<PAGE> 1
AS FILED WITH THE SECURITIES AND EXCHANGE COMMISSION ON MAY 21, 1996
REGISTRATION NO. 333-1744
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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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AMENDMENT NO. 3
TO
FORM S-1
REGISTRATION STATEMENT
UNDER
THE SECURITIES ACT OF 1933
---------------------
GARDEN BOTANIKA, INC.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
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<S> <C> <C>
WASHINGTON 5999 91-1464962
(STATE OR OTHER JURISDICTION OF (PRIMARY STANDARD INDUSTRIAL (I.R.S. EMPLOYER IDENTIFICATION
INCORPORATION OR ORGANIZATION) CLASSIFICATION CODE NUMBER) NUMBER)
</TABLE>
8624 154TH AVENUE N.E.
REDMOND, WASHINGTON 98052
(206) 881-9603
(ADDRESS, INCLUDING ZIP CODE, AND TELEPHONE NUMBER, INCLUDING AREA CODE, OF
REGISTRANT'S PRINCIPAL EXECUTIVE OFFICES)
MYRON E. KIRKPATRICK, VICE PRESIDENT AND CHIEF FINANCIAL OFFICER
GARDEN BOTANIKA, INC.
8624 154TH AVENUE N.E.
REDMOND, WASHINGTON 98052
(206) 881-9603
(NAME, ADDRESS, INCLUDING ZIP CODE, AND TELEPHONE NUMBER, INCLUDING AREA CODE,
OF AGENT FOR SERVICE)
---------------------
COPIES TO:
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<S> <C>
MICHAEL J. ERICKSON STEPHEN A. MCKEON
LAURA A. BERTIN L. MICHELLE WILSON
HELLER, EHRMAN, WHITE & MCAULIFFE PERKINS COIE
6100 COLUMBIA CENTER 1201 THIRD AVENUE
701 FIFTH AVENUE 40TH FLOOR
SEATTLE, WASHINGTON 98104 SEATTLE, WASHINGTON 98101
(206) 447-0900 (206) 583-8888
</TABLE>
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APPROXIMATE DATE OF COMMENCEMENT OF PROPOSED SALE TO THE PUBLIC:
As soon as practicable after this Registration Statement becomes effective.
------------------------
If any of the securities being registered on this Form are to be offered on
a delayed or continuous basis pursuant to Rule 415 under the Securities Act of
1933, check the following box. / /
If this Form is filed to register additional securities for an offering
pursuant to Rule 462(b) under the Securities Act of 1933, please check the
following box and list the Securities Act registration statement number of the
earlier effective registration statement for the same offering. / /
If this Form is a post-effective amendment filed pursuant to Rule 462(c)
under the Securities Act of 1933, check the following box and list the
Securities Act registration statement number of the earlier effective
registration statement for the same offering. / /
If delivery of the prospectus is expected to be made pursuant to Rule 434,
please check the following box. / /
------------------------
THE REGISTRANT HEREBY AMENDS THIS REGISTRATION STATEMENT ON SUCH DATE OR
DATES AS MAY BE NECESSARY TO DELAY ITS EFFECTIVE DATE UNTIL THE REGISTRANT SHALL
FILE A FURTHER AMENDMENT WHICH SPECIFICALLY STATES THAT THIS REGISTRATION
STATEMENT SHALL THEREAFTER BECOME EFFECTIVE IN ACCORDANCE WITH SECTION 8(a) OF
THE SECURITIES ACT OF 1933 OR UNTIL THIS REGISTRATION STATEMENT SHALL BECOME
EFFECTIVE ON SUCH DATE AS THE COMMISSION, ACTING PURSUANT TO SAID SECTION 8(a),
MAY DETERMINE.
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<PAGE> 2
GARDEN BOTANIKA, INC.
CROSS-REFERENCE SHEET
PURSUANT TO ITEM 501 OF REGULATION S-K
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<CAPTION>
FORM S-1 LOCATION OR HEADING
ITEM NUMBER AND CAPTION IN PROSPECTUS
<C> <S> <C>
1. Forepart of the Registration Statement and
Outside Front Cover Page of Prospectus.... Outside Front Cover
2. Inside Front and Outside Back Cover Pages
of Prospectus............................. Inside Front and Outside Back Cover Pages
3. Summary Information, Risk Factors and
Ratio of Earnings to Fixed Charges........ Prospectus Summary; Risk Factors
4. Use of Proceeds........................... Prospectus Summary; Use of Proceeds
5. Determination of Offering Price........... Outside Front Cover Page; Risk Factors;
Underwriting
6. Dilution.................................. Risk Factors; Dilution
7. Selling Security Holders.................. Principal Shareholders
8. Plan of Distribution...................... Outside Front Cover Page; Underwriting
9. Description of Securities to Be
Registered................................ Outside Front Cover Page; Description of
Capital Stock
10. Interests of Named Experts and Counsel.... Not Applicable
11. Information With Respect to the
Registrant................................ Outside Front Cover Page; Prospectus
Summary; Risk Factors; Capitalization;
Selected Financial and Operating Data;
Management's Discussion and Analysis of
Financial Condition and Results of
Operations; Business; Management;
Principal Shareholders; Description of
Capital Stock; Shares Eligible for
Future Sale; Consolidated Financial
Statements
12. Disclosure of Commission Position on
Indemnification for Securities Act
Liabilities............................... Not Applicable
</TABLE>
<PAGE> 3
Information contained herein is subject to completion or amendment. A
registration statement relating to these securities has been filed with the
Securities and Exchange Commission. These securities may
not be sold nor may offers to buy be accepted prior to the time the
registration statement becomes effective. This prospectus shall not
constitute an offer to sell or the solicitation of an offer
to buy nor shall there be any sale of these securities in any State in
which such offer, solicitation or sale would be unlawful prior to
registration or qualification under the securities laws of any such State.
SUBJECT TO COMPLETION, DATED MAY 21, 1996
2,700,000 SHARES
LOGO
LOGO
COMMON STOCK
All of the shares of Common Stock offered hereby are being sold by the
Company. Prior to this offering, there has been no public market for the Common
Stock of the Company. It is currently estimated that the initial public offering
price will be between $16.00 and $18.00 per share. See "Underwriting" for a
discussion of factors to be considered in determining the initial public
offering price.
Approximately 20% of the shares of Common Stock offered hereby have been
reserved for sale to certain customers, existing shareholders, employees and
other persons designated by the Company. The price per share of the shares to be
sold to these persons is the same as the price to the public. See
"Underwriting."
The Common Stock has been approved for listing on the Nasdaq National
Market(R), upon completion of this offering, under the symbol "GBOT."
SEE "RISK FACTORS" BEGINNING ON PAGE 6 FOR A DISCUSSION OF CERTAIN FACTORS
THAT SHOULD BE CONSIDERED BY PROSPECTIVE PURCHASERS OF THE COMMON STOCK OFFERED
HEREBY.
------------------------
THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES
AND EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION NOR HAS THE
SECURITIES AND EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION
PASSED UPON THE ACCURACY OR ADEQUACY OF THIS PROSPECTUS. ANY
REPRESENTATION TO THE CONTRARY IS A CRIMINAL OFFENSE.
<TABLE>
<S> <C> <C> <C>
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Price to Underwriting Proceeds to
Public Discount(1) Company(2)
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Per Share................................ $ $ $
Total(3)................................. $ $ $
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</TABLE>
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(1) See "Underwriting" for information concerning indemnification of the
Underwriters and other matters.
(2) Before deducting expenses estimated at $800,000, payable by the Company.
(3) The Company and the Selling Shareholders have granted the Underwriters a
30-day option to purchase up to 405,000 additional shares of Common Stock
solely to cover over-allotments, if any. If the Underwriters exercise this
option in full, the total Price to Public, Underwriting Discount, Proceeds
to Company and Proceeds to Selling Shareholders will total $ ,
$ , $ and $ , respectively. See "Principal
Shareholders" and "Underwriting."
The shares of Common Stock are offered by the several Underwriters named
herein, as and if delivered to and accepted by the Underwriters and subject to
their right to reject any order in whole or in part. It is expected that
delivery of the certificates representing such shares will be made against
payment therefor at the office of Montgomery Securities on or about ,
1996.
------------------------
MONTGOMERY SECURITIES ALEX. BROWN & SONS
INCORPORATED
, 1996
<PAGE> 4
INSIDE FRONT COVER: GARDEN BOTANIKA LOGO, FOUR REPRESENTATIVE CATALOG COVERS,
OUTSIDE VIEW OF A REPRESENTATIVE STORE.
GATEFOLD: GARDEN BOTANIKA LOGO, OUTSIDE VIEW OF A REPRESENTATIVE STORE,
PHOTOGRAPHS OF SAMPLE SKIN CARE, NATURAL COLOR COSMETICS, AROMATICS, HAIR CARE,
VANILLA DAWN, SKIN RENEWING SYSTEM AND CUSTOM FRAGRANCE PRODUCT LINES.
INSIDE BACK COVER: GARDEN BOTANIKA LOGO, REPRESENTATIVE CATALOG COVER, FOUR
PHOTOGRAPHS OF VARIOUS PRODUCTS.
[PHOTOGRAPHS]
IN CONNECTION WITH THIS OFFERING, THE UNDERWRITERS MAY OVER-ALLOT OR EFFECT
TRANSACTIONS WHICH STABILIZE OR MAINTAIN THE MARKET PRICE OF THE COMMON STOCK OF
THE COMPANY AT A LEVEL ABOVE THAT WHICH MIGHT OTHERWISE PREVAIL IN THE OPEN
MARKET. SUCH TRANSACTIONS MAY BE EFFECTED ON THE NASDAQ NATIONAL MARKET(R) OR
OTHERWISE. SUCH STABILIZING, IF COMMENCED, MAY BE DISCONTINUED AT ANY TIME.
---------------
"Garden Botanika," "BotanikaBaby," "Botanikids," "Garden Botanika Natural
Color," "Sun & Sport" and the Company's GB-and-design stylized logo are all
registered trademarks of the Company. This Prospectus also contains trademarks
other than those of the Company.
<PAGE> 5
PROSPECTUS SUMMARY
The following summary is qualified in its entirety by the more detailed
information, including the Consolidated Financial Statements, and the Notes
thereto, appearing elsewhere in this Prospectus. Each prospective investor is
urged to read this Prospectus in its entirety. Unless otherwise indicated, the
information in this Prospectus: (i) gives effect to the conversion of each
outstanding share of the Company's Preferred Stock, par value $.01 per share,
into one share of Common Stock upon the closing of this offering (see
"Description of Capital Stock"); (ii) gives effect to an approximate 1:7.87
reverse stock split to be voted on by the Company's shareholders on May 20, 1996
and certain other matters to be effected upon the effectiveness or closing of
this offering; and (iii) assumes that the Underwriters' over-allotment option is
not exercised. The Company's fiscal year ends on the Saturday nearest the end of
January and is identified as the preceding calendar year. For example, the
fiscal year ended on February 3, 1996 is referred to as "fiscal 1995."
THE COMPANY
Garden Botanika, Inc. ("Garden Botanika" or the "Company") is a rapidly
growing retailer of high-quality, reasonably priced personal care products. The
Company's proprietary products encompass such categories as skin care, color
cosmetics, fragrances, bath and body care and related accessories and gifts.
Garden Botanika develops its branded products and distributes them for sale
through its 161 Company-owned and -operated specialty retail stores in 31 states
nationwide and the Company's catalog. Since it commenced operations in 1990, the
Company's primary goal has been to establish Garden Botanika as among the most
recognized and respected brands of personal care products in the markets in
which it competes. The Company believes that its strong brand identity is based
upon (i) high-quality products with botanically based formulations subject to
strict ingredient guidelines; (ii) its value-oriented pricing strategy; and
(iii) a high-quality store experience, which the Company provides through its
upscale store design, excellent customer service and the uniform presentation of
its products. Garden Botanika has grown from a three-store start-up company in
1990 to a national chain with fiscal 1995 revenues of $55.3 million.
Garden Botanika's marketing and merchandising efforts primarily target 30-
to 45-year-old working women who have traditionally purchased skin care and
cosmetic products from mall-based department stores and who utilize quality
personal care products both on a daily basis and as an affordable luxury item.
The Company believes these women are increasingly seeking better pricing without
having to sacrifice high quality and personal service. The Company also believes
that its marketing strategy has been successful in attracting a broad
cross-section of other consumers beyond its primary target.
Garden Botanika seeks to become a leading developer, manufacturer and
retailer of personal care products. The key elements of Garden Botanika's
strategy are to provide (i) high-quality, proprietary products; (ii) attractive
pricing; (iii) an extensive product assortment; (iv) continuous new product
development; (v) excellent customer service; (vi) an upscale shopping
environment; and (vii) expanded recognition of the "Garden Botanika" brand name.
Consumer acceptance of the Garden Botanika concept has been demonstrated to
date by the Company's annual average sales per store, average sales per square
foot and store contribution margins, which, for each class of the Company's
stores, have improved significantly as each respective class has matured. After
opening 45 and 66 stores in fiscal 1994 and 1995, respectively, the Company
currently plans to open approximately 100 additional stores in fiscal 1996 and
approximately 120 stores in fiscal 1997, which would broaden the Company's
operations to include most major U.S. markets. Garden Botanika achieved sales
per square foot of $458 in fiscal 1995, at the end of which the average age of
its stores was 18 months. The Company's comparable store sales increased 19.5%,
32.9% and 16.7% during fiscal 1993, 1994 and 1995, respectively.
The Company's principal executive offices are located at 8624 154th Avenue
N.E., Redmond, Washington 98052, and its telephone number is (206) 881-9603.
Upon completion of this offering, the Company's investor relations telephone
number will be (206) 883-GBOT. The Company was incorporated in Washington in
October 1989.
3
<PAGE> 6
THE OFFERING
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<S> <C>
Common Stock offered by the Company............ 2,700,000 shares(1)
Common Stock to be outstanding after the
offering..................................... 6,662,577 shares(2)
Use of proceeds................................ To finance the opening of additional stores;
to repay outstanding bank debt; and for
other capital expenditures related to
expansion of the Company's operations,
working capital and general corporate
purposes. See "Use of Proceeds."
Nasdaq National Market(R) symbol............... GBOT
</TABLE>
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(1) Approximately 20% of the shares of Common Stock offered hereby have been
reserved for sale to certain customers, existing shareholders, employees and
other persons designated by the Company. See "Underwriting."
(2) Does not include (i) 392,825 shares of Common Stock reserved for issuance
upon exercise of options under the Company's 1992 Combined Incentive and
Nonqualified Stock Option Plan (the "Stock Option Plan"), of which 271,665
shares were outstanding on April 18, 1996, (ii) 63,561 shares of Common
Stock reserved for issuance upon exercise of options under the Company's
1996 Directors' Nonqualified Stock Option Plan (the "Directors' Plan"), none
of which were outstanding on April 18, 1996, (iii) 25,424 shares of Common
Stock reserved for issuance upon exercise of outstanding options granted to
a key employee outside of the Company's stock option plans and (iv) 23,724
shares of Common Stock reserved for issuance upon exercise of certain
warrants. As of April 18, 1996, the weighted average exercise price of the
Company's stock options was $10.77 per share. The exercise price of the
warrants is $9.83 per share. See "Capitalization" and Notes to Consolidated
Financial Statements.
4
<PAGE> 7
SUMMARY FINANCIAL AND OPERATING DATA
(IN THOUSANDS, EXCEPT PER SHARE AND SELECTED OPERATING DATA)
<TABLE>
<CAPTION>
FISCAL YEAR ENDED(1)
-------------------------------------------------------
FEB. 1, JAN. 30, JAN. 29, JAN. 28, FEB. 3,
1992 1993 1994 1995 1996
------- -------- -------- -------- --------
<S> <C> <C> <C> <C> <C>
STATEMENT OF OPERATIONS DATA:
Net sales............................................ $ 2,046 $ 6,407 $12,569 $27,510 $55,339
Cost of sales (including buying and occupancy
costs)............................................. 1,609 4,191 7,794 15,521 31,448
------- ------- ------- ------- -------
Gross margin......................................... 437 2,216 4,775 11,989 23,891
Operating expenses:
Stores and catalog(2).............................. 807 2,044 4,093 8,956 18,746
General and administrative......................... 1,086 1,541 2,759 3,917 6,041
Preopening expenses.................................. 178 110 417 733 798
------- ------- ------- ------- -------
Operating loss....................................... (1,634) (1,479) (2,494) (1,617) (1,694)
Interest income, net................................. 154 27 140 230 30
------- ------- ------- ------- -------
Loss before income tax provision..................... (1,480) (1,452) (2,354) (1,387) (1,664)
Income tax provision................................. -- -- -- -- --
------- ------- ------- ------- -------
Net loss............................................. $(1,480) $(1,452) $(2,354) $(1,387) $(1,664)
======= ======= ======= ======= =======
Pro forma net loss per share(3)...................... $ (1.33) $ (1.03) $ (0.88) $ (0.43) $ (0.44)
======= ======= ======= ======= =======
Pro forma common and common equivalent shares........ 1,114 1,416 2,676 3,209 3,781
SELECTED OPERATING DATA:
Stores open at period-end............................ 13 23 41 86 152
Average square footage of stores opened during
period............................................. 765 936 951 1,077 1,256
Sales per square foot(4)............................. $384 $498 $484 $535 $458
Average store age (in months)........................ 6 12 16 16 18
Comparable store sales increase(5)................... 13.9% 34.4% 19.5% 32.9% 16.7%
Number of catalogs mailed (000s)..................... -- -- -- 2,311 5,021
</TABLE>
<TABLE>
<CAPTION>
FEBRUARY 3, 1996
JAN. 28, ----------------------------
1995 ACTUAL AS ADJUSTED(6)
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<S> <C> <C> <C>
BALANCE SHEET DATA:
Working capital................................................ $ 1,415 $ 2,662 $ 39,089
Total assets................................................... $25,518 $47,137 $ 81,024
Total debt..................................................... $ -- $ 2,540 $ --
Shareholders' equity........................................... $18,183 $33,116 $ 75,003
</TABLE>
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(1) The fiscal years ended February 1, 1992 and February 3, 1996 were 53-week
years.
(2) The Company commenced its catalog operations in the third quarter of fiscal
1994.
(3) Based on the number of common and preferred shares outstanding after giving
effect to the conversion of all Preferred Stock into Common Stock. See Notes
to Consolidated Financial Statements.
(4) For stores open at beginning of period indicated.
(5) Stores enter the comparable store base in their 13th full month of
operation. The numbers of comparable stores used to compute such percentages
were 3, 13, 23, 41 and 85 as of the end of each of fiscal 1991 through 1995,
respectively.
(6) As adjusted to reflect the sale of the 2,700,000 shares of Common Stock
offered hereby and the application of the estimated net proceeds therefrom.
See "Use of Proceeds."
5
<PAGE> 8
RISK FACTORS
In addition to the other information contained in this Prospectus, the
following risk factors should be carefully considered in evaluating the Company
and its business before purchasing any of the shares offered hereby.
HISTORICAL NET LOSSES
During the last three fiscal years, the Company incurred net losses of $2.4
million, $1.4 million and $1.7 million. As of the end of fiscal 1995, the
Company had an accumulated deficit of $9.1 million. The Company may report a net
loss in fiscal 1996, and there can be no assurance that the Company will
generate profits in future periods. The Company's future operating results will
depend upon a number of factors, particularly the performance of its existing
and new stores as each class matures; the ability of the Company to manage its
planned rapid store expansion and to successfully identify and respond to
emerging trends in the personal care products industry; the level of
competition; and general economic conditions. See "Management's Discussion and
Analysis of Financial Condition and Results of Operations."
AGGRESSIVE GROWTH STRATEGY
The Company opened its first store in August 1990 and currently operates
161 stores. The Company intends to continue to pursue an aggressive growth
strategy for the foreseeable future, and its future operating results will
depend, in large part, on its ability to open new stores on a timely basis and
enter markets and distribution channels in which it has no previous experience.
The Company, which has never opened more than 66 stores in any one fiscal year,
currently plans to open approximately 100 additional stores in fiscal 1996 and
approximately 120 stores in fiscal 1997, resulting in a significant increase in
the number of stores operated. The Company's net investment to open a new store
averaged approximately $267,000 for the 66 stores opened in fiscal 1995. The
Company expects that the average cost to open a new store during fiscal 1996
will decline materially due to cost reductions associated with bringing certain
lease acquisition and store design functions in-house and to an expected general
increase in the level of lessor construction allowances. See "Business -- Growth
and Profitability Strategy." There can be no assurance, however, that such cost
reductions will occur. Because the Company will be expanding into geographic
markets in which it has no previous operating experience, it may face
competitive challenges that are different from those encountered to date. The
Company's expansion plans include, in addition to mall locations in which it has
substantial historical experience, the possibility of larger mall-based stores
with different product assortments and street-front shops in residential
neighborhoods as well as other less-traditional retail locations, that will
involve different risks than the Company's current mall-based activities. There
can be no assurance that the Company will successfully be able to open the
planned number of new stores, enter new geographic markets or open in non-mall
locations.
The Company's future operating results will also depend on its ability to
operate its new and existing stores in a profitable manner. The profitability of
the Company's stores is dependent on a number of factors, including the
Company's ability to (i) secure suitable store sites on a timely basis and on
satisfactory terms; (ii) integrate its new stores into its existing operations;
(iii) manage operating expenses; (iv) manage its growth effectively; and (v)
secure adequate capital resources on acceptable terms. The Company's future
operating results will also depend on many other factors that are beyond the
Company's control, including the level of mall traffic and general economic
conditions affecting consumer confidence and spending. The Company expects to
open new stores in certain markets in which it is already operating, which could
adversely affect sales at existing stores. There can be no assurance that the
Company's stores will achieve targeted sales and profitability levels in the
future. See "Business -- Store Operations."
Of the Company's 161 stores, 75 stores, or 47%, have been open less than
one year and 120 stores, or 75%, have been open less than two years.
Consequently, the results achieved by these stores to date may not be indicative
of future results for these stores or for other new stores. Although the sales
and profitability of each existing class of the Company's stores have improved
as the class has matured, there can be no assurance that future store classes
will experience similar results.
6
<PAGE> 9
In fiscal 1996, the Company plans to introduce a greater number of new
products on a more frequent basis than it has in the past. The costs associated
with new product introductions, including costs associated with advertising and
marketing expenses, are expected to increase significantly. For example, the
Company's advertising and marketing expenses for product launch signage and
direct-mail new product announcements are expected to be approximately $700,000
in fiscal 1996, compared to similar expenses of approximately $30,000 incurred
in fiscal 1995. There can be no assurance that the sales of new products will
justify the costs associated with their development and marketing. See
"Business -- Growth and Profitability Strategy" and "-- New Product
Development."
ABILITY TO MANAGE GROWTH
In order for the Company to expand successfully, management will be
required to anticipate the changing demands of the Company's growing operations
and to adapt systems and procedures accordingly. There can be no assurance that
the Company will anticipate all of the changing demands that its expanding
operations will impose on such systems. The Company has recently hired several
key officers and employees to supplement its management team. To support the
rapid growth in the number of its stores, the Company will be required to hire
and train a greater number of store managers and sales associates than it has in
the past, and there can be no assurance that the training and supervision of a
large number of new employees will not adversely affect the performance of the
Company's stores or the high standards that the Company seeks to maintain in
such stores. See "Business -- Store Operations -- Management and Employees" and
"-- Store Operations -- Training and Compensation." To enhance its new product
development efforts, the Company acquired its first direct manufacturing
capability in October 1995. The Company's future success will depend, in part,
on its ability to integrate new individuals and capabilities, as well as others,
into its operations as it expands in the future, and there can be no assurance
that the Company will be able to achieve such integration. Because the Company's
existing distribution and fabrication facilities are of inadequate size to
support operations through the fiscal 1996 holiday season, the Company recently
signed a 14-month lease, effective April 1, 1996, for a new and larger
distribution and fabrication facility located in Ontario, California, and is
currently in the process of relocating its existing distribution facilities into
this single larger facility. Following the expiration of the lease term for this
facility in the summer of 1997, the Company intends to establish a build-to-suit
distribution facility which could be expanded in the future to meet the
Company's needs as they grow. The relocation and expansion of its distribution
facilities in 1996 and again in 1997 could cause delays or interruptions in the
normal supply of inventory. The Company will also need to continually evaluate
the adequacy of its management information systems, including its inventory
control and distribution systems. Failure to upgrade its information systems or
unexpected difficulties encountered with these systems during expansion could
adversely affect the Company's business, financial condition and operating
results. See "Risk Factors -- Reliance on Single Management Information Systems
Vendor" and "Business -- Distribution."
The Company's growth also places significant pressures on its inventory
controls. In fiscal 1995, the Company experienced inventory shrinkage higher
than its historical rate. Through use of an independent inventory service, the
Company expects to conduct partial physical inventories on a quarterly basis in
fiscal 1996 and to upgrade its inventory control systems. In addition, subject
to adjustment for results of future physical inventories, the Company will
reserve for inventory shrinkage in fiscal 1996 at the actual rate experienced in
fiscal 1995. There can be no assurance, however, that the Company's inventory
shrinkage rate will not increase as the Company continues to grow and introduce
new products.
The Company believes that cash generated from this offering, from
anticipated bank borrowings under its working capital credit facility and from
operations will be sufficient to satisfy its currently anticipated working
capital and capital expenditure requirements until mid-fiscal 1997. However, in
connection with its aggressive growth strategy, the Company will incur
significant inventory and capital expenditures and preopening costs. The Company
may be required to seek additional sources of funds for such expansion, and
there can be no assurance that such funds will be available on satisfactory
terms. Failure to obtain such financing could delay or prevent the Company's
planned expansion, which could adversely affect the Company's business,
financial condition and operating results.
7
<PAGE> 10
SEASONALITY AND QUARTERLY FLUCTUATIONS
The Company has experienced, and expects to continue to experience,
substantial seasonal fluctuations in its sales and operating results, which is
typical of many mall-based specialty retailers. Historically, a disproportionate
amount of the Company's retail sales, ranging from approximately 45% to 50% of
annual net sales, and all of its profits have been realized during its fourth
fiscal quarter. The Company expects this pattern to continue during the current
fiscal year and anticipates that in subsequent years the fourth quarter will
continue to contribute disproportionately to its operating results, particularly
during November and December. In anticipation of increased sales activity during
the fourth quarter, the Company incurs significant additional expenses,
including the hiring of a substantial number of temporary employees to
supplement its permanent store staff. If, for any reason, the Company's sales
were to fall below its expectations during November and December, the Company's
business, financial condition and annual operating results would be adversely
affected. The Company's quarterly results of operations may also fluctuate
significantly as a result of a variety of other factors, including, among other
things, the timing of new store openings, net sales contributed by new stores,
increases or decreases in comparable store sales, adverse weather conditions,
shifts in the timing of holidays and changes in the Company's product mix.
Primarily as a result of the increasing number of recently opened stores and new
product initiatives, the Company anticipates a larger net loss in each of its
first three quarters of fiscal 1996 as compared to the prior fiscal year. See
"Management's Discussion and Analysis of Financial Condition and Results of
Operations -- Seasonality and Quarterly Fluctuations."
