10-Q 1 b37162aae10-q.txt 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 September 30, 2000. [ ] 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 November 13, 2000, the aggregate market value of the voting equity held by non-affiliates of the Registrant was none. As of November 13, 2000, 608,000 shares of Common Stock, 43,700 shares of Series A Preferred Stock and 70,870 shares of Series B Preferred Stock of the Registrant were issued and 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 1, 2000 and September 30, 2000 3 Consolidated Condensed Statements of Operations for the three and nine months ended October 2, 1999 and September 30, 2000 4 Consolidated Condensed Statements of Cash Flows for the nine months ended October 2, 1999 and September 30, 2000 5 Notes to Consolidated Condensed Financial Statements 6-15 ITEM 2. Management's Discussion and Analysis of Financial Condition and Results of Operations 16-21 ITEM 3. Quantitative and Qualitative Disclosures About Market Risk 21 PART II - OTHER INFORMATION ITEM 1. Legal Proceedings 22 ITEM 2. Changes in Securities and Use of Proceeds 22 ITEM 3. Defaults Upon Senior Securities 22 ITEM 4. Submission of Matters to a Vote of Security Holders 22 ITEM 5. Other Information 22 ITEM 6. Exhibits and reports on Form 8-K 22 SIGNATURES 24 2 3 AAI.FOSTERGRANT, INC. AND SUBSIDIARIES CONSOLIDATED CONDENSED BALANCE SHEETS (IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
ASSETS JANUARY 1, SEPTEMBER 30, 2000 2000 ---------- ------------- CURRENT ASSETS: Cash and cash equivalents $ 2,289 $ 1,880 Accounts receivable less reserves of approximately $12,804 and $10,208 22,231 27,831 Inventories 33,025 37,012 Prepaid expenses and other current assets 794 866 Deferred tax assets 3,743 930 --------- --------- Total current assets 62,082 68,519 --------- --------- Property, plant and equipment, net 19,392 18,987 Intangible assets 13,486 12,994 Other assets 7,588 6,350 Deferred tax assets 5,319 1,959 --------- --------- Total assets $ 107,867 $ 108,809 ========= ========= LIABILITIES AND SHAREHOLDERS' DEFICIT CURRENT LIABILITIES: Borrowings under revolving note payable $ 11,000 $ 27,953 Redeemable preferred stock of a subsidiary 1,000 -- Current maturities of long-term obligations 902 425 Deferred compensation - current portion 10 11 Accounts payable 16,414 17,300 Accrued expenses 23,253 18,654 Accrued income taxes 2,104 2,304 --------- --------- Total current liabilities 54,683 66,647 --------- --------- 10 3/4% series B senior notes due 2006 75,000 51,850 Long-term obligations - less current maturities 420 7,709 Deferred compensation - less current portion 1,662 1,394 Series A redeemable convertible Preferred stock, $.01 par value -- Designated, issued and outstanding -- 43,700 shares stated at redemption value 31,864 34,299 Series B redeemable Preferred stock, $.01 par value-- Designated -- 75,000 shares Issued and outstanding -- 70,870 shares stated at -- 945 redemption value SHAREHOLDERS' DEFICIT: Common stock, $.01 par value-- Authorized -- 4,800,000 shares 6 6 Issued and outstanding -- 608,000 shares Additional paid-in capital 270 270 Accumulated other comprehensive loss (122) (589) Accumulated deficit (55,916) (53,722) --------- --------- Total shareholders' deficit (55,762) (54,035) --------- --------- Total liabilities and shareholders' deficit $ 107,867 $ 108,809 ========= =========
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 SHARE AND PER SHARE DATA)
THREE MONTHS ENDED NINE MONTHS ENDED ------------------------------- ----------------------------- OCTOBER 2, SEPTEMBER 30, OCTOBER 2, SEPTEMBER 30, 1999 2000 1999 2000 ------------- -------------- ------------ -------------- NET SALES $ 38,496 $ 35,750 $ 125,593 $ 123,985 COST OF GOODS SOLD 24,155 21,600 74,900 70,711 --------- --------- --------- --------- Gross profit 14,341 14,150 50,693 53,274 OPERATING EXPENSES: Selling 12,155 9,702 36,951 33,208 General and administrative 4,572 4,346 13,610 13,474 Restructuring charge -- -- -- 2,500 --------- --------- --------- --------- (Loss) Income from operations (2,386) 102 132 4,092 Interest expense (2,657) (3,041) (7,679) (8,422) Other income, net 60 53 44 198 --------- --------- --------- --------- Loss before income tax expense (4,983) (2,886) (7,503) (4,132) Income tax expense (37) (35) (37) (78) --------- --------- --------- --------- Net loss before extraordinary items (5,020) (2,921) (7,540) (4,210) Extraordinary gain, net of $3.2 million and $6.3 million in taxes, respectively -- 4,409 -- 8,838 --------- --------- --------- --------- Net (loss) income before dividends and accretion on preferred stock (5,020) 1,488 (7,540) 4,628 Dividends and accretion on preferred stock 773 847 2,228 2,435 --------- --------- --------- --------- Net (loss) income applicable to common shareholders $ (5,793) $ 641 $ (9,768) $ 2,193 ========= ========= ========= =========
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)
NINE MONTHS ENDED -------------------------- OCTOBER 2, SEPTEMBER 30, 1999 2000 ---------- ----------- CASH FLOWS FROM OPERATING ACTIVITIES: Net (loss) income before dividends and accretion on preferred stock $ (7,540) $ 4,628 Adjustments to reconcile net loss to net cash used in operating Activities -- Depreciation and amortization 8,431 9,106 Extraordinary gain on early extinguishment of debt -- (8,838) Amortization of interest costs related to debt 242 593 Equity in earnings of investments in affiliates (84) -- Minority interest in income of consolidated subsidiary 63 -- Cumulative foreign currency translation adjustment 50 -- Changes in assets and liabilities, net of acquisitions-- Accounts receivable (12,885) (5,715) Inventories 5,024 (4,073) Prepaid expenses and other current assets 911 158 Deferred costs (155) (450) Accounts payable 328 784 Accrued expenses (7,098) (4,611) Accrued income taxes (23) 27 -------- -------- Net cash used in operating activities (12,736) (8,392) -------- -------- CASH FLOWS FROM INVESTING ACTIVITIES Purchases of property, plant and equipment (7,031) (6,568) Increase in other assets (447) (191) -------- -------- Net cash used in investing activities (7,478) (6,759) -------- -------- CASH FLOWS FROM FINANCING ACTIVITIES: Net borrowings under revolving note payable 21,192 16,953 Proceeds from issuance of long-term debt -- 7,087 Repurchase of 10 3/4% Series B Senior Notes due 2006 -- (7,087) Payments on long term obligations and deferred compensation (246) (1,067) Redemption of Preferred Stock of a subsidiary -- (1,000) -------- -------- Net cash provided by financing activities 20,946 14,886 -------- -------- Effect of exchange rate changes on cash and cash equivalents -- (144) NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS 732 (409) CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD 2,207 2,289 -------- -------- CASH AND CASH EQUIVALENTS, END OF PERIOD $ 2,939 $ 1,880 ======== ======== SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION: Cash paid during the period for -- Interest $ 9,183 $ 8,257 ======== ======== Income taxes $ 8 $ 40 ======== ======== SUPPLEMENTAL DISCLOSURE OF NON-CASH ACTIVITIES: Acquisition of equipment under capital lease obligations $ -- $ 557 ======== ======== Issuance of Series B Preferred Stock in connection with debt repurchase $ -- 945 ======== ========
