<PAGE>
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ended May 2, 1998
-----------------------------------
or
[_] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from to
------------------------------------
Commission File Number: 0-23440
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Norton McNaughton, Inc.
(Exact name of registrant as specified in its charter)
Delaware 13-3747173
- --------------------------------- --------------------------------------
(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
463 Seventh Avenue, New York, N.Y. 10018
------------------------------------------
(Address of principal executive offices)
(Zip code)
(212) 947-2960
------------------------------------------------------
(Registrant's telephone number, including area code)
Not Applicable
----------------------------------------------------
(Former name, former address and former fiscal
year, if changed since last report)
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 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 [X] Yes [_] No
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practicable date.
Common Stock, $.01 Par Value, 7,412,613 shares as of June 19, 1998.
<PAGE>
INDEX TO FORM 10-Q
NORTON MCNAUGHTON, INC. AND SUBSIDIARIES
<TABLE>
<CAPTION>
PAGE NO.
--------
<S> <C>
PART I. FINANCIAL INFORMATION
ITEM 1.
Financial Statements:
Consolidated Balance Sheets at May 2, 1998 (Unaudited)
and November 1, 1997 3
Consolidated Statements of Operations for the thirteen and
twenty-six weeks ended May 2, 1998 and May 3, 1997 (Unaudited) 4
Consolidated Statements of Stockholders' Equity for the twenty-six
weeks ended May 2, 1998 (Unaudited) 5
Consolidated Statements of Cash Flows for the twenty-six weeks
ended May 2, 1998 and May 3, 1997 (Unaudited) 6
Notes to Consolidated Financial Statements (Unaudited) 7-11
ITEM 2.
Management's Discussion and Analysis of Financial Condition
and Results of Operations 11-17
ITEM 3.
Quantitative and Qualitative Disclosures About Market Risk - not applicable
PART II. OTHER INFORMATION 18-19
ITEM 1.
Legal Proceedings
ITEM 4.
Submission of matters to vote of security holders
ITEM 6.
Exhibits and Reports on Form 8-K
</TABLE>
2
<PAGE>
PART I - FINANCIAL INFORMATION
- ------------------------------
ITEM 1. FINANCIAL STATEMENTS
NORTON MCNAUGHTON, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(Dollars in Thousands)
<TABLE>
<CAPTION>
May 2, November 1,
1998 1997
(Unaudited) (Note)
------------- -----------
<S> <C> <C>
ASSETS
Current assets:
Cash $ 160 $ 529
Due from factor 69,264 64,644
Inventory 35,583 28,590
Income taxes receivable 2,514 3,201
Prepaid expenses and other current assets 5,379 5,227
------------- -----------
Total current assets 112,900 102,191
Fixed assets, net of accumulated depreciation of $2,951 and
$2,316, respectively 6,339 5,899
Notes receivable from management stockholders 2,655 2,655
Goodwill 3,858 3,853
Deferred financing costs 2,044 2,481
Other assets 3,083 1,683
------------- -----------
Total assets $130,879 $118,762
============= ===========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 11,549 $ 10,420
Revolving credit loans 57,515 44,473
Term loan payable 3,000 3,000
Accrued expenses and other current liabilities 3,939 4,986
------------- -----------
Total current liabilities 76,003 62,879
Term loan payable 10,500 12,000
Other long-term liabilities 1,730 1,720
------------- -----------
Total liabilities 88,233 76,599
Commitments and contingencies
Stockholders' equity:
Common stock, $0.01 par value, authorized 20,000,000 shares, 8,063,613
and 8,060,640 shares issued, respectively, and 7,412,613 and 7,409,640 shares
outstanding, respectively 81 81
Capital in excess of par 23,915 23,903
Retained earnings 24,185 23,714
Treasury stock, at cost, 651,000 shares (5,535) (5,535)
------------- -----------
Total stockholders' equity 42,646 42,163
------------- -----------
Total liabilities and stockholders' equity $130,879 $118,762
============= ===========
</TABLE>
Note: The balance sheet at November 1, 1997 has been derived from the audited
financial statements as of that date.
See accompanying notes.
3
<PAGE>
NORTON MCNAUGHTON, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
<TABLE>
<CAPTION>
Thirteen Weeks Ended Twenty-Six Weeks Ended
-------------------- ----------------------
May 2, May 3, May 2, May 3,
1998 1997 1998 1997
---------- --------- --------- ---------
(In Thousands, Except Per Share Amounts)
<S> <C> <C> <C> <C>
Net sales $94,116 $ 52,873 147,624 $ 94,469
Cost of goods sold 76,080 43,914 118,191 76,211
---------- --------- --------- ---------
Gross profit 18,036 8,959 29,433 18,258
Selling, general and administrative expenses 13,290 14,646 23,963 23,410
Depreciation and amortization 402 238 751 477
---------- --------- --------- ---------
Income (loss) from operations 4,344 (5,925) 4,719 (5,629)
Other expense (income):
Interest expense 2,114 453 3,815 716
Interest income (41) (42) (82) (84)
---------- --------- --------- ---------
Income (loss) before provision (benefit) for
income taxes 2,271 (6,336) 986 (6,261)
Provision (benefit) for income taxes 955 (2,785) 515 (2,753)
---------- --------- --------- ---------
Net income (loss) $ 1,316 $ (3,551) $ 471 $ (3,508)
========== ========= ========= =========
BASIC EARNINGS PER SHARE:
Net income (loss) $0.18 $ (0.47) $ 0.06 $ (0.46)
========== ========= ========= =========
Weighted average number of common shares outstanding 7,413 7,489 7,412 7,563
========== ========= ========= =========
DILUTED EARNINGS PER SHARE:
Net income (loss) $0.18 $ (0.47) $ 0.06 $ (0.46)
========== ========= ========= =========
Weighted average number of common shares outstanding
assuming dilution 7,423 7,489 7,427 7,563
========== ========= ========= =========
</TABLE>
See accompanying notes.
4
<PAGE>
NORTON MCNAUGHTON, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
FOR THE THIRTEEN WEEKS ENDED MAY 2, 1998
(UNAUDITED)
<TABLE>
<CAPTION>
Capital
Common Stock in Excess Retained Treasury
------------
Shares Amount of Par Earnings Stock Total
------ ------ ----- -------- ----- -----
(In Thousands)
<S> <C> <C> <C> <C> <C> <C>
Balance at November 1, 1997 8,061 $ 81 $23,903 $23,714 $(5,535) $42,163
Net income for the twenty-six weeks
ended May 2, 1998 - - - 471 - 471
Issuance of 2,973 shares of common
stock through the employee
stock purchase plan 3 - 12 - - 12
-------- ------- --------- ---------- ---------- ----------
Balance at May 2, 1998 8,064 $ 81 $23,915 $24,185 $(5,535) $42,646
======== ======= ========= ========== ========== ==========
</TABLE>
See accompanying notes.
5
<PAGE>
NORTON MCNAUGHTON, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
<TABLE>
<CAPTION>
Twenty-Six Weeks Ended
----------------------
May 2, May 3,
1998 1997
--------------- ---------------
(In Thousands)
<S> <C> <C>
Net income (loss) $ 471 $ (3,508)
Adjustments to reconcile net income (loss) to net
cash provided by (used for) operating activities:
Depreciation and amortization of fixed assets 637 460
Amortization of intangibles 582 17
Write-off of leasehold improvements - 492
Changes in operating assets and liabilities:
Due from factor, net (4,620) 12,296
Inventory (6,993) (4,277)
Refundable income taxes 687 -
Prepaid expenses and other current assets (152) (3,640)
Other assets (1,417) 146
Accounts payable 1,129 509
Accrued expenses and other current liabilities (1,047) 4,005
Other long-term liabilities 10 110
--------------- ---------------
Net cash (used for) provided by operating activities (10,713) 6,610
--------------- ---------------
INVESTING ACTIVITIES
Additional purchase price (133) -
Purchase of fixed assets (1,077) (974)
--------------- ---------------
Net cash used for investing activities (1,210) (974)
--------------- ---------------
FINANCING ACTIVITIES
Net advances under revolving credit agreement 13,042 -
Payments on term loan (1,500) -
Proceeds from issuance of common stock 12 20
Net (repayments) advances under factoring agreement - (4,443)
Purchase of treasury stock - (1,326)
--------------- ---------------
Net cash provided by (used for) financing activities 11,554 (5,749)
--------------- ---------------
Decrease in cash (369) (113)
Cash at beginning of period 529 333
--------------- ---------------
Cash at end of period $ 160 $ 220
=============== ===============
SUPPLEMENTAL DISCLOSURES
Income taxes paid $ 50 $ 279
Interest paid $ 3,367 $ 691
</TABLE>
See accompanying notes.
