, among Steven
Geller, Maurice A. Halperin, individually and as custodian
for the benefit of Lauren Halperin and Heather Halperin,
Carol A. Minkin, individually and as custodian for the
benefit of Joshua Minkin and Rebecca Minkin, and Halco (the
Halperins and Minkins, collectively, the "Halperin
Group").(5)
10.14 Redemption Agreement, dated September 30, 1994, by and
between the Company and the Halperin Group.(5)
10.15 Omnibus Agreement, dated September 30, 1994, by and among the
Halperin Group, Steven Geller, the Company and EII.(5)
10.16 Stockholders' Agreement, dated October 13, 1994, by and among
Steven Geller, Marvin Smollar and Neil Saul.(5)
10.17 Investor's Rights Agreement, dated October 13, 1994, by and
among the Company, Marvin Smollar, Kar Ye Yeung, Tyler
Bulkley and Harvey Katz.(5)
10.18 Stockholders' Agreement dated October 13, 1994, among Steven
Geller, Marvin Smollar and Neil Saul.(5)
10.19 Debenture Purchase Agreement, dated as of December 2, 1994,
among the Company, WPG Corporate Development Associates IV
(Overseas), Ltd., Westpool Investment Trust PLC, Glenbrook
Partners, L.P., Eugene Matalene, Jr., Richard Hockman, Weiss,
Peck & Greer, as Trustee under Nora E. Kerppola IRA, Peter B.
Pfister and Weiss, Peck & Greer, as Trustee under Craig S.
Whiting IRA and WPG Corporate Development Associates IV, L.P.
(all of such parties, other than the Company, collectively,
the "WPG Group").(20)
10.20 Registration Rights Agreement, dated as of December 22, 1994,
by and between the Company, and the WPG Group.(20)
10.21 Shareholders' Agreement, dated December 22, 1994, by and
among the WPG Group, Steven Geller, Neil Saul, Marvin Smollar
and Champ Enterprises Limited Partnership.(20)
10.22 Stock Purchase Agreement, dated as of December 22, 1994,
between WPG Corporate Development Associates IV (Overseas),
Ltd. and Steven Geller.(20)
10.23 Asset Purchase Agreement, dated as of March 3, 1995, by and
among the Company, Buddy L and BLHK.(14)
10.24 Bid Protection Agreement, dated as of March 3, 1995, between
the Company and Buddy L. (14)
10.25 Assignment and Assumption Agreement dated as of June 21, 1995
between the Company and EAC.(7)
10.26 Assignment dated as of May 22, 1995 between the Company and
Carnichi Limited.(7)
10.27 Lease dated July 7, 1995 between Buddy L and EAC.(7)
10.28 Access Agreement dated as of July 7, 1995 among Buddy L,
BLHK, Smedley Industries, Inc., Liquidating Trust ("SLM"),
and Buddy L Canada Inc., and EAC.(7)
25
<PAGE>
EXHIBIT NO. DESCRIPTION
10.29 Assignment and Assumption of Lease dated as of July 7, 1995
between Buddy L and EAC.(7)
10.30 Form of Subscription Agreement executed in connection with
subscription of Common Stock and Preferred Stock by WPG
Corporate Development Associates IV (Overseas), L. P.,
Westpool Investment Trust PLC, Glenbrook Partners, L.P., and
WPG Corporate Development Associates IV, L.P.(7)
10.31 Shareholders' Agreement ("Shareholders' Agreement") dated
December 22, 1994 among WPG Corporate Development Associates
IV, L.P., WPG Corporate Development Associates IV (Overseas),
Ltd., Weiss, Peck & Greer, as Trustee under Craig S. Whiting
IRA, Peter Pfister, Weiss, Peck & Greer, as Trustee under
Nora E. Kerppola IRA Westpool Investment Trust, PLC,
Glenbrook Partners, L.P., Steve Geller, Neil Saul, Marvin
Smollar and Champ Enterprises Limited Partnership.(21)
10.32 Amendment No. 1 to Shareholders' Agreement dated as of April
10, 1995 among WPG Corporate Development Associates IV, L.P.,
WPG Corporate Development Associates IV (Overseas), Ltd., as
the exempt transferee of WPG Corporate Development Associates
IV (Overseas), Ltd., certain persons identified on Schedule I
of Amendment No. 1 to the Shareholders' Agreement, Steven E.
Geller ("Geller"), Neil B. Saul ("Saul") and The Autumn Glory
Trust, a Cook Islands Registered International Trust
("Trust") as the permitted transferee of Champ Enterprises
Limited Partnership.
10.33 Amendment No. 2 to Shareholders' Agreement dated as of June
29, 1995 among WPG Corporate Development Associates IV, L.P.,
WPG Corporate Development Associates IV (Overseas), Ltd., as
the exempt transferee of WPG Corporate Development Associates
IV (Overseas), Ltd., certain persons identified on Schedule I
of Amendment No. 2 to the Shareholders' Agreement, Geller,
Saul and the Trust as the permitted transferee of Champ
Enterprises Limited Partnership.(7).
10.34 Registration Rights Agreement ("Registration Rights
Agreement") dated as of December 22, 1994 by and among Empire
of Carolina, Inc., WPG Corporate Development Associates IV,
L.P., WPG Corporate Development Associates IV (Overseas),
Ltd., Weiss Peck & Greer, as Trustee under Craig Whiting IRA,
Peter B. Pfister, Weiss, Peck & Greer, as Trustee under Nora
Kerppola IRA, Westpool Investment Trust PLC and Glenbrook
Partners, L.P.(21)
10.35 Amendment No. 1 to Registration Rights Agreement.(7)
10.36 Loan and Security Agreement dated May 29, 1996 among LaSalle
National Bank ("LaSalle"), BT Commercial Corporation ("BTCC")
and EII, with exhibits and security instruments.(22)
10.37 First Amendment to Amended and Restated Loan and Security
Agreement among LaSalle, BTCC, Congress Financial Corporation
(Central) ("Congress") and EII, with exhibits.(23)
10.38 Consent and Second Amendment to Loan and Security Agreement
among LaSalle, BTCC, Congress, the CIT Group/Credit Finance,
Inc. ("CIT"), Finova Capital Corporation ("Finova") and
EII.(24)
10.39 Third Amendment to Loan and Security Agreement among LaSalle,
BTCC, Congress, CIT, Finova and EII.(26)
10.40 Securities Purchase Agreement dated as of May 5, 1997 among
the Company, HPA Associates, LLC and EMP Associates, LLC.(25)
10.41 Amendment No. 1 dated as of June 5, 1997 to Securities
Purchase Agreement dated as of May 5, 1997 among the Company,
HPA Associates, LLC and EMP Associates, LLC.(12)
10.42 Buddy L Settlement Agreement, dated as of June 17, 1997
between the Company and SLM.(12)
26
<PAGE>
EXHIBIT NO. DESCRIPTION
10.43 Letter of the Company to Pellinore Securities Corp., Axiom
Capital Management, Inc. and Commonwealth Associates, Inc.
regarding the registration rights provisions affecting the
Series A Preferred Stock.(12)
10.44 Buddy L Registration Rights Agreement dated as of June 17,
1997 between the Company and SLM.(12)
10.45 WPG Registration Rights Agreement dated as of June 17, 1997
among the Company and WPG Corporate Development Associates
IV, L.P., WPG Corporate Development Associates IV (Overseas),
Ltd., Weiss, Peck & Greer, as trustee under Craig Whiting
IRA, Peter B. Pfister, Weiss, Peck & Greer as Trustee under
Nora Kerppola IRA, Westpool Investment Trust, PLC, Eugene M.
Matalene, Jr., Richard Hochman, and Glenbrook Partners, L.P.
(collectively the "WPG Affiliated Entities").(12)
10.46 WPG Release Agreement dated as of June 17, 1997 between the
Company and the WPG Affiliated Entities.(12)
10.47 Fourth Amendment to Loan and Security Agreement among
LaSalle, BTCC, Congress, CIT, Finova and EII.(31)
10.48 Fifth Amendment to Loan and Security Agreement among LaSalle,
BTCC, Congress, CIT, Finova and EII.(32)
10.49 Sixth Amendment to Loan and Security Agreement amount
LaSalle, Congress, CIT, Finova and EII.(31)
10.50 First Amendment dated January 22, 1998 to the Warrant
Agreement dated June 17, 1997 between Empire of Carolina,
Inc. and the holders from time to time of the Warrants.(31)
21 Subsidiaries of the Company.(22)
23.1 Consent of Deloitte & Touche LLP.
27 Financial Data Schedule.
99.1 Press Release dated January 16, 1997.(27)
99.2 Press Release dated February 5, 1997.(28)
99.3 Press Release dated March 31, 1997.(9)
99.4 Press Release dated April 9, 1997.(9)
99.5 Press Release dated April 23, 1997.(29)
99.6 Press Release dated May 1, 1997.(26)
99.7 Press Release dated May 5, 1997.(16)
99.8 Press Release dated May 8, 1997.(16)
99.9 Press Release dated June 19, 1997.(12)
99.10 Press Release dated June 24, 1997.(12)
99.11 Press Release dated November 21, 1997.(30)
- ----------------
(1) Previously filed as an exhibit to Clabir's Current Report on Form 8-K,
dated December 23, 1988 (File No. 1-7769) and incorporated by
reference.
(2) Previously filed as an exhibit to the Company's Registration Statement
on Form S-4 (File No. 33- 32186, dated November 17, 1989 and
incorporated by reference.
(3) Previously filed as an exhibit to the Company's Current Report on Form
8-K, dated October 6, 1992 and incorporated by reference.
(4) Previously filed as an exhibit to the Company's Current Report on Form
8-K, dated February 1, 1993 and incorporated by reference.
(5) Previously filed as an exhibit to the Company's Current Report on Form
8-K, dated September 30, 1994 and incorporated by reference.
27
<PAGE>
(6) Previously filed as an exhibit to the Company's Current Report on Form
8-K, dated May 19, 1995 and incorporated by reference.
(7) Previously filed as an exhibit to the Company's Current Report on Form
8-K, dated July 21, 1995 and incorporated by reference.
(8) Previously filed as an exhibit to the Company's Annual Report on Form
10-K for the year ended December 31, 1995 and incorporated by
reference.
(9) Previously filed as an exhibit to the Company's Annual Report on Form
10-K/A for the year ended December 31, 1996 and incorporated by
reference.
(10) Previously filed as an exhibit to Amendment No. 1 to the Company's
Annual Report on Form 10- K for the year ended December 31, 1994 and
incorporated by reference.
(11) Previously filed as an exhibit to the Company's Current Report on Form
8-K, dated September 12, 1996 and incorporated by reference.
(12) Previously filed as an exhibit to the Company's Current Report on Form
8-K, dated June 17, 1997 and incorporated by reference.
(13) Previously filed as an exhibit to the Company's Registration Statement
on Form S-1 (File No. 2- 73208), dated July 13, 1981 and incorporated
by reference.
(14) Previously filed as an exhibit to the Company's Annual Report on Form
10-K for the year ended December 31, 1994 and incorporated by
reference.
(15) Previously filed as an exhibit to the Company's Current Report on Form
8-K, dated December 22, 1994 and incorporated by reference.
(16) Previously filed as an exhibit to the Company's Current Report on Form
8-K, dated May 8, 1997 and incorporated by reference.
(17) Previously filed as an exhibit to the Company's Annual Report on Form
10-K for the year ended December 31, 1992 and incorporated by
reference.
(18) Previously filed as an exhibit to the Company's Quarterly Report on
Form 10-Q for the quarter ended June 30, 1994 and incorporated by
reference.
(19) Previously filed as an appendix to the Company's definitive Proxy
Statement filed with the Commission on August 27, 1996 and incorporated
by reference.
(20) Previously filed as an exhibit to Amendment No. 1 to Schedule 13D filed
by the WPG Group, dated December 23, 1994 and incorporated by
reference.
