<PAGE> 1
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 6, 2000
--------------------------------
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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McNaughton Apparel Group Inc.
-----------------------------
(Exact name of registrant as specified in its charter)
<TABLE>
<S> <C>
Delaware 13-3747173
------------------------------------------------------------------ --------------------------------------
(State or other jurisdiction of incorporation or organization) (I.R.S. Employer Identification No.)
</TABLE>
463 Seventh Avenue, New York, N.Y. 10018
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(Address of principal executive offices)
(Zip code)
(212) 947-2960
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(Registrant's telephone number, including area code)
----------------------------------------------------------------------
(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, $0.01 Par Value, 7,588,219 shares as of June 15, 2000.
<PAGE> 2
INDEX TO FORM 10-Q
MCNAUGHTON APPAREL GROUP INC.
<TABLE>
<CAPTION>
PAGE NO.
PART I. FINANCIAL INFORMATION
<S> <C>
ITEM 1.
Financial Statements:
Consolidated Balance Sheets at May 6, 2000 (Unaudited) and November 6, 1999 3
Consolidated Statements of Operations for the thirteen weeks and twenty-six weeks ended
May 6, 2000 and May 1, 1999 (Unaudited) 4
Consolidated Statements of Stockholders' Equity for the twenty-six weeks ended
May 6, 2000 (Unaudited) 5
Consolidated Statements of Cash Flows for the twenty-six weeks ended May 6, 2000
and May 1, 1999 (Unaudited) 6
Notes to Consolidated Financial Statements (Unaudited) 7-12
ITEM 2.
Management's Discussion and Analysis of Financial Condition and Results of Operations 13-18
ITEM 3.
Quantitative and Qualitative Disclosures About Market Risk 19
PART II. OTHER INFORMATION
ITEM 1.
Legal Proceedings 20
ITEM 4.
Submission of Matters to Vote of Security Holders 21
ITEM 6.
Exhibits and Reports on Form 8-K 21
</TABLE>
2
<PAGE> 3
PART I - FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
McNaughton Apparel Group Inc.
Consolidated Balance Sheets
<TABLE>
<CAPTION>
May 6, 2000 November 6, 1999
(Unaudited)
--------------------------------
(In Thousands)
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents $ 191 $ 13,842
Due from factor 107,774 82,189
Inventory 34,061 40,917
Prepaid income taxes - 2,145
Prepaid expenses and other current assets 3,679 3,787
--------- ---------
Total current assets 145,705 142,880
Fixed assets, net 11,886 10,177
Notes receivable from management stockholders 2,095 2,287
Intangible assets, net 61,035 63,198
Deferred financing costs, net 6,103 6,642
Other assets 2,258 2,914
--------- ---------
Total assets $ 229,082 $ 228,098
========= =========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 10,192 $ 14,237
Revolving credit loan 7,186 725
Income taxes payable 3,294 7,151
Accrued expenses and other current liabilities 16,312 27,160
--------- ---------
Total current liabilities 36,984 49,273
12 1/2% Senior Notes due 2005 125,000 125,000
Other long-term liabilities 2,782 3,758
--------- ---------
Total liabilities 164,766 178,031
--------- ---------
Commitments and contingencies
Stockholders' equity:
Common stock, $0.01 par value, authorized 30,000,000 and 20,000,000 shares,
respectively, 8,376,388 and 8,096,324 shares issued, respectively,
and 7,575,588 and 7,445,324 shares outstanding, respectively 84 81
Capital in excess of par 26,440 23,989
Retained earnings 44,481 31,532
Treasury stock, at cost, 800,800 shares and 651,000 shares, respectively (6,689) (5,535)
--------- ---------
Total stockholders' equity 64,316 50,067
--------- ---------
Total liabilities and stockholders' equity $ 229,082 $ 228,098
========= =========
</TABLE>
See accompanying notes.
3
<PAGE> 4
MCNAUGHTON APPAREL GROUP INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
<TABLE>
<CAPTION>
Thirteen Weeks Ended Twenty-Six Weeks Ended
--------------------- ----------------------
May 6, 2000 May 1, 1999 May 6, 2000 May 1, 1999
----------- ----------- ----------- -----------
(In Thousands, Except Per Share Amounts)
<S> <C> <C> <C> <C>
Net sales $ 162,376 $ 123,972 $ 250,094 $ 190,591
Cost of goods sold 116,781 95,184 180,637 146,636
--------- --------- --------- ---------
Gross profit 45,595 28,788 69,457 43,955
Selling, general and administrative expenses 20,405 17,511 34,595 30,810
Depreciation and amortization 1,942 1,005 3,892 2,036
--------- --------- --------- ---------
Income from operations 23,248 10,272 30,970 11,109
Other expense (income):
Interest expense and amortization of deferred financing costs 4,966 4,780 9,293 9,286
Interest income (77) (40) (270) (147)
--------- --------- --------- ---------
Income before provision for income taxes 18,359 5,532 21,947 1,970
Provision for income taxes 7,527 2,490 8,998 887
--------- --------- --------- ---------
Net income $ 10,832 $ 3,042 $ 12,949 $ 1,083
========= ========= ========= =========
BASIC EARNINGS PER SHARE:
Net income $ 1.44 $ 0.41 $ 1.74 $ 0.15
========= ========= ========= =========
Weighted average number of common shares 7,513 7,428 7,451 7,424
========= ========= ========= =========
DILUTED EARNINGS PER SHARE:
Net income $ 1.32 $ 0.41 $ 1.60 $ 0.15
========= ========= ========= =========
Weighted average number of common shares assuming dilution 8,211 7,494 8,084 7,457
========= ========= ========= =========
</TABLE>
See accompanying notes.
4
<PAGE> 5
MCNAUGHTON APPAREL GROUP INC.
CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY
FOR THE TWENTY-SIX WEEKS ENDED MAY 6, 2000
(UNAUDITED)
<TABLE>
<CAPTION>
Common Stock Capital
------------ in Excess
Shares Amount of Par
------ ------ ------
(In Thousands)
<S> <C> <C> <C>
Balance at November 6, 1999 8,096 $81 $23,989
Net income for the twenty-six weeks
ended May 6, 2000 - - -
Treasury stock acquired, 149,800
shares, at cost - - -
Issuance of 216,995 shares for Miss Erika
earn-out obligation 216 2 2,002
Exercise of 57,296 stock options 57 1 374
Tax benefit from exercise of stock
options - - 32
Issuance of 7,073 shares of common
stock through the employee
stock purchase plan 7 - 43
----- --- -------
Balance at May 6, 2000 8,376 $84 $26,440
===== === =======
</TABLE>
<TABLE>
<CAPTION>
Retained Treasury
Earnings Stock Total
-------- ----- -----
(In Thousands)
<S> <C> <C> <C>
Balance at November 6, 1999 $31,532 $(5,535) $50,067
Net income for the twenty-six weeks
ended May 6, 2000 12,949 - 12,949
Treasury stock acquired, 149,800
shares, at cost - (1,154) (1,154)
Issuance of 216,995 shares for Miss Erika
earn-out obligation - - 2,004
Exercise of 57,296 stock options - - 375
Tax benefit from exercise of stock
options - - 32
Issuance of 7,073 shares of common
stock through the employee
stock purchase plan - - 43
------- ------- -------
Balance at May 6, 2000 $44,481 $(6,689) $64,316
======= ======= =======
</TABLE>
See accompanying notes.