6
<PAGE>
NORTON MCNAUGHTON, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
BASIS OF PRESENTATION
The accompanying unaudited consolidated financial statements of Norton
McNaughton, Inc. and Subsidiaries (the "Company") have been prepared in
accordance with the instructions to Form 10-Q and Article 10 of Regulation S-X.
Accordingly, they do not include all of the information and footnotes necessary
for a fair presentation of financial position, results of operations and cash
flows in conformity with generally accepted accounting principles. In the
opinion of management, all normal and recurring adjustments and accruals
considered necessary for a fair presentation of the Company's financial position
at May 2, 1998 and the results of operations for the thirteen weeks and twenty-
six weeks ended May 2, 1998 and May 3, 1997 and cash flows for the twenty-six
weeks ended May 2, 1998 and May 3, 1997 have been included. These statements
should be read in conjunction with the audited consolidated financial statements
and footnotes thereto included in the Company's Annual Report on Form 10-K filed
with the Securities and Exchange Commission. Operating results for the thirteen
and twenty-six weeks ended May 2, 1998 are not necessarily indicative of the
results that may be expected for the fiscal year ending October 31, 1998.
The consolidated financial statements include the accounts of Norton
McNaughton, Inc. and its wholly-owned subsidiaries. All material balances and
transactions have been eliminated in consolidation. Data for the thirteen and
twenty-six weeks ended May 2, 1998 reflects the acquisition of Miss Erika, Inc.
("Miss Erika"), a wholly-owned subsidiary, on September 30, 1997.
The Company operates on a 52-53 week accounting period. The Company's
fiscal year ends on October 31, if such date falls on a Saturday, or the first
Saturday following October 31.
USE OF ESTIMATES
The preparation of the financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the amounts reported in the financial statements and
accompanying notes. Actual results could differ from those estimates.
DEFERRED FINANCING COSTS
Deferred financing costs were incurred in fiscal 1997 in connection with
obtaining the Company's credit facility. Financing costs are amortized on a
straight line basis over the three year term of the related credit facility.
GOODWILL
Goodwill resulting from the acquisition of Miss Erika is being amortized by
the straight-line method over twenty years.
EARNINGS PER SHARE
In February 1997, the Financial Accounting Standards Board issued Statement
of Financial Accounting Standards ("SFAS") No. 128, "Earnings per Share", which
requires adoption for both interim and annual financial statements for periods
ending after December 15, 1997. In the first quarter of fiscal 1998, the
Company changed the method previously used to compute earnings per share and has
restated all prior periods. Under the new requirements for calculating basic
earnings per share, the dilutive effect of stock options is excluded.
Basic earnings per share is computed based on the weighted average number
of common shares outstanding during the period presented. Diluted earnings per
share is computed based on the weighted average number of common shares
outstanding during the period and the effect of dilutive options outstanding
during the period using the treasury stock method. For the thirteen and twenty-
six weeks ended May 2, 1998, the dilutive effect of options outstanding during
the period using the treasury stock method was 10,000 shares and 15,000 shares,
respectively. For the thirteen and twenty-six weeks ended May 3, 1997, options
outstanding during the period using the treasury stock method were excluded from
the net loss per share computation of dilutive earnings per share because they
were antidilutive.
7
<PAGE>
NORTON MCNAUGHTON, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(UNAUDITED)
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
CASH AND CASH EQUIVALENTS
For purposes of the statements of cash flows, cash and cash equivalents
include all liquid debt instruments with a maturity of three months or less when
purchased.
ACCOUNTING FOR STOCK OPTIONS
The Company has elected to follow Accounting Principles Board ("APB")
Opinion No. 25, "Accounting for Stock Issued to Employees" and related
interpretations in accounting for its employee stock options because the
alternative fair value accounting provided for under SFAS No. 123, "Accounting
for Stock-Based Compensation," requires use of option valuation models that were
not developed for use in valuing employee stock options. Under APB No. 25,
because the exercise price of the Company's employee stock options equals or
exceeds the market price of the underlying stock on the date of grant, no
compensation expense is recognized.
SFAS NO. 130, "REPORTING COMPREHENSIVE INCOME" AND SFAS NO. 131, "DISCLOSURES
ABOUT SEGMENTS OF AN ENTERPRISE AND RELATED INFORMATION"
The Financial Accounting Standards Board issued SFAS No. 130, which
requires reclassification of financial statements for earlier periods provided
for comparative purposes, and is effective for fiscal years beginning after
December 15, 1997. The Company believes that the effect of adopting the new
standard will be immaterial.
The Financial Accounting Standards Board issued SFAS No. 131, which is
effective for fiscal years beginning after December 15, 1997. This statement
changes the way that companies report information about operating segments in
financial statements. The Company has not yet determined the impact of SFAS No.
131 on disclosures in its financial statements.
2. INVENTORY
Inventory is stated at the lower of cost (first-in, first-out basis) or market.
Inventories consist of the following:
<TABLE>
<CAPTION>
May 2, November 1,
1998 1997
(Audited)
---------------- ----------------
(In Thousands)
<S> <C> <C>
Raw materials $ 5,633 $ 2,979
Work in process 5,703 2,258
Finished goods 24,247 23,353
------- -------
$35,583 $28,590
======= =======
</TABLE>
3. STOCK REPURCHASE
The Company's Board of Directors has authorized a stock repurchase program,
under which the Company may repurchase up to $7.5 million of the Company's
Common Stock. The Company expects that the shares may be purchased from time to
time in the open market and in block transactions. As of May 2, 1998, the
Company has purchased a total of 651,000 shares at an aggregate cost of
approximately $5.5 million.
8
<PAGE>
NORTON MCNAUGHTON, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(UNAUDITED)
4. NOTES RECEIVABLE FROM MANAGEMENT STOCKHOLDERS
In 1993, the Company loaned certain management stockholders $3,000,000 in
the aggregate. Each loan is evidenced by a limited recourse promissory note with
interest accruing at 5.84% per annum. The Company's recourse on the promissory
notes is limited to the management stockholders' pledges of a portion of their
Common Stock of the Company.
In the event of any sale or transfer of shares of Common Stock by any of
the management stockholders, such person is required to apply a portion of the
net proceeds of the sale or transfer to the principal repayment of his loan from
the Company. No other principal payments are required under the loans except for
the payment at maturity. The loans mature on November 5, 2003 at which time full
payment is to be made by the management stockholders for the balance of their
respective loans. As of the end of the fourth quarter of fiscal 1997, all
necessary payments have been made under the terms of the loans by the management
stockholders.
As of May 2, 1998, the fair market value of the Company's Common Stock
pledged by the management stockholders as security for the loans was $5,161,699,
and the aggregate principal balance of all loans to management stockholders was
$2,654,680. The loan balance set forth above reflects the required principal
payments of $345,320 resulting from sales of Common Stock by management
stockholders.