(21) Previously filed as an exhibit to Amendment No. 1 to Schedule 13D filed
by WPG Corporate Development Associates IV., L.P., WPG Private Equity
Partners, L. P., WPG Corporate Development Associates IV (Overseas),
L.P., WPG Private Equity Partners (Overseas), L P., Steven Hutchinson,
Wesley Lang, Peter Pfister, Craig Whiting, Nora Kerppola, Glenbrook
Partners, L.P., Prim Ventures, Inc., Westpool Investment Trust PLC and
Weiss, Peck & Greer with the Securities and Exchange Commission on
December 23, 1994, and incorporated by reference.
28
<PAGE>
(22) Previously filed as an exhibit to the Company's Registration Statement
on Form S-1 for (Reg. No. 333-4440) declared effective by the
Commission on June 25, 1996 and incorporated by reference.
(23) Previously filed as an exhibit to the Company's Current Report on Form
8-K, dated December 11, 1996 and incorporated by reference.
(24) Previously filed as an exhibit to the Company's Current Report on Form
8-K, dated February 5, 1997 and incorporated by reference.
(25) Previously filed as an exhibit to the Company's Quarterly Report on
Form 10-Q for the quarter ended March 31, 1997 and incorporated by
reference.
(26) Previously filed as an exhibit to the Company's Current Report on Form
8-K, dated May 1, 1997 and incorporated by reference.
(27) Previously filed as an exhibit to the Company's Current Report on Form
8-K, dated January 16, 1997 and incorporated by reference.
(28) Previously filed as an exhibit to the Company's Current Report on Form
8-K, dated February 5, 1997 and incorporated by reference.
(29) Previously filed as an exhibit to the Company's Current Report on Form
8-K, dated April 23, 1997 and incorporated by reference.
(30) Previously filed as an exhibit to the Company's Current Report on Form
8-K, dated November 21, 1997 and incorporated by reference.
(31) Previously filed as an exhibit to the Company's Current Report on Form
8-K, dated March 31, 1998 and incorporated by reference.
(32) Previously filed as an exhibit to the Company's Current Report on Form
8-K, dated August 25, 1997 and incorporated by reference.
(b) The following reports on Form 8-K have been filed by the Company during
the last quarter of the period covered by this report:
Form 8-K dated November 21, 1997 (hiring new Executive Vice President
and changes in the Board of Directors.)
(c) The exhibits to this Form 10-K appear following the Company's
Consolidated Financial Statements and Schedules included in this Form
10-K.
(d) The Financial Statements and Schedules to this Form 10-K begin on page
F-1 of this Form 10-K.
29
<PAGE>
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange
Act of 1934, Empire of Carolina, Inc. has duly caused this Amendment to be
signed on its behalf by the undersigned, thereunto duly authorized, on March 31,
1998.
EMPIRE OF CAROLINA, INC.
Date: March 31, 1998 By: /s/Charles S. Holmes
------------------ ---------------------
Chairman of the Board
Pursuant to the requirements of Securities Exchange Act of 1934, this report has
been signed below by the following persons on behalf of Empire of Carolina,
Inc., in the capacities and on the dates indicated.
<TABLE>
<CAPTION>
<S><C>
Signature Title Date
/s/ Steve Geller Chief Executive Officer and March 31, 1998
- ------------------------------ ---------------
Steve Geller Director
/s/ Timothy Moran President and Chief Operating March 31, 1998
- ---------------------------- --------------
Timothy Moran Officer
/s/ William H. Craig Chief Financial Officer March 31, 1998
- ------------------------------ --------------
William H. Craig
/s/ Lenore H. Schupak Director March 31, 1998
- ----------------------------- --------------
Lenore H. Schupak
/s/ James Pinto Director March 31, 1998
- ----------------------------- --------------
James Pinto
/s/ John J. Doran Director March 31, 1998
- ----------------------------- --------------
John J. Doran
/s/ Frederick W. Rosenbauer, Jr. Director March 31, 1998
- -------------------------------- --------------
Frederick W. Rosenbauer, Jr.
</TABLE>
30
<PAGE>
INDEPENDENT AUDITORS' REPORT
TO THE BOARD OF DIRECTORS OF
EMPIRE OF CAROLINA, INC.
We have audited the accompanying consolidated balance sheets of Empire of
Carolina, Inc. and its subsidiaries (the "Company") as of December 31, 1997 and
1996, and the related consolidated statements of operations, stockholders'
equity and cash flows for each of the three years in the period ended December
31, 1997. These financial statements are the responsibility of the Company's
management. Our responsibility is to express an opinion on these financial
statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, such consolidated financial statements present fairly, in all
material respects, the financial position of Empire of Carolina, Inc. and its
subsidiaries as of December 31, 1997 and 1996, and the results of their
operations and their cash flows for each of the three years in the period ended
December 31, 1997 in conformity with generally accepted accounting principles.
The accompanying consolidated financial statements have been prepared assuming
that the Company will continue as a going concern. As discussed in Note 1 to the
consolidated financial statements, the Company's recurring losses from
operations and current cash constraints raise substantial doubt about its
ability to continue as a going concern. Management's plans concerning these
matters are also described in Note 1. The consolidated financial statements do
not include any adjustments that might result from the outcome of this
uncertainty.
As discussed in Note 2 to the consolidated financial statements, the Company
adopted Statement of Financial Accounting Standards No. 121, "Accounting for the
Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed Of," in
1996.
DELOITTE & TOUCHE LLP
Raleigh, North Carolina
March 30, 1998
F-1
<PAGE>
EMPIRE OF CAROLINA, INC., AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
December 31, 1997 and 1996
(in thousands except share amounts)
<TABLE>
<CAPTION>
1997 1996
ASSETS
Current Assets:
<S> <C> <C>
Cash and cas equivilents $ 3,483 $ 478
Accounts receivable, less allowances and other
deductions (1997-$5,487; 1996-$8,777) 14,052 39,678
Inventories, net 9,933 25,115
Income taxes receivables - 13,004
Prepaid expenses and other current assets 1,980 2,142
Deferred income taxes - 2,183
--------- --------
Total current assets 29,448 82,600
Property, plant and equipment, net 14,135 24,845
Excess cost over fair value of net assets acquired, net 13,491 12,867
Trademarks, patents, tradenames and licenses, net 6,066 6,567
Other noncurrent assets 436 981
--- ---
$ 63,576 127,860
========== =======
LIABILITIES AND STOCKHOLDERS' EQUITY
Current Liabilities:
Notes payable and current portion of long-term debt $ 16,988 58,712
Convertible subordinated debentures - 14,139
Accounts payable - trade 12,317 24,783
Accrued royalties 710 1,217
Indeminification obligations related to sales of subsidiaries 919 1,263
Other accrued liabilities 9,122 12,984
----- ------
Total current liabilities 40,056 113,098
Long-Term Liabilities:
Long-term debt 6,425 7,870
Deferred income taxes - 2,183
Other noncurrent liabilities 1,642 2,938
----- -----
Total long-term liabilities 8,067 12,991
----- ------
Total liabilities 48,123 126,089
Commitments and Contingencies (Note 11)
Stockholders' Equity:
Common stock $.10 par value 60,000,000 shares authorized shares
issued and outstanding: 1997 - 7,849,000 and 196 - 7,404,000 785 740
Preferred stock, $.01 par value, 5,000,000 shares authorized
Issued and outstanding: 1997 - 2,100,000 shares of Series A
convertible preferred stock and 1,461 shares of Series C
convertible preferred stock; 1996 - 0 21 -
Additional paid-in capital 109,282 50,438
Deficit (94,635) (48,860)
Stockholders loans - (547)
------- ----
Total stockholder's equity 15,453 1,771
------ -----
$ 63,576 $127,860
======== ========
</TABLE>
See notes to consolidated financial statments.
F-2
<PAGE>
EMPIRE OF CAROLINA, INC., AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
Years Ended December 31, 1997, 1996 and 1995
<TABLE>
<CAPTION>
1997 1996 1995
(In thousands except per share amounts)
<S> <C> <C> <C>
Net Sales $ 99,516 $ 148,908 $ 153,744
Sales Distribution Settlement 2,400 - -
Cost of Sales (87,524) (133,464) (111,905)
Nonrecurring Inventory Charges -- (12,185) --
------- -------- --------
Gross Profit 14,392 3,259 41,839
Selling and Administrative Expense 24,863 41,751 36,183
Restructuring and Other Charges 3,739 8,800 7,550
------ ------ -----
Operating Loss (14,210) (47,292) (1,894)
Other Income(Expense):
Interest income, dividends and net realized gains(losses) 102 (5) 514
Interest expense (7,022) (11,236) (5,996)
-------- --------- -------
Total other income(expense) (6,920) (11,241) (5,482)
-------- --------- -------
Loss Before Income Taxes (21,130) (58,533) (7,376)
Income Tax Benefit (12,332) (2,875)
--------- -------
Net Loss (21,130) (46,201) (4,501)
Accretion of noncash preferred stock dividend (24,645)
--------
Net loss applicable to common stock $ (45,775) $ (46,201) $ (4,501)
=========== =========== =========
Loss Per Common Share -
Basic and diluted $ (6.04) $ (7.39) $ (0.96)
========= ========= ========
Weighted-average number of common shares
outstanding -
Basic and diluted 7,583 6,248 4,681
====== ====== =====
</TABLE>
See notes to consolidated financial statements.
F-3
<PAGE>
EMPIRE OF CAROLINA, INC., AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
Years Ended December 31, 1997, 1996 and 1995
(In thousands)
<TABLE>
<CAPTION>
Convertible Additional Retained Stock-
Common Stock Preferred Stock Paid-In Earnings holder
Shares Amount Shares Amount Capital (Deficit) Loans Total
------ ------ ------ ------ ------- --------- ----- -----
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Balance, January 1, 1995 4,191 $ 419 - $ - $ 18,972 $ 1,842 $ (656) $ 20,577
Net loss - - - - - (4,501) - (4,501)
Issuance of common stock in Buddy L
acquisition 757 76 - - 9,004 - - 9,080
Issuance of common stock 247 24 - - 1,770 - - 1,794
Issuance of preferred stock - - 442 4 3,202 - - 3,206
Collections on stockholder loans - - - - - - 61 61
Other capital transactions - - - - 245 - - 245
----- ----- ----- ----- ------ ------- ----- -------
Balance, December 31, 1995 5,195 519 442 4 33,193 (2,659) (595) 30,462
Net loss - - - - - (46,201) - (46,201)
Exercise of stock options and warrants 367 37 - - 2,940 - - 2,977
Issuance of common stock in public
offering 1,400 140 - - 14,345 - - 14,485
Conversion of preferred stock 442 44 (442) (4) (40) - - -
Collections on stockholder loans - - - - - 48 48
----- ----- ----- ----- ------ ------- ----- -------
Balance, December 31, 1996 7,404 740 - - 50,438 (48,860) (547) 1,771
Net loss - - - - - (21,130) - (21,130)
Issuance of common stock 250 25 - - 631 - - 656
Issuance of Series A preferred stock - - 2,100 21 18,691 - - 18,712
Issuance of Series C preferred stock
on conversion of subordinated debt - - 2 - 14,897 - - 14,897
Conversion of Series A preferred stock 195 20 - - (20) - - -
Settlement of stockholder loans - - - - - - 547
"Intrinsic" preferred stock dividend - - - - 24,645 (24,645) -
----- ----- ----- ----- ------ ------- ----- -------
Balance, December 31, 1997 7,849 $ 785 2,102 $ 21 $ 109,282 $ (94,635) $ - $ 15,453
===== ====== ====== ===== ========== ========= ==== =========
</TABLE>
See notes to consolidated financial statements.
