-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, BkNsp14aWptSORra2y5J93Om4WHXs1Pzs8NUdxJnEJDs+xjfeE43wFmuizrtMjdK IV+PR09nGviUHypP1mj3uA== 0000950135-99-002839.txt : 19990519 0000950135-99-002839.hdr.sgml : 19990519 ACCESSION NUMBER: 0000950135-99-002839 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 2 CONFORMED PERIOD OF REPORT: 19990403 FILED AS OF DATE: 19990518 FILER: COMPANY DATA: COMPANY CONFORMED NAME: AAI FOSTERGRANT INC CENTRAL INDEX KEY: 0001067346 STANDARD INDUSTRIAL CLASSIFICATION: WHOLESALE-JEWELRY, WATCHES, PRECIOUS STONES & METALS [5094] STATE OF INCORPORATION: RI FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-Q SEC ACT: SEC FILE NUMBER: 333-61119 FILM NUMBER: 99629764 BUSINESS ADDRESS: STREET 1: 500 GEORGE WASHINGTON HWY CITY: SMITHFIELD STATE: RI ZIP: 02917 BUSINESS PHONE: 4012313800 MAIL ADDRESS: STREET 1: 500 GEORGE WASHINGTON HWY CITY: SMITHFIELD STATE: RI ZIP: 02917 10-Q 1 AAI.FOSTERGRANT, INC. 1 UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-Q (Mark One) [X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934. For the quarterly period ended April 3, 1999. [ ] 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 333-61119 AAI.FOSTERGRANT, INC. --------------------- (Exact name of registrant as specified in its charter) RHODE ISLAND 05-0419304 ------------ ---------- (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification Number) 500 GEORGE WASHINGTON HIGHWAY SMITHFIELD, RI 02917 ----------------------------- (Address of principal executive offices) (Zip code) (401) 231-3800 -------------- (Registrant's telephone number, including area code) Indicate by checkmark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15 (d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. YES: [X] NO: [ ] As of May 18, 1999, there were 608,000 shares of the Registrant's Common Stock, $.01 par value, outstanding. 2 AAI.FOSTERGRANT, INC. AND SUBSIDIARIES QUARTERLY REPORT TABLE OF CONTENTS
PAGE PART I. - FINANCIAL INFORMATION ITEM 1. CONSOLIDATED CONDENSED FINANCIAL STATEMENTS Consolidated Condensed Balance Sheets as of January 2, 1999 and April 3, 1999 3 Consolidated Condensed Statements of Operations for the three months ended April 4, 1998 and April 3, 1999 4 Consolidated Condensed Statements of Cash Flows for the three months ended April 4, 1998 and April 3, 1999 5 Notes to Consolidated Condensed Financial Statements 7 FINANCIAL STATEMENTS FOR FANTASMA, LLC A MOSTLY-OWNED SUBSIDIARY OF AAI.FOSTERGRANT, INC Condensed Balance Sheets as of January 2, 1999 and April 3, 1999 20 Condensed Statements of Operations for the three months ended April 4, 1998 and April 3, 1999 21 Condensed Statement of Cash Flows for the three months ended April 4, 1998 and April 3, 1999 22 Notes to Financial Statements 23 ITEM 2. Management's Discussion and Analysis of Financial Condition and Results of Operations 25 ITEM 3. Quantitative and Qualitative Disclosures About Market Risk 34 PART II - OTHER INFORMATION ITEM 1. Legal Proceedings 36 ITEM 2. Changes in Securities and Use of Proceeds 36 ITEM 3. Defaults Upon Senior Securities 36 ITEM 4. Submission of Matters to a Vote of Security Holders 36 ITEM 5. Other Information 36 ITEM 6. Exhibits and reports on Form 8-K 36 SIGNATURES 37
2 3 AAI.FOSTERGRANT, INC. AND SUBSIDIARIES CONSOLIDATED CONDENSED BALANCE SHEETS (In thousands, except share and per share data)
JANUARY 2, APRIL 3, 1999 1999 (Unaudited) ASSETS CURRENT ASSETS: Cash and cash equivalents $ 2,207 $ 1,717 Accounts receivable less reserves of approximately $9,975 and $8,498 29,317 37,932 Inventories 37,162 39,330 Prepaid expenses and other current assets 1,918 2,080 Deferred tax assets 3,743 3,743 --------- --------- Total current assets 74,347 84,802 --------- --------- Property, plant and equipment, net 17,543 17,158 --------- Intangible assets 20,874 20,590 Other assets 8,415 8,327 Deferred tax assets 5,319 5,319 --------- --------- Total assets $ 126,498 $ 136,196 ========= ========= LIABILITIES AND SHAREHOLDERS' DEFICIT CURRENT LIABILITIES: Borrowings under revolving note payable $ 2,576 $ 15,161 Current maturities of long-term obligations 626 622 Deferred compensation - current portion 30 15 Accounts payable 14,899 22,756 Accrued expenses 22,740 12,962 Accrued income taxes 2,130 2,109 --------- --------- Total current liabilities 43,001 53,625 --------- --------- 10 3/4% series B senior notes due 2006 75,000 75,000 Long-term obligations, less current maturities 780 616 Deferred compensation - less current portion 1,448 1,527 Redeemable preferred stock of a subsidiary 909 930 Preferred stock, $.01 par value -- Authorized -- 200,000 shares Designated, issued and outstanding -- 43,700 shares of Series A Redeemable Convertible Preferred Stock, stated at redemption value 28,862 29,579 SHAREHOLDERS' DEFICIT: Common stock, $.01 par value-- Authorized-- 4,800,000 shares Issued and outstanding-- 608,000 shares 6 6 Additional paid-in capital 270 270 Accumulated other comprehensive loss (289) (442) Accumulated Deficit (23,489) (24,915) --------- --------- Total shareholders' deficit (23,502) (25,081) --------- --------- Total liabilities and shareholders' deficit $ 126,498 $ 136,196 ========= =========
The accompanying notes are an integral part of these consolidated condensed financial statements. 3 4 AAI.FOSTERGRANT, INC. AND SUBSIDIARIES CONSOLIDATED CONDENSED STATEMENTS OF OPERATIONS (In thousands, except per share data)
THREE MONTHS ENDED APRIL 4, APRIL 3, 1998 1999 (Unaudited) NET SALES $ 42,703 $ 41,481 COST OF GOODS SOLD 23,431 23,814 --------- --------- Gross profit 19,272 17,667 OPERATING EXPENSES: Selling 11,493 11,704 General and administrative 5,956 4,466 --------- --------- Income from operations 1,823 1,497 Interest expense (1,178) (2,342) Other income, net 76 135 --------- --------- Income (loss) before income tax expense and dividends and accretion on preferred stock 721 (710) Income tax expense (317) -- --------- --------- Net income (loss) before dividends and accretion on preferred stock 404 (710) Dividends and accretion on preferred stock 683 718 --------- --------- Net loss applicable to common shareholders $ (279) $ (1,428) ========= ========= Basic and diluted net loss per share applicable to common shareholders $ (0.46) $ (2.35) ========= ========= Basic and diluted weighted average shares of Common stock outstanding 608,000 608,000 ========= =========
The accompanying notes are an integral part of these consolidated condensed financial statements. 4 5 AAI.FOSTERGRANT, INC. AND SUBSIDIARIES CONSOLIDATED CONDENSED STATEMENTS OF CASH FLOWS (In thousands)
THREE MONTHS ENDED APRIL 4, APRIL 3, 1998 1999 CASH FLOWS FROM OPERATING ACTIVITIES: (Unaudited) Net income (loss) $ 404 $ (710) Adjustments to reconcile net income (loss) to net cash used in operating activities- Depreciation and amortization 2,470 3,203 Amortization of interest costs related to debt -- 296 Equity in earnings of investments in affiliates (60) (84) Minority interest in income of consolidated subsidiary 13 21 Cumulative foreign currency translation adjustment 23 (153) Deferred interest on subordinated promissory notes payable 88 -- Deferred taxes 317 -- Changes in assets and liabilities, net of acquisitions - Accounts receivable (14,920) (8,615) Inventories 1,221 (2,168) Prepaid expenses and other current assets 272 (162) Deferred Costs -- (61) Accounts payable 6,942 7,857 Accrued expenses (2,020) (9,868) Accrued income taxes (6) (21) -------- -------- Net cash used in operating activities (5,256) (10,465) -------- -------- CASH FLOWS FROM INVESTING ACTIVITIES: Acquisitions, net of cash received (5,487) -- Purchases of property, plant and equipment (9,073) (2,135) Advances to officers/shareholders (2,162) -- Increase in investment in affiliates (60) -- Increase in other assets (2) (301) -------- -------- Net cash used in investing activities (16,784) (2,436) -------- -------- CASH FLOWS FROM FINANCING ACTIVITIES: Net borrowings under revolving note payable 17,443 12,585 Proceeds from term note payable 2,737 -- Payments on long term obligations and deferred compensation (480) (174) -------- -------- Net cash provided by financing activities 19,700 12,411 -------- -------- NET DECREASE IN CASH AND CASH EQUIVALENTS (2,340) (490) CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD 2,779 2,207 -------- -------- CASH AND CASH EQUIVALENTS, END OF PERIOD $ 439 $ 1,717 ======== ========