5. ACQUISITION OF MISS ERIKA
On September 30, 1997, the Company completed the acquisition of
substantially all the assets and the assumption of substantially all the
liabilities of Miss Erika, a privately-held manufacturer of women's moderately
priced apparel. The Company will, through a wholly-owned subsidiary, continue
Miss Erika's business. The purchase price of Miss Erika consisted of $24.0
million in cash paid at the closing, the assumption of $2.5 million of
indebtedness for borrowed money and certain other contractual obligations. In
addition, the Company has agreed to pay an additional contingent payment in cash
and/or Company Common Stock in the event that certain earnings targets are
achieved by Miss Erika for the two fiscal years ending November 6, 1999. The
aggregate contingent payment, if any, payable by the Company is equal to the
amount by which four times the average of Miss Erika's earnings before income
taxes, depreciation and amortization, as defined in the Miss Erika purchase
agreement ("EBITDA"), for the two fiscal years ending November 6, 1999, exceeds
$24.0 million. Any additional consideration paid for Miss Erika will be
accounted for as additional purchase price and will be reflected in goodwill. At
the Company's discretion, the Company may, subject to a maximum number of
shares, pay all or any portion of the contingent payment in shares of Common
Stock. The Miss Erika purchase agreement limits the number of shares of Common
Stock payable by the Company to a number of shares which, after giving effect to
their issuance, does not exceed 12% of the aggregate number of outstanding
shares of Common Stock at the time of payment. The Company intends to pay the
cash portion, if any, of the contingent consideration from internally generated
funds and borrowings under the Company's revolving credit facility. The Company
cannot predict whether Miss Erika will achieve the necessary EBITDA targets to
qualify for additional consideration.
In connection with the acquisition, the Company entered into a $140 million
secured term loan and revolving credit facility with NationsBanc Commercial
Corporation and The CIT Group/Commercial Services, Inc. The proceeds were used
to finance the acquisition and for ongoing working capital requirements of the
combined entity. Pursuant to the financing arrangement, the Company continued to
factor its accounts receivable, as well as the accounts receivable of Miss
Erika.
The acquisition was accounted for as a purchase, and Miss Erika's results
are included in the consolidated statements of operations beginning September
30, 1997. The following unaudited pro forma information indicates what net
sales, income (loss) from operations, net loss and net loss per share would have
been had the acquisition of Miss Erika been completed on November 2, 1996.
9
<PAGE>
<TABLE>
<CAPTION>
Twenty-Six Weeks Ended
Thirteen Weeks Ended May 3, 1997 May 3, 1997
------------------------------------------ -------------------------------------------
As reported Pro forma As reported Pro forma
---------------- -------------------- --------------------- -----------------
(In thousands, except per share amounts)
<S> <C> <C> <C> <C>
Net sales $ 52,873 $ 94,061 $ 94,469 $ 149,491
Income (loss) from operations $ (5,925) $ 174 $ (5,629) $ (619)
Net loss $ (3,551) $ (763) $ (3,508) $ (1,828)
Net loss per share:
Basic $ (0.47) $ (0.10) $ (0.46) $ (0.24)
Diluted $ (0.47) $ (0.10) $ (0.46) $ (0.24)
</TABLE>
The pro forma adjustments are based upon available information and
assumptions that management believes are reasonable at the time made. The
unaudited pro forma financial information does not purport to present the
results of operations of the Company had the acquisition of Miss Erika occurred
on the date specified, nor is it necessarily indicative of the financial
position or results of operations that may be achieved in the future. The
unaudited pro forma financial information does not reflect any adjustments for
synergies that management expects to realize. No assurances can be made as to
the amount of cost savings or revenue enhancements, if any, that may be
realized.
6. SHAREHOLDER RIGHTS PLAN
On January 19, 1996, the Company's Board of Directors adopted a Shareholder
Rights Plan in which shareholders of record on February 8, 1996 received a
dividend distribution of one common share purchase right for each outstanding
share of the Company's Common Stock held. Each right entitles the holder to
purchase from the Company Common Stock at an initial exercise price of $32.00.
The rights are not exercisable or transferable apart from the Common Stock
until the earlier to occur of (i) ten days following a public announcement that
a person or group of affiliated or associated persons have acquired beneficial
ownership of 20% or more of the outstanding Common Stock of the Company, or (ii)
ten business days following the commencement of, or announcement of, an
intention to make a tender offer or exchange offer, the consummation of which
would result in the beneficial ownership by a person or group of 20% or more of
such outstanding Common Stock.
The rights are redeemable by the Company's Board of Directors at a price of
$0.01 per right at any time prior to the acquisition by a person or group of
beneficial ownership of 20% or more of the Company's Common Stock.
If a person or group acquires 20% or more of the Company's outstanding
Common Stock, each right will entitle the holder to purchase, at the right's
exercise price, a number of shares of the Company's Common Stock having a market
value at that time of twice the right's exercise price. If the Company is
acquired in a merger or other business combination transaction, each right will
entitle its holder to purchase, at the right's exercise price, a number of the
acquiring company's common shares having a market value at that time of twice
the right's exercise price.
7. SUBSEQUENT EVENTS
On June 18, 1998, the Company completed the acquisition of Jeri-Jo
Knitwear Inc. and Jamie Scott, Inc. (collectively "Jeri-Jo"), acquiring
substantially all the assets and assuming substantially all the liabilities of
the privately-held apparel importers of moderately-priced juniors' and misses'
updated sportswear. Jeri-Jo will operate as a separate subsidiary under the
direction of current management. The purchase price paid in the Jeri-Jo
acquisition was (i) $55.0 million in cash at the closing of the acquisition,
(ii) the assumption of indebtedness of $10.9 million for borrowed money and
certain other contractual obligations. In addition, the Company agreed to pay an
additional contingent payment in cash and its Common Stock, $0.01 par value, in
the event that certain earnings targets are achieved by Jeri-Jo for the two
years subsequent to the closing of the Jeri-Jo acquisition. The Jeri-Jo
purchase agreement requires that the Company pay at least 50% of the required
contingent payment in cash. The aggregate contingent payment, if any, payable
by the Company is equal to the excess of (1) the sum of (A) five times Jeri-Jo's
average EBITDA (as defined in the Jeri-Jo purchase agreement) for the two years
ending June 30, 2000, plus (B) 0.50 times any such average EBITDA between $17.0
million and $20.0 million, plus (C) one times any such average EBITDA over $20.0
million, over (2) $55.0 million. Any additional consideration paid for Jeri-Jo
will be accounted for as additional purchase price and will be reflected in
goodwill. The Company intends to pay the cash portion of the contingent
consideration from internally generated funds and borrowings under the Company's
revolving credit facility. The Company cannot predict whether Jeri-Jo will
achieve the necessary EBITDA targets to qualify for additional consideration.
10
<PAGE>
Concurrent with the closing of the acquisition, the Company entered into a
$175 million secured revolving credit and letter of credit facility with
NationsBanc Commercial Corporation, The CIT Group/Commercial Services, Inc. and
Fleet Bank N.A. (the "New Financing Agreement"). The facility will be used to
finance ongoing working capital requirements of the combined entity. The New
Financing Agreement is a three-year secured revolving credit and letter of
credit facility, with interest on outstanding borrowings determined, at the
Company's option, based upon stated margins below the prime rate or in excess of
LIBOR rates. Initially, the interest rate under the New Financing Agreement is
75 basis points below the prime rate (based upon the current prime rate, the
interest rate under the New Financing Agreement will be 7.75% per annum).
Available credit under the New Financing Agreement is as follows: revolving
credit advances not to exceed $60.0 million, documentary letters of credit not
to exceed $130.0 million and stand-by letters of credit not to exceed $45.0
million (including $30.0 million of stand-by letters of credit necessary to
secure the Company's cash contingent payment obligation in connection with the
Jeri-Jo acquisition), with the aggregate credit available to the Company equal
to the lesser of (i) $175.0 million or (ii) the sum of 85% of eligible accounts
receivable and 60% of eligible inventory. The New Financing Agreement contains a
number of restrictive covenants, including covenants which limit incurrence of
liens and indebtedness, limit transactions with affiliates, acquisitions, sales
of assets, investments and other restricted payments, and require that the
Company maintain certain fixed charge coverage, cash flow coverage and leverage
ratios and meet specified minimum levels of working capital and net worth.
On June 18, 1998, the Company also closed the sale of $125 million of
12 1/2% Senior Notes due 2005 (the "Senior Notes"). The proceeds of the sale
were used to finance the Jeri-Jo acquisition and to refinance existing
indebtedness of the Company and Jeri-Jo. The Senior Notes have not been
registered under the Securities Act of 1933, as amended, and may not be offered
and sold in the United States absent registration under such act or an
applicable exemption from registration. The Company's obligations under the
Senior Notes are guaranteed by all of the Company's subsidiaries.