The accompanying notes are an integral part of these consolidated condensed financial statements. 5 6 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 1, 2000 as reported in the Company's 10-K filed with the SEC on March 31, 2000. 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 1, 2000 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 September 30, 2000 may not be indicative of the results that may be expected for the year ending December 30, 2000, or for any other future period. (b) Revenue Recognition The Company recognizes revenue from product sales, net of estimated agreed upon future allowances and anticipated returns and discounts, taking into account historical experience, upon shipment to the customer. (c) Inventories Inventories are stated at the lower of cost (first-in, first-out) or market and consist of the following at January 1, 2000 and September 30, 2000 (in thousands): JANUARY 1, SEPTEMBER 30, 2000 2000 ---------- ------------- Finished goods..................................... $29,695 $ 34,155 Work-in-process and raw materials.................. 3,330 2,857 ------- -------- $33,025 $ 37,012 ======= ======== (d) 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 customer acquisition costs of approximately $48,000 and $269,000 for the three and nine months ended September 30, 2000 and $92,000 and $464,000 for the three and nine months ended October 2, 1999. 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 and nine months ended October 2, 1999 the Company capitalized approximately $49,000 and $155,000 of these costs. The Company capitalized costs of approximately $220,000 and $449,000 during the three and nine months ended September 30, 2000, respectively. Amortization expense related to these costs as well as previously capitalized costs was approximately $306,000 and $903,000 for the three and nine months ended October 2, 1999 and $382,000 and $1.0 million for the three and nine months ended September 30, 2000. NOTE 2 - 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 $71.3 million received by the Company from the issuance and sale of the Notes were used to repay outstanding indebtedness under a credit facility with a bank and certain 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 Series B 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 6 7 bank credit facility. Accounts receivable and inventory of the Company and its domestic subsidiaries secure the bank credit facility. 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 guaranteed, on a 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 September 30, 2000 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. During 2000, the Company has repurchased $23.15 million face value of the Notes for a purchase price of $7.09 million. The purchase price was financed utilizing a term loan under its existing Senior Credit Facility. The term loan is secured by a mortgage on its Smithfield, RI facility and the agreements of certain preferred shareholders to purchase participations in the term loan. The term loan is being amortized over 60 months commencing April 1, 2001, with the principal balance due at the expiration of the Senior Credit Facility on July 31, 2003. As a result of this transaction, the Company recognized a $8.8 million extraordinary gain, net of $6.3 million in taxes, and wrote off $0.9 million of unamortized issuance costs related to the Notes that were repurchased. These purchases resulted from inquiries from holders of the Notes. The Company does not solicit offers to tender Notes for repurchase, but may, from time to time, consider requests to repurchase Notes, subject to the availability of appropriate financing. In conjunction with the commitment to purchase participations in the term loan, the Company issued 70,870 shares of Series B Preferred Stock. The holders of Series B Preferred Stock are entitled to receive, prior and in preference to any other capital stock of the Company, an amount per share equal to $6.67 multiplied by the number of six month periods and fractions thereof during which the participation commitment was outstanding. The Company has calculated the value of the Series B Preferred Stock to be $945,000 based on the assumption that the participation commitment will be outstanding for one year. This amount is being amortized over the one-year period as interest expense. If the participation commitment is outstanding for a period beyond twelve months, the Company will assign additional value to the stock and amortize the related costs over the additional period of the participation commitment. NOTE 3 - EARNINGS PER SHARE During the quarter ended July 1, 2000, the Company decided to eliminate its earning per share disclosure. This decision was based on the fact that the Company does not have common stock or potential common stock that is traded in a public market, as required by SFAS No. 128, "Earnings Per Share", and the Company's common stock does not have a readily ascertainable fair market value. NOTE 4 - COMPREHENSIVE INCOME (LOSS) Comprehensive income for the three and nine months ended September 30, 2000 was $1.4 million and $5.1 million, respectively, as compared to comprehensive loss for the three and nine months ended October 2, 1999 of $5.0 million and $7.5 million, respectively. Differences between comprehensive income (loss) and income (loss) before dividends and accretion on preferred stock for each period represents the foreign currency translation adjustment for each period. NOTE 5 - RESTRUCTURING CHARGE In March 2000, the Company recorded a restructuring charge of $2.5 million related to the termination of three executives. The charge consists of an accrual of severance payments due to three executives for a two-year period. The severance will be paid through fiscal 2002. Through September 30, 2000 severance benefits of approximately $533,000 were paid to the three executives. RESTRUCTURE CHARGE PAYMENTS