5
<PAGE> 6
MCNAUGHTON APPAREL GROUP INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
<TABLE>
<CAPTION>
Twenty-Six Weeks Ended
----------------------
May 6, 2000 May 1, 1999
------------------------------
(In Thousands)
<S> <C> <C>
Net income $ 12,949 $ 1,083
Adjustments to reconcile net income to net cash (used for) provided by operating
activities:
Depreciation and amortization of fixed assets 1,212 925
Amortization of intangible assets and deferred financing costs 3,473 1,740
Changes in operating assets and liabilities:
Due from factor (25,585) 6,756
Inventory 6,856 8,311
Prepaid income taxes 2,145 (177)
Prepaid expenses and other current assets (860) (511)
Other assets 656 182
Accounts payable (4,045) (9,398)
Income taxes payable (3,857) 287
Accrued expenses and other current liabilities (848) 617
Other long-term liabilities 1,024 (31)
-------- --------
Net cash (used for) provided by operating activities (6,880) 9,784
-------- --------
INVESTING ACTIVITIES
Repayment of notes receivable from management stockholders 192 -
Additional purchase price to Miss Erika (9,546) (92)
Purchase of fixed assets (2,921) (1,616)
-------- --------
Net cash used for investing activities (12,275) (1,708)
-------- --------
FINANCING ACTIVITIES
Purchase of treasury stock (1,154) -
Net advances (repayments) of revolving credit loans 6,461 (3,839)
Proceeds from issuance of common stock 450 28
Deferred financing costs (253) (286)
-------- --------
Net cash provided by (used for) financing activities 5,504 (4,097)
-------- --------
Increase (decrease) in cash and cash equivalents (13,651) 3,979
Cash and cash equivalents at beginning of period 13,842 205
-------- --------
Cash and cash equivalents at end of period $ 191 $ 4,184
======== ========
SUPPLEMENTAL DISCLOSURES
Income taxes paid $ 8,668 $ 230
Interest paid $ 8,765 $ 8,070
</TABLE>
See accompanying notes.
6
<PAGE> 7
MCNAUGHTON APPAREL GROUP INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
ORGANIZATION AND PRINCIPLES OF CONSOLIDATION
BASIS OF PRESENTATION
The accompanying unaudited consolidated financial statements of McNaughton
Apparel Group Inc. and its wholly-owned 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 6, 2000 and the results of operations for the thirteen
and twenty-six weeks ended May 6, 2000 and May 1, 1999 and cash flows for the
twenty-six weeks ended May 6, 2000 and May 1, 1999 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 6, 2000 are not necessarily
indicative of the results that may be expected for the fiscal year ending
November 4, 2000.
The consolidated financial statements include the accounts of McNaughton
Apparel Group Inc. and its wholly-owned subsidiaries. All material intercompany
balances and transactions have been eliminated in consolidation.
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.
The Company changed its name from Norton McNaughton, Inc. to McNaughton
Apparel Group Inc. on February 9, 1999. On March 13, 2000, the Company's
authorized, $0.01 par value, Common Stock ("Common Stock") increased to
30,000,000 shares from 20,000,000 shares.
DEFERRED FINANCING COSTS
Deferred financing costs were incurred in connection with obtaining the
Company's current revolving credit agreement and the Company's issuance of
$125.0 million 12 1/2% Senior Notes due 2005 (the "Senior Notes"). Such deferred
financing costs are being amortized on a straight-line basis over the three-year
term of the current financing agreement and over the seven-year term of the
Senior Notes.
REVENUE RECOGNITION
Revenues are recorded at the time of shipment of merchandise. The Company
establishes reserves for sales discounts, returns and allowances. Sales
discounts represent customary trade discounts which may be negotiated with the
Company's customers as a payment term of the sale. Sales allowances represent
sales rebates which may be granted to customers and other miscellaneous
deductions from accounts receivable. The Company records sales discounts granted
as a reduction of sales at the time of shipment. Sales returns and allowances
are reserved for as a reduction of sales based upon estimated future returns and
allowances related to current sales.
INTANGIBLE ASSETS
Goodwill, trademarks and tradenames resulting from the acquisition of Miss
Erika, Inc. ("Miss Erika") and Jeri-Jo Knitwear, Inc. ("Jeri-Jo") are being
amortized by the straight-line method over twenty years. The Miss Erika and
Jeri-Jo earn-out payments are being treated as additional goodwill and amortized
over the remainder of the twenty year period following the original dates of
acquisition.
Intangible contract rights acquired in connection with the agreement
entered into on August 9, 1999 with Railroad Enterprises, Inc. ("Railroad") and
Cutting Edge Services, Inc., formerly Toni-Linda Productions, Inc. ("Cutting
Edge") (the "Agreement"), are being amortized over the term of the management
arrangement provided for in the Agreement. These intangible contract rights
have been recorded as current assets.
7
<PAGE> 8
MCNAUGHTON APPAREL GROUP INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(UNAUDITED)
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
EARNINGS PER SHARE
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 6, 2000, the dilutive effect of options outstanding
during the period using the treasury stock method was approximately 698,000
shares and 633,000 shares, respectively. For the thirteen and twenty-six weeks
ended May 1, 1999, the dilutive effect of options outstanding during the period
using the treasury stock method was approximately 66,000 shares and 33,000
shares, respectively.
USE OF ESTIMATES
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the amounts reported in the consolidated financial
statements and accompanying notes. Actual results could differ from those
estimates.