8. LEGAL PROCEEDINGS
Norton has exclusive, long-term agreements with two independent contractors
which provide it with finished goods distribution services (Railroad
Enterprises, Inc.) and domestic cutting services (Cutting Edge Services, Inc.,
formerly Toni-Linda Productions, Inc.). In April 1998, in response to Norton's
notice of an intention not to renew its agreements with its distribution and
cutting contractors, Norton received a letter from their attorney alleging that
Norton had breached its agreements and, as a result, alleging that such
contractors had incurred substantial damages. Norton does not believe that it
has breached any of its agreements with these contractors, believes that it has
meritorious defenses to any claim, and will vigorously defend any proceeding.
Under the terms of the agreements with these contractors, claims against Norton
are to be resolved through arbitration proceedings. There can be no assurance
that Norton would be successful in defending any such claim, if made, or that
any determination rendered would not have a material adverse effect on the
business, financial condition and results of operations of the Company.
The Company is involved in certain other legal actions and claims arising
in the ordinary course of business. It is the opinion of management that such
litigation and claims will be resolved without material adverse effect on the
Company's financial position, results of operations and cash flow.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
Recent Events
- -------------
On June 18, 1998, the Company completed the acquisition of Jeri-Jo Knitwear
Inc. and Jamie Scott, Inc. (collectively "Jeri-Jo"), acquiring substantially all
the assets and assuming substantially all the liabilities of the privately-held
apparel importers of moderately-priced juniors' and misses' updated sportswear.
Jeri-Jo will operate as a separate subsidiary under the direction of current
management. The purchase price paid in the Jeri-Jo acquisition was (i) $55.0
million in cash at the closing of the acquisition, (ii) the assumption of
indebtedness of $10.9 million for borrowed money and certain other contractual
obligations. In addition, the Company agreed to pay an additional contingent
payment in cash and its Common Stock, $0.01 par value, in the event that certain
earnings targets are achieved by Jeri-Jo for the two years subsequent to the
closing of the Jeri-Jo acquisition. The Jeri-Jo purchase agreement requires that
the Company pay at least 50% of the required contingent payment in cash. The
aggregate contingent payment, if any, payable by the Company is equal to the
excess of (1) the sum of (A) five times Jeri-Jo's average EBITDA (as defined in
the Jeri-Jo purchase agreement) for the two years ending June 30, 2000, plus (B)
0.50 times any such average EBITDA between $17.0 million and $20.0 million, plus
(C) one times any such average EBITDA over $20.0 million, over (2) $55.0
million. Any additional consideration paid for Jeri-Jo will be accounted for as
additional purchase price and will be reflected in goodwill. The Company intends
to pay the cash portion of the contingent consideration from internally
generated funds and borrowings under the Company's revolving credit facility.
The Company cannot predict whether Jeri-Jo will achieve the necessary EBITDA
targets to qualify for additional consideration.
Concurrent with the closing of the acquisition, the Company entered into a
$175 million secured revolving credit and letter of credit facility with
NationsBank Commercial Corporation, The CIT Group/Commercial Services, Inc. and
Fleet Bank N.A., (the "New Financing Agreement"). The facility will be used to
finance ongoing working capital requirements of the combined entity. The New
Financing Agreement is a three-year secured revolving credit and letter of
credit facility, with interest on outstanding borrowings determined, at the
Company's option, based upon stated margins below the prime rate or in excess of
LIBOR rates. Initially, the interest rate under the New Financing Agreement is
75 basis points below the prime rate (based upon the current prime rate, the
interest rate under the New Financing
11
<PAGE>
Agreement will be 7.75% per annum). Available credit under the New Financing
Agreement is as follows: revolving credit advances not to exceed $60.0 million,
documentary letters of credit not to exceed $130.0 million and stand-by letters
of credit not to exceed $45.0 million (including $30.0 million of stand-by
letters of credit necessary to secure the Company's cash contingent payment
obligation in connection with the Jeri-Jo acquisition), with the aggregate
credit available to the Company equal to the lesser of (i) $175.0 million or
(ii) the sum of 85% of eligible accounts receivable and 60% of eligible
inventory.
The New Financing Agreement contains a number of restrictive covenants,
including covenants which limit incurrence of liens and indebtedness, limit
transactions with affiliates, acquisitions, sales of assets, investments and
other restricted payments, and require that the Company maintain certain fixed
charge coverage, cash flow coverage and leverage ratios and meet specified
minimum levels of working capital and net worth.
On June 18, 1998 the Company also closed the sale of $125 million of
12 1/2% Senior Notes due 2005 (the "Senior Notes"). The proceeds of the sale
were used to finance the Jeri-Jo acquisition and to refinance existing
indebtedness of the Company and Jeri-Jo. The Notes have not been registered
under the Securities Act of 1933, as amended, and may not be offered and sold in
the United States absent registration under such act or an applicable exemption
from registration. The Company's obligations under the Senior Notes are
guaranteed by all of the Company's subsidiaries.
General
- -------
The Company has recently adopted and implemented a new business strategy to
expand its branded product lines, broaden its customer base and further develop
its global product sourcing capabilities. A key component of this new business
strategy involves the selective acquisition of complimentary businesses and
brands.
On September 30, 1997, the Company acquired substantially all the assets
and assumed substantially all the liabilities of Miss Erika, Inc. ("Miss
Erika"), a privately-held manufacturer of women's moderately priced apparel. The
terms of the transaction provided for the payment of approximately $24 million
in cash, with additional consideration payable at the Company's option in cash
or Company common stock based on the profitability of Miss Erika in fiscal years
1998 and 1999.
The Company's continuing focus on improving profitability has led the
Company to undertake certain initiatives to improve gross profit and gross
profit margins. These include the implementation of certain merchandising
changes, as well as the closure of underperforming divisions.
In the merchandising area, the Company has recently reduced the number of
products (i.e. reduced the number of SKU's) offered in any particular collection
of its Norton McNaughton product line in an effort to minimize the number of
unrelated items unsold at the end of a selling period. The Company has
undertaken this initiative to reduce sales allowances required to compensate
retailers for retail price reductions taken to sell unrelated clothing items. In
addition, by taking advantage of product sourcing opportunities, the Company has
been able to offer quality and fashionable products to retailers at lower price
points in an effort to further enhance the sales of the Company's products to
retailers and to consumers and to further reduce sales allowances. These
initiatives have been undertaken without a change to quality of merchandise. As
a result of these initiatives, the Company anticipates that revenue levels in
fiscal 1998, excluding Miss Erika, will decrease from those in fiscal 1997.
The Company continually monitors the success, in terms of sales,
profitability and customer acceptance, of its product lines. In the event that
one or more of its product lines does not meet the Company's expectations, the
Company will discontinue their production. During the third quarter of fiscal
1997, the Company began selling merchandise under its existing product lines to
Sears, including Norton McNaughton and Norton Studio. Correspondingly, the
Company discontinued the Modiano product line, which had been produced
exclusively for Sears, in the fourth quarter of fiscal 1997. In addition, the
Company discontinued the Lauren Alexandra private-label product line produced
for Federated Department Stores and the catalog division in the first quarter of
fiscal 1998, and discontinued the Pant-her private-label product line produced
for The May Department Stores Company in the second quarter of fiscal 1998.
In addition, during the second quarter of fiscal 1997, the Company decided
to close its retail outlet stores due to this division's inability to meet the
Company's profitability targets. The Company utilized these retail outlets to
liquidate excess inventory, including end-of-stock, out-of-season and other
miscellaneous merchandise. Due to the Company's new merchandising strategy, the
Company believes that it will reduce its need to liquidate excess inventory. To
the extent that the Company is required to dispose of excess merchandise in the
future, the Company believes that it can do so on a more cost-effective basis
through discounters and other retailers.
In fiscal 1997, the aforementioned discontinued divisions contributed
approximately $33.4 million to net sales and experienced approximately breakeven
operating results. In connection with the closure of these divisions, the
Company recorded special charges in the fourth quarter of fiscal 1997 of
approximately $3.7 million. These discontinued divisions contributed
approximately $7.9 million to net sales in the second quarter of fiscal 1997.