RESERVE BALANCE DESCRIPTION APRIL 1,2000 THRU Q3 2000 SEPTEMBER 30, 2000 ----------- ------------------ ------------ ------------------ Severance benefits $ 2,500 $ 533 $1,967 ======= ====== ====== 7 8 NOTE 6 - NEW ACCOUNTING STANDARDS In June 1999, FASB issued SFAS No. 137, "Accounting for Derivative Instruments and Hedging Activities--Deferral of the Effective Date of FASB No. 133", which defers the effective date of SFAS No. 133 to all fiscal quarters of all fiscal years beginning after June 15, 2000. SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities, issued in June 1998, establishes accounting and reporting standards for derivative instruments, including certain derivative instruments embedded in other contracts, and hedging activities. It requires an entity to recognize all derivatives as either assets or liabilities in the statement of financial position and measure those instruments at fair value. The Company does not expect adoption of this statement to have a significant impact on its consolidated financial position or results of operations. The Securities and Exchange Commission issued Staff Accounting Bulletin (SAB) No. 101, "Revenue Recognition", in December 1999. The Company is required to adopt this new accounting guidance through a cumulative charge to operations, in accordance with Accounting Principles Board (APB) Opinion No. 20, "Accounting Changes", no later than the fourth quarter of fiscal 2000. The Company does not expect adoption of the guidance provided in SAB No. 101 to have a material impact on future operating results. In March 2000, the FASB issued Interpretation No. 44, "Accounting for Certain Transactions Involving Stock Compensation - an Interpretation of APB Opinion No. 25." The interpretation clarifies the application of APB Opinion No. 25 in certain situations, as defined. The Interpretation is effective July 1, 2000, but covers certain events occurring during the period after December 15, 1998, but before the effective date. To the extent that events covered by this interpretation occur during the period after December 15, 1998, but before the effective date, the effects of applying this interpretation would be recognized on a prospective basis from the effective date. Accordingly, upon initial application of the final interpretation, (a) no adjustments would be made to the financial statements for periods before the effective date and (b) no expense would be recognized for any additional compensation cost measured that is attributable to periods before the effective date. The Company does not expect the adoption of this interpretation to have a significant impact on the accompanying financial statements. NOTE 7 - SEGMENT REPORTING 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. 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. 8 9
CHAIN DRUG THREE MONTHS STORES/COMBO ENDED MASS STORES/ OCTOBER 2, 1999 MERCHANDISERS SUPERMARKETS VARIETY OTHER TOTAL ------------------- ------------------- ---------------- --------- ------- -------- Net sales $28,727 $ 3,699 $ 3,858 $ 2,212 $ 38,496 ======= ======== ======= ======= ======== Segment loss $ (350) $ (1,808) $(1,828) $(1,057) $ (5,043) ======= ======== ======= ======= ========
CHAIN DRUG THREE MONTHS STORES/COMBO ENDED MASS STORES/ SEPTEMBER 30, 2000 MERCHANDISERS SUPERMARKETS VARIETY OTHER TOTAL --------------------------------------------------------------------------------------------------------------- Net sales $21,994 $ 7,056 $ 4,226 $ 2,474 $ 35,750 ======= ======== ======= ======= ======== Segment loss $ (619) $ (720) $ (927) $ (674) $ (2,940) ======= ======== ======= ======= ========
CHAIN DRUG NINE MONTHS STORES/COMBO ENDED MASS STORES/ OCTOBER 2, 1999 MERCHANDISERS SUPERMARKETS VARIETY OTHER TOTAL ------------------- ------------------- ---------------- --------- ------- -------- Net sales $79,509 $ 23,421 $14,581 $ 8,082 $125,593 ======= ======== ======= ======= ======== Segment loss $ (527) $ (937) $(3,769) $(2,314) $ (7,547) ======= ======== ======= ======= ========
CHAIN DRUG NINE MONTHS STORES/COMBO ENDED MASS STORES/ SEPTEMBER 30, 2000 MERCHANDISERS SUPERMARKETS VARIETY OTHER TOTAL --------------------------------------------------------------------------------------------------------------- Net sales $73,141 $ 27,122 $16,976 $ 6,746 $123,985 ======= ======== ======= ======= ======== Segment profit (loss) $ 1,389 $ (378) $(1,606) $(1,231) $ (1,826) ======= ======== ======= ======= ========
Revenues 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 profit (loss) before income tax expense and dividends and accretion on preferred stock by the amount of other income, restructure charge and extraordinary items which are not allocated by segment. The chief operating decision-maker does not review segment assets. Total assets specifically identifiable with each reportable segment are as follows: JANUARY 1, SEPTEMBER 30 2000 2000 ----------- ------------ Mass merchandisers $ 19,730 $ 22,352 Chain drug stores/combo stores/supermarkets 3,495 5,594 Variety 2,708 2,014 Other 2,454 2,145 Unassigned assets 79,480 76,704 --------- ------------ $ 107,867 $108,809 ========= ======== 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. Prior to September 1, 1999, the Company held an 80% interest in Fantasma LLC ("Fantasma") and accordingly Fantasma was included as a mostly owned subsidiary in the supplemental consolidating financial information for such periods. 9 10 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 3, 1999, the assets of the Company's wholly owned guarantor subsidiaries (other than Fantasma) were transferred to the Company. Accordingly, the Company now performs all operations previously performed by these wholly owned guarantor subsidiaries, the results of which are included in the consolidating financial information for periods ending after such date. Effective September 1, 1999, the Company acquired 100% of the interests of Fantasma, which is included as a wholly owned subsidiary in the consolidating financial information for periods ending after such date. SUPPLEMENTAL CONSOLIDATING FINANCIAL INFORMATION