The accompanying notes are an integral part of these consolidated condensed financial statements. 5 6 AAI.FOSTERGRANT, INC. AND SUBSIDIARIES CONSOLIDATED CONDENSED STATEMENTS OF CASH FLOWS (CONTINUED) (In thousands)
THREE MONTHS ENDED APRIL 4, APRIL 3, 1998 1999 SUPPLEMENTAL DISCLOSURE OF NON-CASH INVESTING ACTIVITIES: Conversion of leasehold improvements to building improvements $ 1,393 $ -- ======= ======= SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION: Cash paid during the period for- Interest $ 1,040 $ 3,841 ======= ======= Taxes $ 98 $ 6 ======= ======= SUPPLEMENTAL DISCLOSURE OF CASH FLOWS RELATED TO ACQUISITIONS: During the three months ended April 4, 1998, the Company Acquired Foster Grant UK as described in Note 2 This acquisition is summarized as follows- Fair value of assets acquired, excluding cash $ 7,260 $ -- Payments in connection with the acquisitions, net of cash acquired (5,487) -- ------- ------- Liabilities assumed and notes issued $ 1,773 $ -- ======= =======
The accompanying notes are an integral part of these consolidated condensed financial statements. 6 \ 7 AAI.FOSTERGRANT, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS Note 1 - Significant Accounting Policies (a) Interim Consolidated Condensed Financial Statements The accompanying unaudited interim consolidated condensed financial statements have been prepared in accordance with generally accepted accounting principles for interim financial information and pursuant to the rules and regulations of the Securities and Exchange Commission (SEC) for reporting on Form 10-Q. Accordingly, certain information and footnote disclosure required for complete financial statements are not included herein. It is recommended that these financial statements be read in conjunction with the consolidated financial statements and related notes of AAi.FosterGrant, Inc. (the "Company" or "AAi") for the year ended January 2, 1999 as reported in the Company's 10-K filed with the SEC on April 2, 1999. In the opinion of management, all adjustments (consisting of normal, recurring adjustments) considered necessary for a fair presentation of financial position, results of operations and cash flows at the dates and for the periods presented have been included. The consolidated condensed balance sheet presented as of January 2, 1999 has been derived from the consolidated financial statements that have been audited by the Company's independent public accountants. The results of operations for the period ended April 3, 1999 may not be indicative of the results that may be expected for the year ending January 1, 2000, or for any other future period. (b) Inventories Inventories are stated at the lower of cost (first-in, first-out) or market and consist of the following at January 2, 1999 and April 3, 1999 (in thousands):
January 2, April 3, 1999 1999 Finished goods................................ $ 31,037 $ 34,929 Work-in-process and raw materials............. 6,125 4,401 -------- -------- $ 37,162 $ 39,330 ======== ========
(c) Customer Acquisition Costs The Company incurs direct and incremental costs in connection with the acquisition of certain new customers and new store locations from existing customers under multi-year agreements. The Company may also receive the previous vendor's merchandise from the customer in connection with these agreements. In these situations, the Company values this inventory at its fair market value, representing the lower of cost or net realizable value, and records that value as inventory. The Company sells this inventory through various liquidation channels. Except as provided below, the excess costs over the fair market value of the inventory received is charged to selling expense when incurred. The Company expensed 7 8 AAI.FOSTERGRANT, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS (Continued) customer acquisition costs of approximately $377,000 and $147,000 for the three months ended April 4, 1998 and April 3, 1999, respectively. The excess costs over the fair market value of the inventory received is capitalized as deferred costs and amortized over the agreement period if the Company enters into a minimum purchase agreement with the customer from which the estimated gross profits from future minimum sales during the term of the agreement are sufficient to recover the amount of the deferred costs. During the three months ended April 3, 1999, the Company capitalized approximately $61,000 of these costs in the accompanying consolidated balance sheet. Amortization expense related to these costs as well as previously capitalized costs was approximately $296,000 for the three months ended April 3, 1999. No such costs were capitalized or amortized during the three months ended April 4, 1998. Note 2 - Acquisitions In June 1998, the Company acquired an 80% interest in Fantasma, LLC (Fantasma) for approximately $4.1 million in cash. The remaining 20% interest in Fantasma is held by a previous member of Fantasma. As the result of the termination of the employment of this member, in April 1999, the Company has the obligation to repurchase this interest for nominal consideration. Another employee of Fantasma has options to acquire up to a 2% interest in Fantasma and up to an additional 2% interest if certain earnings targets for Fantasma are met in 1999 and 2000. As of April 3, 1999, the exercise price of the options to purchase member interests of Fantasma was equal to or greater than the fair market value; therefore no expense was recorded. Fantasma is a marketer and distributor of watches and clocks. The acquisition was accounted for using the purchase method; accordingly, the results of operations of Fantasma from the date of acquisition are included in the Company's consolidated statements of operations. The purchase price was allocated based on estimated fair market value of assets and liabilities at the date of acquisition. In connection with the purchase price allocation, the Company recorded goodwill of approximately $4.6 million, which is being amortized ratably over 10 years. In March 1998, the Company acquired certain assets and liabilities of Eyecare Products UK Ltd. (Foster Grant UK), including the Foster Grant trademark in territories not previously owned, for approximately $5.5 million in cash. Foster Grant UK is a marketer and distributor of sunglasses and reading glasses in Europe. The purchase price may be increased by approximately $700,000 in 1998 and 1999 based on Foster Grant UK performance. Based on activity to date, there has been no increase in the purchase price. The acquisition has been accounted for using the purchase method of accounting; accordingly, the results of operation of Foster Grant UK from the date of acquisition are included in the Company's consolidated statements of operations. The purchase price was allocated based on estimated fair values of assets and liabilities at the date of acquisition. 8 9 AAI.FOSTERGRANT, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS (Continued) In connection with the purchase price allocation, the Company recorded goodwill of approximately $1.1 million, which is being amortized on a straight-line basis over 20 years. The following unaudited proforma summary information presents the combined results of operations of the Company, Fantasma and Foster Grant UK as if the acquisitions had occurred at the beginning of 1998. This unaudited proforma financial information is presented for informational purposes only and may not be indicative of the results of operations as they would have been if the Company, Fantasma and Foster Grant UK had been a single entity nor is it necessarily indicative of the results of operations that may occur in the future. Anticipated efficiencies from the consolidation of the Company, Fantasma and Foster Grant UK have been excluded from the amounts in the unaudited pro forma summary presented below.