FLUCTUATIONS IN COMPARABLE STORE SALES RESULTS
A variety of factors affect the Company's comparable store sales results,
including, among others, general economic conditions, the retail sales
environment, timing of promotional events, including the mailing of the
Company's catalogs, new product introductions and the Company's ability to
execute its business strategy efficiently. The Company's comparable store sales
increases were 19.5%, 32.9% and 16.7% for fiscal 1993, 1994 and 1995,
respectively. The Company expects comparable store sales to increase at a
significantly lower rate than in the past. The Company's comparable store sales
results have also fluctuated significantly in the past and are expected to
continue to fluctuate in the future. For example, the comparable store sales
increases in February and March 1996 were 1.8% and 12.7%, respectively, compared
to 6.6% and 13.4% in the third and fourth quarters of fiscal 1995, respectively.
There can be no assurance that comparable store sales for any particular period
will not decrease in the future. Following this offering, the Company's
comparable store sales results could cause the price of the Common Stock to
fluctuate substantially. See "Management's Discussion and Analysis of Financial
Condition and Results of Operations."
GENERAL ECONOMIC CONDITIONS
The success of the Company's operations depends to a significant extent
upon a number of factors relating to discretionary consumer spending. These
factors include economic conditions such as employment, business conditions,
interest rates and taxation, as well as the ability of mall anchors and other
tenants to generate customer traffic in the vicinity of the Company's stores.
The Company's business is also sensitive to consumer spending patterns and
customer preferences. There can be no assurance that consumer spending and
customer traffic will not be adversely affected by general social trends and
economic conditions, thereby impacting the Company's growth, net sales and
profitability. For example, the Company's sales, and sales in the retail
industry generally, were lower than expected during the 1995 holiday season. If
the demand for personal care products and related merchandise were to decline,
the Company's business, financial condition and operating results could also be
adversely affected.
COMPETITION
The personal care, makeup and fragrance businesses are highly competitive.
The Company's products compete directly against personal care, makeup, fragrance
and other functionally similar products sold through a variety of retail
channels, including department stores, mass merchants, drugstores, supermarkets,
telemarketing programs, television "infomercials" and catalogs. The Company
competes against a number of companies that have substantially greater resources
than the Company, including better name recognition, and
8
<PAGE> 11
that sell their products through broader distribution channels than the Company.
Some department stores, which have historically offered personal care products
at higher price points than the Company, have recently introduced less expensive
product lines that may compete more directly with the Company's products. The
Company also competes directly against mall-based specialty retailers of
personal care products, including national and international chains. In general,
there are no provisions in the Company's leases that limit or restrict competing
businesses from operating in the malls in which the Company's stores are
located. The number of local and regional specialty retail outlets selling
personal care products has increased significantly in recent years, and the lack
of significant barriers to entry may result in new competition, including
possible imitators of the Garden Botanika concept. Such competition could have a
material adverse effect on the Company's business, financial condition and
operating results. In addition, should any of the Company's competitors reduce
prices, the Company may be required to implement price reductions in order to
remain competitive, which could have an adverse impact on its business,
financial condition and operating results. The Company believes that success in
the personal care industry depends, in part, on the regular introduction of new
and attractive products. There can be no assurance, however, that the Company
will continue to be able to develop such products or that, if and when
introduced, such products will be accepted by its customers. The Company also
competes generally for store sites, and there can be no assurance that it will
be able to continue to secure suitable sites on satisfactory terms. See
"Business -- Competition."
CATALOG EXPENSES
In the third quarter of fiscal 1994, the Company introduced its mail order
catalog for Garden Botanika products. One purpose of this catalog is to increase
sales at the Company's stores by advertising its products and introducing new
customers to those products in geographic areas that are not yet served by the
Company's stores. Initiation of the catalog resulted in additional costs to the
Company and, to date, those additional costs have exceeded the additional sales
directly attributable to the catalog. In fiscal 1995, the direct operating
expenses of the catalog were $3.7 million. There can be no assurance that mail
order sales directly attributable to the catalog will exceed its direct
operating expenses. The Company seeks to expand the size of its catalog mailing
list and is in the process of acquiring new names from a variety of sources.
There can be no assurance, however, that the Company will be able to obtain new
names in sufficient quantity or that the use of such names will successfully
produce mail order sales. Postal rates, delivery charges and paper and printing
costs directly affect the cost of the Company's catalog, and a significant
increase in any of these expenses could adversely affect the Company's overall
business, financial condition and operating results.
DEPENDENCE ON KEY PERSONNEL
The Company is dependent upon the efforts of its key officers and
employees, including Michael W. Luce, President, Chief Executive Officer and a
director; Arlee J. Jensen, Senior Vice President -- Merchandising and Marketing;
C. Michael Fisher, Senior Vice President -- Operations; and John A. Garruto,
Vice President -- Research and Product Development. Although the Company has
employment agreements with certain key officers, the loss of any of these
individuals could adversely affect the Company's business, financial condition
and operating results. The Company has obtained insurance on the lives of Mr.
Luce and Ms. Jensen in the amounts of $1.5 million and $1.0 million,
respectively. There can be no assurance that the Company's existing management
team will be able to manage the Company's growth or that the Company will be
able to motivate, attract and retain key employees and qualified personnel in
the future. See "Management."
RELIANCE ON SINGLE MANAGEMENT INFORMATION SYSTEMS VENDOR
The Company currently relies on a single outside vendor for the software
and day-to-day support that form the basis of the Company's management
information, distribution and financial systems. The Company believes that this
outside vendor has sufficient experience and commitment to its product lines to
be relied upon for continued support in developing, testing and implementing
systems and controls that are adequate to support the Company's store expansion
plans and its distribution and financial systems. The Company and its
information systems vendor are contemplating upgrades of Garden Botanika's
systems in areas relating to
9
<PAGE> 12
manufacturing, inventory control and distribution in the current fiscal year.
The introduction of new capabilities can be expected to require additional
management time and/or result in delays or complications before the upgrades are
completed. In addition, the Company may have little control, apart from changing
vendors, over the level of systems maintenance and support it receives. In the
event it were to change information systems vendors, the Company could
experience unforeseen delays or interruptions in its access to information. Such
problems, were they to occur, could adversely affect the Company's business,
financial condition and operating results. See "Business -- Management
Information Systems."
CONCENTRATION OF SUPPLIERS AND FOREIGN SOURCING
In fiscal 1995, approximately 55% of the Company's purchases of raw
materials, finished product, packaging and other supplies were obtained from the
Company's nine largest suppliers, with the Company's largest supplier accounting
for approximately 12% of such purchases. With the exception of certain packaging
orders, the Company has no long-term purchase contracts or other contractual
assurance of continued supply, pricing or access to new products. The inability
or failure of one or more key vendors to supply merchandise, the loss of one or
more principal vendors or a material change in the Company's purchase terms
could have a material adverse effect on the Company's business, financial
condition and operating results. There can be no assurance that the Company will
be able to acquire desired materials in sufficient quantities on acceptable
terms in the future.
In fiscal 1995, a significant portion of the Company's merchandise
purchases originated from independent foreign manufacturers, located primarily
in the Far East and Canada, and some of its domestic vendors imported a
substantial portion of their merchandise from abroad. The Company's operations
may be adversely affected by political instability resulting in disruption of
trade from the foreign countries in which the Company's contractors and
suppliers are located; existing or potential duties, tariffs or quotas that may
limit the quantity of certain types of goods that may be imported into the
United States; and any significant fluctuation in the value of the dollar
against foreign currencies. See "Business -- Suppliers and Purchasing."
REGULATION AND POTENTIAL CLAIMS
The Company's advertising and product labeling practices are subject to
regulation by the Federal Trade Commission (the "FTC"), and its cosmetic
manufacturing practices are subject to regulation by the Food and Drug
Administration (the "FDA"), as well as various other federal, state and local
regulatory authorities. Compliance with federal, state and local laws and
regulations, including laws and regulations pertaining to the protection of the
environment, has not had, and is not anticipated to have, a material adverse
effect on the competitive position of the Company. Nonetheless, federal, state
and local regulations in the United States that are designed to protect
consumers or the environment have had, and can be expected to have, an
increasing influence on product claims, manufacturing, contents and packaging.
In addition, if the Company were to expand its manufacturing capabilities to
include over-the-counter drug ingredients, it would become subject to FDA
registration and a higher degree of inspection and greater burden of regulatory
compliance than at present. The nature and use of personal care products could
give rise to product liability claims if one or more of Garden Botanika's
customers were to suffer adverse reactions following use of its products. Such
reactions could be caused by various factors, many of which are beyond the
Company's control, including hypoallergenic sensitivity and the possibility of
malicious tampering with the Company's products. In the event of such an
occurrence, the Company could incur substantial litigation expense, receive
adverse publicity and suffer a loss of sales. See "Business -- Governmental
Regulation."
CONTROL BY DIRECTORS AND EXECUTIVE OFFICERS
The Company's directors, executive officers and their affiliates will, in
the aggregate, beneficially own approximately 20% of the Company's outstanding
shares of Common Stock after this offering, assuming no exercise of the
Underwriters' over-allotment option (approximately 18% if the Underwriters'
over-allotment option is exercised in full). As a result, these shareholders,
acting together, would be able to significantly influence many matters requiring
approval by the shareholders of the Company, including the election of
directors. See "Principal Shareholders."
10
<PAGE> 13
SHARES ELIGIBLE FOR FUTURE SALE
The sale of a substantial number of shares of Common Stock in the public
market following this offering could adversely affect the market price of the
Common Stock. In addition to the 2,700,000 shares offered hereby, approximately
21,700 shares will be eligible for sale in the public market immediately
following this offering in accordance with Rule 144(k) and approximately 18,100
shares will be eligible for sale in accordance with Rules 144 and 701. In
addition, approximately 92,900 and 2,953,100 shares will be eligible for sale
beginning 120 and 180 days, respectively, after the date of this Prospectus upon
the expiration of lock-up agreements and subject to the provisions of Rule 144
of the Securities Act of 1933, as amended (the "Securities Act"). The Company
intends to file a registration statement on Form S-8 30 days after the date of
this Prospectus to register the shares of Common Stock reserved for issuance
upon the exercise of outstanding stock options. As of May 1, 1996, options to
purchase approximately 13,700 shares not subject to lock-up agreements will be
vested and would be eligible for sale pursuant to such registration statement.
In addition, certain existing shareholders possess registration rights with
respect to shares of Common Stock. See "Shares Eligible for Future Sale" and
"Description of Capital Stock -- Registration Rights."
DILUTION
The assumed initial public offering price is substantially higher than the
book value per share of Common Stock. Purchasers of shares of Common Stock in
this offering will therefore incur immediate dilution of $5.80 per share. See
"Dilution."
LACK OF PRIOR PUBLIC MARKET AND VOLATILITY OF STOCK PRICE
Prior to this offering, there has been no public market for the Common
Stock, and there can be no assurance that an active trading market will develop
or be sustained. The initial public offering price for the shares of Common
Stock to be sold in this offering will be determined by agreement among the
Company and the representatives of the Underwriters and may bear no relationship
to the price at which the Common Stock will trade after completion of this
offering. The market price of the Common Stock could be subject to significant
fluctuations in response to the Company's operating results and other factors.
In addition, the stock market in recent years has experienced extreme price and
volume fluctuations that often have been unrelated or disproportionate to the
operating performance of companies. These fluctuations, as well as general
economic and market conditions, may adversely affect the market price of the
Common Stock. See "Underwriting."
ANTITAKEOVER CONSIDERATIONS
The Company's Board of Directors has the authority, without shareholder
approval, to issue up to 10,000,000 shares of Preferred Stock and to fix the
rights and preferences thereof. This authority, together with certain provisions
of the Company's Amended and Restated Articles of Incorporation (the "Restated
Articles"), may have the effect of making it more difficult for a third party to
acquire, or discouraging a third party from attempting to acquire, control of
the Company even if shareholders purchasing shares in this offering may consider
such a change in control to be in their best interests. In addition, Washington
law contains certain provisions that may have the effect of delaying, deterring
or preventing a hostile takeover of the Company. See "Description of Capital
Stock."
11
<PAGE> 14
USE OF PROCEEDS
The net proceeds from the sale of the 2,700,000 shares of Common Stock
offered by the Company hereby are estimated to be approximately $41.9 million
(approximately $48.3 million if the Underwriters' over-allotment option is
exercised in full), after deducting underwriting discounts and the estimated
expenses of this offering and based on an assumed initial public offering price
of $17.00 per share. The Company anticipates that such net proceeds will be used
as follows: (i) approximately $24.0 million to finance the opening of
approximately 100 additional stores (including leasehold improvements,
furniture, fixtures, initial inventory purchases and preopening expenses); (ii)
approximately $8.5 million to repay bank debt anticipated to be outstanding at
the close of this offering; and (iii) the balance for other capital expenditures
related to expansion of the Company's operations, working capital and general
corporate purposes. See "Management's Discussion and Analysis of Financial
Condition and Results of Operations -- Liquidity and Capital Resources" for
information regarding interest rates and maturities of indebtedness. Pending
such uses, the net proceeds will be invested in short-term, interest-bearing
investment grade securities. In the event the Underwriters' over-allotment
option is exercised, the Company will not receive any proceeds from the sale of
Common Stock by the Selling Shareholders.
DIVIDEND POLICY
The Company has never declared or paid cash dividends on its Common Stock
and anticipates that all earnings, if any, for the foreseeable future will be
retained to finance the growth and development of its business. The payment of
any future dividends will be at the discretion of the Company's Board of
Directors and will depend on, among other things, future earnings, capital
requirements, the Company's financial condition and general business conditions.
In addition, under the terms of the Company's current bank line, the Company is
prohibited from paying dividends without the lender's prior written consent and
is required to maintain minimum tangible net worth of $27.0 million through June
29, 1996 and $32.0 million thereafter, a maximum ratio of indebtedness to
capital of 0.7:1 and working capital of at least $4.0 million. U.S. Bank has
waived violations of the working capital covenant and the borrowing base
limitation of the working capital facility which occurred prior to March 22,
1996, and has adjusted the borrowing base limitation of the working capital
facility in a manner expected to permit the Company to access the full
$9,000,000 credit line through May 31, 1996. See "Management's Discussion and
Analysis of Financial Condition and Results of Operations -- Liquidity and
Capital Resources."
12
<PAGE> 15
DILUTION
As of February 3, 1996, the Company's net tangible book value was $32.7
million, or $8.26 per share of Common Stock. Net tangible book value represents
the difference between the Company's net tangible assets and liabilities on a
consolidated basis, divided by the total number of shares of Common Stock
outstanding, assuming conversion of all outstanding Preferred Stock into Common
Stock on a one-for-one basis. Without taking into account any further changes in
net tangible book value after February 3, 1996, other than the sale of Common
Stock offered hereby (assuming an initial public offering price of $17.00 per
share), the pro forma net tangible book value of the Common Stock as of February
3, 1996 would have been approximately $74.6 million, or $11.20 per share. This
represents an immediate increase in net tangible book value of $2.94 per share
to existing investors and an immediate dilution of $5.80 per share to purchasers
of Common Stock in this offering. The following table illustrates this per share
dilution:
<TABLE>
<S> <C> <C>
Assumed initial public offering per share price..................... $17.00
Pro forma net tangible book value per share as of February 3,
1996........................................................... $8.26
Increase per share attributable to new investors.................. 2.94
-----
Pro forma net tangible book value per share after this offering..... 11.20
-------
-
Dilution per share to new investors................................. $ 5.80
========
</TABLE>
The following table sets forth, as of February 3, 1996, after giving effect
to the sale of the shares of Common Stock offered by the Company hereby and the
conversion of the Preferred Stock into Common Stock, the difference between the
existing shareholders and the purchasers of shares in this offering (at an
assumed initial public offering price of $17.00 per share) with respect to the
number of shares of Common Stock purchased from the Company, the total
consideration paid to the Company and the average price per share paid.
<TABLE>
<CAPTION>
SHARES PURCHASED TOTAL CONSIDERATION AVERAGE
------------------- --------------------- PRICE PER
NUMBER PERCENT AMOUNT PERCENT SHARE
--------- ------- ----------- ------- ---------
<S> <C> <C> <C> <C> <C>
Existing shareholders(1)................... 3,962,577 59.5% $42,240,712 47.9% $ 10.66
New investors.............................. 2,700,000 40.5 45,900,000 52.1 17.00
---------- ----- ---------- -----
Total............................ 6,662,577 100.0% $88,140,712 100.0%
========== ===== ========== =====
</TABLE>
- ------------------------------
(1) If the Underwriters' over-allotment option is exercised in full, sales by
the Selling Shareholders in this offering will reduce the number of shares
held by existing shareholders to 3,954,976, or 56.0% of the total number of
shares of Common Stock to be outstanding after this offering, and will
increase the number of shares to be purchased by new investors to 3,105,000,
or 44.0% of the total number of shares of Common Stock to be outstanding
after this offering. See "Principal Shareholders."
Does not include (i) 392,825 shares of Common Stock reserved for issuance
upon exercise of options under the Stock Option Plan, of which 271,665 shares
were outstanding on April 18, 1996, (ii) 63,561 shares of Common Stock reserved
for issuance upon exercise of options under the Directors' Plan, none of which
were outstanding on April 18, 1996, (iii) 25,424 shares of Common Stock reserved
for issuance upon exercise of outstanding options granted to a key employee
outside of the Company's stock option plans and (iv) 23,724 shares of Common
Stock reserved for issuance upon exercise of certain warrants. To the extent
such options and warrants are exercised, there will be further dilution to new
investors in the offering. See "Capitalization" and Notes to Consolidated
Financial Statements.
13
<PAGE> 16
CAPITALIZATION
The following table sets forth (i) the actual capitalization of the Company
as of February 3, 1996; (ii) the pro forma capitalization after giving effect to
the conversion of all outstanding shares of the Company's Preferred Stock into
3,694,031 shares of Common Stock upon the completion of this offering; and (iii)
the adjusted capitalization reflecting the sale of the 2,700,000 shares of
Common Stock offered by the Company hereby at an assumed initial offering price
of $17.00 per share (after deducting underwriting discounts and estimated
offering expenses) and application of the estimated net proceeds therefrom.
<TABLE>
<CAPTION>
FEBRUARY 3, 1996
----------------------------------------------
ACTUAL PRO FORMA(1) AS ADJUSTED
------------ ------------ ------------
<S> <C> <C> <C>
Note payable to bank............................. $ 2,540,000 $ 2,540,000 $ --
============ ============ ============
Shareholders' equity:
Series A Convertible Preferred Stock, 1,282,959
shares authorized, issued and outstanding... $ 10,092,374 $ -- $ --
Series B Convertible Preferred Stock, 1,627,200
shares authorized, issued and outstanding... 15,502,497 -- --
Series C Convertible Preferred Stock, 508,464
shares authorized, issued and outstanding... 9,959,508 -- --
Series D Convertible Preferred Stock, 275,408
shares authorized, issued and outstanding... 6,472,062 -- --
Preferred Stock, $0.01 par value, 10,000,000
shares authorized, none issued(2)........... -- -- --
Common Stock, $0.01 par value, 36,092,374
shares authorized, 268,546 shares issued and
outstanding; 3,962,577 shares issued and
outstanding, pro forma; 6,662,577 shares
issued and outstanding, as adjusted(3)...... 214,271 42,240,712 84,127,712
Accumulated deficit............................ (9,124,633) (9,124,633) (9,124,633)
------------ ------------ ------------
Total shareholders' equity................ $ 33,116,079 $ 33,116,079 $ 75,003,079
============ ============ ============
</TABLE>
- ------------------------------
(1) Gives effect to the conversion of all outstanding shares of Preferred Stock
into Common Stock on a one-for-one basis upon the completion of this
offering.
(2) Reflects the filing of the Restated Articles.
(3) Does not include (i) 392,825 shares of Common Stock reserved for issuance
upon exercise of options under the Stock Option Plan, of which 271,665
shares were outstanding on April 18, 1996, (ii) 63,561 shares of Common
Stock reserved for issuance upon exercise of options under the Directors'
Plan, none of which were outstanding on April 18, 1996, (iii) 25,424 shares
of Common Stock reserved for issuance upon exercise of outstanding options
granted to a key employee outside of the Company's stock option plans and
(iv) 23,724 shares of Common Stock reserved for issuance upon exercise of
certain warrants. See Notes to Consolidated Financial Statements.
14
<PAGE> 17
SELECTED FINANCIAL AND OPERATING DATA
(IN THOUSANDS, EXCEPT PER SHARE AND SELECTED OPERATING DATA)
The following selected financial and operating data should be read in
conjunction with "Management's Discussion and Analysis of Financial Condition
and Results of Operations" and the Company's Consolidated Financial Statements
and Notes thereto and other financial information included elsewhere in this
Prospectus. The statement of operations data presented below for each of the
fiscal years in the three-year period ended February 3, 1996 and the balance
sheet data at January 28, 1995 and February 3, 1996 have been derived from the
consolidated financial statements of the Company audited by Arthur Andersen LLP,
independent public accountants, included elsewhere in this Prospectus. The
statements of operations data for fiscal 1991 and fiscal 1992 and the balance
sheet data as of February 1, 1992, January 30, 1993 and January 29, 1994, are
derived from consolidated financial statements audited by Arthur Andersen LLP
that are not included herein.
<TABLE>
<CAPTION>
FISCAL YEAR ENDED(1)
-----------------------------------------------------------
FEB. 1, JAN. 30, JAN. 29, JAN. 28, FEB. 3,
1992 1993 1994 1995 1996
-------- -------- -------- -------- -------
<S> <C> <C> <C> <C> <C>
STATEMENT OF OPERATIONS DATA:
Net sales........................................ $ 2,046 $ 6,407 $ 12,569 $ 27,510 $55,339
Cost of sales (including buying and occupancy
costs)......................................... 1,609 4,191 7,794 15,521 31,448
------ ------- ------- ------- -------
Gross margin..................................... 437 2,216 4,775 11,989 23,891
Operating expenses:
Stores and catalog(2).......................... 807 2,044 4,093 8,956 18,746
General and administrative..................... 1,086 1,541 2,759 3,917 6,041
Preopening expenses.............................. 178 110 417 733 798
------ ------- ------- ------- -------
Operating loss................................... (1,634) (1,479) (2,494) (1,617) (1,694)
Interest income, net............................. 154 27 140 230 30
------ ------- ------- ------- -------
Loss before income tax provision................. (1,480) (1,452) (2,354) (1,387) (1,664)
Income tax provision............................. -- -- -- -- --
------ ------- ------- ------- -------
Net loss......................................... $ (1,480) $ (1,452) $ (2,354) $ (1,387) $(1,664)
====== ======= ======= ======= =======
Pro forma net loss per share(3).................. $ (1.33) $ (1.03) $ (0.88) $ (0.43) $ (0.44)
====== ======= ======= ======= =======
Pro forma common and common equivalent shares.... 1,114 1,416 2,676 3,209 3,781
SELECTED OPERATING DATA:
Stores open at period-end........................ 13 23 41 86 152
Average square footage of stores opened during
period......................................... 765 936 951 1,077 1,256
Sales per square foot(4)......................... $384 $498 $484 $535 $458
Average store age (in months).................... 6 12 16 16 18
Comparable store sales increase(5)............... 13.9% 34.4% 19.5% 32.9% 16.7%
Number of catalogs mailed (000s)................. -- -- -- 2,311 5,021
BALANCE SHEET DATA (AT PERIOD-END):
Working capital.................................. $ 2,443 $ 2,193 $ 12,522 $ 1,415 $ 2,662
Total assets..................................... $ 6,069 $ 7,293 $ 21,910 $ 25,518 $47,137
Total debt....................................... $ -- $ -- $ -- $ -- $ 2,540
Shareholders' equity............................. $ 5,253 $ 6,393 $ 19,542 $ 18,183 $33,116
</TABLE>
- ---------------
(1) The fiscal years ended February 1, 1992 and February 3, 1996 were 53-week
years.
(2) The Company commenced its catalog operations in the third quarter of fiscal
1994.
(3) Based on the number of common and preferred shares outstanding after giving
effect to the conversion of all Preferred Stock into Common Stock. See Notes
to Consolidated Financial Statements.
(4) For stores open at beginning of period indicated.
(5) Stores enter the comparable store base in their 13th full month of
operation. The numbers of comparable stores used to compute such percentages
were 3, 13, 23, 41 and 85 as of the end of each of fiscal 1991 through 1995,
respectively.
15
<PAGE> 18
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following discussion and analysis of Garden Botanika's financial
condition and results of operations should be read in conjunction with the
Consolidated Financial Statements and Notes thereto included herein. The term
"store months of operations" refers to the aggregate number of full months
during which stores were open during a particular fiscal year and is used to
compare the financial results of various fiscal periods. The term "contribution
margin" refers to store level operating income, exclusive of buying costs.
GENERAL
Garden Botanika opened its first store in August 1990. In the succeeding
years, the Company has achieved a national presence and now markets its
proprietary branded personal care products through 161 Company-owned and
- -operated stores in 31 states and the Company's catalog.
During fiscal 1995, the Company opened 66 new stores, 41 of which were
opened in new markets in which it had no prior store experience. The Company
currently plans to open approximately 100 additional stores in fiscal 1996 and
approximately 120 stores in fiscal 1997. It is expected that approximately 60%
of the fiscal 1996 openings will be in new markets. To date, the Company has
relocated three stores and has not closed any stores.
The Company accelerated its store expansion program following the
introduction of a larger prototype store design in July 1994. Management
believes that the Company's store-level financial results demonstrate the
consumer acceptance of both the Garden Botanika concept and the current store
design. To date, the Company's stores have averaged $374 of sales per square
foot and a contribution margin of 10.4% in their first full fiscal year of
operation. Most importantly, the productivity of each class of the Company's
stores has improved significantly each year as the class has matured.
Historically, the Company has experienced strong comparable store sales
growth, reporting 19.5%, 32.9% and 16.7% increases in fiscal 1993, 1994 and
1995, respectively. The Company believes this performance was due primarily to
the maturation of its store base and, since September 1994, the introduction of
its catalog. While the Company anticipates generating lower comparable store
sales gains in the future as a result of a more mature store base and strong
performance in prior fiscal years, Garden Botanika is embarking on new
initiatives to generate increased store traffic and higher sales. A key element
of these initiatives is an aggressive new product development program. Garden
Botanika plans to introduce several new product lines as well as a number of new
products within existing lines in fiscal 1996, including introduction of its lip
crayon and the April launch of its new signature fragrance. In contrast, the
Company did not introduce any new product lines in fiscal 1995. In support of
the new product introductions, the Company plans to increase its advertising
expenditures as a percentage of net sales. The Company has also increased the
size of its prototype store from approximately 1,000 square feet to 1,200 square
feet to accommodate the larger assortment and improve the display of its
products. As a result of the larger store size, as well as the addition in
fiscal 1996 of approximately 100 new stores that initially have lower sales
productivity, occupancy costs are expected to increase as a percentage of net
sales and sales per square foot are expected to decline. While the Company
believes the implementation of these initiatives will broaden consumer appeal,
increase sales and improve margins, there can be no assurance that comparable
store sales increases will be achieved in the future or that the additional
expenses associated with these initiatives will be offset by higher sales. See
"Risk Factors -- Fluctuations in Comparable Store Sales Results."
The Company also intends to continue to invest in building its catalog
mailing list. The Company believes the image and strength of the Garden Botanika
catalog has been a significant factor in the growth of its store-level sales and
will continue to use the catalog to increase awareness of the Garden Botanika
name and to generate both catalog and store sales.
