<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 August 5, 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
-------
<TABLE>
<CAPTION>
McNaughton Apparel Group Inc.
-----------------------------
(Exact name of registrant as specified in its charter)
<S> <C>
Delaware 13-3747173
--------------------------------------------------------------------- ---------------------------------------------
(State or other jurisdiction of incorporation or organization) (I.R.S. Employer Identification No.)
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)
--------------------------------------------------------------------
(Former name, former address and former fiscal year, if changed since
last report)
</TABLE>
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, 9,726,124 shares as of September 18, 2000.
<PAGE>
INDEX TO FORM 10-Q
McNaughton Apparel Group Inc.
<TABLE>
<CAPTION>
Page No.
<S> <C>
PART I. FINANCIAL INFORMATION
ITEM 1.
Financial Statements:
Consolidated Balance Sheets at August 5, 2000 (Unaudited) and November 6, 1999 3
Consolidated Statements of Income for the thirteen weeks and thirty-nine weeks ended
August 5, 2000 and July 31, 1999 (Unaudited) 4
Consolidated Statements of Stockholders' Equity for the thirty-nine weeks ended
August 5, 2000 (Unaudited) 5
Consolidated Statements of Cash Flows for the thirty-nine weeks ended August 5, 2000
and July 31, 1999 (Unaudited) 6
Notes to Consolidated Financial Statements (Unaudited) 7-13
ITEM 2.
Management's Discussion and Analysis of Financial Condition and Results of Operations 14-20
ITEM 3.
Quantitative and Qualitative Disclosures About Market Risk 21
PART II. OTHER INFORMATION
ITEM 1.
Legal Proceedings 22
ITEM 6.
Exhibits and Reports on Form 8-K 22
</TABLE>
<PAGE>
PART I - FINANCIAL INFORMATION
------------------------------
Item 1. Financial Statements
McNaughton Apparel Group Inc.
Consolidated Balance Sheets
<TABLE>
<CAPTION>
August 5, 2000 November 6, 1999
(Unaudited)
-------------------------------------
(In Thousands)
<S> <C> <C>
Assets
Current assets:
Cash and cash equivalents $ 9,264 $ 13,842
Due from factor 74,905 82,189
Inventory 50,612 40,917
Prepaid income taxes - 2,145
Prepaid expenses and other current assets 3,928 3,787
-------- --------
Total current assets 138,709 142,880
Fixed assets, net 13,528 10,177
Notes receivable from management stockholders 1,951 2,287
Intangible assets, net 220,346 63,198
Deferred financing costs, net 5,671 6,642
Other assets 2,396 2,914
-------- --------
Total assets $382,601 $228,098
======== ========
Liabilities and stockholders' equity
Current liabilities:
Accounts payable $ 9,000 $ 14,237
Revolving credit loan - 725
Income taxes payable 2,251 7,151
Earn-out obligations payable 125,000 10,000
Accrued expenses and other current liabilities 12,472 17,160
-------- --------
Total current liabilities 148,723 49,273
-------- --------
12 1/2% Senior Notes due 2005 125,000 125,000
Other long-term liabilities 37,612 3,758
-------- --------
Total liabilities 311,335 178,031
-------- --------
Commitments and contingencies
Stockholders' equity:
Common stock, $0.01 par value, authorized 30,000,000 and 20,000,000 shares,
respectively, 8,509,496 and 8,096,324 shares issued, respectively,
and 7,640,696 and 7,445,324 shares outstanding, respectively 85 81
Capital in excess of par 27,460 23,989
Retained earnings 51,123 31,532
Treasury stock, at cost, 868,800 shares and 651,000 shares, respectively (7,402) (5,535)
-------- --------
Total stockholders' equity 71,266 50,067
-------- --------
Total liabilities and stockholders' equity $382,601 $228,098
======== ========
</TABLE>
See accompanying notes.
3
<PAGE>
McNaughton Apparel Group Inc.