12
<PAGE>
The Company implemented several other significant initiatives in fiscal
1997. In the second quarter of fiscal 1997, the Company appointed a new
President and Chief Operating Officer, and the Company's former President and a
consultant terminated their relationship with the Company. In addition, the
Company terminated certain lease obligations, and made the determination to
close its retail outlet stores, as discussed above. In connection with these
changes, the Company recorded special charges of approximately $5.7 million in
the second quarter of fiscal 1997.
During the fourth quarter of fiscal 1997, in an effort to further
streamline operations and in conjunction with the Company's decision to
discontinue the various divisions discussed earlier, the Company reduced its
workforce by approximately 33%. Other cost savings measures implemented included
merchandising changes, which will enable the Company to produce fewer samples,
and reductions in executive compensation and ancillary expenses. As a result of
these initiatives and those undertaken in the second quarter of fiscal 1997, the
Company anticipates that it (without taking Miss Erika into account) may achieve
cost savings of up to $3.0 million in fiscal 1998, although savings as a result
of workforce reductions will be offset by any new hires above the Company's
plan. Cost savings realized in the first quarter and second quarter of fiscal
1998 as a result of the above were approximately $1.0 million and $550,000,
respectively.
As is the norm in the apparel industry, the Company engages in promotional
activity with its customers which affects the Company's sales, gross profit and
gross profit margins. Norton McNaughton of Squire, Inc. ("Norton"), a wholly-
owned subsidiary, accomplishes this by granting its customers sales allowances,
while Miss Erika sells merchandise at promotional prices. Accordingly, the
Company's sales, gross profit and gross profit margins vary from fiscal quarter
to quarter and fiscal year to year. In addition, the Company generally ships its
products in accordance with normal apparel industry shipping cycles.
Correspondingly, sales, gross profit and gross profit margins may be affected by
the timing of shipping cycles or the delivery of finished goods. This may result
in shipments to customers occurring before or after a particular fiscal quarter
end, thereby affecting both fiscal quarter to quarter comparisons and quarter to
quarter results during a fiscal year.
The Company contracts for the manufacture of all of its products and
continues to increase the proportion of its products produced overseas. Contract
manufacturing allows the Company to avoid significant capital expenditures for
manufacturing facilities and the fixed costs of maintaining a large production
work force. Foreign contract manufacturing allows it to take advantage of lower
manufacturing costs, thereby allowing it to reduce prices to its customers. The
Company believes that foreign sourcing also allows the Company to avail itself
of a better equipped and more skilled labor force, thereby allowing it to
produce a higher quality, better valued product for its customers. The Company
offsets the longer lead-time necessary for foreign sourced fabrics and
manufacturing by early and timely attention to production planning.
This Management's Discussion and Analysis contains forward-looking
information about the Company's anticipated operating results, including
following the acquisition of Jeri-Jo. The Company's ability to achieve its
projected results, including following the acquisition of Jeri Jo, is dependent
on many factors which are outside of management's control. Some of the most
significant factors would be a further deterioration in retailing conditions for
women's apparel, a further increase in price pressures and other competitive
factors, any of which could result in an unanticipated decrease in gross profit
margins, an unanticipated need to hire additional personnel above the Company's
plan, unanticipated problems arising with Miss Erika's and Jeri-Jo's businesses
or the integration of Miss Erika's and Jeri-Jo's businesses with that of the
Company, the unanticipated loss of a major customer, the unanticipated loss of a
major contractor or supplier, year 2000 issues and weather conditions which
could impact retail traffic and the Company's ability to ship on a timely basis.
Accordingly, there can be no assurance that the Company, including following the
acquisition of Jeri-Jo, will achieve its anticipated operating results.
13
<PAGE>
Results of Operations
- ---------------------
The following table is derived from the Company's Consolidated Statements of
Operations and sets forth, for the periods indicated, selected operating data as
a percentage of net sales:
<TABLE>
<CAPTION>
Thirteen Weeks Ended Twenty-Six Weeks Ended
-------------------------------------------- ---------------------------------------
May 2, 1998 May 3, 1997 May 2, 1998 May 3, 1997
------------------ ------------------ ----------------- ----------------
<S> <C> <C> <C> <C>
Net sales 100.0% 100.0% 100.0% 100.0%
Cost of goods sold 80.8 83.1 80.1 80.7
------------------ ------------------ ----------------- ----------------
Gross profit 19.2 16.9 19.9 19.3
Selling, general and
administrative expenses 14.1 27.7 16.2 24.8
Depreciation and amortization 0.5 0.4 0.5 0.5
------------------ ------------------ ----------------- ----------------
Income (loss) from operations 4.6 (11.2) 3.2 (6.0)
Interest expense 2.3 0.9 2.6 0.7
Interest income (0.1) (0.1) (0.1) (0.1)
------------------ ------------------ ----------------- ----------------
Income (loss) before provision
(benefit) for income taxes 2.4 (12.0) 0.7 (6.6)
Provision (benefit) for income
Taxes 1.0 (5.3) 0.4 (2.9)
------------------ ------------------ ----------------- ----------------
Net income (loss) 1.4% (6.7)% 0.3% (3.7)%
================== ================== ================= ================
</TABLE>
Quarter Ended May 2, 1998 Compared to Quarter Ended May 3, 1997
- ---------------------------------------------------------------
Net sales were $94.1 million for the second quarter of fiscal 1998
compared to $52.9 million for the second quarter of fiscal 1997. The increase in
net sales of $41.2 million was primarily attributable to the addition of net
sales of the Erika product line of $52.9 million, following the acquisition of
Miss Erika on September 30, 1997, increased net sales in the in the Norton
Studio product line of $2.7 million and increased net sales in the D.P.S.
product line of $1.8 million. These increases were offset in part by a decrease
in net sales of $7.7 million in the Norton McNaughton product lines, and
decreases in net sales of $7.9 million, in the aggregate, due to the
discontinuation of the Modiano, Lauren Alexandra and Pant-her product lines.
The gross profit margin was 19.2% for the second quarter of fiscal
1998 compared to 16.9% for the second quarter of fiscal 1997. Gross profit
margin in the second quarter of fiscal 1998 was negatively impacted by sales
allowances of approximately $3.3 million granted to certain customers of
discontinued divisions in order to encourage those customers to continue to do
business with the Company's remaining divisions. Had these sales allowances not
been granted, gross profit margin for the second quarter of fiscal 1998 would
have been 21.9%. The increase in gross profit margin was primarily due to the
addition of gross profit from the Erika product line, following the acquisition
of Miss Erika on September 30, 1997, which represented higher gross profit
margins than those experienced in the Norton McNaughton product lines.
Selling, general and administrative expenses ("SG&A" expenses) were
$13.3 million, or 14.1% of net sales, in the second quarter of fiscal 1998
compared to $14.7 million, or 27.7% of net sales, in the second quarter of
fiscal 1997. SG&A expenses for the second quarter of fiscal 1997 included
special charges of $5.7 million for severance payments resulting from management
changes, the termination of certain lease obligations and the establishment of
reserves for certain contingencies, including the closing of the Company's
retail outlet stores. Excluding the special charge, SG&A expenses for the
second quarter of fiscal 1997 would have been $8.9 million, or 16.9% of net
sales. The increase of $4.4 million, excluding the special charge, resulted
primarily from Miss Erika whose SG&A for the second quarter of fiscal 1998 was
$6.0 million. This increase was offset in part by savings experienced by Norton
in the second quarter of fiscal 1998 due to cost savings measures implemented in
fiscal 1997, including a significant reduction in Norton's workforce and a
decrease in variable distribution and freight expenses due to a decrease in the
volume of products shipped in the second quarter of fiscal 1998 for Norton.
14
<PAGE>
Interest expense increased to $2.1 million in the second quarter of
fiscal 1998 from $453,000 in the second quarter of fiscal 1997. The increase was
primarily attributable to incremental interest expense and amortization of
deferred financing costs associated with borrowings used to effect the
acquisition of Miss Erika on September 30, 1997.
