-----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, VhmOODZSian7IBLXxVKzYH3YafzzNkJhNtupjc70VXH23hObn6njhvimOvJTLmJ0 8gWqwDq9wwHh5OUmpwCLtg== 0000927016-99-001282.txt : 19990403 0000927016-99-001282.hdr.sgml : 19990403 ACCESSION NUMBER: 0000927016-99-001282 CONFORMED SUBMISSION TYPE: 10-K405 PUBLIC DOCUMENT COUNT: 4 CONFORMED PERIOD OF REPORT: 19990102 FILED AS OF DATE: 19990401 FILER: COMPANY DATA: COMPANY CONFORMED NAME: CONVERSE INC CENTRAL INDEX KEY: 0000716934 STANDARD INDUSTRIAL CLASSIFICATION: RUBBER & PLASTICS FOOTWEAR [3021] IRS NUMBER: 041419731 STATE OF INCORPORATION: MA FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-K405 SEC ACT: SEC FILE NUMBER: 001-13430 FILM NUMBER: 99584878 BUSINESS ADDRESS: STREET 1: ONE FORDHAM RD CITY: NORTH READING STATE: MA ZIP: 01864 BUSINESS PHONE: 5086641100 MAIL ADDRESS: STREET 1: ONE FORDHAM ROAD CITY: NORTH READING STATE: MA ZIP: 01864 10-K405 1 FORM 10-K405 ================================================================================ SECURITIES AND EXCHANGE COMMISSION WASHINGTON, DC 20549 FORM 10-K |X| ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE FISCAL YEAR ENDED January 2, 1999. OR |_| TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934 [NO FEE REQUIRED] FOR THE TRANSITION PERIOD FROM _________ TO __________ COMMISSION FILE NUMBER 1-13430 CONVERSE INC. (Exact name of registrant as specified in its charter) DELAWARE 43-1419731 (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No.) ONE FORDHAM ROAD NORTH READING MASSACHUSETTS 01864 (Address of principal executive offices) (Zip Code) Registrant's telephone number, including area code: (978) 664-1100 ----------------------------------------------------------- Securities registered pursuant to Section 12(b) of the Act: TITLE OF EACH CLASS NAME OF EACH EXCHANGE ON WHICH REGISTERED Common stock, without par value New York Stock Exchange 7% Convertible Subordinated Notes New York Stock Exchange due 2004 Securities registered pursuant to Section 12 (g) of the Act: None. ------------------------------------------------------------ Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15 (D) of the Securities Exchange Act of 1934 during the preceding 12 months (or such shorter period that registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days: YES [X] NO [ ] Indicate by check mark if disclosure of delinquent filers pursuant to item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. [X] As of March 12, 1999, the aggregate market value of the registrant's voting stock held by non-affiliates of the registrant was approximately $19,415,852, based on the closing sales price of the registrant's Common Stock as reported on the New York Stock Exchange as of such date ($3 5/8). Indicate with a check mark whether the registrant has filed all documents and reports required to be filed by Section 12, 13 or 15(d) of the Securities Exchange Act of 1934 subsequent to the distribution of securities under a plan confirmed by a Court. YES [X] NO [ ] As of March 12, 1999, 17,345,728 shares of the registrant's Common Stock were outstanding. DOCUMENTS INCORPORATED BY REFERENCE Portions of the Registrant's definitive Proxy Statement to be filed with the Securities and Exchange Commission on or before April 30, 1999 for the Annual Meeting of Stockholders to be held on May 12, 1999 are incorporated by reference into Part III of this Report, as indicated herein. ================================================================================ CONVERSE INC. ANNUAL REPORT ON FORM 10-K TABLE OF CONTENTS Page ---- PART I. Item 1. Business........................................................... 1 Products....................................................... 1 Marketing and Product Development.............................. 3 Sales and Distribution......................................... 3 Licensing Agreements........................................... 4 Sourcing and Manufacturing..................................... 4 Research and Development....................................... 5 Backlog........................................................ 6 Competition.................................................... 6 Trademarks and Patents......................................... 6 Environmental Matters.......................................... 7 Employees...................................................... 7 Risk Factors................................................... 7 Item 2. Properties......................................................... 9 Item 3. Legal Proceedings.................................................. 9 Item 4. Submission of Matters to a Vote of Security Holders................ 9 PART II. Item 5. Market for Registrant's Common Equity and Related Stockholder Matters................................................ 10 Item 6. Selected Financial Data............................................ 10 Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations................................ 12 Item 7A. Quantitative and Qualitative Disclosure About Market Risk.......... 23 Item 8. Financial Statements and Supplemental Data......................... 24 Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure................................ 24 PART III. Item 10. Directors and Executive Officers of the Registrant................. 25 Item 11. Executive Compensation............................................. 26 Item 12. Security Ownership of Certain Beneficial Owners and Management..... 26 Item 13. Certain Relationships and Related Transactions..................... 26 PART IV. Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K........................................................ 27 SIGNATURES Signatures......................................................... 30 Information contained or incorporated by reference in this Report contains "forward-looking statements" which can be identified by the use of forward-looking terminology such as "believes," "expects," "may," "will," "should," or "anticipates" or the negative thereof or other variations thereon or comparable terminology, or by discussions of strategy. See, e.g., "Management's Discussion and Analysis of Financial Condition and Results of Operations." No assurance can be given that the future results covered by the forward-looking statements will be achieved. The Risk Factors contained in "Business--Risk Factors" of this Report constitute cautionary statements identifying important factors with respect to such forward-looking statements, including certain risks and uncertainties, that could cause actual results to vary materially from the future results covered in such forward-looking statements. Other factors could also cause actual results to vary materially from the future results covered in such forward-looking statements. Converse Inc. (hereinafter the "Company" or "Converse") undertakes no obligation to publicly release any revisions to these forward-looking statements to reflect any future events or occurrences. PART I ------ ITEM 1. BUSINESS. - ------------------ Converse is a leading global designer, manufacturer and marketer of high quality athletic footwear for men, women and children. The Company is also a global licensor of sports apparel, accessories and selected footwear. The Company, founded in 1908, began establishing its authentic footwear heritage with the introduction of its original canvas Chuck Taylor(R) basketball shoe in 1923. Throughout its 91-year history, Converse has achieved a high level of brand name recognition due to its reputation for high performance products, quality, value and style. Through its well-known Converse(R) All Star(R) brand, the Company has consistently maintained its position as the American performance brand with authentic sports heritage. The Company's footwear consists of five product categories: basketball, athletic originals, children's, action sports and cross training. The basketball category is comprised of high performance footwear for athletes and typically features innovative design constructions and various proprietary performance technologies. Converse's athletic originals category is centered on the Converse(R) Chuck Taylor(R) All Star(R) canvas athletic shoe, which management believes is the world's all time best-selling athletic shoe with over 560 million pairs sold since its introduction. Converse's children's category consists of colorful and imaginative footwear especially for kids, as well as children's-sized versions of the Company's performance athletic footwear. The Company entered the action sports category in 1998, initially focusing on skateboard athletes and recently expanding to include eco-training, in order to capitalize on the dramatic growth in the popularity of individualistic sports. The cross training category consists of high performance athletic shoes used for sports training and fitness. The Company's products are distributed in over 90 countries to approximately 9,000 customers, which include specialty athletic, sporting goods, department and shoe stores, as well as to 28 Company-operated retail outlet stores. In 1998 the Company reported net sales of $308.4 million. However, this figure understates the total worldwide presence of Converse-branded products since a large amount is sold through licensees, and Converse recognizes only a percentage of these licensees' sales which it records as royalty income. Global wholesale sales of Converse-branded products, which include direct sales by the Company to retailers, sales by Converse distributors and sales of licensed products by Converse licensees, were approximately $680 million in 1998, of which over $469 million, or approximately 69%, were outside of the United States. PRODUCTS In 1998, the Company concentrated its marketing, product development and sales efforts on its five core categories: basketball, athletic originals, children's, action sports and cross training. 1 Basketball Converse basketball footwear offerings are high performance products generally featuring one or more proprietary performance technologies developed by the Company. For example in spring 1999, the All Star(R) Sky will feature REACT(R) II technology designed to provide improved cushioning and stability in addition to an anti-roll lever, a forefoot stability technology designed to reduce forefoot movements, the All Star(R) Smooth will feature the innovative "Shoe within a Shoe" concept allowing the athlete to be closer to the ground increasing foot stability, and the All Star(R) Shakedown will feature lightweight performance with multi-directional traction and flexibility. The Company sells its basketball footwear at suggested retail prices ranging from $45.00 to $95.00 through an extensive network of athletic specialty, department and sporting goods stores. Athletic Originals Converse's athletic originals footwear line is centered on the Chuck Taylor(R) All Star(R) canvas athletic shoe. Since its introduction in 1923 as the world's first basketball shoe, the Company has sold over 560 million pairs, and management believes it to be the all-time best selling athletic shoe ever. Converse's athletic originals footwear encompasses classic, time tested athletic and aftersport shoes. Sold in a wide variety of colors, this line sells at suggested retail prices ranging from $20.00 to $65.00 in athletic specialty, sporting goods, department and shoe stores, as well as specialty apparel retailers. Children's The Company has recently implemented a new strategy in the children's product category that revolves around offering colorful and imaginative footwear designed specifically for children, in addition to offering its traditional children's sized versions of the Company's basketball, athletic originals and cross training products. Converse has also entered into a long term agreement with Koosh(R), a leading marketer and innovator of kids toys rooted in sports. Children's products are sold at suggested retail prices from $18.00 to $40.00 through athletic specialty, children's bootery, sporting goods and department stores. Action Sports In 1998, Converse made the strategic decision to enter the action sports category, a rapidly growing product category that focuses on alternative sports such as skateboarding and eco-training. The Converse ECO system is a line of outdoor footwear built for athletes who enjoy testing their limits of fear through extreme sports like climbing, mountain biking, and adventure running. The Company will sell a full line of both skateboard and eco-training products in fall 1999. These products are sold through a separate U.S. sales force to independent skate shops and through more traditional distribution channels internationally at suggested retail prices from $60.00 to $85.00. Cross Training The Company's cross training category consists of high performance athletic shoes used for multiple sports activities. The All Star(R) Catalyst, to be introduced in spring 1999 is extremely lightweight and breathable and is designed for superior durability in a full range of activities. Converse's cross training footwear sells at suggested retail prices ranging from $50.00 to $75.00 through an extensive network of athletic specialty, sporting goods, department and shoe stores. Sports Apparel, Accessories and Selected Footwear Licensing (Royalty Income) Converse utilizes licensees who manufacture or purchase and distribute sports apparel, accessories and selected footwear to provide consumers globally with Converse-branded products from head-to-toe. Converse has entered into 74 separate licensing agreements permitting the licensees to design and market selected products under the Converse brand name in specific markets. Japanese licensees accounted for approximately 43.0% of Converse's total worldwide royalty 2 income in 1998. Royalty income in the Pacific Region, including Japan, contributed 63.7% of total worldwide royalty income. Royalty income generated in the U.S. represented approximately 15.2% of total worldwide royalty income in 1998. Royalty income for 1996, 1997, and 1998 was $27.6, $22.6, and $20.2 million, respectively. MARKETING AND PRODUCT DEVELOPMENT The Company's marketing strategy is centered on the Converse All Star brand, which is positioned as the American performance brand with authentic sports heritage. The Company believes that there are significant opportunities to build the brand, which commands high consumer awareness generated by reason of its 91-year history. The Company's consumer research has become an integral part of its product development, advertising campaigns and in-store point of purchase materials. In 1998, the Company adopted "Stay True" as its new brand positioning statement and tag line. "Stay True" is intended to convey the concept, through the products, that athletes should stay true to themselves and be proud of who they are and where they came from and to communicate a feeling of continuing respect for people and institutions that enabled the athlete to succeed. To complement its marketing strategies, Converse cultivates the endorsement and promotion of Converse footwear among athletes. The Company's endorsers include prominent current NBA athletes as well as NBA athletes from an earlier era, including Julius "Dr. J" Erving and Larry Bird. The Company is also a leading supplier of athletic shoes to premier NCAA basketball teams, including the University of Arkansas, Indiana University, the University of Louisville, the University of New Mexico and the University of South Carolina. Management believes that there are substantial opportunities to utilize these endorsers to influence its target customers and further build the Converse All Star brand through the Company's focused and integrated marketing strategies. SALES AND DISTRIBUTION The Company's products are distributed in over 90 countries to approximately 9,000 customers, including athletic specialty, sporting goods, department and shoe stores, as well as to 28 Company-operated retail outlet stores. Beginning in 1996, the Company has significantly increased its distribution through specialty athletic retailers that showcase the Company's and its licensees' coordinated head-to-toe product offerings. United States Market The Company's 34-member U.S. sales force markets Converse footwear through approximately 3,800 active retail accounts. In 1998, domestic sales represented 54% of total Company net sales. The Company has recently refined its distribution strategy to increase its focus on key growth accounts such as specialty athletic retailers. National and large regional accounts are serviced by 7 account executives who focus on the product and merchandising needs of these retailers. A majority of the Company's larger domestic customers are served by an electronic data interface ("EDI") ordering system. In addition, a quick response system has been implemented with a number of the Company's high volume accounts. The quick response system provides for rapid replenishment of retailer stock through an inventory management process that produces constant "on hand" inventory quantities. International Market The Company currently markets its products in approximately 90 countries outside of the United States through subsidiaries, branch offices, independent distributors and licensees. Non-U.S. sales accounted for 46% of total net sales in 1998. Management believes that the Company is well-positioned to take advantage of international growth opportunities. Although the tradition of the Converse(R) All Star(R) brand as a high performance brand is not as well known internationally as in the United States, the Company believes that because of the global reach of NBA basketball, music, fashion, media and alternative sports, the styles and trends among the Company's target customer group internationally 3 are similar in many ways to those in the United States. Management believes that the Company has opportunities in Western Europe and the Pacific Rim as well as in the developing markets of Latin America and Eastern Europe. In the key Western European markets of France, Italy, Benelux, United Kingdom, Germany and Scandinavia, Converse has wholly-owned operating units of the Company. These Converse operating units are responsible for the marketing and distribution of Converse-branded footwear, apparel and accessories to sporting goods, department and specialty stores within these territories. Sales in Eastern Europe, the Middle East, Africa and Latin America are made through independent licensees/distributors. The Company has recently executed new distribution and license agreements for Spain, Portugal and Canada to replace wholly-owned operating units in these countries. Sales of footwear in the Pacific region are also made through independent licensees/distributors, the largest of which is MoonStar Chemical Corporation, the Company's exclusive distributor of footwear in Japan since 1980. MoonStar contributes approximately 19% to the Company's total net sales worldwide. The Pacific Region also contributes the largest percentage of international licensing income. The Latin American market is supplied by six footwear licensees/distributors and five apparel licensees. LICENSING AGREEMENTS Converse utilizes licensees who manufacture or purchase and distribute sports apparel, accessories and selected footwear to provide customers head-to-toe Converse-branded products globally. Converse has entered into 74 separate licensing agreements permitting the licensees to design and market selected products under the Converse brand name in specific markets. Under the terms of Converse's licensee arrangements, all products designed by licensees, as well as the related advertising, must be approved in advance by Converse. In addition, the license agreements give Converse the right to monitor the quality of the licensed products on an ongoing basis. The following table details sales by Converse's licensees and the related royalty income to Converse: Fiscal Year Ended --------------------------------------------------- December 28, 1996 January 3, 1998 January 2, 1999 ----------------- --------------- --------------- (Dollars in thousands) Total sales by licensees: Footwear .................. $101,117 $141,344 $121,666 Apparel and accessories ... 307,011 208,866 179,330 -------- -------- -------- Total ......................... $408,128 $350,210 $300,996 ======== ======== ======== Total royalty income: Footwear .................. $ 7,944 $ 10,013 $ 9,776 Apparel and accessories ... 19,694 12,556 10,399 -------- -------- -------- Total ......................... $ 27,638 $ 22,569 $ 20,175 ======== ======== ======== Traditionally, royalty income has accounted for a stable source of income. However, in 1996, royalty income was abnormally high primarily due to a Japanese apparel licensee's "over distribution" of the brand. Converse subsequently charged the licensee a penalty of approximately $1.8 million and streamlined the distribution of the Company's licensed products in order to maintain the high quality of products bearing Converse trademarks. SOURCING AND MANUFACTURING The majority of the Company's footwear models are sourced from various Far East manufacturers. However, most of the Company's athletic originals products are manufactured domestically by Converse. 