-----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, PstolYCTidQhNJLpgZHuf+LLnmjM+kt6+9dfU4ajyhIJsADjOhUdtbNVbeAAukwx PwfKW6Zm2auIm6tzAy8aFA== 0000950144-99-011776.txt : 19991018 0000950144-99-011776.hdr.sgml : 19991018 ACCESSION NUMBER: 0000950144-99-011776 CONFORMED SUBMISSION TYPE: 10-K/A PUBLIC DOCUMENT COUNT: 3 CONFORMED PERIOD OF REPORT: 19990130 FILED AS OF DATE: 19991012 FILER: COMPANY DATA: COMPANY CONFORMED NAME: PERFUMANIA INC CENTRAL INDEX KEY: 0000880460 STANDARD INDUSTRIAL CLASSIFICATION: RETAIL-DRUG STORES AND PROPRIETARY STORES [5912] IRS NUMBER: 650026340 STATE OF INCORPORATION: FL FISCAL YEAR END: 0130 FILING VALUES: FORM TYPE: 10-K/A SEC ACT: SEC FILE NUMBER: 000-19714 FILM NUMBER: 99726045 BUSINESS ADDRESS: STREET 1: 11701 N W 101 RD CITY: MIAMI STATE: FL ZIP: 33178 BUSINESS PHONE: 3058891600 MAIL ADDRESS: STREET 1: 11701 N W 101 RD CITY: MIAMI STATE: FL ZIP: 33178 10-K/A 1 PERFUMANIA, INC FORM 10-K/A #2 FOR 1/30/99 1 SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-K/A AMENDMENT NO. 2 [X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934 (FEE REQUIRED) FOR THE FISCAL YEAR ENDED JANUARY 30, 1999 OR [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 (NO FEE REQUIRED) COMMISSION FILE NUMBER 0-19714 PERFUMANIA, INC. (EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER) FLORIDA (State or other jurisdiction of incorporation or organization) 65-0026340 (I.R.S. Employer Identification Number) 11701 NW 101 ST. ROAD, MIAMI, FL (Address of principal executive offices) 33178 (Zip Code) (305) 889-1600 (Registrant's telephone number, including area code) Securities registered pursuant to Section 12(g) of the Act: Common Stock, $.01 par value (Title of Class) 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 for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes [X] No [ ] 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 [ ]. As of September 17, 1999, the number of shares of the registrant's Common Stock outstanding was 9,156,434. The aggregate market value of the Common Stock held by non affiliates of the registrant as of September 17, 1999 was approximately $21.6 million, based on the closing price of the Common Stock ($3.938) as reported by the Nasdaq National Market on such date. For purposes of the foregoing computation, all executive officers, directors and 5 percent beneficial owners of the registrant are deemed to be affiliates. Such determination should not be deemed to be an admission that such executive officers, directors or 5 percent beneficial owners are, in fact, affiliates of the registrant. DOCUMENTS INCORPORATED BY REFERENCE The information called for by Part III is incorporated to the Proxy Statement for the Annual Meeting of Shareholders of the company, which will be filed no later than 120 days after the close of the fiscal year end. 2 TABLE OF CONTENTS
ITEM PAGE - ----- ---- PART I 1. Business.........................................................................................................3 2. Properties.......................................................................................................9 3. Legal Proceedings................................................................................................9 4. Submission of Matters to a Vote if Security Holders..............................................................9 PART II 5. Market for Registrant's Common Equity and Related Stockholder Matters...........................................11 6. Selected Financial Data.........................................................................................11 7. Management's Discussion and Analysis of Financial Condition and Results of Operations...........................13 7A. Quantitative and Qualitative Disclosures About Market Risks.....................................................22 8. Financial Statements and Supplementary Data.....................................................................23 9. Changes in and Disagreements with Accountants in Accounting and Financial Disclosures...........................46 PART III 10. Directors and Executive Officers of the Registrant..............................................................47 11. Executive Compensation..........................................................................................49 12. Security Ownership of Certain Beneficial Owners and Management..................................................54 13. Certain Relationships and Related Transactions..................................................................55 PART IV 14. Exhibits, Financial Statements, Schedules and Reports on Form 8-K...............................................57
2 3 FORWARD-LOOKING STATEMENTS Certain statements within this Form 10-K constitute "forward-looking statements" within the meaning of the Private Securities Litigation Reform Act of 1995. Such forward-looking statements involve known and unknown risks, uncertainties and other factors that may cause the actual results, performance or achievements of the Company or its industry to be materially different from any future results, performance or achievements expressed or implied by such forward-looking statements. Such factors include, among other things, the Company's seasonality, lack of long-term agreements with suppliers, dependence on line of credit, dependence on key personnel, the ability to manage the Company's growth and potential litigation. See "Risk Factors That May Affect Future Results" in Item 7. PART I. ITEM 1. BUSINESS GENERAL Perfumania, Inc. ("Perfumania" or the "Company") is a leading specialty retailer and wholesale distributor of a wide range of brand name and designer fragrances. As of January 30, 1999, the Company operated a chain of 289 retail stores specializing in the sale of fragrances at discounted prices up to 60% below the manufacturer's suggested retail prices. The Company's wholesale division distributes approximately 1,100 stock keeping units (SKUs) of fragrances and related products to approximately 44 customers, including national and regional chains and other wholesale distributors throughout North America and overseas. The Company's wholesale business is managed and owned by the parent company, Perfumania, Inc. and the Company's retail business is managed and owned by Magnifique Parfumes and Cosmetics, Inc., a wholly owned subsidiary of Perfumania, Inc. The parent and subsidiary are separate and distinct legal entities, but for ease of reference in this Form 10-K, they are referred to as segments. See Item 6 for Selected Financial Data by segment. RETAIL SEGMENT Marketing and Merchandising. Each of the Company's retail stores offers approximately 175 different brands of fragrances for women and men at prices up to 60% below the manufacturer's suggested retail prices. Stores stock brand name and designer brands such as Estee Lauder(R), Fendi(R), Yves Saint Laurent(R), Fred Hayman(R), Karl Lagerfeld(R), Gucci(R), Ralph Lauren/Polo(R), Perry Ellis(R), Liz Claiborne(R), Giorgio(R), Hugo Boss(R), Halston(R), Christian Dior(R), Chanel(R) and Cartier(R). Historically, the Company has carried a narrow private line of bath and body and treatment under the name Jerome Privee. The Company has spent 1998 expanding, repackaging and redesigning its bath and body line. The new line includes approximately 250 SKU's and was reintroduced during April 1998. Also during 1998, the Company continued to develop its own private label Nature's Elements line of cosmetics, treatment and aromatherapy. The cosmetics line, which stresses quality for value, was introduced in May 1998. The treatment line was launched in the fourth quarter of 1998 and the aromatherapy line is expected during the fourth quarter of 1999. The Company believes that the continued expansion of its sales in the bath, body, cosmetic and treatment categories is very important to its future business. These private label lines could generate more frequent visits to the Company's stores and thereby increase sales. The Company also intends to continue to expand its gift accessories category by offering a wider assortment of vanity trays, perfume bottles and oil burners. The cornerstone of the Company's marketing philosophy is customer awareness that Perfumania's stores offer an extensive assortment of brand name and designer fragrances at discount prices. Perfumania posts highly visible price tags for each item in a store, listing both the manufacturers' suggested retail price and the Company's discounted prices in order to enable customers to make price comparisons. In addition, the Company utilizes sales promotions such as "gift with purchase" and "purchase with purchase" offers. From time to time the Company test markets in its stores additional specialty gift items. 3 4 The Company's stores are "full-service" stores. Accordingly, store personnel are trained to establish a personal rapport with each customer, to identify customer preferences with respect to both product and price range, and to successfully conclude a sale. Management believes that attentive personal service and knowledgeable sales personnel are key factors to the success of the Company's retail stores. The Company's store personnel are compensated on a salary plus bonus basis. The Company has several bonus programs that provide incentives for store personnel to sell merchandise on which the Company has higher profit margins. In addition, to provide an incentive to reduce expenses, district and area managers are eligible to receive a bonus if store profit goals are met. Management believes that a key component of the Company's ability to increase profitability will be its ability to locate, train and retain store personnel and regional and district managers. The Company conducts comprehensive training programs designed to increase customer satisfaction. The Company primarily relies on its distinctive store design and window displays to attract the attention of prospective customers. The Company also distributes flyers and brochures in its stores and in the malls in which its stores are located. The Company has refocused a substantial portion of its advertising from national and local newspapers, television and radio to less expensive billboards and in-store promotions. The amount of advertising varies with the seasonality of the business. Retail Stores. The Company's standard store design includes signs and merchandise displays which are designed to enhance customer recognition of Perfumania's stores. The Company's stores average approximately 1,500 square feet, although stores located in manufacturer's outlet malls tend to be larger than the Company's other stores. Each store is managed by one manager and one assistant manager. The average number of employees in a Perfumania store is five, including part-time help. District or area managers visit stores on a regular basis in an effort to ensure knowledgeable and attentive customer service. Information Systems. The Company has a point-of-sale and management information system which integrates data from every significant phase of the Company's operations and provides the Company with information for planning, purchasing, pricing, distribution, financial and human resources decisions. The system also provides, on a real-time basis, information to manage store and warehouse inventories efficiently and to closely monitor individual store and each salesperson's performance. In addition, the system prepares price labels and pick orders and provides for automatic reordering, minimum and maximum stocking levels and optimum order quantities based on actual sales. Further, the system permits analysis of the Company's retail sales data based on product groups, items and manufacturers, enabling the Company to respond to changes in sales patterns. The management information system has bar scanners to record sales, track inventories and conduct physical inventories. The information system also has automated time and attendance modules to capture payroll information through the stores' point-of-sale systems, E-Mail systems allowing daily communication among the stores, district managers and the corporate office, and automated scheduling for store personnel. During the second quarter of 1999, the Company will upgrade the merchandising, inventory management and distribution and finance components of its management information system. During the third quarter of 1999, the Company intends to upgrade its register software so that it will be able to perform promotional discounts automatically, calculate bonuses for employees at store level, perform inventories at store level and expand its E-Mail and printing capabilities. The costs for improvements and upgrades to the Company's management information systems and related point-of-sale software are expected to be approximately $1.5 million in fiscal 1999. See "Year 2000" discussion under Item 7, Management's Discussion and Analysis of Financial Condition and Results of Operations. Acquisition. During November 1996, the Company acquired substantially all of the assets of Nature's Elements Holding Corporation (Nature's) which included the service mark and trade name "Nature's Elements" and the stock of its subsidiary. Prior to the acquisition, all of Nature's liabilities, both at the parent and subsidiary level were transferred to a liquidating trust. Subsequent to the purchase, the stock of the subsidiary was liquidated and the Company received inventory and store fixtures, and assumed the obligation for 34 leases (including 1 seasonal store). The Company has since closed 11 locations, renovated 18 locations during 1998 and the remaining locations will either be renovated or subleased during 1999. The Company continues to use the trade name Nature's Elements for its in-house developed cosmetic, treatment, aromatherapy and bath line. 4 5 Store Location and Expansion. Perfumania's 280 stores are located in 36 states, the District of Columbia and Puerto Rico, including 49 in Florida, 33 in New York, 22 in California and 20 in Texas. Perfumania's strategy for opening new stores is to seek locations throughout the United States principally in regional malls and manufacturers' outlet malls and, selectively, on a stand-alone basis in suburban shopping centers in metropolitan areas. To achieve economies of scale with respect to advertising and management costs, the Company emphasizes opening additional stores in markets where it already has a presence. The Company also plans to expand into additional markets that it believes have a population density to support a cluster of stores. Prior to selecting new store locations, the Company analyzes, among other things, the potential adverse effect of competition from new stores on the sales of existing stores. The number of stores opened by the Company will depend on several factors such as locating satisfactory sites, obtaining leases on favorable terms and general economic and business conditions in the localities of the new stores. Furthermore, although the Company may have executed a lease for a future location, a store may not open if, for example, a developer decides not to construct a mall. See "Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations - Liquidity and Capital Resources". Currently, the Company's average cost for opening a store is approximately $175,000, including equipment, furniture and fixtures, and other items (which average approximately $50,000 per store), build-out costs (which average approximately $120,000 per store), and preopening expenses, such as the hiring and training of new employees and travel (which average approximately $5,000 per store). In addition, initial inventory in a new store ranges from approximately $100,000 during the first fiscal quarter to approximately $140,000 during the Christmas holiday season. To supplement the inventory in its stores, the Company carries at least four months supply of inventory at its warehouse. Through September 17, 1999, the Company had opened 5 stores and closed 14 stores in fiscal year 1999. The Company opened 36 stores in fiscal year 1998, 40 stores in fiscal year 1997 (excluding 18 seasonal locations) and 74 stores in fiscal year 1996, (including 33 stores acquired from Nature's). The Company continuously monitors store performance and from time to time has closed underperforming stores, which typically have been older stores in undesirable locations. The Company attempts to schedule store closings after the Christmas holiday season. During fiscal year 1998, 1997 and 1996, the Company closed 32 stores, 17 stores and 6 stores, respectively. For fiscal 1999, the Company will slow its growth and focus on improving its existing stores profitability. The Company will open a maximum of 8 stores and will close up to 15 stores during 1999. WHOLESALE SEGMENT The Company is one of the largest wholesale distributors of fragrances in the United States. The Company distributes fragrances on a wholesale basis to national and regional retail chains and other wholesale distributors throughout North America and overseas. During fiscal years 1998 and 1997, the wholesale division sold to approximately 41 and 44 customers, respectively. One of the Company's customers accounted for 24.8% and 37.0% of net wholesale sales during fiscal year 1998 and 1997, respectively. Foreign wholesale sales during fiscal year 1998 were $2.9 million, compared to $1.7 million during fiscal year 1997. See Note 14 to the Company's Consolidated Financial Statements included in Item 8 hereof. The wholesale division offers its customers approximately 1,100 SKUs. The wholesale division's strategy for purchasing merchandise is to capitalize on market opportunities, to purchase those products that are in demand and to purchase merchandise available due to overstock situations or close-out sales. In addition, it takes the Company approximately 70 days after purchase to receive inventory for its wholesale division and an additional 20 days for the inventory to arrive at the Company's stores. As a result, the wholesale division generally carries at least four months' supply of inventory. The Company's warehouse inventory is generally higher than other retailers and wholesalers since the Company purchases a large amount of its inventories from the manufacturers and the secondary market and must assure itself of having consistent supplies of desirable inventories at favorable prices. Some of the Company's suppliers require monetary advances to purchase the inventory. 