Consolidated Statements of Income
(Unaudited)
<TABLE>
<CAPTION>
Thirteen Weeks Ended Thirty-Nine Weeks Ended
-------------------- -----------------------
August 5, 2000 July 31, 1999 August 5, 2000 July 31, 1999
--------------- ------------- -------------- -------------
(In Thousands, Except Per Share Amounts)
<S> <C> <C> <C> <C>
Net sales $119,547 $92,856 $369,641 $283,447
Cost of goods sold 84,384 67,757 265,021 214,393
-------- ------- -------- --------
Gross profit 35,163 25,099 104,620 69,054
Selling, general and administrative expenses 16,556 14,977 51,151 45,787
Depreciation and amortization 2,680 1,323 6,572 3,359
-------- ------- -------- --------
Income from operations 15,927 8,799 46,897 19,908
Other expense (income):
Interest expense and amortization of deferred financing 4,732 4,384 14,025 13,670
costs
Interest income (63) (99) (333) (246)
-------- ------- -------- --------
Income before provision for income taxes 11,258 4,514 33,205 6,484
Provision for income taxes 4,616 2,031 13,614 2,918
-------- ------- -------- --------
Net income $ 6,642 $ 2,483 $ 19,591 $ 3,566
======== ======= ======== ========
Basic earnings per share:
Net income $ 0.87 $ 0.33 $ 2.61 $ 0.48
======== ======= ======== ========
Weighted average number of common shares 7,592 7,434 7,498 7,427
======== ======= ======== ========
Diluted earnings per share:
Net income $ 0.78 $ 0.32 $ 2.38 $ 0.47
======== ======= ======== ========
Weighted average number of common shares assuming dilution 8,562 7,856 8,244 7,590
======== ======= ======== ========
</TABLE>
See accompanying notes.
4
<PAGE>
McNaughton Apparel Group Inc.
Consolidated Statement of Stockholders' Equity
for the Thirty-Nine Weeks Ended August 5, 2000
(Unaudited)
<TABLE>
<CAPTION>
Common Stock Capital
--------------- in Excess Retained Treasury
Shares Amount of Par Earnings Stock Total
-------- ------ ------- -------- -------- --------
(In Thousands)
<S> <C> <C> <C> <C> <C> <C>
Balance at November 6, 1999 8,096 $81 $23,989 $31,532 $(5,535) $50,067
Net income for the thirty-nine weeks
ended August 5, 2000 - - - 19,591 - 19,591
Treasury stock acquired, 217,800
shares, at cost - - - - (1,867) (1,867)
Issuance of 216,995 shares for Miss Erika
earn-out obligation 217 2 2,002 - - 2,004
Exercise of 182,021 stock options 182 2 1,160 - - 1,162
Tax benefit from exercise of stock
options - - 222 - - 222
Issuance of 14,156 shares of common
stock through the employee
stock purchase plan 14 - 87 - - 87
----- ------ ------- -------- ------- -------
Balance at August 5, 2000 8,509 $85 $27,460 $51,123 $(7,402) $71,266
===== ====== ======= ======== ======= =======
</TABLE>
See accompanying notes.
5
<PAGE>
McNaughton Apparel Group Inc.
Consolidated Statements of Cash Flows
(Unaudited)
<TABLE>
<CAPTION>
Thirty-Nine Weeks Ended
------------------------------------
August 5, 2000 July 31, 1999
------------------------------------
(In Thousands)
<S> <C> <C>
Net income $ 19,591 $ 3,566
Adjustments to reconcile net income to net cash provided by
operating activities:
Depreciation and amortization of fixed assets 1,879 1,461
Amortization of intangible assets and deferred financing costs 5,926 2,855
Changes in operating assets and liabilities:
Due from factor 7,284 27,857
Inventory (9,695) 511
Prepaid income taxes 2,145 (1,061)
Prepaid expenses and other current assets (1,433) (134)
Other assets 518 36
Accounts payable (5,237) (6,722)
Income taxes payable (4,900) 3,133
Accrued expenses and other current liabilities (4,688) (1,911)
Other long-term liabilities (146) (46)
-------- -------
Net cash provided by operating activities 11,244 29,545
-------- -------
Investing activities
Repayment of notes receivable from management stockholders 336 184
Additional purchase price to Miss Erika (9,546) (92)
Purchase of fixed assets (5,231) (2,199)
-------- -------
Net cash used for investing activities (14,441) (2,107)
-------- -------
Financing activities
Purchase of treasury stock (1,867) -
Net repayments of revolving credit loans (725) (3,839)
Proceeds from issuance of common stock 1,471 62
Deferred financing costs (260) (294)
-------- -------
Net cash used for financing activities (1,381) (4,071)
-------- -------
Increase (decrease) in cash and cash equivalents (4,578) 23,367
Cash and cash equivalents at beginning of period 13,842 205
-------- -------
Cash and cash equivalents at end of period $ 9,264 $23,572
======== =======
Supplemental disclosures
Income taxes paid $ 15,439 $ 557
Interest paid $ 16,936 $15,991
</TABLE>
See accompanying notes.
6
<PAGE>
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 August 5, 2000 and the results of operations for the
thirteen and thirty-nine weeks ended August 5, 2000 and July 31, 1999 and cash
flows for the thirty-nine weeks ended August 5, 2000 and July 31, 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 thirty-nine weeks ended
August 5, 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 acquisitions of Miss
Erika, Inc. ("Miss Erika"), Jeri-Jo Knitwear, Inc. and Jamie Scott, Inc.