2. ACQUISITIONS AND RELATED EARN-OUT OBLIGATIONS
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 purchase price of Miss Erika consisted of $24.0
million in cash paid at the closing, the assumption of $2.5 million of
indebtedness and certain other contractual obligations. In addition, the Company
agreed to pay an additional contingent payment in cash and/or the Company's
Common Stock based upon earnings achieved by Miss Erika for the two fiscal years
ended November 6, 1999. As originally agreed, the aggregate contingent payment
payable by the Company was equal to the amount by which four times the average
of Miss Erika's earnings before interest expense, income taxes, depreciation and
amortization, as defined in the Miss Erika purchase agreement ("Miss Erika
EBITDA"), for the two fiscal years ended November 6, 1999, exceeded $24.0
million. At the Company's discretion, the Company was permitted, subject to a
maximum number of shares, to pay all or any portion of the contingent payment in
shares of Common Stock. The Miss Erika purchase agreement, as originally
executed, limited the number of shares of Common Stock payable by the Company to
a number of shares which, after giving effect to their issuance, did not exceed
12% of the aggregate number of outstanding shares of Common Stock at the time of
payment. Following the early discounted payment of a portion of the Miss Erika
earn-out obligation described below, this percentage limit was amended to
2.822%. The Company has agreed to cause the shares of Common Stock issued as a
contingent payment to be registered under the Securities Act of 1933, as amended
(the "Securities Act").
On August 4, 1999, the Company retired, at a discount, 64.3% of the
earn-out obligation payable to the sellers of Miss Erika for $10.0 million in
cash. The portion of the earn-out obligation which was retired was owned by two
investment funds and their affiliates who were interested in monetizing their
portion of the contingent earn-out payment due to closure of the funds in which
these investments were held. The early cash payment saved the Company
approximately $10.0 million, net of consent fees of $1.2 million paid to senior
noteholders under the indenture dated as of June 18, 1998 governing the Senior
Notes (as amended, the "Indenture"), compared to what would have otherwise been
due and payable in February 2000. The remaining earn-out obligation,
representing 35.7%, continued to be governed by the original earn-out provisions
described above. This remaining interest was held substantially by members of
the current Miss Erika management team, none of whom desired to exercise the
option of receiving a discounted early payment of the contingent earn-out. Miss
Erika achieved Miss Erika EBITDA during fiscal 1998 and fiscal 1999 which
resulted in the payment of additional consideration under the remaining
interests of approximately $11.6 million. Payment was made in March 2000,
approximately $9.6 million of which was paid in cash and approximately $2.0
million of which was paid in Common Stock. The Company paid the cash portion of
the remaining contingent consideration from internally generated funds and
borrowings under the Company's revolving credit facility. All additional
consideration paid for Miss Erika has been accounted for as additional purchase
price and has been reflected in intangible assets.
Jeri-Jo
On June 18, 1998, the Company completed the acquisition of 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. The purchase price
8
<PAGE> 9
MCNAUGHTON APPAREL GROUP INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(UNAUDITED)
2. ACQUISITIONS AND RELATED EARN-OUT OBLIGATIONS (CONTINUED)
Jeri-Jo (continued)
paid in the Jeri-Jo acquisition was (i) $55.0 million in cash at the closing of
the acquisition and (ii) the assumption of indebtedness of $10.9 million and
certain other contractual obligations. In addition, the Company agreed to pay an
additional contingent payment in cash and its Common Stock 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. Such payment must be made no later than
August 29, 2000. The Jeri-Jo purchase agreement requires that the Company pay at
least 50% of the required contingent payment in cash and the Indenture limits
this cash payment to 75% of the total contingent payment. The number of shares
of Common Stock issuable in partial payment of the Jeri-Jo contingent payment
will be determined based upon the average closing prices of the Company's Common
Stock as reported on the NASDAQ Stock Market for the twenty trading days
preceding August 24, 2000. The aggregate contingent payment payable by the
Company is equal to the excess of (1) the sum of (A) five times Jeri-Jo's
average earnings before interest expense, income taxes, depreciation and
amortization, as defined in the Jeri-Jo purchase agreement ("Jeri-Jo EBITDA"),
for the two years ending June 30, 2000, plus (B) 0.50 times any such average
Jeri-Jo EBITDA between $17.0 million and $20.0 million, plus (C) one times any
such average Jeri-Jo EBITDA over $20.0 million, over (2) $55.0 million.
Additional consideration paid for Jeri-Jo will be accounted for as additional
purchase price and will be reflected in intangible assets. The Company partially
secured its obligation to pay the cash portion of the contingent payment by
delivery of a standby letter of credit in the face amount of $30.0 million,
which letter of credit may be drawn upon, in whole or in part, in certain
circumstances, including in the event of a default under the cash contingent
payment obligation. The Company has agreed to cause the shares of Common Stock
issued as a contingent payment to be registered under the Securities Act,
including, if requested, in an underwritten offering. The Jeri-Jo purchase
agreement provides that in certain events, the sellers under the Jeri-Jo
purchase agreement will have the option to accelerate the Company's contingent
payment obligation. In such events, the accelerated contingent payment
obligation would be payable in cash in an amount equal to the amount by which
(i) five times the greater of $17.0 million or an amount equal to Jeri-Jo's
annualized EBITDA (as defined in the Jeri-Jo purchase agreement) at the time of
such event exceeds (ii) $55.0 million. 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.
Jeri-Jo achieved Jeri-Jo EBITDA for the 22 month period ended May 6, 2000
which will result in the payment of significant additional consideration. Based
upon the Jeri-Jo EBITDA achieved for the 22 month period ended May 6, 2000, and
assuming that Jeri-Jo achieves its projected EBITDA for the period from May 7,
2000 through June 30, 2000 (the end of the Jeri-Jo earn-out period), additional
consideration in excess of $170.0 million would be payable in accordance with
the Jeri-Jo purchase agreement. The issuance of shares of Common Stock in
partial payment of the Jeri-Jo contingent payment will result in dilution to the
existing stockholders of the Company. The Company is engaged in preliminary
discussions with the principals of Jeri-Jo regarding the terms of payment of the
Jeri-Jo contingent payment. The Company cannot predict the outcome of these
discussions and, absent any other agreement, payment of the Jeri-Jo contingent
payment will be made in accordance with the terms of the Jeri-Jo purchase
agreement as described above.
3. SALES TO MAJOR CUSTOMERS
For the thirteen weeks ended May 6, 2000 and May 1, 1999, net sales made to
three customers were approximately 18.0%, 13.2%, and 11.6%, and approximately
21.6%, 12.1% and 10.9%, respectively. For the twenty-six weeks ended May 6, 2000
and May 1, 1999, net sales to three customers were approximately 17.4%, 13.3%
and 11.9%, and approximately 21.8%, 12.7% and 11.6%, respectively.
4. INVENTORY
Inventory is stated at the lower of cost (first-in, first-out basis) or market.