JANUARY 1, 2000 -------------------------------------------------------------------- WHOLLY OWNED NON-GUARANTOR COMPANY SUBSIDIARIES SUBSIDIARIES ELIMINATIONS CONSOLIDATED ------- ------------ ------------- ------------ ------------ (IN THOUSANDS) ASSETS CONSOLIDATING BALANCE SHEETS CURRENT ASSETS: Cash and cash equivalents $ 97 $ 8 $ 2,184 $ -- $ 2,289 Accounts receivable, net 16,303 2,427 3,501 -- 22,231 Inventories 28,743 -- 4,282 -- 33,025 Prepaid expenses and other current assets 400 41 353 -- 794 Deferred tax assets 3,743 -- -- -- 3,743 --------- --------- --------- --------- --------- Total current assets 49,286 2,476 10,320 -- 62,082 PROPERTY, PLANT AND EQUIPMENT, NET 17,727 14 1,651 -- 19,392 OTHER ASSETS 43,334 -- 1,712 (18,653) 26,393 --------- --------- --------- --------- --------- Total assets $ 110,347 $ 2,490 $ 13,683 $ (18,653) $ 107,867 ========= ========= ========= ========= ========= LIABILITIES AND SHAREHOLDERS' EQUITY (DEFICIT) CURRENT LIABILITIES: Borrowings under revolving note payable $ 11,000 $ -- $ -- $ -- $ 11,000 Redeemable preferred stock of a subsidiary 1,000 -- -- -- 1,000 Current maturities of long-term obligations 569 -- 343 -- 912 Accounts payable 15,364 209 841 -- 16,414 Accrued expenses 22,545 1,075 1,798 (61) 25,357 Due (from) to affiliate (590) 5,569 4,940 (9,919) -- --------- --------- --------- --------- --------- Total current liabilities 49,888 6,853 7,922 (9,980) 54,683 10 3/4% SENIOR NOTES 75,000 -- -- -- 75,000 LONG-TERM OBLIGATIONS, LESS CURRENT MATURITIES 1,878 -- 204 -- 2,082 Preferred stock 31,864 -- 31,864 Shareholders' (deficit) equity (48,283) (4,363) 5,557 (8,673) (55,762) --------- --------- --------- --------- --------- Total liabilities and shareholders' (deficit) equity $ 110,347 $ 2,409 $ 13,683 $ (18,653) $ 107,867 ========= ========= ========= ========= =========
10 11 SUPPLEMENTAL CONSOLIDATING FINANCIAL INFORMATION
SEPTEMBER 30, 2000 -------------------------------------------------------------------- WHOLLY OWNED NON-GUARANTOR COMPANY SUBSIDIARIES SUBSIDIARIES ELIMINATIONS CONSOLIDATED ------- ------------ ------------- ------------ ------------ (IN THOUSANDS) ASSETS CONSOLIDATING BALANCE SHEETS CURRENT ASSETS: Cash and cash equivalents $ 19 $ 29 $ 1,832 $ -- $ 1,880 Accounts receivable, net 20,309 3,037 4,485 -- 27,831 Inventories 33,872 -- 3,140 -- 37,012 Prepaid expenses and other current assets 618 42 205 -- 866 Deferred tax assets 930 -- -- -- 930 --------- --------- --------- --------- --------- Total current assets 55,748 3,108 9,663 -- 68,519 PROPERTY, PLANT AND EQUIPMENT, NET 17,255 8 1,725 -- 18,987 OTHER ASSETS 40,139 -- 2,028 (20,864) 21,303 --------- --------- --------- --------- --------- TOTAL ASSETS $ 113,141 $ 3,115 $ 13,416 $ (20,864) $ 108,809 ========= ========= ========= ========= ========= LIABILITIES AND SHAREHOLDERS' EQUITY (DEFICIT) CURRENT LIABILITIES: Borrowings under revolving note payable $ 27,753 $ -- $ 200 $ -- $ 27,953 Current maturities of long-term obligations 390 -- 46 -- 436 Accounts payable 15,862 108 1,330 -- 17,300 Accrued expenses 18,483 936 1,539 -- 20,958 Due to (from) affiliate (9,386) 8,417 8,937 (16,418) -- --------- --------- --------- --------- --------- Total current liabilities 61,552 9,461 12,052 (16,418) 66,647 10 3/4% SENIOR NOTES 51,850 -- -- -- 51,850 LONG-TERM OBLIGATIONS, LESS CURRENT MATURITIES 8,900 -- 203 -- 9,103 Preferred stock 35,244 -- -- -- 35,244 Shareholders' (deficit) equity (44,404) (6,346) 1,161 (4,446) (54,035) --------- --------- --------- --------- --------- Total liabilities and shareholders' (deficit) equity $ 113,141 $ 3,115 $ 13,416 $ (20,864) $ 108,809 ========= ========= ========= ========= =========
11 12 SUPPLEMENTAL CONSOLIDATING FINANCIAL INFORMATION
NINE MONTHS ENDED ----------------------------------------------------------------------------------- OCTOBER 2, 1999 ----------------------------------------------------------------------------------- WHOLLY OWNED MOSTLY OWNED NON-GUARANTOR COMPANY SUBSIDIARIES SUBSIDIARIES SUBSIDIARIES ELIMINATIONS CONSOLIDATED ------- ------------ ------------ ------------ ------------ ------------ (IN THOUSANDS) CONSOLIDATING STATEMENTS OF OPERATIONS Net sales $ 102,177 $ 1,509 $ 5,723 $ 16,184 $ -- $ 125,593 Cost of goods sold 60,181 1,437 5,528 7,754 -- 74,900 --------- --------- --------- --------- --------- --------- Gross profit 41,996 72 195 8,430 -- 50,693 Operating expenses 38,773 570 3,475 7,743 -- 50,561 Restructuring charge -- -- -- -- -- -- --------- --------- --------- --------- --------- --------- Income (loss) from operations 3,223 (498) (3,280) 687 -- 132 Interest expense (7,203) (26) (2,093) (241) -- (7,679) Other income (expense), net 427 (14) (25) (428) -- (40) Equity in (losses) earnings of consolidated subsidiaries (415) -- -- -- 499 84 --------- --------- --------- --------- --------- --------- (Loss) income before income tax expense and dividends and accretion and preferred stock (3,968) (538) (3,514) 18 499 (7,503) Income tax expense -- -- -- (37) -- (37) --------- --------- --------- --------- --------- --------- Net (loss) income before dividends and accretion on preferred stock (3,968) (538) (3,514) (19) 499 (7,540) Dividends and accretion on preferred stock 2,228 -- -- -- -- 2,228 --------- --------- --------- --------- --------- --------- Net (loss) income applicable to common shareholders $ (6,196) $ (538) $ (3,514) $ (19) $ 499 $ (9,768) ========= ========= ========= ========= ========= =========
12 13 SUPPLEMENTAL CONSOLIDATING FINANCIAL INFORMATION
NINE MONTHS ENDED --------------------------------------------------------------------- SEPTEMBER 30, 2000 --------------------------------------------------------------------- WHOLLY OWNED NON-GUARANTOR COMPANY SUBSIDIARIES SUBSIDIARIES ELIMINATIONS CONSOLIDATED ------- ------------ ------------- ------------ ------------ (IN THOUSANDS) CONSOLIDATING STATEMENTS OF OPERATIONS Net sales $ 102,134 $ 4,217 $ 17,634 $ -- $ 123,985 Cost of goods sold 59,199 3,325 8,187 -- 70,711 --------- --------- --------- --------- --------- Gross profit 42,935 892 9,447 -- 53,274 Operating expenses 37,200 1,900 7,582 -- 46,682 Restructuring charge 2,500 -- -- -- 2,500 --------- --------- --------- --------- --------- Income (loss) from operations 3,235 (1,008) 1,865 -- 4,092 Interest expense (7,976) (30) (416) -- (8,422) Other income (expense), net 1,112 44 (958) -- 198 Equity in (losses) earnings of consolidated subsidiaries (504) -- -- 504 -- --------- --------- --------- --------- --------- (Loss) income before income tax expense and dividends and accretion on preferred stock (4,133) (994) 491 504 (4,132) Income tax expense (77) (1) -- -- (78) --------- --------- --------- --------- --------- Net (loss) income before extraordinary (4,210) (995) 491 504 (4,210) gain Extraordinary gain, net of tax 8,838 -- -- -- 8,838 --------- --------- --------- --------- --------- Net income (loss) before dividends and accretion on preferred stock 4,628 (995) 491 504 4,628 Dividends and accretion on preferred stock 2,435 -- -- -- 2,435 --------- --------- --------- --------- --------- Net income (loss) applicable to common shareholders $ 2,193 $ (995) $ 491 $ 504 $ 2,193 ========= ========= ========= ========= =========