F-4
<PAGE>
EMPIRE OF CAROLINA, INC., AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
Years Ended December 31, 1997, 1996 and 1995
<TABLE>
<CAPTION>
1997 1996 1995
<S> <C>
Cash Flows From Operating Activities:
Net loss $ (21,130) $ (46,201) $ (4,501)
Adjustments to reconcile net loss to net cash provided by(used in)
operating activities:
Depreciation and amortization 8,053 9,674 7,211
Changes in allowances for losses on assets (7,194) 12,300 1,329
Changes in allowance for deferred income taxes - 9,272 (626)
Net losses on sales of securities and property and equipment 3,650 86 3
Writedown of assets - 5,275 17
Changes in assets and liabilities, net of acquisitions and dispositions of
businesses:
Accounts receivable 28,916 4,947 (31,422)
Inventories 19,886 (2,750) (5,095)
Prepaid expenses and other current assets 162 (96) 135
Other noncurrent assets (925) 571 (58)
Accounts payable - trade (12,522) 7,267 11,436
Accrued and other liabilities (5,796) 514 (1,368)
Current and deferred income taxes 15,526 (20,338) (3,434)
Other noncurrent liabilities 1,235 (163) 1,541
------ ------ -----
Net cash provided by(used in) operating activities 29,861 (19,642) (24,832)
------- --------- --------
Cash Flows From Investing Activities:
Capital expenditures (924) (8,296) (5,750)
Acquisition of Buddy L - - (20,092)
Proceeds from sale of securities and property and equipment 505 85 2,096
Other 520 155 61
---- ---- --
Net cash provided by(used in) investing activities 101 (8,056) (23,685)
---- -------- --------
Cash Flows From Financing Activities:
Net borrowings(repayments) under lines of credit (42,349) 9,514 35,767
Proceeds from issuance of common stock - 14,485 1,794
Proceeds from stock options and warrants exercised - 2,977 -
Net proceeds from issuance of preferred stock 18,712 - 3,206
Repayments of notes payable and long-term debt (3,320) (12,193) -
Proceeds from issuance of long-term debt - 12,100 7,580
Financing costs - (1,275) -
------- ------- ------
Net cash provided by(used in) financing activities (26,957) 25,608 48,347
--------- ------- ------
Net Increase (Decrease) in Cash and Cash Equivalents 3,005 (2,090) (170)
Cash and Cash Equivalents, Beginning of Year 478 2,568 2,738
---- ------ -----
Cash and Cash Equivalents, End of Year $ 3,483 $ 478 $ 2,568
======== ====== ========
Supplemental Disclosures of Cash Flow Information:
Cash paid during the period for:
Interest $ 4,486 $ 7,806 $ 4,246
Income taxes, (net of refunds) (15,785) (1,697) 163
</TABLE>
See notes to consolidated financial statements.
F-5
<PAGE>
EMPIRE OF CAROLINA, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS - CONTINUED
YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995
NONCASH INVESTING AND FINANCING ACTIVITIES
During June 1997, the Company settled its earnout liability with the successor
to Buddy L, resulting in an increase in common stock of $25,000, additional
paid-in capital of $631,000, goodwill of $1,240,000, and earnout liability of
$993,000 and a decrease in other liabilities of $409,000.
Also during June 1997, the convertible subordinated debentures and related
discount, accrued interest and expenses were converted into 1,500 shares of
Series C preferred stock, thus increasing preferred stock by $15 and additional
paid-in capital by $14,897,000.
In 1997 and pursuant to Emerging Issues Task Force Topic No. D-60, the Company
recorded a dividend on its newly issued Series A preferred stock to reflect the
effect of a beneficial conversion feature of such stock and the concurrent
issuance of 10 million warrants. The recording of this dividend resulted in a
transfer from deficit to additional paid-in capital of $24,645,000.
On September 11, 1996, upon the approval by the stockholders of the Company, the
then outstanding shares of Series A preferred stock were converted into common
stock on a share for share basis. The conversion resulted in the issuance of
442,264 shares of common stock to the holders of Series A preferred stock.
On July 7, 1995, the Company acquired certain of the toy business assets and
assumed certain liabilities of Buddy L Inc. and its subsidiary, Buddy L (Hong
Kong) Limited, for an aggregate purchase price of $33,925,000, including
expenses, and including the issuance of (i) $4,753,000 one-year notes and (ii)
756,667 shares of common stock. The acquisition was funded as follows (in
thousands):
<TABLE>
<CAPTION>
<S> <C> <C>
Sale of common stock (247,392 shares)................................................................ $ 1,794
Sale of Series A cumulative convertible preferred stock (442,264 shares)............................. 3,206
Borrowings under line of credit...................................................................... 7,512
Borrowings under senior subordinated notes........................................................... 7,580
One-year notes issued to seller...................................................................... 4,753
Issuance of common stock to seller (756,667 shares).................................................. 9,080
---------
$33,925
</TABLE>
The components of cash used for the acquisition as reflected in the consolidated
statements of cash flows are as follows (in thousands):
<TABLE>
<CAPTION>
<S> <C>
Fair value of assets acquired........................................................................ $37,829
Liabilities assumed.................................................................................. (3,904)
One-year notes issued................................................................................ (4,753)
Common stock issued (756,667 shares)................................................................. (9,080)
---------
Cash paid in acquisition............................................................................. $20,092
=======
</TABLE>
During 1996, the Company finalized its allocation of the purchase price of the
acquisition (exclusive of the contingent earnout liability settled in 1997) by
increasing assets acquired and increasing liabilities assumed by $643,000 and
$167,000, respectively, and decreasing excess cost over fair value of net assets
acquired by $475,000.
During 1995, the Company finalized its allocation of the purchase price of
Marchon, Inc. by decreasing assets acquired and increasing liabilities assumed
by $65,000 and $461,000, respectively, and increasing excess cost over fair
value of net assets acquired by $526,000.
F-6
<PAGE>
EMPIRE OF CAROLINA, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995
SUMMARY OF BUSINESS OPERATIONS AND GOING CONCERN MATTERS
BUSINESS OPERATIONS -- Empire of Carolina, Inc. ("Empire" or the "Company") is
engaged in the design, manufacture and marketing of toys and plastic decorative
holiday products through its wholly-owned subsidiaries Empire Industries, Inc.
("Empire Industries") and Empire Toys (Hong Kong) Limited, formerly Marchon Toys
Limited ("Marchon Toys").
On July 7, 1995, two wholly-owned subsidiaries of Empire acquired certain of the
toy business assets and assumed certain liabilities of Buddy L Inc., a Delaware
corporation and a wholly-owned subsidiary of SLM International, Inc., and Buddy
L (Hong Kong) Limited, a Hong Kong corporation and a subsidiary of Buddy L Inc.
(the toy business of Buddy L Inc. and Buddy L (Hong Kong) Limited, collectively
referred to as "Buddy L"). The acquisition of Buddy L is discussed in Note 4.
The Company's 1996 business plan required it to significantly ramp up production
during the third quarter to meet peak seasonal demand. At the same time,
transfer of the production of acquired Buddy L products, from Buddy L's
facilities in Gloversville, NY, to Tarboro, NC, was in its final stages. In
addition, production equipment included with the acquisition, as well as new
equipment acquired to meet the expanded production schedule, was being
installed. Difficulties associated with integrating the manufacture of Buddy L
products, including the influx of transferred product and machines, lead to
product damage, loss of production efficiency and missed shipping deadlines. The
situation was exacerbated by the loss of the Plant Manager due to a critical
illness, delays in installation and start- up of production equipment and delays
resulting from two hurricanes. Primarily as a result of these circumstances, the
Company incurred a net loss of $46,201,000 and had negative operating cash flows
of $19,642,000 during 1996.
In 1997, in response to the Company's financial needs, the Company issued a
total of 2,100,000 shares of Series A preferred stock and 10,000,000 warrants
(Note 9). The total net proceeds from the sale of such securities was $18.7
million. Concurrently with this offering, the Company's 9% convertible
debentures were exchanged for newly-issued shares of Series C convertible
preferred stock. In connection with this private offering, Charles S. Holmes was
elected to replace Steven Geller as Chairman of the Board, and the Series A
preferred stock received the right to designate two directors and is entitled to
vote on all matters presented to the stockholder, on an as if converted basis.
The Company had positive operating cash flows during 1997 of $29,861,000, while
also reducing accounts payable and other liabilities by $18,318,000. Net
borrowings under bank lines were reduced by $42,614,000 from the December 31,
1996 level. These results were accomplished by converting accounts receivable
and inventory into cash, as well as the receipt of an income tax refund during
1997 of $15,600,000. Margins have improved slightly from 1996 and manufacturing
costs have been reduced. Factory operations have improved significantly since
1996, with a high percentage of on time deliveries and a lower overhead
structure.
The net loss for 1997 was $21,130,000 as compared with a net loss of $46,201,000
for 1996. The Company's borrowing base has been reduced for several reasons: the
exiting of unprofitable product lines, the elimination of unutilized assets, and
the changing of manufacturing processes to reduce work in process inventory
levels. Despite the improvements made during 1997, the Company continues to
operate under tight cash constraints as it endeavors to pay down outstanding
liabilities remaining from 1996, as well as operate under the reduced credit
availability of its lending arrangements due to the reduction of its borrowing
base. Effective March 30, 1998, the bank lenders under the Company's secured
credit facility have agreed to certain amendments to the facility which provide
additional availability during the Company's peak production periods, but which
require that such additional funds be repaid by year end.
F-7
<PAGE>
1. SUMMARY OF BUSINESS OPERATIONS AND GOING CONCERN MATTERS - CONTINUED
The accompanying financial statements have been prepared on a going concern
basis, which contemplates the realization of assets and the satisfaction of
liabilities in the normal course of business. The factors discussed above, among
others, may indicate that the Company will be unable to continue as a going
concern for a reasonable period of time. The financial statements do not include
any adjustments relating to the recoverability and classification of recorded
asset amounts or the amounts and classification of liabilities that might be
necessary should the Company be unable to continue as a going concern. The
Company's ability to continue as a going concern is dependent upon its ability
to generate sufficient cash flow to meet its obligations on a timely basis, and
ultimately to attain profitable operations.
It is anticipated that the Tarboro plant will be further reorganized to increase
operational efficiency, reduce costs and improve gross margins. Rationalization
of the business will be an ongoing process, focused on the elimination of
products or accounts that are not profitable.
2. SIGNIFICANT ACCOUNTING POLICIES
PRINCIPLES OF CONSOLIDATION -- The consolidated financial statements include the
accounts of the Company and all of its majority-owned subsidiaries after
elimination of intercompany accounts and transactions.
CASH AND CASH EQUIVALENTS -- Cash and cash equivalents include all highly liquid
investments having an original maturity of three months or less.
INVENTORIES - Inventories are stated at lower of cost or net realizable value.
Cost is determined on a first-in, first out ("FIFO") basis.
PROPERTY -- Property is stated at original cost, reduced for any identified
long-term impairments, and includes expenditures for major betterments and
renewals. Depreciation is recorded over the estimated useful lives of the assets
using straight-line or accelerated methods. Assets lives by property types are
as follows:
<TABLE>
<CAPTION>
<S> <C>
Buildings and improvements........................................................................ 10-35 years
Machinery and equipment........................................................................... 5-10 years
Molds............................................................................................. 1-3 years
Furniture and fixtures............................................................................ 7-10 years
Computer equipment................................................................................ 3-5 years
</TABLE>
DEBT ISSUE COSTS -- The costs related to the issuance of debt are capitalized
and amortized to interest expense using the effective interest method over the
lives of the related debt. Such amounts are included in other current and
noncurrent assets in the consolidated balance sheets.
SALES -- Sales generally are recorded by the Company when products are shipped
to customers. Sales are recorded net of anticipated returns, discounts and
allowances.
During 1997, the Company received a $2.4 million settlement upon termination of
an international sales distribution agreement.
RESEARCH AND DEVELOPMENT -- Research and development costs, included in selling
and administrative expenses (1997 - $1,244,000; 1996 -- $3,225,000; 1995 --
$2,984,000), are expensed as incurred.
F-8
<PAGE>
EMPIRE OF CAROLINA, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
2. SIGNIFICANT ACCOUNTING POLICIES - CONTINUED
DEFERRED INCOME TAXES -- Deferred income taxes are accounted for in accordance
with Statement of Financial Accounting Standards ("SFAS") No. 109, "Accounting
for Income Taxes." Deferred income taxes (benefits) are provided on temporary
differences between the financial statement carrying values and the tax basis of
assets and liabilities.