Inventories consist of the following:
<TABLE>
<CAPTION>
May 6, 2000 November 6, 1999
----------- ----------------
(In Thousands)
<S> <C> <C>
Raw materials $ 3,008 $ 3,116
Work in process 980 1,104
Finished goods 30,073 36,697
------ ------
$34,061 $40,917
======= =======
</TABLE>
9
<PAGE> 10
MCNAUGHTON APPAREL GROUP INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(UNAUDITED)
5. INTANGIBLE ASSETS
Intangible assets consist of the following:
<TABLE>
<CAPTION>
May 6, 2000 November 6, 1999
----------- ----------------
(In Thousands)
<S> <C> <C>
Tradenames and trademarks $17,585 $17,591
Goodwill 48,475 48,921
------ ------
66,060 66,512
Less: accumulated amortization 5,025 3,314
----- -----
$61,035 $63,198
======= =======
</TABLE>
6. NOTES RECEIVABLE FROM MANAGEMENT STOCKHOLDERS
In 1993, the Company loaned certain management stockholders $3.0 million 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. All necessary payments have been made under the terms of the
loans by the management stockholders.
As of May 6, 2000, the fair market value of the Company's Common Stock
pledged by the management stockholders as security for the loans was $6,705,000,
and the aggregate principal balance of all loans to management stockholders was
$2,095,000 which reflects the required principal payments of $905,000 resulting
from sales of Common Stock by management stockholders.
7. FINANCING ARRANGEMENTS
Concurrent with the closing of the Jeri-Jo acquisition on June 18, 1998,
the Company entered into a $175.0 million secured revolving credit and letter of
credit facility with a bank lending group (as amended, the "Current Credit
Agreement"). The facility is used to finance ongoing working capital
requirements of the Company and its subsidiaries. The Current Credit 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 at Banc of America, N.A. or in excess
of LIBOR rates. Presently, the interest rate under the Current Credit Agreement
is 125 basis points below the prime rate (based upon the current prime rate, the
interest rate under the Current Credit Agreement is 8.25% per annum). Available
credit under the Current Credit Agreement is as follows: revolving credit
advances not to exceed $60.0 million to $100.0 million (depending on the fiscal
month of the Company), documentary letters of credit not to exceed $130.0
million ("Documentary LCs"), standby letters of credit not to exceed $15.0
million ("Standby LCs"), and a $30.0 million standby letter of credit to
partially secure the Company's cash contingent payment obligation in connection
with the Jeri-Jo acquisition. Aggregate Documentary LCs and Standby LCs may not
exceed $130.0 million. Under the Current Credit Agreement, the aggregate credit
available to the Company is equal to the lesser of (i) $175.0 million or (ii)
the sum of 85% of eligible accounts receivable and 60% of eligible inventory,
plus an overadvance amount ranging from zero to $30.0 million depending on the
fiscal month of the Company and the time in such fiscal month. The Company and
its subsidiaries guarantee the Company's obligations under the Current Credit
Agreement and have granted a lien on substantially all of their respective
assets to secure the obligations under the Current Credit Agreement. The
weighted average interest rates on the revolving credit facility were 7.3% and
7.9% for fiscal 1999 and the first half of fiscal 2000, respectively. The
Company continues to factor accounts receivable pursuant to factoring
arrangements.
The Current Credit 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.
10
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MCNAUGHTON APPAREL GROUP INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(UNAUDITED)
7. FINANCING ARRANGEMENTS AND EXTRAORDINARY ITEM (CONTINUED)
On June 18, 1998, the Company also issued the Senior Notes due 2005. The
proceeds of the Senior Notes were used to finance the Jeri-Jo acquisition and to
refinance then existing indebtedness of the Company and Jeri-Jo. The Company's
obligations under the Senior Notes are unsecured and are guaranteed by all of
the Company's subsidiaries. The Indenture contains a number of restrictive
covenants, including covenants which limit the incurrence of liens and
indebtedness, limit transactions with affiliates, sales of assets, investments
and other restricted payments. On August 3, 1999, the Company executed the First
Supplemental Indenture, which amended the Indenture to provide for, among other
matters, the early extinguishment of a portion of the outstanding earn-out
obligation payable to certain of the sellers of Miss Erika and to restrict the
amount of cash (75% of total earn-out) that may be paid with respect to the
Company's earn-out obligation incurred in connection with its acquisition of
Jeri-Jo.
At May 6, 2000 under the Current Credit Agreement, the Company had
borrowings and letters of credit outstanding of $7.2 million and $126.4 million,
respectively. The Company had total additional available credit of $36.1 million
under the Current Credit Agreement as of that date pursuant to the borrowing
base formula set forth therein. In addition, the Company had cash and cash
equivalents totaling $191,000. At May 1, 1999, the Company had no borrowings
under the Current Credit Agreement and letters of credit outstanding of $91.5
million. The Company had total additional available credit of $39.4 million as
of May 1, 1999 pursuant to the borrowing base formula set forth therein, and
cash and cash equivalents totaling $4.2 million. The Company's available credit
under the Current Credit Agreement fluctuates based upon a number of seasonal
factors.
Long-term debt at May 6, 2000 and May 1, 1999 consisted of $125.0 million
12 1/2% Senior Notes due June 1, 2005. The Senior Notes mature in full on June
1, 2005. There are no required principal payments prior to the maturity date.
8. ACCRUED EXPENSES AND OTHER CURRENT LIABILITIES
Accrued expenses and other current liabilities consist of the following:
<TABLE>
<CAPTION>
May 6, November 6,
2000 1999
-------------------------
(In Thousands)
<S> <C> <C>
Miss Erika earn-out obligation $ - $10,000
Interest on $125.0 million 12 1/2%
Senior Notes 6,511 6,837
Contractual bonuses payable 2,528 2,706
Payable to Railroad and Cutting Edge
in connection with the Agreement 1,017 1,967
Reserve for litigation 932 932
Profit sharing contribution payable 401 879
Other accrued expenses and current
liabilities 4,923 3,839
------- -------
$16,312 $27,160
======= =======
</TABLE>
9. STOCK REPURCHASE
The Company's Board of Directors has authorized a stock repurchase program,
under which the Company may repurchase up to $11.5 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 6, 2000, the
Company has purchased a total of 800,800 shares at an aggregate cost of
approximately $6.7 million. The Company's Current Credit Agreement and the
Indenture limit the amounts which may be expended on stock purchases.
11
<PAGE> 12
MCNAUGHTON APPAREL GROUP INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(UNAUDITED)
10. LEGAL PROCEEDINGS
In August 1999, the Company and Norton McNaughton of Squire, Inc.