(collectively, "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. and Cutting Edge
Services, Inc., formerly Toni-Linda Productions, Inc. (the "Agreement"), have
been amortized over the term of the management arrangement provided for in the
Agreement. These intangible contract rights were recorded as current assets.
7
<PAGE>
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 thirty-
nine weeks ended August 5, 2000, the dilutive effect of options outstanding
during the period using the treasury stock method was approximately 970,000
shares and 746,000 shares, respectively. For the thirteen and thirty-nine weeks
ended July 31, 1999, the dilutive effect of options outstanding during the
period using the treasury stock method was approximately 422,000 shares and
163,000 shares, respectively.
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 by the issuance of 216,995 shares. 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>
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 were achieved by Jeri-Jo for the two years subsequent
to the closing of the Jeri-Jo acquisition. As originally agreed, the aggregate
contingent payment payable by the Company was 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. Such payment was to be made no later than August 29,
2000. The Jeri-Jo purchase agreement required that the Company pay at least 50%
of the required contingent payment in cash and the Indenture limited 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 was to 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 Company had 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 granted
"piggyback" registration rights in respect of the shares of Common Stock issued
as part of the contingent payment , including in an underwritten offering.
Jeri-Jo achieved Jeri-Jo EBITDA for the 24 month period ended June 30, 2000
which would have resulted in the payment of additional consideration of
approximately $190.0 million. On August 3, 2000, the Company amended the Jeri-Jo
purchase agreement to provide for the retirement of the earn-out obligation for
an aggregate of $161.0 million, comprised of $125.0 million in cash, $10.0
million in three-year subordinated promissory notes of the Company (the "Jeri-Jo
Notes") and 2.0 million shares of the Company's Common Stock, valued at $26.0
million. Such amendment required the Company to pay $95.0 million in cash by
August 29, 2000 (the "Initial Cash Payment"), as well as the issuance of the
Jeri-Jo Notes and 2.0 million shares of Common Stock. Subject to financing, the
remaining $30.0 million in cash is to be paid on or before November 30, 2000
(the "Remaining Cash Payment"). If the Remaining Cash Payment is not made by
November 30, 2000, in lieu thereof, the Company has agreed, at its option, to
issue an additional $59.0 million of three-year subordinated promissory notes,
issue additional shares of Common Stock and/or pay cash to Jeri-Jo by such date.
The Company's unaudited financial statements at August 5, 2000 reflected an
amended agreed upon Jeri-Jo earn-out payment of $161.0 million, of which $125.0
million was included in current liabilities relating to the cash portion of the
earn-out payment, and $36.0 million was included in other long-term liabilities,
relating to the portion of the earn-out payable in three-year subordinated
promissory notes ($10.0 million) and Common Stock (2.0 million shares valued at
$26.0 million). Of the $125.0 million included in current liabilities, $65.0
million of this amount was paid in cash on August 29, 2000 (see below), the
balance is payable $30.0 million on October 2, 2000 (and is secured by the
Company's pre-existing $30.0 million standby letter of credit) and $30.0 million
on November 30, 2000. All additional consideration to be paid to Jeri-Jo has
been accounted for as additional purchase price and has been reflected in
intangible assets. If the Company does not make the Remaining Cash Payment by
November 30, 2000, and, correspondingly, is required to make an additional
payment of $59.0 million as described above, the amount of the Jeri-Jo earn-out
to be recorded as additional purchase price in intangible assets would be $190.0
million plus or minus the product of (a) the closing share price on the date of
payment less $13.00 per share and (b) 2.0 million shares. This would result in
increased goodwill from the Jeri-Jo transaction.
On August 29, 2000, the Jeri-Jo purchase agreement was further amended to
provide that the Initial Cash Payment to be made on that date would be payable
as follows: $65.0 million on August 29, 2000, and the remaining $30.0 million to
be paid on or before October 2, 2000. The latter amount continues to be secured
by the Company's $30.0 million standby letter of credit. On August 29, 2000, the
Company paid the $65.0 million, as well as issued the 2.0 million shares of its
Common Stock and issued the Jeri-Jo Notes, totaling $36 million that had been
included in other long-term liabilities. Accordingly, this $36.0 million of
other long-term liabilities as of August 5, 2000 has since been recorded as
$26.0 million of Common Stock and capital in excess of par and $10.0 million of
long-term debt. The Company funded the cash portion of this payment from
internally generated funds and borrowings under the Company's revolving credit
facility. See Note 7.