4 Sourcing In 1998, approximately 46% of all Converse footwear was sourced from a variety of Far East manufacturers on a per order basis. These manufacturers produce the Company's footwear according to the Company's own design specifications and quality standards. Sourcing is managed by the Company's corporate headquarters in the United States. In selecting contractors, Converse attempts to use manufacturers that specialize in the type of footwear being produced and to avoid over reliance on any particular supplier by having a sufficient diversity of manufacturing resources. The Company utilizes one sourcing agent in Taiwan who assists the Company in selecting and overseeing third party contractors, ensuring quality, sourcing fabrics and monitoring quotas and other trade regulations. The Company's production staff and independent sourcing agent together oversee all aspects of manufacturing and production. Many of the manufacturers utilized by Converse are also used by the Company's competitors. In 1998, the Company purchased approximately 7.3 million pairs from 11 manufacturers located in China, Taiwan, Macau, Vietnam and the Philippines. While one manufacturer produced approximately 41% of the Company's products, the Company believes any manufacturer can be replaced, if necessary, subject to short-term supply disruptions. Manufacturing Converse is the largest manufacturer of athletic footwear in the United States, producing approximately 8.4 million pairs domestically in 1998. Converse owns and operates a manufacturing facility in Lumberton, North Carolina, and leases manufacturing facilities in Mission, Texas and Reynosa, Mexico. The Company manufactures a majority of its athletic originals models at its 386,761 square foot Lumberton facility. The Company utilizes its Lumberton factory to produce components and for the final assembly, its Mission facility for canvas cutting and limited production, and all stitching and leather cutting is done at the Reynosa facility to capitalize on lower labor costs. The domestic manufacturing of Converse's athletic originals products has enabled the Company to utilize an EDI/quick response system with some of its major customers. Management believes that its ability to produce its best-selling athletic originals models with significantly shorter lead-times than foreign-sourced products is a competitive advantage. The principal materials used in Converse's athletic originals footwear products are canvas, linen and rubber. The Company purchases its raw materials from diverse suppliers. While one supplier accounts for approximately 23% of raw materials purchases, the Company believes that any supplier can be replaced, if necessary, subject to short-term supply disruptions. RESEARCH AND DEVELOPMENT Converse is a leading innovator of new footwear technologies. The Company spent $6.5 million, $8.8 million and $7.7 million on research and development in 1996, 1997 and 1998, respectively. Converse's state of the art biomechanics laboratory, located in a leased facility near the Company's headquarters, continually conducts research on new performance-enhancing technologies. The Company's biomechanical engineers are also involved in the design stages of athletic footwear to help develop new technologies and attributes to improve the function of shoes for specific sports. The Company maintains a full set of production equipment at its biomechanics laboratory to develop prototypes, and to ensure that new products can be manufactured efficiently to Converse's specifications. In addition, Converse maintains a chemistry laboratory that develops and tests midsole and outsole compounds, adhesives and fabrics for use in its products. Many of Converse's basketball shoes use the patented REACT(R) shock absorption technology. REACT gel is a polymer encapsulated in the midsoles of Converse basketball shoes in the heel and forefoot regions that attenuates shock as athletes run and jump and force pressure on their feet. Converse developed a breakthrough method to encapsulate helium molecules in a technology that results in an extremely lightweight shoe that delivers cushioning, stability and comfort. Designed to be among the lightest cushioning 5 technologies available, the helium technology will improve the performance needs of serious athletes. Converse is the first footwear manufacturer to harness the lighter-than-air helium molecule by developing a revolutionary polymer that is impermeable to the helium molecule. The cylindrical metallic gray Helium Capsule is visible through a clear window on the outsole and midsole of the shoes and is attached to the heel of the inner bootie. A Converse patent-in-process polymer known as Nanofilament(TM) allows the Helium Capsule to trap the helium molecules and prevents them from escaping. The new helium technology makes its initial appearance in the All Star(R) He:01 model available at Holiday 1999. Converse plans to introduce a complete line of helium products in 2000 in the product categories of basketball, training, running and action sports. BACKLOG At the end of 1998, the Company's global backlog was $89.8 million, compared to $129.5 million at the end of 1997. The amount of backlog at a particular time is affected by a number of factors, including the scheduling of the introduction of new products and the timing of the manufacturing and shipping of the Company's products. Also, the Company has recently converted two of its wholly-owned operating units to new licensee agreements which had the impact of reducing the Company's global backlog and will lower future net sales offset by increased royalty income. Accordingly, a comparison of backlog as of two different dates is not necessarily meaningful. COMPETITION The athletic footwear market is highly competitive. Industry participants compete with respect to fashion, price, quality, performance and durability. During the second half of 1997, there was an overall weakening of the athletic footwear and apparel market which resulted in an oversupply of inventory in the marketplace. This weakness and oversupply of inventory continued through 1998. The athletic footwear industry in the United States can be broken down into several groups. Nike Inc. ("Nike"), with 1998 estimated U.S. footwear revenues exceeding $3 billion, controls over 40% of the U.S. athletic footwear market. Reebok International, Inc. ("Reebok") and adidas-Solomon AG ("adidas"), each with 1998 estimated U.S. footwear revenues of approximately $1 billion, each control over 10% of the U.S. athletic footwear market. Each of these companies has full lines of product offerings, competes with Converse in the Far East for manufacturing sources, distributes to more than 10,000 outlets worldwide and spends substantially more on advertising and promotion than Converse. New Balance Athletic Shoe, Inc., Stride Rite Corporation and Fila USA, Inc. each have 1998 U.S. branded athletic footwear revenues of between $200 million and $350 million. All of these companies also compete with Converse for access to foreign manufacturing facilities. In addition to these competitors, there are companies with U.S. revenues of under $200 million, including K-Swiss, Vans, Airwalk, ASICS Tiger, Etonic and Saucony among others. Some of these companies emphasize footwear in categories such as running, tennis or team sports that are not currently being produced by the Company. Worldwide footwear industry data is unavailable, but the largest companies worldwide are believed to be Nike, Reebok and adidas. TRADEMARKS AND PATENTS Converse utilizes trademarks on virtually all of its footwear, licensed apparel and accessories. Converse's main trademarks are "Converse(R) All Star(R)", "Chuck Taylor(R)" and "REACT(R)" name and design and the "Converse All Star Chuck Taylor Patch" and "All Star and Design" logos. In addition to those main trademarks, from time to time Converse registers and/or uses other special trademarks for special product lines, or products or features. Converse believes that these trademarks are important in identifying products with the Converse brand image, and the trademarks are often incorporated prominently in product designs. The Company believes the Converse brand to be among its most important and valuable assets for its marketing and generally seeks protection for its trademarks in most countries where significant existing or potential markets for its products exist. Converse takes vigorous action to defend its trademarks in any jurisdiction where infringement is threatened or has occurred or where others have tried to register them. It is impossible to estimate the amount of counterfeiting involving Converse products or the effect such counterfeiting may have on Converse's revenue and brand image. 6 The Company maintains and preserves its trademarks and the related registrations and aggressively protects such rights by taking appropriate legal action against infringement, counterfeiting and misuse when warranted. The Company is not aware of any material claim of infringement or other challenges to the Company's right to use any of its trademarks, tradenames, or patents. The Company has a variety of patents, including a number of U.S. and foreign patents and patent applications on its Helium and REACT(R) technologies. ENVIRONMENTAL MATTERS The Company's operations are subject to federal, state and local laws, regulations and ordinances relating to the operation and removal of underground storage tanks and the storage, handling, generation, treatment, emission, release, discharge and disposal of certain materials, substances and wastes. The nature of the Company's operations expose it to the risk of claims with respect to environmental matters and there can be no assurance that material costs or liabilities will not be incurred in connection with such claims. Based on the Company's experience to date, the Company believes that its future cost of compliance with environmental laws, regulations and ordinances, or exposure to liability for environmental claims, will not have a material adverse effect on the Company's business, operations or financial position. However, future events such as changes in existing laws and regulations, or unknown contamination of sites owned or operated by the Company (including contamination caused by prior owners and operators of such sites) may give rise to additional compliance costs which could have a material adverse effect on the Company's financial condition. EMPLOYEES As of January 2, 1999, Converse employed 2,658 individuals, of which 1,844 were in manufacturing, and 814 were in sales, administration, development and distribution. Management believes its relationship with its employees to be good. Converse has not experienced any material work stoppages or strikes in recent years. The Reynosa, Mexico manufacturing workforce, representing approximately 28% of Converse's work force, is represented by a union. RISK FACTORS Investors should carefully consider the following factors, together with other information contained and incorporated by reference in this Report, in evaluating an investment in the Company. Recent Operating Results; Industry Conditions We suffered significant net losses in 1996, 1997 and 1998. We also had an accumulated stockholders' deficit of $69.3 million at January 2, 1999. Since 1997, there has been a significant slowdown in the branded athletic footwear industry, led by the diminishing importance of basketball shoes worn casually all over the world. The slowdown has been magnified by the economic problems being experienced in the Southeast Asia and Latin America regions. Our sales decline in 1998 is indicative of the continued industry-wide softening of demand for athletic footwear that has negatively impacted the Company. This weakening demand has led to an excessive amount of retail inventory levels of athletic footwear. We can provide no assurance that we can attain profitability or that we can maintain any profitability that we might achieve. Competition; Changes in Consumer Preferences The branded athletic footwear industry is highly competitive. Our success depends on our ability to anticipate and respond to changing merchandise trends and consumer preferences and demands in a timely manner. If we fail to anticipate and respond to changing trends and consumer preferences and demands, consumer acceptance of our brand name and product line could be materially adversely affected. 7 Foreign Production We utilize independent producers located in the Far East, particularly China, Taiwan, Macau, Vietnam and the Philippines, to manufacture approximately 46% of our footwear. We also operate a facility in Mexico for the stitching of canvas uppers for certain athletic originals category footwear. Our operations are subject to the customary risks of doing business abroad, including fluctuations in the value of currencies, import and export duties and trade barriers (including quotas), restrictions on the transfer of funds, work stoppages and, in certain parts of the world, political instability. Economic Conditions and Seasonality Converse and the footwear industry are dependent on the economic environment and levels of consumer spending which affect not only the ultimate consumer, but also retailers, Converse's primary direct customers. Downward trends in the economy or events that adversely affect the economy in general, may adversely affect our results. Sales of Converse's footwear products are somewhat seasonal in nature with the strongest sales generally occurring in the first and third quarters. Any prolonged economic downturn or changes in consumer spending patterns could have a material adverse effect on us. International Sales and Currency Exchange International sales represent a significant portion of our net sales. International sales are made through Company-owned subsidiaries denominated in local currencies and through independent distributors denominated in U.S. dollars. Our future operating results will depend, in part, on the Company's ability to maintain or replace independent distributor relationships in key markets as existing agreements expire. Additionally, changes in demand resulting from fluctuations in currency exchange rates may affect our international sales. All distributor sales are denominated in U.S. dollars and an increase in the value of the U.S. dollar relative to foreign currencies could make Converse products less competitive in those markets. During 1998, we used foreign currency options to protect the Company from the effect of changes in foreign exchange rates on our statement of operations with respect to our European subsidiaries. International sales and operations may also be subject to risks such as the imposition of governmental controls, export license requirements, political instability, trade restrictions, changes in tariffs and difficulties in staffing and managing international operations and managing accounts receivable. In addition, the laws of certain countries do not protect Converse's products and intellectual property rights to the same extent as the laws of the United States. Any of these factors could have a material adverse effect on us. Risks Associated with the Year 2000 The Year 2000 issue is the result of computer programs being written using two digits rather than four to define the applicable year. In other words, date-sensitive software may recognize a date using "00" as the year 1900 rather than the year 2000. This could result in systems failures or miscalculations causing disruptions of operations, including, among others, a temporary inability to process transactions, send invoices or engage in similar normal business activities. While we are in the process of conducting an evaluation of the Year 2000 issue on our business, we do not believe that we have a material exposure to the Year 2000 issue with respect to our own information systems. We are also conducting an analysis to determine the extent to which our major suppliers and customers' systems (insofar as they relate to Converse business) are not Year 2000 compliant or otherwise at risk with respect to the Year 2000 issue. We are currently unable to predict the extent to which the Year 2000 issue will affect our suppliers and customers, or the extent to which we would be vulnerable to our suppliers and customers' failure to remediate any Year 2000 issue on a timely basis. The failure of a major supplier or customer to convert its systems on a timely basis or a conversion that is incompatible with our systems could have a material adverse effect on us. Controlling Stockholders Apollo Investment Fund, L.P. ("Apollo") and its affiliate Lion Advisors, L.P., on behalf of an investment account 8 under management ("Lion"; Apollo and Lion together being referred to herein as the "Apollo Stockholders"), together beneficially owned approximately 65% of the outstanding Common Stock at January 2, 1999. By reason of their ownership of shares of Common Stock, the Apollo Stockholders have the power effectively to control or influence control of Converse, including in elections of the Board of Directors and other matters submitted to a vote of our stockholders, including extraordinary corporate transactions such as mergers. The Apollo Stockholders may exercise such control from time to time. A majority of the Board of Directors consists of individuals associated with affiliates of Apollo and Lion. Shares Eligible for Future Sale The Apollo Stockholders have the right to cause Converse to register the shares of Common Stock that they own pursuant to a registration rights agreement. Investors who bought the Company's Senior Secured Notes in 1998 hold warrants to purchase 360,000 shares of the Company's Common Stock. Future sales of such shares, or the availability of such shares for future sale, could adversely affect the market prices for the Common Stock. Anti-Takeover Provisions Our Restated Certificate of Incorporation (i) provides that our Board of Directors may issue preferred stock without stockholder approval, (ii) prohibits stockholder action by written consent and (iii) requires 75% ("supermajority") stockholder vote to alter, amend, repeal or adopt certain provisions of the Restated Certificate of Incorporation. In addition, our Restated Certificate of Incorporation limits the ability of any person who is the beneficial owner of more than 10% of our outstanding voting stock to effect certain transactions involving Converse unless a majority of the Disinterested Directors (as defined in the Restated Certificate of Incorporation of the Company) approves them. These provisions could make it more difficult for a third-party to acquire us. ITEM 2. PROPERTIES. Converse owns or leases the following principal plants, offices and warehouses: Floor Space Location Type of Facility (Square Feet) Owned/Leased - -------- ---------------- ------------- ------------ North Reading, MA.... Headquarters 106,800 Owned Wilmington, MA....... Research and Development Facility 23,192 Leased Lumberton, NC........ Plant 386,761 Owned Charlotte, NC........ Distribution Center 431,665 Leased Reynosa, Mexico...... Plant 100,948 Leased Mission, TX.......... Plant 55,552 Leased In addition to the above properties, the Company leases space for 27 retail stores in the U.S. and 1 retail store in the United Kingdom. The Company also leases several sales and customer service offices and distribution centers throughout the world. The Wilmington, Massachusetts lease expires in 2003, the Charlotte, North Carolina lease expires in 2001, the Reynosa, Mexico lease expires in 2008 and the Mission, Texas facility lease expires in 2003. For further information regarding the Lumberton, Mission and Reynosa facilities see "Business--Sourcing and Manufacturing". ITEM 3. LEGAL PROCEEDINGS. Converse is or may become a defendant in a number of pending or threatened legal proceedings in the ordinary course of its business. Converse believes the ultimate outcome of any such proceedings will not have a material adverse effect on its financial position or results of operations. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS. Not applicable. 9 PART II ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS The Company's common stock ("Common Stock") is traded on the New York Stock Exchange ("NYSE") under the symbol "CVE." The following table sets forth the range of high and low closing sales prices for the Common Stock as reported by the NYSE for the periods indicated: High Low ---- --- 1996 First Quarter....................... 7 1/8 4 1/8 Second Quarter...................... 5 1/2 3 7/8 Third Quarter....................... 6 7/8 4 1/8 Fourth Quarter...................... 15 3/4 6 1997 - ---- First Quarter....................... 27 3/8 14 1/4 Second Quarter...................... 22 13 1/4 Third Quarter....................... 22 1/8 10 5/16 Fourth Quarter...................... 10 1/4 5 5/8 1998 - ---- First Quarter....................... 8 1/4 5 13/16 Second Quarter...................... 6 9/16 4 1/16 Third Quarter....................... 5 3/16 2 9/16 Fourth Quarter...................... 3 1/4 1 15/16 As of March 12, 1999 there were 17,345,728 shares of Common Stock issued and outstanding, which shares were held by approximately 2,200 holders of record of the Company's Common Stock. The Company has not paid any dividends on its Common Stock during the periods indicated and does not anticipate paying any dividends on its Common Stock in the foreseeable future. Any future payment of dividends will depend upon the financial condition, capital requirements, earnings and loan covenant restrictions of Converse, as well as upon other factors that the Board of Directors may deem relevant. 10 ITEM 6. SELECTED FINANCIAL DATA The following selected consolidated financial data of Converse should be read in conjunction with Converse's historical consolidated financial statements and the notes thereto contained herein. The following selected historical consolidated financial data has been derived from the historical consolidated financial statements of Converse. Prior to the Distribution (as defined on page 12) effected on November 17, 1994, Converse was a wholly-owned subsidiary of Furniture Brands International, Inc. ("Furniture Brands"). The historical consolidated financial statements of Converse for 1994 may not reflect the results of operations or financial position that would have been obtained had Converse been a separate, independent company during that period.
