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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
FORM 10-Q
(X) QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended December 31, 1998
or
( ) TRANSITION REPORT PURSUANT TO SECTION 12 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
Commission File Number 1-13606
SOLA INTERNATIONAL INC.
(Exact name of registrant as specified in its charter)
DELAWARE 94-3189941
(State or other jurisdiction of (I.R.S. employer
incorporation or organization) identification no.)
2420 SAND HILL ROAD, SUITE 200, MENLO PARK, CA 94025
(Address of principal executive offices)
(zip code)
(650) 324-6868
(Registrant's telephone number, including area code)
Indicate by check mark whether the Registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
Registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes _X_ No ___
As of February 8, 1999, 24,864,010 shares of the registrant's common
stock, par value $0.01 per share, which is the only class of common stock of the
registrant, were outstanding.
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<PAGE>
SOLA INTERNATIONAL INC.
<TABLE>
Table of Contents
Form 10-Q for the Quarterly Period
Ended December 31, 1998
<CAPTION>
PART I FINANCIAL INFORMATION PAGE
- ------ --------------------- ----
<S> <C> <C>
Item 1. Financial Statements
Consolidated Condensed Balance Sheet as of December 31, 1998 3
Consolidated Condensed Balance Sheet as of March 31, 1998
(derived from audited financial statements) 3
Consolidated Condensed Statements of Income for the three and nine month
periods ended December 31, 1998 and December 31, 1997 4
Consolidated Condensed Statements of Cash Flows for the nine month
periods ended December 31, 1998 and December 31, 1997 5
Notes to Consolidated Condensed Financial Statements 6
Item 2. Management's Discussion and Analysis of Financial Condition and Results of
Operations 10
PART II OTHER INFORMATION
Item 1. Legal Proceedings 17
Item 2. Changes in Securities and Use of Proceeds 17
Item 3. Defaults upon Senior Securities 17
Item 4. Submission of Matters to a Vote of Security Holders 17
Item 5. Other Information 17
Item 6. Exhibits and Reports on Form 8-K 17
</TABLE>
2
<PAGE>
PART I FINANCIAL INFORMATION
Item 1. Financial Statements
<TABLE>
SOLA INTERNATIONAL INC.
Consolidated Condensed Balance Sheets
(in thousands, except per share data)
<CAPTION>
December March 31, 1998
31, 1998 (derived from
(unaudited) audited financial
ASSETS ----------- statements)
-----------
<S> <C> <C>
Current assets:
Cash and cash equivalents ............................ $ 28,466 $ 34,444
Trade accounts receivable, less allowance for doubtful
accounts of $6,284 and $4,956 at December 31, 1998
and March 31, 1998, respectively ................. 121,043 120,590
Inventories .......................................... 197,013 169,756
Other current assets ................................. 15,191 16,798
--------- ---------
Total current assets .............................. 361,713 341,588
Property, plant and equipment, at cost, less accumulated
depreciation and amortization ........................ 149,805 132,778
Goodwill and other intangibles, net ..................... 196,910 198,341
Other long-term assets .................................. 17,181 11,351
--------- ---------
Total assets ...................................... $ 725,609 $ 684,058
========= =========
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Notes payable to banks and current portion of
long-term debt .................................... $ 20,981 $ 12,600
Accounts payable ..................................... 41,960 60,254
Accrued liabilities .................................. 31,747 35,462
Accrued payroll and related compensation ............. 25,183 30,758
Other current liabilities ............................ 7,387 2,536
--------- ---------
Total current liabilities ......................... 127,258 141,610
Long-term debt, less current portion .................... 5,886 1,790
Bank debt, less current portion ......................... 121,550 95,000
Senior notes ............................................ 99,623 99,596
Other long-term liabilities ............................. 20,125 19,040
--------- ---------
Total liabilities ................................. 374,442 357,036
--------- ---------
Commitments and Contingencies
Shareholders' equity:
Preferred stock, $0.01 par value; 5,000 shares
authorized; no shares issued ...................... -- --
Common stock, $0.01 par value; 50,000 shares
authorized; 24,864 shares (24,723 shares as of
March 31, 1998) issued and outstanding ............ 249 247
Additional paid-in capital ........................... 280,198 278,688
Equity participation loans ........................... (100) (230)
Retained earnings .................................... 83,332 58,057
Cumulative other comprehensive income ................ (12,512) (9,740)
--------- ---------
Total shareholders' equity ........................ 351,167 327,022
--------- ---------
Total liabilities and shareholders' equity ........ $ 725,609 $ 684,058
========= =========
<FN>
The accompanying notes are an integral part of these condensed financial statements
</FN>
</TABLE>
3
<PAGE>
<TABLE>
SOLA INTERNATIONAL INC.