13 14 SUPPLEMENTAL CONSOLIDATING FINANCIAL INFORMATION
NINE MONTHS ENDED -------------------------------------------------------------------------------- OCTOBER 2, 1999 -------------------------------------------------------------------------------- NON- WHOLLY OWNED MOSTLY OWNED GUARANTOR COMPANY SUBSIDIARIES SUBSIDIARIES SUBSIDIARIES ELIMINATIONS CONSOLIDATED ------- ------------ ------------ ------------ ------------ ------------ (IN THOUSANDS) CONSOLIDATING STATEMENTS OF CASH FLOWS Cash flows from operating activities $(14,305) $ 1,371 $ (1,275) $ 1,473 $ -- $(12,736) Cash flows from Investing activities: Purchase of property, plant and equipment (5,988) -- -- (1,043) -- (7,031) Advance to affiliates (239) -- -- -- 239 -- Other investing activities (408) -- (12) (27) -- (447) -------- -------- -------- -------- -------- -------- Net cash (used in) provided by investing activities (6,635) -- (12) (1,070) 239 (7,478) -------- -------- -------- -------- -------- -------- Cash flows from financing activities: Net borrowings under revolving note payable 21,192 -- -- -- -- 21,192 Payments on long-term obligations and Deferred compensation (541) -- -- 295 -- (246) Due to (from) affiliates 177 (1,360) 1,183 239 (239) -- -------- -------- -------- -------- -------- -------- Net cash provided by (used in) financing activities 20,828 (1,360) 1,183 534 (239) 20,946 -------- -------- -------- -------- -------- -------- Net (decrease) increase in cash (112) 11 (104) 937 -- 732 Cash and cash equivalents, beginning of period 134 -- 104 1,969 -- 2,207 -------- -------- -------- -------- -------- -------- Cash and cash equivalents, end of period $ 22 $ 11 $ -- $ 2,906 $ -- $ 2,939 ======== ======== ======== ======== ======== ========
14 15 SUPPLEMENTAL CONSOLIDATING FINANCIAL INFORMATION
NINE MONTHS ENDED -------------------------------------------------------------------------- SEPTEMBER 30, 2000 -------------------------------------------------------------------------- WHOLLY OWNED NON-GUARANTOR COMPANY SUBSIDIARIES SUBSIDIARIES ELIMINATIONS CONSOLIDATED ------- ------------ ------------- ------------ ------------ (IN THOUSANDS) CONSOLIDATING STATEMENTS OF CASH FLOWS Cash flows from operating activities $ (8,354) $ (1,839) $ 1,801 $ -- $ (8,392) Cash flows from Investing activities: Purchase of property, plant and equipment (5,133) -- (1,435) -- (6,568) Advance to affiliates (1,286) -- -- 1,286 -- Other investing activities (191) -- -- -- (191) -------- -------- -------- -------- -------- Net cash (used in) provided by investing activities (6,610) -- (1,435) 1,286 (6,759) -------- -------- -------- -------- -------- Cash flows from financing activities: Net borrowings under revolving note payable 16,953 -- -- -- 16,953 Proceeds from issuance of long-term debt 7,087 -- -- -- 7,087 Repurchase of 10 3/4% Series B Senior Notes due 2006 (7,087) -- -- -- (7,087) Payments on long-term obligations and deferred compensation (1,067) -- -- -- (1,067) Redemption of Series A Preferred Stock (1,000) -- -- -- (1,000) Due to (from) affiliates -- 1,860 (574) (1,286) -- -------- -------- -------- -------- -------- Net cash provided by (used in) financing activities 14,886 1,860 (574) -- 14,886 -------- -------- -------- -------- -------- Net (decrease) increase in cash (78) 21 (208) -- (265) Exchange rate effect on cash -- -- (144) -- (144) Cash and cash equivalents, beginning of period 97 8 2,184 -- 2,289 -------- -------- -------- -------- -------- Cash and cash equivalents, end of period $ 19 $ 29 $ 1,832 $ -- $ 1,880 ======== ======== ======== ======== ========
15 16 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. These risks and uncertainties include the substantial leverage of the Company, customer concentration and consolidation, dependence on licensed brands, a single site distribution facility, operating in international economies, unpredictability of discretionary consumer spending, competition, susceptibility to changing consumer preferences and obtaining full benefits from the new information system. The following discussion and analysis of financial condition and results from operations should be read in conjunction with the Consolidated Financial Statements and related Notes thereto included elsewhere. 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 typically do not contain required minimum sales volumes but may provide for 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 the Company's product line or has prior relationships with a competitor of the Company. 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 may have an impact on the Company's results of operations. In addition, 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 $30 or less. Net sales of the Company's optical products accounted for approximately 62.2% and 47.4% of the Company's net sales for the nine months ended September 30, 2000 and October 2, 1999, respectively. Net sales of the Company's costume jewelry accounted for approximately 32.7% and 42.1% of the Company's net sales for the nine months ended September 30, 2000 and October 2, 1999, respectively, and the balance represented sales of synthetic leather goods, watches, clocks and other accessories. Cost of Goods Sold. The Company outsources manufacturing for all of its products, approximately 85.6% 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 expense on a straight-line basis over the estimated useful life of these fixtures, which are one to three years. If the Company does not retain title to the displays, the display costs are expensed as shipped. During the nine months ended September 30, 2000, the Company recognized a $2.5 million restructuring charge related to the accrual of severance payments due to three executives, which will be paid over a two-year period. 16 17 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 $48,000 and $269,000, respectively for the three and nine months ended September 30, 2000 and $92,000 and $464,000, respectively, for the three and nine months ended October 2, 1999. 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 and nine months ended October 2, 1999, the Company capitalized approximately $49,000 and $155,000 of these costs, respectively. The Company capitalized costs of approximately $220,000 and $449,000 during the three and nine months ended September 30, 2000, respectively. Amortization expense related to the costs as well as previously capitalized costs was approximately $382,000 and $1.0 million, for the three and nine months ended September 30, 2000, respectively and $306,000 and $903,000, for the three and nine months ended October 2, 1999, respectively. 