Twenty-Six Weeks Ended May 2, 1998 Compared to the Twenty-Six Weeks Ended May 3,
- --------------------------------------------------------------------------------
1997
- ----
Net sales were $147.6 million for the first half of fiscal 1998
compared to $94.5 million for the first half of fiscal 1997. The increase in net
sales of $53.1 million was primarily attributable to the addition of net sales
of the Erika product line of $71.1 million, following the acquisition of Miss
Erika on September 30, 1997, increased net sales in the in the Norton Studio
product line of $5.1 million and increased net sales in the D.P.S. product line
of $1.8 million. These increases were offset in part by a decrease in net sales
of $10.0 million in the Norton McNaughton product lines, and decreases in net
sales of $14.1 million, in the aggregate, due to the discontinuation of the
Modiano, Lauren Alexandra and Pant-her product lines.
The gross profit margin was 19.9% for the first half of fiscal 1998
compared to 19.3% for the first half of fiscal 1997. Gross profit margin in the
first half of fiscal 1998 was negatively impacted by sales allowances of
approximately $3.3 million granted to certain customers of discontinued
divisions in order to encourage those customers to continue to do business with
the Company's remaining divisions. Had these sales allowances not been granted,
gross profit margin for the first half of fiscal 1998 would have been 21.7%.
The increase in gross profit margin was primarily due to the addition of gross
profit from the Erika product line, following the acquisition of Miss Erika on
September 30, 1997, which represented higher gross profit margins than those
experienced in the Norton McNaughton product lines.
SG&A expenses were $24.0 million, or 16.2% of net sales, in the first
half of fiscal 1998 compared to $23.4 million, or 24.8% of net sales, in the
first half of fiscal 1997. SG&A expenses for the first half of fiscal 1997
included special charges of $5.7 million for severance payments resulting from
management changes, the termination of certain lease obligations and the
establishment of reserves for certain contingencies, including the closing of
the Company's retail outlet stores. Excluding the special charge, SG&A expenses
for the first half of fiscal 1997 would have been $17.7 million, or 18.7% of net
sales. The increase of $6.3 million, excluding the special charge, resulted
primarily from Miss Erika whose SG&A for the first half of fiscal 1998 was $9.8
million. This increase was offset in part by savings experienced by Norton in
the first half of fiscal 1998 due to cost savings measures implemented in fiscal
1997, including a significant reduction in Norton's workforce and a decrease in
variable distribution and freight expenses due to a decrease in the volume of
products shipped in the first half of fiscal 1998 for Norton.
Interest expense increased to $3.8 million in the first half of fiscal
1998 from $716,000 in the first half of fiscal 1997. The increase was primarily
attributable to incremental interest expense and amortization of deferred
financing costs associated with borrowings used to effect the acquisition of
Miss Erika on September 30, 1997.
Liquidity and Capital Resources
- -------------------------------
The Company's liquidity requirements arise from the funding of the
Company's working capital needs, primarily inventory and accounts receivable.
The Company's primary sources of working capital are cash flow from operations
and, prior to the closing of the new credit facility described below, advances
under the Company's prior credit facility. The Company's borrowing requirements
for working capital purposes are seasonal, with peak working capital needs
generally arising at the end of the first and third fiscal quarters and
extending through the second and fourth fiscal quarters. The Company had working
capital of $36.9 million at May 2, 1998 as compared to $39.3 million at November
1, 1997.
The Company sells its accounts receivable to a factor without
recourse, up to a maximum established by the factor for each customer.
Receivables sold in excess of these limitations are subject to recourse in the
event of nonpayment by the customer.
Prior to the Company's new credit agreement entered into on June 18,
1998, the Company borrowed under its prior credit facility, entered into on
September 30, 1997. Prior thereto, the Company's working capital requirements
were financed under its factoring agreement. The latter provided for borrowings
up to 90% of the net balance due on eligible accounts receivable, up to $10.0
million of additional advances and up to $20.0 million in letter of credit
financing. Interest on factor advances was payable monthly at 0.75% below the
NationsBank of Georgia, N.A. prime rate (the "Nations Prime Rate") for amounts
advanced which were less than the purchase price of eligible accounts
receivable, and 1.25% above the Nations Prime Rate for amounts advanced in
excess of the purchase price of eligible accounts receivable.
15
<PAGE>
The Company entered into a $140.0 million secured term loan and
revolving credit and letter of credit facility with NationsBanc Commercial
Corporation and The CIT Group/Commerical Services, Inc. on September 30, 1997
(the "Prior Financing Agreement") in connection with the acquisition of Miss
Erika. The Prior Financing Agreement provided for a $15.0 million term loan and
$125.0 million revolving credit facility. The proceeds were used to finance the
acquisition of Miss Erika and for working capital requirements of the combined
entity.
Under the Prior Financing Agreement, the Company had available credit
of up to $125.0 million for working capital loans and letters of credit based
upon a borrowing base of 85% and 60% of Eligible Accounts Receivable and
Eligible Inventory, respectively, as defined therein, and overadvances above the
borrowing base of $10.0 million at month end and up to $15.0 million permitted
mid-month ($20.0 million in the months of August, September and October).
Interest on revolving credit loan balances was payable monthly in arrears at an
annual rate equal to, at the Company's option, the Nations Prime Rate less
0.25%, or the LIBOR rate plus 2.75% and a Co-agent fee of $150,000 per annum.
Interest on the term loan was payable monthly in arrears at an annual rate equal
to, at the Company's option, the Nations Prime Rate plus 0.25%, or the
LIBOR rate plus 3.25%. The term loan required monthly principal payments of
$250,000 on the first day of each month and a final installment of approximately
$6.3 million on October 2, 2000. The Prior Financing Agreement contained a
number of restrictive covenants, including requirements that the Company
maintain certain financial ratios and meet specified minimum levels of working
capital and tangible net worth. The Company was in compliance with these
covenants at May 2, 1998.
At May 2, 1998, borrowings and letters of credit outstanding under the
Prior Financing Agreement were $57.4 million and $44.3 million, respectively.
The Company had total additional available credit of $4.1 million under the
Prior Financing Agreement as of that date, pursuant to the borrowing base
formula set forth therein.
The Company entered into a $175.0 million secured revolving credit and
letter of credit facility with NationsBanc Commercial Corporation, The CIT
Group/Commercial Services, Inc. and Fleet Bank N.A. on June 18, 1998. The New
Financing Agreement has an expiration date of June 18, 2001. Available credit
under the New Financing Agreement is as follows: revolving credit advances not
to exceed $60.0 million, documentary letters of credit not to exceed $130.0
million and stand-by letters of credit not to exceed $45.0 million (including
$30.0 million of stand-by letters of credit necessary to secure the Company's
cash contingent payment obligation in connection with the Jeri-Jo acquisition),
with the aggregate credit available to the Company equal to the lesser of (i)
$175.0 million or (ii) the sum of 85% of eligible accounts receivable and 60% of
eligible inventory. Interest on outstanding borrowings will be determined, at
the Company's option, based upon stated margins below the prime rate or in
excess of LIBOR rates. The interest rate under the New Financing Agreement will
be 0.75% below the prime rate (based upon the current prime rate, the interest
rate under the New Financing Agreement will be 7.75% per annum) for the first
six months, and thereafter, will be determined by grid pricing based upon
certain financial ratios set forth therein.
On June 18, 1998, the Company also closed the sale of $125.0 million
of 12 1/2% Senior Notes due 2005 (the "Senior Notes"), which are governed by an
indenture (the "Indenture"). The Company's obligations under the Senior Notes
are guaranteed by all of the Company's subsidiaries. Interest on the Senior
Notes will be payable semiannually on June 1 and December 1 of each year
commencing on December 1, 1998. The Company may not redeem the Notes prior to
June 1, 2003. On or after such date, the Company may redeem the Notes, in whole
or in part, at any time, at redemption prices set forth in the Indenture. In
addition, at any time prior to June 1, 2001, the Company may redeem up to 35% of
the aggregate principal amount of Senior Notes originally issued under the
Indenture at a redemption price of 112.50% thereof, plus accrued and unpaid
interest, if any, thereon to the redemption date, with the net cash proceeds of
an offering of the Company's Common Stock.
The New Financing Agreement contains a number of restrictive
covenants, including covenants which limit the incurrence of liens and
indebtedness, limit transactions with affiliates, acquisitions, sales of assets,
investments and other restricted payments, and require that the Company maintain
certain fixed charge coverage, cash flow coverage and leverage ratios and meet
specified minimum levels of working capital and net worth. The Indenture
contains a number of restrictive covenants, including covenants which limit the
incurrence of liens and indebtedness, and restricted payments, as defined
therein.