THREE MONTHS ENDED APRIL 4, 1998 ------------------ Net sales ..................................................... $ 47,527 Net loss applicable to common shareholders .............................................. (758) Basic and diluted net loss per share applicable to common shareholders .................................... (1.25)
Note 3 - Long-Term Obligations On July 21, 1998, the Company sold $75.0 million of 10 3/4% Senior Series A Notes due 2006 (the Notes) through a Rule 144A offering. The net proceeds of approximately $71.0 million received by the Company from the issuance and sale of the Notes were used to repay outstanding indebtedness under the credit facility with a bank and the Subordinated Promissory Notes to shareholders, net of amounts due the Company from certain of these shareholders. The Company incurred issuance costs of approximately $3.7 million in relation to the Notes. These costs are being amortized over the life of the Notes and are included in other assets in the accompanying consolidated balance sheets. In December 1998 the Notes were exchanged for 10 3/4 % Series B Notes due 2006 registered with the SEC. Interest on the Notes is payable semiannually on January 15 and July 15. The Notes are general unsecured obligations of the Company, rank senior in right of payment to all future subordinated indebtedness of the Company and rank pari passu in right of payment to all existing and future unsubordinated indebtedness of the Company including the bank credit facility. The bank credit facility is secured by accounts receivable and inventory of the Company and its domestic subsidiaries. Accordingly, the Company's obligations under the bank credit facility will effectively rank senior in right of payment to the Notes to the extent of the assets subject to such security interest. The Notes are fully and unconditionally 9 10 AAI.FOSTERGRANT, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS (Continued) guaranteed, on a senior and joint and several basis, by each of the Company's current and future Domestic Subsidiaries (as defined) (the Guarantors). The Indenture under which the Notes were issued (the Indenture) imposes certain limitations on the ability of the Company, and its subsidiaries to, among other things, incur indebtedness, pay dividends, prepay subordinated indebtedness, repurchase capital stock, make investments, create liens, engage in transactions with shareholders and affiliates, sell assets and engage in mergers and consolidations. At April 3, 1999, management believes the Company was in compliance with these covenants The Notes are redeemable at the option of the Company, in whole or in part, on or after July 15, 2002 at various redemption prices, declining from 105.375% of the principal amount to par on and after July 15, 2004. In addition, on or prior to July 15, 2001, the Company may use the net cash proceeds of one or more equity offerings to redeem up to 35% of the aggregate principal amount of the Notes originally issued at a redemption price of 110.750% of the principal amount thereof plus accrued interest to the date of redemption. Upon a change of control, each Note holder has the right to require the Company to repurchase such holder's Notes at a purchase price of 101% of the principal amount plus accrued interest. Note 4 - Earnings Per Share In accordance with SFAS No. 128, Earnings Per Share was determined by dividing net loss by the weighted average common shares outstanding during the period. Diluted earnings per share was determined by dividing net loss by diluted weighted average shares outstanding. Diluted weighted average shares reflect the dilutive effect, if any, of common stock options based on the treasury stock method. Diluted weighted average shares outstanding excludes all 12,000 common equivalent shares at April 4, 1998 and April 3, 1999 as their effect would be anti-dilutive. 10 11 AAI.FOSTERGRANT, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS (Continued) Note 5 - Comprehensive Income (loss) Comprehensive net loss for the three months ended April 3, 1999 was $515,000 as compared to net income of $381,000 for the three months ended April 4, 1998. Differences between comprehensive net income (loss) and net income (loss) before dividends and accretion on preferred stock for each period represents the foreign currency translation adjustment for each period. Note 6 - Restructuring Charge In April 1998, the Company adopted a formal plan to close its Texas distribution center. The Company recorded a restructuring charge of $2.6 million during the year ended January 2, 1999 in connection with this plant closing. The charge included $1.5 million for the writedown of assets to be disposed (which were all disposed during fiscal 1998) and a severance accrual of approximately $1.1 million, which represents severance payments due to 40 office and distribution employees. Through April 3, 1999, all of these 40 employees were terminated and severance benefits of $728,000 were paid. The remaining severance accrual will be paid during the balance of fiscal 1999. Note 7 - Segment Reporting In July 1997, the FASB issued SFAS No. 131, Disclosures About Segments of an Enterprise and Related Information. SFAS No. 131 requires certain financial and supplementary information to be disclosed on an annual and interim basis for each reportable segment of an enterprise. SFAS No. 131 is effective for fiscal years beginning after December 15, 1997. The Company has determined it has three reportable segments: mass merchandisers, chain drug stores/combo stores/supermarkets and variety stores. The Company distributes accessories such as, costume jewelry, optical products, watches, clocks and other accessories. The Company's reportable segments are strategic business units that sell the Company's products to distinct distribution channels. They are managed separately because each business requires different marketing strategies. The Company's approach is based on the way that management organizes the segments within the enterprise for making operating decisions and assessing performance. 11 12 AAI.FOSTERGRANT, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS (Continued) The accounting policies of the segments are the same as those described in the summary of significant accounting policies. The Company evaluates performance based on profit or loss from operations before income taxes not including nonrecurring gains and losses.
CHAIN DRUG STORES/ THREE MONTHS COMBO ENDED MASS STORES/ APRIL 4, 1998 MERCHANDISERS SUPERMARKETS VARIETY OTHER TOTAL Net sales $22,366 $10,067 $ 4,710 $ 5,560 $42,703 ======= ======= ======= ======= ======= Segment profit (loss) $ 504 $ 1,528 $(1,288) $ (99) $ 645 ======= ======= ======= ======= =======
CHAIN DRUG STORES/ THREE MONTHS COMBO ENDED MASS STORES/ APRIL 3, 1999 MERCHANDISERS SUPERMARKETS VARIETY OTHER TOTAL Net sales $ 26,255 $ 7,873 $ 5,413 $ 1,940 $ 41,481 ======== ======== ======== ======== ======== Segment profit (loss) $ 1,058 $ (269) $ (782) $ (852) $ (845) ======== ======== ======== ======== ========
Revenue from segments below the quantitative thresholds are attributable to five operating segments of the Company. Those segments include department stores, armed forces' PX stores, boutique stores, gift shops, bookstores and catalogues. None of these segments have ever met any of the quantitative thresholds for determining reportable segments and their combined results are presented as other. Segment profit (loss) differs from the income (loss) before income tax (expense) benefit and dividends and accretion on preferred stock by the amount of equity in losses of investments in affiliates, minority interest in income of consolidated subsidiary and other income, which are not allocated by segment. The chief operating decision-maker does not review segment assets. 12 13 AAI.FOSTERGRANT, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS (Continued) Total assets specifically identifiable with each reportable segment are as follows:
JANUARY 2, APRIL 3, 1999 1999 Mass merchandisers $ 25,248 $ 28,695 Chain drug stores/combo stores/supermarkets 6,368 10,511 Variety 1,246 4,618 Other 5,068 3,643 Unassigned assets 88,568 88,729 -------- -------- $126,498 $136,196 ======== ========
Note 8 - Supplemental Consolidating Financial Information The following is summarized consolidating financial information for the Company, segregating the Company, wholly owned guarantor subsidiaries, mostly owned guarantor subsidiaries and non-guarantor subsidiaries as they relate to the Notes. The guarantor subsidiaries, both mostly and wholly owned, are domestic subsidiaries of the Company and they guarantee the Notes on a full, unconditional and joint and several basis. Separate financial statements of the wholly owned guarantor subsidiaries have not been included because management believes that they are not material to investors. Separate financial statements of the mostly owned guarantor subsidiary, Fantasma LLC, in which the Company holds an 80% interest, are included after this supplemental consolidating financial information. The Company and guarantor subsidiaries account for investments in subsidiaries on the equity method for the purposes of the consolidating financial data. Earnings of subsidiaries are therefore reflected in the Company's and subsidiary's investment accounts and earnings. The principal elimination entries eliminate investments in subsidiaries and intercompany balances and transactions. Effective January 1, 1999, the assets of the Company's wholly owned guarantor subsidiaries were transferred to the Company. Accordingly, all operations previously performed by these wholly owned guarantor subsidiaries are now performed by the Company. 13 14 AAI.FOSTERGRANT, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS SUPPLEMENTAL CONSOLIDATING FINANCIAL INFORMATION