Pursuant to the employment agreements with certain executive officers of
Jeri-Jo entered into at the time of the Jeri-Jo acquisition, bonus stock options
were granted on August 11, 2000 relating to the 12 months ended June 30, 2000,
under the Jeri-Jo Stock Option Plan to purchase an aggregate of 1,160,000 shares
of Common Stock of the Company at an exercise price of $15.38 per share, which
was the fair market value of the Common Stock on the date of grant. These
options have 10-year terms and were fully vested on the date of grant.
9
<PAGE>
McNaughton Apparel Group Inc.
Notes to Consolidated Financial Statements (Continued)
(Unaudited)
3. Sales to Major Customers
For the thirteen weeks ended August 5, 2000 and July 31, 1999, net sales
made to three customers were approximately 16.2%, 13.0%, and 12.0%, and
approximately 14.9%, 13.2% and 13.7%, respectively. For the thirty-nine weeks
ended August 5, 2000 and July 31, 1999, net sales to three customers were
approximately 17.0%, 13.2% and 12.0%, and approximately 19.6%, 12.8% and 12.3%,
respectively.
4. Inventory
Inventory is stated at the lower of cost (first-in, first-out basis) or market.
Inventories consist of the following:
August 5, 2000 November 6, 2000
-------------- ----------------
(In Thousands)
Raw materials $ 547 $ 3,116
Work in process 2,960 1,104
Finished goods 47,105 36,697
------- -------
$50,612 $40,917
======= =======
5. Intangible Assets
Intangible assets consist of the following:
August 5, 2000 November 6, 2000
-------------- ----------------
(In Thousands)
Tradenames and trademarks $ 17,585 $17,591
Goodwill 209,475 48,921
-------- -------
227,060 66,512
Less: accumulated amortization 6,714 3,314
-------- -------
$220,346 $63,198
======== =======
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 August 5, 2000, the fair market value of the Company's Common Stock
pledged by the management stockholders as security for the loans was
approximately $9.9 million, and the aggregate principal balance of all loans to
management stockholders was $1,951,083, which reflects the required principal
payments of $1,048,917 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 and its subsidiaries 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 Bank 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
10
<PAGE>
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
11
<PAGE>
McNaughton Apparel Group Inc.
Notes to Consolidated Financial Statements (Continued)
(Unaudited)
million. Under the
12
<PAGE>
McNaughton Apparel Group Inc.
Notes to Consolidated Financial Statements (Continued)
(Unaudited)
7. Financing Arrangements (continued)
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 cross guarantee all
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 8.0% for fiscal 1999 and the first nine months of
fiscal 2000, respectively. The Company continues to factor accounts receivable
pursuant to nonrecourse 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.
On June 18, 1998, the Company also issued the $125.0 million of Senior
Notes due 2005 pursuant to 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 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
(including a limit on the amount of indebtedness for money borrowed), 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 contractual 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 August 5, 2000 under the Current Credit Agreement, the Company had no
borrowings and letters of credit outstanding of $113.6 million. The Company had
total available credit of $45.4 million under the Current Credit Agreement as of
that date pursuant to the borrowing base formula set forth therein, including
cash and cash equivalents. At July 31, 1999, the Company had no borrowings under
the Current Credit Agreement and letters of credit outstanding of $92.7 million.
After giving effect to the Jeri-Jo earn-out payment on August 29, 2000, on that
date, the Company had revolving credit advances of $57.0 million, letters of
credit outstanding of $102.8 million (including the pre-existing $30.0 million
standby letter of credit securing a portion of the Jeri-Jo earn-out) and
available credit of approximately $2.3 million, including cash and cash
equivalents. The Company's available credit under the Current Credit Agreement
fluctuates based upon a number of seasonal factors.
The Current Credit Agreement expires on June 18, 2001 and the Company is
currently negotiating an extension to and an increase in this facility, which it
expects to finalize by the end of November 2000.
Long-term debt at August 5, 2000 and July 31, 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. In addition, at August 5, 2000, the Company had approximately $37.6
million of other long-term liabilities which included $36.0 million of the
$161.0 million payable as the Jeri-Jo earn-out payment. On August 29, 2000, the
Company paid the $36.0 million by issuing 2.0 million shares of its Common Stock
(valued at $26.0 million) and issuing its three-year $10.0 million subordinated
promissory note. Accordingly, this $36.0 million of other long-term liabilities
as of August 5, 2000 has since been recorded as $26.0 million of Common Stock
and capital in excess of par and $10.0 million of long-term debt. These
subordinated promissory notes bear interest on the same basis and at the same
rate as the Company's revolving credit borrowings. See Note 2.
13
<PAGE>
McNaughton Apparel Group Inc.