("Norton") entered into an Agreement with Railroad and Cutting Edge, pursuant to
which, among other matters, the lawsuit involving such persons was terminated
and Norton purchased certain assets of Railroad and Cutting Edge, including
fixed assets, machinery and equipment at their facilities, and Railroad's and
Cutting Edge's rights under their existing agreements with Norton. The purchase
price (the "Purchase Price") was $5.5 million, of which $408,333.33 remains
payable on June 30, 2000 and $100,000 remains payable on December 31, 2000. The
Agreement also provided for the termination of Norton's then existing long-term
agreements with Railroad and Cutting Edge. Railroad has agreed to manage the
assets Norton purchased and to continue performing all of Norton's receiving,
warehousing and distribution services from Railroad's New Jersey facilities
through July 31, 2000.
The Company is involved in certain 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 business, financial condition, results of operations and cash flow. At
May 6, 2000, the Company had a reserve for litigation of approximately $900,000
in connection with an ongoing claim.
11. 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 Common Stock held. Each right entitles the holder to purchase
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.
12
<PAGE> 13
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
General
The Company's business strategy is to expand its branded product lines,
broaden its customer base and further develop its global product sourcing
capabilities. A key component of this business strategy involves the selective
acquisition of complementary businesses and brands. In connection therewith, the
Company completed the Miss Erika and Jeri-Jo acquisitions.
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 purchase price of Miss Erika consisted of $24.0
million in cash paid at the closing, the assumption of $2.5 million of
indebtedness and certain other contractual obligations. In addition, the Company
agreed to pay an additional contingent payment in cash and/or Common Stock in
the event that certain earnings targets were achieved by Miss Erika for the two
fiscal years ended November 6, 1999. On August 4, 1999, the Company retired, at
a discount, 64.3% of the earn-out obligation payable to the sellers of Miss
Erika for $10.0 million in cash. The remaining earn-out obligation of
approximately $11.6 million, representing 35.7%, was paid in March 2000,
approximately $9.6 million of which was paid in cash and approximately $2.0
million of which was paid in Common Stock.
On June 18, 1998, the Company completed the acquisition of substantially
all of the assets of Jeri-Jo and assumed substantially all the liabilities of
the privately-held apparel importers of moderately-priced juniors' and misses'
updated sportswear. 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
funded indebtedness of $10.9 million and certain other contractual obligations.
In addition, the Company agreed to pay an additional contingent payment in cash
and Common Stock based upon certain earnings targets for Jeri-Jo for the two
years subsequent to the closing of the Jeri-Jo acquisition. See Item I, Note 2
and "Liquidity and Capital Resources".
Concurrent with the closing of the Jeri-Jo acquisition, the Company entered
into the Current Credit Agreement, a $175.0 million secured revolving credit and
letter of credit facility with a bank lending group. The facility is used to
finance ongoing working capital requirements of the Company and its
subsidiaries.
On June 18, 1998, the Company also sold $125.0 million of unsecured 12 1/2%
Senior Notes due 2005. The terms and conditions of the Senior Notes are governed
by the Indenture. The proceeds of the Senior Notes were used to finance the
Jeri-Jo acquisition and to refinance then existing indebtedness of the Company
and Jeri-Jo. The Company's obligations under the Senior Notes are guaranteed by
all of the Company's subsidiaries.
The Company's continuing focus on improving profitability has also led the
Company to undertake certain merchandising initiatives to improve gross profit
and gross profit margins with respect to the Norton McNaughton product lines.
The Company has reduced the number of products (i.e., reduced the number of
SKU's) offered in any particular collection of its Norton McNaughton product
lines in an effort to minimize the number of unrelated items unsold by retailers
at the end of a selling period and to reduce any related sales allowances. In
addition, by taking advantage of product sourcing opportunities, the Company has
been able to offer higher quality and more diverse products to retailers at
lower price points in an effort to further enhance sales of Norton McNaughton
products and to further reduce sales allowances. As a result of these
initiatives, the revenue levels in its Norton McNaughton product lines decreased
in fiscal 1999 from those recorded in fiscal 1998. However, the Company does not
anticipate a decrease in revenue levels in its Norton McNaughton product lines
in fiscal 2000 as a consequence of those initiatives.
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. The Company also continually explores
cost savings opportunities in an attempt to reduce overhead and improve
operating income.
The Company will finalize the relocation of the warehousing and
distribution operations for its Norton product lines to South Carolina in August
2000. Norton began receiving and shipping operations at this facility in May
2000. In August 1999, the Company and Norton entered into an agreement with
Railroad, its distribution contractor, and Cutting Edge, its cutting contractor,
which provided for the termination of its existing long-term agreements
therewith. Pursuant to the Agreement, Norton purchased certain assets of
Railroad and Cutting Edge, including fixed assets, machinery and equipment at
their facilities, and Railroad's and Cutting Edge's rights under their existing
agreements with Norton. Railroad has agreed to manage the assets Norton
purchased and to continue performing Norton's receiving, warehousing and
distribution services from Railroad's New Jersey facilities through July 31,
2000. See "Liquidity and Capital Resources".
13
<PAGE> 14
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. Accordingly, the Company's sales, gross profit and gross
profit margins vary from quarter to quarter and year to year. In addition, the
Company generally ships its products in accordance with normal apparel industry
shipping cycles. 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.
Correspondingly, sales, gross profit and gross profit margins may be affected by
the timing of shipping cycles or the delivery of finished goods.
The Company contracts for the manufacture of all of its products and
substantially all of its products are 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 for moderately-priced merchandise also
allows it to avail itself of a well-equipped and 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 Quarterly Report on Form 10-Q, including this Management's Discussion
and Analysis of Financial Condition and Results of Operations, contains
forward-looking information about the Company's anticipated operating results.
The Company's ability to achieve its projected results is dependent on many
factors which are outside of management's control. Some of the most significant
factors would be a deterioration in retailing conditions for women's and
juniors' apparel, an increase in price pressures and other competitive factors,
any of which could result in an unanticipated decrease in gross profit margins,
unanticipated problems arising with the integration of Miss Erika's and
Jeri-Jo's businesses, unanticipated delays or other production problems
associated with the foreign sourcing of inventory, the unanticipated loss of a
major customer, the unanticipated loss of a major contractor or supplier,
unanticipated problems arising out of Norton's relocation of its distribution
function to South Carolina where the activities will be performed "in-house",
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 will achieve its anticipated operating results.