APRIL 3, 1999 ------------------------------------------------------------------------------- WHOLLY OWNED MOSTLY OWNED NON-GUARANTOR COMPANY SUBSIDIARIES SUBSIDIARIES SUBSIDIARIES ELIMINATIONS CONSOLIDATED ------- ------------ ------------ ------------- ------------ ------------ (IN THOUSANDS) CONSOLIDATED CONDENSED BALANCE SHEETS ASSETS Current assets Cash and cash equivalents $ 311 $ -- $ 12 $ 1,394 $ -- $ 1,717 Accounts receivable, net 30,376 -- 1,896 5,660 -- 37,932 Inventories 32,586 -- 3,599 3,145 -- 39,330 Prepaid expenses and other current assets 1,613 -- 267 200 -- 2,080 Deferred tax assets 3,743 -- -- -- -- 3,743 -------- ---- ------- ------- -------- -------- Total current assets 68,629 -- 5,774 10,399 -- 84,802 Property, plant and equipment, net 15,643 -- 21 1,494 -- 17,158 Other assets 46,356 -- 4,254 375 (16,749) 34,236 -------- ---- ------- ------- -------- -------- Total assets $130,628 $ -- $10,049 $12,268 $(16,749) $136,196 ======== ==== ======= ======= ======== ======== LIABILITIES AND SHAREHOLDERS' (DEFICIT) EQUITY Current liabilities Borrowings under revolving note payable $ 15,161 $ -- $ -- $ -- -- $ 15,161 Current maturities of long-term obligations and deferred costs 637 -- -- -- -- 637 Accounts payable 20,069 -- 80 2,607 -- 22,756 Accrued expenses 14,149 -- 372 550 -- 15,071 Due to affiliate -- -- 5,946 2,814 (8,760) -- -------- ---- ------- ------- -------- -------- Total current liabilities 50,016 -- 6,398 5,971 (8,760) 53,625 Long-term obligations and deferred costs, less current maturities 2,143 -- -- -- -- 2,143 10 3/4% series B senior notes due 2006 75,000 -- -- -- -- 75,000 Redeemable preferred stock of a subsidiary 930 -- -- -- -- 930 Preferred Stock 29,579 -- -- -- -- 29,579 Shareholders' (deficit) equity (27,040) -- 3,651 6,297 (7,989) (25,081) -------- ---- ------- ------- -------- -------- Total liabilities and shareholders' (deficit) equity $130,628 $ -- $10,049 $12,268 $(16,749) $136,196 ======== ==== ======= ======= ======== ========
14 15 AAI.FOSTERGRANT, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS SUPPLEMENTAL CONSOLIDATING FINANCIAL INFORMATION
JANUARY 2, 1999 ------------------------------------------------------------------------------- WHOLLY OWNED MOSTLY OWNED NON-GUARANTOR COMPANY SUBSIDIARIES SUBSIDIARIES SUBSIDIARIES ELIMINATIONS CONSOLIDATED ------- ------------ ------------ ------------- ------------ ------------ (IN THOUSANDS) CONSOLIDATED CONDENSED BALANCE SHEETS ASSETS Current assets Cash and cash equivalents $ 68 $ 66 $ 104 $ 1,969 $ -- $ 2,207 Accounts receivable, net 20,699 2 5,088 3,528 -- 29,317 Inventories 28,643 -- 3,878 4,641 -- 37,162 Prepaid expenses and other current assets 1,403 132 203 180 -- 1,918 Deferred tax assets 3,743 -- -- -- -- 3,743 -------- ------- ------- ------- -------- -------- Total current assets 54,556 200 9,273 10,318 -- 74,347 Property, plant and equipment, net 16,206 -- 24 1,313 -- 17,543 Other assets 41,512 7,652 4,357 402 (19,315) 34,608 -------- ------- ------- ------- -------- -------- Total assets $112,274 $ 7,852 $13,654 $12,033 $(19,315) $126,498 ======== ======= ======= ======= ======== ======== LIABILITIES AND SHAREHOLDERS' (DEFICIT) EQUITY Current liabilities Borrowings under revolving note payable $ 2,576 $ -- $ -- $ -- $ -- $ 2,576 Current maturities of long-term obligations and deferred costs 656 -- -- -- -- 656 Accounts payable 10,961 998 406 2,534 -- 14,899 Accrued expenses 16,726 5,622 1,554 968 -- 24,870 Due to affiliate -- 3,757 7,088 2,380 (13,225) -- -------- ------- ------- ------- -------- -------- Total current liabilities 30,919 10,377 9,048 5,882 (13,225) 43,001 Long-term obligations and deferred costs, less current maturities 2,228 -- -- -- -- 2,228 10 3/4% series B senior notes due 2006 75,000 -- -- -- -- 75,000 Redeemable preferred stock of a subsidiary -- -- -- -- 909 909 Preferred Stock 28,845 926 -- -- (909) 28,862 Shareholders' (deficit) equity (24,718) (3,451) 4,606 6,151 (6,090) (23,502) -------- ------- ------- ------- -------- -------- Total liabilities and shareholders' (deficit) equity $112,274 $ 7,852 $13,654 $12,033 $(19,315) $126,498 ======== ======= ======= ======= ======== ========
15 16 AAI.FOSTERGRANT, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS SUPPLEMENTAL CONSOLIDATING FINANCIAL INFORMATION
THREE MONTHS ENDED ------------------------------------------------------------------------------- APRIL 3, 1999 ------------------------------------------------------------------------------- WHOLLY OWNED MOSTLY OWNED NON-GUARANTOR COMPANY SUBSIDIARIES SUBSIDIARIES SUBSIDIARIES ELIMINATIONS CONSOLIDATED ------- ------------ ------------ ------------- ------------ ------------ (IN THOUSANDS) CONSOLIDATED CONDENSED STATEMENT OF OPERATIONS Net sales $33,738 $ -- $1,677 $6,066 $ -- $41,481 Cost of goods sold 19,448 -- 1,532 2,834 -- 23,814 ------- ---- ------ ------ ---- ------- Gross profit 14,290 -- 145 3,232 -- 17,667 Selling general and administrative 12,447 -- 1,046 2,677 -- 16,170 ------- ---- ------ ------ ---- ------- Income (loss) from operations 1,843 -- (901) 555 -- 1,497 Interest expense (2,226) -- (84) (32) -- (2,342) Other income (expense), net 246 -- 30 (226) -- 50 Equity in losses of consolidated subsidiaries (599) -- -- -- 684 85 ------- ---- ------ ------ ---- ------- (Loss) income before income tax expense and dividends on accretion on preferred stock (736) -- (955) 297 684 (710) Income tax expense -- -- -- -- -- -- ------- ---- ------ ------ ---- ------- Net (loss) income before dividends and accretion on preferred stock (736) -- (955) 297 684 (710) Dividends and accretion on preferred stock 718 -- -- -- -- 718 ------- ---- ------ ------ ---- ------- Net (loss) income applicable to common shareholders $(1,454) $ -- $ (955) $ 297 $684 $(1,428) ======= ==== ====== ====== ==== =======
16 17
THREE MONTHS ENDED ------------------------------------------------------------------------------- APRIL 4, 1998 ------------------------------------------------------------------------------- WHOLLY OWNED MOSTLY OWNED NON-GUARANTOR COMPANY SUBSIDIARIES SUBSIDIARIES SUBSIDIARIES ELIMINATIONS CONSOLIDATED ------- ------------ ------------ ------------- ------------ ------------ (IN THOUSANDS) CONSOLIDATED CONDENSED STATEMENT OF OPERATIONS Net sales $18,844 $19,783 $ -- $4,076 $ -- $42,703 Cost of goods sold 13,212 8,371 -- 1,848 -- $23,431 ------- ------- ---- ------ ------- ------- Gross profit 5,632 11,412 -- 2,228 -- 19,272 Selling general and administrative 8,717 7,150 -- 1,582 -- 17,449 ------- ------- ---- ------ ------- ------- (Loss) income from operations (3,085) 4,262 -- 646 -- 1,823 Interest expense (797) (313) -- (68) -- (1,178) Other income (expense), net 79 29 -- (32) -- 76 Equity in losses of consolidated subsidiaries 2,723 -- -- -- (2,723) -- ------- ------- ---- ------ ------- ------- (Loss) income before income tax (benefit) expense and dividends on accretion on preferred stock (1,080) 3,978 -- 546 (2,723) 721 Income tax (benefit) expense (1,521) 1,747 -- 91 -- 317 ------- ------- ---- ------ ------- ------- Net income (loss) before dividends and accretion on preferred stock 441 2,231 -- 455 (2,723) 404 Dividends and accretion on preferred stock 683 -- -- -- -- 683 ------- ------- ---- ------ ------- ------- Net (loss) income applicable to common shareholders $ (242) $ 2,231 $ -- $ 455 $(2,723) $ (279) ======= ======= ==== ====== ======= =======
17 18 AAI.FOSTERGRANT, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS SUPPLEMENTAL CONSOLIDATING FINANCIAL INFORMATION
------------------------------------------------------------------------------- APRIL 3, 1999 ------------------------------------------------------------------------------- WHOLLY OWNED MOSTLY OWNED NON-GUARANTOR COMPANY SUBSIDIARIES SUBSIDIARIES SUBSIDIARIES ELIMINATIONS CONSOLIDATED ------- ------------ ------------ ------------- ------------ ------------ (IN THOUSANDS) CONSOLIDATED CONDENSED STATEMENT OF CASH FLOWS Cash flows (used in) provided by operating activities $(11,418) $ -- $ 1,063 $ (110) $ -- $(10,465) Cash flows from investing activities: Purchase of property, plant and equipment (1,373) -- -- (762) -- (2,135) Advance to affiliates 870 -- -- -- (870) -- Other investing activities (313) -- (13) 25 -- (301) -------- ---- ------- ------ ----- -------- Net cash (used in) provided by investing activities (816) -- (13) (737) (870) (2,436) -------- ---- ------- ------ ----- -------- Cash flows from financing activities: Net borrowings under revolving note payable 12,585 -- -- -- -- 12,585 Payments on long-term obligations (19) -- -- -- -- (19) Due (from) to affiliates -- -- (1,142) 272 870 -- Other financing activities (155) -- -- -- -- (155) -------- ---- ------- ------ ----- -------- Net cash provided by (used in) financing activities 12,411 -- (1,142) 272 870 12,411 -------- ---- ------- ------ ----- -------- Net increase (decrease) in cash and cash equivalents 177 -- (92) (575) -- (490) Cash and cash equivalents, beginning of period 134 -- 104 1,969 -- 2,207 -------- ---- ------- ------ ----- -------- Cash and cash equivalents, end of period $ 311 $ -- $ 12 $1,394 $ -- $ 1,717 ======== ==== ======= ====== ===== ========
18 19 AAI.FOSTERGRANT, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS SUPPLEMENTAL CONSOLIDATING FINANCIAL INFORMATION