5 6 Jerome Falic, the Company's President, is primarily responsible for activities of the wholesale division. The Company believes that Mr. Falic has developed strong, reliable relationships with suppliers and customers in the United States, Europe, Asia and South America. The Company continuously seeks to develop new supplier and customer relationships. The wholesale division works closely with the retail division when determining which merchandise to purchase on behalf of the Company and the retail division will frequently direct the wholesale division to locate and purchase particular products. The Company purchases merchandise on behalf of both the wholesale division and the retail division which, the Company believes, allows both divisions to benefit from the Company's supplier relationships and volume discounts thereby obtaining a more reliable source of inventory at lower prices than many other wholesalers or retailers of perfume. The Company believes that its ability to extend credit has been an important factor of wholesale sales. Most sales are made on open account terms, generally net 30 to 60 days following the receipt of goods. Other sales, with the exception of sales to the Company's largest customer, are made on a basis of cash on or in advance of delivery or upon receipt of a letter of credit. The receivable from the Company's largest customer was $0.1 million as of January 30, 1999, compared to $0.9 million as of January 31, 1998. Historically, the credit terms for this customer have been up to six months. See Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations - Liquidity and Capital Resources. SOURCES OF SUPPLY During fiscal years 1998 and 1997, the Company purchased fragrances from 155 and 126 different suppliers, respectively, including national and international manufacturers, distributors, wholesalers, importers and retailers. The Company generally makes its purchases based on the most favorable available combination of prices, quantities and merchandise selection and, accordingly, the extent and nature of the Company's purchases from its various suppliers change constantly. As is customary in the perfume industry, the Company has no long-term or exclusive contract with any supplier. Merchandise is purchased both directly from manufacturers and secondary sources such as distributors, wholesalers, importers and retailers. Merchandise purchased by the Company from secondary sources includes trademarked and copyrighted products manufactured in foreign countries and trademarked and copyrighted products manufactured in the United States that may have been sold to foreign distributors. Substantially all of the Company's merchandise is covered by trademarks or copyrights owned by others. From time to time, United States trademark and copyright owners and their licensees and trade associations have initiated litigation or administrative agency proceedings seeking to halt the importation into the United States of such foreign manufactured or previously exported trademarked products or restrict the sale of such goods in the United States, and Federal legislation for such purposes has been proposed but not yet adopted. In May 1988, the United States Supreme Court in K-MART v. CARTIER ("K-Mart"), upheld United States Customs Service regulations permitting the importation, without the consent of the United States trademark owner, of products manufactured overseas having legitimate foreign trademarks identical to United States trademarks, when the foreign and United States trademarks are owned by the same entity or entities under "common ownership or control." K-MART also held that where the foreign trademarked goods are produced by an unaffiliated entity authorized, but not controlled, by the United States trademark holder, the United States Customs Service cannot permit the importation of the goods without the consent of the United States trademark owner. Certain federal courts have narrowly interpreted the K-MART case as applying to a particular tariff statute, and the courts remain divided on the extent to which trademark, copyright or other laws or regulations may restrict the importation or sale of trademarked or copyrighted merchandise without the consent of the trademark or copyright owner, even where the entities owning and applying the trademark or copyright involved are under common ownership or control. For example, in LEVER BROS. v. UNITED STATES ("LEVER BROS."), a 1993 decision, the District of Columbia Circuit Court of Appeals held that the "common ownership or control" exception does not apply to foreign goods with an identical trademark but with physical material differences from the product produced by the United States trademark holder. Under LEVER BROS., such goods are barred from importation without the permission of the United States trademark holder. In addition, on November 23, 1992, the U.S. District Court for the 6 7 Central District of California, in an unreported decision in PARFUMS GIVENCHY, INC. v. DRUG EMPORIUM, INC. ("PARFUMS"), which purports to follow a decision of the Ninth Circuit Court of Appeals, held that the sale of products manufactured abroad and imported into the United States, which would be covered by a U.S. copyright, without the consent of the U.S. copyright holder, is a copyright violation. This decision was upheld by the 9th Circuit Court of Appeals and on March 6, 1995, the U.S. Supreme Court denied Certiorari, without giving any reason. In March 1998, however, the United States Supreme Court in QUALITY KING DISTRIBUTORS v. L'ANZA RESEARCH INTERNATIONAL ("L'ANZA"), was faced with a situation in which a United States manufacturer had manufactured and sold certain goods with copyrighted labels affixed to a foreign purchaser. These goods somehow found their way from the foreign purchaser back into the United States without L'anza's permission, and were sold by Quality King to unauthorized retailers at discounted prices. The L'ANZA Court unanimously held that there was no copyright violation by Quality King because the "first sale" doctrine applied to imported copies. Although L'ANZA appears favorable to those involved in purchasing through secondary sources, it is still too early to tell how the L'ANZA decision will be applied to future situations. As is often the case in the fragrance and cosmetics business, some of the merchandise purchased by suppliers such as the Company may have been manufactured by entities, particularly foreign licensees and others, who are not the owners of the trademarks or copyrights for the merchandise. If the Company were called upon or challenged by the owner of a particular trademark or copyright to demonstrate that specific merchandise was produced and sold with the proper authority and the Company were unable to do so, the Company could, among other things, be restricted from reselling the particular merchandise or be subjected to other liabilities, which could have an adverse effect on the Company's business and results of operations. The Company may not always be able to know or to demonstrate that the manufacturer of specific merchandise had proper authority from the trademark or copyright owner to produce the merchandise or permit it to be resold in the United States. During fiscal 1998, less than 30 percent of the Company's merchandise was purchased from gray market sources. The Company's gray market sources generally will not disclose the identity of their suppliers, which they consider to be proprietary trade information. As a result, the Company cannot determine specifically what portion of its merchandise purchased from gray market sources could be affected by the potential actions discussed above or actions on other grounds. See "Item 3. Legal Proceedings" for a description of certain pending litigation predicated on grounds of patent infringement. There can be no assurance that future judicial, legislative or administrative agency action, including possible import, export, tariff or other trade restrictions, will not limit or eliminate some of the secondary sources of supply used by the Company or any of the Company's business activities. In addition, there can be no assurance that the Company's business activities will not become the subject of legal or administrative actions brought by manufacturers, distributors or others. DISTRIBUTION The Company's retail and wholesale operations are served by its warehouse in Miami, Florida. The lease for the facility expires in July 2003. The warehouse is approximately 139,000 square feet, of which 20,000 square feet is utilized as office space. The Company's wholesale division also utilizes space in a third party bonded warehouse. The Company delivers merchandise utilizing its own trucks to its South Florida stores and the Company utilizes independent national trucking companies to deliver merchandise to stores outside of the South Florida area. Deliveries generally are made weekly, with more frequent deliveries during the Christmas holiday season. Such deliveries permit the stores to minimize inventory storage space, and increase the space available for display and sale of merchandise. The Company ships merchandise to wholesale customers by truck, ship or plane. In addition, in order to expedite delivery of merchandise to its customers, the Company sometimes instructs its suppliers to ship merchandise directly to wholesale division customers. 7 8 COMPETITION The retail and wholesale perfume businesses are highly competitive. The Company's retail competitors include department stores, regional and national retail chains, independent drug stores, duty free shops and other specialty retail stores. The Company is the largest specialty retailer of discounted fragrances in the United States in terms of number of stores. Some of the Company's competitors sell fragrances at discount prices, and some are part of large national or regional chains that have substantially greater resources and name recognition than the Company. The Company's stores compete on the basis of selling price, customer service, merchandise variety, store location and ambiance. The Company believes that its European-style perfumeries concept, full-service sales staff, discount prices, large and varied selection of brand name and designer fragrances and attractive shopping environment are important to its competitive position. The Company is one of the largest wholesale distributors of fragrances in the United States. The wholesale division competes directly with other perfume wholesalers and perfume manufacturers, some of which have substantially greater resources or merchandise variety than the Company. The wholesale division competes principally on the basis of merchandise selection and availability, selling price and rapid delivery. EMPLOYEES At January 30, 1999, the Company had 1,834 employees, of whom 1,632 were employed in the Company's retail stores, 92 were employed in the Company's warehouse and distribution operations and the balance were employed in executive, administrative and other positions. Temporary and part-time employees are usually added during peak sales periods (principally between Thanksgiving and Christmas). None of the Company's employees are covered by a collective bargaining agreement and the Company considers its relationship with its employees to be good. TRADE NAME AND SERVICE MARK The Company's stores use the trade name and service mark Perfumania(R). The Company also operates 18 stores under the trade name "Nature's Elements" (as of January 31, 1998; see "Acquisition"- page 5), 3 stores under the trade name "Class Perfumes" in malls where the Company also operates a Perfumania(R) store, and 10 stand-alone stores under the trade name "Perfumania Plus". The Company has common law rights to its trade names and service mark in those general areas in which its existing stores are located and has registered the service mark Perfumania(R) with the U.S. Patent and Trademark Office. The registration expires in 2009 and may be renewed for 10-year terms thereafter. RECENT DEVELOPMENTS In February 1999, through a wholly-owned subsidiary, perfumania.com, inc., the Company began operation of an Internet commerce site, perfumania.com. The Company intends to capitalize on its name recognition and cross marketing opportunities with its stores to become a top discount retailer of fragrance and related products on the Internet. All orders placed with the Internet site are shipped from the Company's existing distribution center in Miami, Florida. On August 31, 1999, the Company entered into a stock purchase agreement with an affiliated Company through common ownership. The agreement calls for the transfer of 1,512,406 shares of the Company's treasury stock to this affiliated company in consideration for a partial reduction of the Company's outstanding trade indebtedness balance of approximately $4.5 million. The transfer price was based on a per share price of $2.98, which approximates 90% of the closing price on the Company's common stock for the previous 20 business days. Pursuant to this agreement the parties entered into a registration rights agreement dated August 31, 1999, which grants the affiliated company demand registration rights. On September 28, 1999, perfumania.com, inc., a wholly-owned subsidiary of the Company, made an initial public offering of its common stock representing approximately 47% of the common stock outstanding following the offering. perfumania.com, inc. offered 3,500,000 shares of its common stock, which included 1,000,000 shares held by the Company. The offering raised approximately $24.5 million. The net proceeds of the offering will be used for repayment of outstanding indebtedness to the Company and for working capital and other general corporate purposes as well as reduction of the outstanding balance in the Company's bank line of credit. 8 9 ITEM 2. PROPERTIES The Company's executive offices and warehouse are leased for a ten (10) year period pursuant to a lease which currently provides for monthly rent of approximately $70,000 and specified annual increases thereafter. All of the Company's retail stores are located in leased premises. Most of the Company's store leases provide for the payment of a fixed amount of base rent plus a percentage of sales, ranging from 3% to 10%, over certain minimum sales levels. Store leases typically require the Company to pay all utility charges, insurance premiums, increases in property taxes and certain other costs. Certain of the Company's leases permit the lessor to terminate the lease if specified minimum sales levels are not met. See Note 13 of Notes to the Company's Consolidated Financial Statements for additional information with respect to the Company's store leases. ITEM 3. LEGAL PROCEEDINGS LEGAL PROCEEDINGS Boucheron. In December 1993, the patent holder and exclusive licensee in the U.S. of Boucheron filed a complaint against us in the United States District Court for the Southern District of New York alleging that we infringed upon their exclusive right to sell the Boucheron bottle and is seeking $1.5 million in damages. Their theory is that they have a valid patent for the bottles and that Perfumania's sales of such bottles infringes upon their patent rights. We believe that a patentee cannot control by resort to an infringement suit the resale of a patented article which it has sold. We filed a motion to dismiss during February 1994. On March 20, 1995, the court denied our motion to dismiss, and on April 14, 1995, we filed an answer to the complaint. Discovery is in progress. Other. Perfumania is characterized as an insider as defined by the United States Bankruptcy Code, in the liquidating plan of reorganization filed on April 6, 1998 by L. Luria & Son, Inc. in the United States Bankruptcy Court, Southern District of Florida. In October 1998, the committee of unsecured creditors in Luria's bankruptcy proceedings filed a complaint with the United States Bankruptcy Court, Southern District of Florida to recover substantial funds from Perfumania. The complaint alleges that Luria's made preference payments, as defined by the Bankruptcy Court, to us and seeks to recover preference payments, and seeks to disallow any and all claims of Perfumania against Luria's until Perfumania pays for the preference payments. In July 1999, we agreed with the committee of unsecured creditors to settle all claims held by Luria's against us for the sum of $1.2 million, payable over the next nine months according to a repayment schedule. This settlement is subject to the approval of the Bankruptcy Court. The full amount of the settlement was accrued for in our financial statements for the year ending January 31, 1998 and January 30, 1999. From time to time, we are involved in various legal proceedings in the ordinary course of business. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS On December 16, 1998 the Company held its annual meeting of shareholders. At the annual meeting, the shareholders elected Ilia Lekach, Simon Falic, Jerome Falic, Marc Finer, Robert Pliskin and Carole Ann Taylor to the Board of Directors. 9 10
SHARES SHARES VOTED SHARES VOTED ABSTAIN/ TOTAL VOTED FOR AGAINST WITHHELD NON-VOTES ------ ------ ------------ ------------ -------- --------- Ilia Lekach 3,304,273 3,299,973 -- 4,300 -- Simon Falic 3,304,273 3,299,973 -- 4,300 -- Jerome Falic 3,304,273 3,299,973 -- 4,300 -- Marc Finer 3,304,273 3,299,973 -- 4,300 -- Robert Pliskin 3,304,273 3,299,973 -- 4,300 -- Carole Ann Taylor 3,304,273 3,299,973 -- 4,300 --
10 11 PART II. ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS MARKET INFORMATION The Company's Common Stock is traded on the Nasdaq Stock Market under the symbol PRFM. The following table sets forth the high and low closing sales prices for the Company's Common Stock for the periods indicated, as reported by the Nasdaq Stock Market.