14
<PAGE> 15
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
--------------------
May 6, 2000 May 1, 1999
----------- -----------
<S> <C> <C>
Net sales 100.0% 100.0%
Cost of goods sold 71.9 76.8
------ ------
Gross profit 28.1 23.2
Selling, general and administrative expenses 12.6 14.1
Depreciation and amortization 1.2 0.8
------ ------
Income from operations 14.3 8.3
Interest expense and amortization of deferred
financing costs 3.1 3.9
Interest income (0.1) (0.1)
------ ------
Income before provision for income taxes 11.3 4.5
Provision for income taxes 4.6 2.0
------ ------
Net income 6.7% 2.5%
====== ======
</TABLE>
<TABLE>
<CAPTION>
Twenty-Six Weeks Ended
----------------------
May 6, 2000 May 1,1999
----------- ----------
<S> <C> <C>
Net sales 100.0% 100.0%
Cost of goods sold 72.2 76.9
------ ------
Gross profit 27.8 23.1
Selling, general and administrative expenses 13.8 16.2
Depreciation and amortization 1.6 1.1
------ ------
Income from operations 12.4 5.8
Interest expense and amortization of deferred
financing costs 3.7 4.9
Interest income (0.1) (0.1)
------ ------
Income before provision for income taxes 8.8 1.0
Provision for income taxes 3.6 0.4
------ ------
Net income 5.2% 0.6%
====== ======
</TABLE>
Quarter Ended May 6, 2000 Compared to Quarter Ended May 1, 1999
Net Sales
Net sales were $162.4 million for the second quarter of fiscal 2000
compared to $124.0 million for the second quarter of fiscal 1999. The increase
in net sales of $38.4 million, or 31.0%, was attributable to an increase in net
sales of $14.9 million in the Erika product lines, an increase of $13.3 million
in the Energie, Currants and Jamie Scott product lines and a net increase of
$12.7 million in the Norton McNaughton and Norton Studio product lines.
Gross Profit
Gross profit margin was 28.1% for the second quarter of fiscal 2000
compared to 23.2% for the second quarter of fiscal 1999. The increase in gross
profit margin was attributable to the Energie, Currants and Jamie Scott product
lines and the Norton McNaughton product lines. The improvement in gross profit
margin was primarily attributable to increases in initial markup and decreases
in sales allowances.
Selling, General and Administrative Expenses
Selling, general and administrative expenses ("SG&A" expenses) were $20.4
million, or 12.6% of net sales, for the second quarter of fiscal 2000 as
compared to $17.5 million, or 14.1% of net sales, for the second quarter of
fiscal 1999. The increase in SG&A expense of $2.9 million was due primarily to
increases in personnel costs resulting from salary increases, bonuses and
accruals for benefits, as well as increases in headcount necessitated by an
increase in the volume of products shipped, expenses associated with Norton's
South Carolina warehouse, including rent and salaries, which commenced
operations during the second quarter of fiscal 2000, and an increase in variable
distribution expense due to an increase in sales volume. These increases were
offset in part by a decrease in shipping rates caused by a change in rates under
the agreement with an outside distribution contractor. The latter was offset by
amortization of the intangible assets acquired in the agreement with such
outside distribution contractor - see Depreciation and Amortization below. The
decrease in SG&A as a percentage of net sales was primarily attributable to the
spreading of the fixed component of SG&A expenses over higher net sales in the
second quarter of fiscal 2000.
Depreciation and Amortization
Depreciation and amortization was $1.9 million for the second quarter of
fiscal 2000 compared to $1.0 million for the second quarter of fiscal 1999. The
increase of $0.9 million was primarily attributable to amortization of goodwill
associated with the Miss Erika earn-out payment, for which payments were made in
installments in August 1999 and March 2000 (although the accrual of the
remaining Miss Erika earn-out obligation was made in October 1999) and
amortization of the intangibles resulting from the Agreement with Railroad and
Cutting Edge entered into in August 1999.
Interest Expense
Interest expense increased to $5.0 million in the second quarter of fiscal
2000 from $4.8 million in the second quarter of fiscal 1999. The increase of
$0.2 million was due primarily to an increase in amortization of deferred
financing costs resulting from fees incurred for amendments to the Indenture and
Current Credit Agreement and higher letter of credit fees due to higher balances
during the second quarter of fiscal 2000 compared to the second quarter of
fiscal 1999.
15
<PAGE> 16
Earnings Per Share Before Goodwill Amortization
Earnings per share before goodwill amortization increased in the second
quarter of fiscal 2000 to $1.36 per diluted share, from $0.43 per diluted share
in the second quarter of fiscal 1999.
Twenty-Six Weeks Ended May 6, 20000 Compared to Twenty-Six Weeks Ended May 1,
1999
Net Sales
Net sales were $250.1 million for the first half of fiscal 2000 compared to
$190.6 million for the first half of fiscal 1999. The increase in net sales of
$59.5 million, or 31.2%, was primarily attributable to an increase in net sales
of $23.6 million in the Erika product lines, an increase of $20.0 million in the
Energie, Currants and Jamie Scott product lines and an increase of $17.8 million
in the Norton McNaughton and Norton Studio product lines.
Gross Profit
The gross profit margin was 27.8% for the first half of fiscal 2000
compared to 23.1% for first half of fiscal 1999. The increase in gross profit
margin was attributable to the Energie, Currants and Jamie Scott product lines
and the Norton McNaughton product lines. The improvement in gross profit margin
was primarily attributable to increases in initial markup and decreases in sales
allowances.
Selling, General and Administrative Expenses
SG&A expenses were $34.6 million, or 13.8% of net sales, in the first half
of fiscal 2000 as compared to $30.8 million, or 16.2% of net sales, in the first
half of fiscal 1999. The increase in SG&A expense of $3.8 million was due
primarily to increases in personnel costs resulting from salary increases,
bonuses and accruals for benefits, as well as increases in headcount
necessitated by an increase in the volume of products shipped, expenses
associated with Norton's South Carolina warehouse, including rent and salaries,
which commenced operations during the second quarter of fiscal 2000, an increase
in variable distribution expense due to an increase in sales volume and an
increase in merchandising and advertising expense. These increases were offset
in part by a decrease in shipping rates caused by a change in rates under the
agreement with an outside distribution contractor. The latter was offset by
amortization of the intangible assets acquired in the agreement with such
outside distribution contractor - see Depreciation and Amortization below. The
decrease in SG&A as a percentage of net sales was primarily attributable to the
spreading of the fixed component of SG&A expenses over higher net sales in the
first half of fiscal 2000.
Depreciation and Amortization
Depreciation and amortization was $3.9 million for the first half of fiscal
2000 compared to $2.0 million for the first half of fiscal 1999. The increase of
$1.9 million was primarily attributable to the Miss Erika earn-out payment, for
which payments were made in installments in August 1999 and March 2000 (although
the accrual of the remaining Miss Erika earn-out obligation was made in October
1999) and amortization of the intangibles resulting from the Agreement with
Railroad and Cutting Edge entered into in August 1999.