------------------------------------------------------------------------------- APRIL 4, 1998 ------------------------------------------------------------------------------- WHOLLY OWNED MOSTLY OWNED NON-GUARANTOR COMPANY SUBSIDIARIES SUBSIDIARIES SUBSIDIARIES ELIMINATIONS CONSOLIDATED ------- ------------ ------------ ------------- ------------ ------------ (IN THOUSANDS) CONSOLIDATED CONDENSED STATEMENT OF CASH FLOWS Cash flows (used in) provided by operating activities $ (6,488) $ 1,310 $ -- $ (78) $ -- $ (5,256) Cash flows from investing activities: Purchase of property, plant and equipment (5,143) (3,633) -- (297) -- (9,073) Acquisitions, net of cash received (5,487) -- -- -- -- (5,487) Advance to affiliates (2,856) -- -- -- 2,856 -- Other investing activities (4,244) 2,174 -- (154) -- (2,224) -------- ------- ---- ----- ------- -------- Net cash (used in) provided by investing activities (17,730) (1,459) -- (451) 2,856 (16,784) -------- ------- ---- ----- ------- -------- Cash flows from financing activities: Net borrowings under revolving note payable 18,880 (1,437) -- -- -- $ 17,443 Proceeds from term note payable 2,737 -- -- -- -- 2,737 Payments on long-term obligations (480) -- -- -- -- (480) Due to (from) affiliates 823 1,479 -- 554 (2,856) -- -------- ------- ---- ----- ------- -------- Net cash provided by (used in) financing activities 21,960 42 -- 554 (2,856) 19,700 -------- ------- ---- ----- ------- -------- Net (decrease) increase in cash and cash equivalents (2,258) (107) -- 25 -- (2,340) Cash and cash equivalents, beginning of period 2,354 183 -- 242 -- 2,779 -------- ------- ---- ----- ------- -------- Cash and cash equivalents, end of period $ 96 $ 76 $ -- $ 267 $ -- $ 439 ======== ======= ==== ===== ======= ========
19 20 AAI.FOSTERGRANT, INC. AND SUBSIDIARIES Fantasma, LLC (A Mostly Owned Subsidiary of AAI.FosterGrant, Inc.) Condensed Balance Sheets (In thousands)
JANUARY 2, APRIL 3, 1999 1999 (Unaudited) ASSETS CURRENT ASSETS: Cash and cash equivalents $ 104 $ 12 Accounts receivable less reserves of approximately $373 and $532 5,088 1,896 Inventories 3,878 3,599 Prepaid expenses and other current assets 203 267 ------- ------- Total current assets 9,273 5,774 ------- ------- Property and equipment, net 24 21 Other assets, net 4,357 4,254 ------- ------- Total assets $13,654 $10,049 ======= ======= LIABILITIES AND MEMBERS' EQUITY CURRENT LIABILITIES: Note payable to member $ 7,088 $ 5,946 Accounts payable and accrued liabilities 1,960 452 ------- ------- Total current liabilities 9,048 6,398 Members' Equity 4,606 3,651 ------- ------- Total liabilities and members' equity $13,654 $10,049 ======= =======
The accompanying notes are an integral part of these condensed financial statements 20 21 AAI.FOSTERGRANT, INC. AND SUBSIDIARIES Fantasma, LLC (A Mostly Owned Subsidiary of AAI.FosterGrant, Inc.) Condensed Statements of Operations (In thousands)
THREE MONTHS ENDED APRIL 4, APRIL 3, 1998 1999 (Unaudited) NET SALES $ 3,031 $ 1,677 COST OF GOODS SOLD 1,672 1,532 ------- ------- Gross profit 1,359 145 OPERATING EXPENSES: Selling 648 686 General and administrative 591 360 ------- ------- Income (loss) from operations 120 (901) Interest expense (103) (84) Other income, net -- 30 ------- ------- Net income (loss) $ 17 $ (955) ======= =======
The accompanying notes are an integral part of these condensed financial statements. 21 22 AAI.FOSTERGRANT, INC. AND SUBSIDIARIES Fantasma, LLC (A Mostly Owned Subsidiary of AAI.FosterGrant, Inc.) CONDENSED STATEMENTS OF CASH FLOWS (In thousands)
THREE MONTHS ENDED APRIL 4, APRIL 3, 1998 1999 (Unaudited) CASH FLOWS FROM OPERATING ACTIVITIES: Net income (loss) $ 17 $ (955) Adjustments to reconcile net income (loss) to net cash provided by operating activities- Depreciation and amortization 4 119 Changes in assets and liabilities - Accounts receivable 2,469 3,192 Inventories 64 279 Prepaid expenses and other current assets (32) (64) Accounts payable and accrued expenses (1,070) (1,508) ------- ------- Net cash provided by operating activities 1,452 1,063 ------- ------- CASH FLOWS FROM INVESTING ACTIVITIES: Increase in other assets -- (13) Purchases of property and equipment (2) -- ------- ------- Net cash used in investing activities (2) (13) ------- ------- CASH FLOWS FROM FINANCING ACTIVITIES: Repayments under note payable to member (3,764) -- Advances payable to member 2,076 (1,142) ------- ------- Net cash used in financing activities (1,688) (1,142) ------- ------- NET DECREASE IN CASH AND CASH EQUIVALENTS (238) (92) CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD 238 104 ------- ------- CASH AND CASH EQUIVALENTS, END OF PERIOD $ -- $ 12 ======= ======= SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION: Cash paid during the period for- Interest $ 360 =======
The accompanying notes are an integral part of these condensed financial statements. 22 23 AAI.FOSTERGRANT, INC. AND SUBSIDIARIES FANTASMA, LLC NOTES TO FINANCIAL STATEMENTS Note 1 - Significant Accounting Policies (a) Interim Condensed Financial Statements The accompanying unaudited interim condensed financial statements have been prepared in accordance with generally accepted accounting principles for interim financial information and pursuant to the rules and regulations of the Securities and Exchange Commission (SEC) for reporting on Form 10-Q. Accordingly, certain information and footnote disclosure required for complete financial statements are not included herein. It is recommended that these financial statements be read in conjunction with the consolidated financial statements and related notes of AAi.FosterGrant, Inc. ("AAi" or the "Company") and Fantasma LLC for the year ended January 2, 1999 as reported in the Company's Form 10-K filed with the SEC on April 2, 1999. In the opinion of management, all adjustments (consisting of normal, recurring adjustments) considered necessary for a fair presentation of financial position, results of operations and cash flows at the dates and for the periods presented have been included. The consolidated condensed balance sheet presented as of January 2, 1999 has been derived from the consolidated financial statements that have been audited by the Company's independent public accountants. The results of operations for the period ended April 3, 1999 may not be indicative of the results that may be expected for the year ending January 1, 2000 or for any other future period. (b) Organization and Business Activity Fantasma LLC (Fantasma) was organized under the laws of the State of Delaware on August 22, 1996 and began business operations on September 1, 1996. Fantasma imports and wholesales licensed watches, clocks, and other novelties; and grants credit to customers located throughout the United States. Prior to September 1, 1996, Fantasma operated as a division of Overdrive Capital Corp. (formerly known as Good Stuff Corp.). Overdrive Capital Corp. (Overdrive) sold the division's operating assets to Fantasma LLC in exchange for a two-year, $3,764,366 note. Overdrive maintained a 67% ownership interest in Fantasma, with a former stockholder of Overdrive holding a 33% ownership interest. In June 1998, AAi acquired an 80% interest in Fantasma for approximately $4.1 million in cash. The remaining 20% interest in Fantasma is held by a previous member of Fantasma. As the result of the termination of the employment of this member, in April 1999, the Company has the obligation to repurchase this interest for nominal consideration. Another employee of Fantasma has options to acquire up to a 2% interest in Fantasma and up to an additional 2% interest if certain earnings targets for Fantasma are met in 1999 and 2000. As of April 23 24 AAI.FOSTERGRANT, INC. AND SUBSIDIARIES NOTES TO FINANCIAL STATEMENTS (CONTINUED) 3, 1999, the exercise price of options to purchase membership interests of Fantasma was equal to or greater than the fair market value. (c) Inventory Inventories are stated at the lower of cost (first-in, first-out) or market and consist of finished goods for all years presented. Finished goods inventory consists of material and overhead. (d) Income Taxes Fantasma is treated as a partnership for federal and state income tax purposes, whereby the membership owners are taxed on their proportionate share of Fantasma's income. As a result, Fantasma has not provided for Federal income taxes. Note 2 - Comprehensive Income Comprehensive net income was the same as net income for the periods presented. NOTE 3 - Segment Reporting Fantasma has adopted SFAS No. 131, Disclosures About Segments of an Enterprise and Related Information, in the 1998 fiscal year. SFAS No. 131 establishes standards for reporting information regarding operating segments in annual financial statements and requires selected information for those segments to be presented in interim financial reports issued to stockholders. SFAS No. 131 also establishes standards for related disclosures about products and services and geographic areas. Operating segments are identified as components of an enterprise about which separate discrete financial information is available for evaluation by the chief operating decision maker, or decision making group, in making decisions now to allocate resources and assess performance. To date, Fantasma has viewed its operations and manages its business as principally one segment. 