Unaudited Consolidated Condensed Statements of Income
(in thousands, except per share data)
<CAPTION>
Three Months Ended Nine Months Ended
December 31, December 31, December 31, December 31,
------------ ------------ ------------ ------------
1998 1997 1998 1997
---- ---- ---- ----
<S> <C> <C> <C> <C>
Net sales .................................................. $ 126,345 $ 129,272 $ 388,539 $ 402,624
Cost of sales .............................................. 69,068 66,905 211,100 211,591
--------- --------- --------- ---------
Gross profit ............................................ 57,277 62,367 177,439 191,033
--------- --------- --------- ---------
Research and development expenses .......................... 4,649 4,390 14,043 13,744
Selling and marketing expenses ............................. 24,056 22,999 72,158 72,529
General and administrative expenses ........................ 17,514 13,995 42,025 40,637
--------- --------- --------- ---------
Operating expenses ...................................... 46,219 41,384 128,226 126,910
--------- --------- --------- ---------
Operating income ........................................ 11,058 20,983 49,213 64,123
Interest expense, net ...................................... (4,543) (4,288) (12,881) (13,387)
--------- --------- --------- ---------
Income before provision for income
taxes, minority interest and
extraordinary item ................................... 6,515 16,695 36,332 50,736
Provision for income taxes ................................. (1,491) (5,572) (11,626) (16,946)
Minority interest .......................................... 152 112 570 312
--------- --------- --------- ---------
Income before extraordinary item ........................ 5,176 11,235 25,276 34,102
Extraordinary item, loss due to repurchase
of senior subordinated notes, net of tax ................ -- (5,923) -- (5,923)
--------- --------- --------- ---------
Net income .............................................. $ 5,176 $ 5,312 $ 25,276 $ 28,179
========= ========= ========= =========
Earnings (loss) per share - basic:
Income before extraordinary item ........................ $ 0.21 $ 0.46 $ 1.02 $ 1.40
Extraordinary item ...................................... -- (0.24) -- (0.24)
--------- --------- --------- ---------
Net income .............................................. $ 0.21 $ 0.22 $ 1.02 $ 1.16
========= ========= ========= =========
Weighted average common shares
outstanding ............................................. 24,792 24,409 24,770 24,333
Earnings (loss) per share - diluted:
Income before extraordinary item ........................ $ 0.21 $ 0.44 $ 0.99 $ 1.34
Extraordinary item ...................................... -- (0.23) -- (0.23)
--------- --------- --------- ---------
Net income .............................................. $ 0.21 $ 0.21 $ 0.99 $ 1.11
========= ========= ========= =========
Weighted average common and dilutive
securities outstanding .................................. 25,199 25,554 25,530 25,504
<FN>
The accompanying notes are an integral part of these condensed financial statements
</FN>
</TABLE>
4
<PAGE>
SOLA INTERNATIONAL INC.
Unaudited Consolidated Condensed Statements of Cash Flows
(in thousands)
Nine Months Ended
December 31,
1998 1997
---- ----
Net cash used in operating activities ................ $ (11,009) $ (9,057)
--------- ---------
Cash flows from investing activities:
Purchases of businesses ........................... (8,601) (2,511)
Capital expenditures .............................. (22,028) (22,935)
Proceeds from sale of fixed assets ................ 148 402
--------- ---------
Net cash used in investing activities ................ (30,481) (25,044)
--------- ---------
Cash flows from financing activities:
Payments on equity participation loans/exercise of
stock options .................................. 729 2,244
Net receipts/payments under notes payable to banks,
and long term debt ............................. 10,616 2,699
Borrowings on long term debt ...................... 2,316 5,093
Payments on long term debt ........................ (1,688) (4,447)
Proceeds from bank debt ........................... 22,977 117,374
Repurchase of senior subordinated notes ........... -- (93,152)
--------- ---------
Net cash provided by financing activities ............ 34,950 29,811
Effect of exchange rate changes on cash and cash
equivalents ....................................... 562 (1,150)
--------- ---------
Net decrease in cash and cash equivalents ............ (5,978) (5,440)
Cash and cash equivalents at beginning of period ..... 34,444 24,401
--------- ---------
Cash and cash equivalents at end of period ........... $ 28,466 $ 18,961
========= =========
The accompanying notes are an integral part of
these condensed financial statements
5
<PAGE>
SOLA INTERNATIONAL INC.
Notes to Consolidated Condensed Financial Statements
(unaudited)
1. Basis of Presentation
The accompanying consolidated condensed financial statements of the Company
have been prepared without audit, pursuant to the rules and regulations of the
Securities and Exchange Commission. Certain information and footnote disclosures
normally included in financial statements prepared in accordance with generally
accepted accounting principles have been condensed or omitted pursuant to such
rules and regulations. The consolidated condensed balance sheet as of March 31,
1998 was derived from audited financial statements. The accompanying
consolidated condensed financial statements should be read in conjunction with
the audited consolidated financial statements and notes thereto included in the
Company's annual report on Form 10-K for the fiscal year ended March 31, 1998.
As of April 1998, the Company adopted Statement 130, Reporting
Comprehensive Income. Statement 130 establishes new rules for the reporting and
display of comprehensive income and its components; however, the adoption of
this Statement had no impact on the Company's net income or shareholders'
equity. Statement 130 requires unrealized gains or losses on the Company's net
foreign currency translation adjustments, which prior to adoption were reported
separately in shareholders' equity, to be included in other comprehensive
income.
During the three months ended December 31, 1998 and 1997, total
comprehensive income amounted to $6,254 and $661, respectively. During the nine
months ended December 31, 1998 and 1997 total comprehensive income amounted to
$22,504 and $17,252, respectively.
<TABLE>
The components of comprehensive income, net of related tax are as follows
(in thousands):
<CAPTION>
Three Months Nine Months
Ended December 31, Ended December 31,
1998 1997 1998 1997
---- ---- ---- ----
<S> <C> <C> <C> <C>
Net income $ 5,176 $ 5,312 $ 25,276 $ 28,179
Foreign currency translation adjustments 1,078 (4,651) (2,772) (10,927)
-------- -------- -------- --------
Comprehensive income $ 6,254 $ 661 $ 22,504 $ 17,252
======== ======== ======== ========
</TABLE>
Cumulative other comprehensive income, net of related tax at December 31,
1998 and March 31, 1998 consists solely of foreign currency translation
adjustments.