Notes to Consolidated Financial Statements (Continued)
(Unaudited)
8. Accrued Expenses and Other Current Liabilities
Accrued expenses and other current liabilities consist of the following:
August 5, November 6,
2000 1999
--------------------------------
(In Thousands)
Interest on $125.0 million 12 1/2%
Senior Notes $ 2,605 $ 6,837
Contractual bonuses payable 3,019 2,706
Payable to Railroad and Cutting
Edge in connection with the Agreement 100 1,967
Reserve for litigation 1,161 932
Profit sharing contribution payable 602 879
Other accrued expenses and current
liabilities 4,985 3,839
------- -------
$12,472 $17,160
======= =======
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 August 5, 2000, the
Company has purchased a total of 868,800 shares at an aggregate cost of
approximately $7.4 million. The Company's Current Credit Agreement and the
Indenture limit the amounts which may be expended on stock purchases.
10. 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
August 5, 2000, the Company had a reserve for litigation and other matters of
approximately $1.2 million in connection with ongoing claims.
11. Shareholder Rights Plan
On January 19, 1996, the Company's Board of Directors adopted a Shareholder
Rights Plan (the "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.
11. Shareholder Rights Plan (continued)
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 beneficially 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.
The Rights Plan was amended on August 2, 2000 to permit the issuances of
the Company's Common Stock and options to purchase Common Stock
14
<PAGE>
in connection with the Agreement of Purchase and Sale dated April 15, 1998, as
amended, by and among JJ Acquisition Corp., Jeri-Jo Knitwear Inc., Jamie Scott,
Inc. and the Stockholders of Jamie Scott, Inc. and related employment agreements
without triggering the exercisability of the rights under the Rights Plan.
15
<PAGE>
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 1, 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 issued $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 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 in
fiscal 1999. The Company 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 further 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 finalized 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 then 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 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 August 11, 2000. See
"Liquidity and Capital Resources".
16
<PAGE>
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 an inability to extend the term of and increase the amount of credit
available under its current revolving credit and letter of credit facility, 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 are now being 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.
17
<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 Thirty-Nine Weeks Ended
-------------------- -----------------------
August 5, 2000 July 31, 1999 August 5, 2000 July 31,1999
-------------- ------------- -------------- ------------
<S> <C> <C> <C> <C>
Net sales 100.0% 100.0% 100.0% 100.0%
Cost of goods sold 70.6 73.0 71.7 75.6
----- ----- ----- -----
Gross profit 29.4 27.0 28.3 24.4
Selling, general and administrative
expenses 13.9 16.1 13.8 16.2
Depreciation and amortization 2.2 1.4 1.8 1.2
----- ----- ----- -----
Income from operations 13.3 9.5 12.7 7.0
Interest expense and amortization of
deferred financing costs 4.0 4.7 3.8 4.8
Interest income (0.1) (0.1) (0.1) (0.1)
----- ----- ----- -----
Income before provision for income
taxes 9.4 4.9 9.0 2.3
Provision for income taxes 3.8 2.2 3.7 1.0
----- ----- ----- -----
Net income 5.6% 2.7% 5.3% 1.3%
===== ===== ===== =====
</TABLE>
Quarter Ended August 5, 2000 Compared to Quarter Ended July 31, 1999
--------------------------------------------------------------------
Net Sales
Net sales were $119.5 million for the third quarter of fiscal 2000 compared to
$92.9 million for the third quarter of fiscal 1999. The increase in net sales of
$26.6 million, or 28.7%, was primarily attributable to an increase in net sales
of $19.5 million in the Energie, Currants and Jamie Scott product lines, an
increase of $3.3 million in the Erika product lines, and a net increase of $2.1
million in the Norton McNaughton and Norton Studio product lines.
Gross Profit
Gross profit margin was 29.4% for the third quarter of fiscal 2000 compared to
27.0% for the third quarter of fiscal 1999. The increase in gross profit margin
was attributable to the Energie, Currants and Jamie Scott product lines and
resulted primarily from increases in initial markup.
Selling, General and Administrative Expenses
Selling, general and administrative expenses ("SG&A" expenses) were $16.6
million, or 13.9% of net sales, for the third quarter of fiscal 2000 as compared
to $15.0 million, or 16.1% of net sales, for the third quarter of fiscal 1999.
The increase in SG&A expense of $1.6 million was due primarily to overhead
associated with Norton's South Carolina warehouse, including rent and salaries,
which commenced operations during the second quarter of fiscal 2000, increases
in advertising and merchandising expenses, increases in personnel costs
resulting from salary increases and bonuses, as well as increases in headcount
necessitated by an increase in the volume of products shipped and an increase in
variable distribution expense due to an increase in sales volume. 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 third
quarter of fiscal 2000.