24 25 AAI.FOSTERGRANT, INC. AND SUBSIDIARIES ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The following discussion may contain "forward-looking" statements and are subject to risks and uncertainties that could cause actual results to differ significantly from expectations. In particular, statements contained in this "Management's Discussion and Analysis of Financial Condition and Results of Operations" section which are not historical facts, including, but not limited to, statements regarding the anticipated adequacy of cash resources to meet the Company's working capital and capital expenditure requirements and statements regarding the anticipated proportion of revenues to be derived from a limited number of customers, may constitute forward-looking statements. Although the Company believes the expectations reflected in such forward-looking statements are reasonable, it can give no assurance that such expectations will prove to have been correct. Important factors, which could cause actual results to differ materially from such expectations, are disclosed in the Company's Form 10-K filed with the SEC on April 2, 1999. OVERVIEW The Company is a value-added distributor of optical products, costume jewelry, watches, clocks and other accessories primarily to mass merchandisers, chain drug stores/combo stores/supermarkets and variety stores in North America and the United Kingdom. As a value-added distributor, the Company provides customized store displays, merchandising management and a store-level field service force to replenish and restock displays, reorder product and attend to markdowns and allowances. Upon shipment to the customer, the Company estimates agreed upon future allowances, returns and discounts, taking into account historical experience, and reflects revenue net of these estimates. When establishing or expanding a customer relationship, the Company generally enters into multi-year agreements for the supply of specified product lines to specific customer stores. The agreements may contain required minimum sales volumes or termination penalties equal to the Company's unamortized cost of product displays provided to the customer. The Company believes its relationships with retailers are dependent upon its ability to efficiently utilize allocated floor space to generate satisfactory returns for its customers. To meet this end, the Company strives to consistently deliver competitively priced products and service programs which provide retailers with attractive gross margins and inventory turnover rates. The Company has historically retained customers from year to year, although retailers may drop or add product lines supplied by the Company. Generally, customer loss has been attributable to such customer going out of business or being acquired by a company which does not carry AAi's product line or has prior relationships with a competitor of the Company. 25 26 AAI.FOSTERGRANT, INC. AND SUBSIDIARIES MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED) Certain segments of the retail industry, particularly mass merchandisers, variety stores, drugstores and supermarkets, are experiencing significant consolidation and in recent years many major retailers have experienced financial difficulties. These industry wide developments have had and may continue to have an impact on the Company's results of operations. In addition, as a result of financial pressures, many major retailers have sought to reduce inventory levels in order to reduce their operating costs which has had a negative effect on the Company's results of operations. Net Sales. The Company offers optical products, costume jewelry, small synthetic leather goods, watches, clocks and other accessories, generally at retail price points of $20 or less. Net sales of the Company's optical products accounted for approximately 59.0% and 45.3% of the Company's net sales for the three months ended April 4, 1998 and April 3, 1999, respectively; net sales of the Company's costume jewelry accounted for approximately 29.4% and 34.0% of the Company's net sales for the three months ended April 4, 1998 and April 3, 1999, respectively, and the balance represented sales of synthetic leather goods, watches, clocks and other accessories. Optical products generally have higher gross margins than the Company's other product lines. Cost of Goods Sold. The Company outsources manufacturing for all of its products, 75% of which is sourced to manufacturers in Asia through its joint venture in Hong Kong, with the remainder outsourced to independent domestic manufacturers. Accordingly, the principal element comprising the Company's cost of goods sold is the price of manufactured goods purchased through the Company's joint venture or from independent manufacturers. The Company believes outsourcing manufacturing allows it to reliably deliver competitively priced products to the retail market while retaining considerable flexibility in its cost structure. Operating Expenses. Operating expenses are comprised primarily of payroll and occupancy costs related to the Company's selling, general and administrative activities as well as depreciation and amortization. The Company incurs various costs in connection with the acquisition of new customers and new stores for existing customers, principally the cost of new product display fixtures and costs related to the purchase of the customer's existing inventory. The Company makes substantial investments in the design, production and installation of display fixtures in connection with establishing and maintaining customer relationships. The Company capitalizes the production cost of these display fixtures as long as it retains ownership of them. These costs are amortized to selling expenses on a straight-line basis over their estimated useful life, which is one to three years. If the Company does not retain title to the displays, the display costs are expensed as shipped. 26 27 AAI.FOSTERGRANT, INC. AND SUBSIDIARIES MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED) The Company incurs direct and incremental costs in connection with the acquisition of certain new customers and new store locations from existing customers under multi-year agreements. The Company may also receive the previous vendor's merchandise from the customer in connection with these agreements. In these situations, the Company values this inventory at its fair market value, representing the lower of cost or net realizable value, and records that value as inventory. The Company sells this inventory through various liquidation channels. Except as provided below, the excess costs over the fair market value of the inventory received is charged to selling expense when incurred. The Company expensed customer acquisition costs of approximately $377,000 and $147,000 for the three months ended April 4, 1998 and April 3, 1999, respectively. The excess costs over the fair market value of the inventory received is capitalized as deferred costs and amortized over the agreement period if the Company enters into a minimum purchase agreement with the customer and the estimated gross profits from future minimum sales during the term of the agreement are sufficient to recover the amount of the deferred costs. During the three months ended April 3, 1999, the Company capitalized approximately $61,000 of these costs in the accompanying consolidated balance sheet. Amortization expense related to these costs as well as previously capitalized costs was approximately $296,000 for the three months ended April 3, 1999. No such costs were capitalized or amortized during the three months ended April 4, 1998. Dividends and Accretion on Preferred Stock. The Company has 43,700 shares of Series A Redeemable Convertible Preferred Stock ("Series A Preferred Stock") outstanding, of which 34,200 were issued in May 1996 for gross proceeds of $18.0 million, and an additional 9,500 shares were issued for gross proceeds of $5.0 million in connection with the December 1996 acquisition of Foster Grant Group LP and related companies ("Foster Grant US"). Beginning on June 30, 2002, shares of the Series A Preferred Stock are redeemable at the option of the holder for an amount equal to the original issue price plus accrued and unpaid dividends yielding a 10% compounded annual rate of return, provided, however, that the right to require redemption is suspended as long as any Restrictive Indebtedness (as defined in the Articles of Incorporation) is outstanding. Net loss applicable to common shareholders represents net loss less accretion of original issuance costs and cumulative dividends due on the Series A Preferred Stock. 