In June 1997, the FASB released Statement of Financial Accounting Standards
No. 131, Disclosures about Segments of an Enterprise and Related Information
("FAS 131"). FAS 131 will change the way companies report selected segment
information in annual financial statements and also requires those companies to
report selected segment information in interim financial reports to
shareholders. FAS 131 is effective for fiscal years beginning after December 15,
1997. Segment information is not required to be reported in interim financial
statements in the first year of application. The Company is currently evaluating
the impact of the application of the new rules on the Company's consolidated
financial statements.
In June 1998, the Financial Accounting Standards Board issued Statement No.
133, Accounting for Derivative Instruments and Hedging Activities, which is
required to be adopted in years beginning after June 15, 1999. The Company is
currently evaluating the impact of the application of the new rules on the
Company's consolidated financial statements.
6
<PAGE>
The financial information included herein reflects all adjustments
(consisting of normal recurring adjustments) which are, in the opinion of
management, necessary for a fair presentation of the results for the interim
period. The results of operations for the three and nine months ended December
31, 1998 are not necessarily indicative of the results to be expected for the
full year.
2. Inventories
December 31, 1998 March 31, 1998
(in thousands) (in thousands)
-------------- --------------
Raw Materials $ 17,422 $ 16,714
Work In Progress 7,023 6,872
Finished Goods 126,806 104,966
Molds 45,762 41,204
-------- --------
$197,013 $169,756
======== ========
Molds comprise mainly finished goods for use by manufacturing affiliates in
the manufacture of spectacle lenses.
3. Contingencies
The Company is subject to environmental laws and regulations concerning
emissions to the air, discharges to surface and subsurface waters and the
generation, handling, storage, transportation, treatment and disposal of waste
materials.
The Company is currently participating in a remediation program of one of
its manufacturing facilities under the Comprehensive Environmental Response,
Compensation and Liability Act ("CERCLA") and the Superfund Amendments and
Reauthorization Act of 1986. In March 1997 the U.S. Environmental Protection
Agency ("EPA") consented to the Company curtailing clean-up activities for a six
month period which ended in September 1997. The Company continued to monitor
contamination levels during the curtailment period. During the quarter ended
December 31, 1997 a report on contamination levels, and the impact of curtailed
activities, was submitted to the EPA, and such report is currently under review.
The report indicates no significant impact on the site from the curtailed
activities, and the EPA has consented to continued curtailment of activities
until such time as they have concluded their review of the report. The Company
expects continued reduction of clean-up activities due to relatively low levels
of contamination existing at the site.
The Company is also involved in other investigations of environmental
contamination at several U.S. sites. Some clean-up activities have been
conducted and investigations are continuing to determine future remedial
requirements, if any.
Under the terms of the sale agreement with Pilkington plc ("Pilkington"),
for the purchase of the Sola business in December 1993 ("Acquisition"),
Pilkington has indemnified the Company with regard to expenditures subsequent to
the Acquisition for certain environmental matters relating to circumstances
existing at the time of the Acquisition. Under the terms of the indemnification,
the Company is responsible for the first $1 million spent on such environmental
matters, Pilkington and the Company share equally the cost of any further
expenditures between $1 million and $5 million, and Pilkington retains full
liability for any expenditures in excess of $5 million.
The Company has evaluated its total environmental exposure based on
currently available data and believes that its liability for environmental
remediation costs is immaterial.
In the ordinary course of business, various legal actions and claims
pending have been filed against the Company. While it is reasonably possible
that such contingencies may result in a cost greater than that provided for in
the financial statements, it is the opinion of management
7
<PAGE>
that the ultimate liability, if any, with respect to these matters, will not
materially affect the consolidated operations or financial position of the
Company.
4. Provision for Income Taxes
During the third quarter of fiscal 1999 the Company reduced the combined
state, federal and foreign projected effective annual income tax rate for fiscal
1999 from 34% to 32%, increasing net income by approximately $0.6 million. This
change in estimate resulted in an increase in basic and diluted earnings per
share for the third fiscal quarter and nine months ended December 31, 1998 of
$0.02. The Company's reduction in anticipated tax rate is primarily due to
reduced state income tax rates, mainly as a result of favorable California
Manufacturers' Investment Credits and a reduction in overall tax rates due to a
change in profitability in certain countries, primarily the United States.