Fiscal Year Ended -------------------------------------------------------------------------------- Dec. 31, 1994 Dec. 30, 1995 Dec. 28, 1996 Jan. 3, 1998 Jan. 2, 1999 ------------- ------------- ------------- ------------ ------------ (Dollars in thousands, except per share amounts) Statement of Operations Data: Net sales ...................................... $ 437,307 $ 407,483 $ 349,335 $ 450,199 $ 308,353 Cost of sales .................................. 286,555 293,948 263,098 329,258 237,671 --------- --------- --------- --------- --------- Gross profit ................................... 150,752 113,535 86,237 120,941 70,682 Selling, general and administrative expenses ..................................... 128,876 146,332 114,888 127,261 92,683 Royalty income ................................. 14,212 17,257 27,638 22,569 20,175 Restructuring expense (credit) ................. -- 14,182 (1,177) 1,537 -- --------- --------- --------- --------- --------- Earnings (loss) from operations ................ 36,088 (29,722) 164 14,712 (1,826) Loss (credit) on investment in unconsolidated subsidiary .................... -- 52,160 (1,362) (12,537) -- Interest expense, net .......................... 7,423 14,043 17,776 15,374 17,525 Other expense, net ............................. 504 3,966 6,319 3,026 596 --------- --------- --------- --------- --------- Earnings (loss) from continuing operations before income taxes .......................... 28,161 (99,891) (22,569) 8,849 (19,947) Income tax expense (benefit) ................... 10,565 (28,144) (4,134) 13,154 3,572 --------- --------- --------- --------- --------- Earnings (loss) from continuing operations ..... 17,596 (71,747) (18,435) (4,305) (23,519) Extraordinary (gain) loss, net of tax expense (benefit) of $(576) and $437, respectively ................................... -- -- -- 744 (704) --------- --------- --------- --------- --------- Net earnings (loss) ............................ $ 17,596 $ (71,747) $ (18,435) $ (5,049) $ (22,815) ========= ========= ========= ========= ========= Net basic and diluted earnings (loss) per share: Continuing operations ........................ $ 1.05 $ (4.30) $ (1.10) $ (0.25) $ (1.36) Extraordinary gain (loss) .................... -- -- -- (0.04) 0.04 --------- --------- --------- --------- --------- Net earnings (loss) .......................... $ 1.05 $ (4.30) $ (1.10) $ (0.29) $ (1.32) ========= ========= ========= ========= ========= Balance Sheet Data (at period end): Working capital .............................. $ 131,122 $ 89,680 $ (32,648) $ 20,260 $ 7,058 Total assets ................................. 223,726 224,507 222,603 234,694 195,006 Long-term debt, less current maturities ...... 77,087 112,824 9,644 80,000 101,799 Total stockholders' equity (deficiency) ...... 44,987 (22,685) (38,868) (47,982) (69,310)
11 ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS. The following discussion is based upon and should be read in conjunction with the consolidated financial statements and the notes thereto of the Company included elsewhere herein. General Converse was founded in 1908, and operated as an independent family-owned company until 1971, when it was acquired by Eltra Corporation, a diversified holding company. In 1983, Converse became a publicly-traded company through an initial public offering. In 1986, Furniture Brands, then named INTERCO INCORPORATED, acquired Converse. On November 17, 1994, Furniture Brands distributed to its stockholders all of the outstanding Common Stock of Converse (the "Distribution"), and Converse became an independent publicly-traded company. Converse is a leading global designer, manufacturer and marketer of high quality athletic footwear for men, women and children. The Company is also a global licensor of sports apparel, accessories and selected footwear. The Company's products are distributed in over 90 countries to approximately 9,000 customers, which include athletic specialty, sporting goods, department and shoe stores, as well as to 28 Company-operated retail outlet stores. The primary costs and expenses of the Company result from the following: athletic products sourced from various Far East manufacturers, employee salaries and fringe benefits, advertising and promotion expenses and the purchase of raw materials used in the Company's manufacturing process. The Company's Fiscal 1998 (as defined below) financial results have been affected by several significant factors including: (i) continued weakness in the athletic footwear and apparel market which led to a 31.5% decline in sales revenue; (ii) the strength of the U.S. dollar in the European and Asian markets resulting in weaker sales, gross profit and licensing income; and (iii) the Company's aggressive efforts to reduce operating expenses and improve the inventory position to address the effects of the industry downturn. Results of Operations The Company's fiscal year end is the Saturday closest to December 31 in each year. The results of operations will periodically include a 53-week fiscal year. For purposes of the Company's financial statements, Fiscal 1998 refers to the 52-week period ended January 2, 1999 ("Fiscal 1998"), Fiscal 1997 refers to the 53-week period ended January 3, 1998 ("Fiscal 1997"), and Fiscal 1996 refers to the 52-week period ended December 28, 1996 ("Fiscal 1996"). 12 Comparison of Fiscal 1998 and Fiscal 1997 The following table sets forth certain items related to operations and such items as a percentage of net sales for Fiscal 1998 and Fiscal 1997:
Fiscal Year Ended -------------------------------------------------------------- January 2, 1999 % January 3, 1998 % --------------- ------ --------------- ----- (Dollars in thousands, except per share amounts) Net sales .................................................... $ 308,353 100.0 $ 450,199 100.0 Gross profit ................................................. 70,682 22.9 120,941 26.9 Selling, general and administrative expenses ................. 92,683 30.1 127,261 28.3 Royalty income ............................................... 20,175 6.5 22,569 5.0 Restructuring expenses ....................................... -- -- 1,537 0.3 Earnings (loss) from operations .............................. (1,826) (0.6) 14,712 3.3 (Credit) on investment in unconsolidated subsidiary .......... -- -- (12,537) (2.8) Interest expense, net ........................................ 17,525 5.7 15,374 3.4 Other expense ................................................ 596 0.2 3,026 0.7 Earnings (loss) from continuing operations before income tax.. (19,947) (6.5) 8,849 2.0 Income tax expense ........................................... 3,572 1.2 13,154 2.9 Loss from continuing operations .............................. (23,519) (7.6) (4,305) (1.0) Basic and diluted loss per share from continuing operations .. $ (1.36) -- $ (0.25) -- Extraordinary (gain) loss, net of tax ........................ (704) (0.2) 744 0.2 Net loss ..................................................... $ (22,815) (7.4) $ (5,049) (1.1) Basic and diluted net loss per share ......................... $ (1.32) $ (0.29)
Net Sales Net sales for Fiscal 1998 decreased to $308.4 million from $450.2 million in Fiscal 1997, a 31.5% reduction. The $141.8 million net sales reduction in Fiscal 1998 is attributable to decreases of 53.7%, 51.1%, 37.7% and 2.8% in the basketball, children's, cross training and athletic originals categories, respectively, compared to Fiscal 1997. These decreases were partially offset by a $7.0 million increase in the Company's new action sports category. Net sales in the United States decreased 41.5% to $166.6 million for Fiscal 1998 from $284.9 million for Fiscal 1997. Net sales decreased 14.2% internationally to $141.8 million for Fiscal 1998 from $165.3 million for Fiscal 1997. Net sales in the Europe, Middle East and Africa ("E.M.E.A."), Pacific and Latin America regions were down 3.8%, 15.8% and 57.1%, respectively. The athletic footwear and apparel industry has struggled through a slowdown in branded athletic sales, particularly in the adult's and children's basketball and cross training product categories. The difficult industry conditions have been exacerbated by the excessive levels of athletic footwear inventory in the marketplace. The domestic market also has suffered from the over capacity due to significant retail expansion during a period of softening consumer demand. This change in preference has adversely affected the Company's business, as well as that of many of its competitors. The Company's basketball and cross training categories have been significantly impacted along with the children's category which, in large part, has been comprised of "takedowns" from these categories. The athletic originals category is more closely aligned with the global consumer preference and has been affected to a lesser extent. Also adversely affecting the industry environment was the financial turmoil in the Asia Pacific and Latin America regions which has negatively impacted consumer spending. This industry-wide softening has resulted in an oversupply of branded athletic footwear in the global marketplace, which continued into 1999. Gross Profit Gross profit decreased to $70.7 million in Fiscal 1998 from $120.9 million in Fiscal 1997, a 41.5% decline. The industry downturn and related volume decreases accounted for the majority of the gross profit reduction over the period. As a percentage of net sales, gross profit fell to 22.9% in Fiscal 1998 compared to 26.9% for the prior year period. The 13 decline was caused primarily by the highly promotional and over-inventoried environment that has led to reduced demand in the Company's performance categories and has resulted in price reductions for basketball, children's and cross training products. The Company's efforts to reduce inventory levels through the clearance of product from past seasons have also contributed to the decline. Selling, General and Administrative Expenses In order to address the current industry conditions, the Company took aggressive actions in 1998 to reduce its operating expenses. Selling, general and administrative expenses, which are primarily comprised of direct selling, advertising, and promotion expenses in addition to employee salaries and benefits and other overhead costs, decreased $34.6 million to $92.7 million for Fiscal 1998 from $127.3 million for Fiscal 1997, a 27.2% decrease. This reduction was mainly attributable to decreased spending in global selling, marketing, advertising and promotion activities, as well as staff reductions to partially offset the effects of the industry downturn. Also contributing to the reduction in selling, general and administrative charges in 1998 was a gain of $9.3 million resulting from the termination of the post-retirement medical benefit plan and a gain of $1.6 million resulting from pension curtailment related to workforce reductions. These gains were partially offset by a $1.8 million severance charge related to workforce reduction in 1998. As a percentage of net sales, selling, general and administrative expenses increased to 30.1% for Fiscal 1998 from 28.3% for the prior year. Royalty Income Royalty income decreased 10.6% to $20.2 million in Fiscal 1998 from $22.6 million in Fiscal 1997. International royalty income, which represented 84.8% of the Company's total royalty income, declined 8.8%. The reduction was primarily attributable to decreases of 25.3% and 40.6% in the Southeast Asia and E.M.E.A. regions, respectively. Domestic royalty income decreased by 19.4% to $3.1 million for Fiscal 1998. The decreases are representative of the slowdown in the athletic footwear business and were exacerbated by the deterioration of the economies in Southeast Asia and the strength of the U.S. dollar worldwide. These declines were partially offset by an 11.9% improvement in royalty income derived from Japan. As a percentage of net sales, royalty income increased to 6.5% in Fiscal 1998 compared to 5.0% in the prior year. Restructuring Expenses In the fourth quarter of Fiscal 1997, the Company established pretax restructuring reserves of $2.1 million related to a workforce reduction and the elimination of certain unprofitable retail stores. This restructuring charge was partially offset by the reversal of previously written-off expenses relating to the closing of the Mission, Texas manufacturing facility in the first quarter of Fiscal 1997. At January 2, 1999, there were no remaining restructuring reserves. See Note 4 to the Consolidated Financial Statements of the Company included herein. Earnings (Loss) from Operations The Company recorded a loss from operations in Fiscal 1998 of $1.8 million, compared to earnings from operations of $14.7 million in Fiscal 1997. This change was primarily due to the factors discussed above. Credit on Investment in Unconsolidated Subsidiary In Fiscal 1997, the Company recorded a pretax credit totaling $13.2 million related to the settlement of certain claims by the Company related to the Company's 1995 acquisition of Apex One, Inc. ("Apex"). This amount was partially offset by additional Apex-related legal and settlement costs incurred in the fourth quarter of Fiscal 1997, finalizing all remaining outstanding litigation relating to the Company's investment in Apex. The net activity for Fiscal 14 1997 was a net credit on investment in unconsolidated subsidiary of $12.5 million. At January 2, 1999, there were no remaining claims against the Company related to its 1995 acquisition of Apex. See Note 3 to the Consolidated Financial Statements of the Company included herein. Interest Expense Interest expense for Fiscal 1998 increased 13.6% to $17.5 million from $15.4 million in Fiscal 1997. The increase reflects higher borrowing levels in Fiscal 1998 compared to Fiscal 1997 and the reversal of $1.4 million of interest payments previously paid into escrow on the subordinated notes issued to former owners of Apex and subsequently surrendered to the Company upon settlement of the Company's claims against them in 1997. Other Expense Other expense for Fiscal 1998 of $0.6 million was comprised primarily of foreign exchange losses offset by the $1.0 million gain on the sale of the Company's Reynosa, Mexico manufacturing facility. The Fiscal 1997 expense of $3.0 million was primarily related to foreign exchange losses attributable to the appreciation of the U.S. dollar. Since the third quarter 1997, the Company has entered into foreign exchange contracts and currency options as part of a strategy to reduce its exposure to foreign currency fluctuations. Income Tax Expense Income tax expense, excluding the effect of extraordinary items, for Fiscal 1998 was $3.6 million, compared to $13.2 million for Fiscal 1997. As of January 2, 1999, the Company's gross deferred tax assets were $54.1 million, which was the result of net operating loss carryforwards and other future tax deductible items totaling $133.2 million. Although the period to use these deferred tax assets is 11 to 20 years for tax purposes, the accounting guidance requires that a shorter time frame be used to assess the probability of their realization. As a result of the uncertainty caused by the industry downturn which began in the last half of Fiscal 1997 and the related oversupply of inventory in the marketplace in Fiscal 1998, the Company incurred a charge to income tax expense of $9.4 million to increase its deferred tax valuation allowance to a total of $30.8 million. Extraordinary (Gain) Loss During Fiscal 1998, the Company reported an extraordinary gain of $0.7 million, net of tax. The extraordinary gain related to the cancellation of outstanding subordinated notes the Company exchanged for newly issued secured notes, net of financing fees that were written off in connection with the debt transactions. During Fiscal 1997, the Company entered into a new $150.0 million secured credit agreement replacing its former credit agreement. In connection with the repayment of the former credit agreement, the Company wrote-off deferred financing fees of $1.3 million which resulted in an extraordinary loss net of tax of $0.7 million. Net Loss Due to the factors described above, the Company recorded a net loss of $22.8 million in Fiscal 1998 compared to a $5.0 million net loss in Fiscal 1997. Net Loss Per Share The Company recorded a net loss per share of $1.32 in Fiscal 1998 compared to a net loss per share of $0.29 in Fiscal 1997. The weighted average number of outstanding shares in Fiscal 1998 was 17,319,377 versus 17,271,911 in Fiscal 1997. 15 Comparison of Fiscal 1997 and Fiscal 1996 The following table sets forth certain items related to operations and such items as a percentage of net sales for Fiscal 1997 and Fiscal 1996:
Fiscal Year Ended ------------------------------------------------------------ January 3, 1998 % December 28, 1996 % -------- ----- ----------------- ----- (Dollars in thousands, except per share amounts) Net sales............................................... $450,199 100.0 $349,335 100.0 Gross profit............................................ 120,941 26.9 86,237 24.7 Selling, general and administrative expenses............ 127,261 28.3 114,888 32.9 Royalty income.......................................... 22,569 5.0 27,638 7.9 Restructuring expenses (credit)......................... 1,537 0.3 (1,177) (0.3) Earnings from operations................................ 14,712 3.3 164 0.0 Loss (credit) on investment in unconsolidated subsidiary (12,537) (2.8) (1,362) (0.4) Interest expense........................................ 15,374 3.4 17,776 5.1 Income tax expense (benefit)............................ 13,154 2.9 (4,134) (1.2) Loss from continuing operations......................... (4,305) (1.0) (18,435) (5.3) Extraordinary loss...................................... 744 0.2 -- -- Net loss................................................ $(5,049) (1.1) $ (18,435) (5.3) Net loss per share...................................... $ (0.29) $ (1.10)
Net Sales Net sales for Fiscal 1997 increased to $450.2 million from $349.3 million in Fiscal 1996, a 28.9% improvement. The $100.9 million sales growth in Fiscal 1997 is attributable to increases of 44.3%, 40.1% and 8.5% in the athletic originals, basketball and children's categories, respectively, compared to Fiscal 1996. These gains were partially offset by a 1.1% decline in the cross training category compared to the prior year. Net sales in the United States for Fiscal 1997 increased 46.8% and net sales internationally increased 6.5% compared to the prior year. Net sales in the Pacific region (Japan) improved 62.4% in Fiscal 1997 as a result of strong demand for the Company's athletic originals products while net sales in the Latin/South America region increased 3.2%. Net sales in the Europe, Middle East and Africa region, and Canada recorded declines of 18.2% and 10.6%, respectively, in Fiscal 1997. The strong U.S. dollar continued to have an adverse affect on the Company's results. On a constant dollar basis, Fiscal 1997 international net sales would have increased 11.1% compared to Fiscal 1996. Gross Profit Gross profit increased to $120.9 million in Fiscal 1997 from $86.2 million in Fiscal 1996, a 40.3% improvement. As a percentage of net sales, gross profit increased to 26.9% in Fiscal 1997 compared to 24.7% for the prior year period. This improvement is primarily attributable to strong sales in the first half of Fiscal 1997 in all categories as well as increasing consumer demand for the Company's athletic originals products in the second half of the year, resulting in greater manufacturing utilization and economic efficiencies at the Company's U.S. factories. These gross profit gains were partially offset by weaker margins in the second half of Fiscal 1997 in the basketball, training and children's categories resulting from an oversupply of inventory in the market due to an industry-wide slow down in athletic footwear sales. Selling, General and Administrative Expenses Selling, general and administrative expenses, which are primarily comprised of advertising, promotion and selling expenses in addition to employee salaries and benefits and other overhead costs, increased $12.4 million to $127.3 million for Fiscal 1997 from $114.9 million for Fiscal 1996, a 10.8% increase. This gain was mainly attributable to increased spending in advertising, promotion, and direct selling activities necessary to support the Fiscal 1997 sales 16 growth in the United States and the Pacific region. As a percentage of net sales, selling, general and administrative expenses decreased to 28.3% for Fiscal 1997 from 32.9% for the prior year. Royalty Income Royalty income decreased 18.1% to $22.6 million in Fiscal 1997 from $27.6 million in Fiscal 1996. As a percentage of net sales, royalty income declined to 5.0% in Fiscal 1997 compared to 7.9% in the prior year. International royalty income, which represented 83.1% of the Company's total royalty income, declined 24.9% in Fiscal 1997 primarily as a result of a 37.5% reduction in the Pacific region compared to Fiscal 1996. The Pacific region decline is primarily attributable to streamlining the distribution of the Company's licensed products and to the strengthening of the U.S. dollar. The decline in the Pacific region was partially offset by increases of 141.6% in the Latin/South America region and 33.4% in the Europe, Middle East and Africa region. United States royalty income increased 42.7% to $3.8 million in Fiscal 1997 compared to Fiscal 1996. Restructuring Expenses (Credit) The Company established pretax restructuring reserves of $2.1 million related to a workforce reduction and the elimination of certain unprofitable retail stores in the fourth quarter of Fiscal 1997. The restructuring reserves represent fixed amounts to be paid out during 1998. This restructuring charge was partially offset by the reversal of previously written-off expenses relating to the re-opening of the Mission, Texas manufacturing facility in the first quarter of Fiscal 1997. See Note 4 to the Consolidated Financial Statements of the Company included herein. Earnings from Operations The Company recorded earnings from operations in Fiscal 1997 of $14.7 million, compared to $0.2 million in Fiscal 1996. This change was primarily due to the factors discussed above. Loss (Credit) on Investment in Unconsolidated Subsidiary In the first quarter of Fiscal 1997, the Company recorded a pretax gain totaling $13.1 million relating to the settlement of certain Apex-related obligations. This amount was partially offset by additional Apex-related legal and settlement costs incurred in the fourth quarter of Fiscal 1997, finalizing all remaining outstanding litigation relating to the Company's investment in Apex. The net activity for Fiscal 1997 was a net credit on investment in unconsolidated subsidiary of $12.5 million. At January 3, 1998, there were no remaining claims against the Company relating to its 1995 acquisition of Apex. See Note 3 to the Consolidated Financial Statements of the Company included herein. Interest Expense Interest expense for Fiscal 1997 decreased 13.5% to $15.4 million from $17.8 million in Fiscal 1996. The decrease is primarily attributable to the reversal of $1.4 million of interest payments paid into escrow relating to the subordinated notes issued to the former owners of Apex, the write-off of unamortized bank fees and the issuance of the convertible notes replacing other higher-interest indebtedness. These decreases were partially offset by an increase in interest payments due to higher borrowing levels in Fiscal 1997 compared to Fiscal 1996. Income Tax Expense (Benefit) Income tax expense for Fiscal 1997 was $13.2 million, compared to an income tax benefit of $4.1 million for Fiscal 1996. As of January 3, 1998, the Company's gross deferred tax assets were $44.2 million, which is the result of net operating loss carryforwards and other future tax deductible items totaling $117.2 million. Although the period to use these deferred tax assets is 11 to 20 years for tax purposes, the accounting guidance requires that a shorter time frame be used to assess the probability of their realization. As a result of the uncertainty caused by the industry downturn and the 17 related oversupply of inventory in the marketplace during the fourth quarter of Fiscal 1997, the Company increased its deferred tax valuation allowance by $9.3 million to a total of $20.9 million. Extraordinary Loss During Fiscal 1997, the Company entered into a new $150.0 million secured credit agreement replacing its former credit agreement. In connection with the repayment of the former credit agreement, the Company wrote-off deferred financing fees of $1.3 million which resulted in an extraordinary loss net of tax of $0.7 million. Net Loss Due to the factors described above, the Company recorded a net loss of $5.0 million in Fiscal 1997 compared to an $18.4 million net loss in Fiscal 1996. Net Loss Per Share The Company recorded a net loss per share of $0.29 in Fiscal 1997 compared to a net loss per share of $1.10 in Fiscal 1996. The weighted average number of outstanding shares in Fiscal 1997 was 17,271,911 versus 16,760,620 in Fiscal 1996. Liquidity and Capital Resources Cash Flow Net cash provided by operating activities was $0.6 million in Fiscal 1998 versus net cash required for operating activities of $48.1 million in Fiscal 1997. In Fiscal 1998, the net loss of $22.4 million (after giving effect to adjustments for non-cash items) and requirements for changes in other long-term assets and liabilities of $10.3 million, principally the reduction in the long term liability due to the elimination of deferred postretirement medical benefits, were offset by cash provided of $33.3 million from the reduction in working capital needs fueled by significant reductions in receivables and inventories. In Fiscal 1997, requirements for operating activities were comprised of a net loss of $12.8 million (after giving effect to adjustments for non-cash items), working capital needs of $32.7 million consisting principally of receivables, inventories and payables, and other long-term assets and liabilities of $2.6 million. Net cash used by investing activities was $3.6 million in Fiscal 1998. Additions to property, plant and equipment of $4.8 million were partially offset by proceeds received of $1.2 million from the disposal of assets, principally the sale of a manufacturing facility in Reynosa, Mexico to accommodate the Company's move to a larger leased facility. Net cash used from investing activities was $5.9 million in Fiscal 1997 and consisted entirely of additions to property, plant and equipment. Net cash provided by financing activities was $1.2 million for Fiscal 1998. Net proceeds received from the issuance of Secured Notes (as defined below) of $24.0 million and short term debt of $0.2 million generated by the asset based financing arrangements in the Company's European subsidiaries were used to reduce revolving debt by $23.0 million outstanding under the Credit Facility (see Financing Arrangements below). Net cash provided by financing activities was $52.8 million for Fiscal 1997. Cash was provided from the net proceeds from the sale of 7% Convertible Subordinated Notes (see Financing Arrangements below) in May 1997 of $76.4 million, net borrowings under the Credit Facility of $96.9 million and net proceeds from the exercise of stock options of $0.5 million. This was partially offset by cash used from the decrease of short-term debt of $3.2 million and the repayment of the Old Credit Facility (see Financing Arrangements below) of $117.8 million. 