The Company believes its historical losses have been the result of an
aggressive store opening schedule and an immature store base, the development of
a substantial corporate infrastructure to support its rapid growth and the
recent establishment of its catalog operations. While the Company expects that
sales will continue to increase as a result of the further maturation of its
store base, an active new product development
16
<PAGE> 19
program and increased catalog mailings, future increases in net sales and
achievement of profitability will depend, in large part, on the opening and
successful performance of new stores. The Company plans to continue its
aggressive growth strategy, increasing its store base approximately 66% and 48%
in each of the next two fiscal years. Because of the seasonality of its
business, the Company has historically experienced net losses in the first three
quarters of each fiscal year. Primarily as a result of the increasing number of
recently opened stores and new product initiatives, the Company anticipates a
higher net loss in each of its first three quarters of fiscal 1996 as compared
to the prior year. There can be no assurance that the Company will be able to
achieve its planned expansion on a timely or profitable basis or achieve a net
profit in fiscal 1996. See "Risk Factors -- Aggressive Growth Strategy."
HISTORICAL STORE OPERATING RESULTS
Eighty-six of the Company's 161 stores have been open at least one full
fiscal year; 41 have been open at least two full fiscal years; 23 have been open
at least three full fiscal years; and 13 have been open at least four full
fiscal years. Historically, these 86 stores have performed as follows in
successive full fiscal years of operation:
<TABLE>
<CAPTION>
SALES PER COMPARABLE
FULL FISCAL NUMBER OF STORE WEEK SALES PER STORE SALES CONTRIBUTION
YEAR(1) STORES (000S) SQUARE FOOT GROWTH(2) MARGIN
- ----------- --------- ---------- ----------- ----------- ------------
<S> <C> <C> <C> <C> <C>
First 86(3) $ 7.1 $ 374 22.8% 10.4%
Second 41 $ 8.6 $ 499 20.4% 18.7%
Third 23 $ 10.1 $ 618 20.0% 24.9%
Fourth 13 $ 12.9 $ 835 22.4% 28.5%
</TABLE>
- ------------------------------
(1) Data presented represents full fiscal year. Partial opening years are
excluded.
(2) Stores enter the comparable store base in their 13th full month of
operation.
(3) Due to the timing of store openings, there were 85 stores in the comparable
store base at February 3, 1996.
As of February 3, 1996, the average age of the Company's stores was 18
months. The Company does not expect that the level of performance demonstrated
in the table above will continue to be realized, or that future store classes
will produce comparable results. See "Risk Factors -- Aggressive Growth
Strategy."
17
<PAGE> 20
RESULTS OF OPERATIONS
The following table sets forth, for the periods indicated, the Company's
results of operations for the fiscal years ended January 29, 1994, January 28,
1995 and February 3, 1996, expressed as percentages of net sales. Percentage
amounts may not total 100% due to rounding.
<TABLE>
<CAPTION>
FISCAL YEAR ENDED(1)
-------------------------------------
JAN. 29, JAN. 28, FEB. 3,
1994 1995 1996
-------- -------- -------
<S> <C> <C> <C>
Net sales (000s).......................................... $ 12,569 $ 27,510 $55,339
======= ======= =======
Net sales................................................. 100.0% 100.0% 100.0%
Cost of sales (including buying and occupancy costs)...... 62.0 56.4 56.8
------- ------- -------
Gross margin.............................................. 38.0 43.6 43.2
Operating expenses:
Stores and catalog(2)................................... 32.6 32.6 33.9
General and administrative.............................. 22.0 14.2 10.9
Preopening expenses....................................... 3.3 2.7 1.4
------- ------- -------
Operating loss............................................ (19.8) (5.9) (3.1)
Interest income, net...................................... 1.1 0.8 0.1
------- ------- -------
Net loss.................................................. (18.7)% (5.0)% (3.0)%
======= ======= =======
</TABLE>
- ---------------
(1) The fiscal year ended February 3, 1996 was a 53-week year.
(2) The Company commenced its catalog operations in the third quarter of fiscal
1994.
FISCAL 1995 VS. FISCAL 1994
General. The Company operated 152 stores at the end of fiscal 1995,
compared to 86 stores at the end of fiscal 1994. There were 1,375 store months
of operations during fiscal 1995 versus 681 store months in the prior period, an
increase of 102%. The average age of the Company's stores increased from 16
months to 18 months.
Net Sales. Net sales for fiscal 1995 were $55,339,000, compared to net
sales of $27,510,000 for fiscal 1994. The increase of $27,829,000, or 101%, in
net sales was due primarily to the following factors: (i) the 102% increase in
store months of operations during the year; (ii) an increase of 16.7% in
comparable store sales over the prior year, resulting primarily from an increase
in the number of customer transactions; and (iii) having the Garden Botanika
catalog in operation for the full 53 weeks versus only 22 weeks in the prior
year. Sales per square foot declined by 14%, to $458, during the period, due
primarily to a 12% increase in average square footage per store and the effect
of the 45 new stores, which initially have lower-than-average sales, opened
during fiscal 1994 on a base of only 41 stores. In fiscal 1994 and 1995, the
sales directly attributable to the Company's catalog operation accounted for
3.2% and 6.6%, respectively, of the Company's total net sales. In fiscal 1994
and 1995, the Company mailed approximately 2,311,000 and 5,021,000 catalogs,
respectively.
Gross Margin. Gross margin as a percentage of net sales declined from
43.6% in fiscal 1994 to 43.2% in fiscal 1995. Margin improvements attributable
to improved sourcing and increased buying power and to improved leverage on
buying costs were more than offset by increases in inventory shrinkage and
occupancy costs. The dollar amount of gross margin increased by $11,902,000, or
99%, from the prior year, primarily as a result of increased sales.
Operating Expenses
Stores and Catalog. Store and catalog expenses, including distribution,
increased as a percentage of net sales from 32.6% in fiscal 1994 to 33.9% in
fiscal 1995. Improved leverage on store operating expenses and
18
<PAGE> 21
distribution costs were more than offset by increased catalog costs,
which were primarily attributable to the start-up nature of the Company's
catalog and the fact that it was in operation for 53 weeks in fiscal 1995
compared to only 22 weeks in the prior year. The dollar amount of store expenses
increased by $7,248,000, or 93%, and the dollar amount of catalog expenses
increased from $1,155,000 to $3,696,000, or 220%, over the prior year. The
Company believes that expenses incurred for its catalog also serve to support
sales at the Company's stores.
General and Administrative. General and administrative expenses
declined as a percentage of net sales from 14.2% in fiscal 1994 to 10.9% in
fiscal 1995. This 330 basis point decline reflected the improved leverage
associated with increases in total and comparable store sales. The dollar amount
of general and administrative expenses increased by $2,124,000, or 54%, from the
prior year to support the 102% increase in store months of operations and the
101% increase in net sales.
Preopening Expenses. Preopening expenses increase with the number of new
stores opened and the number of existing stores relocated during a particular
period. In addition, the one-time start-up costs of new operations are
classified as preopening. Preopening expenses were $798,000, or 1.4% of net
sales, in fiscal 1995, when the Company opened 66 new stores, relocated two
existing stores and brought its catalog customer service and fulfillment
operations in-house. The Company incurred preopening expenses of $733,000, or
2.7% of net sales, during the prior year, when it opened 45 new stores and
relocated one existing store. The Company standardized its store-opening process
during fiscal 1995, generally improving control of costs related to the opening
of new stores.
Operating Loss. For the reasons explained above, the fiscal 1995 loss from
operations increased 5%, to $1,694,000, from $1,617,000, in the prior year.
Expressed as a percentage of net sales, however, loss from operations declined
280 basis points, from 5.9% to 3.1%, primarily as a result of improved leverage
from increased sales.
Interest Income, Net. Net interest income during fiscal 1995 was $30,000,
or 0.1% of net sales, compared to $230,000, or 0.8% of net sales, during the
prior year. This change was due primarily to a reduction in the amount of funds
available for temporary investment during fiscal 1995 and to the borrowings
against the Company's bank line of credit occasioned thereby.
Income Taxes. The Company did not record an income tax provision for
either fiscal 1995 or fiscal 1994 due to its pre-tax losses. Net operating loss
carryforwards of $1,537,000 at February 3, 1996, begin to expire in 2005, and
the amount of such carryforwards that can be used in any one year is subject to
limitation, based on the nature of past ownership changes. See Notes to
Consolidated Financial Statements.
Net Loss. For the reasons explained above, during fiscal 1995, the
Company's net loss increased 20%, to $1,664,000, or $0.44 per pro forma common
and common equivalent share, from $1,387,000, or $0.43 per pro forma share, in
fiscal 1994. Although the net loss increased in absolute dollars, it declined
200 basis points to 3.0% of net sales from 5.0% in the prior year due to the
improved operating expense leverage resulting from the 101% increase in net
sales, including a 16.7% increase in comparable store sales.
FISCAL 1994 VS. FISCAL 1993
General. The Company operated 86 stores at the end of fiscal 1994,
compared to 41 stores at the end of fiscal 1993. There were 681 store months of
operations during fiscal 1994 versus 368 store months in the prior year, an
increase of 85%. The average age of the Company's stores was unchanged from the
prior fiscal year-end at 16 months.
Net Sales. Net sales for fiscal 1994 were $27,510,000, compared to net
sales of $12,569,000 for fiscal 1993. The increase of $14,941,000, or 119%, in
net sales was due primarily to the 85% increase in store months of operations
during the year and an increase of 32.9% in comparable store sales over the
prior year, resulting primarily from an increase in the number of customer
transactions. Sales per square foot increased by 11%, to $535, during the year
as a result of the increase in comparable store sales. The Company introduced
its mail order catalog for Garden Botanika products in the third quarter of
fiscal 1994. Sales directly attributable to the catalog represented 3.2% of
total net sales for the year.
19
<PAGE> 22
Gross Margin. Gross margin as a percentage of net sales improved from
38.0% in fiscal 1993 to 43.6% in fiscal 1994. The 560 basis point improvement
was due primarily to the following factors: (i) improved leverage on buying and
occupancy costs; (ii) changes in product mix; and (iii) improved sourcing and
increased purchasing power as the Company's sales volume grew. The dollar amount
of gross margin increased by $7,214,000, or 151%, primarily as a result of
increased sales.
Operating Expenses
Stores and Catalog. Fiscal 1994 store and catalog expenses, including
distribution, were unchanged as a percentage of net sales from the 32.6% level
of fiscal 1993, due primarily to the increased expenses associated with the
Garden Botanika catalog, which commenced operations during the third quarter of
fiscal 1994. The dollar amount of store expenses increased by $3,708,000, or
91%, from the prior year, primarily as a result of the 85% increase in store
months of operations. Expenses directly attributable to the new catalog
operation were $1,155,000.
General and Administrative. General and administrative expenses
declined as a percentage of net sales from 22.0% in fiscal 1993 to 14.2% in
fiscal 1994. This 780 basis point decline reflected the improved leverage
associated with increases in total and comparable store sales. The dollar amount
of general and administrative expenses increased by $1,158,000, or 42%, from the
prior year to support the 85% increase in store months of operations and the
119% increase in net sales.
Preopening Expenses. Preopening expenses were $733,000, or 2.7% of net
sales, during fiscal 1994, when the Company opened 45 new stores and relocated
an existing store. The Company incurred preopening expenses of $417,000, or 3.3%
of net sales, during fiscal 1993, when it opened 18 new stores.
Operating Loss. For the reasons explained above, the fiscal 1994 loss from
operations declined 35%, to $1,617,000, from $2,494,000 in the prior year.
Expressed as a percentage of net sales, the loss from operations declined from
19.8% to 5.9%, primarily as a result of improved leverage from increased sales.
Interest Income, Net. Net interest income during fiscal 1994 was $230,000,
or 0.8% of net sales, compared to $140,000, or 1.1% of net sales, during fiscal
1993. The dollar increase was due primarily to an increase in the amount of
funds available for temporary investment during fiscal 1994.
Income Taxes. The Company did not record an income tax provision for
either fiscal 1994 or fiscal 1993 due to its pre-tax losses.
Net Loss. For the reasons explained above, during fiscal 1994, the
Company's net loss declined 41%, to $1,387,000, or $0.43 per pro forma common
and common equivalent share, from $2,354,000, or $0.88 per pro forma share, in
fiscal 1993. The net loss also declined to 5.0% of net sales from 18.7% in the
prior year due to the improved operating expense leverage resulting from the
119% increase in net sales, including a 32.9% increase in comparable store
sales.
SEASONALITY AND QUARTERLY FLUCTUATIONS
As illustrated in the following table, a disproportionate amount of the
Company's retail sales, ranging from approximately 45% to 50% of annual net
sales, and all of its profits, have historically been realized during the fourth
fiscal quarter, which includes the holiday shopping season. The Company expects
this pattern to continue during the current fiscal year and anticipates that in
subsequent years the fourth quarter will continue to contribute
disproportionately to its operating results, particularly during November and
December. The Company's quarterly results of operations may also fluctuate
significantly as a result of a variety of other factors, including the timing of
new store openings, net sales contributed by new stores, increases or decreases
in comparable store sales, adverse weather conditions, shifts in the timing of
holidays and changes in the Company's product mix. Primarily as a result of the
increasing number of recently opened stores and new product initiatives, the
Company anticipates a higher net loss in each of its first three quarters of
fiscal 1996 as compared to the prior fiscal year. See "Risk Factors--Seasonality
and Quarterly Fluctuations."
20
<PAGE> 23
<TABLE>
<CAPTION>
FISCAL QUARTER(1)
------------------------------------------------------
FIRST SECOND THIRD FOURTH
------ ------- ------- -------
(IN THOUSANDS)
<S> <C> <C> <C> <C>
Fiscal 1993:
Net sales.............................. $1,930 $ 2,179 $ 2,477 $ 5,983
% of full year...................... 15.4% 17.3% 19.7% 47.6%
Gross margin........................... $ 689 $ 718 $ 781 $ 2,587
% of full year...................... 14.4% 15.0% 16.4% 54.2%
Net loss............................... $ (550) $ (622) $ (928) $ (254)
Fiscal 1994:
Net sales.............................. $3,955 $ 4,521 $ 5,551 $13,483
% of full year...................... 14.4% 16.4% 20.2% 49.0%
Gross margin........................... $1,545 $ 1,771 $ 2,178 $ 6,495
% of full year...................... 12.9% 14.8% 18.2% 54.2%
Net income (loss)...................... $ (665) $ (616) $(1,168) $ 1,062
Fiscal 1995(2):
Net sales.............................. $9,532 $10,138 $10,671 $24,998
% of full year...................... 17.2% 18.3% 19.3% 45.2%
Gross margin........................... $4,084 $ 4,212 $ 4,170 $11,425
% of full year...................... 17.1% 17.6% 17.5% 47.8%
Net income (loss)...................... $ (827) $ (836) $(1,986) $ 1,985
</TABLE>
- ------------------------------
(1) Percentage amounts may not total 100% due to rounding.
(2) Fiscal 1995 was a 53-week year.
LIQUIDITY AND CAPITAL RESOURCES
GENERAL
Garden Botanika began fiscal 1995 with cash and cash equivalents totaling
$1,038,000, having previously raised net equity of $25,644,000, primarily
through Series A and Series B Convertible Preferred Stock offerings in fiscal
years 1990 through 1993. Accumulated losses since inception had reduced net
shareholders' equity to $18,183,000 at January 28, 1995.
During February and March 1995, the Company completed an offering of
508,464 shares of Series C Convertible Preferred Stock at $19.67 per share,
raising additional net equity of $9,960,000.
On August 14, 1995, the Company signed a $5,000,000 bank credit line with
Seattle-First National Bank (the "Seafirst Line"), bearing interest at prime
plus 0.25%. Borrowings against this credit line reached the maximum of
$5,000,000 (at 9.00%) on October 31, 1995.
During November and December 1995, the Company completed an offering of
275,408 shares of Series D Convertible Preferred Stock at $23.60 per share,
raising additional net equity of $6,472,000. The proceeds of this offering were
used to substantially reduce the balance outstanding on the Seafirst Line.
On November 30, 1995, the Company completed negotiation of a replacement
bank credit line with U.S. Bank (the "U.S. Bank Line"). The U.S. Bank Line
includes a $5,000,000 revolving working capital facility and a $4,000,000
revolving bridge facility and is secured by substantially all the assets of the
Company. The working capital facility is subject to a borrowing base limitation,
bears interest at U.S. Bank's prime rate (currently 8.25%), and expires on
September 30, 1997. The bridge facility bears interest at prime plus 3.00% and
expires on September 30, 1996. Borrowings of $2,616,000 (at 8.75%) were made
against the working capital facility to pay down the Seafirst Line, which was
then canceled. As of March 21, 1996, the Company had borrowings of $6,023,000
under the U.S. Bank Line.
21
<PAGE> 24
The U.S. Bank Line requires that the Company maintain minimum tangible net
worth of $27,000,000 through June 29, 1996 and $32,000,000 thereafter, a maximum
ratio of indebtedness to capital of 0.7:1 and working capital of at least
$4,000,000. In addition, the Company is prohibited from paying dividends and
assuming additional indebtedness without U.S. Bank's prior written consent. U.S.
Bank has waived violations of the working capital covenant and the borrowing
base limitation of the working capital facility which occurred prior to March
22, 1996, and has adjusted the borrowing base limitation of the working capital
facility in a manner expected to permit the Company to access the full
$9,000,000 credit line through May 31, 1996. Until that date, the working
capital facility will bear interest at U.S. Bank's prime rate plus 1.00%. Upon
completion of this offering, the Company intends to repay all amounts owing
under the U.S. Bank Line and to cancel or no longer access the bridge facility
of that line.
CASH FLOW FOR FISCAL 1995
During fiscal 1995, the Company used $1,892,000 in cash to finance its
operating activities. This cash was used primarily to fund a $4,543,000 increase
in inventory related primarily to store expansion ($2,048,000 net of related
increases in accounts payable and checks drawn in excess of bank balances) and
an increase of $1,043,000 in prepaid rent and other prepaid expenses.
The Company also used $16,800,000 in cash during the same period to fund
new stores ($15,621,000 net of a related increase in accounts payable), to
expand its distribution and central office support facilities and systems and to
fund a $1,230,000 increase in receivables from store lessors.
The primary sources of funds for the Company's operating and investing
activities during fiscal 1995 were the offerings of its Convertible Preferred
Stock and the bank credit lines previously described.
FUTURE CASH REQUIREMENTS AND CASH FLOW EXPECTATIONS
The Company currently plans to open approximately 100 additional stores in
fiscal 1996 and approximately 120 stores in fiscal 1997. Management expects that
substantially all of these new stores will be leased on terms generally
comparable to those of existing store leases. Whenever possible, the Company's
real estate leasing department will negotiate lessor construction allowances to
partially defray the cost of leasehold improvements. For fiscal 1996 and 1997,
the Company has budgeted total capital expenditures of approximately $25,000,000
and $26,000,000, respectively, based on currently planned store openings and the
distribution, manufacturing and central office facilities and systems necessary
to support those openings.
The Company's average expenditure for leasehold improvements, equipment,
furniture and fixtures for the 66 current prototype stores opened during fiscal
1995 was $226,000, after giving effect to lessor construction allowances.
Average preopening expense for these 66 stores was approximately $11,000. In
addition, other working capital requirements, consisting primarily of net
inventory purchases, averaged approximately $30,000 per store. The Company
expects that the average cost to open a new store during fiscal 1996 will
decline materially due to cost reductions associated with bringing certain lease
acquisition and store design functions in-house and to an expected general
increase in the level of lessor construction allowances. The Company also
expects that, while average store inventory levels will vary during the year
based on the timing of promotional events and gift giving periods, they will not
change materially from the levels experienced during fiscal 1995.
On an ongoing basis, the Company expects to be able to finance a portion of
its merchandise inventory cost by using vendor credit terms, generally ranging
from 30 to 60 days. In addition to such vendor financing, the Company may also
finance up to 25% of the cost of its merchandise inventory during the months of
January through March by borrowing against the working capital facility of its
bank credit line. During the months of April through December, the percentage of
merchandise inventory that can be financed under the working capital facility
increases to 50%.
The Company anticipates that the net proceeds from this offering will be
used as follows: (i) approximately $24.0 million to finance the opening of
approximately 100 additional stores (including leasehold improvements,
furniture, fixtures, initial inventory purchases and preopening expenses);
22
<PAGE> 25
(ii) approximately $8.5 million to repay bank debt anticipated to be outstanding
at the close of this offering; and (iii) the balance for other capital
expenditures related to expansion of the Company's operations, working capital
and general corporate purposes. The Company believes that the cash generated
from this offering, from anticipated bank borrowings under its working capital
credit facility and from operations will be sufficient to satisfy its currently
anticipated working capital and capital expenditure requirements until
mid-fiscal 1997. The Company's capital requirements may vary significantly from
those anticipated, however, depending particularly upon such factors as
operating results, the number and timing of new store openings, store
development costs in the markets the Company enters and the extent of lessor
construction allowances received. The Company may be required to seek additional
sources of funds for such expansion, and there can be no assurance that such
funds will be available on satisfactory terms. Failure to obtain such financing
could delay or prevent the Company's planned expansion, which could adversely
affect the Company's business, financial condition and operating results.
IMPACT OF INFLATION AND CHANGING PRICES
Although the Company cannot accurately predict the effect of inflation on
its future operations, it does not believe inflation has had a material effect
on net sales or results of operations. As its operations have expanded to the
present level, the Company has been able to access larger vendors and to realize
certain economies of scale in its purchasing and distribution, thus largely
offsetting any raw material price increases.
ADOPTION OF ACCOUNTING STANDARDS
Financial Accounting Standards Board Statement No. 123 ("SFAS 123"),
"Accounting for Stock-Based Compensation," issued in October 1995 and effective
for fiscal years beginning after December 15, 1995, encourages, but does not
require, a fair value based method of accounting for employee stock options or
similar equity instruments. SFAS 123 also allows an entity to continue to
measure compensation cost under Accounting Principles Board Opinion No. 25 ("APB
25"), "Accounting for Stock Issued to Employees," but requires pro forma
disclosure of net income and earnings per share as if the fair value based
method of accounting encouraged by SFAS 123 had been applied. The Company will
adopt SFAS 123 in fiscal 1996. While the Company is still evaluating SFAS 123,
it currently expects to continue to measure compensation cost under APB 25 and
comply with the pro forma disclosure requirements. If the Company makes this
election, SFAS 123 will have no impact on the Company's results of operations or
financial position because its Stock Option Plan is a fixed plan, the options of
which have no intrinsic value at the grant date under APB 25.
23
<PAGE> 26
BUSINESS
GENERAL
Garden Botanika, Inc. ("Garden Botanika" or the "Company") is a rapidly
growing retailer of high-quality, reasonably priced personal care products. The
Company's proprietary products encompass such categories as skin care, color
cosmetics, fragrances, bath and body care and related accessories and gifts.
Garden Botanika develops its branded products and distributes them for sale
through its 161 Company-owned and -operated specialty retail stores in 31 states
nationwide and the Company's catalog. Since it commenced operations in 1990, the
Company's primary goal has been to establish Garden Botanika as among the most
recognized and respected brands of personal care products in the markets in
which it competes. The Company believes that its strong brand identity is based
upon (i) high-quality products with botanically based formulations subject to
strict ingredient guidelines; (ii) its value-oriented pricing strategy; and
(iii) a high-quality store experience, which the Company provides through its
upscale store design, excellent customer service and the uniform presentation of
its products. Garden Botanika has grown from a three-store start-up company in
1990 to a national chain with fiscal 1995 revenues of $55.3 million.
Garden Botanika's marketing and merchandising efforts primarily target 30-
to 45-year-old working women who have traditionally purchased skin care and
cosmetic products from mall-based department stores and who utilize quality
personal care products both on a daily basis and as an affordable luxury item.
The Company believes these women are increasingly seeking better pricing without
having to sacrifice high quality and service. The Company also believes that its
marketing strategy has been successful in attracting a broad cross-section of
other consumers beyond its primary target.
Customer acceptance of the Garden Botanika concept has been demonstrated to
date by the Company's annual average sales per store, average sales per square
foot and store contribution margin, which, for each class of the Company's
stores, have improved significantly as each respective class has matured. After
opening 45 and 66 stores in fiscal 1994 and 1995, respectively, the Company
currently plans to open approximately 100 additional stores in fiscal 1996 and
approximately 120 stores in fiscal 1997, which would broaden the Company's
operations to include most major U.S. markets. Garden Botanika achieved average
annual sales per square foot of $458 in fiscal 1995, at the end of which the
average age of its stores was 18 months. The Company's comparable stores sales
increased 19.5%, 32.9% and 16.7% during fiscal 1993, 1994 and 1995,
respectively.
INDUSTRY OVERVIEW
The highly fragmented personal care products industry, which includes skin
care, color cosmetics, fragrances and bath and body care, has annual sales
nationwide in excess of $20 billion. Historically, a leading distribution
channel for such products has been department stores. The Company believes that
consumer preferences have shifted in recent years to favor distribution channels
offering generally lower prices and a less intimidating sales environment, such
as drugstores, mass merchandisers, television "infomercials" and, to a lesser
extent, specialty retailers. The Company believes that in targeting their
respective market segments, department stores on the one hand, and the
lower-priced distribution channels on the other, have left a void for customers
seeking high-quality products combining reasonable pricing with personal
service. Specialty retailers, such as Garden Botanika, have addressed this
market need by offering personal service and positioning themselves as
high-value alternatives to the high-priced, high-quality designer brands offered
by department stores and the low-priced products sold by drugstores, mass
merchandisers, supermarkets and other retail outlets.
24
<PAGE> 27
BUSINESS STRATEGY
The Company's principal objective is to become a leading developer,
manufacturer and retailer of proprietary personal care products by establishing
"Garden Botanika" as a nationally recognized brand name associated with high
quality and exceptional value. The key elements of its business strategy are set
forth below.
High-Quality, Proprietary Products. Garden Botanika seeks to develop
unique and distinctive personal care products, focusing on the use of
botanically based ingredients. The Company believes these ingredients appeal to
its customers because they are perceived to be safer and more effective than
many products based on synthetic substances. Garden Botanika maintains control
over its own operations, uses strict product specifications and seeks to ensure
that its third-party suppliers meet those specifications by imposing initial
qualification requirements and conducting periodic product testing. These
procedures allow the Company to introduce new products quickly while maintaining
consistent standards and rigorous quality control.
Attractive Pricing. The Company believes its customers are attracted by
its high-value pricing strategy. Because of its control over the manufacturing
and distribution process, the Company can generally position its products at
prices below department store pricing and at levels competitive with the price
points of comparable products offered by drugstores, supermarkets and mass
merchandisers.
Extensive Product Assortment. The Company currently offers a large
assortment of botanically based skin care, color cosmetics, fragrances, and bath
and body care products, as well as assortments of hair care, men's and
children's products. The Company's extensive product offering allows it to
provide customers with personalized solutions to their skin and hair care needs.
In addition to offering conventional personal care product lines, Garden
Botanika has developed specialty branded product lines, such as Spa Botanika,
that expand the base and reinforce the uniqueness of the Company's proprietary
products.
Continuous New Product Development. The Company continuously develops new
products and new product lines. By striving to maximize the appeal of its
product offering and maintain the freshness of its store presentation, the
Company seeks to encourage return shopping on a regular basis. In October 1995,
the Company acquired direct research and development capabilities and expects to
utilize those capabilities to improve the rate and quality of new product
introductions.