5. Earnings Per Share
<TABLE>
The following table sets forth the computation of basic and diluted
earnings per share for the three and nine months ended December 31, 1998 and
1997, respectively (in thousands except per share data):
<CAPTION>
Three Months Ended Nine Months Ended
December 31, December 31,
1998 1997 1998 1997
---- ---- ---- ----
<S> <C> <C> <C> <C>
Numerator:
Income before extraordinary item .............. $ 5,176 $11,235 $25,276 $34,102
Extraordinary item, loss due to repurchase of
senior subordinated notes, net of tax ....... -- (5,923) -- (5,923)
------- ------- ------- -------
Net income ................................. $ 5,176 $ 5,312 $25,276 $28,179
======= ======= ======= =======
Denominator:
Denominator for basic earnings per share -
Weighted average common shares
outstanding .............................. 24,792 24,409 24,770 24,333
Effect of dilutive securities:
Employee stock options ................... 407 1,145 760 1,171
Denominator for diluted earnings per share -
Weighted average common and dilutive
securities outstanding ................... 25,199 25,554 25,530 25,504
======= ======= ======= =======
Basic earnings (loss) per share:
Income before extraordinary item .............. $ 0.21 $ 0.46 $ 1.02 $ 1.40
Extraordinary item ............................ -- (0.24) -- (0.24)
------- ------- ------- -------
Net income ................................. $ 0.21 $ 0.22 $ 1.02 $ 1.16
======= ======= ======= =======
Diluted earnings (loss) per share:
Income before extraordinary item .............. $ 0.21 $ 0.44 $ 0.99 $ 1.34
Extraordinary item ............................ -- (0.23) -- (0.23)
------- ------- ------- -------
Net income ................................. $ 0.21 $ 0.21 $ 0.99 $ 1.11
======= ======= ======= =======
</TABLE>
6. Shareholder Rights Plan
On August 26, 1998 the Company's Board of Directors adopted a Shareholder
Rights Plan and declared a dividend distribution to be made to shareholders of
record on September 9, 1998 of one Right for each share of the Company's
outstanding common stock. The rights contain provisions which are intended to
protect the Company's stockholders in the event of an
8
<PAGE>
unsolicited and unfair attempt to acquire the Company. The Company is entitled
to redeem the Rights at $.01 per Right at any time before a buyer acquires a 15
percent position in the Company. The Rights will expire on August 27, 2008,
unless previously redeemed or exercised.
7. Extraordinary Item
During the three months ended December 31, 1997 the Company repurchased all
of its 9 5/8% Senior Subordinated Notes due 2003. As a result of the repurchases
the Company recorded an extraordinary charge of $5.9 million for the three
months ended December 31, 1997 resulting from the write-off of unamortized debt
issuance costs and premium over accreted value, net of tax. The repurchase was
funded by borrowings under the Bank Credit Agreement.
8. Subsequent Event
During January 1999 the Brazilian Real devalued against the U.S. Dollar. As
of December 31, 1998 the Company's Brazilian subsidiary, which has the U.S.
dollar as its functional currency, had net monetary assets in Brazilian Reals
amounting to approximately $9.5 million. By January 31, 1999 the Real had
deteriorated to 1.98 against the U.S. dollar, compared to an exchange rate of
1.21 against the U.S. dollar as of December 31, 1998.
9
<PAGE>
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations
Overview
The following discussion of the Company's financial condition and results
of operations should be read in conjunction with the Company's consolidated
condensed financial statements and notes thereto included elsewhere herein.
Results of Operations
Three months ended December 31, 1998 compared to three months ended December 31,
1997
Net Sales
Net sales totaled $126.3 million in the three months ended December 31,
1998, reflecting a decrease of 2.3% from net sales of $129.3 million for the
same period in the prior year. Using constant exchange rates, the percentage
decrease was 3.4%, and using constant exchange rates but excluding Brazilian
frame and equipment business sales (see below), the percentage decrease was
2.2%. The decline in net sales is primarily attributable to the North American
and Rest of World regions. The sales decline in the North American region
(primarily the United States) resulted from lower sales of Spectralite
photocromic products, caused by the release of a new generation Transitions
product in plastic together with lower progressive and polycarbonate lens sales.
Also contributing to the net sales shortfall was softness of the Asian and
Australian economies, although Asia only accounts for approximately 5% of net
sales. Underperformance in the Company's Australian operations was partially
caused by weakness of the Australian dollar against the U.S. dollar. In
addition, during April 1998 the Company sold its Brazilian frame and equipment
business, which had contributed approximately $1.6 million of net sales in the
three months ended December 31, 1997.
The foregoing decreases were offset, in part, by growth in CR39 photocromic
lens sales, high index lenses, new progressive lens designs and in net sales of
the Company's new Matrix lens product. Higher priced products accounted for
approximately 66% of net lens sales in the three months ended December 31, 1998
compared to approximately 65% for the three months ended December 31, 1997.
Progressive lens net sales for the three months ended December 31, 1998 were
down by 4.0% from the same period in the prior year. Net sales performances by
region were as follows: North America declined by 3.5%, Europe increased by 4.0%
and Rest of World declined by 9.2%. Using constant exchange rates the regional
performances were as follows: North America declined by 3.5%, Europe declined by
0.7% and Rest of World declined by 7.3%.
Gross Profit and Gross Margin
Gross profit totaled $57.3 million for the three months ended December 31,
1998, reflecting a decrease of 8.2% from gross profit of $62.4 million for the
same period in the prior year. Gross profit as a percentage of net sales ("gross
margin") decreased from 48.2% for the three months ended December 31, 1997 to
45.3% for the three months ended December 31, 1998. The margin decrease was
principally due to product mix changes and underabsorption of overhead due to a
slow-down in production levels to reduce inventory balances.
Operating Expenses
Operating expenses in the three months ended December 31, 1998 totaled
$46.2 million, an increase of $4.8 million over operating expenses of $41.4
million for the same period in the prior year. Research and development expenses
for the three months ended December 31, 1998 and 1997 were $4.6 million and $4.4
million, respectively, which represent 3.7% and 3.4% of net sales, respectively.