IDENTIFIABLE AND UNIDENTIFIABLE INTANGIBLE ASSETS -- Excess of cost over fair
value of net assets acquired relating to the Company's acquisitions of Marchon
and Buddy L are being amortized on a straight-line basis over a period of twenty
years. Amortization expense for 1997, 1996 and 1995 was $833,000, $832,000, and
$641,000, respectively. Accumulated amortization at December 31, 1997 and 1996
was $2,410,000 and $1,577,000, respectively. In June 1997, the Company settled
its contingent five-year earnout liability related to the Buddy L acquisition,
resulting in an adjustment of the purchase price and a corresponding increase of
the excess of cost over fair value of net assets acquired of $1,240,000, which
amount is being amortized over the remaining useful life (see Note 4).
Patents, trademarks, trade names, and licensing agreements represent assets
acquired relating to the Company's acquisitions of Marchon and Buddy L and are
carried at fair market value on the date of acquisition less accumulated
amortization. These assets are being amortized on a straight-line basis over
their estimated useful lives, which range from one to fifteen years.
Amortization expense for 1997, 1996 and 1995 was $501,000, $686,000, and
$1,091,000, respectively. Accumulated amortization at December 31, 1997 and 1996
was $2,478,000 and $1,977,000, respectively.
During 1996, the Company adopted SFAS No. 121, "Accounting for the Impairment of
Long-Lived Assets and for Long-Lived Assets to be Disposed Of." Accordingly,
long-lived assets are reviewed for impairment, generally on a product line by
product line basis; whenever events or changes in circumstances indicate that
the carrying amount of an asset may not be recoverable. If an evaluation is
required, the projected future cash flows attributable to each product line are
compared to the carrying value of the long-lived assets (including an allocation
of goodwill, if appropriate) of that product line to determine if a write-down
to fair value is required. The Company also evaluates the remaining useful lives
to determine whether events and circumstances warrant revised estimates of such
lives (see Note 3).
FOREIGN CURRENCY -- The financial position and results of operations of Marchon
Toys are measured using local currency as the functional currency. Foreign
currency assets and liabilities are translated into their U.S. dollar
equivalents based on rates of exchange prevailing at the end of each respective
year. Revenue and expense accounts are translated at prevailing exchange rates
during the year. Gains and losses resulting from foreign currency translation
are accumulated as a separate component of stockholders' equity. Transactions in
foreign currencies are translated at the rates in effect on the dates of the
transactions.
ACCOUNTING FOR STOCK-BASED COMPENSATION -- The Company accounts for employee
stock compensation in accordance with Accounting Principles Board Opinion
("APB") No. 25, "Accounting for Stock Issued to Employees." Under APB No. 25,
the total compensation expense is equal to the difference between the award's
exercise price and the intrinsic value at the measurement date, which is the
first date that both the exercise price and number of shares to be issued is
known. SFAS No. 123, "Accounting for Stock-Based Compensation," became effective
January 1, 1996. SFAS No. 123 requires expanded disclosures of stock-based
compensation arrangements with employees and encourages (but does not require)
compensation cost to be measured based on the fair value of the equity
instrument awarded. Companies are, however, permitted to continue to apply APB
No. 25. The Company has elected to continue to apply APB No. 25 for accounting
purposes of stock-based compensation awards to employees and discloses the
required pro forma effect on net income and earnings per share and other
information required by SFAS No. 123.
F-9
<PAGE>
EMPIRE OF CAROLINA, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
2. SIGNIFICANT ACCOUNTING POLICIES - CONTINUED
EARNINGS PER SHARE -- In 1997, the Company adopted SFAS No. 128, "Earnings Per
Share." SFAS No. 128 establishes standards for computing and presenting earnings
per share ("EPS") and simplifies the standards for computing earnings per share
previously found in APB Opinion No. 15, "Earnings Per Share" making them
comparable to international EPS standards. It replaces the presentation of
primary EPS with a presentation of basic EPS which is based on the
weighted-average shares of common stock. It also requires dual presentation of
basic and diluted EPS on the face of the income statement for all entities with
complex capital structures and requires a reconciliation of the numerator and
denominator of the basic EPS computation to the numerator and denominator of the
diluted EPS computation. Earnings per share for all periods presented have been
restated to conform to the requirements of SFAS No. 128.
All of the Company's options, warrants, convertible securities and contingently
issuable shares are excluded from basic and diluted earnings per share because
they are anti-dilutive. For purposes of calculating EPS for the year ended
December 31, 1997, "intrinsic" dividends of $24,645,000 representing the
accretion of discounts on the Series A preferred stock and warrants issued, have
been included in the computation (Note 9).
USE OF ESTIMATES -- The preparation of the financial statements in conformity
with generally accepted accounting principles requires management to make
estimates and assumptions that affect the reported amounts of assets and
liabilities and disclosure of contingent assets and liabilities at the date of
the financial statements and the reported amounts of revenues and expenses
during the period. Actual results could differ from those estimates.
RECLASSIFICATIONS -- Certain amounts for 1996 and 1995 have been reclassified to
conform to 1997 presentation.
3. NONRECURRING INVENTORY AND RESTRUCTURING AND OTHER CHARGES
NONRECURRING INVENTORY CHARGES -- During 1996, difficulties experienced at the
Company's Tarboro, NC plant, resulted in significant nonrecurring costs related
to inventory. These costs included the excess cost of temporarily outsourcing
production of certain products and an increase in scrap and damaged inventory at
the Tarboro plant. In addition, the Company determined that a substantial amount
of work in process and parts inventory, obtained as part of the Buddy L
acquisition, was no longer usable. Furthermore, the Company decided to
discontinue the production and sale of certain toys marketed under the Empire,
Marchon or Buddy L names. These nonrecurring inventory charges are summarized as
follows (in thousands):
<TABLE>
<CAPTION>
1996
----
<S> <C>
Provisions for, or write-offs of unsaleable, scrapped and damaged inventories.................... $9,285
Costs related to outsourcing certain production.................................................. 2,400
Write-offs of inventories associated with discontinued product lines............................. 500
------
Total............................................................................................ $12,185
=======
</TABLE>
RESTRUCTURING AND OTHER CHARGES -- During 1997, the Company determined that a
substantial amount of machinery, equipment and molds, much of which was received
during the acquisition of Buddy L (see Note 4), was no longer necessary to
support the current product line or future operations. Such assets disposed of,
or being held for sale, were written off with a charge of $3,531,000.
Also during 1997, the Company decided to dispose of the steel-walled pool
product line acquired in the Buddy L acquisition. Assets, primarily inventory,
machinery and equipment, with a book value of $3,243,000 were sold, resulting in
a loss of $1,008,000 of which $800,000 is included in cost of sales. Of the
sales price, $135,000 was
F-10
<PAGE>
EMPIRE OF CAROLINA, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
3. NONRECURRING INVENTORY AND RESTRUCTURING AND OTHER CHARGES - CONTINUED
received in cash, and $2,100,000 is included in accounts receivable, secured by
a letter of credit payable monthly at $350,000 per month through June 1998.
The restructuring costs and other charges incurred during the year ended
December 31, 1996, resulted from actions taken in response to the reduction in
operating margins experienced. The Company had restructured its operations and
reduced costs by eliminating administrative and manufacturing jobs and
curtailing non-essential spending. The Company has also provided additional
amounts for costs related to (i) exiting the Gloversville, New York facility,
(ii) lease termination costs for duplicate facilities and (iii) chargebacks by
customers for late or missed shipping dates. Additionally, a review of the
carrying value of long-lived and intangible assets related to the discontinued
products has been made in accordance with SFAS No. 121, "Accounting for the
Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed Of."
Based on this evaluation, the Company wrote off patents, trademarks and trade
names associated with the discontinued products, including a pro-rata portion of
goodwill attributed to them.
The restructuring costs incurred during the year ended December 31, 1995, were
related primarily to the acquisitions of Buddy L and Marchon and included the
cost of (i) relocation of production from the Gloversville, New York facility,
(ii) establishing a corporate headquarters in Delray Beach, Florida, (iii)
employee severance costs and (iv) lease termination cost of duplicate
facilities. Substantially all restructuring and other charges as of December 31,
1997 have been expended. Restructuring costs and other charges for the years
ended December 31, 1997, 1996 and 1995 are summarized as follows (in thousands):
<TABLE>
<CAPTION>
1997 1996 1995
Restructuring Charges:
<S> <C> <C> <C>
Employee severance costs.................................................. $ -- $1,100 $ 783
Relocation of Buddy L operations to Tarboro, NC........................... -- 2,000 4,200
Cost of establishing a corporate headquarters in Delray Beach, FL......... -- 2,267 300
Lease termination costs for duplicate facilities.......................... -- 400 300
Impairment of long-lived assets related to discontinued product lines,
including pro-rata portion of goodwill.................................... 3,531 4,000 --
Loss of disposition of product lines........................................ 208 -- --
Other:
Provision for chargebacks by customers for late or missed shipping
deadlines................................................................ -- 1,000 --
Miscellaneous............................................................. -- 300 --
------ ------- ----------
Total ($3,739,000, $1,300,000 and $6,451,000 incurred in the fourth
quarters of 1997, 1996, and 1995, respectively).......................... $ 3,739 $8,800 $7,550
====== ====== ======
</TABLE>
4. ACQUISITION OF BUDDY L
On July 7, 1995, two subsidiaries of the Company acquired certain of the toy
business assets and assumed certain liabilities of Buddy L. The purchased assets
comprise the former toy manufacturing, design and marketing business of Buddy L.
The consideration for the acquisition included the following: (i) 756,667 shares
of the Company's common stock (and up to 454,000 shares of common stock as price
protection in the event Buddy L sells the aforementioned received common stock
under certain circumstances between July 7, 1996 and December 31, 1997
F-11
<PAGE>
EMPIRE OF CAROLINA, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
4. ACQUISITION OF BUDDY L - CONTINUED
for less than $12.00 per share); (ii) approximately $15,600,000 in cash and
$4,753,000 of one-year 10% notes issued to Buddy L for the purchase of domestic
and Canadian inventory and receivables; and (iii) a five-year earnout, as
defined. Buddy L also received certain demand and "piggyback" registration
rights with respect to the Company's common stock.
In June 1997, the Company and Smedley Industries, Inc. Liquidating Trust, the
successor to Buddy L, entered into an agreement where the Company was released
of certain claims to earnout, price protection and registration rights in
exchange for: (i) $100,000 in cash; (ii) 250,000 shares of Common stock of the
Company; (iii) a $2.5 million 9% note from the Company's major subsidiary, and
guaranteed by the Company, providing for $625,000 principal payments on the
first four anniversaries of the June 18th closing date of the Initial
Investment, (which note includes certain affirmative and negative covenants
which could in certain circumstances permit the acceleration of payments with
respect to such note); and (iv) certain other benefits, including registration
rights. As a result of this settlement, common stock, additional paid-in
capital, goodwill and accrued liabilities were increased by $25,000, $631,000,
$1,240,000 and $584,000, respectively.
5. INVENTORIES
A summary of inventories, by major classification, at December 31, 1997 and 1996
is as follows (in thousands):
<TABLE>
<CAPTION>
1997 1996
---- ----
<S> <C> <C>
Finished goods........................................................................... $7,336 $11,864
Raw materials and purchase parts......................................................... 1,990 8,658
Work-in-process.......................................................................... 607 4,593
-------- ---------
$9,933 $25,115
</TABLE>
Inventories are net of writedowns for estimated obsolescence and lower of cost
or market reserves of $7,050,000 and $10,954,000 at December 31, 1997 and 1996,
respectively.