Excellent Customer Service. Garden Botanika is committed to achieving
customer satisfaction and to building a loyal customer base by providing a high
level of attentive and personalized customer service. Management believes that
knowledgeable sales associates are essential in identifying and relating the
unique benefits of Garden Botanika products. As a result, the Company trains its
sales associates to make product recommendations specific to customers'
individual needs. In addition, the Company seeks to provide excellent customer
service through well-designed store signage, product handbooks, its catalog and
a toll-free customer service number.
Upscale Shopping Environment. Garden Botanika seeks to offer a distinctive
shopping environment, maintained at a uniformly high standard, that showcases
the Company's product offerings and promotes product testing and trial by
customers. The Company's brightly lit stores are designed to project a clean,
upscale atmosphere and to reinforce the distinctive Garden Botanika brand image.
The Company has continually refined and improved its store design, and, as new
products and promotions are introduced, it tests reconfigurations of its store
merchandise displays to maintain the stores' fresh, contemporary look.
Expanded Recognition of the "Garden Botanika" Brand Name. In order to
maintain the association of the Garden Botanika name with high quality and high
value, the Company's comprehensive product assortment is sold to consumers only
in Company stores or through the Company's catalog. In the future, as it
explores other possible channels of distribution, the Company intends to
continue to exercise strict control over the use of the "Garden Botanika" name.
The Company also seeks to further brand awareness through targeted mailings of
its catalog and other promotional materials.
25
<PAGE> 28
GROWTH AND PROFITABILITY STRATEGY
Garden Botanika plans to continue its aggressive growth strategy.
Management expects the Company to expand its market share by increasing its
store base and by exploring other potential channels of distribution, as well as
increasing sales and profitability in existing stores.
New Store Locations. Garden Botanika believes that opportunities for store
expansion exist throughout the nation and that the broad appeal of its concept
allows it to compete successfully in a variety of markets. The principal element
of the Company's growth strategy is to continue to open new stores in major
metropolitan malls, certain secondary regional malls and select street-front
shops in residential neighborhoods that satisfy its demographic and financial
return criteria. The Company opened 66 stores in fiscal 1995 and currently plans
to open approximately 100 additional stores in fiscal 1996 and approximately 120
stores in fiscal 1997. As it enters new markets, the Company seeks to cluster
the general location and timing of its store openings within geographic areas in
order to achieve management and operating efficiencies and to enhance awareness
of the Garden Botanika name. The Company has found that the opening of
additional stores within existing markets can also increase sales by enhancing
awareness of the Garden Botanika brand, and the Company believes that such
openings will continue to be an element of its growth strategy.
New and Expanded Distribution Channels. The Company's growth strategy is
primarily focused on opening new stores; however, the Company is also exploring
alternative distribution strategies for increasing sales. The Company commenced
its catalog operations in the third quarter of fiscal 1994 with the objective,
among others, of increasing awareness of the Company's stores. Management
expects the contribution of mail-order sales to the Company's total revenue base
to increase as the Company increases the circulation of its catalogs. The
Company has also entered into an agreement to license Garden Botanika products
to be used as amenities in certain luxury hotels and resorts. The Company
continues to explore other new distribution opportunities domestically and
internationally.
Increasing Sales and Store-Level Profitability. The Company believes that
maturation of its existing stores, which, as of February 3, 1996, had an average
age of 18 months, presents a compelling growth opportunity. Through fiscal 1995,
the Company's stores have averaged sales per square foot of $374 and a
contribution margin of 10.4% in their first full fiscal year of operation. More
importantly, however, the productivity of each class of the Company's stores has
improved significantly each year as each respective class has matured. The 13
stores that have been in operation for four full fiscal years averaged sales per
square foot of $835 and a contribution margin of 28.5% on comparable store sales
growth of 22.4% in their fourth full fiscal year of operation. The Company's net
store investment has ranged from approximately $222,000 per store (excluding any
lease buyout and relocation costs) for stores open in fiscal 1990 and 1991 to
approximately $267,000 per store for the 66 stores opened in fiscal 1995.
Management expects that the average cost to open a new store will decline
materially during fiscal 1996 due to cost reductions associated with bringing
certain lease acquisition and store design functions in-house and to an expected
general increase in the level of lessor construction allowances. See "Risk
Factors -- Historical Net Losses" and "-- Aggressive Growth Strategy" and
"Management's Discussion and Analysis of Financial Condition and Results of
Operations."
MERCHANDISING
Product Quality. Garden Botanika develops its products with high-quality
ingredients, using botanical extracts and natural plant oils in its
formulations. New products undergo appropriate quality and stability testing,
and the Company's policy is to utilize ingredients of the highest purity
available for use in personal care products. With the recent acquisition of
manufacturing capabilities, the Company expects that its in-house quality
control activities will increase.
Garden Botanika's strict ingredient policy is a major factor underlying the
quality of the Company's products. Garden Botanika believes that botanical
ingredients are more appealing to its customers because they are perceived to be
safer and more effective than many synthetic substances. Garden Botanika also
believes that its customers value the Company's use of ingredients that have
been tested through centuries of historical use. The Company avoids the use of
common petrochemicals and comedogenic materials that can
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<PAGE> 29
block pores and cause blemishes, as well as many common allergens. Many of the
ingredients that the Company avoids, such as mineral oil and petrolatum, are
used regularly by some of its competitors. Garden Botanika's strict ingredient
policy has also led to the development and successful introduction of products
and product lines that the Company believes are unique in its industry. For
example, the Company's Natural Color line of color cosmetics is based on corn
starch and natural plant oils, instead of talc and mineral oil that are used in
the products of some of its competitors. Customer surveys and comments received
on feedback forms distributed by the Company demonstrate that Garden Botanika's
customers recognize the quality and efficacy of its products.
Product Assortment. While all Garden Botanika products feature a high
level of functional quality, care has also been taken to maintain a sense of
variety and fun in the Company's product assortment. Garden Botanika blends
high-quality personal care products with an array of colorful and novel impulse
and gift items which is accomplished, in part, through the use of color,
fragrance and customization. For example, the Aromatics assortment uses the
principle of a color multiplier (with a single product available in various
colors and fragrances) to create a strong visual impact. In addition, the
Company seeks to give each of its products a distinctive fragrance. Garden
Botanika customers also enjoy the opportunity to develop personal fragrances
that can be blended into a dozen different products at each store's custom
fragrance counter or to have personalized gift baskets made at the point of
purchase. An extensive collection of complementary accessory items, ranging from
overnight moisture gloves to Japanese body brushes, are color-coordinated with
related products and add to the broad appeal of the Company's merchandise
assortment. Complementary accessories are intended to appeal to customers'
senses and encourage customers to extend a personal care product selection to
include a larger family of products. The combination of sight, smell and touch
is meant to inspire add-on sales and heighten the customer's experience of
Garden Botanika's products and the ambiance of its stores.
In addition to offering conventional personal care lines such as skin care
and cosmetics, Garden Botanika has developed specialty branded product lines to
reinforce the uniqueness and expand the base of the Company's proprietary
products. These product lines include the Spa Botanika line, which is intended
to offer affordable luxury items such as body polishers, muds, soaks, tonics and
special shampoos; the Sun & Sport line, which treats skin exposure and fatigue
with specially formulated lotions and soaks, as well as offering water-resistant
sunblocks and self-tanning creams; and the BotanikaBaby and Botanikids lines,
which use gentle cleansers uniquely formulated for children's skin. The Company
is committed to the development of further extensions of its brand identity and
intends to introduce new specialty branded product lines in the future on a
regular basis.
Product Lines and Categories. Over 95% of the items available for sale in
the Company's stores and through its catalog are proprietary Garden Botanika
products. Since the Company began doing business in 1990, its principal product
categories have included skin care, bath products, body care and custom
fragrances. Color cosmetics, which were first offered in the fall of 1992, have
also become one of the Company's principal product categories. The Company
tracks sales of its accessories and of its custom- and ready-made gifts as
distinct product categories and, together, these categories have consistently
accounted for approximately 15% of the Company's sales. The Men's Care line was
part of Garden Botanika's initial product mix, and, in fiscal 1991, the Company
began to expand its specialty branded products with the Sun & Sport, Botanikids
and BotanikaBaby lines. The Company added the Spa Botanika line to its list of
specialty branded products in fiscal 1993. Specialty lines currently constitute
approximately 10% of the Company's sales. In fiscal 1994, the Company introduced
its first fine fragrance, Vanilla Dawn, and in April 1996, it introduced Garden
Botanika, the Fragrance, both of which the Company markets as specialty brands.
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<PAGE> 30
A description of the Company's principal product lines and categories is
set forth below.
<TABLE>
<CAPTION>
PRODUCT LINE/CATEGORY DESCRIPTION
- ----------------------------- ------------------------------------------------------
<S> <C>
Skin Care Cleansers, exfoliants, toning lotions, moisture
creams, eye treatments and masks
Bath and Body Care Bath oils, moisturizers, shower gels, soaps, body
scrubs and massage oils
Hair Care Shampoos, color-enhancing shampoos, conditioning
rinses, styling gels and finishing sprays
Aromatics Hand and body lotions, bubble bath, shower gels and
shampoos
Custom Fragrances Perfume oils, colognes, shampoos, body lotions, bath
oil and bubble bath
Color Cosmetics Eyeshadows, lipsticks, foundations and powders
Gift Baskets Prepackaged and custom assortments, primarily of
Aromatics and bath and body care products
Accessories Bath brushes and sponges, combs, spa gloves, candles,
massagers, potpourri, cassette tapes and compact discs
Spa Botanika Mineral soaks, mud masks, face tonics, body washes,
body cleansers and clarifying shampoos
Men's Care After-shave, face wash, shaving gel, shaving creams,
hair-thickening shampoos and conditioners
Sun & Sport Body moisturizers and gels, sunblock, muscle soak,
self-tanning creams and sport shampoos
Botanikids and BotanikaBaby Baby powder, lotion and shampoos, barrier creams,
bubbling bath gels and liquid soap
Fine Fragrance Vanilla Dawn and Garden Botanika, the Fragrance
</TABLE>
Product Pricing. Garden Botanika is committed to providing high value to
its customers. The Company seeks to price its products at a substantial discount
to those offered at department stores for comparable products, and, as a result,
the Company's prices are often near the top of the range of prices for similar
products offered by drugstores, mass merchandisers and supermarkets. Promotional
offerings may offer greater savings to customers. See "Business -- Marketing."
As part of its pricing policy, the Company regularly monitors the price levels
of products offered by its competitors to ensure that Garden Botanika products
remain competitive.
Packaging. The Company believes that attractive merchandise displays and
well-designed, aesthetically pleasing product packaging also play an important
role in enhancing the image of its products and the Garden Botanika brand name.
Garden Botanika generally seeks to minimize layers in its packaging while
maintaining a distinctive visual image. The packaging of each product
classification shares certain common elements, but the graphic designs are
unique to increase the ease of category identification. The Company's packaging
has won several awards for both bottle design and the graphic presentation of
its labels.
NEW PRODUCT DEVELOPMENT
The Company is committed to the introduction of new products and
formulations on a regular basis. The Company also devotes substantial resources
to monitoring, market by market, which products are becoming more or less
important to its customers and uses this information in its new product
development efforts. For example, soon after consumers showed interest in
products containing alpha hydroxy acids, the Company introduced its "Skin
Renewing" treatment and lotion with a fruit-based acid complex. Garden Botanika
continues to tailor product offerings in response to customer comments, product
rankings and sales results. Since its inception, an average of approximately 20%
of the Company's product assortment offered in any one
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<PAGE> 31
year was first introduced during that year. The Company believes that its
ability to develop, test and market new products has been a key element to its
success and that new product development helps reinforce the appealing, fresh
nature of the Garden Botanika brand. See "Risk Factors -- Aggressive Growth
Strategy."
In October 1995, the Company's new product development efforts were
enhanced with the acquisition of substantially all of the assets of Innovative
Biosciences Corporation ("IBC"), a personal care product manufacturer located in
Oceanside, California, and the employment by the Company of its principal
product developer and an additional research chemist. Prior to the acquisition,
IBC had been one of the Company's suppliers and had originated a majority of the
Company's proprietary formulas. The Company's control of its product development
and manufacturing capabilities allows for in-house research and development and
the introduction of new products more quickly and at a lower cost. In addition,
the laboratory capabilities acquired allow the Company to conduct quality
testing of both the products it manufactures as well as those products produced
for Garden Botanika by outside suppliers. See "Certain Transactions."
STORE ENVIRONMENT
The Company seeks to offer a uniquely attractive store environment that
showcases the Company's product offerings and promotes product testing and trial
by its customers. Garden Botanika's brightly lit stores are designed to project
a clean, upscale atmosphere and to reinforce the Company's distinctive brand
image. The design of the Company's stores incorporates neutral white fixtures
with merchandise displays and product arrangements that are designed to
encourage hands-on interaction with the merchandise and allow for self-
selection. Simply designed shelves showcase the Company's products, which are
segmented by function and product line. Brief descriptions that highlight
product benefits and ingredients are posted on shelves next to each product and
provide an information-rich environment. In addition, Garden Botanika's friendly
and knowledgeable sales associates encourage customers to sample products as
well as educate customers concerning the benefits of the products' ingredients.
In addition to providing product testers, Garden Botanika's stores feature
custom fragrance bars that allow customers to mix and match up to 65 fragrances
to develop their own personal fragrances. Stores also offer a wide assortment of
prominently displayed, specially priced starter selections to encourage product
trial by new customers. In addition, as new products and promotions are offered,
the Company tests reconfigurations of its store merchandise displays to maintain
the stores' fresh, contemporary look. In some stores, sinks further allow
customers to test and handle the Company's products. Management believes that
emphasizing product experimentation in the Company's stores encourages customers
to shop for an extended period and promotes impulse and add-on purchases.
Since opening its first store in August 1990, Garden Botanika has
continually refined and improved its store design to position itself and
establish its distinctive image in the marketplace. In 1993, the Company won
"Retail Store of the Year" honors for small, nonapparel stores from Chain Store
Age for its store design. In July 1994, the Company introduced a new prototype
design for its stores and has incorporated many of these design elements in all
new store locations. When an appropriate opportunity exists, the Company may
relocate or upgrade an existing store. With an average store age of 18 months at
February 3, 1996, approximately two-thirds of the Company's stores were of the
latest prototype design. From fiscal 1991 to fiscal 1995, the average size of
the new stores opened in each fiscal year increased from 765 to 1,256 square
feet to accommodate the Company's expanding product assortment. See
"Management's Discussion and Analysis of Financial Condition and Results of
Operations -- Results of Operations."
The Company maintains a uniform high operating standard by requiring that
each store follow procedures set forth in store presentation manuals. Adherence
to these standards is monitored by monthly visits and detailed evaluations by
the district manager responsible for each store. As the Company opens new
stores, it intends to hire additional district managers to allow for continued
effective supervision.
MARKETING
The Company's marketing strategy is to create brand awareness, encourage
trial purchases through high-value promotional offerings, educate prospective
customers about the benefits of Garden Botanika's products
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<PAGE> 32
and promote repeat business by reinforcing positive experiences with the
Company's products. Garden Botanika has committed significant resources to a
direct-mail program and has assembled an in-house mailing list of its customers,
which currently consists of approximately 1.5 million names. The Company
typically uses its in-house list to target direct-mail postcards and folios to
support promotions and new product introductions, which are reinforced with
point-of-sale materials. Used in conjunction with the Company's database of
customers, catalog operations have become an important element of Garden
Botanika's efforts to create brand awareness and encourage store visits. Most
catalogs contain an insert featuring pictures of a typical Garden Botanika
store, a full listing of all store locations and an invitation to shop and
experiment with Garden Botanika products. The Company also has developed a
"Grand Opening" catalog for use in new markets where it plans to open a store.
For such markets, the Company obtains a list of the households in the new
store's primary trading area that most closely match profiles of the Company's
most active customers. Catalogs and promotional materials are then mailed to
approximately 10,000 of these targeted customers to build brand awareness and
enthusiasm for each new store. See "Business -- Catalog Operations."
The Company also relies on highly visible store locations, an attractive
store design and word-of-mouth advertising to attract prospective customers to
its stores. Brochures and information-rich displays that reinforce the
association of the Garden Botanika brand with high quality and value are also
important aspects of the Company's marketing strategy. Garden Botanika offers
value-priced bundles of many of its most popular products on a regular basis to
promote trial use. These and other in-store promotions generally account for
between 10% and 20% of the Company's sales. To build customer loyalty and
develop repeat customers, the Company offers a frequent-shopper program, the
"Garden Club," whereby purchasers of $100 in merchandise can receive a $10
credit toward the purchase of additional products. In addition, the Company
seeks to be viewed as a responsible member of its community and sponsors a
variety of public relations activities, including holiday donations to CARE, a
worldwide hunger relief effort.
CUSTOMER SERVICE
Garden Botanika is committed to achieving customer satisfaction and to
building a loyal customer base by providing a high level of knowledgeable,
attentive and personalized customer service. The Company believes that educating
consumers about the benefits of its product offerings is a critical component of
its success, and management considers its sales associates' knowledge of the
Company's customers and products to be essential to its marketing approach and
customer satisfaction. To ensure knowledgeable, responsive sales associates, the
Company has devoted significant resources to developing and implementing
employee training and incentive programs. The Company trains its sales
associates to inform customers about new product offerings and to suggest
products that suit each customer's specific needs. The Company's return policy
permits customers who are not completely satisfied with their purchases to
return items for an exchange, credit or refund. The Company also monitors the
level of customer service on an on-going basis through various initiatives, such
as customer comment forms. In addition, the Company uses a professional service
to "mystery shop" the Company's stores anonymously and to prepare detailed
reports on each store's performance on a monthly basis.
STORE LOCATIONS
In selecting new store sites, the Company seeks high-traffic locations
ranging from 1,000 to 1,500 square feet within regional malls. Based on the
broad appeal of its concept, the Company believes it can open stores in a
variety of markets. The Company conducts extensive analyses of potential store
sites and bases its selection on the performance of other specialty retail
tenants, the perceived strength of the mall's anchor stores, the size of the
mall and the demographics of the surrounding area. Although the Company's
current stores are located primarily in regional malls, the Company is
evaluating alternative locations, such as street-front shops in residential
neighborhoods.
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<PAGE> 33
The following map and list of stores show the location of each of Garden
Botanika's 161 stores as of April 25, 1996:
[MAP OF UNITED STATES REPRESENTING
NUMBER OF STORES]
ARIZONA (3)
Mesa
Phoenix
Tucson
CALIFORNIA (25)
Arcadia
Brea
Burlingame
Carlsbad
Corte Madera
Glendale
Laguna Hills
Lakewood
Montclair
Moreno Valley
National City
Newport Beach
Palm Desert
Pleasanton
Redondo Beach
Riverside
San Diego
San Luis Obispo
Santa Ana
Santa Barbara
Santa Clarita
Santa Monica
Santa Rosa
West Covina
Westminster
COLORADO (3)
Aspen
Aurora
Boulder
CONNECTICUT (4)
Danbury
Glastonbury
Meriden
Waterford
DELAWARE (2)
Newark
Wilmington
FLORIDA (13)
Boynton Beach
Brandon
Coral Springs
Jacksonville
Melbourne
Naples
Ocala
Ococee
Palm Beach Gardens
Pembroke Pines
Plantation
Sanford
Tampa
GEORGIA (3)
Atlanta
Duluth
Kennesaw
ILLINOIS (6)
Aurora
Chicago
Joliet
Skokie
Vernon Hills
West Dundee
INDIANA (5)
Bloomington
Greenwood
Indianapolis (2)
Lafayette
IOWA (1)
Davenport
KENTUCKY (2)
Florence
Louisville
MAINE (1)
South Portland
MARYLAND (4)
Baltimore
Bethesda
Owings Mills
Wheaton
MASSACHUSETTS (6)
Burlington
East Taunton
Holyoke
Natick
North Attleboro
Peabody
MICHIGAN (1)
Troy
MINNESOTA (4)
Bloomington
Burnsville
Minnetonka
Rochester
NEVADA (2)
Henderson
Reno
NEW JERSEY (7)
Deptford
Hackensack
Lawrenceville
Livingston
Shrewsbury
Tom's River
Westfield
NEW MEXICO (1)
Albuquerque
NEW YORK (10)
Albany
Bay Shore
Garden City
Huntington Station
Johnson City
Lake Grove
Poughkeepsie
Rochester
Saratoga Springs
Yorktown Heights
NORTH CAROLINA (3)
Fayetteville
Pineville
Wilmington
OHIO (6)
Akron
Beachwood
Cincinnati
Dayton
North Olmsted
Youngstown
OKLAHOMA (2)
Oklahoma City (2)
OREGON (5)
Eugene
Portland (3)
Tigard
PENNSYLVANIA (12)
Chestnut Hill
Exton
Harrisburg
King of Prussia
Lancaster
Langhorne
Media
Philadelphia
Pittsburgh (2)
Scranton
York
RHODE ISLAND (1)
Warwick
SOUTH CAROLINA (2)
Charleston
Greenville
TEXAS (10)
Austin
Dallas (2)
Fort Worth
Houston (3)
San Antonio
Sugarland
The Woodlands
VIRGINIA (6)
Arlington
Charlottesville
Chesapeake
Richmond (2)
Virginia Beach
WASHINGTON (8)
Bellevue
Bellingham
Lynnwood
Seattle
Silverdale
Spokane
Tacoma
Tukwila
WISCONSIN (3)
Milwaukee (2)
Greendale
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<PAGE> 34
STORE OPERATIONS
Management and Employees. The Company's stores are organized into two
geographic regions (East and West), each of which has a regional director who is
responsible for the store operations within his or her region and who reports to
the Company's Vice President -- Stores. The Company's 15 district managers
report to the regional directors and frequently visit the cluster of
approximately eight to twelve stores within their respective geographic areas to
monitor financial performance and ensure adherence to the Company's operating
standards. The typical staff of a Garden Botanika store consists of one store
manager, one assistant store manager and eight to ten additional hourly sales
associates, most of whom work part-time. In order to maintain its high operating
standards, the Company seeks to recruit as its new store managers individuals
who ideally have a minimum of two years' experience as a store manager in the
specialty retail environment and, at the district manager level, the Company
seeks individuals who ideally have a minimum of three years' comparable
experience as a district manager. To allow increased opportunities for promotion
internally, the Company recently instituted a Senior Store Manager program,
which allows individuals to work closely with a district manager as a trainee.
The Company intends for store employees to focus substantially all of their
efforts on customer service. As a consequence, the Company has centralized as
many administrative functions as possible, including all buying, development of
in-store merchandising displays, inventory allocation, human resources and
accounting functions, at its Redmond, Washington corporate office.
Training and Compensation. New store employees typically receive
approximately 16 hours of initial training, with emphasis on product knowledge,
merchandising standards and operating guidelines, which include customer service
and sales techniques. Store managers are also required to complete a training
program of approximately three weeks' duration, during which they are instructed
in the technical aspects of personal care products, communication skills and
employee relations. New store and district managers are then typically required
to work alongside individuals in comparable positions for two to three weeks
before they are asked to perform their duties without direct supervision. The
Company has found that such hands-on training, together with the use of detailed
operating and training manuals, is a highly effective way to introduce new
managers to the Garden Botanika concept. Performance appraisals and product
manuals are also used to help ensure that sales associates are thoroughly
familiar with the Company's product offerings. Training bulletins are
distributed from the Company's headquarters on a regular basis to educate store
managers and sales associates about new products as they are introduced.
District managers participate in an incentive plan that ties compensation
awards to the achievement of specified sales and other financial performance
criteria, and each store manager receives a commission based on a percentage of
store sales. The Company also seeks to instill enthusiasm and dedication in its
sales associates through targeted promotions, including prizes for successful
sales efforts, and regularly solicits employee suggestions regarding store
operations.
SUPPLIERS AND PURCHASING
The Company deals with its suppliers principally on an order-by-order basis
and, with the exception of certain packaging orders, has no long-term purchase
contracts or other contractual assurance of continued supply or pricing with its
suppliers. In fiscal 1995, the Company's largest supplier, Randall
International, accounted for approximately 12% of the Company's purchases, and
approximately 55% of the Company's purchases of raw materials, finished
products, packaging and other supplies were obtained from the Company's nine
largest suppliers. During that time, a significant portion of the Company's
merchandise purchases originated from independent foreign manufacturers, located
primarily in the Far East and Canada, with the majority of those purchases
consisting of finished accessories and packaging. The Company has not
experienced and does not anticipate any significant difficulty in obtaining
satisfactory or adequate sources of supply.
In October 1995, Garden Botanika acquired a manufacturing facility that
currently employs approximately 15 persons in Oceanside, California. Because of
its manufacturing capabilities, Garden Botanika now has additional flexibility
to introduce new products more quickly and supply various quantities more
efficiently
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<PAGE> 35
than had been possible through outside suppliers. The Company intends to
integrate its new capability with its existing operations, first, for greater
control over research and new product development and, second, for quality
control testing and limited production of Garden Botanika products. Based on the
current capabilities of its manufacturing division and available equipment, the
Company contemplates manufacturing approximately 20% of its production
requirements from its own facilities; however, this percentage may change
depending upon the initial success of its manufacturing division and further
investment in manufacturing capabilities.
The Company maintains its own central buying staff, which negotiates
payment terms and merchandise discounts and generally determines inventory
allocation among the stores. In many instances in which the Company does not
manufacture products itself, its ownership of substantially all of its formulas
allows it to obtain favorable pricing through competitive bidding. The Company's
buyers consistently utilize management information systems to monitor the flow
of merchandise through its stores and to ensure that in-stock availability will
be maintained in accordance with customer demands and the specific requirements
of each store.
DISTRIBUTION
Management believes that the Company's retail store distribution system
allows it to support a wide selection of inventory in its stores while
minimizing inventory requirements and maintaining effective inventory control.
Prior to April 1996, the Company's distribution facilities consisted exclusively
of two buildings that totaled approximately 48,000 square feet, located
approximately five miles apart in Southern California. The principal facility,
located in Ontario, California, is currently leased on a month-to-month basis. A
second facility, located in Fontana, California, is currently operated under a
lease that expires in July 1996, and has served the Company's catalog business
and warehousing needs, as well as serving as the Company's gift basket assembly
plant. The Company is currently in the process of relocating and consolidating
these facilities into a single larger facility, consisting of approximately
92,000 square feet, in Ontario, California. The Company recently signed a
14-month lease for this new facility, effective April 1, 1996, and it expects
that it will commence relocation of its store distribution functions in
mid-April 1996 and its basket fabrication and catalog fulfillment functions by
the end of July 1996. The combined facilities will eliminate the Company's past
need for a shuttle service and will increase efficiency by eliminating
duplicative receiving and supervisory functions. Following the expiration of the
lease term of its new facility in the summer of 1997, the Company intends to
establish a build-to-suit distribution center that could be expanded in the
future to meet the Company's needs as they grow.
Merchandise is delivered by suppliers to the Company's distribution
facilities, where relevant information is entered into the Company's
computerized management information system. Merchandise is then allocated to
stores on the basis of sales trends, historical patterns and anticipated
responses to special promotions. Inventory is typically shipped to stores on a
weekly or biweekly basis using United Parcel Service, thereby providing each
store with a steady flow of merchandise. The Company strives to keep
substantially all of its in-store inventory on display and available for sale.
The Company's information and control systems have enabled management to more
efficiently manage store inventories and ensure better in-stock availability by
tracking local preferences and historical merchandise sales of each store.