Depreciation and Amortization
Depreciation and amortization was $2.7 million for the third quarter of
fiscal 2000 compared to $1.3 million for the third quarter of fiscal 1999. The
increase of $1.4 million was primarily attributable to the amortization of
goodwill associated with the Jeri-Jo earn-out payment, which was recorded at
June 30, 2000, amortization of goodwill associated with the Miss Erika earn-out
payment, payments of which were made in installments in August 1999 and March
2000 (although the accrual of this portion of the Miss Erika earn-out
obligation was recorded 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 $4.7 million in the third quarter of fiscal
2000 from $4.4 million in the third quarter of fiscal 1999. The increase of
$300,000 was due primarily to slightly higher borrowings under the Current
Credit Agreement during the third quarter of fiscal 2000 compared to the third
quarter of fiscal 1999, 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 and activity
during the third quarter of fiscal 2000 compared to the third quarter of fiscal
1999.
Earnings Per Share Before Goodwill Amortization
Earnings per share before goodwill amortization increased in the third quarter
of fiscal 2000 to $0.88 per diluted share, from $0.34 per diluted share in the
third quarter of fiscal 1999.
18
<PAGE>
Thirty-Nine Weeks Ended August 5, 2000 Compared to Thirty-Nine Weeks Ended July
-------------------------------------------------------------------------------
31, 1999
--------
Net Sales
Net sales were $369.6 million for the first nine months of fiscal 2000
compared to $283.4 million for the first nine months of fiscal 1999. The
increase in net sales of $86.2 million, or 30.4%, was primarily attributable to
an increase in net sales of $39.4 million in the Energie, Currants and Jamie
Scott product lines, an increase of $26.8 million in the Erika product lines,
and a net increase of $19.9 million in the Norton McNaughton and Norton Studio
product lines.
Gross Profit
The gross profit margin was 28.3% for the first nine months of fiscal 2000
compared to 24.4% for first nine months 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 $51.2 million, or 13.8% of net sales, in the first nine
months of fiscal 2000 as compared to $45.8 million, or 16.2% of net sales, in
the first nine months of fiscal 1999. The increase in SG&A expense of $5.4
million was due primarily to overhead associated with Norton's South Carolina
warehouse, including rent and salaries, which commenced operations during the
second quarter of fiscal 2000, increases in advertising and merchandising
expenses, 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 and an increase in variable
distribution expense due to an increase in sales volume. These increases were
offset in part by a decrease in professional fees, as well as 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 nine months of
fiscal 2000.
Depreciation and Amortization
Depreciation and amortization was $6.6 million for the first nine months of
fiscal 2000 compared to $3.4 million for the first nine months of fiscal 1999.
The increase of $3.2 million was primarily attributable to the Miss Erika earn-
out payment, payments of which were recorded in installments in August 1999
and March 2000 (although the accrual of this portion of the remaining Miss Erika
earn-out obligation was recorded in October 1999), amortization of goodwill
associated with the Jeri-Jo earn-out payment which was recorded at June 30,
2000 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 $14.0 million in the first nine months of fiscal
2000 from $13.7 million in the first nine months of fiscal 1999. The increase of
$0.3 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
and activity during the first nine months of fiscal 2000 compared to the first
nine months of fiscal 1999.
Earnings Per Share Before Goodwill Amortization
Earnings per share before goodwill amortization increased in the first nine
months of fiscal 2000 to $2.57 per diluted share, from $0.56 per diluted share
in the first nine months 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 connection with the Jeri-Jo
acquisition (total of $161.0 million of which $60.0 million remains unfunded).
On August 5, 2000, the Company had $125.0 million of Senior Notes outstanding,
no borrowings under the Current Credit Agreement, obligations under undrawn
letters of credit in the aggregate face amount of approximately $83.6 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. As of August 5, 2000, the
Company had total available credit of $45.4 million under the Current Credit
Agreement pursuant to the borrowing base formula set forth therein, including
cash and cash equivalents.
19
<PAGE>
After giving effect to the payment of a portion of the Jeri-Jo earn-out
payment as described below, on August 29, 2000, the Company had revolving credit
advances of $57.0 million, letters of credit outstanding of $102.8 million
(including the pre-existing $30.0 million standby letter of credit securing a
portion of the Jeri-Jo earn-out) and available credit of approximately $2.3
million including cash and cash equivalents.