6. PROPERTY, PLANT AND EQUIPMENT, NET
Property, plant and equipment at December 31, 1997 and 1996 consists of the
following (in thousands):
<TABLE>
<CAPTION>
1997 1996
---- ----
<S> <C> <C>
Land..................................................................................... $ 223 $ 223
Buildings and improvements............................................................... 11,639 11,716
Machinery and equipment.................................................................. 18,883 26,176
Molds.................................................................................... 8,412 18,279
Furniture and fixtures................................................................... 190 747
-------- --------
Total.................................................................................... 39,347 57,141
Less accumulated depreciation............................................................ 25,212 32,296
------ ------
Property, plant and equipment, net....................................................... $14,135 $24,845
======= =======
</TABLE>
F-12
<PAGE>
EMPIRE OF CAROLINA, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
7. NOTES PAYABLE AND LONG TERM DEBT
The following table summarizes notes payable and long-term debt as of December
31, 1997 and 1996 (in thousands):
<TABLE>
<CAPTION>
1997 1996
<S> <C> <C>
Lines of credit.................................................................. (a) $13,540 $55,372
Bank term note................................................................... (a) 7,370 10,690
Four- year note issued for Buddy L earnout....................................... (b) 2,500 --
Hong Kong facilities............................................................. (c) 3 520
9% convertible subordinated debentures........................................... (d) -- 14,139
------- ------
23,413 80,721
Less notes payable and current portion of long-term debt......................... 16,988 72,851
------ ------
Total long-term debt............................................................. $ 6,425 $ 7,870
======== ========
</TABLE>
(a) In May 1996, Empire Industries entered into a secured bank facility
which provided up to $85,000,000 in financing. The facility is for a
three-year term at an interest rate of prime plus 1% or LIBOR plus 275
basis points. Of the $85,000,000, $12,100,000 is in the form of a
three-year term loan which requires monthly principal payments of
$235,000. The balance of the availability of borrowings under the
facility is based on, and secured by, the Company's domestic accounts
receivable and inventory balances as defined, less outstanding
commitments under letters of credit ($701,000 at December 31, 1997). The
collateral under the loan agreement is substantially all of the domestic
assets of Empire Industries, including all machinery, equipment, real
property, accounts receivable, inventories and intangible assets; and
65% of the common stock of Marchon Toys.
The facility was first amended in December 1996. The first amendment
increased the interest rate to prime plus 1.75% (10.25% at December 31,
1997) and eliminated the LIBOR option. The amendment provided for
changes in certain terms, including certain formulas used to calculate
the eligible loan base, and required the Company to obtain an additional
$6 million equity investment no later than April 30, 1997, which date
was ultimately extended to June 30, 1997 by the third and fourth
amendments. The first amendment enabled the Company to borrow up to
$4,000,000 against its 1996 income tax refund.
In February 1997, the Company entered into a second amendment with
respect to its $85,000,000 secured bank facility. Maximum borrowings
under the amendment were reduced to $75,000,000. Actual availability of
borrowings under the amendment is based on and secured by the Company's
domestic accounts receivable, inventory, property, plant and equipment
as defined by the amendment. In addition, certain financial covenants,
including tangible net worth, interest coverage, and weekly cash
availability, as defined, were amended. An additional $4,500,000,
secured by the Company's Federal income tax receivable was made
available to the Company to fund working capital requirements. The
Company incurred a fee of $1,687,500 for the amendment. Of the
$1,687,500 fee, $187,500 was paid in February 1997 and the balance is
payable in quarterly installments in 1998 or earlier under certain
circumstances.
In August 1997, the Company entered into an amendment of the secured
bank facility which eliminated certain covenants and waived others.
On March 30, 1998, the secured bank facility was amended, creating
greater availability to the Company. Maximum borrowings under the
facility are capped at $60 million. Interest on the loan may increase in
certain circumstances, by up to 1/4% from current levels. Monthly
principal payments on the long-term portion of the bank facility have
been reduced to $133,000 from $235,000.
F-13
<PAGE>
EMPIRE OF CAROLINA, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
7. NOTES PAYABLE AND LONG TERM DEBT - CONTINUED
(b) In June 1997, Empire Industries issued a $2.5 million 9% note,
guaranteed by the Company, to the successor to the seller under the
Company's agreement to purchase the assets of Buddy L, in partial
settlement of their claim to certain earnout, price protection and
registration rights. The note provides for four $625,000 annual
principal payments, plus quarterly interest payments, and includes
certain affirmative and negative covenants which could in certain
circumstances permit the acceleration of payments with respect to the
note.
(c) Marchon Toys meets its working capital needs through a bank credit
facility which is due on demand. Under the loan agreement, Marchon Toys
can borrow up to $2,597,000 at interest rates ranging from .5% to 1.50%
over the bank's best lending rates (10% to 11% at December 31, 1997).
The availability of borrowings under the loan agreement is based on
Marchon Toys' eligible accounts receivable and inventory balances, as
defined. All of Marchon Toys' assets are collateral under the loan
agreement.
(d) On December 22, 1994, the Company issued 9%, five-year subordinated
debentures in the aggregate principal amount of $15,000,000, convertible
into an aggregate of up to 2,000,000 shares of the Company's common
stock at $7.50 per share. Concurrent with and dependent upon the closing
of the debenture financing, the Company issued warrants to purchase an
additional 1,000,000 shares of common stock at an exercise price of
$7.50 per share, which expired in 1997. The proceeds from the debenture
financing were allocated between the debentures and the warrants based
on fair values. On December 31, 1996, the Company did not make the
quarterly interest payments on the debentures and was not in compliance
with certain financial covenants. As a result, the convertible
subordinated debentures were classified as current on the consolidated
balance sheet at December 31, 1996. In June 1997, the 9% subordinated
debentures were exchanged by the holders thereof for 1,500 newly-issued
shares of the Company's Series C preferred stock with an aggregate
stated value of $15,000,000. The debenture holders also released, among
other things, their claim to accrued and unpaid interest, fees and
expenses. (See Note 9.)
Long-term debt is carried net of any related discount or premium.
Certain of the Company's debt arrangements contain requirements as to the
maintenance of minimum levels of working capital, leverage ratios and tangible
net worth, and prohibit the Company from paying dividends. Also, certain of the
debt arrangements contain various security interests and restrictive covenants
which limit the ability of the subsidiaries to loan, advance and dividend
substantially all of their net assets. At December 31, 1997, the company was not
in compliance with respect to the tangible net worth requirement, as defined,
contained in its $75,000,000 secured bank facility. On March 30, 1998, the
Company entered into an amended facility whereby maximum borrowings under the
facility have been reduced to $60,000,000. The various loan covenants, including
the tangible net worth requirement, have been amended based on the Company's
current and projected operating results. Consequently, the instance of
noncompliance has been cured as of March 30, 1998. All property, plant and
equipment, with a net book value of approximately $14,135,000 at December 31,
1997, and inventories and accounts receivable (approximately $23,985,000 at
December 31, 1997) have been pledged as collateral for the Company's
indebtedness.
Principal maturities of notes payable and long-term debt are as follows (in
thousands):
<TABLE>
<CAPTION>
<S> <C>
1998................................................................................................. $16,988
1999................................................................................................. 5,175
2000................................................................................................. 625
2001................................................................................................. 625
</TABLE>
F-14
<PAGE>
EMPIRE OF CAROLINA, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
8. INCOME TAXES
The balances of deferred income tax assets and liabilities at December 31, 1997
and 1996 are as follows (in thousands):
<TABLE>
<CAPTION>
1997 1996
------ ------
Current deferred income tax assets relate to:
<S> <C> <C>
Reserves for indemnification obligations of companies sold............................. $ 271 $ 276
Accruals to related parties............................................................ 128 354
Other accruals not currently deductible................................................ 1,033 2,292
Inventories............................................................................ 3,047 4,465
Allowance for accounts receivable...................................................... 722 1,310
Prepaid assets relating to common stock warrants....................................... -- 77
Other.................................................................................. 444 333
------ -----
5,645 9,107
Less valuation allowance................................................................. 5,645 6,924
------- ------
Net current deferred tax assets.......................................................... $ -- $ 2,183
======= =======
Noncurrent deferred income taxes assets (liabilities) relate to:
Basis in the stock of a majority-owned subsidiary...................................... $3,472 $ 3,472
Net operating loss carryfowards........................................................ 12,707 2,613
Accruals and reserves not currently deductible......................................... 586 490
Basis and depreciation differences..................................................... (2,063) (2,663)
Other.................................................................................. (72) (80)
--------- --------
14,630 3,832
Less valuation allowance................................................................. 14,630 6,015
--------- --------
Net noncurrent deferred tax liability.................................................... $ -- $ (2,183)
========= ========
</TABLE>
The components of income tax expense (benefit) for the years ended December 31,
1997, 1996 and 1995 are as follows (in thousands):
<TABLE>
<CAPTION>
1997 1996 1995
Current income taxes (benefits):
<S> <C> <C> <C>
Federal..................................................................... $ -- $(15,845) $(1,792)
State....................................................................... -- (1,821) (260)
---------- ---------- --------
Total current income taxes (benefits)......................................... -- (17,666) (2,052)
Deferred income taxes (benefits).............................................. -- 5,334 (823)
---------- ---------- --------
Total......................................................................... $ -- $(12,332) $(2,875)
========== ======== =========
</TABLE>
F-15
<PAGE>
EMPIRE OF CAROLINA, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
8. INCOME TAXES - CONTINUED
The following is a reconciliation of income tax expense (benefit) to that
computed by applying the federal statutory rate of 34% to income (loss) before
income taxes for the years ended December 31, 1997, 1996 and 1995 (in
thousands):
<TABLE>
<CAPTION>
1997 1996 1995
<S> <C> <C> <C>
Federal tax (benefit) at the statutory rate..................................... $ (7,180) $(19,901) $(2,508)
Equity earnings (loss) of foreign subsidiary.................................... 110 (88) (203)
Amortization of goodwill........................................................ 209 576 187
Change in valuation allowance................................................... 7,336 9,272 (626)
State income taxes, net of federal tax benefit.................................. -- (1,821) (369)
Other........................................................................... (475) (370) 644
---------- --------- ----------
Total........................................................................... $ -- $(12,332) $(2,875)
========== ========= ========
</TABLE>
The Company files a consolidated federal income tax return with its subsidiaries
for any period that it possesses the required ownership. On December 30, 1993,
the Company sold 25% of the common stock of CLR Corporation ("CLR"), previously
a wholly-owned subsidiary of the Company. Effective on this date, CLR was no
longer included in the Company's consolidated federal income tax return.
Management has determined, based on the Company's recent history of earnings and
alternative tax strategies that the Company's future earnings may not be
sufficient to recognize its net deferred tax assets. Accordingly, the Company
increased its valuation allowance to approximately $20,275,000 and $12,939,000
at December 31, 1997 and 1996, respectively.
The Company's federal net operating loss carryfowards at December 31, 1997 of
approximately $28 million expire in 2012. State economic loss carryfowards at
December 31, 1997 expire at various years through 2012.
The Company is currently involved in a federal and various state income tax
audits. The Company believes it has adequate reserves for the potential impact
of such audits.
9. STOCKHOLDERS' EQUITY
CAPITAL STOCK -- The Company has 65,000,000 shares of capital stock authorized,
comprised of (i) 60,000,000 shares of common stock, $.10 par value and (ii)
5,000,000 shares of preferred stock, $.01 par value. In 1995, the Board of
Directors designated 442,264 shares of preferred stock as Series A cumulative
convertible preferred stock (with a stated liquidation value of $7.25 per share)
and, as of December 31, 1995, 442,264 shares of Series A cumulative convertible
preferred stock were issued and outstanding. On September 11, 1996, upon the
approval by the stockholders of the Company, the then outstanding shares of
Series A preferred stock were converted into common stock on a share for share
basis. The conversion resulted in the issuance of 442,264 shares of common stock
to the holders of Series A preferred stock. The holders of Series A preferred
were not entitled to receive any dividend during the period such shares were
outstanding.
On June 25, 1996, the Company sold 1,400,000 shares of its common stock in a
public offering (the "Offering") which resulted in net proceeds to the Company
of approximately $17,396,000 (including proceeds to the Company upon the
exercise by certain selling stockholders of stock options and warrants to
acquire 356,100 shares of common stock).