CATALOG OPERATIONS
The Company's catalogs offer a comprehensive assortment of Garden Botanika
products for its customers. In addition, the catalog has been used successfully
to introduce new Garden Botanika stores to customers in markets where the
Company has not previously operated a store. The Garden Botanika catalog was
first introduced by the Company in the third quarter of fiscal 1994, and its
success is measured, in part, by the sales increases experienced at the
Company's stores in the periods immediately following the catalog's
introduction. In 1994, the Company won the "Gold Award" for the best new
consumer catalog from the American Catalog Awards, sponsored by Catalog Age, a
leading industry publication.
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<PAGE> 36
In fiscal 1995, the Company prepared and circulated 11 editions of its
catalog, which averaged 32 pages with total mailings of approximately five
million. This compares with total mailings of approximately 2.3 million in
fiscal 1994. The Company's catalog management staff includes a director and
three managers who handle the catalog's merchandise, call center and order
fulfillment functions. The Company began its catalog operations by using a
contract company to manage its order fulfillment functions but assumed
responsibility for these functions after the first year. The Company currently
uses a combination of in-house marketing support and an outside catalog design
agency to monitor the catalog production process and develop effective catalog
presentations, emphasizing functional information about the Company's products.
The Company's overall catalog strategy has focused on the acquisition of
additional customer names, improved segmentation of customer files and excellent
customer service.
MANAGEMENT INFORMATION SYSTEMS
Garden Botanika's management information systems include fully integrated
store, distribution and financial systems. These systems utilize a Unix-based
minicomputer to run third-party software, and the Company currently relies on a
single outside vendor for both its software and the day-to-day support of its
systems. Sales information is updated daily in the sales audit and merchandise
reporting systems by polling transaction data from each store's point-of-sale
("POS") terminals. The Company's POS system consists of registers providing
price look-up, scanning of bar-coded tickets and capture of credit information
and payroll hours. The POS system also tracks store-initiated transfers, which
are uploaded to the host system, and price changes, which are downloaded into
the POS devices. Nightly communication with the stores also enables the Company
to receive store transfer and physical inventory details and updates for the
Company's in-house customer database. Information obtained from nightly polling
also results in automatic merchandise replenishment in response to the specific
SKU requirements of each store. The Company evaluates information obtained
through such reporting to implement decisions regarding merchandising
assortment, allocation and markdowns. In addition, this information allows the
Company to forecast purchasing requirements for its distribution center months
in advance, based on the combination of recent sales trends and historical
purchase patterns. The Company believes that its management information systems
are an important factor in allowing the Company to efficiently support its rapid
growth and maintain a competitive industry position. See "Risk
Factors -- Reliance on Single Management Information Systems Vendor."
COMPETITION
The personal care, makeup and fragrance businesses are highly competitive.
The Company's products compete directly against personal care, makeup, fragrance
and other functionally similar products sold through a variety of channels,
including department stores, drugstores, mass merchandisers, supermarkets,
telemarketing programs, television "infomercials" and catalogs. The Company
competes against a number of companies, many of which have substantially greater
resources and better name recognition than the Company and which sell their
products through broader distribution channels. Some department stores have
recently introduced less expensive product lines that the Company believes may
compete more directly with its products.
The Company also competes directly against mall-based specialty retailers
of personal care products, including national and international chains such as
Bath and Body Works, The Body Shop International PLC and Crabtree & Evelyn, as
well as local and regional specialty retailers. The number of specialty retail
outlets selling personal care products has increased significantly in recent
years, and the lack of significant barriers to entry may result in new
competition, including possible imitators of the Company. In addition to
competing for customers, the Company also competes generally with specialty
retailers for store sites, and there can be no assurance that management will be
able to continue to secure suitable sites on satisfactory terms.
Management believes that the primary elements of competition in its
business are quality, price and level of customer service, and that Garden
Botanika competes successfully on the basis of each of these factors. The
Company believes that successful competition in the personal care industry
depends, in part, on the regular introduction of new and appealing products and
has devoted substantial resources to new product development. See "Risk
Factors -- Competition" and "Business -- New Product Development."
34
<PAGE> 37
EMPLOYEES
At March 25, 1996, the Company employed approximately 1,450 persons, of
whom approximately 1,330 were store employees. Of the latter, approximately 25%
were full-time employees and approximately 75% were part-time employees. The
number of part-time associates employed by the Company fluctuates depending on
seasonal needs and has reached as high as 1,350 during peak selling periods. At
March 25, 1996, the Company had approximately 120 non-store employees who work
in the Company's corporate headquarters, two distribution centers, manufacturing
division and in different parts of the country as regional or district managers.
None of the Company's employees are covered by collective bargaining
agreements, and management believes that its relations with its employees are
good.
PROPERTIES
The Company currently leases all of its existing store locations and
expects that its policy of leasing, rather than owning, will continue as it
expands. The Company's store leases generally provide for initial lease terms of
five to 12 years. Management believes that these terms, in contrast to longer
lease terms, allow the Company flexibility to pursue various expansion
opportunities resulting from changing market conditions. Rent is generally the
greater of a percentage, ranging from 5% to 8%, of the store's sales volume or a
fixed minimum base rent. Lease rental payments are also subject to annual
increases for taxes, common area maintenance and insurance. See Notes to
Consolidated Financial Statements.
As most of the Company's stores were opened during the last three years,
most of the store leases have at least seven more years under their current
terms. As current leases expire, the Company believes that it will be able
either to obtain lease renewals if desired for present store locations or to
obtain leases for equivalent or better locations in the same general area. To
date, the Company has not had any experience renewing leases for existing
locations or experienced unusual difficulty in securing leases for suitable
locations for new stores.
In addition to its stores, the Company currently leases approximately
12,000 square feet of office space in two buildings in Redmond, Washington for
its corporate headquarters, and, as of May 1, 1996, will lease an additional
12,400 square feet of office space in a third building, also in Redmond,
Washington. The additional office space has been required primarily as a result
of the Company's taking substantial creative and marketing functions, and all
catalog call center and customer service functions, in-house. The Company also
leases approximately 92,000 square feet in Ontario, California as its principal
distribution facility and is in the process of moving out of a 27,000
square-foot building, currently leased on a month-to-month basis, that had been
its principal retail store distribution facility. The Company currently leases a
21,000 square-foot distribution facility in Fontana, California for its catalog
operations and its gift basket assembly facility, and expects to commence moving
out of this building into the new Ontario facility by the end of July 1996. The
Company recently acquired limited manufacturing capabilities and entered into a
sublease for an 8,700 square-foot building and storage facility in Oceanside,
California. In addition, the Company maintains a small office facility of 1,300
square feet in Howard County, Maryland as the headquarters of its East Coast
regional operations.
TRADEMARKS
The name "Garden Botanika" is registered as a trademark with the United
States Patent and Trademark Office. Management believes that the "Garden
Botanika" name is an important element of the Company's marketing strategy.
Accordingly, the Company intends to maintain its mark and the related
registration. The Company also has a number of other registered trademarks,
including "Sun & Sport," "Botanikids," "BotanikaBaby," "Garden Botanika Natural
Color" and the GB-and-design stylized logo, as well as other pending
applications for registration in the United States, Canada and selected other
foreign countries. The Company believes that establishing and maintaining brand
identities are important to the Company's operations.
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<PAGE> 38
GOVERNMENTAL REGULATION
The Company and its products are subject to regulation by the FDA and the
FTC in the United States, as well as various other federal, state and local
regulatory authorities. Such regulations relate principally to the ingredients,
labeling, packaging and marketing of the Company's products. The Company
believes that it is in substantial compliance with such regulations, as well as
applicable federal, state, local and foreign rules and regulations governing the
discharge of materials hazardous to the environment. There are no significant
capital expenditures for environmental control matters either estimated in the
current fiscal year or expected in the near future. See "Risk
Factors -- Regulation and Potential Claims."
LEGAL PROCEEDINGS
The Company is involved in various routine legal proceedings incident to
the ordinary course of its business. The Company believes that the outcome of
all pending legal proceedings in the aggregate will not have a material adverse
effect on its business, financial condition, liquidity or operating results.
36
<PAGE> 39
MANAGEMENT
EXECUTIVE OFFICERS AND DIRECTORS
The Company's executive officers and directors are as follows:
<TABLE>
<CAPTION>
NAME AGE POSITION
- ------------------------------------- --- -----------------------------------------------
<S> <C> <C>
Jeffrey H. Brotman(1)................ 53 Chairman of the Board and Secretary
Michael W. Luce...................... 45 Director, President and Chief Executive Officer
Arlee J. Jensen...................... 47 Senior Vice President -- Merchandising and
Marketing
C. Michael Fisher.................... 49 Senior Vice President -- Operations
John A. Garruto...................... 43 Vice President -- Research and Product
Development
Michael O. Jaglois................... 48 Vice President -- Marketing
Myron E. Kirkpatrick................. 53 Vice President -- Finance, Chief Financial
Officer and Treasurer
Jeffrey C. Mason..................... 33 Vice President -- Real Estate and Construction
Susan M. Walker...................... 36 Vice President -- Stores
Damon H. Ball(2)..................... 38 Director
David A. Ederer(2)................... 53 Director
Gerald R. Gallagher(1)............... 55 Director
William B. Randall................... 75 Director
Dale J. Vogel(1)(2).................. 51 Director
</TABLE>
- ------------------------------
(1) Member of the Compensation Committee.
(2) Member of the Audit Committee.
Jeffrey H. Brotman is a co-founder of the Company and has served as
Chairman of the Board and Secretary since January 1990. Mr. Brotman is also a
founder and currently Chairman of the Board of PriceCostco, Inc., a
warehouse-format discount retailer. In addition, Mr. Brotman is a director of
Seattle-First National Bank, The International Council of Shopping Centers,
Starbucks Corporation and The Sweet Factory. Mr. Brotman also serves as a
Trustee of the University of Washington Medical Center, the Seattle Foundation
and The Seattle Art Museum.
Michael W. Luce is a co-founder of the Company and has served as a director
and its President and Chief Executive Officer since its formation in 1989. Prior
to founding Garden Botanika, Mr. Luce was President and Chief Operating Officer
of Eddie Bauer Company ("Eddie Bauer"), an outdoor clothing retailer, until it
was acquired by Spiegel, Inc. in 1988. From 1984 to 1988, before becoming its
President, Mr. Luce held various positions in the store and mail-order divisions
of Eddie Bauer, including General Merchandise Manager and Vice President of
Marketing. Prior to joining Eddie Bauer, Mr. Luce was employed for nine years at
the Meier and Frank Company ("Meier and Frank"), a Portland, Oregon-based
department store chain and a division of May Company, where, among other
positions, he served as a Divisional Vice President. Mr. Luce graduated from
Harvard University and obtained a Masters of Business Administration degree from
the Amos Tuck School of Dartmouth College.
Arlee J. Jensen has been the Company's Senior Vice
President -- Merchandising and Marketing since June 1995 and was its Vice
President -- Merchandising since the Company began operations in 1990. Prior to
joining Garden Botanika, Ms. Jensen was employed at Eddie Bauer from 1983 to
1989, where, from 1986 to 1989, she was Divisional Vice President of Womenswear,
responsible for the women's segment of both the catalog and retail outlet
operations. Prior to 1983, Ms. Jensen was employed at Frederick & Nelson, a
Seattle-based department store chain, where she was Divisional Merchandise
Manager for Women's Apparel, and at Meier and Frank, where she was Creative
Merchandising Director.
C. Michael Fisher has been the Company's Vice President -- Operations since
October 1993 and was made a Senior Vice President in 1995. Prior to joining the
Company, Mr. Fisher was Chief Operating Officer
37
<PAGE> 40
of Imaginarium, Inc., a mall-based specialty retailer, from 1988 to 1993. Prior
to 1988, Mr. Fisher was President of Vintan Ltd., the Canadian subsidiary of
General Nutrition Centers Inc., and spent 15 years with Sears Roebuck & Co. in
various operating and merchandising management positions.
John A. Garruto has been the Company's Vice President -- Research and
Product Development since October 1995. From February 1991 to October 1995, Mr.
Garruto was Vice President -- Research and Development for Innovative
Biosciences Corporation, a manufacturer of personal care products sold to, among
others, Garden Botanika. Mr. Garruto held the same position with Randall
International, which was founded by a director of the Company, from 1989 to
1991.
Michael O. Jaglois has been the Company's Vice President -- Marketing since
September 1994. From July 1991 to September 1994, Mr. Jaglois was Executive Vice
President and General Manager of Borders, Perrin & Norrander, Inc., an
advertising firm, where he was responsible for maintaining client relationships,
generating new business and overseeing the financial performance of the firm.
From March 1991 to July 1991, Mr. Jaglois was Senior Vice President of Wall &
Associates, an advertising firm, and from 1989 to 1991, Vice President of the
advertising firm Livingston & Co.
Myron E. Kirkpatrick has been the Company's Vice President -- Finance,
Chief Financial Officer since April 1995 and was appointed Treasurer in 1996.
From May 1992 to April 1995, Mr. Kirkpatrick was employed at Eagle Hardware &
Garden, Inc. as Vice President -- Finance (later serving as Executive Vice
President -- Finance) and Chief Financial Officer. From June 1989 to July 1991,
Mr. Kirkpatrick was Director of Finance and Administration for the City of Ocean
Shores, Washington and from August 1991 to May 1992 served in a similar capacity
at the Port of Grays Harbor, Washington. Mr. Kirkpatrick's retail experience
also includes five years as Vice President -- Corporate Controller for Costco
Wholesale Corporation (1984 to 1989) and six years in various accounting and
information systems capacities (including Vice President -- MIS and Vice
President -- Controller) with the Gold Circle Division of Federated Department
Stores (1975 to 1981).
Jeffrey C. Mason has been the Company's Vice President -- Real Estate and
Construction since February 1995. From January 1986 to January 1995, he was
Senior Vice President of Real Estate for Merry-Go-Round Enterprises National
Retail Company, an apparel retailer, where he managed that company's retail
leasing responsibilities. In January 1994, Merry-Go-Round Enterprises commenced
reorganization proceedings under Chapter 11 of the Federal Bankruptcy Code.
Susan M. Walker has been the Company's Vice President -- Stores since March
1996. Prior to joining the Company, Ms. Walker was employed by Zales Jewelers, a
national jewelry retailer, from 1980 to 1996, where, from 1993 to 1996, she was
a Director of Stores responsible for supervising 13 regional managers and 127
stores, as well as recruiting, hiring and training all levels of store
personnel.
Damon H. Ball has been a director of the Company since October 1995. Mr.
Ball has been a Senior Vice President of Desai Capital Management Incorporated
("DCMI") since December 1993 and, for more than five years prior thereto, served
as a Vice President of DCMI. DCMI is a specialized equity investment management
firm which manages the assets of various institutional clients, including
Equity-Linked Investors, LP and Equity-Linked Investors II and a public mutual
fund. He serves as Chairman and Chief Executive Officer of Northstar Television
Group, Inc., an operator of a television station, and is a director of Community
Care of America, Inc., Finlay Enterprises Inc. and several privately held
portfolio companies.
David A. Ederer has been a director of the Company since 1990. Mr. Ederer
is chairman and owner of numerous manufacturing concerns on the West Coast,
including Washington Metallurgical Services, Inc., Portland Bolt and
Manufacturing Company and Color Craft, Inc. Mr. Ederer is also a director of
nine companies in the Puget Sound area, including The Curtis Group, a venture
capital fund, and Cascade Natural Gas, a company listed on the New York Stock
Exchange.
Gerald R. Gallagher has been a director of the Company since 1991. Since
April 1987, Mr. Gallagher has been a general partner of Oak Investment Partners,
a venture capital partnership. For more than 25 years, he has been involved with
the retail industry, holding positions as a research analyst, manager and
venture capitalist. Before joining Oak Investment Partners, Mr. Gallagher was
Vice Chairman of Dayton Hudson
38
<PAGE> 41
Corporation where, for ten years, he served in both operating and staff
positions. From 1969 to 1977, Mr. Gallagher was the retail company research
analyst at Donaldson, Lufkin & Jenrette Securities Corporation. Mr. Gallagher is
also a director of PETsMART, Inc. and eight private retail and restaurant
companies.
William B. Randall has been a director of the Company since 1990. Mr.
Randall founded Randall International in 1989 and has been its President and
Chief Executive Officer since its inception. Randall International is engaged in
manufacturing and packaging personal care products for private spas, resorts and
hotels, and manufactures certain products for Garden Botanika in accordance with
the Company's specifications. From 1974 to 1986, Mr. Randall was President of La
Costa Products International, which created and manufactured numerous body care
products under the "La Costa Spa" brand. Prior to that, Mr. Randall was
President and the founder of Renauld Incorporated, a marketer of fashion
sunglasses, and Sea and Ski Company, a marketer of sun protection products.
Dale J. Vogel has been a director of the Company since 1991. Mr. Vogel has
been a general partner with U.S. Venture Partners since 1990. From 1984 to 1990,
Mr. Vogel was a general partner of Norwest Venture Capital and, from 1980 to
1984, President of K2 Corporation, a privately held ski company. Mr. Vogel was
President of JanSport, a sporting goods apparel manufacturer, from 1979 to 1980.
Mr. Vogel is also a director of Leeann Chin, Inc. and Cucina, Cucina, Inc., both
of which are restaurant companies, Chronology Corporation, Portable Software,
Inc. and XactLabs, Inc.
BOARD OF DIRECTORS
Pursuant to the Company's Restated Articles, commencing with the first
election of directors to occur after the completion of this offering, the Board
of Directors will be classified into three classes, each of which shall be as
nearly equal in number as possible. At the first annual meeting of shareholders
after the offering, one class will be elected for a one-year term, one class
will be elected for a two-year term and one class will be elected for a
three-year term. All directors hold office until the annual meeting of
shareholders at which their terms expire and the election and qualification of
their successors. Officers are elected by, and serve at the discretion of, the
Board of Directors.
COMMITTEES
The Company has established two standing committees of the Board of
Directors: an Audit Committee and a Compensation Committee. The Audit Committee
will review the functions of the Company's management and independent auditors
pertaining to the Company's consolidated financial statements and perform such
other related duties and functions as are deemed appropriate by the Audit
Committee and the Board of Directors. The Compensation Committee will determine
officer and director compensation and administer the Stock Option Plan.
39
<PAGE> 42
EXECUTIVE COMPENSATION
The following table sets forth the compensation paid by the Company to its
Chief Executive Officer and the four next most highly compensated executive
officers of the Company (collectively, the "Named Executive Officers") for
services rendered during fiscal 1995.
SUMMARY COMPENSATION TABLE
<TABLE>
<CAPTION>
LONG-TERM
COMPENSATION AWARDS
-------------------
ANNUAL COMPENSATION SECURITIES
-------------------- UNDERLYING ALL OTHER
NAME AND PRINCIPAL POSITION YEAR SALARY BONUS OPTIONS(#) COMPENSATION
- ---------------------------- ---- -------- ------- ------------------- ---------------
<S> <C> <C> <C> <C> <C>
Michael W. Luce............. 1995 $216,923 $30,000 31,780 $ 2,023(1)
President and Chief
Executive Officer
C. Michael Fisher........... 1995 $174,423 $40,820 19,067 $ 240(1)
Senior Vice President --
Operations
Arlee J. Jensen............. 1995 $170,192 $36,094 19,067 $ 1,286(1)
Senior Vice President --
Merchandising and
Marketing
Myron E. Kirkpatrick........ 1995 $117,115 $ -- 15,889 $ --
Vice President --
Finance and Chief
Financial Officer(2)
Jeffrey C. Mason............ 1995 $148,846 $ -- 12,710 $25,243(3)
Vice President --
Real Estate and
Construction(2)
</TABLE>
- ------------------------------
(1) Represents term life insurance and medical insurance premiums.
(2) Messrs. Kirkpatrick and Mason joined the Company during fiscal 1995. If
Messrs. Kirkpatrick and Mason had been employed by the Company during the
entire fiscal year at the same annual base salary rate, their annual
salaries would have been $145,000 and $150,000, respectively.
(3) Represents relocation and related expenses.
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<PAGE> 43
STOCK OPTION PLANS
The Company grants options pursuant to its 1992 Combined Incentive and
Nonqualified Stock Option Plan (the "Stock Option Plan") and its 1996 Directors'
Nonqualified Stock Option Plan (the "Directors' Plan").
The Stock Option Plan contains an incentive stock option component under
which options for the purchase of Common Stock are intended to qualify under
Section 422 of the Internal Revenue Code of 1986, as amended ("Incentive
Options"), and a nonqualified stock option component under which options for the
purchase of Common Stock will not qualify under Section 422 ("Nonqualified
Options"). The Compensation Committee of the Company's Board of Directors is
currently the Plan Administrator of the Stock Option Plan. Incentive Options may
be granted to any employee, including employees who are directors, and
Nonqualified Options may be granted to employees, directors, consultants or
independent contractors of the Company as the Plan Administrator shall select.
The Plan Administrator determines the terms and conditions of options granted
under the Stock Option Plan, including the exercise price, provided that the
exercise price for Incentive Options must be equal to or greater than the fair
market price of the Common Stock on the date of grant. Options granted under the
Stock Option Plan generally vest at a rate of 20% after the first year and
thereafter at 20% per year over a four-year period so that all options are fully
vested after five years, except that options granted for service prior to
December 10, 1990 vested at a rate of 25% per year so that such options were
fully vested after four years. Outstanding options vest, at the discretion of
the Plan Administrator, upon the occurrence of certain transactions, including
certain mergers and other business combinations involving the Company. Incentive
Options are exercisable for a period of ten years from the date of grant, except
that Incentive Options granted to persons who own more than 10% of the Common
Stock terminate after five years. Nonqualified Options are exercisable for a
period of ten years and two days from the date of grant.
Options granted under the Stock Option Plan are nontransferable other than
by will or the laws of descent and distribution. Options granted to nonemployee
directors expire ten years from the date of grant.
An aggregate of 392,825 shares of Common Stock are available for issuance
pursuant to the Stock Option Plan. At April 18, 1996, options to purchase an
aggregate of 271,665 shares of Common Stock were outstanding under the Stock
Option Plan and a total of 121,131 shares of Common Stock remained available for
grant. Under the Stock Option Plan, the outstanding options were held by 96
individuals and were exercisable at prices ranging from $7.87 to $17.70 per
share. Shares subject to options granted under the Stock Option Plan that have
lapsed or terminated may again be subject to grants under the Stock Option Plan.
At April 18, 1996, options to purchase an aggregate of 79,026 shares of Common
Stock were fully vested under the Stock Option Plan.
The Directors' Plan provides for the automatic grant to each nonemployee
director of the Company of an option to purchase 1,271 shares of Common Stock
upon their election or appointment to the Board of Directors and thereafter at
each annual meeting of the Board of Directors for as long as the individual
continues to serve as a director of the Company. The exercise price of options
granted under the Directors' Plan must equal the fair market value of the Common
Stock on the date of grant. Options vest at the rate of one-twelfth per month so
that all options are fully vested at the end of one year. Options under the
Directors' Plan are scheduled to be granted at the first annual meeting of the
Board of Directors following this offering, at which time the Company expects
options to purchase an aggregate of 7,626 shares will be granted to current
directors. To date, no options have been granted under the Directors' Plan.
STOCK OPTION GRANTS
The following table sets forth information concerning stock options granted
to the Named Executive Officers in fiscal 1995. In addition, in accordance with
the regulations of the Securities and Exchange Commission (the "Commission"),
hypothetical gains or "option spreads" that would exist for the respective
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<PAGE> 44
options are shown. These gains are based on assumed rates of annual stock price
appreciation of 5% and 10% from the date the options were granted.
OPTION GRANTS IN LAST FISCAL YEAR
<TABLE>
<CAPTION>
POTENTIAL REALIZABLE
INDIVIDUAL GRANTS VALUE AT ASSUMED
------------------------------------------------------------------ ANNUAL RATES OF
PERCENT OF STOCK PRICE
TOTAL APPRECIATION
NUMBER OF OPTIONS GRANTED FOR OPTION TERM(3)
SECURITIES UNDERLYING TO EMPLOYEES IN EXERCISE PRICE EXPIRATION ---------------------
NAME OPTIONS GRANTED(#)(1) FISCAL 1995(2) ($/SH)(1) DATE 5%($) 10%($)
- ---------------------- --------------------- --------------- -------------- ---------- -------- --------
<S> <C> <C> <C> <C> <C> <C>
Michael W. Luce....... 31,780 19.5% $13.77 3/31/05 $275,215 $697,571
C. Michael Fisher..... 19,067 11.7% $13.77 3/31/05 $165,120 $418,521
Arlee J. Jensen....... 19,067 11.7% $13.77 3/31/05 $165,120 $418,521
Myron E.
Kirkpatrick......... 15,889 9.7% $13.77 4/10/05 $137,599 $348,764
Jeffrey C. Mason...... 9,533 5.8% $ 9.83 2/03/05 $ 58,914 $149,382
3,177 1.9% $13.77 4/25/05 $ 27,513 $ 69,735
</TABLE>
- ------------------------------
(1) All options were granted at fair market value at the date of grant. All
options vest annually over a five-year period and expire after 10 years and
two days, except Mr. Mason's initial 1995 grant which vests monthly over a
five-year period. See also "Management -- Employment Agreements and Change
of Control Arrangements."
(2) Based on an aggregate of 163,014 shares subject to options granted to
employees in the fiscal year ended February 3, 1996.
(3) The assumed rates of growth are prescribed by the Commission for
illustrative purposes only and are not intended to predict or forecast
future stock prices.
The following table sets forth, as of February 3, 1996, certain information
regarding unexercised options held by the Named Executive Officers. As of that
date, no stock options had been exercised by any Named Executive Officer.
FISCAL YEAR-END OPTION VALUES
<TABLE>
<CAPTION>
NUMBER OF SECURITIES VALUE OF UNEXERCISED
UNDERLYING UNEXERCISED OPTIONS AT IN-THE-MONEY OPTIONS AT
FEBRUARY 3, 1996(#) FEBRUARY 3, 1996(1)
--------------------------------- -----------------------------
NAME EXERCISABLE UNEXERCISABLE EXERCISABLE UNEXERCISABLE
- --------------------------------------- ----------- ------------- ----------- -------------
<S> <C> <C> <C> <C>
Michael W. Luce........................ -- 31,780 $ -- $ 102,649
C. Michael Fisher...................... 15,569 41,633 $ 111,630 $ 223,384
Arlee J. Jensen........................ 12,710 27,012 $ 113,553 $ 124,157
Myron E. Kirkpatrick................... -- 15,889 $ -- $ 51,321
Jeffrey C. Mason....................... 1,906 10,804 $ 13,666 $ 64,948
</TABLE>
- ------------------------------
(1) Calculated based on the spread between the assumed initial public offering
price of $17.00 per share of Common Stock and the exercise price of the
grants.
DIRECTOR COMPENSATION
Nonemployee directors of the Company are reimbursed for their reasonable
out-of-pocket expenses in connection with their travel to and attendance at
Board of Directors meetings. In the future, directors will receive options to
purchase Common Stock upon their election or appointment to the Board of
Directors and annually thereafter on the date of the annual meeting of the Board
of Directors. See "Management -- Stock Option Plans."
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<PAGE> 45
EMPLOYMENT AGREEMENTS AND CHANGE OF CONTROL ARRANGEMENTS
The Company has entered into an employment agreement with Mr. Luce which
provides for an annual base salary of $150,000 and pursuant to which the Company
agreed, among other things, to review the level of Mr. Luce's compensation every
six months and, with the proceeds of insurance (if any) on the life of Mr. Luce
obtained by the Company, to repurchase Company stock owned by his estate in the
event of his death at the "fair market value" of such stock, as determined by an
appraisal. In addition, Mr. Luce agreed not to participate, while an employee of
the Company and for a period of two years thereafter, in a business or
enterprise that competes with the Company.