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 US and related companies. 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 income (loss) applicable to common shareholders represents net income (loss) less accretion of original issuance costs and cumulative dividends due on the Series A Preferred Stock. Extraordinary Gain. During 2000, the Company repurchased $23.15 million face value of the Notes for a purchase price of $7.09 million. As a result of this transaction, the Company recognized a $8.8 million extraordinary gain, net of $6.3 million in taxes. See further discussion in "Liquidity and Capital Resources". 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, excluding the restructuring charge of $2.5 million and the extraordinary gain of $8.8 million, was approximately $3.2 million and $15.9 million for the three and nine months ended September 30, 2000, respectively, as compared to $227,000 and $8.6 million for the three and nine months ended October 2, 1999, respectively. The year-to-date increase, excluding the restructuring charge and extraordinary gain, of $7.3 million or 85% is principally due to the increase in operating income. EBITDA, including the restructuring charge and extraordinary gain, was $7.6 million and $22.2 million for the three and nine months ended September 30, 2000, respectively. Net loss before dividends and accretion on preferred stock, excluding the restructuring charge and extraordinary gain, was $2.9 million and $1.7 million for the three and nine months ended September 30, 2000 respectively, as compared to a net loss before dividends and accretion on preferred stock of $5.0 million and $7.5 million for the three and nine months ended October 2, 1999, respectively. Net income before dividends and accretion on preferred stock, including the restructuring charge and extraordinary gain, was $1.5 million and $4.6 million for the three and nine months ended September 30, 2000, respectively. 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: 17 18
THREE MONTHS ENDED NINE MONTHS ENDED ------------------------------------------------------ OCTOBER 2, SEPTEMBER 30, OCTOBER 2, SEPTEMBER 30, 1999 2000 1999 2000 ---------- ------------- ---------- ------------- Net sales 100.0% 100.0% 100.0% 100.0% Cost of goods sold 62.7 60.4 59.6 57.0 ------- ------- ------- ------- Gross profit 37.3 39.6 40.4 43.0 Operating expenses, excluding restructuring charge 43.5 39.3 40.3 37.7 Restructuring charge -- -- -- 2.0 ------- ------- ------- ------- (Loss) income from operations (6.2) 0.3 0.1 3.3 Interest expense (6.9) (8.5) (6.1) (6.8) Other income, net 0.2 0.1 -- 0.2 ------- ------- ------- ------- Loss before taxes and dividends and accretion on preferred stock (12.9) (8.1) (6.0) (3.3) Income tax expense (0.1) (0.1) -- (0.1) ------- ------- ------- ------- Net loss before extraordinary items, dividends and accretion on preferred stock (13.0) (8.2) (6.0) (3.4) Extraordinary gain, Net -- 12.3 -- 7.1 ------- ------- ------- ------- Net (loss) income before dividends and accretion on preferred stock (13.0) 4.1 (6.0) 3.7 Dividend and accretion on preferred stock 2.0 2.3 1.8 2.0 ------- ------- ------- ------- Net (loss) income applicable to common shareholders (15.0)% 1.8% (7.8)% 1.7% ======= ======= ======= =======
THREE MONTHS ENDED SEPTEMBER 30, 2000 COMPARED TO THREE MONTHS ENDED OCTOBER 2, 1999 Net Sales. Consolidated net sales were $35.8 million for the three months ended September 30, 2000 as compared to $38.5 million for the three months ended October 2, 1999, a decrease of $2.7 million. The decrease in sales was mainly due to a reduction in the Mass Merchandisers segment, resulting from a planned restructuring in the relationship of a major customer which reduced selling space and increased competition in the jewelry product line. Also, the Company has continued its de-emphasis on clocks and watches and small leather goods. These decreases were partially offset by the recognition of income of $1.7 million related to the Company's most recent evaluation of its estimated sales allowances, which from time to time, the Company reconciles with its contractual agreements. Gross Profit. Gross profit was $14.1 million for the three months ended September 30, 2000 as compared to $14.3 million for the three months ended October 2, 1999. Gross profit as a percentage of net sales increased to 39.6% for the three months ended September 30, 2000 from 37.3% for the three months ended October 2, 1999. The percentage increase is primarily due to a heavy volume of product returns in 1999, which was the result of an unsuccessful promotion with a significant customer and a higher level of closeout sales at low margins in 1999. Operating Expenses. Operating expenses were $14.0 million for the three months ended September 30, 2000 as compared to $16.7 million for the three months ended October 2, 1999, a decrease of 16.2% or $2.7 million. The decrease is primarily attributable to the realignment of territories within the field service organization and lower sales related expenses in the distribution center. The Company has continued its focus on expense control. Interest Expense. Interest expense was $3.0 million for the three months ended September 30, 2000 as compared to $2.7 million for the three months ended October 2, 1999, an increase of 11.1% or $300,000. This resulted primarily from additional borrowings under the Company's credit facilities to fund increased purchases of optical products related to anticipated shipments in the fourth quarter of 2000 and the first quarter of 2001. Income Tax. Income tax expense was $35,000 for the three months ended September 30, 2000 as compared to $37,000 for the three months ended October 2, 1999. Net Loss. As a result of the factors discussed above, net loss before dividends and accretion on preferred stock, excluding the extraordinary gain was $2.9 million for the three months ended September 30, 2000 as compared to net loss before dividends and accretion on preferred stock of $5.0 million for the three months ended October 2, 1999, an increase of $2.1 million in earnings. Net income before dividends and accretion on preferred stock, after the extraordinary gain was $1.5 million for the three months ended September 30, 2000. The extraordinary gain of $4.4 million was recognized as a result of the early extinguishment of debt. Net Loss Applicable to Common Shareholders. Net loss applicable to common shareholders excluding the extraordinary gain was $3.8 million for the three months ended September 30, 2000 as compared to a loss of $5.8 million for the three months ended October 2, 1999, a decrease of $2.0 million. 