F-16
<PAGE>
EMPIRE OF CAROLINA, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
9. STOCKHOLDERS' EQUITY - CONTINUED
On June 17, 1997, pursuant to the Securities Purchase Agreement, the Company
issued to HPA Associates, LLC ("HPA") and EMP Associates LLC ("EMP), and other
accredited investors, 1,100,000 shares of the Company's Series A preferred
stock, $.01 par value per share, $10 face value per share (the "Series A
preferred stock") and 5,000,000 warrants to purchase shares of the Company's
common stock, $.10 par value per share. The Series A preferred stock bears no
dividend, is convertible into common stock at an initial conversion price of
$1.25 per share (subject to anti-dilution adjustment in certain circumstances),
has the right to designate two members of the Board of Directors and is entitled
to vote on all other matters presented to stockholders on an as if converted
basis. Each warrant has a six-year term and entitles the holder thereof to
purchase one share of common stock at an initial exercise price of $1.375 per
share (subject to anti-dilution adjustment in certain circumstances) and is
callable by the Company in certain circumstances. On June 18, 1997, the Company
issued to HPA and other accredited investors an additional 500,000 shares of the
Series A preferred stock and an additional 2,500,000 warrants. The gross
proceeds from the June 17 and June 18, 1997 transactions was $16 million.
In June 1997, the Company issued 1,500 shares of Series C preferred stock with
an aggregate Stated Value (as defined in the Series C preferred stock
certificate of designation) of $15 million in exchange for the retirement of the
Company's $15 million 9% convertible debentures. Each share of Series C
preferred stock is convertible at any time, at the option of the holder thereof,
into fully paid and nonassessable shares of common stock at a rate of one share
of common stock for each $2.00 of Stated Value of Series C preferred stock
(subject to adjustment in certain circumstances). Except as otherwise expressly
provided in the Charter or the By-laws of the Company, the Certificate of
Designation relating to the Series C preferred stock, or as may otherwise be
required by law, the Series C Stockholders, by virtue of their ownership
thereof, have no voting rights.
On October 10, 1997, following shareholders approval at the annual meeting, the
Company completed the sale of an additional $5 million in securities, by issuing
500,000 shares of Series A preferred stock and warrants to purchase shares of
the Company's common stock upon the same terms and conditions as the sale of the
1.6 million shares of Series A preferred stock and warrants completed in June.
The Company received gross consideration of $5 million for the sale of these
securities, bringing the total gross proceeds from the sale of Series A
preferred stock and warrants to $21 million.
The staff of the Securities and Exchange commission ("SEC") has issued an
announcement regarding accounting for the issuance of convertible preferred
stock and debt securities. The announcement dealt with, among other things, the
belief by the SEC staff that the issuance of convertible preferred stock that
contains a beneficial conversion feature should be recognized and measured by
allocating a portion of the proceeds equal to the intrinsic value of that
feature to additional paid in capital, and that any discount resulting from such
allocation is analogous to a dividend and should be recognized as a return to
the preferred shareholders. The SEC position is discussed in Emerging Issues
Task Force Topic D-60, "Accounting for the Issuance of Convertible Preferred
Stock and Debt Securities with a Non-detachable Conversion Feature," issued in
May 1997.
Under this accounting treatment, the intrinsic value of the beneficial
conversion feature of the Series A preferred stock issued in the second and
fourth quarters of 1997, as well as a discount resulting from the concurrent
issuance of detachable warrants, totaling $24,645,000, has been reflected in the
consolidated financial statements as preferred dividends. The dividends on the
Series A preferred stock, representing the accretion of these issuance
discounts, are considered in the calculation of net loss per share. These
dividends have no effect on the net loss of the Company or on its cash flows.
To the knowledge of the Company, no purchaser of the Series A preferred stock
and warrants beneficially owns securities representing 10% or more of the voting
power on matters to be presented to the Company's stockholders.
F-17
<PAGE>
9. STOCKHOLDERS' EQUITY - CONTINUED
If however, the individual Purchasers of the preferred stock and warrants were
to vote together as a group, the transaction could be deemed to have resulted in
a change in control of the Company.
DIVIDENDS - The Company has not paid any cash dividends in 1997, 1996 or 1995.
STOCK OPTIONS -- The Company currently has three stock option plans: the Amended
and Restated 1994 Stock Option Plan (the "1994 Plan"); the 1996 Employee Stock
Purchase Plan (the "1996 Plan") and the Non-Employee Stock Option Plan (the
"Directors Plan"). Options to acquire shares of the Company's common stock under
the 1994 Plan are granted to key employees or consultants at prices equal to the
market price at the close of the market on the date of the grant. Vesting of
options under the 1994 Plan is determined by the Compensation Committee at the
time of the grant, and has generally been set at two to four years. The 1996
Plan, although authorized by the shareholders at the 1996 Annual Meeting, has
not been implemented by the Company. The Directors Plan grants options to each
outside director at the conclusion of every Annual Meeting of Stockholders.
Eligible directors shall receive up to 5,000 options in the first year after
their election, and 2,500 options each year thereafter. The Company is
authorized to grant options to acquire up to 1,800,000 shares under the 1994
plan, up to 200,000 shares under the 1996 Plan, and up to 75,000 shares under
the Directors Plan.
In May 1997, the Compensation Committee approved (i) the retirement of
significantly all options outstanding at exercise prices ranging between $4.50
and $9.25 and (ii) their subsequent reissuance at $2.00, to better enhance
incentives to management in light of reduced market prices of the Company's
common stock.
A summary of the status of the plans as of December 31, 1997, 1996 and 1995 and
changes during the years ending on those dates is as follows:
<TABLE>
<CAPTION>
Weighted
Average
Exercise
Shares Price
<S> <C> <C> <C>
Balance, January 1, 1995.............................................................. 1,350,000 $6.37
Expired or canceled................................................................... (10,000) 6.19
Granted or reissued................................................................... 497,500 7.07
Balance, December 31, 1995............................................................ 1,837,500 6.55
Exercised............................................................................. (9,940) 6.63
Expired............................................................................... (707,060) 6.54
Granted............................................................................... 564,500 4.99
Balance, December 31, 1996............................................................ 1,685,000 5.99
Expired or canceled................................................................... (1,947,208) 5.41
Granted or reissued................................................................... 2,130,750 2.14
---------
Balance, December 31, 1997............................................................ 1,868,542 2.05
=========
</TABLE>
F-18
<PAGE>
EMPIRE OF CAROLINA, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
9. STOCKHOLDERS' EQUITY - CONTINUED
The following table summarizes information about stock options outstanding at
December 31, 1997:
<TABLE>
<CAPTION>
Currently Exercisable
<S> <C>
Range of Number Average Remaining Weighted Weighted
Exercise of Shares Contractual Average Number Average
Prices Outstanding Life (Years) Exercise Price of Shares Exercise Price
$2.00-4.94 1,868,542 5 $2.05 332,601 $2.01
</TABLE>
The Company applies APB No. 25 and related interpretations in accounting for its
plans. Accordingly, no compensation cost has been recognized for its plans. Had
compensation cost for the plans been determined based on the fair value at the
grant dates for awards under the plans consistent with the method of SFAS No.
123, the Company's net loss and loss per share for the years ended December 31,
1997,1996 and 1995 would have been increased to the pro forma amounts indicated
below (in thousands, except per share amounts):
<TABLE>
<CAPTION>
1997 1996 1995
Net loss:
<S> <C> <C> <C>
As reported ......................................................... $ (21,130) $(46,201) $(4,501)
Pro forma............................................................ (22,530) (47,309) (6,321)
Loss per share - basic and diluted:
As reported.......................................................... (6.04) (7.39) (0.96)
Pro forma............................................................ (6.22) (7.57) (1.35)
</TABLE>
The fair value of options granted under the Company's plans during 1997, 1996
and 1995 was estimated using the Black-Scholes option-pricing model with the
following weighted-average assumptions used:
<TABLE>
<CAPTION>
1997 1996 1995
<S> <C> <C> <C>
Dividend yield......................................................... 0.00% 0.00% 0.00%
Expected volatility.................................................... 112.10% 56.33% 82.11%
Risk free interest rate................................................ 5.50% 6.10% 6.10%
Expected lives(years).................................................. 3.0 2.5 2.5
</TABLE>
WARRANTS -- In connection with the Series A preferred stock transactions
referred to above, warrants to purchase a total of 10,000,000 shares of common
stock were issued. On August 21, 1997, the Company issued 200,000 warrants to
Gerard Klauer Mattison & Co., Inc. ("GKM") in connection with the Company's
settlement of fees owed to GKM for services rendered with respect to certain
financings and sales transactions. The warrants are exercisable at $1.375 per
share for a term of six years from date of issuance.
F-19
<PAGE>
EMPIRE OF CAROLINA, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
9. STOCKHOLDERS' EQUITY - CONTINUED
In 1995, the holders of the 12% three-year senior subordinated notes were issued
four-year warrants for the purchase of up to 758,000 shares of the Company's
common stock on the basis of one share of common stock for each $10 of notes
acquired, exercisable commencing on the second anniversary of issuance at an
exercise price of $9.00 per share. On July 5, 1996, the Company exercised its
option to redeem all $7,580,000 senior subordinated notes at a premium of 10% of
the principal balance and, thus, retired the related 758,000 warrants to
purchase common stock.
During 1995 and 1994, the Company issued warrants to certain investment bankers
and consultants to purchase 321,000 shares of common stock at $7.50 per share in
exchange for future services. During 1996, 116,100 warrants were exercised;
during 1997, 125,900 warrants expired; and in January 1998, the remaining 79,000
warrants expired.
10. EMPLOYEE BENEFIT PLANS
During the fourth quarter of 1995, Empire Industries converted a contributory
profit sharing plan into a 401(k) plan. All employees with greater than one year
of service may participate in the 401(k) Plan. This plan allows for voluntary
contributions by employees as well as an employer matching contribution. The
employer's contribution is determined each year by the Board of Directors.
Participants are 100% vested in their tax-deferred, rollover, and after-tax
accounts. Employer contributions are subject to a vesting schedule by which
employees are 100% vested after five years of employment. Company contributions
to the 401(k) plan were $3,000 and $41,000 in 1997 and 1996, respectively, and
Company contributions to the predecessor profit sharing plan were $0 during
1995.
Marchon Toys has an employee benefit plan under which the subsidiary is required
to make annual contributions equal to 5% or 7.5% of each employee's individual
annual contributions based on employee compensation.
The Company assumed the liability of a defined benefit plan of a former CLR
subsidiary. The plan benefits were frozen at such time. During 1995, the plan
was terminated and the plan obligations were settled through the purchase of a
nonparticipating annuity contract to cover vested benefits. In accordance with
the provisions of SFAS No. 88, "Employers' Accounting For Settlements and
Curtailments of Defined Benefit Pension Plans and For Termination Benefits," the
unrecognized net gain at December 31, 1994 of approximately $605,000 is
eliminated against the excess of the cost of the annuity contract over the
previously recorded projected benefit obligation. The cost of the annuity
contract was approximately $3,114,000, which also approximated the plan's net
assets. Accordingly, no gain or loss was recognized upon termination of the
plan. There was no pension cost associated with this plan for each of the three
years in the period ended December 31, 1997.
With respect to former businesses, the Company retained sponsorship of the
Popsicle Industries Ltd. pension plan, which was effectively terminated at the
closing of the sale of Popsicle Industries Ltd. The Company is responsible for
winding up this plan. The Company is in the process of distributing to the
participants the assets of the plan.
The Company has assumed the liability for postretirement health care and life
insurance benefits to former employees of a CLR subsidiary. The benefits will be
funded as they are paid. The present value of the projected
F-20
<PAGE>
EMPIRE OF CAROLINA, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
10. EMPLOYEE BENEFIT PLANS - CONTINUED
benefits due these former employees has been accrued, using a discount rate of
8.5% for 1997 and 1996, in the consolidated financial statements in accordance
with SFAS No. 106, "Employers' Accounting For Postretirement Benefits Other Than
Pensions." The Company has accrued $755,000 and $822,000 as of December 31, 1997
and 1996, respectively, for these benefits. The net postretirement benefit cost
for each of the three years ended December 31, 1997 is not material to the
consolidated financial statements.