In the event that Mr. Luce is terminated for any reason other than for
cause, including termination in connection with a change of control of the
Company, he is entitled to one year's salary, any benefits that would have
accrued during such one-year period and any reimbursable out-of-pocket expenses
incurred prior to termination. Mr. Luce forfeits such termination benefits in
the event he breaches either the noncompete or confidentiality provisions of his
employment agreement.
The Company has entered into an Option and Severance Agreement with Mr.
Garruto, which provides for an annual salary of $130,000. In addition, Mr.
Garruto received stock options to purchase 25,424 shares of Common Stock at
$1.97 per share, which options vest monthly over a five-year period for as long
as Mr. Garruto is employed by the Company. These options were not granted under
the Company's Stock Option Plan. In the event Mr. Garruto is terminated without
cause (as determined by the Company's Board of Directors), he will be entitled
to severance payments equal to his then-current salary for nine months following
the effective date of termination.
In addition, the Company has entered into a Stock Option Agreement and
Payment Obligation with Mr. Mason, which includes the grant of options to
purchase 9,533 shares of Common Stock at $9.83 per share, which options vest
monthly over a five-year period (the "Option Period"). The agreement with Mr.
Mason obligates the Company at the end of the Option Period to pay him the
difference, if any, between the value of all options granted and Common Stock
issued to Mr. Mason prior to such date and $1.0 million, except that, if and to
the extent the value of such options and Common Stock shall have exceeded
$670,000 at any time during the Option Period, the Company's obligation shall be
reduced. The Company, which will record a liability for this agreement on a
quarterly basis during the Option Period, recorded a liability of $192,500 for
fiscal 1995. The payment obligation will vary, depending on the extent of future
option grants, if any, and the value of Mr. Mason's options. The obligation may
be satisfied by accelerating existing options, granting additional options or
making a cash payment. The Company has a similar obligation in the event of a
change of control of the Company. In addition, in the event he is not employed
throughout the Option Period and has not been terminated for cause, Mr. Mason is
entitled to vested options, upon termination of employment, for shares with a
value of $200,000 for each year or part of a year in which he has worked for the
Company. The Company has also entered into an employment agreement with Mr.
Mason which provides a base annual salary of $150,000 and for the reimbursement
of certain housing, relocation and related expenses.
Under the Stock Option Plan, outstanding options vest, at the discretion of
the Plan Administrator, upon the occurrence of certain transactions, including
certain mergers and other business combinations involving the Company.
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<PAGE> 46
CERTAIN TRANSACTIONS
Prior to this offering, Garden Botanika entered into transactions and
business relationships with certain of its officers, directors and shareholders
owning 5% or more of the voting securities of the Company. Any future
transactions between the Company and officers, directors or shareholders owning
5% or more of the voting securities of the Company will be subject to approval
by a majority of the disinterested directors after a finding that the proposed
transaction is no less favorable to the Company than would be available from
independent third parties.
Since its inception, the Company has acquired through arm's-length
transactions a significant portion of its finished personal care products,
particularly in its Aromatics line, from Randall International, the President
and majority shareholder of which, William B. Randall, is a member of the
Company's Board of Directors. The costs of products purchased from Randall
International by the Company in fiscal 1993 through 1995 were $973,596,
$1,696,811 and $2,545,231, respectively. These purchases represented
approximately 21%, 11% and 12%, respectively, of the Company's total purchases
for these fiscal years.
On October 30, 1995, in order to establish in-house research and
development, quality control and manufacturing capabilities, the Company
purchased substantially all the assets of Innovative Biosciences Corporation
("IBC"). At all relevant times, John A. Garruto was, and remains, the beneficial
owner of 49% of the outstanding securities of IBC. At all relevant times, Mr.
Garruto's wife, Michelle Garruto, was, and remains, the beneficial owner of the
balance of the outstanding securities of IBC. The purchase price paid for IBC's
principal assets was approximately $156,000, of which $25,000 was paid in cash
and the balance with 4,156 shares of the Company's Common Stock. These shares
have certain registration rights. See "Description of Capital
Stock -- Registration Rights." Following this acquisition, Mr. Garruto became
the Company's Vice President -- Research and Product Development and, in
connection with his employment, received options to purchase 25,424 shares of
the Company's Common Stock. See "Management -- Employment Agreements and Change
of Control Arrangements."
From 1991 until the acquisition of IBC by the Company and the appointment
of Mr. Garruto as the Company's Vice President -- Research and Product
Development in October 1995, the Company obtained a number of its finished
personal care products from IBC and retained Mr. Garruto as a consultant who
supplied the Company with formulation services. Initially, IBC primarily
manufactured Garden Botanika's massage, bath and body oils, but subsequently
developed and manufactured shampoos, a number of products in the Spa Botanika
line and other commodities. The costs of products purchased from IBC by the
Company in fiscal 1993 through fiscal 1995 (prior to the acquisition) were
$182,301, $396,920 and $566,541, respectively. In addition to its purchases of
finished merchandise, the Company paid IBC to obtain the consulting services of
Mr. Garruto at the rate of $42,000 per year during fiscal 1993 and fiscal 1994
and $31,500 during fiscal 1995 (prior to the acquisition).
In connection with the Company's lease in 1989 of its third store, located
in Bellevue, Washington, Michael W. Luce, the Company's President and Chief
Executive Officer, and his wife, together with Jeffrey H. Brotman, the Company's
Chairman of the Board and Secretary, and his wife, were each required to execute
a guarantee in favor of the store's landlord to ensure monthly lease payments.
Minimum monthly lease payments ranged from $3,235 per month for the first three
years of the lease to $3,648 for the remaining term of the lease. In connection
with the subsequent relocation of the Company's Bellevue store and renegotiation
of the underlying lease, Mr. and Mrs. Luce and Mr. and Mrs. Brotman were
released from their guarantees.
Beginning in October 1993, the Company retained the advertising firm of
Borders, Perrin & Norrander, Inc. ("BP&N") to prepare and administer a
comprehensive advertising program for the Company, including visual sales
materials, display cards and direct mail pieces. Michael O. Jaglois, the
Company's Vice President -- Marketing since September 1994, was the Executive
Vice President and General Manager of BP&N from July 1991 until he joined Garden
Botanika. The Company paid BP&N $75,648, $467,001 and $595,346 in fiscal 1993,
1994 and 1995, respectively.
44
<PAGE> 47
In the last three years, the Company has sold a number of shares of its
Preferred Stock to directors, executive officers and holders of more than 5% of
the Company's securities. On September 8, 1992, the Company raised $2,592,374 in
a private placement of Series A Convertible Preferred Stock ("Series A Stock")
and, on May 24, June 25 and September 20, 1993, the Company raised an aggregate
of $16,000,000 in a private placement of Series B Convertible Preferred Stock
("Series B Stock"). On February 1 and March 13 and 31, 1995, the Company raised
an aggregate of $10,000,000 in a private placement of Series C Convertible
Preferred Stock ("Series C Stock") and, on November 1 and December 8, 1995, the
Company raised an aggregate of $6,500,000 in a private placement of Series D
Convertible Preferred Stock ("Series D Stock"). All of the shares of Series A,
B, C and D Stock (and the Common Stock acquired upon conversion) have certain
registration rights. See "Description of Capital Stock -- Registration Rights."
The following persons, who are directors, who are executive officers and/or who
currently beneficially own more than 5% of the Company's outstanding Common
Stock (giving effect to the foregoing conversion), purchased the number of
shares of Series A, B, C and D Stock indicated:
<TABLE>
<CAPTION>
NUMBER OF SHARES
--------------------------------------------
SERIES SERIES SERIES
A B C SERIES D
NAME STOCK STOCK STOCK STOCK
- ---------------------------------------------------- ------- ------- ------- --------
<S> <C> <C> <C> <C>
Jeffrey H. Brotman(1)............................... 44,492 15,255 24,760 13,250
David A. Ederer..................................... 6,355 19,070 4,357 2,860
William B. Randall.................................. -- 5,085 870 571
Michael W. Luce..................................... -- -- 23,433 --
Arlee J. Jensen..................................... -- -- 4,085 --
BankAmerica Ventures................................ 444,930 152,549 102,428 59,323
Equity-Linked Investors, L.P.(1).................... -- 406,795 69,724 45,785
U.S. Venture Partners III(1)........................ 234,374 152,550 62,020 33,572
Oak Investment Partners IV, Limited
Partnership(1).................................... 234,374 91,529 55,860 36,681
Olympus Private Placement Fund, L.P................. -- 305,095 52,294 21,187
Fourcar B.V......................................... -- 203,397 32,603 17,648
</TABLE>
- ------------------
(1) Includes shares purchased by entities affiliated with the named shareholder.
See "Principal Shareholders."
45
<PAGE> 48
PRINCIPAL SHAREHOLDERS
The following table sets forth as of April 29, 1996, and as adjusted to
reflect the sale of shares of Common Stock offered hereby, certain information
regarding the beneficial ownership of the Common Stock of the Company with
respect to (i) each person known by the Company to own beneficially more than 5%
of the outstanding Common Stock, (ii) each of the Company's directors, (iii)
each of the Named Executive Officers, and (iv) all current directors and
executive officers of the Company as a group. Unless otherwise indicated, the
Company believes that the beneficial owners of the Common Stock listed below,
based on information furnished by such owners, have sole investment and voting
power with respect to all shares of Common Stock owned by such person, subject
to community property laws where applicable and the information set forth in the
footnotes to the table below. Pursuant to the rules of the Commission, in
calculating percentage ownership, each person is deemed to beneficially own his,
her or its own shares subject to options exercisable within 60 days after the
date of this table, but options owned by others (even if exercisable within 60
days) are deemed not to be outstanding shares.
<TABLE>
<CAPTION>
PERCENT
----------------------
AMOUNT AND NATURE OF PRIOR TO AFTER
NAME AND ADDRESS BENEFICIAL OWNERSHIP OFFERING OFFERING
- ------------------------------------------------- -------------------- -------- --------
<S> <C> <C> <C>
BankAmerica Ventures............................. 759,232 19.2% 11.4%
950 Tower Lane, Suite 700
Foster City, California 94404
Equity-Linked Investors, L.P.(1)................. 522,307 13.2% 7.8%
540 Madison Avenue, 36th Floor
New York, New York 10022
Damon H. Ball(2)................................. 445 * *
U.S. Venture Partners III(3)..................... 482,519 12.2% 7.2%
c/o U.S. Venture Partners
777 - 108th Avenue N.E.
Bellevue, Washington 98004
Dale J. Vogel(4)................................. 485,443 12.2% 7.3%
Oak Investment Partners IV, Limited
Partnership(5)................................. 418,447 10.6% 6.3%
c/o Oak Investment Partners
4550 Norwest Center
90 South Seventh Street
Minneapolis, Minnesota 55402
Gerald R. Gallagher(6)........................... 420,862 10.6% 6.3%
Olympus Private Placement Fund, L.P.............. 378,577 9.6% 5.7%
One Station Place
Stanford, Connecticut 06902
Fourcar B.V. .................................... 253,650 6.4% 3.8%
Yves Sisteron
602 N. Crescent Drive
Beverly Hills, California 90210
Jeffrey H. Brotman(7)............................ 141,452 3.6% 2.1%
David A. Ederer(8)............................... 36,203 * *
Michael W. Luce(9)............................... 139,199 3.5% 2.1%
William B. Randall(10)........................... 10,088 * *
C. Michael Fisher(11)............................ 23,305 * *
Arlee J. Jensen(12).............................. 48,579 1.2% *
Myron E. Kirkpatrick(13)......................... 3,178 * *
Jeffrey C. Mason(14)............................. 3,176 * *
All directors and executive officers as a group
(14 persons)(15)............................... 1,317,102 32.6% 19.5%
</TABLE>
46
<PAGE> 49
- ------------------------------
* Less than 1%.
(1) Includes 261,153 shares of Common Stock held by Equity-Linked Investors II.
(2) Represents 445 shares of Common Stock that are issuable upon the exercise
of currently exercisable options.
(3) Represents 463,218 shares of Common Stock held by U.S. Venture Partners
III, a California Limited Partnership, 4,825 shares of Common Stock held by
U.S.V. Entrepreneur Partners, a California limited partnership, and 14,476
shares of Common Stock held by Second Ventures Limited Partnership.
(4) Represents 463,218 shares of Common Stock held by U.S. Venture Partners
III, a California Limited Partnership, 4,825 shares of Common Stock held by
U.S.V. Entrepreneur Partners, a California limited partnership, and 14,476
shares of Common Stock held by Second Ventures Limited Partnership. Mr.
Vogel is a partner of U.S. Venture Partners III and disclaims beneficial
ownership of such shares. Also includes 2,924 shares of Common Stock that
are issuable upon the exercise of currently exercisable options.
(5) Represents 402,638 shares of Common Stock held by Oak Investment Partners
IV, a Limited Partnership, and 15,809 shares of Common Stock held by Oak IV
Affiliates Fund, Limited Partnership.
(6) Represents 402,638 shares of Common Stock held by Oak Investment Partners
IV, a Limited Partnership, and 15,809 shares of Common Stock held by Oak IV
Affiliates Fund, Limited Partnership. Mr. Gallagher is a general partner of
Oak Associates IV, Limited Partnership, which is the general partner of Oak
Investment Partners IV, a Limited Partnership. Mr. Gallagher is also a
general partner of Oak IV Affiliates, the general partner of Oak IV
Affiliates Fund, Limited Partnership. Mr. Gallagher has shared voting and
investment power with respect to such shares but disclaims beneficial
ownership. Also includes 2,415 shares of Common Stock that are issuable
upon the exercise of currently exercisable options.
(7) Includes 22,337 shares of Common Stock held by Mr. Brotman's wife, Susan
Brotman, 28,564 shares held by the 1991 Brotman Children's Trust, John
Meisenbach TTE for which Mr. Brotman disclaims beneficial ownership, and
10,323 shares held by the Michael Kates Trust, Talisman Trustee Ltd., as
trustee. Also includes 3,559 shares of Common Stock that are issuable upon
the exercise of currently exercisable options.
(8) Includes 11,737 shares of Common Stock held by David A. Ederer Keogh, David
A. Ederer, TTEE/Administrator. Also includes 3,559 shares of Common Stock
that are issuable upon the exercise of currently exercisable options.
(9) Includes 5,084 shares of Common Stock held by certain family members of Mr.
Luce for which Mr. Luce may be deemed a beneficial owner. Also includes
6,356 shares of Common Stock that are issuable upon the exercise of
currently exercisable options.
(10) Includes 1,064 shares of Common Stock held by Southwest Securities, Inc.
FBO William Randall IRA and 3,559 shares of Common Stock that are issuable
upon the exercise of currently exercisable options.
(11) Represents 20,975 shares of Common Stock that are issuable upon the
exercise of currently exercisable options and 2,330 shares of Common Stock
that are issuable upon the exercise of options exercisable within 60 days.
(12) Includes 19,386 shares of Common Stock that are issuable upon the exercise
of currently exercisable options and 1,271 shares of Common Stock that are
issuable upon the exercise of options exercisable within 60 days.
(13) Represents 3,178 shares of Common Stock that are issuable upon the exercise
of options exercisable within 60 days.
(14) Represents 2,859 shares of Common Stock that are issuable upon the exercise
of currently exercisable options and 317 shares of Common Stock that are
issuable upon the exercise of options exercisable within 60 days.
(15) See footnotes (2), (4) and (6)-(14) above. Also includes 4,067 options to
purchase shares of Common Stock that are issuable upon the exercise of
currently exercisable options and 847 shares of Common Stock that are
issuable upon the exercise of options exercisable within 60 days.
In the event that the Underwriters' over-allotment option is exercised in
full, the following shareholders (the "Selling Shareholders") will sell the
number of shares indicated below:
<TABLE>
<CAPTION>
BENEFICIAL OWNERSHIP BENEFICIAL
PRIOR TO NUMBER OF OWNERSHIP AFTER
OVER-ALLOTMENT SHARES BEING OVER-ALLOTMENT
NAME EXERCISE OFFERED EXERCISE
- ----------------------------------------------- -------------------- ------------ ---------------
<S> <C> <C> <C>
Anthony J. Swies............................... 5,156 635 4,521
Habatt Partners................................ 6,966 6,966 0
</TABLE>
47
<PAGE> 50
DESCRIPTION OF CAPITAL STOCK
Upon completion of the offering, the Company's authorized capital stock
will consist of 46,092,374 shares, of which 36,092,374 shares will be designated
Common Stock, par value $.01 per share, and 10,000,000 shares will be designated
Preferred Stock, par value $.01 per share.
COMMON STOCK
As of March 29, 1996, there were 3,962,577 shares of Common Stock issued
and outstanding and held of record by 119 individuals or entities. Holders of
Common Stock are entitled to cast one vote for each share held of record on all
matters acted upon at any shareholders meeting. Holders of Common Stock are
entitled to receive ratably such dividends if, as and when declared by the
Company's Board of Directors out of funds legally available therefor, subject to
preferences that may be applicable to any outstanding Preferred Stock. There are
no cumulative voting rights, the absence of which will, in effect, allow the
holders of a majority of the outstanding shares of Common Stock to elect all the
directors then standing for election. The absence of cumulative voting rights
could have the effect of delaying, deterring or preventing a change of control
of the Company. In the event of any liquidation, dissolution or winding up of
the Company, each holder of the Company's Common Stock will be entitled to
participate, subject to the rights of any outstanding Preferred Stock, ratably
in all assets of the Company remaining after payment of liabilities. Holders of
Common Stock have no preemptive or conversion rights. All outstanding shares of
Common Stock are, and all shares of Common Stock offered in this offering will
be, fully paid and nonassessable.
PREFERRED STOCK
The Board of Directors has the authority to issue shares of Preferred Stock
in one or more series and to fix the rights, preferences, privileges and
restrictions thereof, including dividend rights, conversion rights, voting
rights, redemption rights, liquidation preferences and the number of shares
constituting any series, without any further vote or action by the shareholders.
The issuance of Preferred Stock with voting and conversion rights may adversely
affect the voting power of the holders of Common Stock. In addition, because the
terms of such Preferred Stock may be fixed by the Board of Directors without
shareholder action, the Preferred Stock could be designated and issued quickly
in the event that the Company requires additional equity capital. The Preferred
Stock could also be designated and issued with terms calculated to defeat a
proposed takeover of the Company, or with terms that may have the effect of
delaying, deterring or preventing a change of control of the Company. Under
certain circumstances, this could have the effect of decreasing the market price
of the Common Stock.
WARRANTS
The investment banking firm of Donaldson, Lufkin & Jenrette Securities
Corporation has in the past provided investment banking services to the Company.
As partial compensation for services rendered in connection with the sale of the
Company's Series B Stock, DLJ Capital Corporation was given and beneficially
owns warrants to purchase 21,984 shares of Common Stock, and certain affiliates
of DLJ Capital Corporation beneficially own in the aggregate warrants to
purchase 1,740 shares of Common Stock, in each case at a purchase price of $9.83
per share.
REGISTRATION RIGHTS
The Company is a party to an agreement pursuant to which it granted to the
initial purchasers of its Preferred Stock, assignees of Preferred Stock who
received a minimum of 12,712 shares and shares held by IBC, certain rights with
respect to registration under the Securities Act of 3,623,673 shares of Common
Stock (the "Registrable Securities"). Under this agreement, the holders of at
least 711,888 shares of Registrable Securities can require the Company, subject
to certain limitations, to file a registration statement under the Securities
Act covering all or any part of their Registrable Securities, except that the
Company is obligated to effect only two registrations on Form S-1, unless there
remain holders of Registrable Securities as of October 1, 1996, in which case
the Company is obligated to effect a third registration on Form S-1. In
48
<PAGE> 51
addition, at the request of holders of Registrable Securities, the Company is
required, at its expense, to file a registration statement or statements on Form
S-3 (if the Company becomes eligible to use Form S-3) covering Registrable
Securities, so long as the aggregate price to the public, net of underwriters'
discounts or commissions, is equal to at least $500,000. In addition, if the
Company proposes to register additional securities under the Securities Act in
the future (other than pursuant to a registration requested by holders of
Registrable Securities), the holders of Registrable Securities may require the
Company, subject to certain volume and other limitations, to include all or any
portion of their Registrable Securities in such registration at the Company's
expense.
WASHINGTON LAW
Washington law contains certain provisions that may have the effect of
delaying or discouraging a takeover of the Company. Chapter 23B.17 of the
Washington Business Corporation Act (the "WBCA") prohibits, subject to certain
exceptions, a merger, sale of assets or liquidation of a corporation involving
an "Interested Shareholder" (defined generally as a person or affiliated group
of persons acting in concert or under common control which beneficially owns 20%
or more of the corporation's outstanding voting securities), unless determined
to be at a "fair price" or otherwise approved by a majority of the corporation's
disinterested directors or the holders of two-thirds of the votes of each voting
group entitled to vote separately on the transaction, excluding the votes of the
Interested Shareholder. In addition, Chapter 23B.19 of the WBCA prohibits a
corporation having a class of securities registered pursuant to Section 12 of
the Securities Exchange Act of 1934, as amended, with certain exceptions, from
engaging in certain significant business transactions with a person or group of
persons acting in concert or under common control which beneficially acquires
10% or more of the corporation's outstanding voting securities for a period of
five years after such acquisition. The prohibited transactions include, among
others, a merger with, disposition of assets to, or issuance or redemption of
stock to or from such person or group of persons, or allowing such person or
group of persons to receive a disproportionate benefit as a shareholder.
Notwithstanding the foregoing, an otherwise prohibited transaction may be
consummated if such transaction is approved by a majority of the members of the
Board of Directors prior to the date that the third parties became Interested
Shareholders. These provisions may have the effect of delaying, deterring or
preventing a change of control of the Company.
CERTAIN PROVISIONS IN AMENDED AND RESTATED ARTICLES OF INCORPORATION AND BYLAWS
The Articles of Incorporation and Bylaws provide that special meetings of
the shareholders may be called by the Company's President, the Board of
Directors or holders of not less than 30% of the outstanding shares entitled to
vote at the meeting.
At the first election of directors after the completion of this offering,
the Board of Directors will be divided into classes, as determined by the Board
of Directors. This classification may have the effect of deterring hostile
takeovers or delaying changes of control or management of the Company. For
purposes of determining their term of office, directors will be divided into
three classes, with the term of office of Class 1 to expire at the 1998 annual
meeting of shareholders, the term of office of Class 2 to expire at the 1999
annual meeting of shareholders and the term of office of Class 3 to expire at
the 2000 annual meeting of shareholders. Directors elected to succeed those
directors whose term expires will be elected for a three-year term of office.
All directors hold office until the next annual meeting of shareholders at which
their terms expire and until their successors have been duly elected and
qualified. Directors may be removed only for cause and only by a vote of
two-thirds of the shares of the Company's capital stock entitled to vote on an
election of directors.
Certain business combinations, such as a merger or share exchange of the
Company or any of its subsidiaries with another corporation or the sale of a
substantial part of the Company's or any of its subsidiaries' assets, must be
approved by the holders of not less than two-thirds of the outstanding Common
Stock and of any series of Preferred Stock; provided, however, that if certain
continuing members of the Company's Board approve such business combination, it
need only be approved by the holders of a majority of the outstanding Common
Stock and any other series of Preferred Stock entitled to vote on such matters.
49
<PAGE> 52
The Company's Bylaws may be amended or repealed by the Board of Directors
or holders of the outstanding Common Stock and any other stock entitled to vote
thereon.
It is possible that the provisions described above may have the effect of
delaying, deterring or preventing a change of control of the Company.
LIABILITY AND INDEMNIFICATION OF OFFICERS AND DIRECTORS OF THE COMPANY
As permitted by Section 23B.08.320 of the WBCA, Article 10 of the Company's
Articles eliminates in certain circumstances the personal liability of the
Company's directors to the Company or its shareholders for monetary damages
resulting from their conduct as an officer or director. This provision does not
eliminate the liability of directors for (i) acts or omissions that involve
intentional misconduct or a knowing violation of law, (ii) improper declarations
of dividends, or (iii) transactions from which a director received an improper
personal benefit.
The Company's Bylaws require the Company to indemnify its directors and
officers to the fullest extent permitted by Washington law, including under
circumstances in which indemnification is otherwise discretionary. The Company
intends to obtain officers' and directors' liability insurance for members of
its Board of Directors and key employees.
TRANSFER AGENT AND REGISTRAR
The transfer agent and registrar for the Company's Common Stock is First
Interstate Bank of Washington, N.A.
50
<PAGE> 53
SHARES ELIGIBLE FOR FUTURE SALE
Upon completion of this offering, the Company will have 6,662,577 shares of
Common Stock outstanding (assuming no exercise of the Underwriters'
over-allotment option or of outstanding options or warrants after April 18,
1996). Of these shares, the 2,700,000 shares offered hereby will be freely
tradeable without restriction under the Securities Act, unless they are
purchased by "affiliates" of the Company, as that term is used under the
Securities Act. The remaining 3,962,577 shares will be "restricted securities"
as defined in Rules 144 and 701 under the Securities Act ("Restricted Shares").
Immediately after the date of this Prospectus, approximately 21,700 of such
Restricted Shares not subject to the lock-up agreements described below will be
eligible for sale in the public market in accordance with Rule 144(k). In
addition, approximately 18,100 Restricted Shares not subject to lock-up
agreements will be eligible for sale in the public market in accordance with
Rules 144 and 701 and approximately 9,500 Restricted Shares will become eligible
for sale after December 1996.
The Company, all executive officers and directors of the Company and
certain other shareholders, holding an aggregate of approximately 3,785,700
Restricted Shares, have agreed with the Underwriters not to sell, directly or
indirectly, any shares owned by them for a period of 180 days after the date of
this Prospectus without the prior written consent of Montgomery Securities. Upon
the expiration of this 180-day period (or earlier upon the consent of Montgomery
Securities), approximately 2,953,100 of these Restricted Shares (plus shares
issuable upon exercise of then-vested outstanding options) will become eligible
for sale subject to the restrictions of Rule 144 and, in some cases, Rule 701,
of which approximately 459,700 will be freely tradeable under Rule 144(k).
Approximately 832,700 additional shares will become eligible for sale in the
public market pursuant to Rule 144 over the 12 months following expiration of
the 180-day period. In addition, certain of the Company's shareholders who hold
an aggregate of approximately 127,500 shares are subject to 120-day lock-up
agreements. Upon the expiration of the 120-day lock-up period, approximately
92,900 of such shares will be eligible for resale subject to the provisions of
Rule 144 of which approximately 69,000 will be freely tradeable under Rule
144(k).
In general, under Rule 144, as currently in effect, any person who has
beneficially owned restricted securities (as that term is defined in Rule 144)
for at least two years is entitled to sell, within any three-month period, a
number of such securities that does not exceed the greater of 1% of the
then-outstanding shares of Common Stock (approximately 66,625 shares immediately
after this offering) or the average weekly trading volume during the four
calendar weeks preceding the date on which notice of such sale was filed under
Rule 144, provided certain requirements concerning availability of public
information, manner of sale and notice of sale are satisfied. A person who is
not an affiliate, has not been an affiliate within three months prior to such
sale and has beneficially owned the restricted securities for at least three
years is entitled to sell such shares under Rule 144(k) without regard to any of
the limitations described above. In meeting the two- and three-year holding
periods described above, a holder of Restricted Securities may include the
holding period of a prior owner who is not an affiliate of the Company.