FISCAL 1997 HIGH LOW ----------- ---- --- First Quarter $ 3 11/16 $ 2 19/64 Second Quarter $ 4 5/16 $ 2 7/8 Third Quarter $ 3 7/8 $ 2 5/8 Fourth Quarter $ 3 3/4 $ 2 1/4 FISCAL 1998 HIGH LOW ----------- ---- --- First Quarter $ 3 1/4 $ 2 1/4 Second Quarter $ 2 13/16 $ 1 9/16 Third Quarter $ 1 11/16 $ 13/32 Fourth Quarter $ 12 $ 17/32 FISCAL 1999 HIGH LOW ----------- ---- --- First Quarter $ 8 11/16 $ 2 3/4 Second Quarter $ 4 7/32 $ 3 Third Quarter (through September 17) $ 3 15/16 $ 2 5/16
As of September 17, 1999, there were 81 holders of record of the 9,156,434 outstanding shares of Common Stock. The closing sales price for the Common Stock on September 17, 1999 was $3 15/16. DIVIDEND POLICY The Company has not declared or paid any dividends on the Common Stock and does not currently intend to declare or pay cash dividends in the foreseeable future. Payment of dividends, if any, will be at the discretion of the Board of Directors after taking into account various factors, including the Company's financial condition, results of operations, current and anticipated cash needs and plans for expansion. The Company is prohibited from paying cash dividends under its line of credit with LaSalle National Bank. ITEM 6. SELECTED FINANCIAL DATA The selected financial data presented below for the last five fiscal years and as of the end of each such fiscal years are derived from the Company's consolidated financial statements and should be read in conjunction with such financial statements and related notes. The Company's fiscal year end is the Saturday closest to January 31. All references herein to fiscal years are to the calendar year in which the fiscal year begins; for example, fiscal year 1998 refers to the fiscal year that began on February 1, 1998 and ended on January 30, 1999. 11 12
FISCAL YEAR ENDED -------------------------------------------------------------------------- JANUARY 30, JANUARY 31, FEBRUARY 1, FEBRUARY 3, JANUARY 28, 1999 1998 1997 1996 1995 ----------- ----------- ----------- ----------- ----------- (IN THOUSANDS, EXCEPT FOR PER SHARE AMOUNTS) STATEMENT OF OPERATIONS DATA: Net sales, wholesale division ....................... $ 40,466 $ 34,032 $ 30,317 $ 36,200 $ 38,484 Net sales, retail division .......................... 134,790 129,562 108,603 92,957 77,094 ---------- ---------- ---------- ----------- ----------- Total net sales .................................. 175,256 163,594 138,920 129,157 115,578 ---------- ---------- ---------- ----------- ----------- Gross profit, wholesale division .................... 7,545 7,942 7,614 8,784 7,573 Gross profit, retail division ....................... 57,072 58,032 52,346 43,384 36,076 ---------- ---------- ---------- ----------- ----------- Total gross profit ............................... 64,617 65,974 59,960 52,168 43,649 ---------- ---------- ---------- ----------- ----------- Selling, general and administrative expenses......... 72,502 64,219 48,165 43,372 37,081 Provision for doubtful accounts ..................... -- 1,730 500 310 27 Provision for impairment of assets and store closings.......................................... 1,035 2,515 169 1,232 623 Depreciation and amortization ....................... 4,480 4,698 3,772 3,300 2,903 ---------- ---------- ---------- ----------- ----------- Total operating expenses ......................... 78,017 73,162 52,606 48,214 40,634 ---------- ---------- ---------- ----------- ----------- Income (loss) from operations before other income (expense) ........................................ (13,400) (7,188) 7,354 3,954 3,015 Other income (expense) Interest expense, net* ........................... (4,882) (4,696) (4,110) (3,144) (2,415) Other, net ....................................... 645 762 478 396 357 ---------- ---------- ---------- ----------- ----------- Income (loss) before income taxes* .................. (17,637) (11,122) 3,722 1,206 957 (Provision) benefit for income taxes ................ (1,337) 321 (1,647) 796 368 ---------- ---------- ---------- ----------- ----------- Income (loss) before cumulative effect of change in accounting principle* ......................... (18,974) (10,801) 2,075 2,002 1,325 ---------- ---------- ---------- ----------- ----------- Cumulative effect of change in accounting principle, net of income tax benefit of $380,958 . -- (632) -- -- -- Net income (loss)* .................................. $ (18,974) $ (11,433) $ 2,075 $ 2,002 $ 1,325 ========== ========== ========== =========== =========== Weighted average shares outstanding: Basic ............................................ 6,659,882 7,025,236 7,183,462 6,973,670 6,155,733 Diluted .......................................... 6,659,882 7,025,236 7,633,588 7,067,291 6,210,542 Basic income (loss) per share net of cumulative effect of change in accounting principle* ........ $ (2.85) $ (1.63) $ 0.29 $ 0.29 $ 0.22 Diluted income (loss) per share net of cumulative effect of change in accounting principle* ........ $ (2.85) $ (1.63) $ 0.27 $ 0.28 $ 0.21 SELECTED OPERATING DATA: Number of stores open at end of period .............. 289 285 262 194 175 Comparable store sales increase ..................... 0% 0% 3.6% 4.1% 5.9% BALANCE SHEET DATA: Working capital (deficit) ........................... $ (3,835) $ 18,473 $ 32,614 $ 29,688 $ 26,452 Total assets ........................................ 95,129 113,908 129,365 93,026 78,916 Long-term debt, less current portion(1) ............. 3,404 5,643 5,708 1,815 1,367 Total stockholders' equity .......................... 17,636 35,169 48,782 44,761 42,946
- -------------- * As disclosed in Note 11 to the consolidated financial statements, the net income and the net income per share for fiscal year 1996 was restated to account for the value attributable to the beneficial conversion feature on certain debt issued in fiscal year 1996. (1) Amount includes redeemable common equity of $471 as of January 30, 1999 but does not include long-term severance payables of $1,038 as of January 30, 1999. (2) Amount includes notes and interest receivable from shareholder and officers as of January 28, 1995, February 3, 1996, February 1, 1997, January 31, 1998 and January 30, 1999 in the amount of $913, $538, $543, $814 and $542, respectively. The fiscal 1998 financial statements have been prepared assuming we will continue as a going concern. We have violated certain debt covenants contained in our bank line of credit agreement; however, we obtained a waiver from the bank on July 14, 1999. 12 13 ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS GENERAL During the last three fiscal years, the Company's retail division has accounted for the majority of the Company's net sales and gross profit. The Company's overall profitability depends principally on the Company's ability to purchase a wide selection of merchandise at favorable prices. Other factors affecting the Company's profitability include general economic conditions, the availability to the Company of volume discounts and, in the retail division, the number of stores in operation, the timing of store openings and closings and the effect of special promotions offered by the Company. The following table sets forth items from the Company's Consolidated Statements of Operations expressed as a percentage of net sales for the periods indicated. PERCENTAGE OF NET SALES
FISCAL YEAR -------------------------------- 1998 1997 1996 ------- ------- ------ Net sales, wholesale division ..................................... 23.1% 20.8% 21.8% Net sales, retail division ....................................... 76.9 79.2 78.2 ------ ------ ------ Total net sales ................................................ 100.0 100.0 100.0 Gross profit, wholesale division .................................. 18.6 23.3 25.1 Gross profit, retail division ..................................... 42.3 44.8 48.2 ------ ------ ------ Total gross profit ................................................ 36.9 40.3 43.2 Selling, general and administrative expenses ...................... 41.4 39.2 34.6 Provision for doubtful accounts ................................... -- 1.1 0.4 Provision for impairment of assets and store closings ............. 0.6 1.5 0.2 Depreciation and amortization ..................................... 2.6 2.9 2.7 ------ ------ ------ Total operating expenses ....................................... 44.6 44.7 37.9 ------ ------ ------ Income (loss) from operations before other income (expenses) ... (7.7) (4.4) 5.3 ------ ------ ------ Other income (expense): Interest, net .................................................. (2.8) (2.9) (2.9) Other, net ..................................................... 0.4 0.5 0.3 ------ ------ ------ Income (loss) before income taxes* ................................ (10.1) (6.8) 2.7 ------ ------ ------ (Provision) benefit for income taxes .............................. (0.8) 0.2 (1.2) Income (loss) before cumulative effect of change in accounting principle ...................................................... (10.9) (6.6) 1.5 ------ ------ ------ Cumulative effect of change in accounting principle, net of income tax benefit .................................................... -- (0.4) -- ------ ------ ------ Net income (loss)* ................................................ (10.9)% (7.0)% 1.5% ====== ====== ======
* As disclosed in Note 11 to the Consolidated Financial Statements, the net income and net income per share for 1996 was restated to account for the value of the beneficial conversion feature of certain debt issued in fiscal year 1996. RESULTS OF OPERATIONS RISK FACTORS THAT MAY AFFECT FUTURE RESULTS Perfumania does not provide forecasts of future financial performance. Forward-looking statements in this Annual Report are made pursuant to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995, and, in connection therewith, the Company wishes to caution readers that the following important factors, among others, in some cases have affected and in the future could affect the Company's actual results and could 13 14 cause such results to differ materially from those expressed in forward-looking statements made by or on behalf of the Company. Seasonality. The Company has historically experienced higher sales in the third and fourth fiscal quarters than in the first and second fiscal quarters. Significantly higher fourth fiscal quarter retail sales result from increased purchases of fragrances as gift items during the Christmas holiday season. The Company's quarterly results may also vary due to the timing of new store openings, net sales contributed by new stores and fluctuations in comparable sales of existing stores. A variety of factors affect the sales levels of new and existing stores, including the retail sales environment and the level of competition, the effect of marketing and promotional programs, acceptance of new product introductions, adverse weather conditions and general economic conditions. Lack of Long-term Agreements With Suppliers. The Company's success depends to a large degree on its ability to provide an extensive assortment of brand name and designer fragrances. The Company has no long-term purchase contracts or other contractual assurance of continued supply, pricing or access to new products. While the Company believes it has good relationships with its vendors, the inability to obtain merchandise from one or more key vendors on a timely basis, or a material change in the Company's ability to obtain necessary merchandise could have a material adverse effect on its results of operations. Dependence on Line of Credit. As discussed above, the Company experiences significant seasonal fluctuations in its sales and operating results, as is common with many specialty retailers. The Company utilizes its line of credit to fund inventory purchases and to support new retail store openings. Any future limitation on the Company's borrowing ability and access to financing could limit the Company's ability to open new stores and to obtain merchandise on satisfactory terms. The Company has violated certain debt covenants contained in its bank line of credit agreement. On July 14, 1999, the Company obtained a waiver of default from the bank through September 30, 1999 and for the year ended January 30, 1999. See additional discussion under "Liquidity and Capital Resources." Dependence on Key Personnel. Jerome Falic, the Company's President, is primarily responsible for the Company's merchandise purchases, and has developed strong, reliable relationships with suppliers, as well as customers of the Wholesale division in the United States, Europe, Asia and South America. The loss of service his, or any of the Company's other current executive officers could have a material adverse effect on the Company. Qualified Accountants' Report. In reporting on the Company's audited consolidated financial statements as of January 30, 1999 and January 31, 1998 and for each of the three years in the period ended January 30, 1999, the report of the Company's independent accountants contained an explanatory paragraph indicating factors which create substantial doubt about the Company's ability to continue as a going concern. Such factors include recurring net losses in fiscal 1998 and 1997 and a default on the Company's bank line of credit agreement as a result of the Company's violation of certain debt covenants. On July 14, 1999 the Company obtained a waiver of default from the bank through September 30, 1999 as of and for the year ending January 30, 1999. Ability to Manage Growth. While the Company has grown significantly in the past several years, there is no assurance that the Company will sustain the growth in the number of retail stores and revenues that it has achieved historically. The Company's growth is dependent, in large part, upon the Company's ability to open and operate new retail stores on a profitable basis, which in turn is subject to, among other things, the Company's ability to secure suitable store sites on satisfactory terms, the Company's ability to hire, train and retain qualified management and other personnel, the availability of adequate capital resources and the successful integration of new stores into existing operations. There can be no assurance that the Company's new stores will achieve sales and profitability comparable to existing stores, or that the opening of new locations will not cannibalize sales at existing locations. Litigation. As is often the case in the fragrance and cosmetics business, some of the merchandise purchased by suppliers such as the Company may have been manufactured by entities who are not the owners of the trademarks or copyrights for the merchandise. If the Company were called upon or challenged by the owner of a particular trademark or copyright to demonstrate that the specific merchandise was produced and sold with the proper authority and the Company were unable to do so, the Company could, among other things, be restricted from 14 15 reselling the particular merchandise or be subjected to other liabilities, which could have an adverse effect on the Company's business and results of operations. Year 2000 Readiness. The Year 2000 issue is the result of computer and other business systems being written using two digits rather than four to represent the year. Many of our time sensitive applications and business systems and the applications and business systems of our business partners may recognize a date using "00" as the year 1900 rather than the year 2000, which could result in system failure or disruption of operations. Although the Year 2000 problem will impact us and our business partners, we have made a preliminary assessment of our Year 2000 exposure and, primarily because our major management information systems are in the process of being upgraded, we believe we will be able to achieve Year 2000 readiness for our internal systems by the fourth quarter of 1999. We are also developing a plan of communication with our significant business partners to obtain appropriate assurances that the Year 2000 issues are resolved in a timely manner. We believe that we will satisfactorily resolve all significant Year 2000 problems and that the related costs will not be material. However, our estimates of Year 2000 related costs are based on numerous assumptions, including the continued availability of certain resources, the ability to acquire accurate information regarding third party suppliers and the ability to correct all relevant applications and third party modification plans. We may not achieve our estimated costs and actual costs could differ materially from those anticipated. Moreover, the failure of a major vendor's systems to operate properly with respect to the Year 2000 problem on a timely basis or a Year 2000 conversion that is incompatible with our systems could seriously harm our business, financial condition and results of operations. In addition, a significant portion of our stores' purchases are made with credit cards, and our operations may be seriously harmed if our customers are unable to use their credit cards due to Year 2000 problems that are not remedied by their credit card vendors. We are preparing contingency plans which will include the identification of our most reasonably likely worst case scenarios. Currently, the most reasonably likely sources of risk to us include (a) the disruption of our internal inventory management system, (b) the inability of principal suppliers or logistics providers to be Year 2000-ready, which could result in delays in product deliveries from the suppliers or logistics providers, and (c) failure of systems and necessary infrastructure including electricity supply. We are preparing plans to flow inventory around an assumed period of disruption to our stores, which could include accelerating distribution of high volume merchandise and critical products to reduce the impact of significant failure. Other. We have been characterized as an insider as defined by the United States Bankruptcy Code, in the liquidating plan of reorganization filed on April 6, 1998 by L. Luria & Son, Inc. in the United States Bankruptcy Court, Southern District of Florida. In October 1998, the committee of unsecured creditors in Luria's bankruptcy proceedings filed a complaint with the United States Bankruptcy Court, Southern District of Florida. The complaint alleges that Luria's made preference payments, as defined by the Bankruptcy Court, to us. The complaint seeks recovery of the preference payments, and disallows any and all of our claims against Luria's until we have made full payment of the preference payments. In July 1999, we agreed with the committee of unsecured creditors to settle all claims held by Luria's against us for the sum of $1.2 million, payable over the next nine months according to a repayment schedule. This settlement is subject to the approval of the Bankruptcy Court. The full amount of the settlement was accrued for in our financial statements for the years ending January 31, 1998 and January 30, 1999. In December 1993, the patent holder and exclusive licensee in the U.S. of Boucheron filed a complaint against us in the United States District Court for the Southern District of New York alleging that the Company infringed upon their exclusive right to sell the Boucheron bottle and is seeking $1.5 million in damages. Their theory is that they have a valid patent for the bottles and that our sales of such bottles infringes upon their patent rights. The Company believes that a patentee cannot control by resort to an infringement suit the resale of a patented article which it has sold. The Company filed a motion to dismiss during February 1994. On March 20, 1995, the court denied our motion to dismiss, and on April 14, 1995, the Company filed an answer to the complaint. Discovery is in progress. 15 16 RESTATEMENT OF 1996 NET INCOME PER COMMON SHARE TO REFLECT RECENT SEC ANNOUNCEMENT REGARDING CERTAIN TREATMENT OF CONVERTIBLE DEBT TRANSACTIONS In a 1997 announcement, the staff of the Securities and Exchange Commission ("SEC") indicated that when debt is convertible at a discount from the then current common stock market price, the discounted amount reflects at that time an incremental yield, e.g. a "beneficial conversion feature", which should be recognized as a return to the debt holders. In March 1996, the Company issued $3,000,000 of 5% Convertible Debentures (the "Debentures") in a Regulation S offering to non-U.S. persons. The debentures were convertible into shares of common stock of the Company at any time after May 21, 1996. Based on the market price of the Company's common stock, the debentures had a beneficial conversion feature of $529,412 at such point in time. Because of the SEC announcement, the Company has restated its 1996 net income and net income per common share information to reflect such accounting treatment. The net effect of the restatement represents a non-cash interest charge in the determination of net income. COMPARISON OF FISCAL YEARS 1998 AND 1997 NET SALES Net sales increased 7.1% from $163.6 million in fiscal year 1997 to $175.3 million in fiscal year 1998. The increase in net sales during fiscal year 1998 was due to a 4.0% increase in retail sales (from $129.6 million to $134.8 million), and a 18.9% increase in wholesale sales (from $34.0 million to $40.5 million). The increase in retail sales was principally due to an increase in the number of stores operated during fiscal year 1998 compared to fiscal year 1997, as comparable store sales were flat compared to the prior year. We believe that various sales promotions held during the year to stimulate sales and reduce inventory levels resulted in lower average sales per customer, which contributed to the flat comparable store sales. We operated 289 and 285 stores at the end of fiscal years 1998 and 1997, respectively. The increase in wholesale sales was due to our efforts to reduce inventory levels of certain non-designer fragrances. GROSS PROFIT Gross profit decreased 2.1% from $66.0 million in fiscal year 1997 (40.3% of total net sales) to $64.6 million in fiscal year 1998 (36.9% of total net sales) as a result of higher inventory loss provisions (see below), higher sales and gross profit in the retail division offset by lower gross profit in the wholesale division. Gross profit for the wholesale division decreased from $7.9 million in fiscal year 1997 to $7.5 million in fiscal year 1998 due mainly to a $330,000 increase in inventory provisions. The wholesale division's gross margin in fiscal 1998 was 18.6% compared to 23.3% in fiscal year 1997. The decrease in gross margin was due to the increase in sales of non-designer fragrances in the wholesale division and the overall ratio of wholesale sales to retail sales in fiscal year 1998. Wholesale sales historically yield a lower gross margin when compared to retail sales. Gross profit for the retail division decreased 1.7% from $58.0 million in fiscal year 1997 to $57.1 million in fiscal year 1998, principally as a result of $1.6 million increase in the inventory provision, offset by higher retail sales volume. As a percentage of net retail sales, gross profit for the retail division decreased from 44.8% in fiscal year 1997 to 42.3% in fiscal year 1998. The decrease was due to store promotions discussed above as well as increases in the inventory provisions, freight expense and inventory shrinkage. Inventory provisions were increased to bring the carrying cost of certain non-designer fragrance merchandise to their estimated carrying values. The Company will reduce inventory levels of this non-designer fragrance merchandise in fiscal year 1999. Freight expenses increased primarily due to the necessity of shipping merchandise from the Company's distribution center to its retail stores using express freight service during the 1998 holiday season. This resulted from a temporary failure in our inventory management system to properly replenish the merchandise at our retail stores. Inventory shrinkage increased due to the replenishment situation discussed above and increased movement of inventory due to the closing of 32 retail stores. We expect these expenses to decrease in fiscal year 1999 because non-designer fragrance merchandise will be reduced to a minimum, the management information system will be upgraded in fiscal year 1999 and the Company will not be closing a significant number of retail stores. Furthermore, we have 16 17 hired additional loss prevention and distribution center management personnel to ensure that shrinkage expense is reduced to an acceptable level. OPERATING EXPENSES Operating expenses increased $4.9 million in fiscal year 1998 compared to fiscal year 1997, due principally to (a) a $8.3 million increase in selling, general and administrative expenses, which includes a charge of $1.9 million related to severance agreements with two executive officers and (b) a $1.0 million provision for disposition of fixed assets relating to retail stores which were either closed during fiscal year 1998, or are scheduled to close during fiscal year 1999. We do not expect to incur a significant provision for disposition of fixed assets in fiscal year 1999 as the fixed assets for all stores expected to be closed in fiscal year 1999 were expensed in fiscal year 1998. The increase in selling, general and administrative expense was primarily the result of increases in rent, payroll and other costs associated with the operation of an average of 10 additional stores during fiscal year 1998. Depreciation and amortization decreased $0.2 million in fiscal year 1998 compared to fiscal year 1997. As a percentage of net sales, operating expenses decreased from 44.7% in fiscal year 1997 to 44.6% in fiscal year 1998. INTEREST EXPENSE Interest expense (net) increased 4.0% from $4.7 million in fiscal year 1997 to $4.9 million