11. COMMITMENTS AND CONTINGENCIES
LETTERS OF CREDIT -- At December 31, 1997, the Company had outstanding
commitments under letters of credit totaling $701,000.
LEASES -- The Company is committed under various noncancelable operating leases.
Future minimum lease obligations under these operating leases by year are as
follows: 1998 -- $1,784,000; 1999 -- $1,544,000; 2000 -- $1,247,000; 2001 --
$989,000; 2002 -- $610,000; thereafter -- $1,189,000.
The net rental expense for operating leases was approximately $1,586,000 in
1997, $1,641,000 in 1996, and $1,196,000 in 1995.
INDEMNIFICATIONS -- From 1989 through early 1993, the Company was engaged in
additional businesses through other subsidiaries. Control of these businesses
was acquired through stock acquisitions during 1989 and through the December 29,
1989 merger of AmBrit, Inc. into the Company and the December 29, 1989 merger of
Clabir Corporation into the Company's newly formed subsidiary, CLR. Isaly
Klondike Company and Popsicle Industries Ltd. were sold to Lipton on February 1,
1993, and Wilbur Chocolate Co., Inc. was sold on October 6, 1992. The Company
provided certain indemnifications to the purchasers. The Company has established
reserves for all claims known to it and for other contingencies in connection
with the sales. Although there can be no assurance that claims and other
contingencies related to the sale will not exceed established reserves, the
Company believes that additional exposure related to the indemnification
obligations will not be material to the consolidated financial statements.
During 1995, the Company and its majority-owned subsidiary, CLR, were released
from substantially all indemnification obligations including certain tax matters
arising from the December 23, 1988 sale of General Defense Corporation ("GDC")
to Olin Corporation by CLR's predecessor, Clabir Corporation. In exchange for
the release, the Company paid $475,000 and extended the expiration date of the
options granted to Olin Corporation from September 30, 1996 to September 30,
1997. Such options expired on September 30, 1997. The Company believes future
obligations, if any, related to the indemnification will not have a material
adverse effect on its consolidated financial statements.
LITIGATION -- During December 1990, George Delaney and Rehkemper I.D., Inc. v.
Marchon, Inc. commenced a suit against Marchon claiming infringement of various
intellectual property rights. The plaintiffs have filed an amended complaint
against the Company and the case is set for trial in 1998. Although the company
is vigorously contesting the matters set forth in the amended complaint, it is
unable to determine at this time the extent of its financial exposure.
The Company's operating subsidiaries and its former operating subsidiaries are
subject to various types of consumer claims for personal injury from their
products. The Company's subsidiaries maintain product liability insurance.
Various product liability claims, each of which management believes is
adequately covered by insurance and/or reserves, are currently pending.
F-21
<PAGE>
EMPIRE OF CAROLINA, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
11. COMMITMENTS AND CONTINGENCIES - CONTINUED
The Company does not believe the outcome of any of this litigation either
individually or in the aggregate would have a material adverse effect on the
Company's consolidated financial statements.
In January 1997, the Company filed suit against Marvin Smollar, a former
director and the former Chief Operating Officer of the Company, in which the
Company sought to enforce a certain guarantee by Mr. Smollar of debt owed to the
Company by 555 Corporate Woods Parkway, Inc. During February 1997, Mr. Smollar
commenced an action against the Company claiming breaches by the Company of
certain agreements between the Company and Smollar. During January 1998, the
Company and Mr. Smollar entered into a settlement agreement resolving each of
these claims in addition to a claim that had been brought by 1431 Kingsland
Avenue, L.P. alleging that the Company had breached a lease at 1431 Kingsland
Avenue in Pagedale, Missouri. The settlement is included in other liabilities in
the Company's consolidated balance sheet.
CONTINGENCIES -- The Company has been identified as a potentially responsible
party, along with numerous other parties, at various U.S. Environmental
Protection Agency ("EPA") designated superfund sites. The Company is vigorously
contesting these matters. It is the Company's policy to accrue remediation costs
when it is probable that such costs will be incurred and when they can be
reasonably estimated. As of December 31, 1997 and 1996, the Company had reserves
for environmental liabilities of $125,000 and $500,000, respectively. During
1997, the Company entered into consent decrees in regard to various of these
matters and made payments totaling $335,000. The amount accrued for
environmental liabilities was determined without consideration of possible
recoveries from third parties. Estimates of costs for future remediation are
necessarily imprecise due to, among other things, the allocation of costs among
potentially responsible parties. Although it is possible that additional
environmental liability related to these matters could result in amounts that
could be material to the Company's consolidated financial statements, a
reasonably possible range of such amounts cannot presently be estimated. Based
upon the facts presently known, the large number of other potentially
responsible parties and potential defenses that exist, the Company believes that
its share of the costs of cleanup for its current remediation sites will not, in
the aggregate, have a material adverse impact on its consolidated financial
statements.
12. SEGMENT INFORMATION
As permitted, the Company early adopted SFAS No. 131, "Disclosure About Segments
Of An Enterprise and Related Information." SFAS No. 131 establishes standards
for the way that public business enterprises report information about operating
segments in annual financial statements. It also establishes standards for
related disclosures about products and services, geographic areas and major
customers. This statement supersedes SFAS No. 14, "Financial Reporting For
Segments Of A Business Enterprise," but retains the requirement to report
information about major customers.
Pursuant to the provisions of SFAS No. 14, the Company historically reported two
operating segments - toys and holiday products. However, both products are
generally manufactured from plastic resins using equivalent manufacturing
processes. Additionally, these products share similar distribution channels and
are marketed and sold to similar customers. The Company does not review
operating results separately to make decisions about resources to be allocated
among these products.
F-22
<PAGE>
EMPIRE OF CAROLINA, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
12. SEGMENT INFORMATION - CONTINUED
Consequently, the Company has aggregated these former operating segments.
Accordingly, segment information for each prior period is not presented.
Geographic information is as follows (in thousands):
<TABLE>
<CAPTION>
As of and for the year ended December 31,
1997 1996 1995
<S> <C> <C> <C>
Net sales to foreign customers......................................... $ 6,836 $14,942 $21,912
Long-lived assets located in the Far East...................................... $16,572 $18,242 $17,793
</TABLE>
The Company has a Hong Kong based subsidiary which oversees the sourcing of
products from manufacturers in the Far East. Sales of products sourced through
the Company's Hong Kong based subsidiary in each of the last three years ended
December 31 were: 1997 -- $36,075,000; 1996 -- $42,891,000 and 1995--
$41,845,000, respectively.
Intercompany sales between the Company's foreign and domestic operations for the
years ended December 31, 1997, 1996, and 1995 were $6,654,000, $12,700,000, and
$11,557,000, respectively.
Sales to significant customers, individually, were 26%, 21%, and 13% of sales,
respectively, in 1997; 25%, 19%, and 9% of sales, respectively, in 1996; and
19%, 15%, and 10% of sales, respectively, in 1995. No other customer accounted
for more than 10% of the Company's sales in those years.
13. RELATED PARTIES
In connection with the Series A preferred stock transactions described in Note
10, the following members of the Company's Board of Directors had investments in
the Company at December 31, 1997:
<TABLE>
<CAPTION>
SHARES OF WARRANTS TO
SERIES A ACQUIRE
PREFERRED STOCK COMMON STOCK
----------------- ----------------
<S> <C> <C>
Charles S. Holmes 125,000 2,753,752
James J. Pinto 100,000 2,678,752
Lenore H. Schupak 22,500 22,500
John Doran 10,000 10,000
</TABLE>
In connection with the proposed acquisition of the Apple Companies (Note 14),
Timothy Moran, the Company's President and Chief Operating Officer, who is also
the president and a significant shareholder of the Apple Companies, and Mark
Rose, the majority shareholder of the Apple Companies, participated in the
Series A preferred stock transactions, acquiring 50,000 shares of Series A
preferred stock and warrants to acquire 50,000 shares of common stock, each.
During 1995, in connection with the Company's acquisition of Buddy L, affiliates
of Weiss, Peck & Greer, L.L.C. (collectively referred to as "WPG"), an
investment firm, purchased 247,392 shares of common stock at $7.25 per share and
442,264 of Series A cumulative convertible preferred stock at $7.25 per share
for an aggregate purchase price of $5,000,006. See Note 4. On September 11,
1996, upon the approval by the stockholders of the Company, the outstanding
shares of Series A cumulative convertible preferred stock were converted into
common
F-23
<PAGE>
EMPIRE OF CAROLINA, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
13. RELATED PARTIES - CONTINUED
stock on a share for share basis. The conversion resulted in the issuance of
442,264 shares of common stock to WPG. At December 31, 1997 and 1996, WPG was
the holder of 721,595 shares of common stock. Two principals of WPG were members
of the Company's Board of Directors from 1994 through November 1997.
WPG, on behalf of investment funds for which they are managers, was the holder
of approximately $14,900,000 of the Company's 9%, five-year, subordinated
convertible debentures. Concurrent with the closing of this debenture financing
in December 1994, WPG was issued warrants to purchase 100,000 shares of common
stock at the exercise price of $7.50 per share. In June 1997, these debentures
were exchanged for 1,490 newly-issued Series C preferred stock of the Company.
WPG released, amount other things, their claims to accrued and unpaid interest,
fees and expenses. Each share of Series C preferred stock is convertible at any
time, at the option of the holder thereof, into fully paid and nonassessable
shares of common stock at a rate of one share of common stock for each $2.00 of
stated value of Series C preferred stock.
Steven Geller, Chief Executive Officer of the Company, has the right to vote
734,039 shares of common stock of the Company owned by a former control group of
the Company. Geller's right to vote such shares terminates upon the former
control group's disposal thereof. Geller has certain rights of first refusal
relative to the former control group's disposal of their remaining shares.
Geller has a rolling three year employment agreement with the Company.
At December 31, 1996, the Company had an unsecured receivable from the owner of
its facility in Vernon Hills, Illinois of $538,000, respectively, related to
costs incurred during its construction which receivable was guaranteed by Marvin
Smollar, a former Company director and former President and Chief Operating
Officer. See Note 11. This receivable bore interest at an annual rate of 7.5%
and was due on December 31, 1998. Subsequent to December 31, 1994, the
operations of Marchon were moved to the Company's facilities in Tarboro, North
Carolina. Marchon terminated the lease on the Illinois facility effective June
1995. In connection with the Marchon acquisition, the Company assumed a lease
related to Marchon's Pagedale, Missouri facility from an entity of which Mr.
Smollar is a principal. The lease provided for a monthly rental of $15,000
through December 15, 1995 and $20,000 thereafter. The lease per its terms,
expired during 2013. This facility had not been occupied by the Company since
Marchon moved operations to the main Tarboro plant in the first quarter of 1995.
The settlement agreement between the Company and Mr. Smollar during January
1998, inter alia, released Mr. Smollar from his guarantee of the receivable due
from the owner of the facility in Vernon Hills, Illinois and terminated the
Company's lease at the facility in Pagedale, Missouri. See Note 11.
14. SUBSEQUENT EVENT
On February 11, 1998, the Company signed a letter of intent to acquire all of
the stock of Apple Sports, Inc. and Apple Golf Shoes, Inc. ("the Apple
Companies"), manufacturers and distributors of golf equipment sold under license
from Wilson Sporting Goods Co. for 5 million shares of the Company's common
stock. The Apple Companies are located in Ronkonkoma, New York and they have
manufactured and distributed Wilson(R) and Staff(R) golf shoes and other
Wilson(R) accessories since 1986. In 1997, the Apple Companies had revenues in
excess of $24 million.