The Company anticipates that in the remainder of fiscal 1998 it will
incur capital expenditures of approximately $1.3 million to $1.5 million,
principally in connection with the upgrade of its management information
systems, which includes the Company's migration to a new financial reporting
system during fiscal 1998, on which it expects to incur approximately $500,000
(see "The Year 2000 Issue"). The Company expects to finance these capital
expenditures from internally generated funds and advances under the New
Financing Agreement. Additional expenditures will be required to modify portions
of the Company's software so that it will function properly in the year 2000.
Maintenance or modification costs will be expensed as incurred, while the costs
of new software will be capitalized and amortized over the software's useful
life.
16
<PAGE>
The Company's Board of Directors has authorized a stock repurchase
program, under which the Company may repurchase up to $7.5 million of the
Company's Common Stock. The Company expects that the shares may be purchased
from time to time in the open market and in block transactions. As of May 2,
1998, the Company has purchased a total of 651,000 shares at an aggregate cost
of approximately $5.5 million. The New Financing Agreement and the Indenture
limit the amount of shares that can be repurchased.
Management believes that cash generated from operations and advances
under the New Financing Agreement will provide sufficient cash resources to
finance the Company's working capital and capital expenditure requirements for
the current and next fiscal year.
The moderate rate of inflation over the past few years has not had a
significant impact on the Company's sales or profitability. Inflation is not
expected to have a significant impact on the Company's business.
Seasonality
- -----------
Historically, the Company has achieved its highest sales in the fourth
quarter and, to a lesser extent, the second quarter of each fiscal year. As a
result of the acquisition of Miss Erika, the Company anticipated that it would
experience its highest sales in the second quarter, followed by the fourth
quarter. As a result of the acquisition of Jeri-Jo, the Company anticipates that
it will experience its highest sales in the second and fourth quarters equally.
This pattern results primarily from the timing of shipments for each season,
although the timing of shipments can vary from quarter to quarter and season to
season. Spring season merchandise is generally shipped in the Company's second
fiscal quarter between February and April, and fall season merchandise is
generally shipped in the Company's fourth fiscal quarter between August and
October.
The Year 2000 Issue
- -------------------
The year 2000 issue is the result of computer programs being written
using two digits rather than four digits to define the applicable year. Any of
the Company's computer programs that have time-sensitive software 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 a temporary inability to process transactions, send invoices, or
engage in similar normal business activities.
The Company has assessed that additional expenditures will be required
to modify certain portions of the Company's existing software so that it will
function properly in the year 2000. Preliminary estimates of the total costs to
be incurred on existing software prior to the year 2000 are immaterial and will
not have a material impact on the Company's business, operations or its
financial condition. However, in connection with the Company's year 2000
compliance program, it intends to migrate to a new financial reporting system
during fiscal 1998, on which it expects to incur approximately $500,000.
The Company has initiated formal communications with all of its
significant suppliers and customers to determine the extent to which the
Company's interface systems are vulnerable to those third parties' failure to
remedy their own year 2000 issues. The Company's total year 2000 project cost
and estimates to complete include the estimated costs and time associated with
the impact of third party year 2000 issues based on presently available
information. However, there can be no assurances that the systems of other
companies on which the Company's systems rely will be timely converted and would
not have an adverse effect on the Company's systems.
17
<PAGE>
PART II. OTHER INFORMATION
Item 1. Legal Proceedings
Norton has exclusive, long-term agreements with two independent
contractors which provide it with finished goods distribution services (Railroad
Enterprises, Inc.) and domestic cutting services (Cutting Edge Services, Inc.,
formerly Toni-Linda Productions, Inc.). In April 1998, in response to Norton's
notice of an intention not to renew its agreements with its distribution and
cutting contractors, Norton received a letter from their attorney alleging that
Norton had breached its agreements and, as a result, alleging that such
contractors had incurred substantial damages. Norton does not believe that it
has breached any of its agreements with these contractors, believes that it has
meritorious defenses to any claim, and will vigorously defend any proceeding.
Under the terms of the agreements with these contractors, claims against Norton
are to be resolved through arbitration proceedings. There can be no assurance
that Norton would be successful in defending any such claim, if made, or that
any determination rendered would not have a material adverse effect on the
business, financial condition and results of operations of the Company.
The Company is involved in certain other legal actions and claims
arising in the ordinary course of business. It is the opinion of management
that such litigation and claims will be resolved without material adverse effect
on the Company's financial position, results of operations and cash flow.
Item 4. Submission of matters to vote of security holders.
The Company's annual meeting of stockholders was held on April 6, 1998. The
following directors were elected:
<TABLE>
<CAPTION>
WITHHOLDING
NAME FOR AUTHORITY
---- --- ---------
<S> <C> <C>
Sanford Greenberg 6,714,071 10,587
Peter Boneparth 6,714,071 10,587
Amanda J. Bokman 6,714,071 10,587
David M. Blumberg 6,714,071 10,587
Stuart Bregman 6,714,071 10,587
Bradley P. Cost 6,714,071 10,587
Jerald S. Politzer 6,714,071 10,587
</TABLE>
The 1998 Long Term Incentive Plan was approved with 4,705,258 shares voting in
favor, 700,738 shares voting against and 10,000 shares abstaining.
The Stock Option Plan for non-employee Directors was approved with 4,769,883
shares voting in favor, 636,038 shares voting against and 10,075 shares
abstaining.
The appointment of Ernst and Young LLP as independent auditors for the fiscal
year ended October 31, 1998 was ratified with 6,702,858 shares voting in favor,
11,900 shares voting against and 9,900 shares abstaining.
Item 6. Exhibits and Reports on Form 8-K
a) Exhibit 3.1 Certificate of Incorporation of Norton McNaughton,
Inc., as amended (incorporated herein by reference to
Exhibit 3 to the Registrant's Quarterly Report on Form
10-Q for the quarter ended May 5, 1995).
Exhibit 3.2 By-Laws of the Company (incorporated herein by
reference to Exhibits to the Registrant's Registration
Statement on Form S-1 No. 33-74200).
Exhibit 10.1 Third Amendment, dated as of June 12, 1998, to the
Financing Agreement, dated as of September 25, 1997, as
amended, by and among Norton McNaughton, Inc., Norton
McNaughton of Squire, Inc., Miss Erika, Inc., the
lenders to the Financing Agreement, NationsBanc
Commercial Corporation and the CIT Group/Commercial
Services, Inc.
Exhibit 27 Financial Data Schedule (For SEC use only).
18
<PAGE>
b) The Registrant filed a Current Report on Form 8-K on April 22, 1998
reporting under Item 5, "Other Events" and Item 7, "Exhibits." The
Registrant filed two current reports on Form 8-K subsequent to May 2,
1998 under Item 5, "Other Events" and Item 7, "Exhibits."
19
<PAGE>
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
NORTON MCNAUGHTON, INC.
-----------------------
(Registrant)
Date: June 22, 1998 By /s/Amanda J. Bokman
---------------------
AMANDA J. BOKMAN
Vice President, Chief Financial Officer,
Secretary and Treasurer
(Duly Authorized Officer and Principal
Financial and Accounting Officer)
20
<PAGE>
Exhibit 10.1
Third Amendment, dated as of June 12, 1998 to the Financing Agreement,
dated as of September 25, 1997, as amended and supplemented prior to the date
hereof, (as so amended and supplemented, the "Financing Agreement"), by and
among Norton McNaughton, Inc., a Delaware corporation (the "Company"), Norton
McNaughton of Squire, Inc., a New York corporation ("Squire"), Miss Erika, Inc.,
a Delaware corporation formerly known as ME Acquisition Corp. ("Miss Erika" and
together with Squire, each a "Borrower" and collectively, the "Borrowers"), the
lenders listed on Schedule 1.01A to the Financing Agreement (each a "Lender" and
collectively the "Lenders"), NationsBanc Commercial Corporation, as collateral
agent for the Lenders (in such capacity, the "Collateral Agent") and The CIT
Group/Commercial Services, Inc., as administrative agent for the Lenders (in
such capacity, the "Administrative Agent" and together with the Collateral
Agent, each an "Agent" and collectively, the "Agents").