27 28 AAI.FOSTERGRANT, INC. AND SUBSIDIARIES MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED) Earnings Before Interest, Taxes, Depreciation and Amortization (EBITDA). Although EBITDA is not a measure of performance calculated in accordance with Generally Accepted Accounting Principles (GAAP), the Company believes that EBITDA is accepted as a generally recognized measure of performance in the distribution industry and provides an indicator of the earnings available to meet the Company's debt service obligations. EBITDA should not be considered in isolation or as a substitute for operating income, net income, net cash provided by operating activities or any other measure for determining the Company's operating performance or liquidity which is calculated in accordance with GAAP. EBITDA was $4.4 million and $4.8 million for the three months ended April 4, 1998 and April 3, 1999, respectively. In June 1998, the Company acquired 80% of the membership interests of Fantasma for $4.1 million in cash. A former member of Fantasma holds the remaining 20% membership interest of Fantasma. As the result of the termination of the employment of this member, in April 1999, the Company has the obligation to repurchase this interest for nominal consideration. Another employee of Fantasma has options to acquire up to a 2% interest in Fantasma and up to an additional 2% interest if certain earnings targets for Fantasma are met in 1999 and 2000. AAi's acquisition of Fantasma added watches and clocks to AAi's product lines and Disney and Warner Bros. stores to its customer base. As a result of this transaction, the Company recorded approximately $4.6 million in intangible assets, which are being amortized over 10 years. In March 1998, the Company acquired certain assets of Foster Grant UK for the aggregate book value of certain acquired assets, including inventory items of $3.3 million and accounts receivable of $1.7 million, less the aggregate amount of trade payables assumed of $1.1 million and bank debt assumed of $1.7 million. In addition, the Company acquired the Foster Grant trademark in the United Kingdom and Europe for $0.7 million, which amount is subject to upward adjustment at the end of 1998 and 1999 based on annual sales, up to a maximum additional payment of $0.7 million. No adjustment to the purchase price is required as result of sales to date. As a result of this acquisition, the Company recorded approximately $1.1 million of intangible assets, which are being amortized over 20 years. Net loss before dividends and accretion on preferred stock for the first quarter of fiscal 1999 was $710,000 as compared to net income before dividends and accretion on preferred stock of $404,000 in the first quarter of fiscal 1998. 28 29 AAI.FOSTERGRANT, INC. AND SUBSIDIARIES MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED) RESULTS OF OPERATIONS The following table sets forth, for the periods indicated, the percentage relationship to net sales of certain items included in the Company's Consolidated Condensed Statements of Operations:
THREE MONTHS ENDED APRIL 4, APRIL 3, 1998 1999 Net sales 100.0% 100.0% Cost of goods sold 54.9 57.4 ----- ----- Gross profit 45.1 42.6 Operating expenses 40.9 39.0 ----- ----- Income (loss) from operations 4.2 3.6 Interest expense (2.8) (5.6) Other expense, net 0.2 0.3 ----- ----- Income (loss) before taxes and Dividends and accretion on Preferred stock 1.6 (1.7) Income tax (expense) benefit (0.7) -- ----- ----- Net income (loss) before Dividends and accretion on Preferred stock 0.9 (1.7) Dividends and accretion on Preferred stock 1.6 1.7 ----- ----- Net loss applicable to common Shareholders (0.7)% (3.4)% ===== =====
29 30 AAI.FOSTERGRANT, INC. AND SUBSIDIARIES MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED) THREE MONTHS ENDED APRIL 3, 1999 COMPARED TO APRIL 4, 1998 Net Sales. Consolidated net sales were $41.5 million for the three months ended April 3, 1999 as compared to $42.7 million for the three months ended April 4, 1998, a decrease of 2.9% or $1.2 million. The decrease in net sales is attributable to a reduction in sales to chain drug stores/combo stores/supermarkets of $2.2 million and a reduction of $3.6 million in other channels partially offset by improved sales with mass merchandisers of $3.9 million and with variety stores of $0.7 million. Gross Profit. Gross profit was $17.7 million for the three months ended April 3, 1999 as compared to $19.3 million for the three months ended April 4, 1998. Gross profit as a percentage of net sales decreased to 42.6% for the three months ended April 3, 1999 from 45.1% for the three months ended April 4, 1998. The $1.6 million or 8.3% decrease is primarily due to increased sales of promotional products, which have lower margins, and a change in product sales mix from higher margin optical products to lower margin jewelry products. Operating Expenses. Operating expenses were $16.2 million for the three months ended April 3, 1999 as compared to $17.5 million for the three months ended April 4, 1998, a decrease of 7.3% or $1.3 million. The decrease is primarily attributable to payroll and overhead savings generated from the closing of the Dallas distribution facility. Interest Expense. Interest expense was $2.3 million for the three months ended April 3, 1999 as compared to $1.2 million for the three months ended April 4, 1998, an increase of 99% or $1.1 million. This resulted from additional borrowings under the Company's credit facilities to fund operations and a higher effective interest rate related to the Company's 10 3/4% Senior Notes. Income Tax. No income tax benefit was recorded for the three months ended April 3, 1999 as compared to $317,000 of expense for the three months ended April 4, 1998. Net Income (Loss). As a result of the factors discussed above, net loss before dividends and accretion on preferred stock was $710,000 for the three months ended April 3, 1999 as compared to net income before dividends and accretion on preferred stock of $404,000 for the three months ended April 4, 1998, a decrease of $1.1 million. Net Loss Applicable to Common Shareholders. Net loss applicable to common shareholders was $1.4 million for the three months ended April 3, 1999 as compared to a loss of $279,000 for the three months ended April 4, 1998, an increase of $1.1 million. The increase was attributable to the $1.1 million decrease in earnings and an increase of $35,000 30 31 AAI.FOSTERGRANT, INC. AND SUBSIDIARIES MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED) in dividends and accretion on Series A Preferred Stock due to the compounding of accrued dividends. LIQUIDITY AND CAPITAL RESOURCES At April 3, 1999 the Company had cash and cash equivalents of $1.7 million and working capital of $31.2 million. To date, the Company has funded its operations through credit facilities, issuance of equity and debt securities, and cash generated from operations. The Company used $10.5 million of cash in operations during the three months ended April 3, 1999 compared to a use of $5.3 million during the three months ended April 4, 1998. Cash used in operating activities increased due to lower operating results, increased inventory purchases, higher accounts receivables and timing of payments for accruals and accounts payable offset by increases in non-cash depreciation and amortization charges. The Company used $2.4 million in investing activities during the three months ended April 3, 1999 compared to a use of $16.9 million during the three months ended April 4, 1998. The uses of funds for investing activities during the three months ended April 3, 1999 consisted primarily of $2.1 million for the purchase of equipment (primarily display fixtures). The Company generated $12.4 million from financing activities during the three months ended April 3, 1999 compared to $19.7 million during the three months ended April 4, 1998. The funds generated from financing activities consisted mainly of borrowings under the revolving note payable. The Company has 43,700 shares of Series A Preferred Stock which has a redemption value at April 3, 1999 of $29.6 million. Shares of Series A Preferred Stock are convertible into Common Stock at a rate of 10 for 1, adjustable for certain dilutive events. Conversion is at the option of the shareholder, but is automatic upon the consummation of a qualified public offering. The holders of Series A Preferred Stock have the right to require redemption for cash for any unconverted shares, beginning June 30, 2002, provided, however, that the right to require redemption is suspended as long as any Restrictive Indebtedness (as defined in the Company's Articles of Incorporation) is outstanding. The Notes constitute Restrictive Indebtedness. The redemption price of the Series A Preferred Stock is an amount equal to the original issue price, $526.32 per share, plus any accrued and unpaid dividends yielding a 10% compounded annual rate of return. 31 32 AAI.FOSTERGRANT, INC. AND SUBSIDIARIES MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED) In connection with the purchase of Foster Grant US, the Company's wholly-owned subsidiary, Foster Grant Holdings, Inc. (FG Holdings) issued 100 shares of FG Preferred Stock, which are redeemable on February 28, 2000, or earlier upon the occurrence of certain specified capital transactions. The redemption price will range between $1.0 million and $4.0 million depending upon the net sales of sunglasses, reading glasses and accessories by FG Holdings and the Company, and upon the total transaction value. The Company is continually engaged in evaluating potential acquisitions. The Company expects that funding for future acquisitions may come from a variety of sources, depending on the size and nature of any such acquisition. Potential sources of capital include cash generated from operations, borrowings under the Company's Senior Credit Facility with Bank of America, as an agent and lender, or other external debt or equity financings. There can be no assurance that such additional capital sources will be available to the Company, if at all, on terms that the Company finds acceptable. The Company has substantial indebtedness and significant debt service obligations. As of April 3, 1999, the Company had total indebtedness, including borrowings under the Senior Credit Facility, in the aggregate principal amount of $91.4 million. The Company had current liabilities of approximately $53.6 million. In addition, the Company has significant annual obligations that include interest on the Notes of approximately $8.1 million, minimum royalty obligations over the next two years of approximately $3.6 million and minimum payments under its operating leases of approximately $1.8 million. The Indenture permits the Company to incur additional