18 Working Capital The Company's working capital position, net of cash, was $3.8 million on January 2, 1999 versus $14.5 million on January 3, 1998. Total current assets, net of cash, decreased $38.4 million to $138.1 million at January 2, 1999 from $176.5 million in the prior year. The reduction in receivables of $14.3 million and in inventories of $23.4 million is reflective of the volume decrease in business activity and the Company's emphasis on working capital management to keep these key asset categories in line with the reduced sales. Prepaid expenses and other current assets decreased $0.7 million. Total current liabilities decreased $27.7 million from $162.0 million at January 3, 1998 to $134.3 million at January 2, 1999. As discussed above, revolving debt under the Credit Facility was reduced $23.0 million, principally from the proceeds of the issuance of the Secured Notes. Payables and accrued expenses decreased $5.2 million, due principally to the reduction in business activity, while short term debt increased $0.5 million. Financing Arrangements In September 1998, the Company issued $28.6 million aggregate principal amount of 15% Senior Secured Notes (the "Secured Notes") due September 16, 2000 (the "Initial Maturity Date"). Interest on the Secured Notes is payable quarterly in arrears. The Initial Maturity Date may be extended an additional 12 months at the Company's option upon written notification of its election to extend and payment of a fee equal to 3% of the then outstanding principal amount of the Secured Notes (the "First Extended Maturity Date"). The First Extended Maturity Date may be extended to May 21, 2002, at the Company's option, upon written notification of its election to extend and payment of an additional fee equal to 3% of the then outstanding principal amount of the Secured Notes. The Secured Notes were issued in two series: Series A in the aggregate principal amount of $24.8 million (the "Series A Secured Notes") and Series B in the aggregate principal amount of $3.8 million (the "Series B Secured Notes"). The Secured Notes are redeemable at any time at face amount plus accrued interest. The Secured Notes require compliance with customary affirmative and negative covenants, including certain financial covenants, substantially the same as the requirements contained in the Credit Facility. Upon issuance of the Series A Secured Notes the Company received gross proceeds of $24.0 million after discount from the face amount. In connection with the issuance of the Series A Secured Notes, the Company issued warrants to purchase 360,000 shares of the Company's common stock to the purchasers and paid funding fees to certain purchasers amounting to $0.4 million. The warrants were valued at $1.22 per share, vest immediately and expire on March 16, 2003. The Company paid a placement fee of 4% of the gross proceeds, or $1.0 million, with respect to the Series A Secured Notes. The Series A Secured Notes carry a second priority perfected lien on all real and personal, tangible and intangible assets of the Company. The Series B Secured Notes were issued in exchange for the surrender of $5.7 million face amount of Convertible Notes (see below), which were subsequently cancelled by the Company. In connection with the issuance of the Series B Secured Notes, the Company paid a placement fee of 2% of the face amount, or $0.1 million. The Series B Secured Notes carry a third priority perfected lien on all real and personal, tangible and intangible assets of the Company. In May 1997, the Company issued $80.0 million of 7% Convertible Subordinated Notes due June 1, 2004 (the "Convertible Notes"). As discussed above, in September 1998 the Company received, and subsequently cancelled, $5.7 million of Convertible Notes in exchange for the issuance of the Series B Secured Notes. The Convertible Notes are subordinated to all existing and future Senior Indebtedness (as defined therein). The Convertible Notes are convertible at any time prior to maturity, unless previously redeemed into common stock of the Company, at the option of the holder, at a conversion price of $21.83 per share, subject to adjustment in certain events. In addition, the Convertible Notes may be redeemed, in whole or in part, at the option of the Company, at any time on or after June 5, 2000, at redemption prices set forth therein plus accrued interest to the date of redemption. Interest is payable semi-annually on June 1 and 19 December 1, commencing on December 1, 1997. Proceeds from the Convertible Notes were used to repay indebtedness under the Company's then existing credit agreement (the "Old Credit Facility"). Simultaneously with the issuance of the Convertible Notes in May 1997, the Company entered into a new $150.0 million secured credit agreement (the "Credit Facility") with BT Commercial Corporation ("BTCC") for revolving loans, letters of credit, foreign exchange contracts and banker acceptances and repaid the Old Credit Facility. In July 1997, BTCC, as agent, syndicated the Credit Facility to a group of participating lenders (the "Banks"). In September 1998, the Credit Facility was amended to decrease the commitment from $150.0 million to $120.0 million in conjunction with the issuance of the Secured Notes. The amount of credit available to the Company at any time is limited by a borrowing base formula, as defined in the Credit Facility, consisting primarily of U.S. and Canadian accounts receivable and inventory (the "Borrowing Base"). The aggregate of letters of credit, foreign exchange contracts and banker acceptances may not exceed $80.0 million at any time; revolving loans are limited only by the Credit Facility's maximum availability less any amounts outstanding for letters of credit, foreign exchange contracts or banker acceptances. The Credit Facility is for a five-year term and, accordingly, has an expiration date of May 21, 2002. However, the total revolving loans and banker acceptances outstanding under the Credit Facility of $73.8 million are classified as current due to the Company's lockbox arrangement (whereby payments by the Company's customers are deposited in a lockbox controlled by the Banks) and certain clauses contained in the Credit Facility regarding mandatory repayment that involve subjective judgments by the Banks. This classification is required by Emerging Issues Task Force 95-22, "Balance Sheet Classification of Borrowings Outstanding under a Revolving Credit Agreement that Includes both a Subjective Acceleration Clause and a Lockbox Arrangement". As of January 2, 1999, the Borrowing Base was $80.4 million. Utilization under the Credit Facility at year end amounted to $76.1 million consisting of revolving loans of $72.4 million, banker acceptances of $1.4 million and outstanding letters of credit of $2.3 million. Accordingly, $4.3 million of the maximum available Borrowing Base remained unutilized as of January 2, 1999. Revolving loans under the Credit Facility bear interest either at the Prime Lending Rate (as defined therein) plus one percent (1.00%) per annum or at the Adjusted LIBOR Rate (as defined therein) plus a margin of two and one-half percent (2.50%) per annum. The foregoing LIBOR margin is subject to a reduction based upon the Company achieving certain interest coverage ratios specified in the Credit Facility. At January 2, 1999, revolving loans outstanding under the Credit Facility bore interest of 7.79% based upon the weighted average of the Prime Lending Rate and Adjusted LIBOR Rate. Obligations outstanding under the Credit Facility are secured by first priority liens on substantially all of the Company's U.S. and Canadian assets. The Credit Facility, as amended, requires compliance with customary affirmative and negative covenants, including certain financial covenants. In September 1998, the Company's Credit Facility was amended to permit the issuance of the Secured Notes. The amendment decreased the commitment under the Credit Facility from $150.0 million to $120.0 million, increased the annual collateral management fee from $0.1 million to $0.125 million and changed a financial performance covenant contained therein. As of January 2, 1999, the Company was in compliance with its financial covenants and believes that it will remain in compliance during 1999. Subsidiaries of the Company maintain asset based financing arrangements in certain European countries with various lenders. In general, these financing arrangements allow for borrowings based upon eligible accounts receivable and inventory at varying advance rates and varying interest rates. Total short-term borrowings outstanding under these financing arrangements were $9.6 million as of January 2, 1999. Interest is payable at the respective lender's base rate plus 1.5% (varying by country from 4.5% to 8.0%). Additionally, letters of credit outstanding under these financing arrangements totaled $3.9 million at year end. The obligations are secured by first priority liens on the respective European assets being financed. In addition, Converse Inc. provided guarantees with respect to the outstanding borrowings for certain of the financing arrangements. 20 Capital Expenditures Capital expenditures were $4.8 million, $5.9 million and $5.3 million in Fiscal 1998, Fiscal 1997 and Fiscal 1996, respectively. In Fiscal 1998, investments were made in information technology and software, principally to upgrade systems in the Company's European subsidiaries for $1.9 million, in ongoing improvements in the Company's manufacturing processes at its facilities in North Carolina, Texas and Mexico for $1.8 million and other various smaller projects and expenditures for $1.1 million. Fiscal 1997 investments included $0.5 million on building improvements primarily to upgrade the heating system at the corporate office, $0.5 million on leasehold improvements primarily to open or remodel the Company's retail stores, $1.6 million to maintain and upgrade the Company's manufacturing facilities in North Carolina, Texas and Mexico, $0.7 million to maintain and upgrade the Company's distribution facility in Charlotte, North Carolina, $1.2 million in information technology to support improvements in networking and international operations and $1.4 million on various smaller projects and improvements. In Fiscal 1996, the Company spent $1.4 million on leasehold improvements primarily to open or remodel the Company's retail stores, $1.0 million to maintain and upgrade the Company's manufacturing facility in Lumberton, North Carolina, $0.9 million in information technology to support improvements in networking, retail store operations and international operations, $0.9 million to upgrade the Company's trade show booth and $1.1 million on various smaller projects and improvements. The Year 2000 Background The "Year 2000 Problem" is the result of many existing computer programs and embedded chip technology containing programming code in which calendar year data is abbreviated by using only two digits rather than four to refer to a year. As a result of this, some of these programs may fail to operate or may not properly recognize a year that begins with "20" instead of "19." This may cause such software to recognize a date using "00" as the year 1900 rather than the year 2000. Even systems and equipment that are not typically thought of as computer-related often contain embedded hardware or software that may improperly interpret dates beginning with the year 2000. The Company's Year 2000 Project Converse began working on Year 2000 compliance issues in 1996 when it established a Company-wide Year 2000 project team (the "Year 2000 Project Team") to identify all potential non-compliant software, hardware and imbedded chip technology and determine to what extent modification or replacement was necessary to mitigate the Year 2000 Problem. The first task of the Year 2000 Project Team was to conduct an assessment of all internal hardware, software and imbedded chip technology to determine Year 2000 compliance and to assess the risks associated with non-compliance by the Company's vendors, suppliers and customers. The Year 2000 Project Team divided the action steps necessary to minimize any Year 2000 non-compliance into two distinct categories: internal compliance of software, hardware and imbedded chip technology, and external non-compliance by the Company's vendors, suppliers and customers. Internal Year 2000 Compliance. The Company began the process of executing ----------------------------- the necessary code changes and upgrading existing systems in 1996. As a result, most of the Company's software, hardware and imbedded chip technology are already Year 2000 compliant. The Year 2000 Project Team developed an ongoing program designed to bring the remaining software, hardware and imbedded chip technology at all of its domestic and international locations into Year 2000 compliance in time to minimize any significant detrimental affects on the Company's business and operations. In many cases these upgrades were already planned as part of ongoing business process improvements. 21 Currently, the Company has completed approximately 90% of the work believed to be required to bring all internal systems into compliance. Converse's current target is to complete all remaining work by the end of the second quarter of 1999. External Year 2000 Compliance. The Year 2000 Project Team reviewed all ----------------------------- material relationships between Converse and each of its vendors and suppliers and determined which ones were critical to Converse's business and operations. "Critical" Suppliers. Converse deemed 165 of its vendors and suppliers to ------------------- be "critical" to the Company's business and operations. Converse has sent each of its critical suppliers a detailed Year 2000 readiness questionnaire and checklist, followed in some cases by formal communication and/or site visits. Response rate to date is 97%, with 93% of the respondents indicating all systems have been or will be verified Year 2000 compliant. For those critical suppliers that do not respond or that do not have adequate compliance plans, Converse is developing contingency plans that assume an estimated level of noncompliance. These plans may consist of early purchase of materials, components, work-in-process or finished goods. Even so, these contingency plans are subject to much uncertainty and may not be sufficient to mitigate any business interruption. Thus, some material adverse impact to Converse may result from one or more third parties regardless of Converse's defensive contingency plans. "Non-Critical" Suppliers. The Company sent letters to 2,193 suppliers and ----------------------- vendors deemed to be "non-critical" advising them of the Year 2000 Problem and requesting that they address compliance. Non-compliance by such suppliers would not have a material adverse affect on the Company. Costs Associated with Year 2000 Compliance. Through the end of 1998 the Company spent approximately $1.8 million on incremental costs associated with the Year 2000 Problem. These costs consisted of new hardware and software as well as the cost of contracted programmers and the salaries and fringe benefits of employees dedicated to addressing the Year 2000 Problem. These costs have been funded through operating cash flows. Approximately $0.8 million of this amount relates to hardware and software which the Company has capitalized and the remainder has been expensed as incurred. The Company estimates that an additional $0.7 million will be incurred during the first half of 1999 to complete this process. These additional expenditures will be comprised of some additional new hardware and software, as well as the cost of contracted programmers and the salaries and benefits of employees dedicated to addressing the Year 2000 Problem. These estimates are based on currently available information and may change in the event of unforeseen future developments. Risks Associated with the Year 2000 Problem. The failure to correct a material Year 2000 Problem could result in the interruption in, or failure of, certain normal business activities or operations of the Company. 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 primarily from uncertainty of the Year 2000 readiness of third-party vendors and suppliers, the Company is unable at this time to determine whether the consequences of any Year 2000 failures will have a material impact on the Company. As discussed above, Converse is dependent on a large number of vendors and suppliers in most of the locations in which the Company operates to deliver a wide range of goods and services. These vendors and suppliers, in turn, rely on many sub-tier vendors and suppliers. Converse believes that this extended supply chain presents the area of greatest risk of Year 2000 noncompliance, due to Converse's limited ability to influence actions of some of these third parties and because of Converse's inability to accurately estimate the level and impact of noncompliance of third parties throughout the extended supply chain. 22 Impact of Recently Issued Accounting Pronouncements The Company has adopted Statement of Financial Accounting Standard No. 130, "Reporting Comprehensive Income." This Statement establishes standards for reporting and display of comprehensive income and its components in a full set of general-purpose financial statements. The Company has adopted Statement of Financial Accounting Standard No. 131, "Disclosure about Segments of an Enterprise and Related Information." This Statement requires an enterprise to report financial and descriptive information about its reportable operating income. Operating segments are components that are evaluated regularly by chief operating decision makers in deciding how to allocate resources and in assessing performance. This Statement requires a business enterprise to report a measure of segment profit or loss, certain specific revenue and expense items (including interest, depreciation, and income taxes), and segment assets. It also establishes standards for related disclosures about products and services, geographic areas, and major customers. The Company has adopted Statement of Financial Accounting Standard No. 132, "Employers' Disclosures about Pensions and Other Postretirement Benefits." This Statement revises employers' disclosures about pensions and other postretirement plans. The Statement does not change the measurement or recognition of those types of plans and, accordingly, will not have a material impact on the Company's consolidated financial position or results of operations. The Financial Accounting Standards Board issued Statement No. 133, "Accounting for Derivative Instruments and Hedging Activities." This Statement requires that all derivative instruments be recorded on the balance sheet at their fair value. Changes in the fair value of derivatives are recorded each period in current earnings or other comprehensive income, depending on whether a derivative is designated as part of a hedge transaction and, if it is, the type of hedge transaction. This Statement is required to be adopted in the Company's fiscal year end 2000. Management of the Company anticipates that, due to its limited use of derivative instruments, the adoption of this Statement will not have a significant effect on the Company's results of operations or its financial position. ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK - ------------------------------------------------------------------- Interest Rate Risk The Company's exposure to market risk associated with changes in interest rates relates primarily to its debt obligations. The Company's Credit Facility bears interest at the Prime Lending Rate (as defined therein) plus 1% or the adjusted LIBOR (as defined therein) plus 2.5%. The Company's foreign borrowings also have variable interest rates. The Company's Convertible Notes and Secured Notes bear fixed rates of interest. See Item 7 - Management's Discussion and Analysis of Financial Condition and Results of Operations - Liquidity and Capital Resources for further information. Converse does not use derivative financial instruments to hedge its interest rate risks. Foreign Currency Risk Converse sells its products in a number of countries throughout the world and, as a result, is exposed to movements on foreign currency exchange rates. Although Converse has some of its products manufactured outside of the United States on a per order basis, these purchases are made in U.S. dollars. The major foreign currency exposures involve the markets in Western Europe, Japan and Australia. In order to protect against the volatility associated with earnings currency translations of foreign subsidiaries and royalty income from sources outside the United States, the Company uses forward foreign exchange contracts and foreign currency options with durations of generally from three to twelve months. 23 As of January 2, 1999, the company had outstanding the following foreign exchange forward contracts and currency options:
(currency per USD) Notional Average Estimated Amount Contract Rate Fair Value ------ ------------- ---------- (Dollars in thousands) Foreign exchange sell forward contracts: Japanese Yen............................. $9,887.4 115.87 $(394.3) Australian Dollar........................ $1,978.5 1.57 $ 85.0 Spanish Pesetas.......................... $4,288.8 140.66 $ 33.4 Foreign exchange buy forward contracts: Japanese Yen............................. $5,170.2 114.74 $ 165.1 Currency put options: British Pounds........................... $1,480.0 0.63 $(55.0)* Italian Lira............................. $6,052.8 1,681.69 $(111.9)* French Franc............................. $6,710.6 5.72 $(149.0)* Danish Krone............................. $2,946.6 6.51 $(72.7)* German Mark.............................. $5,885.7 1.70 $(107.7)* Dutch Gilders $3,017.5 1.92 $(66.5)*
* These amounts do not represent economic losses as out of-the-money options would not be exercised. Commodity Price Risk Raw materials used by the Company are subject to price volatility caused by weather, supply conditions and other unpredictable factors. The Company does not have a program of hedging activity to address these risks. ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTAL DATA - --------------------------------------------------- The information required by this Item is submitted in a separate section of this report. See Item 14 for index to financial statements required by this Item. ITEM 9. CHANGE IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL - -------------------------------------------------------------------------------- DISCLOSURE - ---------- Not applicable. 24 PART III -------- ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT. - ------------------------------------------------------------- The information required by this Item with respect to the Company's directors is incorporated herein by reference to the Company's definitive proxy statement for the Annual Meeting of Stockholders to be held on May 12, 1999, which will be filed with the Securities and Exchange Commission on or before April 30, 1999 (the "1999 Proxy Statement"). Information required by this Item with respect to the Company's executive officers is set forth below. Executive Officers of the Company Name Age Position - ---- --- -------- Glenn N. Rupp.............. 54 Chairman of the Board and Chief Executive Officer Donald J. Camacho.......... 48 Senior Vice President and Chief Financial Officer Edward C. Frederick........ 52 Senior Vice President, Research, Design and Development Jack A. Green.............. 53 Senior Vice President Administration, General Counsel and Secretary Herbert R. Rothstein....... 57 Senior Vice President, Production James E. Solomon........... 43 Senior Vice President, Sales and Marketing Alistair M. Thorburn....... 41 Senior Vice President, International James E. Lawlor............ 44 Vice President, Finance and Treasurer Mr. Rupp was elected Chairman of the Board and Chief Executive Officer by Converse's Board of Directors on April 11, 1996. From August 1994 to April 1996, Mr. Rupp was the Acting Chairman of McKenzie Sports Products, Inc. and a Strategic Planning Advisor for CRC Industries, Inc. Mr. Rupp was President and Chief Executive Officer of Simmons Upholstered Furniture Inc. ("Simmons") from August 1991 until May 1994. Prior to 1991, Mr. Rupp held various positions with Wilson Sporting Goods Co., including President and Chief Executive Officer from 1987 to 1991. Mr. Rupp is also a director of Consolidated Papers, Inc. and Johnson Worldwide Associates, Inc. In July 1994, a voluntary petition for reorganization under Chapter 11 of the U.S. Bankruptcy Code was filed on behalf of Simmons. Mr. Camacho has served as Senior Vice President and Chief Financial Officer since September 1994. Previously, Mr. Camacho held the positions of Vice President and Controller from 1992 to 1994, Controller from 1984 to 1992, Assistant Controller from 1980 to 1984, and several other positions of increasing responsibility since 1974. Dr. Frederick has served as Senior Vice President, Research, Design and Development since April 1997. From February 1996 to April 1997, Dr. Frederick was a consultant to Converse through his wholly-owned consulting company, Exeter Research, Inc. ("Exeter") and held the title of Chief Product Executive of Converse. Dr. Frederick has been the President of Exeter since 1987. Since 1995, Dr. Frederick has also served as an Adjunct Professor in the Department of Exercise Sciences, School of Public Health and Health Sciences, University of Massachusetts. Dr. Frederick worked as a consultant for adidas in the fields of development, design and technology from 1991 to 1996. Previously, Dr. Frederick worked as the Director of Research for Nike from 1980 to 1986 and as a design consultant for Nike from 1978 to 1980 and from 1986 to 1990. 25 Mr. Green has served as Senior Vice President Administration, General Counsel and Secretary since May 1998. Prior to that, Mr. Green served as Senior Vice President, General Counsel and Secretary since August 1985, having joined the Company as Vice President, Legal in 1983. Since 1996, Mr. Green has also served as an Adjunct Professor at Emmanuel College in Boston, Massachusetts. Mr. Green is a director of Arrow Mutual Liability Insurance Company. Mr. Rothstein has served as Senior Vice President, Production since January 1996. Previously, Mr. Rothstein was Senior Vice President, Sourcing from 1992 to 1996, Senior Vice President of Materials Management and Manufacturing from 1991 to 1992 and Vice President of Materials Management from 1988 to 1991. Before joining Converse, Mr. Rothstein held several senior management positions with Reebok International Ltd. from 1985 to 1988; Morse Shoe Inc. from 1973 to 1985, BGS Shoe Corporation from 1969 to 1972 and Signet from 1964 to 1969. Mr. Solomon has served as Senior Vice President, Sales and Marketing since May 1998. Prior to that, Mr. Solomon served as Senior Vice President, Marketing since October 1996. Previously, Mr. Solomon worked for Lenox Inc. from August 1990 to September 1996 in a number of senior positions, including President and Chief Operating Officer of the Dansk International Design division from May 1994 to September 1996 and Gorham, Kirk-Stieff, Dansk division from July 1991 to May 1994. He also has experience in the athletic footwear industry, having served as Executive Vice President of Kangaroos USA from 1989 to 1990, Vice President, Marketing of Avia Athletic Footwear from 1985 to 1988, and Group Product Manager, New Balance Athletic Shoes from 1981 to 1983. Mr. Thorburn has served as Senior Vice President, International since December 1993. Prior to joining the Company, Mr. Thorburn was Vice President Europe/Asia Pacific for the Wilson Sporting Goods Co., Ltd. from 1987 to 1993. Mr. Lawlor has served as Vice President, Finance and Treasurer since June 1995. Previously, Mr. Lawlor held the positions of Vice President and Treasurer from September 1994 to June 1995, Treasurer from 1984 to 1994 and other positions of increasing responsibility since 1975. ITEM 11. EXECUTIVE COMPENSATION. - --------------------------------- The information required by this Item is incorporated by reference from the 1999 Proxy Statement. ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT. - ------------------------------------------------------------------------- The information required by this Item is incorporated by reference from the 1999 Proxy Statement. ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS. - --------------------------------------------------------- The information required by this Item is incorporated by reference from the 1999 Proxy Statement. 26 PART IV ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K. - -------------------------------------------------------------------------- (a) List of documents filed as part of this report. 1. Financial statements: The following consolidated financial statements are included in Item 8 and presented as a separate section of this report: Page ---- Report of Independent Accountants F-2 Consolidated Balance Sheet at January 3, 1998 and January 2, 1999 F-3 For each of the fiscal years ended December 28, 1996, January 3, 1998 and January 2, 1999: Consolidated Statement of Operations F-4 Consolidated Statement of Cash Flows F-5 Consolidated Statement of Stockholders' Equity F-6 and Comprehensive Income Notes to Consolidated Financial Statements F-7 2. Financial Statement Schedule: Schedule II - Valuation and Qualifying Accounts F-25 All other schedules are omitted because they are not applicable or because the required information is presented in the consolidated financial statements or notes thereto. 3. Exhibits 3.1 Restated Certificate of Incorporation (3) 3.2 By-laws (3) 4. Indenture dated as of May 21, 1997 between Converse and First Union National Bank, as Trustee, relating to Converse Inc. 7% Convertible Subordinated Notes due 2004 in the principal amount of $80.0 million, including the form of Note (12) 10.1 Credit Agreement dated as of May 21, 1997, among Converse Inc., its subsidiaries, BT Commercial Corporation, as agent, and the financial institutions party thereto (the "Credit Agreement") (12) 10.2 Amendment Number One to Credit Agreement (12) 10.3 Amendment Number Two to Credit Agreement (14) 27 10.4 Amendment Number Three Credit Agreement (14) 10.5 Amendment Number Four to Credit Agreement (17) 10.6 Waiver Number One to Credit Agreement (15) 10.7 Waiver Number Two to Credit Agreement (16) 10.8 Amendment and Reaffirmation of Lease dated June 29, 1988, between Godley Construction Company Inc. ("Godley") and Converse Inc. and Lease Agreement dated as of March 26, 1974, between Godley and Charlotte Footwear, Inc. (1) 10.9 Sublease Agreement dated as of September 28, 1993, between Kmart Corporation and Converse Inc. (1) 10.10 Lease Agreement - Reynosa, Mexico (16) 10.11 Registration Rights Agreement dated as of November 17, 1994, between Apollo Interco Partners, L.P. and Converse Inc. (3) 10.12 Consulting Agreement dated as of November 17, 1994, between Apollo Advisors, L.P. and Converse Inc. (3) 10.13 Amendment to Consulting Agreement Dated as of November 17, 1998 between Apollo Advisors L.P. and Converse Inc. (15) 10.14 Converse Inc. Executive Incentive Plan (1) 10.15 Converse Inc. Team Incentive Plan (1) 10.16 Converse Inc. Supplemental Executive Retirement Plan (6) 10.17 Converse Inc. 1994 Stock Option Plan, as Amended and Restated as of February 25, 1998 (16) 10.18 Converse Inc. 1995 Non-Employee Director Stock Option Plan, as amended and restated as of July 30, 1997 (13) 10.19 Converse Inc. Employee Stock Purchase Plan (16) 10.20 Agreement among Julius W. Erving, the Erving Group and Converse Inc., dated October 1, 1984 as amended by an Amendment dated September 16, 1988, a Second Amendment dated July 18, 1989, a Third Amendment dated October 17, 1991, and a Fourth Amendment dated February 7, 1994 (2) 10.21 Fifth Amendment to Agreement among Julius W. Erving, The Erving Group, Inc. and Converse Inc.(5) 10.22 Sixth Amendment to Agreement among Julius W. Erving, the Erving Group, Inc. and Converse Inc.(7) 10.23 Seventh Amendment to Agreement among Julius W. Erving, the Erving Group, Inc. and Converse Inc.(7) 28 10.24 Lease Agreement dated as of January 3, 1995 between Talbot Operations Inc. and Converse Inc. (4) 10.25 Employment Agreement between Converse and Glenn N. Rupp (8) 10.26 Employment Agreement between Converse and James E. Solomon (9) 10.27 Employment Agreement between Converse and Donald J. Camacho (6) 10.28 Form of Employment Agreement dated as of October 25, 1995, between Converse and each of the following: Jack A. Green, Herbert R. Rothstein, Alistair M. Thorburn, and James E. Lawlor (6) 10.29 Employment Agreement between Converse and Edward C. Frederick (11) 10.30 Purchase Agreement dated June 1, 1997 between Converse and Exeter Research, Inc. (12) 10.31 Senior Secured Note Purchase Agreement dated September 16, 1998 (17) 10.32 Senior Secured Note dated September 16, 1998 (17) 10.33 Warrant Agreement dated September 16, 1998 (17) 21. List of subsidiaries* 23. Consent of PricewaterhouseCoopers LLP* 27. Financial Data Schedule* * Filed herewith (1) Filed as an Exhibit to Converse Inc. Form 10 dated October 14, 1994 filed with the SEC on October 14, 1994, and incorporated by reference herein. (2) Filed as an Exhibit to Converse Inc. Form 10/A Amendment No. 1, filed with the SEC on November 8, 1994, and incorporated by reference herein. (3) Filed as an Exhibit to Converse Inc. Form 10/A Amendment No. 2, filed with the SEC on November 23, 1994, and incorporated by reference herein. (4) Filed as an Exhibit to Converse Inc. Annual Report on Form 10-K for the year ended December 31, 1994, and incorporated by reference herein. (5) Filed as an Exhibit to Converse Inc. Quarterly Report on Form 10-Q for the quarter ended April 1, 1995, and incorporated by reference herein. (6) Filed as an Exhibit to Converse Inc. Annual Report on Form 10-K for the year ended December 30, 1995, and incorporated by reference herein. (7) Filed as an Exhibit to Converse Inc. Quarterly Report on Form 10-Q for the quarter ended March 30, 1996, and incorporated by reference herein. (8) Filed as an Exhibit to Converse Inc. Quarterly Report on Form 10-Q for the quarter ended June 29, 1996, and 29 incorporated by reference herein. (9) Filed as an Exhibit to Converse Inc. Quarterly Report on Form 10-Q for the quarter ended September 28, 1996, and incorporated by reference herein. (10) Filed as an Exhibit to Converse Inc. Annual Report on Form 10-K for the year ended December 28, 1996, and incorporated by reference herein. (11) Filed as an Exhibit to Converse Inc. Quarterly Report on Form 10-Q for the quarter ended March 29, 1997, and incorporated by reference herein. (12) Filed as an Exhibit to Converse Inc. Quarterly Report on Form 10-Q for the quarter ended June 28, 1997, and incorporated by reference herein. (13) Filed as an Exhibit to Converse Inc. Quarterly Report on Form 10-Q for the quarter ended September 29, 1997, and incorporated by reference herein. (14) Filed as an Exhibit to Converse Inc. Annual Report on Form 10-K for the year ended January 3, 1998, and incorporated herein by reference. (15) Filed as an Exhibit to Converse Inc. Quarterly Report on Form 10-Q for the quarter ended April 4, 1998, and incorporated herein by reference. (16) Filed as an Exhibit to Converse Inc. Quarterly Report on Form 10-Q for the quarter ended July 4, 1998, and incorporated herein by reference. (17) Filed as an Exhibit to Converse Inc. Quarterly Report on Form 10-Q for the quarter ended October 3, 1998, and incorporated herein by reference. (b) No reports on Form 8-K were filed by the Company during the last quarter of Fiscal 1998. UPON WRITTEN REQUEST TO THE COMPANY'S SECRETARY, THE COMPANY WILL FURNISH SHAREHOLDERS WITH A COPY OF ANY OR ALL SUCH EXHIBITS REQUESTED AT A CHARGE OF TEN CENTS PER PAGE, WHICH REPRESENTS THE COMPANY'S REASONABLE EXPENSES IN FURNISHING SUCH EXHIBITS. SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized, in North Reading, Massachusetts on March 19, 1999. CONVERSE INC. By: /s/ Glenn N. Rupp ---------------------------- Glenn N. Rupp Chairman of the Board and Chief Executive Officer 30 Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrants and in the capacities and on the date indicated.
Signature Title Date - --------- ----- ---- /s/ Glenn N. Rupp Chairman of the Board, Chief Executive Officer March 19, 1999 - --------------------------- and Director (Principal Executive Officer) Glenn N. Rupp /s/ Donald J. Camacho Senior Vice President and Chief Financial Officer March 19, 1999 - --------------------------- (Principal Financial and Accounting Officer) Donald J. Camacho /s/ Donald J. Barr Director March 19, 1999 - --------------------------- Donald J. Barr /s/ Leon D. Black Director March 19, 1999 - --------------------------- Leon D. Black /s/ Julius W. Erving Director March 19, 1999 - --------------------------- Julius W. Erving /s/ Robert H. Falk Director March 19, 1999 - --------------------------- Robert H. Falk /s/ Gilbert Ford Director March 19, 1999 - --------------------------- Gilbert Ford /s/ Michael S. Gross Director March 19, 1999 - --------------------------- Michael S. Gross /s/ John J. Hannan Director March 19, 1999 - --------------------------- John J. Hannan /s/ Joshua J. Harris Director March 19, 1999 - --------------------------- Joshua J. Harris /s/ John H. Kissick Director March 19, 1999 - --------------------------- John H. Kissick /s/ Richard B. Loynd Director March 19, 1999 - --------------------------- Richard B. Loynd /s/ John J. Ryan, III Director March 19, 1999 - --------------------------- John J. Ryan, III /s/ Michael D. Weiner Director March 19, 1999 - --------------------------- Michael D. Weiner
CONVERSE INC. AND SUBSIDIARIES INDEX TO CONSOLIDATED FINANCIAL STATEMENTS Page Report of Independent Accountants ....................................... F-2 Consolidated Balance Sheet............................................... F-3 Consolidated Statement of Operations..................................... F-4 Consolidated Statement of Cash Flows..................................... F-5 Consolidated Statement of Stockholders' Equity and Comprehensive Income.. F-6 Notes to Consolidated Financial Statements............................... F-7 Report of Independent Accountants To the Board of Directors and Stockholders of Converse Inc. In our opinion, the accompanying consolidated balance sheet and the related consolidated statements of operations, cash flows and stockholders' equity and comprehensive income present fairly, in all material respects, the financial position of Converse Inc. and its subsidiaries at January 3, 1998 and January 2, 1999, and the results of their operations and their cash flows for each of the three years in the period ended January 2, 1999, in conformity with generally accepted accounting principles. These financial statements are the responsibility of the Company's management; our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits of these statements in accordance with generally accepted auditing standards which require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for the opinion expressed above. /s/ PricewaterhouseCoopers LLP - ------------------------------- PRICEWATERHOUSECOOPERS LLP Boston, Massachusetts February 23, 1999 F-2 CONVERSE INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEET (Dollars in thousands, except per share amounts)
January 3, 1998 January 2, 1999 --------------- --------------- ASSETS Current assets: Cash and cash equivalents................................................... $ 5,738 $ 3,274 Receivables, less allowances of $2,066 and $2,086, respectively............. 72,083 57,826 Inventories (Note 5)........................................................ 94,681 71,292 Prepaid expenses and other current assets (Note 10)......................... 9,713 8,962 ------------- ------------- Total current assets...................................................... 182,215 141,354 Net property, plant and equipment (Note 6).................................... 20,086 20,838 Other assets (Note 10)........................................................ 32,393 32,814 ------------- ------------- $234,694 $195,006 ============= ============= LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIENCY) Current liabilities: Short-term debt (Note 8).................................................... $ 9,036 $ 9,557 Credit facility (Note 8).................................................... 96,844 73,833 Accounts payable............................................................ 41,318 37,184 Accrued expenses (Note 7)................................................... 14,279 10,861 Income taxes payable (Note 10).............................................. 478 2,861 ------------- ------------- Total current liabilities................................................. 161,955 134,296 Long-term debt (Note 8)....................................................... 80,000 101,799 Current assets in excess of reorganization value (Note 2)..................... 30,299 28,221 Accrued postretirement benefits other than pensions (Note 11)................. 10,422 -- Commitments and contingencies (Note 14) Stockholders' equity (deficiency): Common stock, $1.00 stated value, 50,000,000 shares authorized, 17,317,956 and 17,319,556 shares issued and outstanding at January 3, 1998 and January 2, 1999, respectively............................................. 17,318 17,320 Preferred stock, no par value, 10,000,000 shares authorized, none issued and outstanding............................................................... -- -- Additional paid-in capital.................................................. 2,271 3,695 Unearned compensation....................................................... -- (758) Retained deficit............................................................ (65,314) (88,129) Accumulated other comprehensive income...................................... (2,257) (1,438) ------------- ------------- Total stockholders' equity (deficiency)................................... (47,982) (69,310) ------------- ------------- $234,694 $195,006 ============= =============
See accompanying notes to consolidated financial statements. F-3 CONVERSE INC. AND SUBSIDIARIES CONSOLIDATED STATEMENT OF OPERATIONS (Dollars in thousands, except per share amounts)
Fiscal Year Ended -------------------------------------------------------- December 28, 1996 January 3, 1998 January 2, 1999 ----------------- --------------- --------------- Net sales .............................................. $ 349,335 $ 450,199 $ 308,353 Cost of sales .......................................... 263,098 329,258 237,671 ---------- ---------- ---------- Gross profit ........................................... 86,237 120,941 70,682 Selling, general and administrative expenses ........... 114,888 127,261 92,683 Royalty income ......................................... 27,638 22,569 20,175 Restructuring expense (credit) (Note 4) ................ (1,177) 1,537 -- ---------- ---------- ---------- Earnings (loss) from operations ........................ 164 14,712 (1,826) Loss (credit) on investment in unconsolidated subsidiary (Note 3) .................................... (1,362) (12,537) -- Interest expense ....................................... 17,776 15,374 17,525 Other expense, net (Note 15) ........................... 6,319 3,026 596 ---------- ---------- ---------- Earnings (loss) from continuing operations before income taxes ........................................... (22,569) 8,849 (19,947) Income tax expense (benefit) (Note 10) ................. (4,134) 13,154 3,572 ---------- ---------- ---------- Loss from continuing operations ........................ (18,435) (4,305) (23,519) Extraordinary (gain) loss, net of tax expense (benefit) of $(576) and $437, respectively (Note 9) .... -- 744 (704) ---------- ---------- ---------- Net loss ............................................... $ (18,435) $ (5,049) $ (22,815) ========== ========== ========== Net basic and diluted loss per share (Note 2): Continuing operations ............................... $ (1.10) $ (0.25) $ (1.36) Extraordinary gain (loss) ........................... -- (0.04) 0.04 ---------- ---------- ---------- Net loss ............................................ $ (1.10) $ (0.29) $ (1.32) ========== ========== ========== Weighted average common shares outstanding (Note 2) .... 16,761 17,272 17,319 ========== ========== ==========
See accompanying notes to consolidated financial statements. F-4 CONVERSE INC. AND SUBSIDIARIES CONSOLIDATED STATEMENT OF CASH FLOWS (Dollars in thousands, except per share amounts)