Selling and marketing expenses for the three months ended December 31, 1998
increased $1.1 million to $24.1 million, due primarily to increased distribution
expenses,
10
<PAGE>
which compares to $23.0 million for the three months ended December 31, 1997
which represent 19.0% and 17.8%, of net sales, respectively. General and
administrative expenses were $17.5 million, or 13.9% of net sales, for the three
months ended December 31, 1998, compared to $14.0 million, or 10.8% of net sales
for the three months ended December 31, 1997. The growth in general and
adtministrative expenses is primarily as a result of a charge of $1.6 million
representing employee termination costs incurred in the United States, primarily
in Petaluma, California, and Miami, Florida during the quarter, the impact of
higher information technology related spending and reduced discounts taken on
early payment of accounts payable.
Operating Income
Operating income, for the three months ended December 31, 1998 totaled
$11.1 million, a decrease of $9.9 million, or 47.3%, from the three months ended
December 31, 1997 of $21.0 million.
Net Interest Expense
Net interest expense totaled $4.5 million for the three months ended
December 31, 1998 compared to $4.3 million for the three months ended December
31, 1997, an increase of $0.2 million. During the third quarter of fiscal 1998
the Company repurchased its 9 5/8% Senior Subordinated Notes, and during the
fourth quarter of fiscal 1998 the Company issued 6 7/8% Senior Notes. The net
effect of these two transactions has been to reduce current period interest
rates. This reduction in interest rates and therefore interest expense was
offset by an increase in interest expense due to increased borrowing levels in
the current year.
Provision for Income Taxes
The Company's combined state, federal and foreign tax rate represents an
effective tax rate projected for the full fiscal 1999 year of 32%, which is a
reduction in the projected annual rate by 2%. This results in an effective tax
rate for the three months ended December 31, 1998 of 22.9%. The Company's
reduction in the projected rate is primarily due to reduced state income tax
rates, mainly as a result of favorable California Manufacturers' Investment
Credits, and a reduction in overall tax rates due to a change in profitability
in certain countries, primarily the United States. For the three months ended
December 31, 1997 the Company recorded an effective income tax rate of 33.4%.
The Company has deferred tax assets on its balance sheet as of December 31, 1998
amounting to approximately $15.1 million. The ultimate utilization of these
deferred tax assets is dependent on the Company's ability to generate taxable
income in the future.
Nine months ended December 31, 1998 compared to nine months ended December 31,
1997
Net Sales
Net sales totaled $388.5 million in the nine months ended December 31,
1998, reflecting a decrease of 3.5% from net sales of $402.6 million for the
same period in the prior year. Using constant exchange rates, the percentage
decrease was 2.0%, and using constant exchange rates but excluding Brazilian
frame and equipment business sales (see below), the percentage decrease was
1.0%. The decline in net sales is primarily attributable to the North American
region. The sales decline in the North American region (primarily the United
States) resulted from softness in the United States retail optical market
following strong sales in the prior year resulting from the launch of Percepta
and Durathins progressive lens products, product returns of older plastic and
Spectralite photocromic products due to the introduction of a new generation
Transitions product, and reduced net sales to laboratory customers that were
acquired in fiscal 1998 by Essilor Laboratories of America. Also contributing to
the net sales shortfall is a continuing softness of the Asian economies,
although Asia only accounts for approximately 5% of net sales, and
underperformance in the Company's Australian operations partially caused by
softness of the Australian dollar against the U.S. dollar. In addition, during
April 1998 the
11
<PAGE>
Company sold its Brazilian frame and equipment business, which had contributed
approximately $4.2 million of net sales in the nine months ended December 31,
1997.
The foregoing decreases were offset, in part, by growth in plastic
photocromic lens sales and growth in net sales of the Company's new Matrix lens
product. Higher priced products accounted for approximately 67% of net lens
sales in the nine months ended December 31, 1998 compared to approximately 65%
for the nine months ended December 31, 1997. However, progressive lens net sales
for the nine months ended December 31, 1998 declined 4.2% from the same period
in the prior year. Net sales performances by region were as follows: North
America declined by 5.9%, Europe increased by 7.4% and Rest of World declined by
13.5%. Using constant exchange rates the regional performances were as follows:
North America declined by 5.9%, Europe increased by 7.1% and Rest of World
decreased by 6.2%.
Gross Profit and Gross Margin
Gross profit totaled $177.4 million for the nine months ended December 31,
1998, reflecting a decrease of 7.1% from gross profit of $191.0 million for the
same period in the prior year. Gross profit as a percentage of net sales ("gross
margin") decreased to 45.7% for the nine months ended December 31, 1998 from
47.5% for the nine months ended December 31, 1997. The margin decrease was
principally due to lower progressive product sales, product mix changes and
underabsorption of overhead due to slow down in production levels during the
second and third quarters to align production with sales demand expectations.