in fiscal 1998. The increase was principally due to increased use of lease financing for new store furniture and fixtures. See "Liquidity and Capital Resources." INCOME TAXES The provision for income taxes in fiscal 1998 was $1.3 million, which includes an increase in the valuation allowance of $1.2 million to provide fully for the net deferred tax assets since management believes that it is more likely than not that these amounts will not be realized due to our recurring losses. As a result of the foregoing, we had a net loss of $19.0 million in fiscal 1998 compared to a net loss of $11.4 million in fiscal 1997. COMPARISON OF FISCAL YEARS 1997 AND 1996 NET SALES Net sales increased 17.8% from $138.9 million in fiscal year 1996 to $163.6 million in fiscal year 1997. The increase in net sales during fiscal year 1997 was due to a 19.3% increase in retail sales (from $108.6 million to $129.6 million), and a 12.3% increase in wholesale sales (from $30.3 million to $34.0 million). The increase in retail sales was principally due to an increase in the number of stores operated during fiscal year 1997 compared to fiscal year 1996, as comparable store sales were flat compared to the prior year. We believe that various promotions held during the year to stimulate sales and reduce and rebalance inventory levels resulted in lower average sales per customer, which contributed to the flat comparable store sales. We operated 285 and 262 stores at the end of fiscal years 1997 and 1996, respectively. GROSS PROFIT Gross profit increased 10.0% from $60.0 million in fiscal year 1996 (43.2% of total net sales) to $66.0 million in fiscal year 1997 (40.3% of total net sales) as a result of higher sales and gross profit in both the wholesale and retail divisions. Gross profit for the wholesale division increased from $7.6 million in fiscal year 1996 to $7.9 million in fiscal year 1997. The wholesale division's gross margin in fiscal 1997 was 23.3% compared to 25.1% in fiscal year 1996. Gross profit for the retail division increased 10.9% from $52.3 million in fiscal year 1996 to $58.0 million in fiscal year 1997, principally as a result of higher retail sales volume. As a percentage of net retail sales, gross 17 18 profit for the retail division decreased from 48.2% in fiscal year 1996 to 44.8% in fiscal year 1997. The decrease was due to promotions discussed above as well as a $1.3 million increase in inventory provisions. Inventory provisions were increased to bring the carrying cost of certain non-designer fragrance merchandise to their estimated carrying values. OPERATING EXPENSES Operating expenses increased $20.6 million in fiscal year 1997 compared to fiscal year 1996, due principally to (a) a $16.1 million increase in selling, general and administrative expenses, which includes $1.7 million of losses suffered from operating Perfumania's Nature's Elements stores before their conversion and/or closure, (b) a $2.4 million increase in provision for impairment of assets and store closing and (c) a $1.2 million write off of accounts receivable from L. Luria & Son, Inc. The increase in selling, general and administrative expense was primarily the result of increases in rent, payroll and other costs associated with the operation of an average of 64 additional stores during fiscal year 1997. The average number of stores during fiscal 1997 includes 20 temporary holiday-only stores. We intend to continue to use temporary stores in an effort to reduce our inventories. The increase in provision for doubtful account occurred primarily because of increased write-offs of wholesale accounts receivable. See "Liquidity and Capital Resources." After performing a review of certain retail store locations with significant negative cash flows, we recognized a non-cash impairment charge of $2.2 million, representing a reduction of the carrying amounts of fixed assets at those store locations to their estimated recoverable amounts. We also recorded a loss of $0.3 million on disposition of fixed assets relating to retail stores which were closed during fiscal year 1997. Due to the heavy concentration of sales in the fourth quarter of each fiscal year, we do not believe it is meaningful to make impairment determinations on an interim basis during the year. Depreciation and amortization increased $0.9 million in fiscal year 1997 compared to fiscal year 1996, due to increased fixed assets associated with retail stores. As a percentage of net sales, operating expenses increased from 38.0% in fiscal year 1996 to 44.7% in fiscal year 1997 due to the above reasons. INTEREST EXPENSE Interest expense (net) increased 14.3% from $4.2 million in fiscal year 1996 to $4.7 million in fiscal 1997. The increase was principally due to the increase in our line of credit from $30 to $35 million during fiscal 1997, as well as increased use of lease financing for new store furniture and fixtures, offset by a one-time non-cash interest charge of $529,412 for a beneficial conversion feature of convertible debt in fiscal 1996 (see Note 11 to the consolidated financial statements). See "Liquidity and Capital Resources". INCOME TAXES The benefit for income taxes in fiscal 1997 was $0.3 million, which includes an increase in the valuation allowance of $3.4 million for deferred tax assets due to their uncertain realization. As a result of the foregoing, we had a loss before cumulative effect of a change in accounting principle of $10.8 million in fiscal 1997 compared to a net income of $2.1 million in fiscal 1996. LIQUIDITY AND CAPITAL RESOURCES Our principal capital requirements are to fund inventory purchases and for new store openings. We financed these capital requirements primarily through borrowings under our working capital lines of credit, cash flows from operations, lease financing of store furniture and fixtures and short-term borrowings from related parties and other individuals. On May 15, 1998, we extended our $35 million revolving line of credit facility with LaSalle National Bank, from April 1999 to April 2001. Advances made under the line of credit are based on a formula of eligible inventories and receivables, bear interest at 2% above the bank's prime rate (9.75% at January 30, 1999, however, see discussion below regarding events of default and default rate interest), and are payable on demand. Advances are secured by a first lien on all of our assets and assignment of a life insurance policy on one of our officers. 18 19 Our $35 million line of credit contains covenants requiring the maintenance of minimum tangible net worth and book value and the achievement of specified levels of quarterly results of operations. The line of credit also contains limitations on additional borrowings, capital expenditures, number of new store openings and purchases of treasury stock and prohibits distribution of dividends. As of January 30, 1999, we were in violation of some of the above covenants and, as a result of these violations, were in default under the line of credit agreement. As a result, the Company incurred the default rate of interest, prime plus 4% (11.75% at January 30, 1999) beginning December 1998 and the bank can demand payment of the amounts outstanding under the line of credit agreement. The violations consist primarily of the Company failing to maintain the minimum tangible net worth and net income levels established by the financial covenants, purchasing treasury stock and exceeding the limit on new store openings. On July 14, 1999, the Company obtained a waiver of default from the bank through September 30, 1999 as of and for the year ended January 30, 1999. Future outstanding borrowings will bear interest at the prime rate plus four percent. The bank agreed to less restrictive covenants provided that certain events commence prior to September 30, 1999. One such event includes that perfumania.com, inc. (a wholly-owned subsidiary) is to receive at least $10 million from a contemplated initial public offering of its shares, of which at least $2 million is to be repaid to the Company. Management believes that the conditions included in the waiver will be met by September 30, 1999, however, there can be no assurance of this. Should we be unable to meet these conditions, we may be required to repay outstanding amounts (totaling approximately $34.8 million as of September 17, 1999) and obtain alternative sources of financing. Although we believe we would be able to obtain a comparable line of credit with another lender, in the interim period, we could also be required to take other actions to reduce our reliance on working capital financing and generate additional working capital, which could include delaying the opening of new stores, reducing inventory purchases and/or reducing our wholesale and retail selling prices to generate more cash. Any such actions, or our failure to obtain additional financing in an amount sufficient to support our current and planned levels of operation, could adversely affect our business and operating results. Management believes that its borrowing capacity under the current bank line of credit facility, or from an alternative line of credit facility, projected cash flows from operations, anticipated proceeds from the initial public offering of perfumania.com, inc. and other short term borrowings will be sufficient to support working capital needs, capital expenditures and debt service for the next twelve months. On August 31, 1999, we entered into a stock purchase agreement with an affiliated Company through common ownership. The agreement calls for the transfer of 1,512,406 shares of our treasury stock to this affiliated company in consideration for a partial reduction of our outstanding trade indebtedness balance of approximately $4.5 million. The transfer price was based on a per share price of $2.98, which approximates 90% of the closing price of our common stock for the previous 20 business days. Pursuant to this agreement the parties entered into a registration rights agreement dated August 31, 1999, which grants the affiliated company demand registration rights. We recorded an extraordinary loss of approximately $314,000 which will be taken to income in the third quarter of fiscal year 1999. In July 1999, we entered into a Securities Purchase Agreement and issued an aggregate of $2 million worth of our Series B Convertible Notes, which are convertible into common stock. The Notes contain a beneficial conversion feature of approximately $981,000 which will be taken by us as a non-cash interest charge to income in the second quarter of fiscal year 1999. The agreement requires us to file a registration statement with the Securities and Exchange Commission within forty-five days after the date of issuance of the convertible notes. The Conversion Price is the lower of (A) $3.40625 per share, subject to adjustment and (B) the floating conversion price determined by multiplying (1) the average closing bid price of the common stock for the three trading days immediately preceding the date of determination, by (2) 80%, subject to adjustment. The conversion price may be adjusted pursuant to antidilution provisions in the convertible note. In July 1999, we obtained a $2.5 million unsecured loan from a wholesale customer bearing an interest rate of 24%. The loan is payable in full December 1999. In April 1999, we entered into a Securities Purchase Agreement and issued an aggregate of $2 million worth of our Series A Convertible Notes, which are convertible into common stock. The Notes contain a beneficial conversion feature of approximately $385,000 which will be taken by us as a non-cash interest charge to income in the first quarter of fiscal year 1999. The agreement requires us to file a registration statement with the Securities and Exchange Commission within forty-five days after the date of issuance of the convertible notes. The conversion price is the lower of (A) $4.35 per share, subject to adjustment and (B) the floating conversion price determined by multiplying (1) the average closing bid price of the common stock for the three trading days immediately preceding the date of determination, by (2) 80%, subject to adjustment. The conversion price may be adjusted pursuant to antidilution provisions in the convertible note. If the conversion price decreases, we are obligated to issue additional shares of common stock. In March 1999, we entered into Subscription Agreements for the sale of 235,293 shares of our common stock to a group of private investors at a price of $8.50 per share. The proceeds of $2 million were received in January 1999. The Subscription Agreements require that we file this registration statement with the Securities and Exchange Commission within six months from the date of the agreement to permit the registered resale of the shares by the investors in open market transactions. If, on the effective date of the registration statement, the market price is less than $8.50 per share, we are obligated to reimburse the investor group the lesser of (a) the product of the difference between $8.50 and the closing bid price of the common stock on the effective date of this registration statement multiplied by the number of shares issued under the Subscription Agreements or (b) the product of $2.00 multiplied by the number of shares issued under the Subscription Agreements. As of January 30, 1999, the potential redeemable amount of $470,588 was recorded as redeemable common equity and the remaining $1,529,412 was recorded as capital in excess of par value in the accompanying balance sheets. 19 20 On March 21, 1996, we sold 180,000 shares of common stock for approximately $956,000 in a private placement. On March 25, 1996, we issued $3,000,000 of 5% Convertible Debentures in a Regulation S offering to non-U.S. persons. The debentures were convertible at any time after May 21, 1996 into shares of common stock, at a conversion price for each share of common stock equal to eighty-five percent of the market price of the common stock on the date of conversion, not to exceed $8.50 per share of common stock. The debentures were converted to approximately 918,000 shares of the common stock in the second quarter of fiscal 1996. See Note 11 of the consolidated financial statements. In fiscal year 1998, net cash provided by operating activities was approximately $13.0 million, which was primarily due to our reduction in inventories and receivables. Trade receivables primarily relate to our wholesale business. Trade receivables due from customers at January 30, 1999 were $4.1 million. At fiscal year end 1998, approximately $1.3 million of the trade receivables, net, were more than 90 days past due. Allowance for doubtful accounts was approximately $0.7 million at January 30, 1999 and was considered adequate by management based on its write-off experience during the last three years and an analysis of the aging of its trade receivables at January 30, 1999. During fiscal year 1998, inventories decreased by approximately $15.5 million due to (a) our efforts to reduce inventory levels and (b) an inventory provision during the fourth quarter of $3.8 million related primarily to non-designer fragrances Perfumania intends to liquidate in fiscal 1999. Net cash used in investing activities in fiscal year 1998 was approximately $9.5 million, principally due to capital expenditures related to opening new stores and renovation of existing stores. We intend to slow our growth and open only 7 stores in fiscal 1999 versus 36 stores in fiscal 1998. In addition, we do not plan any significant renovations of existing stores in fiscal 1999, whereas 18 Nature's stores were completely remodeled in fiscal 1998. Thus, store-related capital expenditures for fiscal 1999 are projected to be significantly lower than fiscal 1998. Although we intend to upgrade various components of our management information systems and will also make various hardware and software enhancements, total capital expenditures for fiscal 1999 are projected to be $4.0 million of which approximately $1.8 million pertains to new store openings and $2.2 million pertains to hardware, software and other corporate improvements. Currently, our average capital expenditure for opening a store is approximately $175,000, including furniture and fixtures, equipment and other items, which average approximately $50,000 per store, build-out costs, which average approximately $120,000 per store, and pre-opening expenses, such as the hiring and training of new employees and travel, which average approximately $5,000 per store. In addition, initial inventory (not including inventory replenishment) in a new store ranges from approximately $100,000 during the first fiscal quarter to approximately $140,000 during the Christmas holiday season. Wholesale inventory levels vary significantly during the fiscal year depending upon availability, price and selection of merchandise available for purchase, and seasonality. We generally carry at least four months' supply of inventory for our retail and wholesale divisions. We also repurchased approximately 294,000 shares of our common stock for $0.9 million in fiscal 1998. SEASONALITY AND QUARTERLY RESULTS Our operations have historically been seasonal, with generally higher sales in the third and fourth fiscal quarters than in the first and second fiscal quarters. Significantly higher fourth fiscal quarter retail sales result from increased purchases of fragrances as gift items during the Christmas holiday season. Our quarterly results may also vary due to the timing of new store openings, net sales contributed by new stores and fluctuations in comparable sales of existing stores. Wholesale sales vary by fiscal quarter as a result of the selection of merchandise available for sale and the need for us to stock our retail stores for the Christmas holiday season. Therefore, the results of any interim period are not necessarily indicative of the results that may be expected during a full fiscal year. See Note 15 of the Notes to Consolidated Financial Statements for additional information regarding quarterly financial data. 20 21 YEAR 2000 COMPLIANCE The following critical application systems areas are the focus of our Y2K compliance efforts: (a) merchandising, (b) inventory management and distribution, (c) point-of-sales systems, (d) human resources and (e) finance and accounting. The merchandising and finance and accounting systems are currently being upgraded utilizing vendor software certified as Y2K compliant. The inventory management and distribution systems as well as the point-of-sales and human resources systems will be upgraded in the third quarter of 1999. Our hardware and communications network is currently being inventoried, assessed, and where instances of non-compliance are noted, upgraded and tested. We have not incurred material costs to date in the process, and do not believe that the cost of additional actions will have a material effect on our operating results or financial condition. However, we have established a budget totaling approximately $1.5 million for the acquisition of computer hardware and software that will assist in the Year 2000 assessment and remediation activities to be completed no later than the third quarter of 1999. Our current systems may contain undetected errors or defects with Year 2000 date functions that may result in material costs. In addition, we use third-party equipment and software, including non-information technology systems, such as facilities and distribution equipment, that may not be Year 2000 compliant. Failure of third-party equipment, software or content to operate properly with regard to the Year 2000 issue could require us to incur unanticipated expenses to remedy problems, which could have a material adverse effect on our business, operating results and financial condition. We are currently assessing whether third parties in our supply and distribution chain are adequately addressing their Year 2000 compliance issues. We have initiated formal communications with our significant suppliers and service providers to determine the extent to which our systems may be vulnerable if suppliers and providers fail to address and correct their own Year 2000 issues. We cannot guarantee that the systems of suppliers or other companies on which we rely will be Year 2000 compliant. We will track the Year 2000 compliance status of our material vendors and suppliers via our own internal vendor compliance effort. Year 2000 correspondence will be sent to critical vendors and suppliers by the second quarter of 1999, with continued follow up for those who fail to respond. All vendor responses will be evaluated to assess any possible risk to or effect on our operations. Prior to mid 1999, we expect to implement additional procedures for assessing the Year 2000 compliance status of our most critical vendors and will modify our contingency plans accordingly. We are preparing contingency plans which will include the identification of our most reasonably likely worst case scenarios. Currently, the most reasonably likely sources of risk to us include (a) the disruption of our internal inventory management system, (b) the inability of principal suppliers or logistics providers to be Year 2000-ready, which could result in delays in product deliveries from such suppliers or logistics providers and (c) failure of hardware and software utilized by transportation vendors as a result of a general failure of systems and necessary infrastructure such as electricity supply. We are preparing plans to flow inventory around an assumed period of disruption to our stores, which could include accelerating distribution of high volume merchandise and critical products to reduce the impact of significant failure. Based on our current assessment efforts, we do not believe that Year 2000 issues will have a material adverse effect on our financial condition or results of operations. However, our Year 2000 issues and any potential business interruptions, costs, damages or losses related thereto, are dependent, to a significant degree, upon the Year 2000 compliance of third parties, such as government agencies, vendors and suppliers. Consequently, we are unable to determine at this time whether Year 2000 failures will materially affect our business. We believe that our compliance efforts have and will reduce the impact of any failures. RECENT ACCOUNTING STANDARDS. In June 1997, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards No. 130 ("SFAS 130"), "Reporting Comprehensive Income," which establishes standards for reporting and display of comprehensive income and its components. In June 1997, the FASB also issued Statement of 21 22 Financial Accounting Standards No. 131 ("SFAS 131"), "Disclosures about Segments of an Enterprise and Related Information." This Statement establishes standards for reporting information about a company's operating segments and related disclosures about its products, services, geographic areas of operations and major customers. Both Statements were adopted by us in 1998. In March 1998, the AICPA issued Statement of Financial Position 98-1, ("SOP 98-1") "Accounting for the Costs of Computer Software Developed or Obtained for Internal Use." SOP 98-1 provides guidance for capitalization of certain costs incurred in the development of internal-use software and is effective for financial statements for years beginning after December 15, 1998. SOP 98-1 was adopted in fiscal 1998 and had no significant impact on the results of operations, cash flows or financial position. In April 1998, the American Institute of Certified Public Accountants issued Statement of Position 98-5 ("SOP 98-5"), "Reporting on the Costs of Start-Up Activities," which requires us to expense preopening expenses as incurred. We early adopted SOP 98-5 in fiscal year 1997. See Note 2 of Notes to Consolidated Financial Statements. In June 1998, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 133 "Accounting for Derivative Instruments and Hedging Activities" ("SFAS No. 133"). Among other provisions, SFAS No. 133 establishes accounting the reporting standards for derivative instruments and for hedging activities. It also requires that an entity recognize all derivatives as either assets or liabilities in the statement of financial position and measure those instruments at fair value. SFAS No. 133 is effective for financial statements for fiscal years beginning after June 15, 2000. Management has not determined the effect, if any, of adopting SFAS No. 133. CHANGES IN FOREIGN EXCHANGE RATES CREATE RISK. Although large fluctuations in foreign exchange rates could have a material effect on the prices we pay for products we purchase from outside the United States, the prices obtainable for sales denominated in foreign currencies and wholesale sales to foreign customers, such fluctuations have not been material to our results of operations to date. Transactions with foreign suppliers generally are in United States dollars. We believe that inflation has not had a material impact on our results of operations and that we are generally able to pass through any cost increases in the form of increased sales prices. ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISKS The Company's exposure to market risk for changes in interest rates relates primarily to its bank line of credit. The bank line of credit bears interest at a variable rate, as discussed above under "Liquidity and Capital Resources". The Company mitigates interest rate risk by continuously monitoring the interest rates. The table below presents the outstanding principal amount and the related fair value, together with maturity date as of January 30, 1999 and the weighted average interest rate for the Company's bank line of credit. (See "Liquidity and Capital Resources" and Notes 2 and 8 of the Notes to Consolidated Financial Statements.)