The Company, the Borrowers, the Lenders and the Agents desire to amend
the Financing Agreement on the terms and conditions hereafter set forth.
Accordingly, the Company, the Borrowers, the Agents and the Lenders hereby agree
as follows:
1. Definitions. All capitalized terms used herein and not otherwise
-----------
defined herein are used herein as defined in the Financing Agreement.
2. Financial Covenants.
-------------------
(a) Tangible Net Worth. Section 7.02(p)(i) of the Financing
-------------------
Agreement is hereby amended by deleting the amount corresponding to the Fiscal
Quarter ending May 2, 1998 and substituting in lieu thereof $35,400,000.
(b) Working Capital. Section 7.02(p)(iii) of the Financing
----------------
Agreement is hereby amended by deleting the amount corresponding to the Fiscal
Quarter ending May 2, 1998 and substituting in lieu thereof, $39,400,000.
(c) Fixed Charge Coverage Ratio. Section 7.02(p)(iv) of the
---------------------------
Financing Agreement is hereby amended by deleting the ratio corresponding to the
Fiscal Quarter ending May 2, 1998 and substituting in lieu thereof, 1.50:1.0.
(d) Cash Flow Ratio. Section 7.02(p)(v) of the Financing
----------------
Agreement is hereby amended by deleting the ratio corresponding to the Fiscal
Quarter ending May 2, 1998 and substituting in lieu thereof 2.30:1.0
3. Conditions to Effectiveness. This Amendment shall become
---------------------------
effective only upon satisfaction in full of the following conditions precedent
(the first date upon which all such conditions shall have been satisfied being
herein called the "Amendment Effective Date"):
(a) The representations and warranties contained in this
Amendment and in Article VI of the Financing Agreement shall be correct in all
material respects on and as of the Amendment Effective Date as though made on
and as of such date (except where such representations and warranties relate to
an earlier date in which case such representations and warranties shall be true
and correct as of such earlier date); no Event of Default or Default shall have
occurred and be continuing on the Amendment Effective Date, or result from this
Amendment becoming effective in accordance with its terms.
(b) The Agents shall have received counterparts of this Amendment
which bear the signatures of the Company, the Borrowers and each of the Lenders.
(c) All legal matters incident to this Amendment shall be
satisfactory to the Agents and their counsel.
4. Representations and Warranties. Each of the Company and the
------------------------------
Borrowers represents and warrants to the Lenders as follows:
(a) The Company and each Borrower (i) is duly organized, validly
existing and in good standing under the laws of the state of its organization
and (ii) has all requisite power, authority and legal right to execute, deliver
and perform this Amendment, and to perform the Financing Agreement, as amended
hereby.
(b) The execution, delivery and performance by the Company and
the Borrowers of this Amendment and the performance by the Company and the
Borrowers of the Financing Agreement as amended hereby (i) have been duly
authorized by all necessary action, (ii) do not and will not violate or create a
default under the Company's or any Borrower's organizational documents, any
applicable law or any contractual restriction binding on or otherwise affecting
the Company or any Borrower or any of the Company's or such Borrower's
properties, and (iii) except as provided in the Loan Documents, do not and will
not result in or require the creation of any Lien, upon or with respect to the
Company's or any Borrower's property.
<PAGE>
(c) No authorization or approval or other action by, and no
notice to or filing with, any Governmental Authority or other regulatory body is
required in connection with the due execution, delivery and performance by the
Company or any of the Borrowers of this Amendment and the performance by the
Company and the Borrowers of the Financing Agreement as amended hereby.
(d) This Amendment and the Financing Agreement, as amended
hereby, constitute the legal, valid and binding obligations of the Company and
the Borrowers party thereto, enforceable against such Persons in accordance with
their terms except to the extent the enforceability thereof may be limited by
any applicable bankruptcy, insolvency, reorganization, moratorium or similar
laws from time to time in effect affecting generally the enforcement of
creditors' rights and remedies and by general principles of equity.
(e) The representations and warranties contained in Article VI of
the Financing Agreement are correct on and as of the Amendment Effective Date as
though made on and as of the Amendment Effective Date (except to the extent such
representations and warranties expressly relate to an earlier date), and no
Event of Default or Default, has occurred and is continuing on and as of the
Amendment Effective Date.
5. Continued Effectiveness of Financing Agreement. Each of the
----------------------------------------------
Company and the Borrowers hereby (i) confirms and agrees that each Loan Document
to which it is a party is, and shall continue to be, in full force and effect
and is hereby ratified and confirmed in all respects except that on and after
the Amendment Effective Date of this Amendment all references in any such Loan
Document to "the Financing Agreement", "thereto", "thereof", "thereunder" or
words of like import referring to the Financing Agreement shall mean the
Financing Agreement as amended by this Amendment, and (ii) confirms and agrees
that to the extent that any such Loan Document purports to assign or pledge to
the Collateral Agent, or to grant to the Collateral Agent a Lien on any
collateral as security for the Obligations of the Company and the Borrowers from
time to time existing in respect of the Financing Agreement and the Loan
Documents, such pledge, assignment and/or grant of a Lien is hereby ratified and
confirmed in all respects.
6. Miscellaneous.
-------------
(a) This Amendment may be executed in any number of counterparts
and by different parties hereto in separate counterparts, each of which shall be
deemed to be an original, but all of which taken together shall constitute one
and the same agreement.
(b) Section and paragraph headings herein are included for
convenience of reference only and shall not constitute a part of this Amendment
for any other purpose.
(c) This Amendment shall be governed by, and construed in
accordance with, the laws of the State of New York.
(d) The Borrowers will pay on demand all reasonable out-of-pocket
costs and expenses of the Agents in connection with the preparation, execution
and delivery of this Amendment, including, without limitation, the reasonable
fees, disbursements and other charges of Schulte Roth & Zabel LLP, counsel to
the Agents.
<PAGE>
IN WITNESS WHEREOF, the parties hereto have caused this Amendment to
be executed by their respective officers thereunto duly authorized as of the day
and year first above written.
NORTON MCNAUGHTON, INC.
By:_____________________________________
Title:__________________________________
NORTON MCNAUGHTON OF SQUIRE, INC.
By:_____________________________________
Title:__________________________________
MISS ERIKA, INC.
By:_____________________________________
Title:__________________________________
AGENTS AND LENDERS
------------------
THE CIT GROUP/COMMERCIAL SERVICES,
INC., as Administrative Agent and Lender
By:_____________________________________
Title:__________________________________
NATIONSBANC COMMERCIAL
CORPORATION, as Collateral Agent and Lender
By:_____________________________________
Title:__________________________________
LENDERS
BANKBOSTON, N.A.
By:_____________________________________
Title:__________________________________
<PAGE>
FLEET BANK, N.A.
By:_____________________________________
Title:__________________________________
PNC BANK, NATIONAL ASSOCIATION
By:_____________________________________
Title:__________________________________
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM SEC 10-Q
AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS.
</LEGEND>
<MULTIPLIER> 1,000
<CURRENCY> U.S. DOLLARS
<S> <C>
<PERIOD-TYPE> 6-MOS
<FISCAL-YEAR-END> OCT-31-1998
<PERIOD-START> NOV-02-1997
<PERIOD-END> MAY-02-1998
<EXCHANGE-RATE> 1
<CASH> 160
<SECURITIES> 0
<RECEIVABLES> 69,264
<ALLOWANCES> 0
<INVENTORY> 35,583
<CURRENT-ASSETS> 112,900
<PP&E> 9,290
<DEPRECIATION> 2,951
<TOTAL-ASSETS> 130,879
<CURRENT-LIABILITIES> 76,003
<BONDS> 0
0
0
<COMMON> 81
<OTHER-SE> 42,565
<TOTAL-LIABILITY-AND-EQUITY> 130,879
<SALES> 147,624
<TOTAL-REVENUES> 147,624
<CGS> 118,191
<TOTAL-COSTS> 24,715
<OTHER-EXPENSES> 0
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<INCOME-CONTINUING> 471
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<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 471
<EPS-PRIMARY> 0.06
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