Operating Expenses
Operating expenses in the nine months ended December 31, 1998 totaled
$128.2 million, an increase of $1.3 million, compared to operating expenses of
$126.9 million for the same period in the prior year. Operating expenses for the
nine months ended December 31, 1998 and 1997 as a percentage of net sales were
33.0% and 31.5%, respectively. Research and development expenses for the nine
months ended December 31, 1998 totaled $14.0 million, compared to $13.7 million
for the nine months ended December 31, 1997, which represent 3.6% and 3.4% of
net sales, respectively. Selling and marketing expenses for the nine months
ended December 31, 1998 decreased $0.4 million to $72.2 million, compared to
$72.6 million for the nine months ended December 31, 1997 which represent 18.6%
and 18.0%, of net sales, respectively. As a percentage of net sales, general and
administrative expenses increased to 10.8% for the nine months ended December
31, 1998 compared to 10.1% for the nine months ended December 31, 1997. The
change in general and administrative expenses relates to $1.6 million
representing employee termination costs incurred in the United States in the
third quarter, increased information technology related expenses and impact of
currency rates in the second quarter, offset by improvements due to lower
accruals for performance based management bonuses and favorable changes in
estimates related to certain reserves and accruals in the first quarter of
fiscal 1999.
Operating Income
Operating income for the nine months ended December 31, 1998 was $49.2
million, a decrease of $14.9 million, or 23.3%, from the nine months ended
December 31, 1997 operating income of $64.1 million.
Net Interest Expense
Net interest expense totaled $12.9 million for the nine months ended
December 31, 1998 compared to $13.4 million for the nine months ended December
31, 1997, a decrease of $0.5 million. During the third quarter of fiscal 1998
the Company repurchased its 9 5/8% Senior Subordinated Notes, and during the
fourth quarter of fiscal 1998 the Company issued 6 7/8% Senior Notes. The net
effect of these two transactions has been to reduce current interest rates and
expense, offset in part by an increase in interest expense due to increased
borrowing levels.
12
<PAGE>
Liquidity and Capital Resources
Net cash used in operating activities for the nine months ended December
31, 1998 amounted to $11.0 million, compared to net cash used in operating
activities of $9.1 million for the nine months ended December 31, 1997. The
primary cause of the increase in cash usage was the reduced operating income
offset in part by a reduced investment in working capital in the current year
period.
During the nine months ended December 31, 1998, using a three month net
sales annualized convention, inventories as a percentage of net sales were 39.0%
compared to 32.5% for the nine months ended December 31, 1997. Accounts
receivable as a percentage of net sales for the nine months ended December 31,
1998 was 24.0% compared to 21.8% for the same period a year ago. Lower than
anticipated net sales is the primary contributor to the increase in these
ratios.
Cash flows from investing activities in the nine months ended December 31,
1998 amounted to an outflow of $30.5 million. Of this amount $22.0 million
represented capital expenditures and $8.6 million represented investment in
acquisitions. The $8.6 million spent on acquisitions represents the acquisition
of the assets of an anti-reflection coating laboratory in Oregon, USA, acquired
by the Company in June 1998. Capital expenditures for the nine months ended
December 31, 1997 amounted to $22.9 million and acquisitions amounted to $2.5
million in the comparable quarter in the prior year. Management anticipates
capital expenditures of approximately $30 million annually over the next several
years, of which approximately $5 million annually is viewed as discretionary.
Net cash provided by financing activities in the nine months ended December
31, 1998 amounted to $35.0 million. The most significant source was the increase
in bank borrowings and borrowings of long term debt to fund the growth in
working capital and to fund the lab acquisition. Net cash provided by financing
activities in the nine months ended December 31, 1997 amounted to $29.8 million.
In the third quarter of fiscal 1998 the Company repurchased all of its remaining
9 5/8% Senior Subordinated Notes due 2003. The notes repurchase was funded by
borrowings under the Credit Agreement (as defined below).
In conjunction with the repurchase of its Senior Subordinated Notes the
Company amended its bank credit agreement with The Bank of America National
Trust and Savings Association, for itself and as agent for a syndicate of other
financial institutions ("Credit Agreement"). Borrowings are divided into two
tranches. Tranche A permits borrowings up to $30 million in either U.S. dollars
or foreign currencies, to be used for working capital and consummating certain
permitted acquisitions. Tranche B permits borrowings of up to $270 million and
can be used for working capital purposes and consummating certain permitted
acquisitions. The Tranche A Facility matures on October 31, 2000 and the Tranche
B Facility matures on May 31, 2001.
Borrowings under the Tranche A and Tranche B revolvers (other than swing
line loans, which may only be Base Rate loans) may be made as Base Rate Loans or
LIBO Rate Loans. Base Rate Loans bear interest at rates per annum equal to the
higher of (a) 0.50% per annum above the latest Federal Funds Rate, or (b) the
Bank of America Reference Rate. LIBO Rate Loans bear interest at a rate per
annum equal to the sum of the LIBO Rate and a margin varying from 0.450% to
0.750% based on the Company's leverage ratio. Fixed rate borrowings in foreign
currencies bear interest at rates per annum equal to the referenced currency's
local IBOR plus a margin varying from 0.450% to 0.750% based on the Company's
leverage ratio. Local currency Base Rate Loans are also available at a spread
similar to US Base Rate Loans described above.
During the fourth quarter of fiscal 1998 the Company issued 6 7/8% Senior
Notes ("Notes") due 2008, for which the Company received approximately $98.5
million net proceeds, after discounts and issuance expenses. Net proceeds were
used to pay down borrowings under the Credit Agreement. The Notes are unsecured
senior obligations of the Company, limited to $100 million aggregate principal
amount at maturity, and will mature on March 15, 2008. The Notes
13
<PAGE>
are redeemable, as a whole or from time to time in part, at the option of the
Company on any date at a redemption price equal to the aggregate principal
amount plus a make whole premium.