Jeri-Jo achieved Jeri-Jo EBITDA for the 24 month period ended June 30, 2000
which would have resulted in the payment of additional consideration of
approximately $190.0 million. On August 3, 2000, the Company amended the Jeri-
Jo purchase agreement to provide for the extinguishment of the earn-out
obligation for an aggregate of $161.0 million, comprised of $125.0
million in cash, $10.0 million in three-year subordinated promissory notes of
the Company (the "Jeri-Jo Notes") and 2.0 million shares of the Company's Common
Stock, valued at $26.0 million. Such amendment required the Company to pay
$95.0 million in cash by August 29, 2000 (the "Initial Cash Payment"), as well
as the issuance of the Jeri-Jo Notes and 2.0 million shares of Common Stock.
Subject to financing, the remaining $30.0 million in cash is to be paid on or
before November 30, 2000 (the "Remaining Cash Payment"). If the Remaining
Cash Payment is not made by November 30, 2000, in lieu thereof, the Company has
agreed, at its option, to issue an additional $59.0 million of the Company's
three-year subordinated promissory notes, issue additional shares of Common
Stock and/or pay cash to Jeri-Jo by such date. The issuance has resulted, of
shares of Common Stock in partial payment of the Jeri-Jo contingent payment has
resulted, and, if additional shares are issued, will result, in dilution to the
existing stockholders of the Company. See Item 1, Note 2.
The Company's unaudited financial statements at August 5, 2000 reflected an
amended agreed upon Jeri-Jo earn-out payment of $161.0 million, of which $125.0
million was included in current liabilities relating to the cash portion of the
earn-out payment, and $36.0 million was included in other long-term liabilities,
relating to the portion of the earn-out payable in three-year subordinated
promissory notes ($10.0 million) and Common Stock (2.0 million shares valued at
$26.0 million). Of the $125.0 million included in current liabilities, $65.0
million of this amount was paid in cash on August 29, 2000 (see below), the
balance is payable $30.0 million on October 2, 2000 (and is secured by the
Company's pre-existing $30.0 million standby letter of credit) and $30.0 million
on November 30, 2000. All additional consideration to be paid to Jeri-Jo has
been accounted for as additional purchase price and has been reflected in
intangible assets. If the Company does not make the Remaining Cash Payment by
November 30, 2000, and, correspondingly, is required to make an additional
payment of $59.0 million as described above, the amount of the Jeri-Jo earn-out
to be recorded as additional purchase price in intangible assets would be $190.0
million plus or minus the product of (a) the closing share price on the date of
payment less $13.00 per share and (b) 2.0 million shares. This would result in
increased goodwill from the Jeri-Jo transaction. See Item 1, Note 7.
On August 29, 2000, the Jeri-Jo purchase agreement was further amended to
provide that the Initial Cash Payment to be made on that date would be payable
as follows: $65.0 million on August 29, 2000 and the remaining $30.0 million to
be paid on or before October 2, 2000. The latter amount continues to be secured
by the Company's $30.0 million standby letter of credit. On August 29, 2000, the
Company paid the $65.0 million, as well as issued the 2.0 million shares of its
Common Stock and issued the Jeri-Jo Notes. The Company funded the cash portion
of this payment from internally generated funds and borrowings under the
Company's Current Credit Agreement.
The Company is currently in negotiations with its lenders to extend the term
of and increase the available credit under the Current Credit Agreement, which
expires in June 2001. The increase in available credit is necessary to provide
the Company with sufficient liquidity to fund the remainder of the Jeri-Jo earn-
out payment, as well as meet the Company's operating needs. Based upon current
and forecasted levels of operations, management believes that it will be
successful in negotiating a new credit facility, which, coupled with cash flow
from operations, will be adequate to meet the Company's liquidity requirements
for the foreseeable future, including fiscal 2001. However, there can be no
assurances that management will be successful in these efforts. In addition,
the Company's ability to fund the remainder of the earn-out payment and to make
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.
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 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 will also increase. The Company's primary sources of working
capital are cash flow from operations and advances under the Current Credit
Agreement, which, as noted above, expires in June 2001 and is currently being
renegotiated.
The Company had negative working capital of approximately $10.0 million at
August 5, 2000 as compared to working capital of $93.6 million at November 6,
1999. The decrease in working capital resulted primarily from the recordation
of the Jeri-Jo earn-out payment of $161.0 million, of which $125.0 million was
recorded as a current liability, and was partially offset by net income for the
thirty-nine weeks ended August 5, 2000. Based upon current and forecasted
levels of operations, management believes that working capital will be positive
by the end of fiscal 2000.