indebtedness, including secured indebtedness, subject to certain limitations. The Company has up to $36.4 million available for borrowings under the Senior Credit Facility as of April 3, 1999. Interest rates on the revolving loans under the Senior Credit Facility are based, at the Company's option, on the Base Rate (as defined) or LIBOR plus an applicable margin. The Senior Credit Facility contains certain restrictions and limitations, including financial covenants that require the Company to maintain and achieve certain levels of financial performance and limit the payment of cash dividends and similar restricted payments. Subsequent to the end of the first quarter of fiscal 1999, the Company successfully negotiated an amendment to the Senior Credit Facility to modify the financial covenants. Covenants for the first quarter of fiscal 1999 have been waived with the new covenants beginning with the six months ended July 3, 1999. The Company's ability to make scheduled payments of principal, or to pay the interest on, or to refinance, its indebtedness (including the Notes), or to fund planned capital expenditures will depend 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 the current level of operations and anticipated cost savings and revenue growth, the Company believes that cash flow from operations and available cash, 32 33 AAI.FOSTERGRANT, INC. AND SUBSIDIARIES MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED) together with available borrowings under the Senior Credit Facility, will be adequate to meet the Company's future liquidity needs for at least the next several years. The Company may, however, need to refinance all or a portion of the principal of the Notes on or prior to maturity. There can be no assurance that the Company's business will generate sufficient cash flow from operations, that anticipated cost savings and revenue growth will be realized or that future borrowings will be available under the Senior Credit Facility in an amount sufficient to enable the Company to service its indebtedness, including the Notes, or to fund its other liquidity needs. In addition, there can be no assurance that the Company will be able to effect any such refinancing on commercially reasonable terms or at all. YEAR 2000 The Company uses several application programs written over many years using two-digit fields to define the applicable year, rather than four-digit year fields. Programs that are time-sensitive may recognize a date using "00" as the year 1900 rather than the year 2000. This misinterpretation of the year could result in an incorrect computation or a computer shutdown. As a result of the Company's growth, AAi is implementing a new information management system which is expected to be Year 2000 compliant. The new system is scheduled for completion by late-summer 1999. Accordingly, the Company believes that with the successful conversion to the new software, the Year 2000 issue will not pose significant operational problems for the Company's systems. The Company will evaluate the need for contingency planning in the second quarter of 1999 based on the status of the system installation. Since Year 2000 compliance is being addressed with the implementation of the Company's new system, the costs of addressing the Year 2000 issue are not separately identifiable. No material additional costs are anticipated at this time. The Company has completed a compliance review of its property which uses embedded technology. Although the Company believes that the Year 2000 issue will not pose a significant problem for any of the Company's systems or property utilizing embedded technology, there can be no assurance that the Year 2000 issue will not interfere with the function and use of such property. The Company has engaged in formal communications with its major customers and most significant vendors to determine the extent to which the Company's interface systems are vulnerable to those third parties' failure to remediate their own Year 2000 issues. These major customers and vendors have informed the Company that they are currently addressing the Year 2000 issue and expect to be Year 2000 compliant by mid-1999. While there can be 33 34 AAI.FOSTERGRANT, INC. AND SUBSIDIARIES MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED) no guarantee that the systems of other companies on which the Company's systems rely will be timely converted and will not have an adverse effect on the Company's systems, the Company does not believe that its operations are materially vulnerable to the failure of any vendor or customer to properly address the Year 2000 issue. The Company's contingency plan in the event other parties are unable to provide Year 2000 compliant electronic data is to revert to paper documentation from these parties. The failure to correct a material Year 2000 problem could result in an interruption in, or failure of, certain normal business activities or operations. Such failures could materially and adversely affect the Company's results of operations, liquidity and financial condition. Due to the general uncertainty inherent in the Year 2000 problem, resulting in part from the uncertainty of the Year 2000 readiness of third-party suppliers and customers, the Company is unable to determine at this time whether the consequences of Year 2000 failures will have a material impact on the Company's results of operations, liquidity or financial condition. The aforementioned steps being undertaken by the Company are expected to significantly reduce the Company's level of uncertainty about the Year 2000 problem and, in particular, about the Year 2000 compliance and readiness of its material customers and vendors. The Company believes that, with the implementation of its new information management system and the other steps being taken, the possibility of significant interruptions of normal operations should be reduced. ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK. The following discussion about the Company's market risk disclosures includes forward-looking statements. Actual results could differ materially from those projected in the forward-looking statements. The Company is exposed to market risk related to changes in interest rates and foreign currency exchange rates. The Company does not use derivative financial instruments for speculative or trading purposes. Interest Rate Risk. The Company is exposed to market risk from changes in interest rates primarily through its borrowing activities. In addition, the Company's ability to finance future acquisition transactions may be impacted if the Company is unable to obtain appropriate financing at acceptable interest rates. The Company manages its borrowing exposure to changes in interest rates by optimizing the use of fixed rate debt with extended maturities. At April 3, 1999, approximately 99% of the carrying values of the Company's long-term debt were at fixed interest rates. 34 35 AAI.FOSTERGRANT, INC. AND SUBSIDIARIES QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK (CONTINUED) Foreign Currency Risk. The Company's results of operations are affected by fluctuations in the value of the U.S. dollar as compared to the value of currencies in foreign markets primarily related to changes in the British Pound, the Canadian Dollar, the Mexican Peso and the Hong Kong Dollar. During the three months ended April 3, 1999, the net impact of foreign currency changes was not material to the Company's financial condition or results of operations. The Company manages its exposure to foreign currency exchange risk by trying to minimize the Company's net investment in its foreign subsidiaries. The Company generally does not enter into derivative financial instruments to manage foreign currency exposure. The Company's operations in Europe are not significant and, therefore, the Company does not expect to be materially impacted by the introduction of the Euro dollar. 35 36 AAI.FOSTERGRANT, INC. AND SUBSIDIARIES PART II. OTHER INFORMATION ITEM 1. LEGAL PROCEEDINGS None. ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS None ITEM 3. DEFAULTS UPON SENIOR SECURITIES None ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS None ITEM 5. OTHER INFORMATION None ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K (a) Exhibits EX-27.1 Financial Data Schedule (b) Report on Form 8-K The registrant filed no reports on form 8-K during the quarter ended April 3, 1999. 36 37 AAI.FOSTERGRANT, INC. AND SUBSIDIARIES 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 hereunto duly authorized. AAi.FosterGrant, Inc. (Registrant) Dated: May 18, 1999 /s/ Gerald F. Cerce ----------------------------------------------- Gerald F. Cerce Chairman, President and Chief Executive Officer (Principal Executive Officer) Dated: May 18, 1999 /s/ Duane M. DeSisto ----------------------------------------------- Duane M. DeSisto Assistant Secretary and Chief Financial Officer (Principal Financial Officer)
37 EX-27 2 FINANCIAL DATA SCHEDULE
5 THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE CONDENSED BALANCE SHEET AS OF APRIL 3, 1999 (UNAUDITED) AND THE CONDENSED STATEMENT OF OPERATIONS FOR THE THREE MONTHS ENDED APRIL 3, 1999 (UNAUDITED) AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS CONTAINED IN FORM 10-K FOR THE YEAR ENDED JANUARY 2, 1999. 1,000 U.S. DOLLARS 3-MOS JAN-01-2000 JAN-02-1999 APR-03-1999 1 1,717 0 46,430 8,498 39,330 84,802 39,268 22,110 136,196 53,625 75,616 0 30,509 6 (25,087) 136,196 41,481 41,481 23,814 16,170 (135) 0 2,342 (710) 0 (710) 0 0 0 (1,428) (2.35) 0
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