Interest Expense
Interest expense remained constant at $9.3 million in the first half of
fiscal 2000 as compared to the first half of fiscal 1999. Increases in
amortization of deferred financing costs resulting from fees incurred for
amendments to the Indenture and Current Credit Agreement and letter of credit
fees due to higher balances were offset in full by the reversal of one week's
interest on the Senior Notes, which was accrued into the fourth quarter of
fiscal 1999, which was a 53 week year.
Earnings Per Share Before Goodwill Amortization
Earnings per share before goodwill amortization increased in the first half
of fiscal 2000 to $1.69 per diluted share, from $0.19 per diluted share in the
first half of fiscal 1999.
Liquidity and Capital Resources
The Company is highly leveraged and significant additional earn-out
payments will be required to be made by the Company in August 2000 in connection
with the Jeri-Jo acquisition. On May 6, 2000, the Company had $125.0 million of
Senior Notes outstanding, borrowings under the Current Credit Agreement of
approximately $7.2 million, obligations under undrawn letters of credit in the
aggregate face amount of approximately $96.4 million and a $30.0 million
standby letter of credit securing the Company's obligation to pay a portion of
the Jeri-Jo earn-out payment. Under the terms of its credit documentation, the
Company can incur substantial additional indebtedness in the future. Based upon
actual results of Miss Erika, the Company paid approximately $11.6 million in
additional consideration to certain of the sellers of Miss Erika in March 2000,
approximately $9.6 million of which was paid in cash and approximately $2.0
million of which was paid in shares of Common Stock. In addition, based on
Jeri-Jo's results of operations through May 6, 2000, and assuming Jeri-Jo
achieves its projected results through June 30, 2000, the Company will be
required to pay the sellers of Jeri-Jo in excess of $170.0 million in August
2000, with at least 50% thereof being payable in cash and the balance payable in
shares of Common Stock. In August 2000, based upon the Company's forecasts, the
Company anticipates that it will have in excess of $85.0 million in cash and
revolving credit advances available to fund the cash portion of such payment.
The issuance of shares of Common Stock in partial payment of the Jeri-Jo
contingent payment will result in dilution to the existing stockholders of the
Company. The
16
<PAGE> 17
Company is engaged in preliminary discussions with the principals of Jeri-Jo
regarding the terms of payment of the Jeri-Jo contingent payment. The Company
cannot predict the outcome of these discussions and, absent any other agreement,
payment of the Jeri-Jo contingent payment will be made in accordance with the
terms of the Jeri-Jo purchase agreement as described above. See Item I, Note 2.
The Company's ability to make earn-out payments and scheduled payments of
principal of, to pay the interest on, to increase availability of or to
refinance, as needed, its indebtedness, and to fund working capital requirements
and planned capital expenditures, will depend, in part, on its future
performance, which, to a certain extent, is subject to general economic,
financial, competitive, legislative, regulatory and other factors that are
beyond its control. Based upon current and forecasted levels of operations,
management believes that cash flow from operations, together with available
borrowings under the Current Credit Agreement, will be adequate to meet the
Company's liquidity needs for 2000.
The Company's liquidity requirements arise from the funding of the
Company's earn-out obligation pursuant to the acquisition of Jeri-Jo and,
additionally, from the Company's working capital needs, primarily inventory and
accounts receivable, interest on indebtedness and planned capital expenditures.
The Company's primary sources of working capital are cash flow from operations
and advances under the Current Credit Agreement. The Company's borrowing
requirements for working capital purposes are seasonal, with peak working
capital needs generally arising at the end of the first fiscal quarter and
extending through the second and third fiscal quarters. As the Company's
business continues to expand, the Company's need for additional working capital,
including under its Current Credit Agreement, will also increase.
The Company had working capital of $108.7 million at May 6, 2000 as
compared to $93.6 million at November 6, 1999. The increase in working capital
resulted primarily from net income for the twenty-six weeks ended May 6, 2000.
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. The factor receives a commission for all purchased accounts
receivable which is calculated based on the net amount of gross sales less sales
discounts.
Concurrent with the closing of the Jeri-Jo acquisition on June 18, 1998,
the Company entered into the Current Credit Agreement, a $175.0 million secured
revolving credit and letter of credit facility with a bank lending group. The
facility is used to finance ongoing working capital requirements of the Company
and its subsidiaries. The Current Credit 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 at Banc of America, N.A. or in excess of LIBOR rates. Presently,
the interest rate under the Current Credit Agreement is 125 basis points below
the prime rate (based upon the current prime rate, the interest rate under the
Current Credit Agreement is 8.25% per annum). Available credit under the Current
Credit Agreement is as follows: revolving credit advances not to exceed $60.0
million to $100.0 million (depending on the fiscal month of the Company),
Documentary LCs not to exceed $130.0 million, Standby LCs not to exceed $15.0
million, and a $30.0 million standby letter of credit to partially secure the
Company's cash contingent payment obligation in connection with the Jeri-Jo
acquisition. Aggregate Documentary LCs and Standby LCs may not exceed $130.0
million. Under the Current Credit Agreement, the aggregate credit available to
the Company is equal to the lesser of (i) $175.0 million or (ii) the sum of 85%
of eligible accounts receivable and 60% of eligible inventory, plus an
overadvance amount ranging from zero to $30.0 million depending on the fiscal
month of the Company and the time in such fiscal month. The Company and its
subsidiaries guarantee the Company's obligations under the Current Credit
Agreement and have granted a lien on substantially all of their respective
assets to secure the obligations under the Current Credit Agreement. The
weighted average interest rates on the revolving credit facility were 7.3% and
7.9% for fiscal 1999 and the first half of fiscal 2000, respectively. The
Company continues to factor accounts receivable pursuant to factoring
arrangements. The Current Credit 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.
On June 18, 1998, the Company also issued the Senior Notes due 2005. The
proceeds of the Senior Notes were used to finance the Jeri-Jo acquisition and to
refinance then existing indebtedness of the Company and Jeri-Jo. The Company's
obligations under the Senior Notes are unsecured and are guaranteed by all of
the Company's subsidiaries. The Indenture contains a number of restrictive
covenants, including covenants which limit the incurrence of liens and
indebtedness, limit transactions with affiliates, sales of assets, investments
and other restricted payments, as defined therein.
In August 1999, the Company and Norton entered into an agreement with
Railroad and Cutting Edge, pursuant to which, among other matters, contract
disputes were settled, Norton purchased certain assets of Railroad and Cutting
Edge, including fixed assets, machinery and equipment at their facilities, and
Railroad's and Cutting Edge's rights under their existing agreements with
Norton. The Purchase Price was $5.5 million, of which $408,333.33 remains
payable on June 30, 2000 and $100,000 remains payable on December 31, 2000. The
Agreement also provided for the termination of Norton's then existing long-term
agreements with Railroad (distribution) and Cutting Edge (cutting). Railroad has
agreed to manage the assets Norton purchased and to continue performing all of
Norton's receiving, warehousing and distribution services from Railroad's New
Jersey facilities through July 31, 2000. Norton began receiving and shipping
operations
17
<PAGE> 18
at its new warehouse and distribution facility in South Carolina in May 2000 and
anticipates that this facility will be fully operational in August 2000.