Any employee or director of or consultant to the Company who has been
granted options to purchase shares of Common Stock or who has purchased shares,
in either case pursuant to a written compensatory plan or written contract prior
to the effective date of this offering, will be entitled to rely on the resale
provisions of Rule 701, which permits nonaffiliates to sell their Rule 701
shares without having to comply with the public information, holding period,
volume limitation or notice provisions of Rule 144 and permit affiliates to sell
their Rule 701 shares without having to comply with Rule 144's holding period
restrictions, in each case commencing 90 days after the date of this Prospectus.
The Company intends to file a registration statement on Form S-8 under the
Securities Act 30 days after the date of this Prospectus to register the shares
of Common Stock reserved for issuance pursuant to outstanding stock options,
including, in some cases, shares for which an exemption under Rule 144 or 701
would also be available, thus permitting the resale of shares issued under the
Company's stock option plans or under options by nonaffiliates in the public
market without restriction under the Securities Act. As of May 1, 1996, options
to purchase an aggregate of approximately 13,700 shares will be vested and would
be eligible for sale in the public market pursuant to such registration
statement, excluding options to purchase 73,500 shares
51
<PAGE> 54
held by persons subject to the 180-day lockup agreements described above, which
will become eligible for sale upon the expiration of such 180-day period,
subject to Rule 144.
The Company is unable to estimate the number of shares that may be sold in
the future by its existing shareholders or the effect, if any, that sales of
such shares will have on the market price of the Common Stock prevailing from
time to time. Sales of substantial amounts of Common Stock by existing
shareholders could adversely affect prevailing market prices.
52
<PAGE> 55
UNDERWRITING
The Underwriters named below, represented by Montgomery Securities and
Alex. Brown & Sons Incorporated (the "Representatives"), have severally agreed,
subject to the terms and conditions contained in the underwriting agreement (the
"Underwriting Agreement"), by and among the Company, the Selling Shareholders
and the Underwriters, to purchase from the Company the number of shares of
Common Stock indicated below opposite their respective names, at the initial
public offering price less the underwriting discount set forth on the cover page
of this Prospectus. The Underwriting Agreement provides that the obligations of
the Underwriters are subject to certain conditions precedent and that the
Underwriters are committed to purchase all of the shares of Common Stock if they
purchase any.
<TABLE>
<CAPTION>
NUMBER
UNDERWRITER OF SHARES
-------------------------------------------------------------------------- ---------
<S> <C>
Montgomery Securities.....................................................
Alex. Brown & Sons Incorporated...........................................
-------
Total........................................................... 2,700,000
=======
</TABLE>
The Representatives have advised the Company and the Selling Shareholders
that the Underwriters propose initially to offer the shares of Common Stock to
the public on the terms set forth on the cover page of this Prospectus. The
Underwriters may allow to selected dealers a concession of not more than
$ per share; and the Underwriters may allow, and such dealers may
reallow, a concession of not more than $ per share to certain other
dealers. After the initial public offering, the public offering price and other
selling terms may be changed by the Representatives. The Common Stock is offered
subject to receipt and acceptance by the Underwriters, and to certain other
conditions, including the right to reject orders in whole or in part.
The Company and the Selling Shareholders have granted an option to the
Underwriters, exercisable during the 30-day period after the date of this
Prospectus, to purchase up to a maximum of 397,399 and 7,601 additional shares
of Common Stock, respectively, to cover over-allotments, if any, at the same
price per share as the initial shares to be purchased by the Underwriters. To
the extent that the Underwriters exercise this option, the Underwriters will be
committed, subject to certain conditions, to purchase such additional shares in
approximately the same proportion as set forth in the above table. The
Underwriters may purchase such shares only to cover over-allotments made in
connection with this offering.
The Underwriting Agreement provides that the Company and the Selling
Shareholders will indemnify the Underwriters against certain liabilities,
including civil liabilities under the Securities Act, or will contribute to
payments the Underwriters may be required to make in respect thereof.
The Company's directors, executive officers and certain other shareholders
holding an aggregate of approximately 3,785,700 shares of Common Stock have
agreed that they will not directly or indirectly offer to sell, sell or
otherwise dispose of any shares of Common Stock of the Company owned by them
without the prior written consent of Montgomery Securities, for a period of 180
days after the date of this Prospectus. Holders of an aggregate of approximately
127,500 shares of Common Stock are subject to a restriction prohibiting the sale
or disposition of any shares of Common Stock for a period of 120 days after the
date of the Prospectus. The Company has agreed not to sell any shares of Common
Stock for a period of 180 days from the date of this Prospectus without the
prior written consent of Montgomery Securities, except that the Company may,
without consent, issue shares of Common Stock upon exercise of outstanding stock
options.
53
<PAGE> 56
The Representatives have informed the Company that the Underwriters do not
expect to make sales of Common Stock offered by this Prospectus to accounts over
which they exercise discretionary authority in excess of 5% of the shares of
Common Stock offered hereby.
Prior to this offering, there has been no public trading market for the
Common Stock. Consequently, the initial public offering price will be determined
by negotiations among the Representatives and the Company. Among the factors to
be considered in such negotiations are the history of, and the prospects for the
Company and the industry in which it competes, an assessment of the Company's
management, its past and present earnings and the trend of such earnings, the
prospects for future earnings of the Company, the present state of the Company's
development, the general condition of securities markets at the time of this
offering and the market price of publicly traded stock of comparable companies
in recent periods.
Approximately 540,000 shares of Common Stock, or approximately 20% of the
shares offered hereby, have been reserved for sale to certain customers,
existing shareholders, employees and other persons designated by the Company.
The price per share of the shares to be sold to these persons is the same as the
price to the public in this offering. Sales will be made only to persons
investing a minimum of $750, and the maximum investment of any such person may
be limited by the Company in its sole discretion. This program will be
administered by Donaldson, Lufkin & Jenrette Securities Corporation. The number
of shares available for sale to the general public in this offering will be
reduced to the extent such designated persons purchase reserved shares. Any
reserved shares not so purchased will be offered by the Underwriters to the
general public on the same basis as the other shares offered hereby.
LEGAL MATTERS
The validity of the Common Stock offered hereby will be passed upon for the
Company by Heller, Ehrman, White & McAuliffe, Seattle, Washington. Certain legal
matters relating to this offering will be passed upon for the Underwriters by
Perkins Coie, Seattle, Washington.
EXPERTS
The consolidated financial statements included in this Prospectus and
elsewhere in the Registration Statement have been audited by Arthur Andersen
LLP, independent public accountants, as indicated in their reports with respect
thereto, and are included in reliance upon the authority of such firm as experts
in accounting and auditing.
ADDITIONAL INFORMATION
The Company has filed with the Commission a Registration Statement under
the Securities Act on Form S-1 (together with all amendments and exhibits
thereto, the "Registration Statement") with respect to the Common Stock offered
hereby. This Prospectus does not contain all the information set forth in the
Registration Statement and the exhibits thereto, certain parts of which have
been omitted in accordance with the rules and regulations of the Commission. For
further information with respect to the Company and the Common Stock offered
hereby, reference is made to the Registration Statement and the exhibits
thereto. Statements contained in this Prospectus regarding the contents of any
contract or other document are not necessarily complete and in each instance
reference is hereby made to the copy of such contract or document filed as an
exhibit to the Registration Statement. Copies of the Registration Statement and
the exhibits thereto may be inspected, without charge, at the principal office
of the Commission located at 450 Fifth Street, N.W., Washington, D.C. 20549, the
New York Regional Office located at 7 World Trade Center, Suite 1300, New York,
New York 10048, and the Chicago Regional Office located at Citicorp Center, 500
West Madison Street, Suite 1400, Chicago, Illinois 60661, or obtained upon
payment of prescribed rates from the Public Reference Section of the Commission
at its principal office in Washington, D.C.
54
<PAGE> 57
As a result of this offering, the Company will become subject to the
periodic reporting and other informational requirements of the Securities
Exchange Act of 1934, as amended. For so long as the Company is subject to such
periodic reporting and information requirements, it will file with the
Commission all reports, proxy statements and other information required thereby,
which may be inspected at the public reference facilities maintained by the
Commission at Room 1024, 450 Fifth Street, N.W., Washington, D.C. 20549 and at
the Commission's regional offices located at Citicorp Center, 500 West Madison
Street, Suite 1400, Chicago, Illinois 60661 and 7 World Trade Center, Suite
1300, New York, New York 10048. Copies of such material may be obtained by mail
from the Public Reference Section of the Commission at 450 Fifth Street, N.W.,
Washington, D.C. 20549 at prescribed rates.
The Company intends to furnish its shareholders with annual reports
containing audited consolidated financial statements and an opinion thereon
expressed by independent certified public accountants and may furnish its
shareholders quarterly reports for the first three quarters of each fiscal year
containing unaudited summary consolidated financial information.
55
<PAGE> 58
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
Audited Financial Statements
Report of Independent Public Accountants............................................ F-2
Consolidated Balance Sheets at January 28, 1995 and February 3, 1996................ F-3
Consolidated Statements of Operations for the fiscal years ended January 29, 1994,
January 28, 1995 and February 3, 1996............................................ F-4
Consolidated Statements of Shareholders' Equity for the fiscal years ended January
29, 1994, January 28, 1995 and February 3, 1996.................................. F-5
Consolidated Statements of Cash Flows for the fiscal years ended January 29, 1994,
January 28, 1995 and February 3, 1996............................................ F-6
Notes to Consolidated Financial Statements.......................................... F-7
</TABLE>
F-1
<PAGE> 59
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To the Shareholders of
Garden Botanika, Inc.:
We have audited the accompanying consolidated balance sheets of Garden
Botanika, Inc. (a Washington corporation) and subsidiary as of January 28, 1995
and February 3, 1996, and the related consolidated statements of operations,
shareholders' equity and cash flows for the fiscal years ended January 29, 1994,
January 28, 1995 and February 3, 1996. 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, the financial statements referred to above present fairly,
in all material respects, the financial position of Garden Botanika, Inc. and
subsidiary as of January 28, 1995 and February 3, 1996, and the consolidated
results of their operations and their cash flows for the fiscal years ended
January 29, 1994, January 28, 1995 and February 3, 1996, in conformity with
generally accepted accounting principles.
ARTHUR ANDERSEN LLP
Seattle, Washington
March 21, 1996
F-2
<PAGE> 60
GARDEN BOTANIKA, INC.
CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
PRO FORMA
SHAREHOLDERS'
EQUITY AT
FEBRUARY 3,
JANUARY 28, FEBRUARY 3, 1996
1995 1996 (NOTE 7)
----------- ----------- -------------
<S> <C> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents................................................... $ 1,038,373 $ 1,308,533
Inventories................................................................. 5,559,222 10,176,172
Prepaid expenses:
Rent...................................................................... 378,859 795,287
Other..................................................................... 681,588 1,307,787
Receivable from lessors..................................................... 409,053 1,638,933
Other....................................................................... 104,810 346,360
----------- -----------
Total current assets.................................................. 8,171,905 15,573,072
----------- -----------
Property and equipment:
Leasehold improvements...................................................... 17,227,841 31,362,255
Furniture and equipment..................................................... 2,437,857 5,002,216
Equipment under capital lease............................................... 239,263 261,483
----------- -----------
19,904,961 36,625,954
Less--accumulated depreciation and amortization............................. (2,654,884) (5,450,792)
----------- -----------
Net property and equipment............................................ 17,250,077 31,175,162
----------- -----------
Other assets.................................................................. 95,765 388,345
----------- -----------
Total assets.......................................................... $25,517,747 $47,136,579
=========== ===========
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Checks drawn in excess of bank balances..................................... $ 2,123,015 $ 3,615,854
Note payable to bank........................................................ -- 2,540,000
Accounts payable............................................................ 2,956,399 5,137,668
Accrued salaries, wages and benefits........................................ 770,875 780,155
Accrued sales tax........................................................... 340,151 297,046
Other....................................................................... 566,486 540,497
----------- -----------
Total current liabilities............................................. 6,756,926 12,911,220
Deferred rent and other....................................................... 577,385 1,109,280
----------- -----------
Total liabilities..................................................... 7,334,311 14,020,500
----------- -----------
Commitments
Shareholders' equity:
Series A Preferred Stock, $.01 par value;
1,282,959 shares authorized, issued and outstanding....................... 10,092,374 10,092,374 $ --
Series B Preferred Stock, $.01 par value;
1,627,200 shares authorized, issued and outstanding....................... 15,502,497 15,502,497 --
Series C Preferred Stock, $.01 par value;
508,464 shares authorized, issued and outstanding......................... -- 9,959,508 --
Series D Preferred Stock, $.01 par value;
275,408 shares authorized, issued and outstanding......................... -- 6,472,062 --
Preferred Stock, $.01 par value; 10,000,000 shares authorized subsequent
to February 3, 1996; none issued and outstanding.......................... -- -- --
Common stock, $.01 par value;
36,092,374 shares authorized; 268,546 issued and outstanding
(3,962,577 pro forma)..................................................... 48,875 214,271 42,240,712
Accumulated deficit......................................................... (7,460,310) (9,124,633) (9,124,633)
----------- ----------- -----------
Total shareholders' equity............................................ 18,183,436 33,116,079 $ 33,116,079
===========
----------- -----------
Total liabilities and shareholders' equity............................ $25,517,747 $47,136,579
=========== ===========
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
F-3
<PAGE> 61
GARDEN BOTANIKA, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
<TABLE>
<CAPTION>
FISCAL YEAR ENDED
-------------------------------------------
JANUARY 29, JANUARY 28, FEBRUARY 3,
1994 1995 1996
----------- ----------- -----------
<S> <C> <C> <C>
Net sales........................................... $12,568,724 $27,509,803 $55,339,227
Cost of sales (including buying and occupancy
costs)............................................ 7,793,651 15,520,855 31,448,390
----------- ----------- -----------
Gross margin...................................... 4,775,073 11,988,948 23,890,837
Operating expenses:
Stores and catalog................................ 4,093,300 8,956,100 18,745,536
General and administrative........................ 2,759,226 3,916,406 6,041,382
Preopening expenses................................. 416,720 733,461 797,545
----------- ----------- -----------
Operating loss.................................... (2,494,173) (1,617,019) (1,693,626)
Interest income, net................................ 140,436 230,309 29,303
----------- ----------- -----------
Net loss.......................................... $(2,353,737) $(1,386,710) $(1,664,323)
=========== =========== ===========
Pro forma net loss per share, giving effect to the
assumed conversion of all preferred shares to
common............................................ $ (0.88) $ (0.43) $ (0.44)
Pro forma weighted average common and common
equivalent shares................................. 2,675,985 3,209,181 3,780,990
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
F-4
<PAGE> 62
GARDEN BOTANIKA, INC.
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
<TABLE>
<CAPTION>
PREFERRED STOCK COMMON STOCK
----------------------- ------------------ ACCUMULATED
SHARES AMOUNT SHARES AMOUNT DEFICIT TOTAL
--------- ----------- ------- -------- ----------- -----------
<S> <C> <C> <C> <C> <C> <C>
Balance, January 30, 1993.............................. 1,282,959 $10,092,374 258,998 $ 20,375 $(3,719,863) $ 6,392,886
Sale of Series B Preferred Stock..................... 1,627,200 15,502,497 -- -- -- 15,502,497
Net loss............................................. -- -- -- -- (2,353,737 ) (2,353,737)
---------- ----------- ------- -------- ----------- -----------
Balance, January 29, 1994.............................. 2,910,159 25,594,871 258,998 20,375 (6,073,600 ) 19,541,646
Exercise of stock options............................ -- -- 3,050 28,500 -- 28,500
Net loss............................................. -- -- -- -- (1,386,710 ) (1,386,710)
---------- ----------- ------- -------- ----------- -----------
Balance, January 28, 1995.............................. 2,910,159 25,594,871 262,048 48,875 (7,460,310 ) 18,183,436
Sale of Series C Preferred Stock..................... 508,464 9,959,508 -- -- -- 9,959,508
Sale of Series D Preferred Stock..................... 275,408 6,472,062 -- -- -- 6,472,062
Exercise of stock options............................ -- -- 2,342 19,600 -- 19,600
Issuance of Common Stock in connection with
acquisition........................................ -- -- 4,156 130,796 -- 130,796
Deferred compensation................................ -- -- -- 15,000 -- 15,000
Net loss............................................. -- -- -- -- (1,664,323 ) (1,664,323)
---------- ----------- ------- -------- ----------- -----------
Balance, February 3, 1996.............................. 3,694,031 $42,026,441 268,546 $214,271 $(9,124,633) $33,116,079
========== =========== ======= ======== =========== ===========
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
F-5
<PAGE> 63
GARDEN BOTANIKA, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
FISCAL YEAR ENDED
---------------------------------------------
JANUARY 29, JANUARY 28, FEBRUARY 3,
1994 1995 1996
----------- ------------ ------------
<S> <C> <C> <C>
Cash flows from operating activities:
Net loss........................................ $(2,353,737) $ (1,386,710) $ (1,664,323)
----------- ------------ ------------
Adjustments to reconcile net loss to net cash
(used) provided by operating activities--
Depreciation and amortization................ 821,782 1,429,733 2,907,901
Loss on retirement of property and
equipment.................................. 110,628 61,717 --
Changes in assets and liabilities:
Inventories................................ (1,313,599) (3,069,405) (4,542,714)
Prepaid rent............................... (55,271) (204,273) (416,428)
Other assets............................... 62,449 (615,491) (1,116,591)
Accounts payable and checks drawn in excess
of bank balances........................ 613,079 3,930,669 2,494,272
Accrued expenses........................... 523,353 788,215 (37,505)
Deferred rent and other.................... 143,540 287,686 483,548
----------- ------------ ------------
Total adjustments....................... 905,961 2,608,851 (227,517)
----------- ------------ ------------
Net cash (used) provided by operating
activities............................ (1,447,776) 1,222,141 (1,891,840)
----------- ------------ ------------
Cash flows from investing activities:
Additions to property and equipment............. (3,865,027) (11,438,837) (16,800,343)
Increase (decrease) in construction accounts
payable...................................... 226,487 (33,440) 1,179,836
Increase in receivable from lessors............. (92,753) (251,300) (1,229,880)
Other........................................... -- -- (25,000)
----------- ------------ ------------
Net cash used by investing activities... (3,731,293) (11,723,577) (16,875,387)
----------- ------------ ------------
Cash flows from financing activities:
Sale of Preferred Stock......................... 15,502,497 -- 16,431,570
Advances on note payable to bank................ -- -- 13,855,625
Payments on note payable to bank................ -- -- (11,315,625)
Other, net...................................... (38,759) (18,400) 65,817
----------- ------------ ------------
Net cash provided (used) by financing
activities............................ 15,463,738 (18,400) 19,037,387
----------- ------------ ------------
Net increase (decrease) in cash and cash
equivalents..................................... 10,284,669 (10,519,836) 270,160
Cash and cash equivalents, beginning of period.... 1,273,540 11,558,209 1,038,373
----------- ------------ ------------
Cash and cash equivalents, end of period.......... $11,558,209 $ 1,038,373 $ 1,308,533
=========== ============ ============
Supplemental disclosures:
Cash paid for interest.......................... $ -- $ 14,738 $ 82,113
Cash paid for income taxes...................... $ -- $ -- $ --
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
F-6
<PAGE> 64
GARDEN BOTANIKA, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FEBRUARY 3, 1996
1. ORGANIZATION
The fiscal 1995 consolidated financial statements include the accounts of
Garden Botanika, Inc. and its wholly owned subsidiary, Garden Botanika Direct,
Inc. (together referred to as the "Company"). All significant intercompany
transactions have been eliminated.
Garden Botanika was incorporated in the state of Washington on October 5,
1989, and was in the development stage until August 1990. Garden Botanika
markets cosmetic and personal care products which feature natural and herbal
ingredients. These products are sold in a chain of Company-owned specialty
retail stores. As of February 3, 1996, the Company operated 152 retail locations
in 29 states.
During fiscal 1994, the Company formed Garden Botanika Direct for the
purpose of selling its products by mail order. Subsequent to February 3, 1996,
Garden Botanika Direct was merged into Garden Botanika, Inc.
On October 30, 1995, in order to establish its initial in-house research
and development, quality control and manufacturing capabilities, the Company
purchased the principal assets of Innovative Biosciences Corporation of
Oceanside, California ("IBC"). IBC was in the business of formulating,
manufacturing and selling personal care products, including a number of such
products formulated and manufactured for the Company. The purchase price paid
for IBC's principal assets was approximately $156,000, which was paid in cash
and shares of the Company's Common Stock. The acquisition was accounted for as a
purchase and the operations of IBC have been included in the consolidated
results of operations beginning October 31, 1995. IBC's operations to date have
not been a material part of the Company's operations.
The Company has had active operations since August 1990 and, consequently,
has only a limited operating history. The Company's future operations are
subject to risks inherent in an emerging business. The principal risk factors
relate to the need for additional capital to finance further expansion and the
ability to obtain satisfactory expansion sites at terms favorable to the
Company.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Fiscal Year
The Company's 52/53-week fiscal year ends on the Saturday nearest the end
of January. Fiscal years 1991 and 1995 were 53-week years.
Estimates and Assumptions
The preparation of 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 the
disclosure of contingent assets and liabilities at the date of the financial
statements, as well as the amounts of revenues and expenses reported during the
period. Actual results could differ from those estimates.
Cash and Cash Equivalents
The Company considers all short-term investments with maturities of 90 days
or less to be cash equivalents. Cash includes all depository accounts maintained
at financial institutions, including amounts invested in money-market mutual
funds. The Company estimates that the fair value of its financial instruments
approximate their carrying value, and therefore no separate disclosure of fair
value is made.
F-7
<PAGE> 65
GARDEN BOTANIKA, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
The Company's cash management system provides for the reimbursement of all
major bank disbursement accounts on a daily basis. Checks issued but not
presented for payment to the bank are reflected as checks drawn in excess of
bank balances on the balance sheet.
Inventory
Inventory is recorded at the lower of weighted average cost or net
realizable value.
Property and Equipment
Property and equipment are stated at cost and include the costs of
acquiring new store leases and leasehold improvements. Depreciation of equipment
under capital leases, furniture, and fixtures is provided using the
straight-line method over estimated useful lives ranging from five to seven
years. The costs of acquiring new store leases and the costs of leasehold
improvements are capitalized and amortized over the shorter of the life of the
lease or the useful lives of the assets. Leasehold acquisition costs capitalized
in fiscal years 1993, 1994 and 1995 were $210,311, $569,085 and $754,411,
respectively. Depreciation and amortization expense was $781,274, $1,389,225 and
$2,985,767 for fiscal years 1993, 1994 and 1995, respectively.
When a store is relocated, the unamortized cost of leasehold improvements
at the original store is expensed in the period the lease for the new store is
signed. Although the Company has not closed any stores to date, its policy in
the event of a closure would be to record any loss on the closure in the period
in which the decision to close the store is made.
Preopening Expense
Store preopening costs are expensed as incurred.
Organization Costs
Certain costs related to the organization and start-up of the business have
been deferred, and are being amortized over five years. Amortization was $40,508
for each of fiscal years 1993 and 1994 and $29,891 for fiscal 1995.
Deferred Rent
The Company expenses rent on a straight-line basis over the life of the
lease. During the initial years of a store lease, cash payments are typically
less than the straight-line expense. The differential is recorded as deferred
rent on the balance sheet.
Income Taxes
The Company accounts for income taxes under Statement of Financial
Accounting Standards (SFAS) No. 109. Accordingly, deferred taxes are provided to
reflect temporary differences between financial and tax reporting. Deferred tax
assets and liabilities are measured based on enacted tax laws and rates. Due to
cumulative net operating losses, the Company has not paid federal income taxes
since its inception.
Pro Forma Earnings per Common and Common Share Equivalent
For all periods presented, pro forma earnings per common and common share
equivalent are based on the number of common and preferred shares and, in
periods of profitability, share equivalents outstanding. Pro forma net loss per
share amounts, giving effect to the assumed conversion of preferred shares to
common and treating the preferred shares as if they were originally issued as
common, more accurately reflect the Company's capitalization than do historical
earnings per share. Accordingly, historical data is not included.
F-8
<PAGE> 66
GARDEN BOTANIKA, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Common share equivalents used in the calculation of earnings per share
include options to purchase common stock granted and outstanding under the
Company's employee and director stock option plans. Common share equivalents are
determined under the assumption that outstanding stock options are exercised at
the beginning of the periods presented and the proceeds used to purchase stock
at an assumed initial public offering price of approximately $16.00 per share.
Pursuant to Securities and Exchange Commission Staff Accounting Bulletins,
18,432 common and common equivalent shares issued during the 12-month period
prior to the initial public offering are included in the calculations as if they
were outstanding for all periods presented (using the treasury stock method at
the assumed public offering price).
3. INVENTORIES
Inventories at fiscal year-end are composed of the following:
<TABLE>
<CAPTION>
1994 1995
---------- -----------
<S> <C> <C>
Finished products held for sale............................ $4,410,704 $ 8,449,144
Raw materials and components............................... 1,148,518 1,727,028
---------- -----------
$5,559,222 $10,176,172
========== ===========
</TABLE>
4. LEASES
The Company is obligated under noncancelable operating leases for its
retail store outlets. Lease terms range from five to 12 years, with options to
renew at varying terms. The leases generally provide for contingent payments
based upon a percentage of sales. Contingent payments were $16,125, $133,708 and
$184,163, and rent expense was $1,522,055, $2,816,046 and $5,683,091 for fiscal
years 1993, 1994 and 1995, respectively.
Future minimum rental payments under operating leases are:
<TABLE>
<CAPTION>
FISCAL YEAR AMOUNT
- ----------- ------------
<S> <C> <C>
1996...................................................................... $ 7,206,908
1997...................................................................... 7,385,257
1998...................................................................... 7,400,088
1999...................................................................... 7,500,985
2000...................................................................... 7,501,894
Thereafter................................................................ 28,888,993
-----------
$ 65,884,125
===========
</TABLE>
5. LINE OF CREDIT
At February 3, 1996, the Company operated under a $9,000,000 credit line
provided by U.S. Bank of Washington, N.A. ("USBW"). This credit line includes a
$5,000,000 revolving working capital facility, which expires on September 30,
1997 and bears interest at USBW's prime rate (currently 8.25%), as well as a
$4,000,000 revolving bridge facility, which expires on September 30, 1996, and
bears interest at prime plus 3.00% (currently 11.25%). Borrowings under the
working capital facility are limited to 25% of eligible inventory during the
months of January through March and to 50% of eligible inventory during the
remainder of the year, while borrowings under the bridge facility and are not
subject to limitation. At February 3, 1996, $2,540,000 was outstanding under the
two facilities.
Borrowings under the USBW credit line are secured by the assets of the
Company. In addition, the Company is prohibited under the terms of the line from
paying dividends or incurring additional indebtedness without USBW's prior
written consent and is required to maintain minimum tangible net worth of
$27,000,000 through June 29, 1996 and $32,000,000 thereafter, a maximum ratio of
indebtedness to capital of 0.7:1 and
F-9
<PAGE> 67
GARDEN BOTANIKA, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
working capital of at least $4,000,000. As of February 3, 1996, the Company was
not in compliance with the working capital covenant; however, USBW has waived
this violation, which could have been cured by borrowing under the bridge
facility to repay a portion of the borrowings under the working capital
facility.