Fiscal Year Ended ------------------------------------------------------- December 28, 1996 January 3, 1998 January 2, 1999 ----------------- --------------- --------------- Cash flows from operating activities: Net loss ....................................................... $ (18,435) $ (5,049) $ (22,815) Adjustments to reconcile net loss to net cash provided by (required for) operating activities: Loss (credit) on investment in unconsolidated subsidiary, less cash payments of $3,439, $8,064 and $0, respectively ......... (4,801) (20,601) -- Provision for restructuring actions, less cash payments of $5,316, $3,763 and $2,438, respectively ...................... (6,493) (2,226) -- Extraordinary loss on write-off of deferred financing fees ..... -- 1,320 809 Extraordinary gain on cancellation of convertible notes ........ -- -- (1,950) Depreciation of property, plant and equipment .................. 3,100 3,589 3,939 Amortization of intangible assets .............................. 539 548 468 Amortization of current assets in excess of reorganization value (2,078) (2,077) (2,078) Amortization of note discount/warrants ......................... -- -- 189 Gain on sale of property, plant and equipment .................. -- -- (1,042) Amortization of deferred compensation .......................... -- -- 217 Deferred income taxes .......................................... (5,614) 11,709 (162) Changes in assets and liabilities: Receivables .................................................... (759) (12,359) 14,937 Inventories .................................................... (5,844) (8,775) 23,423 Prepaid expenses and other current assets ...................... 10,859 114 30 Accounts payable and accrued expenses .......................... 16,889 (8,751) (7,443) Income taxes payable ........................................... 1,612 (2,929) 2,383 Other long-term assets and liabilities ......................... 3,009 (2,620) (10,347) ----------- ----------- ----------- Net cash (required for) provided from operating activities .. (8,016) (48,107) 558 ----------- ----------- ----------- Cash flows from investing activities: Proceeds from disposal of assets ............................... 5,101 -- 1,169 Additions to property, plant and equipment ..................... (5,305) (5,909) (4,787) ----------- ----------- ----------- Net cash used by investing activities ........................ (204) (5,909) (3,618) ----------- ----------- ----------- Cash flows from financing activities: Net proceeds from exercise of stock options .................... 2,385 512 11 Net proceeds from (payment of) short-term debt ................. 231 (3,236) 169 Net proceeds from (repayment of) old credit facility ........... 8,261 (117,765) -- Net proceeds from (repayment of) new credit facility ........... -- 96,844 (23,011) Net proceeds from issuance of senior secured notes ............. -- -- 24,000 Net proceeds from bond issue ................................... -- 76,400 -- ----------- ----------- ----------- Net cash provided by financing activities .................... 10,877 52,755 1,169 ----------- ----------- ----------- Effect of foreign currency rate fluctuations on cash and cash equivalents ....................................................... 513 1,091 (573) ----------- ----------- ----------- Net increase (decrease) in cash and cash equivalents .............. 3,170 (170) (2,464) Cash and cash equivalents at beginning of period .................. 2,738 5,908 5,738 ----------- ----------- ----------- Cash and cash equivalents at end of period ........................ $ 5,908 $ 5,738 $ 3,274 =========== =========== =========== Supplemental Disclosures: Cash payments for (refunds of) income taxes, net ............... $ (10,150) $ 3,719 $ 1,803 =========== =========== =========== Cash payments for interest ..................................... $ 13,283 $ 16,663 $ 17,083 =========== =========== ===========
See accompanying notes to consolidated financial statements. F-5 CONVERSE INC. AND SUBSIDIARIES CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY AND COMPREHENSIVE INCOME (Dollars in thousands, except per share amounts)
Total Accumulated Stockholders' Retained Other Additional Equity Comprehensive Earnings Comprehensive Common Paid-in Unearned (Deficiency) Income (Loss) (Deficit) Income Stock Capital Compensation ------------ ------------- --------- ------ ----- ------- ------------ Balance, December 30, 1995 ............ $(22,685) $(41,830) $ (1,075) $ 16,692 $ 3,528 $ -- Comprehensive income (loss) Net loss ............................ (18,435) $ (18,435) (18,435) Other comprehensive income (loss), net of tax ........................ Foreign currency translation adjustments ..................... (133) (133) (133) ---------- Comprehensive income (loss) ........... (18,568) ========== Exercise of common stock options ...... 2,385 521 1,864 -------- --------- ------- --------- --------- ----------- Balance, December 28, 1996 ............ (38,868) (60,265) (1,208) 17,213 5,392 -- Comprehensive income (loss) ........... Net loss ............................ (5,049) (5,049) (5,049) Other comprehensive income (loss), net of tax ........................ Foreign currency translation adjustments ................... (1,049) (1,049) (1,049) ---------- Comprehensive income (loss) ........... (6,098) ========== Exercise of common stock options ...... 512 105 407 Cancellation of common stock warrants (Note 3) ............................ (3,528) (3,528) -------- --------- ------- --------- --------- ----------- Balance, January 3, 1998 .............. (47,982) (65,314) (2,257) 17,318 2,271 -- Comprehensive income (loss) ........... Net loss ............................ (22,815) (22,815) (22,815) Other comprehensive income (loss), net of tax ........................ Foreign currency translation adjustments ................... 819 819 819 ---------- Comprehensive income (loss) ........... $ (21,996) ========== Exercise of common stock options ...... 11 2 9 Issuance of common stock warrants (Note 8) .......................... 440 440 Issuance of restricted stock (Note 12) -- 975 (975) Amortization of unearned compensation . 217 217 --------- --------- --------- --------- --------- ----------- Balance, January 2, 1999 .............. $(69,310) $(88,129) $ (1,438) $ 17,320 $ 3,695 $ (758) ========= ========= ========= ========= ========= ===========
See accompanying notes to consolidated financial statements. F-6 CONVERSE INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Dollars in thousands, except per share amounts) 1. Summary of Business Operations Converse Inc. ("Converse" or the "Company") is a leading global designer, manufacturer and marketer of high quality athletic footwear for men, women and children. The Company is also a global licensor of sports apparel, accessories and selected footwear. Converse's principal markets are the United States, Europe and the Pacific Rim. Distribution Prior to November 17, 1994, Converse was a wholly-owned subsidiary of Furniture Brands International, Inc. ("Furniture Brands"), which until March 1, 1996 was named INTERCO INCORPORATED. On November 17, 1994, Furniture Brands distributed to the holders of Furniture Brands common stock all outstanding shares of common stock of Converse (the "Distribution"). 2. Significant Accounting Policies The major accounting policies of Converse are set forth below. Fiscal year Converse's fiscal year end is the Saturday closest to December 31 in each year. For 1998, Converse's fiscal year ended on January 2, 1999 ("Fiscal 1998"), for 1997, Converse's fiscal year ended on January 3, 1998 ("Fiscal 1997") and for 1996, Converse's fiscal year ended on December 28, 1996 ("Fiscal 1996"). Fiscal Years 1998 and 1996 include 52 weeks whereas Fiscal Year 1997 includes 53 weeks. Basis of consolidation The consolidated financial statements include the accounts of Converse and its subsidiaries. All material intercompany transactions are eliminated in consolidation. Management estimates The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. Cash and cash equivalents Converse considers all short-term investments with an original maturity of three months or less to be cash equivalents. Fair value of financial instruments The carrying amount of cash, cash equivalents, trade receivables and trade payables approximates their fair value because of the short maturity of these financial instruments. Except for the Convertible Notes (See Note 8) at January 2, 1999, the carrying amount of the Company's long-term instruments approximates fair value, which is estimated based on market values for similar instruments. At January 2, 1999, the fair value of the $74.3 million Convertible Notes was $24.6 million, as estimated using quoted market prices. F-7 Inventories Inventories are stated at the lower of cost (first-in, first-out) or market. Property, plant and equipment Property, plant and equipment are recorded at cost when acquired. Expenditures for improvements are capitalized while normal repairs and maintenance are expensed as incurred. When properties are disposed of, the related cost and accumulated depreciation or amortization are removed from the accounts, and gains or losses on the dispositions are reflected in results of operations. For financial reporting purposes, Converse utilizes the straight-line method of computing depreciation and amortization while accelerated methods are used for tax purposes. Such expense is computed based on the estimated useful lives of the respective assets. Current assets in excess of reorganization value In 1992, in connection with a reorganization under the bankruptcy code, Furniture Brands and its domestic subsidiaries, including Converse, were required to adopt "fresh-start" reporting. As a result of adopting "fresh-start" reporting, Converse recorded current assets in excess of reorganization value of approximately $41,553. This deferred credit is being amortized on a straight-line basis over a 20 year period. Foreign currency transactions Assets and liabilities of international operations are translated into U.S. dollars at current exchange rates. Income and expense accounts are translated into U.S. dollars at average rates of exchange prevailing during the period. Adjustments resulting from the translation of foreign functional currency financial statements into U.S. dollars are recorded in a separate component of stockholders' equity. Other foreign currency transaction gains and losses are included in the determination of net income. During Fiscal 1998, the Company used foreign exchange forward contracts and foreign currency options to protect the Company from the effects of changes in foreign exchange rates on the statement of operations. These instruments do not qualify for hedge accounting. Option premiums are amortized over the respective life of the instrument. Accordingly, as of January 2, 1999, unamortized currency option premiums recorded on the consolidated balance sheet of the Company were $225. During the year ended January 2, 1999, the Company recorded amortization expense of $673 with respect to the currency options. At January 2, 1999, the Company had open "out of the money" currency options totaling $26,100 and open foreign exchange forward contracts totaling $21,300 with a maximum remaining term to maturity of less than one year. The Company recorded unrealized losses totaling $111 on these open forward contracts for the year ended January 2, 1999. The Company recorded realized gains of $128 and $124 on exercised currency options and closed forward contracts, respectively, during the year ended January 2, 1999. Revenue recognition Revenue from the sale of product is recognized at the time of shipment. Royalty income is recognized by Converse when all events have occurred to establish the royalty amount payable to the Company (typically, when sales are made by the licensees to retail distribution in their respective territories or, in the case of certain footwear license agreements whereby royalties are payable based upon factory cost, when shipment is made from the manufacturer to the licensee). Advertising Advertising production costs are expensed the first time an advertisement is run. Media placement costs are expensed the first time the advertising appears. F-8 Endorsement contracts Accounting for endorsement contracts is based upon specific contract provisions. Generally, endorsement payments are expensed uniformly over the term of the contract after giving recognition to periodic performance compliance provisions of the contracts. Earnings per share In February 1997, Statement of Financial Accounting Standards No. 128, "Earnings per Share" ("SFAS No. 128") was issued which supersedes the old methodology for calculation of earnings per share, as promulgated under Accounting Principles Board Opinion No. 15. SFAS No. 128 requires presentation of "basic" earnings per share (which excludes dilution as a result of unexercised stock options and convertible subordinated debentures) and "diluted" earnings per share. The Statement was adopted in Fiscal 1997, and all prior periods were retroactively restated. For the fiscal years ended, December 28, 1996, January 3, 1998 and January 2, 1999 basic and diluted earnings per share are the same. Concentration of risk Converse purchases dyed canvas raw material primarily from two dye houses. A change in dye houses could cause a delay in manufacturing; however, management does not expect such a change to impact long-term supply due to the existence of alternative suppliers. Financial instruments which potentially expose the Company to concentration of credit risk include trade accounts receivable and foreign currency options and forward contracts. Concentration of credit risk with respect to trade accounts receivable is limited due to the large number of customers and their international dispersion. In addition, the Company maintains reserves for potential credit losses, and such losses, in the aggregate, have not exceeded management expectations. Concentration of credit risk with respect to foreign currency options and forward contracts is limited because the Company maintains these financial instruments with various major financial institutions. The Company performs periodic evaluations of the relative credit standing of these financial institutions and limits the amount of credit exposure with any institution. Reclassifications Certain amounts in the prior year financial statements and related notes have been reclassified to conform with the Fiscal 1998 presentation. 3. Investment in Unconsolidated Subsidiary On May 18, 1995, Converse consummated the acquisition of Apex One, Inc. ("Apex"). Under the terms of the Securities Purchase Agreement, the total consideration paid by Converse to the sellers in exchange for 100% of the outstanding common stock consisted of: (i) subordinated promissory notes in the aggregate principal amount of $11,000 discounted to $9,644 at a rate of 12%; and (ii) warrants, expiring May 18, 2000, to purchase 1,750,000 shares of Converse common stock at an exercise price of $11.40 with an aggregate value of $3,528 at the date of the acquisition. Subsequent to the acquisition of Apex, Converse, through its integration of Apex's information systems and in-depth review of Apex operating procedures and financial condition, determined that the operating losses of Apex and its weak financial position could not be corrected without additional significant investment or financing. On August 11, 1995, Converse's Board of Directors voted to cease funding Apex's operations as of that date. As a result of this decision, Apex ceased operations and was unable to meet its obligations and on September 14, 1995 filed for Chapter 11 bankruptcy protection. Because Converse's control of Apex was temporary in nature, its investment in Apex was recorded as an unconsolidated equity investment. During 1995, Converse recorded a loss of $52,160 on this unconsolidated subsidiary, comprised primarily of: (i) the Company's initial investment in Apex; (ii) additional funding advances; (iii) contractual obligations, bank guarantees, professional fees and other closing costs; and (iv) loss on the sale of Apex inventory purchased by Converse for sale to independent third parties. F-9 During 1996, the Company recorded a $1,362 credit on investment in unconsolidated subsidiary which was comprised of: (i) an additional loss of $515 relating to unanticipated credits issued to customers to settle claims of discrepancies on shipments of the Apex inventory; and (ii) a credit of $1,877 relating to the Company's entering into agreements with two of the former owners of Apex to settle certain obligations for less than originally anticipated, resulting in an adjustment of the accrual recorded in 1995 for the loss on investment in unconsolidated subsidiary. In the first quarter of 1997, the Company prevailed in a breach of warranty lawsuit brought against several former owners of Apex. Subsequently, the Company entered into settlement agreements with substantially all of the former owners of Apex. As a result of these settlements in the first quarter, the Company recorded a credit on investment in unconsolidated subsidiary of $13,051. In the fourth quarter of 1997, the Company recorded a loss on investment in unconsolidated subsidiary of $514 relating to the settlement of outstanding litigation with the one remaining former Apex owner and final settlement of a vendor suit against the Company. The net activity for Fiscal 1997 was a credit on investment in unconsolidated subsidiary of $12,537. At January 3, 1998, there were no remaining claims by or against the Company relating to its 1995 acquisition of Apex, and one former owner of Apex continues to hold subordinated notes issued by Converse in the amount of $774. This amount is included within accrued expenses in the accompanying consolidated balance sheet. 4. Restructuring Charges During 1995, Converse recorded restructuring charges of $14,182 relating primarily to initiatives aimed at reducing future operating costs. Principal costs included in the charge were: (i) contract termination costs relating to licensed apparel and certain marketing activities; (ii) estimated losses on the sale or disposal of assets, including a writedown for the proposed sale of a warehouse facility in Chester, South Carolina; (iii) costs for employee severance and related benefits for the termination of 140 employees; and (iv) lease termination costs relating to the shutdown of the manufacturing facility in Mission, Texas and a distribution facility in the United Kingdom. During the second quarter of 1996, the Company sold the warehouse facility in Chester, South Carolina. Proceeds from this sale exceeded the Company's estimate, resulting in a reversal of $2,209 of restructuring reserves. During the third quarter of 1996, certain contracts were terminated on terms more advantageous than originally anticipated resulting in a reversal of $1,000 of restructuring accruals. In addition, while implementing its fourth quarter 1995 restructuring plans, the Company incurred additional severance charges of $1,000 and $356 in the third and fourth quarters of 1996, respectively, and additional asset write-offs of $676 during the fourth quarter of 1996. Such additional charges were in excess of previously estimated amounts. During the first quarter of 1997, the Company re-opened the manufacturing facility located in Mission, Texas for cutting and limited production due to an unexpected increase in demand for athletic originals products. Accordingly, the remaining lease termination restructuring reserve of $563 was reversed into income. During the fourth quarter of 1997, the Company recorded a restructuring charge of $2,100. The costs included in the charge were primarily: (i) employee severance and related benefits of $1,192 for the termination of 35 employees; (ii) costs of $464 related to the closing of three unprofitable retail stores; and (iii) termination costs of $444 related to marketing endorser contracts. During 1998 all remaining restructuring liabilities were paid out. At January 2, 1999, there were no remaining restructuring liabilities. 5. Inventories Inventories are summarized as follows:
January 3, 1998 January 2, 1999 --------------- --------------- Retail merchandise...................... $ 5,245 $ 4,535 Finished products....................... 81,311 57,365 Work-in-process......................... 4,560 5,009 Raw materials........................... 3,565 4,383 -------- -------- $ 94,681 $ 71,292 ======== ========
F-10 6. Property, Plant and Equipment Property, plant and equipment consisted of the following:
Estimated Useful Life (Years) January 3, 1998 January 2, 1999 ------------ --------------- --------------- Building and leasehold improvements 5 - 10 $ 7,832 $ 8,129 Machinery and equipment............... 3 - 11 12,012 14,139 Furniture and fixtures................ 5 - 8 2,944 3,049 Office and computer equipment......... 7 8,381 10,171 -------- -------- 31,169 35,488 Less accumulated depreciation......... 11,083 14,650 -------- -------- $ 20,086 $ 20,838 ======== ========
7. Accrued Expenses Accrued expenses consisted of the following:
January 3, 1998 January 2, 1999 --------------- --------------- Employee compensation............................ $ 3,325 $ 2,944 Advertising and promotion........................ 2,520 1,730 Accrued interest................................. 1,155 1,410 Restructuring charges............................ 2,438 -- Other ........................................... 4,841 4,777 -------- -------- $14,279 $10,861 ======== ========
8. Debt Debt consisted of the following:
January 3, 1998 January 2, 1999 --------------- --------------- Current: Short-term debt................................. $ 9,036 $ 9,557 Credit facility................................. $96,844 $73,833 Long-Term: Senior secured notes (net of unamortized bond discount)....................................... -- $27,534 Convertible subordinated notes.................. $80,000 $74,265