The Company's capital expenditures were approximately $2.9 million and $1.6
million in the first half of fiscal 2000 and the first half of fiscal 1999,
respectively. The Company anticipates that in the remainder of fiscal 2000, it
will incur capital expenditures of approximately $3.5 million to $4.5 million,
primarily in connection with Norton's new warehouse and distribution facility in
South Carolina, which includes an automated materials handling system,
management information systems, including hardware and software, machinery and
equipment and furniture and fixtures, and a new operating system for the Company
which will address production, sales and order fulfillment functions. This
operating system will first be implemented at Miss Erika, with anticipated
implementation at Norton and Jeri-Jo during fiscal 2001 and fiscal 2002,
respectively. The Company expects to finance these capital expenditures from
internally generated funds and advances under the Current Credit Agreement.
The Company's Board of Directors has authorized a stock repurchase program,
under which the Company may repurchase up to $11.5 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 6, 2000, the
Company has purchased a total of 800,800 shares at an aggregate cost of
approximately $6.7 million. The Company's Current Credit Agreement and the
Indenture limit the amounts which may be expended on stock purchases.
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 Miss Erika and Jeri-Jo acquisitions, the Company anticipates that
it will experience its highest sales in the second quarter and, to a lesser
extent, the fourth quarter of each fiscal year. 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 Company believes it has resolved the potential impact of the year 2000
(the "Year 2000") on its processing of date sensitive information and network
systems.
The Company, to date, has not experienced any negative effects due to the
Year 2000 problem, either internally or with its customers or vendors. If the
Company encounters Year 2000 problems during the year 2000, and if customers or
vendors cannot rectify Year 2000 issues, the Company could incur additional
costs, which may be substantial, to develop alternative methods of managing its
business and replacing non-compliant equipment, and may experience delays in
receipts from vendors, shipments to customers, or payments to vendors. The
Company has contingency plans for critical functions in the event of
non-compliance by its customers and vendors.
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<PAGE> 19
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The following table provides information about the Company's financial
instruments that are sensitive to changes in interest rates. The table presents
principal cash flows and weighted-average interest rates by expected maturity
dates for the Company's debt obligations at May 6, 2000.
<TABLE>
<CAPTION>
Fiscal Year
----------------------------------------------------------------------------
2000 2001 2002 2003
---- ---- ---- ----
(Dollars In Thousands)
<S> <C> <C> <C> <C>
Short-term debt:
Revolving credit $7,186 - - -
Prime rate less 125 basis points(1) 8.25% - - -
Long-term debt:
$125 million Senior Notes - - - -
Interest rate 12.5% 12.5% 12.5% 12.5%
</TABLE>
<TABLE>
<CAPTION>
Fiscal Year
----------------------------------------------
2004 Thereafter Total
---- ---------- -----
(Dollars In Thousands)
<S> <C> <C> <C>
Short-term debt:
Revolving credit - - $7,186
Prime rate less 125 basis points(1) - - 8.25%
Long-term debt:
$125 million Senior Notes - $125,000 $125,000
Interest rate 12.5% 12.5% 12.5%
</TABLE>
----------------------
(1) Prior to April 1, 2000, the rate was prime rate less 100 basis points.
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<PAGE> 20
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
The Company is involved in certain 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 business, financial condition, results of operations and cash flow. At
May 6, 2000, the Company had a reserve for litigation of approximately $900,000
in connection with an ongoing claim.
20
<PAGE> 21
ITEM 4. SUBMISSION OF MATTERS TO VOTE OF SECURITY HOLDERS
The Company's annual meeting of stockholders was held on March 15, 1999.
The following directors were elected:
<TABLE>
<CAPTION>
WITHHOLDING
NAME FOR AUTHORITY
---- --- ---------
<S> <C> <C>
Sanford Greenberg 4,653,953 753,100
Peter Boneparth 4,868,453 538,600
Amanda J. Bokman 4,868,453 538,600
Stuart Bregman 4,868,453 538,600
Bradley P. Cost 4,868,453 538,600
Ben Mayo 4,868,453 538,600
Robert C. Siegel 4,868,453 538,600
</TABLE>
The amendment to the McNaughton Apparel Group Inc. 1998 Long Term Incentive
Plan was approved with 2,672,764 shares voting in favor, 740,955 shares voting
against and 1,000 shares abstaining.
The amendment to Article Four of the Certificate of Incorporation of the
Company increasing the authorized number of shares of Common Stock from
20,000,000 shares to 30,000,000 shares was approved with 4,832,292 shares voting
in favor, 568,761 shares voting against and 1,000 shares abstaining.
The appointment of Ernst & Young LLP as independent auditors for the fiscal
year ended November 6, 1999 was ratified with 5,405,542 shares voting in favor,
211 shares voting against and 1,300 shares abstaining.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
Exhibit 3.1 Certificate of Second Amendment of Certificate of Incorporation
of McNaughton Apparel Group Inc. (incorporated herein by
reference to Exhibit 3.1 of the Registrant's Form 10-Q for the
quarter ended February 5, 2000).
Exhibit 3.2 Certificate of Amendment of Certificate of Incorporation of
McNaughton Apparel Group Inc. (incorporated herein by reference
to Exhibit 3.1 of the Registrant's Form 10-Q for the quarter
ended January 30, 1999).
Exhibit 3.3 By-Laws of McNaughton Apparel Group Inc. (incorporated herein by
reference to Exhibit 3.2 to the Registrant's Registration
Statement on Form S-1 No. 33-74200).
Exhibit 10.1 McNaughton Apparel Group Inc. Audit Committee Charter
Exhibit 10.2 Software License Agreement dated May 24, 2000 between Essentus
International Inc. and McNaughton Apparel Group Inc.
Exhibit 27 Financial Data Schedule (For SEC use only).
---------------------
The Registrant filed no current reports on Form 8-K for the thirteen weeks
ended May 6, 2000.
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<PAGE> 22
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.
MCNAUGHTON APPAREL GROUP INC.
(Registrant)
By /s/ Amanda J. Bokman
---------------------------------
Date: June 20, 2000 AMANDA J. BOKMAN
Vice President, Chief Financial Officer,
Secretary and Treasurer
(Duly Authorized Officer and Principal Financial
and Accounting Officer)
22