The Company did not incur interest expense in fiscal 1993. During fiscal
years 1994 and 1995, the Company incurred interest expense of $14,738 and
$82,113, respectively.
Subsequent to the fiscal year-end, the Company had increased its borrowings
under the USBW credit line to $6,023,000 by March 21, 1996. During this period,
the Company exceeded the borrowing base limitation of the working capital
facility. USBW has waived this violation and adjusted the borrowing base
limitation in a manner expected to permit the Company to access the full
$9,000,000 credit line through May 31, 1996. Until that date, the working
capital facility will bear interest at USBW's prime rate plus 1.00%.
6. INCOME TAXES
The components of the deferred tax accounts at February 3, 1996, assuming a
35% statutory tax rate, were as follows:
<TABLE>
<CAPTION>
1994 1995
----------- -----------
<S> <C> <C>
Net operating loss carryforward........................... $ 1,614,000 $ 1,537,000
Depreciation.............................................. 523,000 764,000
Inventory................................................. 219,000 315,000
Deferred rent............................................. 193,000 369,000
Reserves not currently deductible......................... 106,000 152,000
Other..................................................... 11,000 (9,000)
Valuation allowance....................................... (2,666,000) (3,128,000)
----------- -----------
Net deferred taxes........................................ $ -- $ --
=========== ===========
</TABLE>
The Company has established a valuation allowance because the net deferred
tax asset does not meet the recognition criteria established by SFAS No. 109.
Deferred state taxes have not been disclosed, as amounts are not material.
The Company's net operating loss carryforward begins to expire in 2005. Of
the $1,537,000 carryforward benefit at February 3, 1996, $1,360,000 is subject
to a limitation of $646,000. This limitation will increase by an additional
$250,000 each year thereafter until the entire $1,360,000 has been realized or
expires.
7. SHAREHOLDERS' EQUITY
Common and Preferred Stock
Subsequent to February 3, 1996, the Company's board of directors approved
an approximate 1:7.87 reverse stock split. The accompanying financial statements
have been adjusted to reflect this action.
At February 3, 1996, the Company was authorized to issue 36,092,374 shares
of Common Stock and 3,694,031 shares of Preferred Stock at a par value of $.01
each. The Company was authorized to issue four series of its Preferred Stock:
Series A Convertible Preferred, consisting of 1,282,959 shares; Series B
Convertible Preferred, consisting of 1,627,200 shares; Series C Convertible
Preferred, consisting of 508,464 shares, and Series D Convertible Preferred,
consisting of 275,408 shares.
Each share of Common and Preferred stock is entitled to one vote at
shareholders' meetings. The holders of Series A, B, C and D Convertible
Preferred are entitled to receive a liquidation preference of $7.87, $9.83,
$19.67 and $23.60 per share, respectively, adjusted for stock splits, on
liquidation of the Company's assets.
F-10
<PAGE> 68
GARDEN BOTANIKA, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Each share of Series A, B, C and D Preferred is convertible to common on a
one-for-one basis, adjusted for stock splits upon certain conditions, including
an initial public offering of the Company's Common Stock.
The Company has filed a Registration Statement with the Securities and
Exchange Commission for an underwritten public offering of 2,700,000 shares of
its Common Stock. Management intends to use the net proceeds of this offering,
estimated at approximately $41,900,000 based on a mid-range offering price of
$17.00 per share and assuming the 15% over-allotment option is not exercised, to
finance the opening of additional stores, to repay outstanding bank debt and for
other capital expenditures relating to expansion of the Company's operations,
working capital and general corporate purposes. If the initial public offering
is consummated as presently anticipated, (i) 3,694,031 outstanding shares of
Convertible Preferred Stock will automatically convert into an equal number of
shares of Common Stock; (ii) the various series of Convertible Preferred Stock
will cease to exist; and (iii) 10,000,000 shares of a new class of Preferred
Stock will be authorized. Pro forma shareholders' equity, as adjusted for these
Preferred Stock contingencies, is disclosed in the accompanying balance sheet.
Stock Options
The Company has an approved stock option plan (the "Stock Option Plan") for
employees, directors, consultants and independent contractors of the Company.
The number of shares authorized for issuance under the Stock Option Plan was
398,217 at February 3, 1996. Under the terms of the Stock Option Plan, the
exercise price of shares subject to incentive stock options will not be less
than 100% of fair market value at the date of grant, while the exercise price of
shares subject to nonqualified stock options may be greater than or less than
fair market value. All options outstanding at February 3, 1996 vest on schedules
of four to five years and terminate after ten years and two days. Transactions
and balances relating to the Stock Option Plan during fiscal years 1993, 1994
and 1995 were as follows:
<TABLE>
<CAPTION>
SHARES PRICE
------- ---------------
<S> <C> <C>
Fiscal 1993
Balance, January 30, 1993............................... 38,784 $7.87
Granted................................................. 59,469 $9.83
--------
-
Balance, January 29, 1994............................... 98,253 $7.87 to $9.83
=========
Fiscal 1994
Granted................................................. 50,521 $9.83
Exercised............................................... (3,050) $7.87 to $9.83
Canceled................................................ (13,774) $7.87 to $9.83
--------
-
Balance, January 28, 1995............................... 131,950 $7.87 to $9.83
=========
Fiscal 1995
Granted................................................. 145,210 $9.83 to $13.77
Exercised............................................... (2,342) $7.87 to $9.83
Canceled................................................ (6,237) $7.87 to $13.77
--------
-
Balance, February 3, 1996............................... 268,581 $7.87 to $13.77
=========
Options exercisable at February 3, 1996................. 55,386 $7.87 to $13.77
Shares available for future grant....................... 124,245
</TABLE>
As part of the agreement for the October 30, 1995 purchase of IBC, one of
the owners of IBC became Vice President -- Research and Product Development of
the Company. In connection with his employment, this individual was granted
options to purchase 25,424 shares of the Company's Common Stock at an exercise
price of $1.97 per share (the "IBC Options"). In connection with issuance of
these options, the Company recorded $300,000 of deferred compensation expense,
which will be amortized over the five-year option
F-11
<PAGE> 69
GARDEN BOTANIKA, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
vesting period. Any unexercised IBC Options will terminate after 10 years; at
February 3, 1996, 1,538 of these options were exercisable.
In connection with the grant to an officer of options to purchase 9,533
shares of Common Stock, the Company has agreed to pay, at the end of the
five-year vesting period, the difference, if any, between the value of all
options granted and Common Stock issued to the officer and $1,000,000, except
that, if and to the extent the value of such options and Common Stock has
exceeded $670,000 at any time during the option period, the Company's obligation
shall be reduced. In fiscal 1995, the Company recorded a liability of $192,500
related to this agreement. The Company's payment obligation may be satisfied by
accelerating existing options, granting additional options or making a cash
payment. The Company has a similar obligation in the event of a change of
control of the Company. In the event the officer is terminated without cause
during the option period, he is entitled to vested options upon termination for
shares having a value of $200,000 for each year or part of a year in which he
worked for the Company.
In addition to the Stock Option Plan described above, the Company's Board
of Directors has adopted, subject to shareholder approval, a Directors'
Nonqualified Stock Option Plan (the "Directors' Plan"). This plan provides for
the automatic grant to each non-employee director of the Company of an option to
purchase 1,271 shares of Common Stock upon election or appointment to the Board
of Directors and thereafter at each annual meeting of the Board of Directors for
so long as the individual continues to serve as a director of the Company. The
exercise price of options granted under the Directors' Plan must equal the fair
market value of the Common Stock on the date of grant. Options vest monthly over
a one-year period. To date, no options have been granted under the Directors'
Plan.
Warrants
In connection with the issuance of certain shares of Series B Convertible
Preferred Stock, the Company's investment advisor received warrants to purchase
23,724 shares of common stock at $9.83 per share. These warrants expire in 1998.
Adoption of Accounting Standards
Financial Accounting Standards Board Statement No. 123 ("SFAS 123"),
"Accounting for Stock-Based Compensation," issued in October 1995 and effective
for fiscal years beginning after December 15, 1995, encourages, but does not
require, a fair value based method of accounting for employee stock options or
similar equity instruments. SFAS 123 also allows an entity to continue to
measure compensation cost under Accounting Principles Board Opinion No. 25 ("APB
25"), "Accounting for Stock Issued to Employees," but requires pro forma
disclosure of net income and earnings per share as if the fair value based
method of accounting encouraged by SFAS 123 had been applied. The Company will
adopt SFAS 123 in fiscal 1996. While the Company is still evaluating SFAS 123,
it currently expects to continue to measure compensation cost under APB 25 and
comply with the pro forma disclosure requirements. If the Company makes this
election, SFAS 123 will have no impact on the Company's results of operations or
financial position because its Stock Option Plan is a fixed plan, the options of
which have no intrinsic value at the grant date under APB 25.
8. RELATED PARTY TRANSACTIONS
Approximately 21%, 11% and 12% of merchandise purchases during fiscal years
1993, 1994 and 1995, respectively, were from a supplier whose president is a
director of the Company.
F-12
<PAGE> 70
GARDEN BOTANIKA, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
9. QUARTERLY FINANCIAL DATA (UNAUDITED)
<TABLE>
<CAPTION>
(000 OMITTED)
----------------------------------------------
PRO FORMA PRO FORMA
WEIGHTED NET INCOME
AVERAGE (LOSS) PER
COMMON AND COMMON AND
NET COMMON COMMON
NET GROSS INCOME EQUIVALENT EQUIVALENT
SALES MARGIN (LOSS) SHARES SHARE(1)
------- ------- ------- ---------- ----------
<S> <C> <C> <C> <C> <C>
Fiscal Year Ended January 29, 1994
First quarter..................... $ 1,930 $ 689 $ (550) 1,581 $(0.35)
Second quarter.................... $ 2,179 $ 718 $ (622) 1,581 $(0.39)
Third quarter..................... $ 2,477 $ 781 $ (928) 2,269 $(0.41)
Fourth quarter.................... $ 5,983 $ 2,587 $ (254) 3,208 $(0.08)
Fiscal Year Ended January 28, 1995
First quarter..................... $ 3,955 $ 1,545 $ (665) 3,208 $(0.21)
Second quarter.................... $ 4,521 $ 1,771 $ (616) 3,208 $(0.19)
Third quarter..................... $ 5,551 $ 2,178 $(1,168) 3,210 $(0.36)
Fourth quarter.................... $13,483 $ 6,495 $ 1,062 3,274 $ 0.32
Fiscal Year Ended February 3, 1996
First quarter..................... $ 9,532 $ 4,084 $ (827) 3,706 $(0.22)
Second quarter.................... $10,138 $ 4,212 $ (836) 3,707 $(0.23)
Third quarter..................... $10,671 $ 4,170 $(1,986) 3,707 $(0.54)
Fourth quarter.................... $24,998 $11,425 $ 1,985 4,066 $ 0.49
</TABLE>
- ---------------
(1) Interim per share amounts may not accumulate to annual amounts.
The above quarterly financial data is unaudited; however, in the opinion of
management, all adjustments, which are of a normal or recurring nature,
necessary for fair presentation of the selected data for these interim periods
have been included.
F-13
<PAGE> 71
- ------------------------------------------------------
- ------------------------------------------------------
No dealer, sales representative or any other person has been authorized to
give any information or to make any representations in connection with this
offering other than those contained in this Prospectus, and, if given or made,
such information or representations must not be relied upon as having been
authorized by the Company, any of the Selling Shareholders or any of the
Underwriters. This Prospectus does not constitute an offer to sell or a
solicitation of any offer to buy any securities offered hereby by any person in
any jurisdiction where such an offer or solicitation would be unlawful. Neither
the delivery of this Prospectus nor any sale made hereunder shall, under any
circumstances, create an implication that there has been no change in the
affairs of the Company since the date hereof.
----------------------------
TABLE OF CONTENTS
----------------------------
<TABLE>
<CAPTION>
Page
---------
<S> <C>
Prospectus Summary................... 3
Risk Factors......................... 6
Use of Proceeds...................... 12
Dividend Policy...................... 12
Dilution............................. 13
Capitalization....................... 14
Selected Financial and Operating
Data............................... 15
Management's Discussion and Analysis
of Financial Condition and Results
of Operations...................... 16
Business............................. 24
Management........................... 37
Certain Transactions................. 44
Principal Shareholders............... 46
Description of Capital Stock......... 48
Shares Eligible for Future Sale...... 51
Underwriting......................... 53
Legal Matters........................ 54
Experts.............................. 54
Additional Information............... 54
Index to Consolidated Financial
Statements......................... F-1
</TABLE>
----------------------------
Until , 1996 (25 days after the date of this Prospectus), all
dealers effecting transactions in the Common Stock, whether or not participating
in this distribution, may be required to deliver a Prospectus. This is in
addition to the obligation of dealers to deliver a Prospectus when acting as
underwriters with respect to their unsold allotments or subscriptions.
- ------------------------------------------------------
- ------------------------------------------------------
- ------------------------------------------------------
- ------------------------------------------------------
2,700,000 SHARES
LOGO
COMMON STOCK
------------------------
PROSPECTUS
------------------------
MONTGOMERY SECURITIES
ALEX. BROWN & SONS
INCORPORATED
, 1996
- ------------------------------------------------------
- ------------------------------------------------------
<PAGE> 72
PART II
INFORMATION NOT REQUIRED IN PROSPECTUS
ITEM 13. OTHER EXPENSES OF ISSUANCE AND DISTRIBUTION.
The following table sets forth the costs and expenses, other than
underwriting discounts and commissions, payable by the Registrant in connection
with the issuance and distribution of the securities being registered. All the
amounts shown are estimated, except the Securities and Exchange Commission
registration fee, the NASD filing fee and the Nasdaq National Market(R) listing
fee.
<TABLE>
<S> <C>
Securities and Exchange Commission Registration Fee....................... $ 16,060
NASD Filing Fee........................................................... 5,158
Nasdaq National Market(R) Listing Fee..................................... 37,252
Blue Sky Fees and Expenses (includes fees and expenses of counsel)........ 10,000
Transfer Agent and Registrar Fees......................................... 10,000
Accounting Fees and Expenses.............................................. 200,000
Legal Fees and Expenses................................................... 200,000
Printing, Engraving and Delivery Expenses................................. 100,000
Insurance Coverage Acquired for the Offering.............................. 130,000
Miscellaneous............................................................. 91,530
--------
Total........................................................... $800,000
========
</TABLE>
ITEM 14. INDEMNIFICATION OF DIRECTORS AND OFFICERS.
Sections 23B.08.500 through 23B.08.600 of the Washington Business
Corporation Act (the "WBCA") authorize a corporation to indemnify its directors,
officers, employees and agents against certain liabilities they may incur in
such capacities, including liabilities under the Securities Act of 1933, as
amended (the "Securities Act"), provided they acted in good faith and in a
manner reasonably believed to be in or not opposed to the best interests of the
corporation. The Registrant's Bylaws (Exhibit 3.4 hereto) require the Registrant
to indemnify its officers and directors to the fullest extent permitted by
Washington law.
Section 23B.08.320 of the WBCA authorizes a corporation to limit or
eliminate its directors' liability to the corporation or its shareholders for
monetary damages for breaches of fiduciary duties, other than for (1) acts or
omissions that involve intentional misconduct or a knowing violation of law, (2)
improper declaration of dividends, or (3) transactions from which a director
derives an improper personal benefit. The Registrant's Amended and Restated
Articles of Incorporation (Exhibit 3.1 hereto) contain provisions limiting the
liability of the directors to the Registrant and to its shareholders to the
fullest extent permitted by Washington law.
The above discussion, although complete in all material respects, is not
intended to be exhaustive and is qualified in its entirety by the Registrant's
Bylaws and Amended and Restated Articles of Incorporation.
The Registrant intends to obtain officers' and directors' liability
insurance on its directors and officers. In addition, the Underwriting Agreement
(Exhibit 1.1 hereto) will contain provisions for the indemnification of, among
others, controlling persons, directors and officers of the Registrant for
certain liabilities.
ITEM 15. RECENT SALES OF UNREGISTERED SECURITIES.
The numbers in this item give effect to an approximate 1:7.87 reverse stock
split to be effected upon the effectiveness of this offering.
1. From July 26, 1994 to April 18, 1996, the Registrant issued an aggregate
of 5,392 shares of Common Stock to seven individuals upon the exercise of stock
options granted pursuant to the Registrant's stock option plan. Such issuances
were exempt from registration pursuant to Rule 701 under the Securities Act.
II-1
<PAGE> 73
2. From May 24, 1993 to September 20, 1993, the Registrant sold an
aggregate of 1,627,200 shares of its Series B Convertible Preferred Stock for an
aggregate offering price of $16,000,000 in private transactions exempt from
registration pursuant to Rule 506 of Regulation D under Section 4(2) of the
Securities Act. All 37 purchasers were accredited investors.
3. From February 1, 1995 to March 13, 1995, the Registrant sold an
aggregate of 508,464 shares of its Series C Convertible Preferred Stock for an
aggregate offering price of $10,000,000 in private transactions exempt from
registration pursuant to Rule 506 of Regulation D under Section 4(2) of the
Securities Act. All 56 purchasers were accredited investors.
4. On October 30, 1995, the Registrant sold 4,156 shares of Common Stock to
John A. Garruto and Michelle B. Garruto, Trustees of the Garruto Family Trust
1994, at $31.47 per share, pursuant to the Asset Purchase and Sale Agreement
among the Registrant, Innovative Biosciences Corporation and its shareholders.
This transaction involved the acquisition of assets by the Registrant, the
issuance of Common Stock and stock options to Mr. Garruto and the employment of
Mr. Garruto by the Registrant. The transaction was exempt from registration
pursuant to Section 4(2) of the Securities Act.
5. From November 1, 1995 to December 8, 1995, the Registrant sold an
aggregate of 275,408 shares of its Series D Convertible Preferred Stock for an
aggregate offering price of $6,500,000 in private transactions exempt from
registration pursuant to Rule 506 of Regulation D under Section 4(2) of the
Securities Act. All 59 purchasers were accredited investors.
ITEM 16. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES.
a. Exhibits.
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION
- ------- --------------------------------------------------------------------------------
<C> <C> <S>
1.1 -- Form of Underwriting Agreement.
3.1 -- Sixth Restated Articles of Incorporation.
3.2 -- Form of Seventh Restated Articles of Incorporation.
3.3 -- Form of Eighth Restated Articles of Incorporation.
3.4 -- Amended and Restated Bylaws.
4.1 -- Specimen Common Stock Certificate.
4.2 -- See Articles 4.2, 5 and 6 of Exhibit 3.1 and Articles 3 and 7 of Exhibit 3.4,
which confirm some of the rights of holders of Common Stock.
5.1 -- Opinion of Heller, Ehrman, White & McAuliffe.
10.1 -- Employment Agreement by and between Garden Botanika, Inc. (formerly known as
American Body Care, Inc.) and Michael Luce, dated January 1, 1990.
10.2 -- Employment Agreement by and between Garden Botanika, Inc. and Jeffrey Mason,
dated November 18, 1994.
10.3 -- Hardware Purchase and Software License Agreement by and between Garden Botanika,
Inc. (formerly known as American Body Care, Inc.) and STS Systems, Ltd., dated
June 22, 1990.
10.3A -- Addendum 65 to Hardware Purchase and Software License Agreement by and between
Garden Botanika, Inc. and STS Systems, Ltd., dated June 22, 1990.
10.4 -- Equipment Maintenance Agreement by and between Garden Botanika, Inc. (formerly
known as American Body Care, Inc.) and STS Systems, Ltd., dated June 22, 1990.
10.5 -- Software Maintenance Agreement by and between Garden Botanika, Inc. (formerly
known as American Body Care, Inc.) and STS Systems, Ltd., dated June 22, 1990.
10.6 -- Credit Agreement by and among U.S. Bank of Washington, National Association and
Garden Botanika, Inc. and Garden Botanika Direct, Inc., dated November 30, 1995.
</TABLE>
II-2
<PAGE> 74
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION
- ------- --------------------------------------------------------------------------------
<C> <C> <S>
10.7 -- Revolving Note in the amount of $5,000,000 dated November 30, 1995 in favor of
U.S. Bank of Washington, National Association.
10.8 -- Bridge Note in the amount of $4,000,000 dated November 30, 1995 in favor of U.S.
Bank of Washington, National Association.
10.9 -- Security Agreement dated November 30, 1995 by and between Garden Botanika, Inc.
and U.S. Bank of Washington, National Association.
10.10 -- Distribution Agreement by and between Garden Botanika, Inc. and Essential
Amenities, Inc., dated November 2, 1995.
10.11 -- Corporate Headquarters lease agreement by and between Westpark "P" Limited
Partnership and Garden Botanika, Inc., dated October 8, 1992, as amended.
10.12 -- Corporate Headquarters expansion lease agreement by and between Teachers
Insurance & Annuity Association and Garden Botanika, Inc., dated September 27,
1995.
10.13 -- Ontario Distribution Facility lease agreement by and between Grumet-Goodrich
Corporation and Garden Botanika, Inc., dated December 16, 1992.
10.14 -- Fontana Distribution Facility lease agreement by and between the Tuffli Company
and Garden Botanika, Inc., dated June 29, 1995.
10.15 -- Garden Botanika, Inc. 1992 Combined Incentive and Nonqualified Stock Option Plan
(as amended through October 30, 1995).
10.16 -- Form of 1996 Directors' Nonqualified Stock Option Plan.
10.17 -- Stock Option Agreement and Payment Obligation by and between Garden Botanika,
Inc. and Jeffrey Mason, dated January 4, 1995.
10.18 -- Option and Severance Agreement by and between Garden Botanika, Inc. and John
Garruto, dated October 30, 1995.
10.19 -- Warrant to Purchase 1,740 Shares of Common Stock, dated September 20, 1993, held
by DLJ First ESC L.L.C.
10.20 -- Warrant to Purchase 166 Shares of Common Stock, dated September 20, 1993, held
by DLJ Capital Corporation.
10.21 -- Warrant to Purchase 21,817 Shares of Common Stock, dated September 20, 1993,
held by DLJ Capital Corporation.
10.22 -- Asset Purchase and Sale Agreement by and among Garden Botanika, Inc., Innovative
Biosciences Corporation and its Shareholders, dated September 19, 1995, as
amended by Amendment Number 1 to Asset Purchase and Sale Agreement dated October
30, 1995.
10.23 -- Amended and Restated Investors Rights Agreement, by and among certain Investors
and Garden Botanika, Inc., dated November 1, 1995, as amended.
10.24 -- Standard Industrial Lease, between William D. Vogel and Garden Botanika, Inc.,
dated February 21, 1996.
10.25 -- Corporate Headquarters Expansion Lease Agreement by and between Persis
Corporation and Garden Botanika, Inc., dated March 29, 1996.
10.26 -- U.S. Bank waiver letter, dated March 27, 1996.
10.27 -- U.S. Bank borrowing base amendment letter, dated April 11, 1996.
10.28 -- Letter of Understanding to Purchase By Garden Botanika from Momentis of System
Development and Maintenance Services dated March 28, 1996.
23.1* -- Consent of Independent Auditor.
24.1 -- Powers of Attorney.
</TABLE>
II-3
<PAGE> 75
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION
- ------- --------------------------------------------------------------------------------
<C> <C> <S>
99.1 -- Donaldson, Lufkin & Jenrette Securities Corporation question and answer
materials and related documents.
</TABLE>
- ------------------------------
* See page II-6.
b. Financial Statement Schedules.
All schedules have been omitted because the information is not required or
is not applicable, or because the information required is included in the
consolidated financial statements or the notes thereto.
ITEM 17. UNDERTAKINGS.
The undersigned Registrant hereby undertakes to provide to the underwriters
at the closing specified in the underwriting agreement, certificates in such
denominations and registered in such names as required by the underwriters to
permit prompt delivery to each purchaser.
Insofar as indemnification for liabilities arising under the Securities Act
may be permitted to directors, officers and controlling persons of the
Registrant pursuant to the foregoing provisions, or otherwise, the Registrant
has been advised that in the opinion of the Securities and Exchange Commission
such indemnification is against public policy as expressed in the Securities Act
and is, therefore, unenforceable. In the event that a claim for indemnification
against such liabilities (other than the payment by the Registrant of expenses
incurred or paid by a director, officer or controlling person of the Registrant
in the successful defense of any action, suit or proceeding) is asserted by such
director, officer or controlling person in connection with the securities being
registered, the Registrant will, unless in the opinion of its counsel the matter
has been settled by controlling precedent, submit to a court of appropriate
jurisdiction the question of whether such indemnification by it is against
public policy as expressed in the Securities Act and will be governed by the
final adjudication of such issue.
The undersigned Registrant hereby undertakes that:
(1) For purposes of determining any liability under the Securities
Act, the information omitted from the form of prospectus filed as part of
this registration statement in reliance upon Rule 430A and contained in a
form of prospectus filed by the Registrant pursuant to Rule 424(b)(1) or
(4) or 497(h) under the Securities Act shall be deemed to be part of this
registration statement as of the time it was declared effective.
(2) For the purpose of determining any liability under the Securities
Act, each post-effective amendment that contains a form of prospectus shall
be deemed to be a new registration statement relating to the securities
offered therein, and the offering of such securities at that time shall be
deemed to be the initial bona fide offering thereof.
II-4
<PAGE> 76
SIGNATURES
Pursuant to the requirements of the Securities Act of 1933, the Registrant
has duly caused this Pre-Effective Amendment No. 3 to the registration statement
to be signed on its behalf by the undersigned, thereunto duly authorized, in the
City of Redmond, State of Washington, on May 21, 1996.
GARDEN BOTANIKA, INC.
By: /s/ MICHAEL W. LUCE
------------------------------------
Michael W. Luce
President and Chief Executive
Officer
Pursuant to the requirements of the Securities Act of 1933, this
Pre-Effective Amendment No. 3 to the registration statement has been signed by
the following persons in the capacities indicated below on the 21st day of May,
1996.
<TABLE>
<CAPTION>
SIGNATURE TITLE
- --------------------------------------------- ----------------------------------------------
<S> <C>
* JEFFREY H. BROTMAN Chairman of the Board
- ---------------------------------------------
Jeffrey H. Brotman
/s/ MICHAEL W. LUCE President, Chief Executive Officer and
- --------------------------------------------- Director
Michael W. Luce (Principal Executive Officer)
/s/ MYRON E. KIRKPATRICK Vice President -- Finance and Chief Financial
- --------------------------------------------- Officer
Myron E. Kirkpatrick (Principal Financial Officer)
* DAMON H. BALL Director
- ---------------------------------------------
Damon H. Ball
* DAVID A. EDERER Director
- ---------------------------------------------
David A. Ederer
* GERALD R. GALLAGHER Director
- ---------------------------------------------
Gerald R. Gallagher
* WILLIAM B. RANDALL Director
- ---------------------------------------------
William B. Randall
* DALE J. VOGEL Director
- ---------------------------------------------
Dale J. Vogel
*By /s/ MYRON E. KIRKPATRICK
- ---------------------------------------------
As Attorney-In-Fact
</TABLE>
II-5
<PAGE> 77
CONSENT OF INDEPENDENT AUDITORS
As independent public accountants, we hereby consent to the use of our reports
(and to all references to our Firm) included in or made a part of this
registration statement.
ARTHUR ANDERSEN LLP
Seattle, Washington
May 20, 1996
II-6