18 19 NINE MONTHS ENDED SEPTEMBER 30, 2000 COMPARED TO NINE MONTHS ENDED OCTOBER 2, 1999 Net Sales. Consolidated net sales were $124.0 million for the nine months ended September 30, 2000 as compared to $125.6 million for the nine months ended October 2, 1999, a decrease of $1.6 million or 1.3%. The decrease in sales was mainly due to a reduction in the Mass Merchandisers segment, resulting from a planned restructuring in the relationship of a major customer which reduced selling space and increased competition in the jewelry product line. Also, the Company has continued its de-emphasis on clocks and watches and small leather goods. These decreases were partially offset by the recognition of income of $1.7 million related to the Company's most recent evaluation of its estimated sales allowances, which from time to time, the Company reconciles with its contractual agreements. Gross Profit. Gross profit was $53.3 million for the nine months ended September 30, 2000 as compared to $50.7 million for the nine months ended October 2, 1999. Gross profit as a percentage of net sales increased to 43.0% for the nine months ended September 30, 2000 from 40.4% for the nine months ended October 2, 1999. The $2.6 million or 5.1% increase is primarily due to the shift in mix to higher margin optical products and lower royalties expense related to the planned de-emphasis of branded watches, clocks and other accessories. Also, in 1999, a significant promotion was conducted with a major customer, which resulted in lower than expected margin. Operating Expenses. Operating expenses were $46.7 million, before the restructuring charge of $2.5 million for the nine months ended September 30, 2000 as compared to $50.6 million for the nine months ended October 2, 1999, a decrease of $3.9 million or 7.7%. The decrease is primarily attributable to the realignment of territories within the field service organization and lower sales related expenses in the distribution center. The Company has continued its focus on expense control. Interest Expense. Interest expense was $8.4 million for the nine months ended September 30, 2000 as compared to $7.7 million for the nine months ended October 2, 1999, an increase of $0.7 million or 9.1%. This resulted from additional borrowings under the Company's credit facilities to fund operations during 1999 as well as to fund increased purchases of optical products related to increased shipments as compared to the prior year. Income Tax. Income tax expense was $78,000 for the nine months ended September 30, 2000 as compared to $37,000 for the nine months ended October 2, 1999. Net Loss. As a result of the factors discussed above, net loss before dividends and accretion on preferred stock, excluding the extraordinary gain of $8.8 million and the restructuring charge of $2.5 million was $1.7 million for the nine months ended September 30, 2000 as compared to a net loss before dividends and accretion on preferred stock of $7.5 million for the nine months ended October 2, 1999, an increase of $5.8 million in earnings. Net income before dividends and accretion on preferred stock, after the extraordinary gain and the restructuring charge was $4.6 million for the nine months ended September 30, 2000. Net Loss Applicable to Common Shareholders. Net loss applicable to common shareholders excluding the extraordinary gain and the restructuring charge, was $4.1 million for the nine months ended September 30, 2000, as compared to a loss of $9.8 million for the nine months ended October 2, 1999, a decrease of $5.7 million. The decrease is attributable to the $6.5 million increase in earnings offset by the increase in interest expense. Net income applicable to common shareholders, including the extraordinary gain and the restructuring charge, was $2.2 million for the nine months ended September 30, 2000. LIQUIDITY AND CAPITAL RESOURCES At September 30, 2000, the Company had cash and cash equivalents of $1.9 million and working capital of $1.9 million as compared to $2.3 million and $7.4 million, respectively, at January 1, 2000. The decline in cash and cash equivalents is due to the Company's enhanced focus on utilizing worldwide cash reserves to fund payments on its Senior Credit Facility. The decline in working capital was driven by increased borrowings under the revolving note payable. The Company used $8.4 million of cash in operations during the nine months ended September 30, 2000 compared to a use of $12.7 million during the nine months ended October 2, 1999. The decrease in cash used is principally due to significant improvements in receivables' days outstanding and the timing of payments in accrued expenses in the quarter ended October 2, 1999. The Company used $6.8 million in investing activities during the nine months ended September 30, 2000 compared to a use of $7.5 million during the nine months ended October 2, 1999. These investments were primarily related to the purchase of display fixtures used in the merchandising of both optical and jewelry products and represent normal purchases. The Company generated $14.9 million from financing activities during the nine months ended September 30, 2000 compared to $20.9 million during the nine months ended October 2, 1999. The funds generated from financing activities consisted mainly of borrowings under the revolving note payable. 19 20 The Company has 43,700 shares of Series A Preferred Stock that has a redemption value at September 30, 2000 of $34.3 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 $75.0 million 10 3/4% Senior Notes due 2006 (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. 