Short-term debt Converse maintains asset based financing arrangements in certain European countries with various lenders. In general, these financing arrangements allow the Company to borrow against varying percentages of eligible customer receivable balances based on pre-established credit lines, along with varying percentages of inventory, as defined. Interest is payable at the respective lender's base rate plus 1.5% (varying by country from 4.5% to 8.0% at January 2, 1999). The obligations are secured by a first priority lien on the respective European assets being financed. In addition, Converse has provided guarantees of these borrowings in certain of the European countries. F-11 Credit facility Simultaneously with the issuance of the $80,000 principal amount of Convertible Subordinated Notes (the "Convertible Notes") in May 1997 (see below), the Company entered into a new $150,000 secured credit agreement (the "Credit Facility") with BT Commercial Corporation ("BTCC") for revolving loans, letters of credit, foreign exchange contracts and banker acceptances and repaid the indebtedness under the Company's then existing credit agreement (the "Old Credit Facility"). In July 1997, BTCC, as agent, syndicated the Credit Facility to a group of participating lenders (the "Banks"). In September 1998, the Credit Facility was amended to decrease the commitment from $150,000 to $120,000 in conjunction with the issuance of the Secured Notes (see below). The amount of credit available to the Company at any time is limited by a borrowing base formula, as defined in the Credit Facility, consisting primarily of U.S. and Canadian accounts receivable and inventory (the "Borrowing Base"). The aggregate of letters of credit, foreign exchange contracts and banker acceptances may not exceed $80,000 at any time; revolving loans are limited only by the Credit Facility's maximum availability less any amounts outstanding for letters of credit, foreign exchange contracts or banker acceptances. The Credit Facility is for a five-year term and, accordingly, has an expiration date of May 21, 2002. However, the total revolving loans and banker acceptances outstanding under the Credit Facility of $73,833 are classified as current due to the Company's lockbox arrangement (whereby payments by the Company's customers are deposited in a lockbox controlled by the Banks) and certain clauses contained in the Credit Facility regarding mandatory repayment that involve subjective judgments by the Banks. This classification is required by Emerging Issues Task Force 95-22, "Balance Sheet Classification of Borrowings Outstanding under a Revolving Credit Agreement that Includes both a Subjective Acceleration Clause and a Lockbox Arrangement." As of January 2, 1999, the Borrowing Base was $80,440. Utilization under the Credit Facility at year end amounted to $76,097 consisting of revolving loans of $72,386, banker acceptances of $1,447 and outstanding letters of credit of $2,264. Accordingly, $4,343 of the maximum available Borrowing Base remained unutilized as of January 2, 1999. Revolving loans under the Credit Facility bear interest either at the Prime Lending Rate (as defined therein) plus one percent (1.00%) per annum or at the Adjusted LIBOR Rate (as defined therein) plus a margin of two and one-half percent (2.50%) per annum. The foregoing LIBOR margin is subject to reduction based upon the Company achieving certain interest coverage ratios specified in the Credit Facility. At January 2, 1999, revolving loans outstanding under the Credit Facility bore interest of 7.79% based upon the weighted average of the Prime Lending Rate and Adjusted LIBOR Rate. Obligations outstanding under the Credit Facility are secured by first priority liens on substantially all of the Company's U.S. and Canadian assets. The Credit Facility requires compliance with customary affirmative and negative covenants, including certain financial covenants. In September 1998, the Company's Credit Facility was amended to permit the issuance of the Secured Notes as discussed below. The amendment decreased the commitment under the Credit Facility from $150,000 to $120,000, increased the annual collateral management fee from $100 to $125 and changed a financial performance covenant contained therein. As of January 2, 1999, the Company was in compliance with its financial covenants and believes that it will remain in compliance during 1999. The Credit Facility provides for customary ongoing fees including an unused line fee of .50% per annum on the unutilized portion of the credit commitment and fees with respect to documentary or stand-by letters of credit varying from 1.25% to 2.25% per annum on the outstanding face amount of the respective credit. The Company is obligated to pay BTCC, as agent for the Credit Facility, an annual collateral management fee of $125. In May 1997, the Company paid a funding fee with respect to the Credit Facility of 2% of the total commitment, or $3,000, to BTCC. In September 1998, a fee of $150 was paid to the Banks with respect to the above-referenced amendment. The Company has capitalized these fees (adjusted for a write-off to extraordinary loss of $442 in the funding fee when the commitment was reduced from $150,000 to $120,000 in September 1998) and is amortizing these costs over the term of the Credit Facility. Accordingly, unamortized financing fees relating to the Credit Facility, recorded in other assets on the consolidated balance sheet of the Company, were $1,765 at January 2, 1999. Any unamortized costs relating to an amendment fee of $150 incurred in November 1997 and a waiver fee of $100 incurred in May 1998, originally capitalized, were written off to extraordinary loss in September 1998. F-12 Senior secured notes In September 1998, the Company issued $28,643 aggregate principal amount of 15% Senior Secured Notes (the "Secured Notes") due September 16, 2000 (the "Initial Maturity Date"). Interest on the Secured Notes is payable quarterly in arrears. The Initial Maturity Date may be extended an additional 12 months at the Company's option upon written notification of its election to extend and payment of a fee equal to 3% of the then outstanding principal amount of the Secured Notes (the "First Extended Maturity Date"). The First Extended Maturity Date may be extended to May 21, 2002 at the Company's option upon written notification of its election to extend and payment of an additional fee equal to 3% of the then outstanding principal amount of the Secured Notes. The Secured Notes were issued in two series: Series A in the aggregate principal amount of $24,858 (the "Series A Secured Notes") and Series B in the aggregate principal amount of $3,785 (the "Series B Secured Notes"). The Secured Notes are redeemable at any time at face amount plus accrued interest. The Secured Notes require compliance with customary affirmative and negative covenants, including certain financial covenants, substantially the same as the requirements contained in the Credit Facility. Upon issuance of the Series A Secured Notes the Company received gross proceeds of $24,000 after discount from the face amount of $858. The Company is amortizing this discount over 24 months to the Initial Maturity Date. Accordingly, the unamortized note discount was $733 on January 2, 1999. In connection with the issuance of the Series A Secured Notes, the Company issued warrants to purchase 360,000 shares of the Company's common stock to the purchasers and paid funding fees to certain purchasers amounting to $350. The warrants were valued at $1.22 per share, vest immediately and expire on March 16, 2003. The total warrant valuation, $440, is considered additional bond discount and is being amortized over a 24 month period to the Initial Maturity Date. As of January 2, 1999, the unamortized warrant cost was $376. The Company paid a placement fee of 4% of the gross proceeds, or $960, with respect to the Series A Secured Notes. The Series A Secured Notes carry a second priority perfected lien on all real and personal, tangible and intangible assets of the Company. The Series B Secured Notes were issued in exchange for the surrender of $5,735 face amount of Convertible Notes (see below), which were subsequently cancelled by the Company. In connection with the issuance of the Series B Secured Notes, the Company paid a placement fee of 2% of the face amount, or $76. The Series B Secured Notes carry a third priority perfected lien on all real and personal, tangible and intangible assets of the Company. The Company has capitalized the fees and expenses associated with the issuance of the Secured Notes and is amortizing these costs over a 24 month period to the Initial Maturity Date. Accordingly, total unamortized financing fees and expenses relating to the Secured Notes, recorded in other assets on the consolidated balance sheet of the Company, were $1,419 at January 2, 1999. Convertible subordinated notes On May 21, 1997, the Company completed the sale of $80,000 of Convertible Notes due June 1, 2004. As discussed above, in September 1998 the Company received, and subsequently cancelled, $5,735 of Convertible Notes in exchange for the issuance of the Series B Secured Notes. The Convertible Notes are subordinated to all existing and future Senior Indebtedness (as defined therein). The Convertible Notes are convertible at any time prior to maturity, unless previously redeemed into common stock of the Company, at the option of the holder, at a conversion price of $21.83 per share, subject to adjustment in certain events. In addition, the Convertible Notes may be redeemed, in whole or in part, at the option of the Company, at any time on or after June 5, 2000 at the redemption prices set forth therein plus accrued interest to the date of redemption. Interest is payable semi-annually on June 1 and December 1, commencing on December 1, 1997. The Company capitalized deferred note issuance costs of $3,673 in conjunction with the issuance of the Convertible Notes. These deferred costs are being amortized over the seven year life of the Convertible Notes. Unamortized bond issue fees of $151 with respect to the Convertible Notes exchanged in September 1998 were written off as an extraordinary loss in 1998. Accordingly, unamortized convertible note issuance costs, recorded as other assets on the consolidated balance sheet of the Company, were $2,685 at January 2, 1999. F-13 Subordinated notes (Apex) On May 18, 1995, in conjunction with Converse's acquisition of 100% of the outstanding common stock of Apex (see Note 3), Converse issued subordinated notes in the face amount of $11,000, discounted at a rate of 12%, to $9,644. During Fiscal 1997 substantially all of these notes were returned to Converse in connection with the settlement of the Apex litigation. The Company had accrued $1,354 of interest expense related to these notes which was included as restricted cash on the December 28, 1996 balance sheet. In connection with the settlement of the subordinated notes, this interest expense was reversed in Fiscal 1997. Total interest expense consisted of the following:
Fiscal Year Ended ---------------------------------------------------- December 28, 1996 January 3, 1998 January 2, 1999 ----------------- --------------- --------------- Interest on short-term debt, Credit Facility and Old Credit Facility. $ 11,368 $ 9,777 $ 7,829 Interest on Convertible Notes ..... -- 3,508 5,346 Interest on subordinated notes .... 880 (1,354) -- Amortization of Convertible Notes issuance costs .................. -- 320 668 Credit line fees .................. 1,518 1,819 1,380 Amortization of Old Credit Facility financing fees .. 1,767 694 -- Old Credit Facility amendment and other fees .................. 2,243 240 -- Amortization of Credit Facility financing fees .................. -- 370 604 Amortization of Secured Notes issuance costs .................. -- -- 421 Interest on Secured Notes ......... -- -- 1,277 -------- -------- -------- $ 17,776 $ 15,374 $ 17,525 ======== ======== ========
9. Extraordinary (Gain) Loss In May 1997, the Company entered into the Credit Facility and repaid the Old Credit Facility. In connection with the repayment of the Old Credit Facility, the Company wrote-off deferred financing fees of $1,320 in the second quarter of Fiscal 1997. This write-off is presented as an extraordinary loss of $744, net of income tax benefit of $576, on the statement of operations. During the third quarter of Fiscal 1998, the Company reported an extraordinary gain of $704, net of tax of $437. The extraordinary gain related to the issuance of Series B Secured Notes of $3,785 in exchange for the surrender of $5,735 face amount of Convertible Notes which were subsequently cancelled, net of financing fees of $809 which were written off. 10. Income Taxes The domestic and foreign components of income (loss) from continuing operations before income taxes were as follows:
Fiscal Year Ended ------------------------------------------------------- December 28, 1996 January 3, 1998 January 2, 1999 ----------------- --------------- --------------- Domestic............. $(17,967) $ 29,730 $ (4,040) Foreign.............. (4,602) (20,881) (15,907) -------- -------- -------- $(22,569) $ 8,849 $(19,947) ======== ======== ========
F-14 Income tax expense (benefit) related to continuing operations was comprised of the following:
Fiscal Year Ended ----------------------------------------------------- December 28, 1996 January 3, 1998 January 2, 1999 ----------------- --------------- --------------- Current: Federal............. $(3,617) $ -- $ -- State............... 299 362 501 Foreign............. 3,571 2,336 2,848 ------- ------- ------- 253 2,698 3,349 ------- ------- ------- Deferred: Federal............. (3,906) 8,574 281 State............... (481) 1,882 (58) ------- ------- ------- (4,387) 10,456 223 ------- ------- ------- $(4,134) $13,154 $ 3,572 ======= ======= =======
The following table reconciles the differences between the Federal corporate statutory rate and Converse's effective income tax rate:
Fiscal Year Ended ----------------------------------------------------- December 28, 1996 January 3, 1998 January 2, 1999 ----------------- --------------- --------------- Federal corporate statutory tax rate (benefit) . (35.0)% 35.0% (35.0)% State taxes (benefit), net of Federal tax effect (2.9) 13.9 (0.9) Foreign income taxes ........................... 10.1 -- 8.5 Valuation allowance ............................ 12.7 105.0 47.2 Other .......................................... (3.2) (5.3) (1.9) -------------- -------------- ------------ Effective income tax (benefit) rate ............ (18.3)% 148.6% 17.9% ============== ============== ============
Deferred income taxes reflect the effect of temporary differences between the tax basis of assets and liabilities and the reported amounts of assets and liabilities for financial reporting purposes net of any valuation allowance. Converse's deferred tax assets and liabilities at January 3, 1998 and January 2, 1999, consisted of the following:
January 3, 1998 January 2, 1999 --------------- --------------- Deferred tax assets: Tax benefit of loss carryforwards......................... $ 36,526 $ 53,236 Fair value adjustments.................................... 3,234 2,574 Employee postretirement benefits other than pensions...... 4,012 -- Expense accruals.......................................... 1,539 2,132 Receivable, inventory and other reserves.................. 2,660 2,262 Depreciation.............................................. 1,604 714 -------- -------- Gross deferred tax assets............................. 49,575 60,918 Deferred tax liabilities: Employee pension plans.................................... (627) (1,272) Other..................................................... (4,739) (5,527) -------- -------- Net deferred tax assets before valuation allowance.... 44,209 54,119 Valuation allowance....................................... (20,877) (30,756) -------- -------- Net deferred tax assets............................... $ 23,332 $ 23,363 ======== ========
F-15 The net deferred tax assets are included in the consolidated balance sheet as follows: January 3, 1998 January 2, 1999 --------------- --------------- Prepaid expenses and other current assets.... $ 2,063 $ 1,142 Other assets................................. 21,269 22,221 ------- ------- $23,332 $23,363 ======= ======= Statement of Financial Accounting Standards No. 109, "Accounting for Income Taxes," requires that a valuation allowance be recorded against deferred tax assets for which there is a greater than fifty percent chance that the tax assets will not be realized. Although the period to use these deferred tax assets is 11 to 20 years for tax purposes, the accounting guidance requires that a shorter time frame be used to assess the probability of their realization. Converse believes its deferred tax assets will be realized; however, as a result of the uncertainty caused by the industry downturn which began in the second half of Fiscal 1997 and the related oversupply of inventory in the marketplace during the fourth quarter of Fiscal 1997, the Company increased its deferred tax valuation allowance by $9,292 to a total of $20,977 at January 3, 1998. During Fiscal 1998, the industry downturn continued. The Company assessed the realizability of its deferred tax assets each quarter. In assessing the realizability of the deferred tax assets, Converse has based its quarterly judgments on estimated future earnings and the adoption of various business and tax planning strategies. These tax planning strategies include the sale and conversion of unprofitable foreign operations and anticipated enhancement of the Company's financial structure. Converse continues to believe its deferred tax assets will be realized. However, given the accounting guidance referred to above and current industry conditions, the Company established additional valuation allowances totaling $9,879 representing approximately the tax benefit of the Fiscal 1998 quarterly losses. At January 2, 1999, Converse had operating loss carryforwards of $134,038. The loss carryforwards expire between the years 2009 and 2018. 11. Employee Benefits Converse sponsors or contributes to retirement plans covering substantially all domestic employees. Converse has a defined benefit pension plan in addition to other retirement plans and benefits. The annual cost for the defined benefit plan is determined using the projected unit credit actuarial cost method which includes significant actuarial assumptions and estimates which are subject to change in the near term. Prior service cost is amortized on a straight-line basis over the average remaining service period of employees expected to receive benefits. In certain foreign countries, contributions are made to defined contribution plans as well as to government sponsored plans, as required in the respective jurisdictions. Liabilities and expenses related to these foreign employees are not material. Defined benefit pension plan Converse has a non-contributory defined benefit pension plan covering substantially all salaried employees at its domestic operations. Retirement benefits generally are based on years of service and final average compensation with employees becoming vested upon completion of five years of service. The plan is funded by company contributions to trust funds which are held for the sole benefit of the employees. It is Converse's practice to fund pension costs to the extent that such costs are tax deductible and in accordance with ERISA. The assets of the plan are primarily comprised of equity securities and fixed income investments. In Fiscal 1998, the net periodic pension costs were subject to a $1,625 curtailment gain resulting from workforce reductions. F-16
December 28, 1996 January 3, 1998 January 2, 1999 ----------------- --------------- --------------- Change in benefit obligation Benefit obligation at beginning of year ...... $ 44,738 $ 46,781 $ 58,553 Service cost ................................. 1,410 1,751 1,718 Interest cost ................................ 3,375 3,769 3,851 Curtailment (gains) .......................... -- -- (1,625) Actuarial loss (gain) ........................ (371) 8,731 440 Benefits paid ................................ (2,371) (2,479) (2,640) -------- -------- -------- Benefit obligation at end of year ............ $ 46,781 $ 58,553 $ 60,297 ======== ======== ======== Change in plan assets Fair value of plan assets at beginning of year $ 44,853 $ 51,122 $ 59,507 Actual return on plan assets ................. 6,365 10,458 8,863 Employer contribution ........................ 2,275 406 -- Benefits paid ................................ (2,371) (2,479) (2,640) -------- -------- -------- Fair value of plan assets at end of year ..... $ 51,122 $ 59,507 $ 65,730 ======== ======== ======== Reconciliation of Funded Status Benefit obligation at end of year ............ $(46,781) $(58,553) $(60,297) Fair value of plan assets as end of year ..... 51,122 59,507 65,730 -------- -------- -------- Funded status at end of year ................. 4,341 954 5,433 Unrecognized prior service cost .............. (82) (75) (62) Unrecognized net actuarial loss (gain) ....... (2,166) 895 (1,889) -------- -------- -------- Prepaid benefit cost ......................... $ 2,093 $ 1,774 $ 3,482 ======== ======== ======== Weighted Average Assumptions Discount rate ................................ 7.50% 7.00% 6.75% Expected return on plan assets ............... 9.50% 9.50% 9.50% Rate of compensation increase ................ 4.50% 4.50% 4.75% Components of Net Periodic Benefit Cost Service cost ................................. $ 1,410 $ 1,751 $ 1,718 Interest cost ................................ 3,375 3,769 3,851 Expected return on plan assets ............... (4,248) (4,788) (5,646) Amortization of prior service costs .......... (7) (7) (6) Curtailment gains ............................ -- -- (1,625) -------- -------- -------- Net periodic benefit cost .................... $ 530 $ 725 $ (1,708) ======== ======== ========
Defined benefit postretirement plan In addition to pension benefits, certain retired employees had previously been provided with specified health care and life insurance benefits. Employees who retired after a certain age with specified years of service were eligible for these benefits if they agreed to contribute a portion of the cost. At December 28, 1996 and January 3, 1998, the Company had an accrued postretirement benefit obligation of $10,231 and $10,422, respectively. Net periodic postretirement benefit cost totaled $221 and $215 for Fiscal 1996 and Fiscal 1997, respectively. Measurement of the Fiscal 1996 accumulated postretirement benefit obligation was based upon a weighted average discount rate of 7.50%, a 15.0% annual rate of increase in the cost of health care benefits and an assumed long-term rate of compensation increase of 4.5%. In Fiscal 1997, the accumulated postretirement benefit obligation was measured based upon a weighted average discount rate of 7.0%, a 9.0% annual rate of increase in the cost of health care benefits and an assumed long-term rate of compensation increase of 4.0%. F-17 In the second quarter of Fiscal 1998, the Company announced its intentions to cease the accrual of benefits to active employees under the plan. Unless the employees were eligible for and elected to retire by December 31, 1998, all vested benefits under the postretirement plan ceased to exist. As a result of this action, the defined benefits for future services of a significant number of plan participants were eliminated and the Company recognized a $3,284 curtailment gain. In the third quarter of Fiscal 1998, the Company notified retired employees that their medical and life benefits would terminate on January 1, 1999 and the employees would receive transition payments based on age and dependents. As a result, the Company settled its obligations under the postretirement plan and recorded a settlement gain of $5,990. The transition payments, totaling $587 will be made in three equal installments over a three-year period beginning January 5, 1999. The accrual for these future payments is included in accrued expenses on the consolidated balance sheet. Other retirement plans and benefits Converse has a non-contributory defined contribution plan covering all hourly employees with at least one year of service at its domestic manufacturing and warehouse facilities. Contributions under this plan are fixed at $0.41 per hour of service with a maximum contribution based on 2,000 hours per employee. The defined contribution expense was $318, $625 and $975 for Fiscal 1996, 1997 and 1998, respectively. Converse also sponsors a savings plan. The total cost of this plan for Fiscal 1996, 1997 and 1998 was $329, $333 and $325, respectively. 12. Stock Option Plans Converse 1994 stock option plan The Board of Directors of Converse adopted the Converse Inc. 1994 Stock Option Plan (the "1994 Plan") as a means to encourage ownership of Converse common stock by key employees and enable Converse to attract and retain the services of outstanding employees in competition with other employers. The 1994 Plan authorizes grants to key employees, including executive officers of Converse and its subsidiaries, and to its consultants, of incentive and non-qualified options to purchase shares of common stock. In 1998, the 1994 Plan was amended by the Company's Board of Directors and Stockholders to permit the granting of restricted stock in addition to stock options. The plan administrator has discretion to grant non-qualified options at less than 100% of the fair market value per share of the common stock of Converse on the date of grant. Converse incentive stock options must be granted with an exercise price of not less than 100% of the fair market value per share of common stock of Converse on the date of grant. Option prices are payable in full and in cash, upon the exercise of a stock option, and the proceeds are added to the general funds of Converse. As of January 2, 1999, the number of shares of common stock which may be issued under the 1994 Plan is 3,300,000 subject to adjustment upon the occurrence of certain contingencies. The maximum number of shares with respect to which options or restricted stock may be granted to any individual during any calendar year and during the term of the 1994 Plan is 500,000 and 750,000, respectively. Options under the 1994 Plan generally expire nine years from the grant date. The 1994 Plan will terminate in October 2004, subject to the right of the Board of Directors to suspend or discontinue the 1994 Plan at any prior date and the rights of holders of options to exercise options after such date in accordance with the terms of such options. F-18 The following table summarizes stock option activity under the 1994 Plan:
Weighted Average Number of Exercise Exercise Price Options Price per Share Per Share ------- --------------- --------- Outstanding at December 30, 1995................... 1,124,000 $5.00 - $23.00 $ 7.71 Granted............................................ 1,221,000 $4.00 - $23.00 7.17 Canceled........................................... (520,200) $5.00 - $23.00 11.71 Exercised.......................................... (246,000) $5.00 - $7.00 5.57 ----------- Outstanding at December 28, 1996................... 1,578,800 $4.00 - $23.00 6.31 Granted............................................ 442,000 $10.94 - $26.88 17.30 Canceled........................................... (127,250) $5.27 - $26.88 9.34 Exercised.......................................... (104,800) $4.00 - $9.40 5.96 ----------- Outstanding at January 3, 1998..................... 1,788,750 $4.00 - $26.88 8.85 Granted............................................ 438,000 $4.75 - $7.50 7.43 Canceled........................................... (468,400) $5.265 - $26.875 14.51 Exercised.......................................... (1,600) $7.00 7.00 ----------- Outstanding at January 2, 1999..................... 1,756,750 $4.00 - $26.875 $ 6.99 =========== ========= Exercisable at January 2, 1999..................... 675,350 =========== Restricted stock outstanding at January 2, 1999.... 200,000 =========== Available for future grants........................ 990,850 ===========
The following table summarizes information about the 1994 Plan stock options outstanding at January 2, 1999:
Options Outstanding Options Exercisable ---------------------------------------------------- --------------------------------------- Weighted Average Number Remaining Number Range of Outstanding at Contractual Life Weighted Average Exercisable at Weighted Average Exercise Prices January 2, 1999 (Years) Exercise Price January 2, 1999 Exercise Price - --------------- --------------- ------- -------------- --------------- -------------- $4.00-$6.00 720,750 6 5.18 320,150 5.20 $6.125-$8.645 848,000 7 7.06 259,200 6.88 $9.00-$13.00 138,000 6 10.88 76,000 10.82 $15.00-$21.00 35,000 7 19.13 15,000 18.53 $23.00-$26.875 15,000 6 25.58 5,000 24.55 ----------- --------- 1,756,750 675,350 =========== =========
On September 5, 1996, Converse repriced certain stock options granted under the 1994 Plan. Options to purchase 105,000 shares of common stock at prices ranging from $5.00 to $23.00 per share were repriced to an exercise price of $6.375 per share, which represented the closing price of Converse's common stock on September 5, 1996. In connection with this repricing, options to purchase 45,000 shares of common stock were canceled. None of the repriced options had vested prior to the repricing date and they did not begin to vest until September 5, 1997. The above option activity table reflects all options at their amended price and vesting terms. On February 25, 1998, Converse repriced certain additional stock options granted under the 1994 Plan. Options to purchase 278,000 shares of common stock were repriced to an exercise price of $7.50 per share, which exceeded the closing price of Converse's common stock on February 25, 1998. The original vesting schedules and expiration dates associated with these stock options remained the same as the original grants. None of the foregoing stock option grants had vested prior to the repricing date. F-19 Converse 1995 non-employee director plan On March 22, 1995, the Board of Directors of Converse adopted the 1995 Non-Employee Director Plan (the "1995 Plan") as a means of fostering and promoting the long-term financial success of Converse by attracting and retaining Non-Employee Directors of outstanding ability. Converse has reserved an aggregate of 45,000 shares for issuance under the 1995 Plan. Options to purchase 22,500 of these shares were granted during 1995 at the fair market value on the date of grant of $9.88. No grants have been made since this time. These stock options become exercisable in equal one-third increments on the anniversaries of the grant date beginning on March 22, 1996 and expire ten years from the date of grant. No such options were exercised since their grant and all options remain outstanding at January 3, 1998. Restricted stock awards In 1998, the Company amended the 1994 Plan to permit the granting of restricted stock. All restricted stock grants are subject to restrictions as to continuous employment. The restricted stock vests 100% on the third anniversary of the grant date. As there is no exercise payment associated with the restricted stock awards, the cost of the awards, determined as the fair market value of the shares on the date of grant, is charged to expense ratably over the three year vesting period. In 1998, 200,000 shares of restricted stock were granted in 1998, resulting in $975 of unearned compensation, of which $217 was amortized in Fiscal 1998. Employee stock purchase plan The Company adopted an Employee Stock Purchase Plan (the "ESPP") in 1998. The company reserved 500,000 shares of common stock for issuance under the ESPP. Eligible employees may invest up to $10 per year through payroll deductions. The purchase price of the shares is equal to 85% of the lower of the fair market value of the stock as of the first or last trading day of each purchase period. The first purchase period began on October 1, 1998 and runs through February 28, 1999. Thereafter, each purchase period will run for six months. There were no shares issued under the ESPP during 1998. Stock-based compensation The Company accounts for stock-based compensation using the method prescribed in Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees." Accordingly, no compensation cost has been recognized for the Company's stock option plans. The Company has adopted the disclosure-only provisions Statement of Financial Accounting Standards No. 123 "Accounting for Stock-Based Compensation" ("SFAS 123"). Had compensation cost been determined based on the fair value at the grant dates for awards in 1996, 1997, and 1998 consistent with the provisions of SFAS 123, the Company's net loss and loss per share would have been increased to the pro forma amounts indicated below:
Fiscal Year Ended ----------------------------------------------------------------------- December 28, 1996 January 3, 1998 January 2, 1999 ----------------- --------------- --------------- Net loss - as reported................... $(18,435) $(5,049) $(22,815) Net loss - pro forma..................... (19,559) (7,041) (24,493) Basic and diluted loss per share as reported............................ (1.10) (0.29) (1.32) Basic and diluted loss per share pro forma.............................. (1.17) (0.41) (1.41)
F-20 The fair value of options granted at date of grant was estimated using the Black-Scholes model with the following weighted average assumptions:
Fiscal Year Ended ----------------------------------------------------------- December 28, 1996 January 3, 1998 January 2, 1999 ----------------- --------------- --------------- Expected life (years)........ 6.0 6.0 6.0 Interest rate................ 6.27% 6.18% 5.12% Volatility................... 65.00% 67.00% 59.44% Dividend yield............... -- -- --
The weighted average grant date fair value of options granted during Fiscal 1996, Fiscal 1997 and Fiscal 1998 was $3.37, $12.20 and $3.07, respectively. The pro forma net income and earnings per share amounts reflected above do not include a tax benefit for Fiscal 1996, 1997 or 1998 as a full valuation allowance would have been provided against any such benefit. The pro forma effect on net income for Fiscal 1996, Fiscal 1997 and Fiscal 1998 is not necessarily indicative of future amounts as it does not take into consideration pro forma compensation expense related to grants made prior to 1995 as SFAS 123 does not apply to awards prior to 1995. 13. Lease Commitments Substantially all of Converse's retail outlets and certain other real properties and equipment are operated under lease agreements expiring at various dates through the year 2012. Leases covering retail outlets and equipment generally require, in addition to stated minimums, contingent rentals based on retail sales and equipment usage. Generally, the leases provide for renewal for various periods at stipulated rates. Rental expense under operating leases was as follows:
Fiscal Year Ended ------------------------------------------------------ December 28, 1996 January 3, 1998 January 2, 1999 ----------------- --------------- --------------- Minimum rentals..................... $4,244 $4,713 $4,510 Contingent rentals.................. 825 1,588 1,763 ------ ------ ------ $5,069 $6,301 $6,273 ====== ====== ======
Future minimum lease payments under operating leases are $4,870, $3,655, $2,823, $2,085 and $4,112 for 1999 through 2003 and thereafter, respectively. 14. Commitments and Contingencies Converse is or may become a defendant in a number of pending or threatened legal proceedings in the ordinary course of its business. Converse believes the ultimate outcome of any such proceedings will not have a material adverse effect on its financial position or results of operations. 15. Related Party Transactions In connection with the Distribution, Converse and Furniture Brands entered into a Tax Sharing Agreement (the "Agreement") providing, among other things, for an equal allocation between Furniture Brands and Converse of benefits derived from a carryback of federal and state tax liabilities to periods prior to completion of the Distribution. On February 21, 1996, Converse amended this Tax Sharing Agreement with Furniture Brands, under which Converse agreed to carryback certain federal income tax operating losses for the years ended December 30, 1995 and December 28, 1996 to one or more Pre-Distribution tax periods. For the year ended December 30, 1995, the amendment applied to the F-21 first $41,000 of tax operating losses generated, which approximated the taxable income available in the carryback period. For the year ended December 30, 1995, tax operating losses of approximately $31,000 were carried back generating a tax refund of $10,832. In accordance with the Agreement, as amended, Furniture Brands paid Converse $8,000 on February 29, 1996 and in return Furniture Brands was entitled to the full amount of the tax refund. Furniture Brands is not entitled to any refund of the $8,000 payment in the event the ultimate tax refund it receives from the Internal Revenue Service is less than anticipated. In accordance with the agreement, Furniture Brands was also entitled to tax refunds resulting from the carryback of approximately $10,000 of the Company's Fiscal 1996 tax operating losses. The $2,832 excess of the Fiscal 1995 tax refund over Furniture Brands' payment to Converse and the $3,616 tax refund associated with the aforementioned $10,000 of 1996 tax operating losses of Converse being carried back to Furniture Brands have been recorded by Converse as other expense in Fiscal 1995 and 1996, respectively. In November 1995, Apollo Investment Fund, L.P. ("Apollo"), owner with its affiliates of a majority of the outstanding common stock of the Company, caused a standby letter of credit to be provided to the Banks to enable Converse to borrow an additional $25,000 above its defined borrowing base under the Old Credit Facility. The Company paid Apollo a fee of 3% of the face amount of the letter of credit and a subsequent extension fee of $100. The standby letter of credit arrangement ceased to exist upon the repayment of the Old Credit Facility. On November 17, 1994, Converse entered into a consulting agreement with Apollo Advisors, L.P., an affiliate of Apollo, pursuant to which Apollo Advisors, L.P. provides corporate advisory, financial and other consulting services to Converse. Fees under the agreement were initially payable at an annual rate of $500 plus out-of-pocket expenses. During Fiscal 1997, this agreement was amended to decrease the rate for the year ended January 3, 1998 from $500 to $375. The consulting agreement continues on a year-to-year basis unless terminated by the Converse Board of Directors. 16. Other Financial Data Items charged to earnings during Fiscal 1996, 1997 and 1998 included the following:
Fiscal Year Ended ------------------------------------------------------- December 28, 1996 January 3, 1998 January 2, 1999 ----------------- --------------- --------------- Advertising and promotion......... $28,544 $34,887 $23,713 Research and development.......... $6,503 $8,817 $7,659
17. Business Segment Information Converse adopted Statement of Financial Accounting Standards No. 131 "Disclosures about Segments of an Enterprise and Related Information" ("SFAS No. 131"), during the fourth quarter of 1998. SFAS No 131 established standards for reporting information about business segments in annual financial statements and requires selected information about operating segments in interim financial reports issued to stockholders. Converse operates in one industry segment; designing, manufacturing and marketing of athletic and leisure footwear, apparel and accessories. Business segments are defined as components of an enterprise about which separate financial information is available that is evaluated regularly by the chief operating decision maker, or decision making group, in deciding how to allocate resources and in assessing performance. Converse's chief operating decision making group is the Company's Operating committee, which is comprised of the Chairman and the lead executives of each of the Company's business segments. The Company's business units have been aggregated into four reportable segments [United States; Europe, Middle East, Africa; Asia Pacific; and Americas (excluding Unites States)]. Each of these segments have separate management teams and infrastructures and offer different products and services. The lead executive for each business segment manages the profitability and cash flow of each respective segment's various product lines and businesses. Converse has a diversified customer base with one customer accounting for 12% of the Company's net sales in Fiscal 1996, 14% in Fiscal 1997 and 19% in Fiscal 1998. The accounting policies of the reportable segments are the same as those described in Note 2 of Notes to Consolidated Financial Statements except the disaggregated financial results for Converse's business segments have been F-22 prepared using a management approach, which is consistent with the basis and manner in which Converse management internally disaggregates financial information for the purposes of assisting in making internal operating decisions. The Company evaluates the performance of its business segments based on net sales, gross margin, royalty income, depreciation and amortization, interest expense, other operating costs, other (income) expense, pretax profit and total assets. The intersegment sales are accounted for based one established sales prices between the related companies and pertain primarily to sales from the United States to various foreign operations. For SFAS 131 disclosures, the Company has allocated interest expense to each segment based on its respective accounts receivable and inventory balances. Certain other operating costs have been allocated based on gross footwear sales. The $9,300 gain related to the termination of the post retirement medical benefit plan has been allocated fully to the United States. Summarized financial information concerning the Company's reportable business segments is shown in the following table. The information for Fiscal 1997 and 1996 has been restated from the prior year's presentation in order to conform to the Fiscal 1998 presentation.
Europe, Americas Middle East, (excluding United States Africa Asia Pacific United States) Eliminations Consolidated ------------- ------ --------------------------- ------------ ------------ Fiscal 1998 Net sales to customer ................ $ 166,555 $ 72,603 $ 59,719 $ 9,476 $ -- $ 308,353 Intersegment net sales ............... 47,344 -- -- -- (47,344) -- Gross margin ......................... 35,376 15,973 17,697 1,636 -- 70,682 Royalty income ....................... 3,069 1,820 12,846 2,440 -- 20,175 Depreciation and amortization ........ 1,337 117 192 71 -- 1,717 Net interest expense ................. 10,060 4,523 2,157 785 -- 17,525 Other operating costs ................ 41,412 29,956 16,439 4,769 -- 92,576 Other (income) expense ............... (678) (93) (241) (2) -- (1,014) --------- --------- --------- --------- --------- --------- Segment pretax profit (loss) ......... $ (13,686) $ (16,710) $ 11,996 $ (1,547) $ -- $ (19,947) ========= ========= ========= ========= ========= ========= Segment total assets ................. 153,107 33,066 4,834 3,999 -- 195,006 Segment long-lived assets ............ 18,839 1,767 182 50 -- 20,838 Segment capital expenditures ......... 4,232 540 54 14 -- 4,840 Fiscal 1997 Net sales to customer ................ $ 284,895 $ 75,452 $ 70,953 $ 18,899 $ -- $ 450,199 Intersegment net sales ............... 44,890 -- -- -- (44,890) -- Gross margin ......................... 82,932 14,371 20,373 3,265 -- 120,941 Royalty income ....................... 3,809 3,060 13,331 2,369 -- 22,569 Depreciation and amortization ........ 1,271 112 160 86 -- 1,629 Net interest expense ................. 10,029 3,150 1,460 735 -- 15,374 Other operating costs ................ 70,945 34,085 15,551 6,581 -- 127,162 Other (income) expense..Other inc./exp (11,584) 2,645 (478) (87) -- (9,504) --------- --------- --------- --------- --------- --------- Segment pretax profit (loss) ......... $ 16,080 $ (22,561) $ 17,011 $ (1,681) $ -- $ 8,849 ========= ========= ========= ========= ========= ========= Segment total assets ................. 192,923 32,973 4,390 4,408 -- 234,694 Segment long-lived assets ............ 18,838 1,125 65 58 -- 20,086 Segment capital expenditures ......... 5,501 558 11 42 -- 6,112 Fiscal 1996 Net sales to customer ................ $ 194,060 $ 92,207 $ 43,695 $ 19,373 $ -- $ 349,335 Intersegment net sales ............... 63,095 -- -- -- (63,095) -- Gross margin ......................... 48,733 21,830 12,324 3,350 -- 86,237 Royalty income ....................... 2,670 2,294 21,338 1,336 -- 27,638 Depreciation and amortization ........ 1,087 130 127 73 -- 1,417 Net interest expense ................. 11,595 3,643 1,687 851 -- 17,776 Other operating costs ................ 61,507 35,262 12,758 5,484 -- 115,011 Other (income) expense..Other inc./exp 1,638 1,167 (484) (81) -- 2,240 --------- --------- --------- --------- --------- --------- Segment pretax profit (loss) ......... $ (24,424) $ (16,078) $ 19,574 $ (1,641) $ -- $ (22,569) ========= ========= ========= ========= ========= ========= Segment total assets ................. $ 177,767 $ 32,305 $ 8,495 $ 4,036 $ -- $ 222,603 Segment long-lived assets ............ 16,596 1,131 88 34 -- 17,849 Segment capital expenditures ......... 4,847 385 -- -- -- 5,232
F-23 18. Quarterly Financial Information (Unaudited) Following is a summary of unaudited quarterly information:
First Second Third Fourth Quarter Quarter Quarter Quarter ------- ------- ------- ------- Year ended January 3, 1998: Net sales ................... $135,969 $103,324 $121,903 $ 89,003 Gross profit ................ $ 42,160 $ 30,885 $ 32,104 $ 15,792 Net earnings (loss) ......... $ 12,680 $ 4 $ 175 $(17,908) ======== ======== ======== ======== Net earnings (loss) per share $ 0.71 $ 0.00 $ 0.01 $ (1.03) ======== ======== ======== ======== First Second Third Fourth Quarter Quarter Quarter Quarter ------- ------- ------- ------- Year ended January 2, 1999: Net sales ................... $ 95,240 $ 78,351 $ 78,286 $ 56,476 Gross profit ................ $ 27,815 $ 19,737 $ 16,044 $ 7,086 Net earnings (loss) ......... $ (1,163) $ (1,516) $ (4,274) $(15,862) ======== ======== ======== ======== Net earnings (loss) per share $ (0.07) $ (0.09) $ (0.25) $ (0.92) ======== ======== ======== ========
F-24 SCHEDULE II VALUATION AND QUALIFYING ACCOUNTS (Dollar amounts in thousands)
Additions (Reversals) Charged to Beginning Costs and Deductions Ending Description Balance Expenses (Additions) Balance ----------- ------- -------- ----------- ------- Year Ended December 28, 1996: Allowance for Doubtful Accounts... $ 2,237 $ 670 $ 913 $ 1,994 Inventory Reserve ................ 7,216 306 1,951 5,571 Deferred Tax Asset Valuation Allowance ........................ 6,650 4,934 -- 11,584 Year Ended January 3, 1998: Allowance for Doubtful Accounts... $ 1,994 $ 1,074 $ 1,002 $ 2,066 Inventory Reserve ................ 5,571 (769) 1,840 2,962 Deferred Tax Asset Valuation Allowance ........................ 11,584 9,293 -- 20,877 Year Ended January 2, 1999: Allowance for Doubtful Accounts... $ 2,066 $ 1,073 $ 1,053 $ 2,086 Inventory Reserve ................ 2,962 410 327 3,045 Deferred Tax Asset Valuation Allowance ........................ 20,877 9,406 (473) 30,756
F-25 EX-21 2 SUBSIDIARIES OF THE REGISTRANT Exhibit 21 CONVERSE INC. SUBSIDIARIES ------------ Converse Star I, Inc., a subsidiary of Converse Inc. Incorporated in Massachusetts on March 26, 1985 (branch in England and Wales) Converse EMEA Ltd., a subsidiary of Converse Inc. Incorporated in Delaware on January 29, 1990 (branch in England and Wales) Converse France, Inc., a subsidiary of Converse Benelux Holding Company, Inc. Incorporated in Delaware on November 23, 1993 (branch in France) Converse Europe, Inc., a subsidiary of Converse Inc. Incorporated in Delaware on November 23, 1993 (branch in the Netherlands) Converse Benelux, Inc., a subsidiary of Converse Benelux Holding Company, Inc. Incorporated in Delaware on November 23, 1993 (branches in the Netherlands and Belgium) Converse Benelux Holding Company, Inc., a subsidiary of Converse Europe, Inc. Incorporated in Delaware on November 23, 1993 Converse Germany, Inc., a subsidiary of Converse Europe, Inc. Incorporated in Delaware on March 21, 1994 (branch in Germany) Converse Iberia, Inc., a subsidiary of Converse Europe, Inc. Incorporated in Delaware on July 8, 1994 (branches in Portugal and Spain) Converse Italy, Inc., a subsidiary of Converse Europe, Inc. Incorporated in Delaware on September 21, 1994 (branch in Italy) Converse Shelf, Inc., a subsidiary of Converse Inc. Incorporated in Delaware on November 21, 1994 (branch is no longer registered in Japan as of 6/15/98) Converse Scandinavia, Inc., a subsidiary of Converse Europe, Inc. Incorporated in Delaware on June 7, 1995 (branch in Denmark) Converse Japan Corporation, a subsidiary of Converse Inc. Incorporated in Delaware on May 2, 1996 (branch in Japan) Converse Mexico, Inc., a subsidiary of Converse Inc. Incorporated in Delaware on October 23, 1996 (branch in Mexico) Converse All Star do Brasil Industria e Comercio Ltda., a subsidiary of Converse Inc. Incorporated in Brazil Calzado Deportivo de Reynosa, S.A. de C.V., a subsidiary of Converse Inc. Incorporated in Mexico on January 25, 1984 Converse Export Co. Limited, a subsidiary of Converse Inc. Incorporated in Barbados on December 28, 1984 (a foreign sales corporation) Apex One, Inc., a subsidiary of Converse Inc. Incorporated in New Jersey on July 8, 1988 EX-23 3 CONSENT OF INDEPENDENT ACCOUNTANTS Exhibit 23 CONSENT OF INDEPENDENT ACCOUNTANTS We hereby consent to the incorporation by reference in the Registration Statements on Form S-8 (Nos. 33-87806, 333-13269 and 333-62691) of Converse Inc. of our report dated February 23, 1999, appearing in Converse Inc.'s January 2, 1999 Annual Report on Form 10-K. We also consent to the application of such report to the Financial Statement Schedule for the three years ended January 2, 1999 when such schedule is read in conjunction with the financial statements referred to in our report. The audits referred to in such report also included this Financial Statement Schedule. /s/ PricewaterhouseCoopers LLP PRICEWATERHOUSECOOPERS LLP Boston, Massachusetts March 26, 1999 EX-27 4 FINANCIAL DATA SCHEDULE
5 THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM CONVERSE INC. AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS. 1,000 YEAR JAN-02-1999 JAN-04-1998 JAN-02-1999 3,274 0 59,912 2,086 71,292 141,354 35,488 14,650 195,006 134,296 74,265 0 0 17,320 (86,630) 195,006 308,353 328,528 237,671 330,354 596 0 17,525 (19,947) 3,572 (23,519) 0 (704) 0 (22,815) (1.32) (1.32)
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