OUTSTANDING WEIGHTED PRINCIPAL AVERAGE AMOUNT FAIR VALUE INTEREST RATE MATURITY DATE ----------- ---------- ------------- ------------- Bank Line of Credit..................... $30,035,019 $30,035,019 10.83% April 2001
22 23 ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA The financial information and the supplementary data required in response to this Item are as follows:
PAGE ---- Report of Independent Certified Public Accountants................................................ 24 Consolidated Balance Sheets as of January 30, 1999 and January 31, 1998........................... 25 Consolidated Statements of Operations for the Fiscal Years Ended January 30, 1999, January 31, 1998 and February 1, 1997...................................................................... 26 Consolidated Statements of Changes in Stockholders' Equity for the Fiscal Years Ended January 30, 1999, January 31, 1998 and February 1, 1997.................................................... 27 Consolidated Statements of Cash Flows for the Fiscal Years Ended January 30, 1999, January 31, 1998 and February 1, 1997...................................................................... 28 Notes to Consolidated Financial Statements........................................................ 29 Schedule II - Valuation and Qualifying Accounts and Reserves...................................... 45
23 24 REPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS To the Board of Directors and Stockholders of Perfumania, Inc. In our opinion, the consolidated financial statements listed in the index appearing under Item 8 and Item 14(a)(1) and (2) of this Form 10-K present fairly, in all material respects, the financial position of Perfumania, Inc. and its subsidiaries at January 30, 1999 and January 31, 1998, and the results of its operations and its cash flows for each of the three years in the period ended January 30, 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 financial 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. The accompanying consolidated financial statements have been prepared assuming that the Company will continue as a going concern. As discussed in Note 2 to the consolidated financial statements, the Company has incurred recurring net losses in fiscal 1998 and 1997 and has a working capital deficit of $3.8 million at January 30, 1999. In addition, the Company was in default of its bank line of credit agreement as a result of its violation of certain debt covenants. These debt covenant violations have been subsequently waived by the bank. There is no assurance that the Company will be able to generate future net income or secure a long-term credit facility, which creates substantial doubt about its ability to continue as a going concern. Management's plans in regard to these matters are also described in Note 2. The consolidated financial statements do not include any adjustments that might result from the outcome of this uncertainty. As discussed in Note 11, in 1997 the Company restated its fiscal 1996 net income and net income per common share calculation to comply with new requirements of the Securities and Exchange Commission Staff position on accounting for convertible securities having beneficial conversion features. As explained in Note 2, in 1997 the Company changed its method of accounting for preopening expenses to conform with new requirements of the American Institute of Certified Public Accountants. PricewaterhouseCoopers LLP Miami, Florida April 29, 1999, except for the fourth paragraph of Note 2 and the second paragraph of Note 8 as to which the date is July 14, 1999. 24 25 PERFUMANIA, INC. CONSOLIDATED BALANCE SHEETS
JANUARY 30, JANUARY 31, 1999 1998 ----------- ------------- ASSETS: Current assets: Cash and cash equivalents ................................................ $ 1,745,603 $ 1,554,117 Trade receivables, less allowance for doubtful accounts of $704,954 in 1999 and 1998 .......................................................... 4,108,847 5,186,473 Advances to suppliers .................................................... 8,065,301 7,611,036 Inventories, net of reserve of $4,163,251 and $2,750,000 in 1999 and 1998, respectively ..................................................... 53,880,132 73,137,842 Prepaid expenses and other current assets ................................ 1,417,187 2,044,658 Tax refund receivable .................................................... -- 814,766 Deferred tax asset, net .................................................. -- 1,219,856 ------------ ------------- Total current assets ................................................... 69,217,070 91,568,748 Property and equipment, net ................................................. 23,180,462 18,307,240 Leased equipment under capital leases, net .................................. 1,373,878 2,266,674 Other assets, net ........................................................... 1,357,966 1,764,906 ------------ ------------- Total assets ........................................................... $ 95,129,376 $ 113,907,568 ============ ============= LIABILITIES AND STOCKHOLDERS' EQUITY: Current liabilities: Bank line of credit and current portion of notes payable ................. $ 32,800,627 $ 34,139,766 Accounts payable - non-affiliates ........................................ 14,329,013 13,308,914 Accounts payable - affiliates ............................................ 15,812,240 16,958,163 Accrued expenses and other liabilities ................................... 9,205,316 6,848,923 Income taxes payable ..................................................... 485,098 505,098 Current portion of obligations under capital leases ...................... 419,487 1,030,340 Due to related parties ................................................... -- 304,483 ------------ ------------- Total current liabilities .............................................. 73,051,781 73,095,687 Long-term portion of notes payable .......................................... 2,370,684 4,709,434 Long-term portion of obligations under capital leases ....................... 562,552 933,615 Long-term severance payables ................................................ 1,037,859 -- ------------ ------------- Total liabilities ...................................................... 77,022,876 78,738,736 Commitments and contingencies ............................................... -- -- Redeemable common equity (Note 11) .......................................... 470,588 -- Stockholders' equity: Preferred stock, $.01 par value, 1,000,000 shares authorized, none issued ................................................................. -- -- Common stock, $.01 par value, 25,000,000 shares authorized, 8,614,491 and 7,845,291 shares issued at 1999 and 1998, respectively ............. 86,145 78,453 Capital in excess of par value ........................................... 54,440,009 52,386,361 Treasury stock, at cost, 1,512,406 and 1,218,360 shares at 1999 and 1998, respectively ..................................................... (5,413,002) (4,521,068) Accumulated deficit ...................................................... (30,935,097) (11,960,599) Notes and interest receivable from shareholder and officers .............. (542,143) (814,315) ------------ ------------- Total stockholders' equity ............................................. 17,635,912 35,168,832 ------------ ------------- Total liabilities and stockholders' equity ............................. $ 95,129,376 $ 113,907,568 ============ =============
See accompanying notes to consolidated financial statements. 25 26 PERFUMANIA, INC. CONSOLIDATED STATEMENTS OF OPERATIONS
FISCAL YEAR ENDED ------------------------------------------------------ JANUARY 30, JANUARY 31, FEBRUARY 1, 1999 1998 1997 ------------- ------------- ------------- (AS RESTATED, NOTE 11) Net sales: Non-affiliated customers ................................. $ 175,255,633 $ 161,593,736 $ 136,446,104 Affiliates ............................................... -- 1,999,823 2,473,623 ------------- ------------- ------------- 175,255,633 163,593,559 138,919,727 ------------- ------------- ------------- Cost of goods sold: Non-affiliated customers ................................. 110,638,432 96,053,329 76,706,903 Affiliates ............................................... -- 1,566,489 2,252,850 ------------- ------------- ------------- 110,638,432 97,619,818 78,959,753 ------------- ------------- ------------- Gross profit ............................................... 64,617,201 65,973,741 59,959,974 ------------- ------------- ------------- Operating expenses: Selling, general and administrative expenses ............. 72,501,987 64,219,379 48,165,392 Provision for doubtful accounts .......................... -- 1,730,000 500,000 Provision for impairment of assets and store closings .... 1,034,717 2,514,818 169,159 Depreciation and amortization ............................ 4,480,681 4,697,816 3,771,508 ------------- ------------- ------------- Total operating expenses ............................ 78,017,385 73,162,013 52,606,059 ------------- ------------- ------------- Income (loss) from operations before other income (expense) ............................................... (13,400,184) (7,188,272) 7,353,915 ------------- ------------- ------------- Other income (expense): Interest expense: Affiliates ............................................. (22,486) (124,250) (148,647) Other .................................................. (4,938,365) (4,617,070) (4,004,754) ------------- ------------- ------------- (4,960,851) (4,741,320) (4,153,401) ------------- ------------- ------------- Interest income: Affiliates ............................................. 43,440 42,450 39,480 Other .................................................. 35,057 2,660 3,499 ------------- ------------- ------------- 78,497 45,110 42,979 ------------- ------------- ------------- Other income ............................................. 645,446 762,138 478,179 ------------- ------------- ------------- Total other income (expense) ............................... (4,236,908) (3,934,072) (3,632,243) ------------- ------------- ------------- Income (loss) before income taxes .......................... (17,637,092) (11,122,344) 3,721,672 (Provision) benefit for income taxes ....................... (1,337,406) 321,192 (1,646,731) ------------- ------------- ------------- Income (loss) before cumulative effect of change in accounting principle .................................... (18,974,498) (10,801,152) 2,074,941 Cumulative effect of change in accounting principle, net of income tax benefit of $380,958 ....................... -- (631,418) -- ------------- ------------- ------------- Net income (loss) .......................................... $ (18,974,498) $ (11,432,570) $ 2,074,941 ============= ============= ============= Basic income (loss) per common share: Income (loss) before cumulative effect of change in accounting principle .................................... $ (2.85) $ (1.54) $ 0.29 Cumulative effect of change in accounting principle ........ -- (0.09) -- ------------- ------------- ------------- Net income (loss) .......................................... $ (2.85) $ (1.63) $ 0.29 ============= ============= ============= Diluted income (loss) per common share: Income (loss) before cumulative effect of change in accounting principle .................................... $ (2.85) $ (1.54) $ 0.27 Cumulative effect of change in accounting principle ........ -- (0.09) -- ------------- ------------- ------------- Net income (loss) .......................................... $ (2.85) $ (1.63) $ 0.27 ============= ============= ============= Weighted average number of shares outstanding: Basic .................................................... 6,659,882 7,025,236 7,183,462 ============= ============= ============= Diluted .................................................. 6,659,882 7,025,236 7,633,588 ============= ============= =============
See accompanying notes to consolidated financial statements. 26 27 PERFUMANIA, INC. CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY FOR THE FISCAL YEAR ENDED FEBRUARY 1, 1997 (AS RESTATED, NOTE 11) FISCAL YEAR ENDED JANUARY 31, 1998 AND FISCAL YEAR ENDED JANUARY 30, 1999
COMMON STOCK CAPITAL IN TREASURY STOCK ------------- EXCESS OF --------------- SHARES AMOUNT PAR VALUE SHARES AMOUNT ------ ------ --------- ------ ------ Balance at February 3, 1996 ............ 6,707,700 $67,077 $ 47,959,464 23,000 $ (123,323) Exercise of stock options .............. 2,000 20 8,230 -- -- Conversion of debentures ............... 918,091 9,181 2,978,085 -- -- Beneficial conversion feature of debentures ............... -- -- 529,412 -- -- Issuance of common stock ............... 180,000 1,800 954,450 -- -- Purchases of treasury stock ........... -- -- -- 644,900 (2,531,787) Net change in notes and interest receivable from shareholder and officers ............................ -- -- -- -- -- Net income for the fiscal year ended February 1, 1997 ......... -- -- -- -- -- ---------- ------- ------------ ---------- ----------- Balance at February 1, 1997 ............ 7,807,791 78,078 52,429,641 667,900 (2,655,110) Exercise of stock options .............. 37,500 375 116,812 -- -- Purchases of treasury stock ............ -- -- -- 550,460 (1,865,958) Other .................................. -- -- (160,092) -- -- Net change in notes and interest receivable from shareholder and officers ....... -- -- -- -- -- Net loss for the fiscal year ended January 31, 1998.......... -- -- -- -- -- ---------- ------- ------------ ---------- ----------- Balance at January 31, 1998............. 7,845,291 78,453 52,386,361 1,218,360 (4,521,068) Exercise of stock options .............. 684,200 6,842 310,865 -- -- Purchases of treasury stock............. -- -- -- 294,046 (891,934) Issuance of common stock ............... 85,000 850 213,371 -- -- Proceeds on common stock to be issued ........................ -- -- 1,529,412 -- -- Net change in notes and interest receivable from shareholder and ................ -- -- -- -- -- officers Net loss for the fiscal year ended January 30, 1999 ......... -- -- -- -- -- ---------- ------- ------------ ---------- ----------- Balance at January 30, 1999 ............ 8,614,491 $86,145 $ 54,440,009 1,512,406 $(5,413,002) ========== ======= ============ ========== =========== NOTES AND INTEREST RECEIVABLE FROM ACCUMULATED SHAREHOLDER DEFICIT AND OFFICERS TOTAL ----------- ------------ ----------- Balance at February 3, 1996 ............ $ (2,602,970) $(538,065) $ 44,762,183 Exercise of stock options .............. -- -- 8,250 Conversion of debentures ............... -- -- 2,987,266 Beneficial conversion feature of debentures ............... -- -- 529,412 Issuance of common stock ............... -- -- 956,250 Purchases of treasury stock ............ -- -- (2,531,787) Net change in notes and interest receivable from shareholder and officers ............................ -- (4,791) (4,791) Net income for the fiscal year ended February 1, 1997 ......... 2,074,941 -- 2,074,941 ------------ --------- ------------ Balance at February 1, 1997 ............ (528,029) (542,856) 48,781,724 Exercise of stock options .............. -- -- 117,187 Purchases of treasury stock ............ -- -- (1,865,958) Other .................................. -- -- (160,092) Net change in notes and interest receivable from shareholder and ................ -- (271,459) (271,459) officers Net loss for the fiscal year ended January 31, 1998.......... (11,432,570) -- (11,432,570) ------------ --------- ------------ Balance at January 31, 1998 ............ (11,960,599) (814,315) 35,168,832 Exercise of stock options .............. -- -- 317,707 Purchases of treasury stock............. -- -- (891,934) Issuance of common stock ............... -- -- 214,221 Proceeds on common stock to be issued ........................ -- -- 1,529,412 Net change in notes and interest receivable from shareholder and ................ -- 272,172 272,172 officers Net loss for the fiscal year ended January 30, 1999 ......... (18,974,498) -- (18,974,498) ------------ --------- ------------ Balance at January 30, 1999 ............ $(30,935,097) $(542,143) $ 17,635,912 ============ ========= ============
See accompanying notes to consolidated financial statements. 27 28 PERFUMANIA, INC. CONSOLIDATED STATEMENTS OF CASH FLOWS
FISCAL YEAR ENDED ------------------------------------------------------ JANUARY 30, 1999 JANUARY 31, 1998 FEBRUARY 1, 1997 ---------------- ---------------- ---------------- (As restated, Note 11) Cash flows from operating activities: Net income (loss).................................................. $(18,974,498) $ (11,432,570) $ 2,074,941 Adjustments to reconcile net income (loss) to net cash provided by operating activities: Provision for deferred taxes ...................................... 1,219,856 -- 380,528 Capitalized preopening costs ...................................... -- -- (940,550) Provision for doubtful accounts ................................... -- 1,730,000 500,000 Provision/writedown for inventory losses .......................... 3,764,665 1,810,000 190,000 Depreciation and amortization ..................................... 4,480,681 4,697,816 3,771,508 Provisions for impairment of assets ............................... -- 2,200,000 -- Loss on disposition of property and equipment ..................... 1,034,717 314,818 169,159 Beneficial conversion feature of debentures ....................... -- -- 529,412 Cumulative effect of change in accounting principle, net .......... -- 631,418 -- of tax benefit Stock compensation ................................................ 214,221 -- -- Change in operating assets and liabilities, (increase) decrease in: Trade receivables: Customers ..................................................... 1,077,626 5,358,686 716,959 Affiliates .................................................... -- 653,657 (653,657) Advances to suppliers ........................................... (454,265) (2,587,318) (712,058) Inventories ..................................................... 15,493,045 10,162,581 (24,288,235) Prepaid expenses and other current assets ....................... 627,471 (184,818) (707,745) Tax refund receivable ........................................... 814,766 (814,766) -- Other assets .................................................... 406,940 (539,266) (123,998) Increase (decrease) in: Accounts payable ................................................ (125,824) (5,861,438) 17,314,213 Accrued expenses and other liabilities .......................... 2,356,398 2,908,483 1,088,386 Income taxes payable ............................................ (20,006) (816,105) 1,321,203 Long term severance payable ..................................... 1,037,859 -- -- Negative goodwill ............................................... -- (470,000) -- ------------ ------------ ------------ Net cash provided by operating activities ...................... 12,953,652 7,761,178 630,066 ------------ ------------ ------------ Cash flows from investing activities: Additions to property and equipment ............................... (9,495,824) (7,207,114) (7,341,901) ------------ ------------ ------------ Net cash used in financing activities ............................. (9,495,824) (7,207,114) (7,341,901) ------------ ------------ ------------ Cash flows from financing activities: Net borrowings under bank line of credit and loans payable ........ (3,677,888) 2,957,170 7,208,943 Net increase (decrease) in due to related parties ................. (304,483) (465,517) 90,000 Principal payments under capital lease obligations ................ (981,916) (952,805) (639,892) Net advances to shareholder and officers .......................... 272,172 (271,459) (4,791) Issuance of debentures ............................................ -- -- 2,935,361 Proceeds from issuance of common stock ............................ 2,000,000 -- 956,250 Proceeds from exercise of stock options ........................... 317,707 117,187 8,250 Stock issuance costs .............................................. -- (160,092) -- Purchases of treasury stock ....................................... (891,934) (1,865,958) (2,531,787) ------------ ------------ ------------ Net cash (used in) provided by financing activities ............ (3,266,342) (641,474) 8,022,334 ------------ ------------ ------------ Increase (decrease) in cash and cash equivalents ..................... 191,486 (87,410) 1,310,499 Cash and cash equivalents at beginning of period ..................... 1,554,117 1,641,527 331,028 ------------ ------------ ------------ Cash and cash equivalents at end of period ........................... $ 1,745,603 $ 1,554,117 $ 1,641,527 ============ ============ ============