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 were redeemable for $1.0 million on February 28, 2000. The $1.0 million was paid on April 3, 2000. The former holder of the FG Preferred Stock is entitled to receive an additional payment of up to $3.0 million, depending upon transaction value, in the event of an initial public offering, merger or similar transaction, or private placement of securities representing more than 50% of the Company's capital stock, at a specified valuation. In July 1998, the Company issued, under an Indenture, $75.0 million of 10.75% Senior Notes due 2006 (the "Notes"). The Notes are unsecured obligations of the Company. The Notes are redeemable at the option of the Company, in whole and 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. Upon a "Change of Control" (as defined in the Indenture), 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. The Indenture contains certain affirmative and negative covenants and restrictions. As of September 30, 2000, the Company is in compliance with the various covenants of the Indenture. During 2000, the Company has repurchased $23.15 million face value of the Notes for a purchase price of $7.09 million. The purchase price was financed utilizing a term loan under its existing Senior Credit Facility. The term loan is secured by a mortgage on its Smithfield, RI facility and the agreements of certain preferred shareholders to purchase participations in the term loans. The term loan is being amortized over 60 months commencing April 1, 2001, with the principal balance due at the expiration of the Senior Credit Facility on July 31, 2003. As a result of this transaction, the Company recognized a $8.8 million extraordinary gain, net of $6.3 million in taxes, and wrote off $0.9 million of unamortized issuance costs related to the Notes that were repurchased. These purchases resulted from inquiries from holders of the Notes. The Company does not solicit offers to tender Notes for repurchase, but may, from time to time, consider requests to repurchase Notes, subject to the availability of appropriate financing. In conjunction with the commitment to purchase participations in the term loan, the Company issued 70,870 shares of Series B Preferred Stock. The holders of Series B Preferred Stock are entitled to receive, prior and in preference to any distribution with respect to any other capital stock of the Company, an amount per share equal to $6.67 multiplied by the number of six month periods and fractions thereof during which the participation commitment was outstanding. The Company has calculated the value of the Series B Preferred Stock to be $945,000 based on the assumption that the participation commitment will be outstanding for one year. This amount is being amortized over the one-year period as interest expense. If the participation commitment is outstanding for a period beyond twelve months, the Company will assign additional value to the stock and amortize the related costs over the additional period of the participation commitment. The Company has substantial indebtedness and significant debt service obligations. As of September 30, 2000, the Company had total indebtedness, including borrowings under the Senior Credit Facility, in the aggregate principal amount of $89.3 million. The Company had current liabilities of approximately $66.6 million. In addition, the Company has significant annual obligations that include interest on the Notes of approximately $5.6 million, minimum royalty obligations over the next two years of approximately $2.6 million and minimum payments under its operating leases of approximately $620,000. The Indenture permits the Company to incur additional indebtedness, including secured indebtedness, subject to certain limitations. The Company has up to $4.2 million available for borrowings under the Senior Credit Facility as of September 30, 2000. 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. On March 24, 2000, the Company entered into a second amendment to the Senior Credit Facility that modified the financial covenants and waived non-compliance with the prior covenants. As of September 30, 2000, the Company is in compliance with the financial covenants, as modified. 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 20 21 operations and anticipated cost savings and revenue growth, the Company believes that cash flow from operations and available cash, together with available borrowings under the Senior Credit Facility, will be adequate to meet the Company's future liquidity needs for the next twelve months. 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. SEASONALITY AND QUARTERLY INFORMATION Significant portions of the Company's business are seasonal. Sunglasses are shipped primarily during the first half of the year as retailers build inventory for the spring and summer selling seasons, while costume jewelry and other accessories are shipped primarily during the second half of the fiscal year as retailers build inventory for the holiday season. Reading glasses sales are generally uniform throughout the year. As a result of these shipping trends, the Company's working capital requirements grow throughout the first half of the year to fund purchases and accounts receivable. In the second half of the year, the Company's working capital requirements decrease as accounts receivable are collected and inventory purchases decline relative to first half needs. 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 September 30, 2000, 100% of the carrying values of the Company's long-term debt were at fixed interest rates. 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, the Euro Dollar and the Hong Kong Dollar. During the nine months ended September 30, 2000, 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 has not been materially impacted by the introduction of the Euro dollar. 21 22 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 By written consent dated as of August 10, 2000, the Shareholders approved an Amendment to the Company's Articles of Incorporation authorizing an increase in the number of and modifying the terms of Senior Series B Preferred Stock. The vote was: FOR* AGAINST ABSTAIN Common 517,753 0 0 Series A 32,822 0 0 Series B 27,500 0 0 * The holders of the Series A Preferred Stock are entitled to vote separately as a class and together with the Common Stock based on the number of shares of Common Stock into which such shares are convertible, currently 10 to 1. ITEM 5. OTHER INFORMATION None ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K (a) Exhibits 3.1.1(b) Articles of Amendment to Articles of Incorporation filed on August 11, 2000 10.1.4 Fourth Amendment to Second Amended and restated Financing and Security Agreement dated as of August 14, 2000 27.1 Financial Data Schedule (b) Report on Form 8-K The registrant filed no reports on form 8-K during the quarter ended September 30, 2000. 22 23 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: November 13, 2000 /s/ Gerald F. Cerce --------------------------------------------- Gerald F. Cerce Chairman of the Board Dated: November 13, 2000 /s/ John R. Ranelli ----------------------------------------- John R. Ranelli Director, President, and Chief Executive Officer (Principal Executive Officer) Dated: November 13, 2000 /s/ Mark D. Kost ----------------------------------------- Mark D. Kost Chief Financial Officer (Principal Financial Officer) 23