The Company's foreign subsidiaries maintain local credit facilities to
provide credit for overdraft, working capital and some fixed asset investment
purposes. As of December 31, 1998 the Company's total credit available under
such facilities was approximately $29.9 million, of which $19.0 million had been
utilized.
The Company continues to have significant liquidity requirements. In
addition to working capital needs and capital expenditures, the Company has
substantial cash requirements for debt service. The Company expects that the
Credit Agreement and other overseas credit facilities, together with cash on
hand and internally generated funds, if available as anticipated, will provide
sufficient capital resources to finance the Company's operations, fund
anticipated capital expenditures, and meet interest requirements on its debt,
including the Notes, for the foreseeable future. As the Company's debt matures,
the Company may need to refinance such debt. There can be no assurance that such
debt can be refinanced on terms acceptable to the Company.
Restructuring and Other Charges - Fourth Quarter Results
The Company recently announced that it has identified certain initiatives
to improve future Company performance. These initiatives include consolidating
certain manufacturing and distribution facilities and further reducing staffing
levels. As a result of these planned initiatives, the Company expects to record
pre-tax charges to earnings of approximately $13 million, all or a majority of
which is expected to be recorded in the quarter ending March 31, 1999.
Additionally, the recent devaluation of the Brazilian Real and the related
impact on asset realization, primarily for the recently sold frame and equipment
business, is likely to result in a significant pre-tax charge being recorded in
the quarter ending March 31, 1999. Should current exchange rates prevail through
March 31, 1999, the Company expects to record an additional pre-tax charge of
approximately $12 million in respect of these items.
Currency Exchange Rates
As a result of the Company's worldwide operations, currency exchange rate
fluctuations tend to affect the Company's results of operations and financial
position. The principal effects of currency exchange rates on the Company's
results of operations and financial position are (i) translation adjustments for
subsidiaries where the local currency is the functional currency (ii)
translation adjustments for subsidiaries where the U.S. dollar is the functional
currency and (iii) translation adjustments for subsidiaries in
hyper-inflationary countries. Translation adjustments for functional local
currencies have been made to shareholders' equity, whereas translation
adjustments for subsidiaries where the U.S. dollar is the functional currency
and subsidiaries in hyper-inflationary countries have been made to earnings. For
the nine months ended December 31, 1998 and 1997 translation adjustments to
equity were approximately $(2.8) million and $(10.9) million, respectively.
During January 1999 the Brazilian Real devalued against the U.S. dollar. As
of December 31, 1998 the Company's Brazilian subsidiary, which has the U.S.
dollar as its functional currency, had net monetary assets in Brazilian Reals
amounting to approximately $9.5 million. By January 31, 1999 the Real had
deteriorated to 1.98 against the U.S. dollar, compared to 1.21 against the U.S.
dollar as of December 31, 1998. See "Restructuring and Other Charges - Fourth
Quarter Results".
Seasonality
The Company's business is somewhat seasonal, with third quarter results
generally weaker than the other three quarters as a result of lower sales during
the holiday season, and fourth quarter results generally the strongest.
14
<PAGE>
Inflation
Inflation continues to affect the cost of the goods and services used by
the Company. The competitive environment in many markets limits the Company's
ability to recover higher costs through increased selling prices, and the
Company is subject to price erosion in many of its standard product lines. The
Company seeks to mitigate the adverse effects of inflation through cost
containment and productivity and manufacturing process improvements. For a
description of the effects of inflation on the Company's reported revenues and
profits and the measures taken by the Company in response to inflationary
conditions, see "Currency Exchange Rates".
Year 2000
The Year 2000 issue is the result of computer programs being written using
two digits rather than four to define the applicable year. Any of the Company's
computer programs or hardware that have date-sensitive software or embedded
chips may recognize a date using "00" as the year 1900 rather than the year
2000. This could result in a system failure or miscalculations causing
disruptions of operations, including, among other things, a temporary inability
to process transactions, send invoices, or engage in similar normal business
activities.
The Company has completed its Year 2000 assessment of critical business
systems. Based on these assessments, the Company determined that it will be
required to modify or replace certain portions of its software so that those
systems will properly utilize dates beyond December 31, 1999. The Company
presently believes that with modifications or replacements of existing software,
the Year 2000 issue can be mitigated. Year 2000 expenditures to-date have not
been material, and the overall cost to the Company of making its Information
Technology ("IT") systems Year 2000 compliant is also estimated to not be
material to the Company's results of operations (less than $2 million over a
three fiscal year period).
The Company has also performed extensive testing of operating equipment
("embedded chips") to ensure that they are Year 2000 compliant. To date no
material exposures have been detected.
For those IT systems that are requiring upgrade to make them Year 2000
compliant, the Company believes it has commenced upgrade programs in a timely
manner so that the systems will be available for extensive testing prior to
implementation. The Company does not have detailed contingency plans, if
upgrades do not function properly when implemented, but given the Company's
status on upgrade programs it believes it has allowed sufficient time to correct
material malfunctions.
The cost of the Company's Year 2000 program and its beliefs regarding its
compliance program are based on the Company's best estimates, which were derived
utilizing a number of assumptions about future events, such as the availability
and cost of personnel trained in this area, the ability to locate and correct
all relevant computer codes, the performance of key software and hardware
vendors and other similar uncertainties. However, we are not sure that our
estimates will be achieved and actual results could differ materially from those
anticipated.