20
<PAGE>
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 Bank 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 cross guarantee all 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 8.0% for fiscal
1999 and the first nine months of fiscal 2000, respectively. The Company
continues to factor accounts receivable pursuant to nonrecourse 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 (including a limit on the amount of indebtedness for money
borrowed), 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 $100,000 remains payable on December 31, 2000,
and $500,000 remains subject to the settlement of a dispute concerning the
Company's obligations under a guaranty of Railroad's lease. The Agreement also
provided for the termination of Norton's then existing long-term agreements with
Railroad (distribution) and Cutting Edge (cutting). Railroad 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 August 11, 2000. Norton began receiving and shipping
operations at its new warehouse and distribution facility in South Carolina in
May 2000 and this facility was fully operational in August 2000.
Based upon actual results of Miss Erika, the Company paid approximately $11.6
million in additional earn-out 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 of
216,995 shares.
The Company's capital expenditures were approximately $5.2 million and $2.2
million in the first nine months of fiscal 2000 and the first nine months of
fiscal 1999, respectively. The Company anticipates that in the remainder of
fiscal 2000, it will incur capital expenditures of approximately $2.0 million to
$2.5 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 during fiscal 2001, 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 August 5, 2000, the
Company has purchased a total of 868,800 shares at an aggregate cost of
approximately $7.4 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.
21
<PAGE>
Seasonality
-----------
The Company experiences 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.
22
<PAGE>
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 August 5, 2000.
<TABLE>
<CAPTION>
Fiscal Year
----------------------------------------------------------------------------------
2000/(2)/ 2001/(2)/ 2002/(2)/ 2003/(2)/ 2004 Thereafter Total
--------- -------- --------- --------- ---- ---------- -----
(Dollars In Thousands)
<S> <C> <C> <C> <C> <C> <C> <C>
Short-term debt:
Revolving credit $ - - - - - - $ -
Prime rate less 125 basis points/(1)/ 8.25% - - - - - 8.25%
Long-term debt:
$125 million Senior Notes - - - - - $125,000 $125,000
Interest rate 12.5% 12.5% 12.5% 12.5% 12.5% 12.5% 12.5%
</TABLE>
______________________
(1) Prior to April 1, 2000, the rate was prime rate less 100 basis points.
(2) Does not include $10.0 of three-year subordinated promissory notes of the
Company issued on August 29, 2000 as partial payment of the Jeri-Jo earn-out
payment. See Item 1, Notes 2 and 7 and Item 2, "Liquidity and Capital
Resources". These subordinated promissory notes bear interest on the same basis
and at the same rate as the Company's revolving credit borrowings.
23
<PAGE>
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 August 5, 2000, the Company had a reserve for litigation and other matters of
approximately $1.2 million in connection with ongoing claims.
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 Sixth Amendment, dated as of August 29, 2000 to the Amended and
Restated Financing Agreement, dated as of June 18, 1998, as
amended through the date hereof, by and among McNaughton Apparel
Group Inc., formerly known as Norton McNaughton, Inc., Norton
McNaughton of Squire, Inc., Miss Erika, Inc., Jeri-Jo Knitwear,
Inc., formerly known as JJ Acquisition Corp., the lenders party
thereto, Banc of America Commercial Corporation, as successor by
merger to NationsBanc Commercial Corporation, as collateral agent
for the Lenders, The CIT Group/Commercial Services, Inc., as
administrative agent for the Lenders, and Fleet Bank NA, as
documentation agent for the Lenders.
Exhibit 10.2 Amendment dated August 29, 2000 to the Agreement of Purchase and
Sale dated as of April 15, 1998, as amended, by and among JJ
Acquisition Corp. (now Jeri-Jo Knitwear, Inc.), Norton
McNaughton, Inc. (now McNaughton Apparel Group Inc.), Jeri-Jo
Knitwear, Inc. , Jamie Scott, Inc. and the Stockholders of Jamie
Scott, Inc.
Exhibit 10.3 Lease Agreement dated July 21, 2000 between Gettinger Associates
and Miss Erika, Inc. for a portion of the fourth floor of 1407
Broadway, New York, NY 10018.
Exhibit 10.4 First Amendment dated as of August 2, 2000 to Shareholder Rights
Plan dated January 19, 1996 between McNaughton Apparel Group Inc.
(formerly known as Norton McNaughton, Inc.) and American Stock
Transfer & Trust Company.
Exhibit 10.5 Agreement dated as of May 1, 2000 by and between Norton
McNaughton of Squire, Inc. and McNaughton Apparel Holdings 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
August 5, 2000. The Registrant filed a current report on Form 8-K on August 15,
2000.
24
<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.
MCNAUGHTON APPAREL GROUP INC.
(Registrant)
By /s/ Amanda J. Bokman
-------------------------------------
Date: September 21, 2000 AMANDA J. BOKMAN
Vice President, Chief Financial Officer,
Secretary and Treasurer
(Duly Authorized Officer and Principal
Financial and Accounting Officer)