See accompanying notes to consolidated financial statements. 28 29 PERFUMANIA, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS NOTE 1 - NATURE OF BUSINESS: Perfumania, Inc. ("Perfumania") and its subsidiaries (collectively, the "Company") is a specialty retailer and wholesaler of fragrances and related products. The Company's retail stores consist of stores located in regional malls, manufacturer's outlet malls, airports and on a stand-alone basis in suburban strip shopping centers. The number of retail stores in operation at January 30, 1999, January 31, 1998 and February 1, 1997 were 289, 285 and 262, respectively. NOTE 2 - SIGNIFICANT ACCOUNTING POLICIES: Significant accounting principles and practices used by the Company in the preparation of the accompanying consolidated financial statements are as follows: FISCAL YEAR END The Company's fiscal year ends the Saturday closest to January 31 to enable the Company's operations to be reported in a manner which more closely coincides with general retail reporting practices and the financial reporting needs of the Company. In the accompanying notes, fiscal year 1998, 1997 and 1996 refers to the year ended January 30, 1999, January 31, 1998 and February 1, 1997, respectively. 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. The most significant estimates made by management in the accompanying financial statements relate to the allowance for doubtful accounts, inventory reserves, self insurance health care reserves, long-lived asset impairments and estimated useful lives of property and equipment. Actual results could differ from those estimates. BASIS OF PRESENTATION The accompanying consolidated financial statements have been prepared on a going concern basis, which contemplates the realization of assets and the satisfaction of liabilities in the normal course of business. As shown in the consolidated financial statements, the Company incurred net losses of approximately $18.9 million and $11.4 million during the fiscal years ended January 30, 1999 and January 31, 1998, respectively, and has a working capital deficit of $3.8 million at January 30, 1999. In addition, the Company was in violation of certain debt covenants contained in its bank line of credit agreement as of and for the year ended January 30, 1999. These debt covenant violations have been subsequently waived by the bank as of July 14, 1999 (See Note 8). Management's plan to improve the results of operations include decreasing the number of store openings in 1999, closing a number of its non-profitable stores, improving the effectiveness of its sales promotions practices, continuing to improve the existing merchandise mix and to promote the private label bath, body and cosmetic line, continuing to liquidate slow moving inventories and reducing selling, general and administrative expenses. In order to obtain additional funding, the Company plans to make an initial public offering of the common stock of perfumania.com, inc., a wholly owned subsidiary of the Company, to raise approximately $25-$32 million. The net proceeds of the offering will be used for working capital and other general corporate purposes and also repayment of any outstanding indebtedness to the Company as well as reduction of the outstanding balance in the Company's line of credit (See Note 16). Additionally, in April 1999 and July 1999, the Company issued a total of $4 million of convertible notes to a group of private investors and in July 1999 the Company obtained a $2.5 million short-term unsecured loan from a wholesale customer (See Note 16). Although management believes that its borrowing capacity under the current line of credit facility, or from an alternative line of credit facility, projected cash flows from operations, anticipated proceeds from the initial public offering of perfumania.com, inc. and other short term borrowings will be sufficient to support working capital needs, capital expenditures and debt service for the next twelve months, there is no assurance, however, that the Company will be able to improve its results of operations based on management's plan or obtain such funding on a timely basis. These factors among others may indicate that the Company will be unable to continue as a going concern for a reasonable period of time. The consolidated financial statements do not include any adjustments that might result from the outcome of this uncertainty. 29 30 PRINCIPLES OF CONSOLIDATION The consolidated financial statements include the accounts of Perfumania and its subsidiaries. All significant intercompany balances and transactions have been eliminated in consolidation. REVENUE RECOGNITION Revenue from wholesale transactions is recorded upon shipment of inventory. Revenue from retail sales is recorded, net of discounts and estimated returns, upon customer purchase. Estimates of returns are based on the Company's operating history and are reviewed on a quarterly basis for adequacy. ADVANCES TO SUPPLIERS Advances to suppliers represent prepayments to wholesale vendors on pending inventory purchase orders. INVENTORIES Inventories, consisting predominantly of finished goods, are stated at the lower of cost or market, cost being determined on a moving average cost basis. The cost of inventory includes product cost and freight charges. Provision for potentially slow moving or damaged inventory is recorded based on management's analysis of inventory levels, turnover ratios, future sales forecasts and through specific identification of obsolete or damaged merchandise. PROPERTY AND EQUIPMENT Property and equipment is carried at cost, less accumulated depreciation and amortization. Depreciation is calculated using the straight-line method over the estimated useful lives of the related assets. Leasehold improvements are amortized over the term of the lease or the estimated useful lives of the improvements, whichever is shorter. Costs of major additions and improvements are capitalized and expenditures for maintenance and repairs which do not extend the useful life of the asset are expensed when incurred. Gains or losses arising from sales or retirements are included in income currently. PREOPENING EXPENSES Prior to fiscal 1997, the Company capitalized expenses associated with the opening of new retail locations and training of personnel. These costs typically included occupancy costs incurred prior to store opening, travel expenses, store managers' salaries and grand opening costs paid to the mall. The Company amortized these amounts over 18 months. In April 1998, the American Institute of Certified Public Accountants issued Statement of Position 98-5 ("SOP 98-5"), "Reporting on the Costs of Start-Up Activities", which requires the Company to expense preopening expenses as incurred. SOP 98-5 is effective for financial statements for fiscal years beginning after December 15, 1998, does not require restatement of prior periods and is applied as of the beginning of the fiscal year in which the SOP is first adopted. The Company early adopted SOP 98-5 in fiscal 1997 and has reported the initial application as a cumulative effect of a change in accounting principle in the Consolidated Statement of Operations for the year ended January 31, 1998. The effect of the change in accounting principle was to increase the net loss before cumulative effect of change in accounting principle reported for 1997 by approximately $631,000 or $0.09 per share. INCOME TAXES Income tax expense is based principally on pre-tax financial income. Deferred tax assets and liabilities are recognized for the difference between financial reporting and tax bases of assets and liabilities and are measured using the enacted tax rates and laws that will be in effect when the differences are expected to reverse. 30 31 BASIC AND DILUTED INCOME (LOSS) PER SHARE Basic income (loss) per common share is computed by dividing income (loss) available to common stockholders, after giving effect in fiscal year 1996 to the restatement related to the beneficial conversion feature in connection with convertible debt (See Note 11), by the weighted average number of common shares outstanding during the period. Diluted income (loss) per common share includes the dilutive effect of those stock options where the average market price of the common shares exceeds the option exercise prices for the respective years, and the dilutive effect of those convertible notes which are convertible into common stock. Basic and diluted earnings per share for income (loss) before cumulative effect of change in accounting principle is computed as follows:
FISCAL YEAR ---------------------------------------------------------- 1998 1997 1996 ---- ---- ---- (AS RESTATED, NOTE 11) Numerator: Income (loss) before cumulative effect of change in accounting principle $ (18,974,498) $ (10,801,152) $ 2,074,941 ------------- ------------- ------------- Denominator: Denominator for basic income (loss) per share(1) 6,659,882 7,025,236 7,183,462 Effect of dilutive securities: Options to purchase common stock -- -- 450,126 ------------- ------------- ------------- Denominator for dilutive income (loss) per share(1) 6,659,882 7,025,236 7,633,588 ------------- ------------- ------------- Income (loss) per share before cumulative effect of change in accounting principle: Basic $ (2.85) $ (1.54) $ 0.29 ============= ============= ============= Diluted $ (2.85) $ (1.54) $ 0.27 ============= ============= ============= Antidilutive securities not included in the diluted earnings (loss) per share computation: Options to purchase common stock 391,222 1,724,150 1,472,861 Exercise price $0.41 - $2.75 $2.75 - $5.63 $2.75 - $8.50
- ---------------- (1) The fiscal year 1998 amounts include the weighted average effect of 235,293 shares, which were contingently issuable as of January 30, 1999. CASH AND CASH EQUIVALENTS The Company considers all highly liquid investments purchased with an original maturity of three months or less to be cash equivalents. FAIR VALUE OF FINANCIAL INSTRUMENTS Statement of Financial Accounting Standards No. 107 ("SFAS 107"), "Disclosures about Fair Value of Financial Instruments" requires disclosure on the fair value of financial instruments held by the Company. SFAS 107 defines the fair value of a financial instrument as the amount at which the instrument could be exchanged in a current transaction between willing parties. The following methods and assumptions were used to estimate fair value: 31 32 - The carrying amounts of cash and cash equivalents, accounts receivable and accounts payable approximate fair value due to their short-term nature; - The fair value of the Company's bank line of credit, obligations under capital leases and loans payable are based on current interest rate and repayment terms of the individual notes, and; - Long-term severance payable approximates fair value because discounted cash flows using current interest rates for debt with similar characteristics and maturity were used to estimate its carrying value. ASSET IMPAIRMENT The Company reviews long-lived assets and makes a provision for impairment whenever events or changes in circumstances indicate that the projected cash flows of related activities may not provide for cost recovery. An impairment loss is recorded when the net book value of assets exceeds projected undiscounted future cash flows on a store by store basis. The impairment loss is determined based on the difference between the carrying amount and the fair value of the assets, at a particular store location. The estimated fair value is based on anticipated future cash flows discounted at a rate commensurate with the risk involved. STOCK BASED COMPENSATION The Company accounts for stock-based compensation using the intrinsic value method prescribed in Accounting Principles Board Opinion No. 25, "Accounting for stock Issued to Employees ("APB 25"), and provides pro forma disclosure of net income and earnings per share as if the fair value based method prescribed by Statement of Financial Accounting Standards No. 123 ("SFAS 123") had been applied in measuring compensation expense for options granted in 1998 and 1997. In accordance with APB 25 compensation cost for stock options is measured as the excess, if any, of the quoted market price of the Company's stock at the date of the grant over the amount an employee must pay to acquire the stock. RECLASSIFICATION Certain fiscal 1996 and 1997 amounts have been reclassified to conform with the fiscal 1998 presentation. RECENT ACCOUNTING PRONOUNCEMENTS In June 1997, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards No. 130 ("SFAS 130"), "Reporting Comprehensive Income," which establishes standards for reporting and display of comprehensive income and its components. In June 1997, the FASB also issued Statement of Financial Accounting Standards No. 131 ("SFAS 131"), "Disclosures about Segments of an Enterprise and Related Information." This Statement establishes standards for reporting information about a company's operating segments and related disclosures about its products, services, geographic areas of operations and major customers. Both Statements were adopted by us in 1998. In March 1998, the AICPA issued Statement of Financial Position 98-1 ("SOP 98-1"), "Accounting for the Costs of Computer Software Developed or Obtained for Internal Use." SOP 98-1 provides guidance for capitalization of certain costs incurred in the development of internal-use software and is effective for financial statements for years beginning after December 15, 1998. SOP 98-1 was adopted in fiscal 1998 and had no significant impact on the results of operations, cash flows or financial position. In June 1998, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 133 "Accounting for Derivative Instruments and Hedging Activities" ("SFAS No. 133"). Among other provisions, SFAS No. 133 establishes accounting the reporting standards for derivative instruments and for hedging activities. It also requires that an entity recognize all derivatives as either assets or liabilities in the statement of financial position and measure those instruments at fair value. SFAS No. 133 is effective for financial 32 33 statements for fiscal years beginning after June 15, 2000. Management has not determined the effect, if any, of adopting SFAS No. 133. NOTE 3 - ACQUISITION: In November 1996, the Company acquired substantially all of the assets of Nature's Elements Holding Corporation ("Nature's") which included the service mark and trade name "Nature's Elements" and the stock of its subsidiary. Prior to the acquisition, all of Nature's liabilities, both at the parent and subsidiary level were transferred to a liquidating trust. Subsequent to the acquisition, the stock of the subsidiary was liquidated and the Company received inventory and store fixtures and assumed the obligation for 34 leases (including 1 seasonal store) for approximately $2.2 million, of which $1.7 million was represented by a note payable. The Company has since closed 11 locations, renovated 18 locations and the remaining locations will either be renovated or subleased by mid 1999. The acquisition was accounted for as a purchase and accordingly, Nature's results are included in the consolidated financial statements since the date of acquisition. The estimated fair value of the acquired assets exceeded the purchase price. The excess of estimated fair value of the assets acquired over cost was $3.5 million of which $3 million reduced the fair value of non-current assets acquired to a zero value and $0.5 million was allocated to negative goodwill, which was reduced to zero in 1997 due to writedown of inventory purchased. The assets and business acquired were not material in relation to consolidated financial statements. NOTE 4 - STATEMENTS OF CASH FLOWS: Supplemental disclosures of cash flow information:
FISCAL YEAR ENDED ---------------------------------------------------- JANUARY 30, JANUARY 31, FEBRUARY 1, 1999 1998 1997 ----------- ----------- ----------- Cash paid during the period for: Interest...................................... $ 4,830,230 $ 4,671,039 $ 3,459,563 Income taxes.................................. $ 20,000 $ 1,012,000 $ 71,138
Supplemental disclosures of noncash activities: The Company issued in 1996 a $1.7 million note payable due to the acquisition discussed in Note 3. In December 1996, the Company entered into an agreement with a vendor whereby approximately $3.6 million of accounts payable was converted to a note payable (see Note 8). NOTE 5 - INVENTORIES: During 1998, 1997 and 1996, the Company recorded a provision of $3.8 million, $1.8 million and $0.2 million, respectively, to reduce the carrying value of certain fragrances the Company intends to liquidate. These amounts represent management's best estimate of the inventories' net realizable value. NOTE 6 - PROPERTY AND EQUIPMENT: Property and equipment includes the following:
ESTIMATED JANUARY 30, JANUARY 31, USEFUL LIVES 1999 1998 (IN YEARS) ------------- ------------- ----------- Furniture, fixtures and equipment $ 15,959,500 $ 15,213,721 5-7 Leasehold improvements 21,235,443 14,995,361 10 ------------- ------------- 37,194,943 30,209,082 Less: Accumulated depreciation and amortization (14,014,481) (11,901,842) ------------- ------------- $ 23,180,462 $ 18,307,240 ============= =============