As part of its overall assessment package, the Company is also in the
process of assessing the possible effects on the Company's operations of the
Year 2000 readiness of key suppliers and customers. The Company has developed a
worksheet for all sites to utilize as an aid in collecting information about
Year 2000 compliance including that of business partners. Initial emphasis has
been on partners with Electronic Data Interfaces ("EDI"), with the second stage
being communication with key suppliers and customers on their readiness. The
Company's largest customer accounts for approximately 5% of net sales and the
ten largest customers account for approximately 22% of net sales.
Due to the Company's decentralized operations, and lack of reliance on one
company-wide IT system, the Company believes that the risk of isolated Year 2000
failures should not be material to the Company's consolidated operations.
However, difficulties in making the
15
<PAGE>
Company's IT systems Year 2000 compliant in a number of its significant
geographic regions or the failure of a number of the Company's major vendors,
customers or other material service providers to adequately address their Year
2000 issues would have a material adverse effect on the Company.
Certain of the Company's North American operations are implementing a
significant upgrade of their computer operating systems (unrelated to the Year
2000 issues), which entail the installation of certain modules of an enterprise
wide IT system. This system underwent extensive testing in the month of November
1998, and since December 1998 the system has been fully operational.
European Union Conversion to the "Euro"
The Company has instituted a "Euro" conversion team and begun preliminary
preparation for the conversion by eleven member states of the European Union to
a common currency, the "Euro". Conversion to the Euro by these member states of
the union will take place on a "no compulsion, no prohibition" basis between
January 1, 1999 and January 1, 2002. By January 1, 2002 all companies operating
in the eleven member states will be required to be fully operational using the
new currency. The Euro conversion team has primarily addressed the accounting
and information systems changes that are necessary to facilitate trading in the
Euro, the possible market place implications of a common currency and the
currency exchange rate risks, with the initial emphasis placed on the system
modifications. The Company has not completed the evaluation of the possible
effect of the changes to the Euro on foreign currency loans, or the impact if
any, on the market place implications of a common currency. Preliminary
assessments indicate that the financial impact of conversion to a Euro based
currency will not be material to the Company's consolidated financial position,
results of operations or cash flows.
Information Relating to Forward-Looking Statements
This quarterly report includes forward-looking statements within the
meaning of Section 21E of the Securities Exchange Act of 1934, including
statements regarding among other items, (i) the Company's interest expense, (ii)
the impact of inflation and seasonality, (iii) future income tax rates and
capital expenditures, (iv) the costs and other consequences related to the Year
2000 and conversion to the Euro and (v) certain expected charges. These
forward-looking statements reflect the Company's current views with respect to
future events and financial performance. The words "believe", "expect",
"anticipate" and similar expressions identify forward-looking statements. The
Company undertakes no obligation to publicly update or revise any
forward-looking statements, whether as a result of new information, future
events or otherwise. Actual results could differ materially from the
forward-looking statements as a result of among other things, the highly
competitive nature of the eyeglass lens and coating industry; the Company's need
to develop new products; potential adverse developments in the domestic and
foreign economic and political environment, including exchange rates, tariffs
and other trade barriers and potentially adverse tax consequences; potential
difficulties in staffing and managing foreign operations; and the other factors
described in "Factors Affecting Future Operating Results" included in Exhibit
99.1 of the Company's Form 10-K for the fiscal year ended March 31, 1998, and
the factors described in "Business-Environmental Matters", also included in the
Company's Form 10-K for the fiscal year ended March 31, 1998.
16
<PAGE>
PART ll OTHER INFORMATION
Item 1. Legal Proceedings
Not applicable
Item 2. Changes in Securities and use of Proceeds
Not applicable
Item 3. Defaults upon Senior Securities
Not applicable
Item 4. Submission of Matters to a Vote of Security Holders
Not applicable
Item 5. Other Information
Not applicable
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits
Exhibit Number Description Page Number
-------------- ----------- -----------
27 Financial Data Schedule 20
(b) Reports on Form 8-K
Not applicable
17
<PAGE>
SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
Sola International Inc.
(Registrant)
Dated: February 12, 1999 By: /s/Steven M. Neil
------------------- --------------------
Steven M. Neil
Executive Vice President, Chief
Financial Officer, Secretary and
Treasurer
18
<PAGE>
EXHIBIT INDEX
Exhibit Number Description Page Number
-------------- ----------- -----------
27 Financial Data Schedule 20
19
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE THIRD
QUARTER 10-Q AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH 10-Q.
</LEGEND>
<S> <C>
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> MAR-31-1999
<PERIOD-END> DEC-31-1998
<CASH> 28,445
<SECURITIES> 21
<RECEIVABLES> 127,327
<ALLOWANCES> 6,284
<INVENTORY> 197,013
<CURRENT-ASSETS> 361,713
<PP&E> 205,200
<DEPRECIATION> 55,395
<TOTAL-ASSETS> 725,609
<CURRENT-LIABILITIES> 127,258
<BONDS> 238,983
0
0
<COMMON> 249
<OTHER-SE> 350,918
<TOTAL-LIABILITY-AND-EQUITY> 725,609
<SALES> 388,539
<TOTAL-REVENUES> 388,539
<CGS> 211,100
<TOTAL-COSTS> 211,100
<OTHER-EXPENSES> 128,226
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 12,881
<INCOME-PRETAX> 36,332
<INCOME-TAX> 11,626
<INCOME-CONTINUING> 25,276
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 25,276
<EPS-PRIMARY> 1.02
<EPS-DILUTED> 0.99
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