F-24
<PAGE>
EMPIRE OF CAROLINA, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
14. SUBSEQUENT EVENT - CONTINUED
The proposed transaction is subject to a number of conditions, including
satisfactory completion of due diligence, the negotiation and execution of a
definitive agreement, and the approval by the Company's shareholders. The
Company can give no assurance that the proposed transaction will be consummated,
or, if consummated, that it will be on the terms and conditions described above.
On February 19, 1998, Timothy Moran, president of the Apple Companies, became
president and chief operating officer of the Company (Note 13).
F-25
<PAGE>
EMPIRE OF CAROLINA, INC. AND SUBSIDIARIES
SUPPLEMENTARY FINANCIAL DATA
SELECTED QUARTERLY DATA
UNAUDITED
(in thousands, except per share data)
<TABLE>
<CAPTION>
1997
First Second Third Fourth
<S> <C> <C> <C> <C>
Net sales ....................................................................... $25,686 $27.616 $29,390 $16,824
Gross profit (loss).............................................................. 3,808 7,743 5,648 (2,807)
Restructuring and other charges.................................................. -- -- -- 3,739
Net income (loss)................................................................ (3,251) (761) (3,403) (13,715)
Net Income (loss) per common share:
Basic and diluted earnings per share ............................................ (.44) (2.69) ( .44) (2.44)
1996
Net sales........................................................................ $22,186 $33,422 $50,453 $42,847
Nonrecurring inventory charges................................................... -- -- 10,325 1,860
Gross profit (loss).............................................................. 5,969 7,515 (890) (9,335)
Restructuring and other charges.................................................. -- -- 7,497 1,303
Net income (loss)................................................................ (2,156) (1,700) (12,884) 29,461)
Net Income (loss) per common share:
Basic and diluted earnings per share............................................. (.41) (.32) (1.82) (3.98)
</TABLE>
.
F-16
<PAGE>
INDEPENDENT AUDITORS' REPORT
TO THE BOARD OF DIRECTORS OF
EMPIRE OF CAROLINA, INC.
We have audited the consolidated financial statements of Empire of Carolina,
Inc. and its subsidiaries as of December 31, 1997 and 1996, and for each of the
three years in the period ended December 31, 1997, and have issued our report
thereon dated March 30, 1998, which report includes an explanatory paragraph as
to an uncertainty regarding the Company's ability to continue as a going
concern; such report is included elsewhere in this Form 10-K. Our audits also
included the consolidated financial statement schedule of Empire of Carolina,
Inc. and its subsidiaries, listed in Item 14. This financial statement schedule
is the responsibility of the Company's management. Our responsibility is to
express an opinion based on our audits. In our opinion, such consolidated
financial statement schedule, when considered in relation to the basic
consolidated financial statements taken as a whole, presents fairly in all
material respects the information set forth therein.
DELOITTE & TOUCHE LLP
Raleigh, North Carolina
March 30, 1998
<PAGE>
SCHEDULE 1 - CONDENSED FINANCIAL INFORMATION OF REGISTRANT
EMPIRE OF CAROLINA, INC., (PARENT)
STATEMENTS OF OPERATIONS
Years Ended December 31, 1997, 1996 and 1995
<TABLE>
<CAPTION>
1997 1996 1995
---- ---- ----
(In thousands)
<S> <C> <C> <C>
Administrative Income(Expenses) $ 129 $ 401 $ (710)
Other Income(Expense):
Interest income, dividends and net realized gains(losses) 6 (82) 1,241
Interest expense (930) (2,816) (1,912)
Equity in earnings of subsidiaries (20,395) (44,232) (5,621)
Management fee income 60 60 3,060
Other (197)
-----
Total other income(expense) (21,259) (47,267) (3,232)
--------- --------- -------
Loss Before Income Taxes (21,130) (46,866) (3,942)
Income Tax Expense(Benefit) (665) 559
------ ---
Net Loss $ (21,130) $ (46,201) $ (4,501)
=========== =========== =========
</TABLE>
S-2
<PAGE>
SCHEDULE 1 - CONDENSED FINANCIAL INFORMATION OF REGISTRANT
EMPIRE OF CAROLINA, INC., (PARENT)
BALANCE SHEETS
December 31, 1997 and 1996
(In thousands)
<TABLE>
<CAPTION>
1997 1996
ASSETS
Current Assets:
<S> <C> <C>
Cash and cash equivalents $ 31 $ 90
Receivables from subsidiaries - -
Prepaid expenses and other current assets 1 29
------------ ------------
Total current assets 32 119
Investment in and note receivable from subsidiaries 17,727 18,513
Other noncurrent assets - 416
------------- ------------
$ 17,759 $ 19,048
============= ============
LIABILITIES AND STOCKHOLDERS' EQUITY
Current Liabilities:
Accounts payable and accrued expenses $ 1,325 $ 1,529
Indemification obligations related to sales of subsidiaries 380 393
---- ---
Total current liabilities 1,705 1,922
------ -----
Convertible subordinated debentures - 14,139
Other noncurrent liabilities 601 669
---- ---
Total liabilities 2,306 16,730
------ ------
Stockholders' Equity:
Common stock, $.10 par value, 60,000,000 shares authorized, shares
issued and outstanding: 1997 - 7,849,000 and 1996 - 7,404,000 785 740
Preferred stock, $.01 par value, 5,000,000 shares authorized.
Issued and outstanding: 1997 - 2,100,000 shares of Series A
convertible preferred stock and 1,461 shares of Series C
convertible preferred stock; 1996 - 0 21
Additional paid-in capital 109,282 50,438
Deficit (94,635) (48,860)
--------- --------
Total stockholders' equity 15,453 2,318
------- -----
$ 17,759 $ 19,048
========= ========
</TABLE>
The note receivable from subsidiary is subordinated to the subsidiary's bank
facility and bears interest at the prime rate.
Note: The Parent accounts for its investment in its majority-owned
subsidiaries using the equity method of accounting. Under the equity method,
original investments are recorded at cost and adjusted by the Parent's share
of undistributed earnings or losses for these companies.
S-3
<PAGE>
SCHEDULE 1 - CONDENSED FINANCIAL INFORMATION OF REGISTRANT
EMPIRE OF CAROLINA, INC., (PARENT)
STATEMENTS OF CASH FLOWS
Years Ended December 31, 1997, 1996 and 1995
<TABLE>
<CAPTION>
1997 1996 1995
Cash Flows From Operating Activities:
<S> <C> <C> <C>
Net loss $ (21,130) $ (46,201) $ (4,501)
Adjustments to reconcile net loss to net cash provided by(used in)
operating activities:
Non-cash adjustments 21,226 43,403 6,305
Changes in assets and liabilities 738 (471) 87
---- ------ --
Net cash provided by(used in) operating activities 834 (3,269) 1,891
---- -------- -----
Cash Flows From Investing Activities:
Proceeds from sale of marketable securities - 85 1,655
Note receivable from subsidiary (19,609) (8,933) (9,580)
Net advances to subsidiaries - 1,607 (5,220)
Management fees received from subsidiaries 60 60 3,060
Collections from stockholder 35
--
Net cash provided by(used in) investing activities (19,549) (7,181) (10,050)
--------- -------- --------
Cash Flows From Financing Activities:
Repayments of notes payable - - (3,250)
Repayment of senior subordinated notes - (8,338) -
Proceeds from issuance of common stock - 14,485 1,794
Net proceeds from issuance of preferred stock 18,656 - 3,206
Proceeds from issuance of senior subordinated notes - - 7,580
Proceeds from stock options and warrants exercised - 2,977 -
Other 245
---
Net cash provided by financing activities 18,656 9,124 9,575
------- ------ -----
Net Increase (Decrease) in Cash and Cash Equivalents (59) (1,326) 1,416
Cash and Cash Equivalents, Beginning of Year 90 1,416
--- -----
Cash and Cash Equivalents, End of Year $ 31 $ 90 $ 1,416
===== ===== ========
</TABLE>
S-4
<PAGE>
SCHEDULE 1 - CONDENSED FINANCIAL INFORMATION OF REGISTRANT
EMPIRE OF CAROLINA, INC., (PARENT)
STATEMENTS OF CASH FLOWS - Continued
Years Ended December 31, 1997, 1996 and 1995
<TABLE>
<CAPTION>
Supplemental Disclosures of Cash Flow Information:
Cash paid during the period for:
<S> <C> <C>
Interest $ $ 3,301 $ 1,046
Income taxes, (net of refunds) (94) (1,834) 97
</TABLE>
Noncash Investing and Financing Activities
During June 1997, the Company settled its earnout liability with the
successor to Buddy L, resulting in an increase in common stock of $25,000,
additional paid-in capital of $631,000, goodwill of $1,240,000, and earnout
liability of $993,000 and a decrease in other liabilities of $409,000.
Also during June 1997, the convertible subordinated debentures and related
discount, accrued interest and expenses were converted into 1,500 shares of
Series C preferred stock, thus increasing preferred stock by $15 and
additional paid-in capital by $14,897,000.
Pursuant to Emerging Issues Task Force Topic No.D-60, the Company during 1997
recorded a dividend on its newly-issued Series A preferred stock to reflect
the effect of a beneficial conversion feature of such stock and the
concurrent issuance of 10 million warrants. The recording of this dividend
resulted in a transfer from deficit to additional paid-in capital of
$24,645,000.
On September 11, 1996, upon the approval by the stockholders of the Company,
the outstanding shares of Series A preferred stock were converted into common
stock on a share for share basis. The conversion resulted in the issuance of
442,264 shares of common stock to the holders of Series A preferred stock.
On July 7, 1995, two subsidiaries of the Company acquired the toy business
assets and assumed certain liabilities of Buddy L Inc. and its affiliate,
Buddy L (Hong Kong) Limited, for an aggregate purchase price of $33,925,000,
including (i) the issuance of $4,753,000 one-year notes and (ii) the issuance
of 756,667 shares of common stock. Funding for the acquisition included (i)
issuance of 247,392 shares of common stock, (ii) issuance of 442,264 shares
of Series A cumulative convertible preferred stock and (iii) borrowings under
senior subordinated notes ($7,580,000).
S-5
<PAGE>
EXHIBIT 23.1
INDEPENDENT AUDITORS' CONSENT
We consent to the incorporation by reference in Registration Statement No.
33-93284 of Empire of Carolina, Inc. on Form S-8 of our reports dated March 30,
1998 (which reports include an explanatory paragraph as to an uncertainty
regarding the Company's ability to continue as a going concern), appearing in
this Annual Report on Form 10-K of Empire of Carolina, Inc. for the year ended
December 31, 1997.
DELOITTE & TOUCHE LLP
Raleigh, North Carolina
March 30, 1998
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
THE SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED
FROM THE AUDITED CONSOLIDATED BALANCE SHEET AND THE AUDITED
STATEMENT OF INCOME AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE
TO SUCH FINANCIAL STATEMENTS.
</LEGEND>
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 12-MOS
<FISCAL-YEAR-END> DEC-31-1997
<PERIOD-START> JAN-01-1997
<PERIOD-END> DEC-31-1997
<CASH> 3,483
<SECURITIES> 0
<RECEIVABLES> 14,052
<ALLOWANCES> 5,487
<INVENTORY> 9,933
<CURRENT-ASSETS> 29,448
<PP&E> 39,347
<DEPRECIATION> 25,212
<TOTAL-ASSETS> 63,576
<CURRENT-LIABILITIES> 40,056
<BONDS> 0
0
21
<COMMON> 785
<OTHER-SE> 14,647
<TOTAL-LIABILITY-AND-EQUITY> 63,576
<SALES> 99,516
<TOTAL-REVENUES> 101,916
<CGS> 87,524
<TOTAL-COSTS> 87,524
<OTHER-EXPENSES> 24,863
<LOSS-PROVISION> 609
<INTEREST-EXPENSE> (6,920)
<INCOME-PRETAX> (21,130)
<INCOME-TAX> 0
<INCOME-CONTINUING> (21,130)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (21,130)
<EPS-PRIMARY> (6.04)
<EPS-DILUTED> (6.04)
</TABLE>