33 34 NOTE 7 - NOTE AND INTEREST RECEIVABLE FROM SHAREHOLDER AND OFFICERS: Notes and interest receivable from shareholder and officers consists of the following:
JANUARY 30, JANUARY 31, 1999 1998 ---------- ----------- Notes and interest receivable from officers $ -- $ 315,612 Note and interest receivable from shareholder 542,143 498,703 ---------- ---------- $ 542,143 $ 814,315 ========== ==========
The note receivable from shareholder resulted from the sale of a condominium to the shareholder at its book value in 1991. The shareholder assumed the balance of the related mortgage and issued an unsecured note payable to the Company for $282,519, bearing interest at 9.5%. The note initially matured in December 1993 and has been subsequently renewed through December 2000. Total interest income recognized during fiscal years 1998, 1997 and 1996 was approximately $43,000, $43,000 and $40,000, respectively. Accrued interest receivable at January 30, 1999 and January 31, 1998 amounted to approximately $85,000 and $42,000, respectively. Purchases of products from a company affiliated through common ownership amounted to approximately $24,333,000, $21,437,000, and $30,735,000, in fiscal year 1998, 1997 and 1996, respectively. The amount due to this company at January 30, 1999 and January 31, 1998, was approximately $15,812,000 and $16,958,000, respectively. Amounts due to this affiliate are non-interest bearing. Other income in fiscal year 1996 includes $110,000 of warehousing fees received from an affiliated company. Prior to signing an employment agreement effective February 1, 1999, the Company's Chief Executive Officer provided consulting services to the Company. Total consulting expense to this officer was $500,000 during 1998, of which $325,000 was accrued as of January 30, 1999. NOTE 8 - BANK LINE OF CREDIT AND NOTES PAYABLE: The bank line of credit and notes payable consist of the following:
JANUARY 30, JANUARY 31, 1999 1998 ------------- ----------- Bank line of credit, bearing interest at the bank's prime rate plus 2% (11.75% at January 30, 1999), interest payable monthly, expiring in April 2001, secured by a pledge of substantially all of the Company's assets.............. $ 30,035,019 $ 31,657,946 Notes payable bearing interest ranging from approximately 10.0% - 14.7%, payable in monthly installments ranging from $481 to $7,500 including interest, through July 1999 secured by equipment.................................... 14,928 61,374 Notes payable bearing interest ranging from approximately 8.5%-10.8%, payable in monthly installments of $109,315, including interest, through December 2001, secured by fixtures.................................................. 2,841,267 3,394,396 Note payable bearing interest at approximately 10.25%, payable in monthly installments of $50,000, including interest, with final payment of $200,000 in November 1999 (See Note 3)....................................................... 727,609 1,119,744 Note payable bearing interest at approximately 10.25%, payable in monthly installments of $75,000, including interest, with final payment of $65,736 in November 2000 (See Note 4)...................................................... 1,552,488 2,615,740 ------------ ------------- 35,171,311 38,849,200 Less: current portion.............................................................. (32,800,627) (34,139,766) ------------ ------------- Long-term portion.................................................................. $ 2,370,684 $ 4,709,434 ============ =============
34 35 The aggregate maturities of the bank line of credit and notes payable at January 30, 1999 are as follows:
FISCAL YEAR 1999........................................................ $32,800,627 2000........................................................ 1,698,120 2001........................................................ 528,540 2002........................................................ 123,966 2003........................................................ 20,058 ----------- $35,171,311 ===========
The Company's $35 million line of credit contains covenants requiring the maintenance of minimum tangible net worth, book value and achieving specified levels of quarterly results of operations. The line of credit also contains limitations on additional borrowings, capital expenditures, number of new store openings, purchases of treasury stock and prohibits distribution of dividends. As of January 30, 1999, the Company was in violation of certain of the above covenants. As a result, the bank can demand payment of the amounts outstanding under the line of credit agreement. In addition, as a result of these violations, the Company incurred the default rate of interest, prime plus 4% (11.75% at January 30, 1999) beginning December 1998. On July 14, 1999, the Company obtained a waiver of default from the bank through September 30, 1999 as of and for the year ended January 30, 1999 (See Note 16). Advances made under the line of credit are based on a formula of eligible inventories and receivables. At January 30, 1999, the Company had available under the line of credit approximately $4,248,000. Advances are secured by a first lien on substantially all of the Company's assets and assignment of a life insurance policy on one of the Company's officers. The Company's line of credit is guaranteed to the extent of $3,000,000 each by two stockholders of the Company. NOTE 9 - IMPAIRMENT OF ASSETS: Based on a review of the Company's retail store locations with negative cash flows, the Company recognized non-cash impairment charges relating to its retail segment of $0.2 million, $2.5 million and $1.0 million during fiscal years ended 1996, 1997 and 1998, respectively. These charges were determined based on the difference between the carrying amount of the assets, representing primarily fixtures and leasehold improvements, at a particular store location and the fair value of the assets on a store by store basis. The estimated fair value was based on anticipated future cash flow discounted at a rate commensurate with the risk involved. These impairment losses are included in "Provision for impairment of assets and store closings," in the accompanying Consolidated Statement of Operations. 35 36 NOTE 10 - INCOME TAXES: The (provision) benefit for income taxes is comprised of the following amounts:
FISCAL YEAR ENDED -------------------------------------------------------- JANUARY 30, JANUARY 31, FEBRUARY 1, 1999 1998 1997 ----------- ----------- ----------- Current: Federal ................... $ -- $ 814,766 $(1,084,088) State ..................... (117,550) (459,000) (182,244) ----------- ----------- ----------- (117,550) 355,766 (1,266,332) ----------- ----------- ----------- Deferred: Federal ................... (1,219,856) 346,384 (380,399) State ..................... -- -- -- ----------- ----------- ----------- (1,219,856) 346,384 (380,399) ----------- ----------- ----------- Total tax (provision) benefit $(1,337,406) $ 702,150 $(1,646,731) =========== =========== ===========
The income tax provision differs from the amount obtained by applying the statutory Federal income tax rate to pretax income as follows:
FISCAL YEAR ENDED ------------------------------------------------ JANUARY 30, JANUARY 31, FEBRUARY 1, 1999 1998 1997 ------------- ------------- ------------- Benefit (provision) at federal statutory rates............ $ 7,161,669 $ 4,066,060 $(1,531,251) Valuation allowance against current year benefit.......... (7,161,669) State taxes............................................... (117,550) Recognized net operating loss carryforward................ -- -- 115,810 (Increase) reduction in the valuation allowance........... (1,219,856) (3,405,000) -- Beneficial conversion feature of debentures............... -- -- (205,000) Other..................................................... -- 41,090 (26,290) ------------- ----------- ----------- (Provision) benefit for income taxes...................... $ (1,337,406) $ 702,150 $(1,646,731) ============= =========== ===========
Net deferred tax assets reflect the tax effect of the following differences between financial statement carrying amounts and tax bases of assets and liabilities:
JANUARY 30, JANUARY 31, 1999 1998 ------------ ----------- Assets: Net operating losses carryforward....................................... $ 7,473,729 $ 244,771 Inventory............................................................... 1,923,888 1,944,521 Property and equipment.................................................. 1,904,756 1,283,375 Allowance for doubtful accounts and other............................... 319,011 319,011 Reserves................................................................ 982,601 714,970 Other................................................................... 136,157 118,208 ------------ ----------- Total deferred tax assets.................................................. 12,740,142 4,624,856 ---------- ----------- Valuation allowance........................................................ (12,740,142) (3,405,000) ------------ ----------- Net deferred tax assets.................................................... $ -- $ 1,219,856 ============ ===========
During fiscal 1998, the Company provided a valuation allowance of $12,740,142 for deferred tax assets as management believes that it is more likely than not that the benefit of the deferred tax asset will not be realized. Realization of future tax benefits related to the deferred tax assets is dependent on many factors, including the Company's ability to generate taxable income within the net operating loss carryforward period. Management has considered these factors in reaching its conclusion as to the valuation allowance for financial reporting purposes. 36 37 NOTE 11 - STOCKHOLDERS' EQUITY: STOCK SUBSCRIPTION In March 1999, the Company entered into Subscription Agreements for the sale of 235,293 shares of the Company's common stock to a group of private investors at the agreed upon price of $8.50 per share. The proceeds of $2 million were received in January 1999. The Subscription Agreements require that the Company file the appropriate registration statements with the Securities and Exchange Commission within six months from the date of the Subscription Agreements to permit the registered resale of the shares by the investors in open market transactions. If on the effective date of the registration statement, the market price is less than $8.50 per share, the Company is obligated to reimburse the investor group the lesser of 1) the product of the difference between $8.50 and the closing bid price of the Company's common stock on the effective date of the registration statement multiplied by the number of shares issued under the Subscription Agreements or 2) the product of $2.00 multiplied by the number of shares issued under the Subscription Agreements. As of January 30, 1999, the potential redeemable amount of $470,588 was recorded as redeemable common equity and the remaining $1,529,412 was recorded as capital in excess of par value in the accompanying balance sheets. In March 1996, the Company sold 180,000 shares of common stock for approximately $956,000 in a private placement. DEBENTURES In March 1996, the Company issued $3,000,000 of 5% Convertible Debentures (the "Debentures") in a Regulation S offering to non-U.S. persons. The debentures were convertible into shares of common stock of the Company, at any time after May 21, 1996, at a conversion price for each share of common stock equal to eighty-five percent of the market price of the common stock on the date of conversion, not to exceed $8.50 per share of common stock. The debentures were converted into approximately 918,000 shares of common stock in the second quarter of 1996. In a 1997 announcement, the staff of the Securities and Exchange Commission ("SEC") indicated that when debt is convertible at a discount from the then current common stock market price, the discounted amount represents an incremental yield, e.g. a "beneficial conversion feature", which should be recognized as a return to the debt holders. Based on the market price of the Company's debentures at the date of issuance, the debentures issued by the Company had a beneficial conversion feature of $529,412 at such point in time. Because of the SEC announcement, the Company has restated its 1996 net income and net income per common share information to reflect such accounting treatment. The net effect of the restatement represents a non-cash interest charge to net income. STOCK WARRANTS In connection with its initial public offering, the Company issued warrants to purchase 150,000 shares of common stock. The warrants were exercisable until December 19, 1996 at an exercise price equal to $12.75. The holders of such warrants attempted to exercise the warrants in fiscal 1996. The Company disputed the method of determining the exercise price for such warrants which resulted in litigation. During fiscal year 1997, the Company settled the litigation and agreed to issue an aggregate of 85,000 shares of common stock. These shares were issued during the first quarter of fiscal year 1998 and accordingly, the Company recorded an expense of approximately $214,000 which represented the fair value of the common stock on the date of issuance. PREFERRED STOCK The Company's Articles of Incorporation authorize the issuance of up to 1,000,000 shares of preferred stock. The preferred stock may be issued from time to time at the discretion of the Board of Directors without stockholders' approval. The Board of Directors is authorized to issue these shares in different series and, with 37 38 respect to each series, to determine the dividend rate, and provisions regarding redemption, conversion, liquidation preference and other rights and privileges. As of January 30, 1999, no preferred stock had been issued. STOCK OPTION PLANS Under the Company's Stock Option Plan (the "Stock Option Plan") and Directors Stock Option Plan (the "Directors Plan") (collectively, the "Plans"), 2,500,000 shares of common stock and 60,000 shares of common stock, respectively, are reserved for issuance upon exercise of options. The Company's Board of Directors, or a committee thereof, administers and interprets the Stock Option Plan. The Stock Option Plan provides for the granting of both "incentive stock options" (as defined in Section 422A of the Internal Revenue Code) and non-statutory stock options. Options can be granted under the Stock Option Plan on such terms and at such prices as determined by the Board, except that the per share exercise price of options will not be less than the fair market value of the common stock on the date of grant. Only non-employee directors are eligible to receive options under the Directors Plan. The Directors Plan provides for an automatic grant of an option to purchase 2,000 shares of common stock upon election as a director of the Company and an automatic grant of 4,000 shares of common stock upon such person's re-election as a director of the Company, in both instances at an exercise price equal to the fair value of the common stock on the date of grant. During October 1998, the Company offered each employee, who had previously been granted options to purchase the Company's stock, the opportunity to change the option price effective October 27, 1998 (the "Repricing"). Under the terms of the Repricing, all previously granted stock options would be cancelled, and the employee would be granted the same number of options at the fair market value of the Company's common stock on October 27, 1998, which was $0.50 per share. No other terms to the stock options were amended. At the time of the offer, the Company had approximately 80 employees who had been granted options to purchase the Company's common stock with option prices ranging from $2.75 to $6.84. The Repricing plan was accepted by all employees with respect to outstanding stock options. The Company uses the measurement prescribed by APB 25. Had compensation costs for the Company's Plans been determined based on the fair market value at the grant dates of options granted consistent with the method of SFAS 123, the Company's net (loss) income and diluted net (loss) income per share would have been reduced (increased) to the pro forma amounts indicated below:
FISCAL YEARS ------------------------------------------------ 1998 1997 1996 ------------ ------------ ------------- (AS RESTATED, NOTE 11) Net income (loss): As reported $(18,974,498) $(11,432,570) $ 2,074,941 Proforma $(19,735,008) $(11,939,613) $ 1,946,867 Diluted net income (loss) per share: As reported $ (2.85) $ (1.63) $ 0.27 Proforma $ (2.96) $ (1.68) $ 0.26
In calculating the pro forma net income (loss) and net income (loss) per share for 1998, 1997 and 1996, the fair value of each option grant is estimated on the date of grant using the Black-Scholes option-pricing model with the following weighted average assumptions used for grants in 1998, 1997 and 1996:
1998 1997 1996 ------------- ------------- ------------ Expected life (years)....................................... 3 - 7 years 3 - 7 years 4 - 7 years Interest rate............................................... 6.02% 6.52% 6.39% Volatility.................................................. 102% 39% 41% Dividend yield.............................................. 0% 0% 0%
38 39 Options granted under the Stock Option Plan are exercisable after the period or periods specified in the option agreement, and options granted under the Directors Plan are exercisable immediately. Options granted under the Plans are not exercisable after the expiration of 10 years from the date of grant. The Plans also authorize the Company to make loans to optionees to enable them to exercise their options. A summary of the Company's option activity, and related information for each of the three fiscal years ended January 30, 1999 follows:
1998 1997 1996 ------------ ------------ ------------ WEIGHTED- WEIGHTED- WEIGHTED- AVERAGE AVERAGE AVERAGE EXERCISABLE EXERCISABLE EXERCISABLE SHARES PRICE SHARES PRICE SHARES PRICE ---------- ------------ ---------- ------------ ---------- ------------ Outstanding at beginning of year 1,724,150 $ 3.18 1,494,600 $ 3.19 1,348,800 $ 3.16 Granted ........................ 1,926,750 (1) 0.46 332,750 3.28 149,000 3.50 Exercised ...................... (684,200) 0.45 (37,500) 3.13 (2,000) 4.13 Cancelled ...................... (1,208,100)(1) 2.99 (65,700) 3.84 (1,200) 2.96 ---------- ------------ ---------- ------------ ---------- ------------ Outstanding at end of year ..... 1,758,600 $ 0.46 1,724,150 $ 3.18 1,494,600 $ 3.19 ---------- ------------ ---------- ------------ ---------- ------------ Options exercisable at end of year ........................ 1,600,275 $ 0.46 1,541,400 $ 3.14 1,475,500 $ 3.17 Weighted-average fair value of options granted during the year ........................ 1,926,750 $ 0.46 332,750 $ 1.48 149,000 $ 1.49
(1) Includes 1,130,600 options cancelled and then subsequently re-granted as part of the repricing. The following table summarizes information about stock options outstanding at January 30, 1999:
WEIGHTED- WEIGHTED- WEIGHTED- RANGE OF AVERAGE AVERAGE AVERAGE EXERCISE NUMBER EXERCISE CONTRACTUAL NUMBER EXERCISE PRICES OUTSTANDING PRICE LIFE OUTSTANDING PRICES ----------- --------- ----------- ----------- --------- $0.41 - $0.50.................... 1,750,600 $ 0.46 7 1,592,275 $ 0.46 $2.75............................ 8,000 2.75 7 8,000 2.75 ----------- --------- ------- ----------- -------- 1,758,600 $ 0.46 7 1,600,275 $ 0.46 =========== ======== ======= =========== =======
NOTE 12 - EMPLOYEE BENEFIT PLANS: The Company has a 401(k) Savings and Investment Plan ("the Plan"). Pursuant to such plan, participants may make contributions to the Plan up to a maximum of 15% of total compensation or $9,500 (or such higher amount as is prescribed by the Secretary of the Treasury for cost of living adjustments), whichever is less, and the Company, in its discretion, may match such contributions to the extent of 25% of the first 4% of a participant's contribution. The Company's matching contributions vest over a 5-year period. In addition to matching contributions, the Company may make additional contributions on a discretionary basis in order to comply with certain Internal Revenue Code regulations prohibiting discrimination in favor of highly compensated employees. The Company's matching contributions during fiscal years 1998, 1997 and 1996 were not significant. NOTE 13 - COMMITMENTS AND CONTINGENCIES: The Company is self-insured for employee medical benefits under the Company's group health plan. The Company maintains stop loss coverage for individual medical claims in excess of $50,000 and for annual Company medical claims which exceed approximately $2,000,000 in the aggregate. While the ultimate amount of claims incurred are dependent on future developments, in management's opinion, recorded reserves are adequate to cover the future payment of claims. However, it is possible that recorded reserves may not be adequate to cover the future payment of claims. Adjustments, if any, to estimates recorded resulting from ultimate claim payments will be reflected in operations in the periods in which such adjustments are known. The self-insurance reserve at January 30, 1999 and January 31, 1998 was approximately $520,000 and $338,000, respectively. 39 40 In the fourth quarter of 1998, the Company entered into severance agreements with two executive officers. The Company, using the borrowing interest rate on its line of credit, (prime plus 2%) discounted the future commitment payments resulting in a non-recurring charge of approximately $1,900,000. Under the terms of the agreements, both officers will receive severance payments over a three-year term beginning December 1998. The resulting expense is reflected in selling, general and administrative expenses in the accompanying consolidated statements of operation. In addition, as part of the severance agreement with one of the executive officers, the officer received 429,000 shares of common stock at no cost and, accordingly, the Company recorded additional compensation expense of approximately $176,000. The Company leases space for its office, warehouse and retail stores. The lease terms vary from one to ten years, in some cases with options to renew for longer periods. Various leases contain clauses which adjust the base rental rate by the prevailing Consumer Price Index, as well as additional rent based on a percentage of gross sales in excess of a specified amount. Rent expense for fiscal year 1998, 1997, and 1996 approximated $15,972,000, $14,398,000, and $11,223,000, respectively. Future minimum lease commitments under these operating leases at January 30, 1999 are as follows:
FISCAL YEAR - ----------- 1999.................................................................................... $15,750,000 2000.................................................................................... 14,196,000 2001.................................................................................... 11,575,000 2002.................................................................................... 8,556,000 2003.................................................................................... 5,855,000 Thereafter.............................................................................. 12,908,000 ----------- Total future minimum lease payments..................................................... $68,840,000 ===========
The following is a schedule of future minimum lease payments under capital leases together with the present value of the net minimum lease payments, at January 30, 1999:
FISCAL YEAR - ----------- 1999 $ 526,050 2000 265,314 2001 190,485 2002 194,724 2003 8,774 ---------- Total future minimum lease payments 1,185,347 Less: amount representing interest (203,308) ---------- Present value of minimum lease payments $ 982,039 Less: current portion (419,487) ---------- $ 562,552 ==========
The depreciation expense relating to capital leases is included in depreciation and amortization expense. As of January 30, 1999, the Company had entered into 7 additional store leases at locations under construction. In December of 1993, the patent holder and exclusive licensee in the U.S. of Boucheron filed a complaint against the Company in the Southern District of New York for infringing upon their exclusive right to sell the Boucheron bottle. The plaintiffs' theory is based on the fact that they have a valid patent for the bottles and that Perfumania's sales of such bottles infringes upon their patent rights. The Company believes that a patent holder cannot in any way control by resort to an infringement suit the resale of a patented article which he has sold. The Company filed a motion to dismiss during February 1994. On March 20, 1995 the Court denied the Company's motion to dismiss and on April 14, 1995, the Company filed its answer to the complaint. Discovery is in progress. 40 41 In the opinion of management and counsel, the ultimate outcome of the aforementioned litigation will not have a material effect on the accompanying financial statements. During 1997 and 1996, the Company made sales to L. Luria & Son, Inc, ("Luria's") in the amounts of $1,999,823 and $2,473,623, respectively. The Company wrote off in 1997 receivables from Luria's in the approximate amount of $1,200,000. The Company has been characterized as an insider as defined by the United States Bankruptcy Code, in the liquidating plan of reorganization filed on April 6, 1998 by Luria's in the United States Bankruptcy Court as defined by the United States Bankruptcy Code, Southern District of Florida. In October 1998, the committee of unsecured creditors in Luria's bankruptcy proceedings filed a complaint with the United States Bankruptcy Court, Southern District of Florida to recover substantial funds from the Company. The complaint alleges that Luria's made preference payments, as defined by the Bankruptcy Court, to the Company and seeks recovery of said preference payments, as well as disallowing any and all claims of the Company against Luria's until full payment of the preference payments have been made (See Note 16). The Company is also involved in various other legal proceedings in the ordinary course of business. Management cannot presently predict the outcome of these matters, although management believes, upon the advice of legal counsel, that the Company would have meritorious defenses and that the ultimate resolution of these matters should not have a materially adverse effect on the Company's financial position or result of operations. NOTE 14 - SEGMENT INFORMATION: The Company operates in two industry segments, specialty retail sale and wholesale distribution of fragrances and related products. Financial information for these segments is summarized in the following table:
FISCAL YEAR ENDED ---------------------------------------------------- JANUARY 30 JANUARY 31 FEBRUARY 1 1999 1998 1997 ------------ ------------ ------------ Net sales to external customers: Wholesale ............................. $ 40,465,689 $ 34,031,744 $ 30,316,598 Retail ................................ 134,789,944 129,561,815 108,603,129 ------------ ------------ ------------ Total net sales to external customers $175,255,633 $163,593,559 $138,919,727 ============ ============ ============ Intersegment sales: Wholesale ............................. $ 18,477,729 $ 80,022,607 $ 77,956,573 Retail ................................ -- -- -- ------------ ------------ ------------ Total intersegment sales ............ $ 18,477,729 $ 80,022,607 $ 77,956,573 ============ ============ ============ Cost of goods sold: Wholesale ............................. $ 32,920,317 $ 26,090,395 $ 22,702,968 Retail ................................ 77,718,115 71,529,423 56,256,785 ------------ ------------ ------------ Total cost of goods sold ............ $110,638,432 $ 97,619,818 $ 78,959,753 ============ ============ ============ Gross profit: Wholesale ............................. $ 7,545,372 $ 7,941,349 $ 7,613,630 Retail ................................ 57,071,829 58,032,392 52,346,344 ------------ ------------ ------------ Total gross profit .................. $ 64,617,201 $ 65,973,741 $ 59,959,974 ============ ============ ============ Inventories: Wholesale ............................. $ 8,227,522 $ 20,368,792 $ 32,051,346 Retail ................................ 45,652,610 52,769,050 53,059,077 ------------ ------------ ------------ Total inventories ................... $ 53,880,132 $ 73,137,842 $ 85,110,423 ============ ============ ============ Depreciation and amortization: Retail ................................ $ 4,480,681 $ 4,697,816 $ 3,771,508 ------------ ------------ ------------ $ 4,480,681 $ 4,697,816 $ 3,771,508 ============ ============ ============ Capital expenditures: Retail ................................ $ 8,849,837 $ 6,831,944 $ 6,798,159 ------------ ------------ ------------ $ 8,849,837 $ 6,831,944 $ 6,798,159 ============ ============ ============
41 42 An unaffiliated customer of the wholesale segment accounted for approximately 6%, 8% and 11% of the consolidated net sales in fiscal year 1998, 1997 and 1996, respectively, and 0% and 18% of the consolidated net trade accounts receivable balance at January 30, 1999 and January 31, 1998, respectively. In fiscal year 1998, 1997 and 1996, the wholesale segment included foreign sales of approximately $2.9 million, $1.7 million and $3.8 million, respectively. 42 43 NOTE 15 - QUARTERLY FINANCIAL DATA (UNAUDITED): The following table sets forth the Company's unaudited quarterly summarized financial data for the periods indicated (dollar amounts are in thousands). Certain of the quarterly information has been restated, as described below.
FISCAL YEAR 1998 FISCAL YEAR 1997 -------------------------------------------- -------------------- 1ST 2ND 3RD 4TH 1ST 2ND QTR QTR QTR QTR QTR QTR -------- -------- -------- -------- -------- -------- Wholesale division .......................... $ 13,468 $ 10,235 $ 6,993 $ 9,770 $ 6,541 $ 8,333 Retail division ............................. 25,000 29,450 30,091 50,249 23,447 28,952 Total net sales ............................. 38,468 39,685 37,084 60,019 29,988 37,285 Gross profit ................................ 14,806 16,511 15,020 18,280 12,906 15,628 Loss before cumulative effect of change in accounting principle ..................... (2,772) (1,273) (3,859) (11,070) (1,998) (457) Cumulative effect of change in accounting principle ................................ -- -- -- -- (632) -- Net loss .................................... $ (2,772) $ (1,273) $ (3,859) $(11,070) $ (2,630) $ (457) Basic loss per common share: Loss before cumulative effect of change in accounting principle ............... $ (0.42) $ (0.20) $ (0.59) $ (1.64) $ (0.28) $ (0.06) Cumulative effect of change in accounting principle ............................. -- -- -- -- (0.09) -- Net loss .................................... $ (0.42) $ (0.20) $ (0.59) $ (1.64) $ (0.37) $ (0.06) Diluted loss per common share: Loss before cumulative effect of change in accounting principle ............... $ (0.42) $ (0.20) $ (0.59) $ (1.64) $ (0.28) $ (0.06) Cumulative effect of change in accounting principle ............................. -- -- -- -- $ (0.09) -- Net loss .................................... $ (0.42) $ (0.20) $ (0.59) $ (1.64) $ (0.37) $ (0.06) % of total net sales for fiscal year ........ 21.9% 22.6% 21.2% 34.3% 18.3% 22.8% # of retail stores at end of each period .... 284 287 294 289 270 271 Net loss as previously reported ............. $ (2,772) $ (1,273) $ (3,859) $(11,070) $ (2,039) $ (498) Cumulative effect of change in accounting ... -- -- -- -- (564) 68 principle Provision for doubtful accounts ............. -- -- -- -- -- -- Income tax (provision) benefit .............. -- -- -- -- (27) (27) Net loss as adjusted ........................ $ (2,772) $ (1,273) $ (3,859) $(11,070) $ (2,630) $ (457) FISCAL YEAR 1997 -------------------- 3RD 4TH QTR QTR -------- -------- Wholesale division .......................... $ 8,590 $ 10,568 Retail division ............................. 30,185 46,978 Total net sales ............................. 38,775 57,546 Gross profit ................................ 15,913 21,527 Loss before cumulative effect of change in accounting principle ..................... (1,226) (7,122) Cumulative effect of change in accounting principle ................................ -- -- Net loss .................................... $ (1,226) $ (7,122) Basic loss per common share: Loss before cumulative effect of change in accounting principle ............... $ (0.17) $ (1.05) Cumulative effect of change in accounting principle ............................. -- -- Net loss .................................... $ (0.17) $ (1.05) Diluted loss per common share: Loss before cumulative effect of change in accounting principle ............... $ (0.17) $ (1.05) Cumulative effect of change in accounting principle ............................. -- -- Net loss .................................... $ (0.17) $ (1.05) % of total net sales for fiscal year ........ 23.7% 35.2% # of retail stores at end of each period .... 283 285 Net loss as previously reported ............. $ (878) $ (7,555) Cumulative effect of change in accounting ... 121 21 principle Provision for doubtful accounts ............. (700) 700 Income tax (provision) benefit .............. 231 (288) Net loss as adjusted ........................ $ (1,226) $ (7,122)
43 44 As disclosed in Note 2, the Company changed its method of accounting for preopening expenses in 1997 and has reported the initial applications as a cumulative effect of a change in accounting principle. Accordingly, the Company's net loss and net loss per common share for all quarters in 1997 in the above table has been restated to reflect this change. The Company originally recorded a $700,000 provision for doubtful accounts in relation to Luria's (See Note 13) in the fourth quarter of 1997. It was subsequently determined that the provision should have been recorded in the third quarter of 1997, the time of Luria's filing its liquidating plan of reorganization. During the fourth quarter of fiscal year 1998 and 1997, the Company recorded a reserve for inventory losses of approximately $3.8 million and $1.8 million, respectively (See Note 5). NOTE 16 - EVENTS SUBSEQUENT TO THE REPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS (UNAUDITED): In April 1999, the Company entered into a Securities Purchase Agreement and issued an aggregate of $2 million worth of its Series A Convertible Notes, which are convertible into common stock. The Notes contain a beneficial conversion feature of approximately $385,000 which will be taken by the Company as a non-cash interest charge to income in the first quarter of fiscal year 1999. The agreement requires the Company to file a registration statement with the Securities and Exchange Commission within forty-five days after the date of issuance of the convertible notes. The conversion price is the lower of (A) $4.35 per share, subject to adjustment and (B) the floating conversion price determined by multiplying (1) the average closing bid price of the common stock for the three trading days immediately preceding the date of determination, by (2) 80%, subject to adjustment. The conversion price may be adjusted pursuant to antidilution provisions in the convertible note. If the conversion price decreases, the Company is obligated to issue additional shares of common stock. On July 14, 1999, the Company obtained a waiver of default from the bank though September 30, 1999 as of and for the year ended January 30, 1999. Future outstanding borrowings will bear interest at the prime rate plus four percent. The bank agreed to less restrictive covenants provided that certain events commence prior to September 30, 1999. One such event includes that perfumania.com, inc. (a wholly-owned subsidiary) is to receive at least $10 million from a contemplated initial public offering of its shares, of which at least $2 million is to be repaid to the Company. In July 1999, the Company agreed with the committee of unsecured creditors to settle all claims held by Luria's against us for the sum of $1.2 million, payable over the next nine months according to a repayment schedule. This settlement is subject to the approval of the Bankruptcy Court. The full amount of the settlement was accrued for in the Company's financial statements as of January 31, 1998, January 30, 1999 and May 1, 1999. In July 1999, the Company entered into a Securities Purchase Agreement and issued an aggregate of $2 million worth of its Series B Convertible Notes, which are convertible into common stock. The Notes contain a beneficial conversion feature of approximately $981,000 which will be taken by the Company as a non-cash interest charge to income in the second quarter of fiscal year 1999. The agreement requires the Company to file a registration statement with the Securities and Exchange Commission within forty-five days after the date of issuance of the convertible notes. The Conversion Price is the lower of (A) $3.40625 per share, subject to adjustment and (B) the floating conversion price determined by multiplying (1) the average closing bid price of the common stock for the three trading days immediately preceding the date of determination, by (2) 80%, subject to adjustment. The conversion price may be adjusted pursuant to antidilution provisions in the convertible note. In July 1999, the Company obtained a $2.5 million unsecured loan from a wholesale customer bearing an interest rate of 24%. The loan is payable in full December 1999. On August 31, 1999, the Company entered into a stock purchase agreement with an affiliated Company through common ownership. The Agreement calls for the transfer of 1,512,406 shares of the Company's treasury stock to this affiliated company in consideration for a partial reduction of the Company's outstanding trade indebtedness balance of approximately $4.5 million. The transfer price was based on a per share price of $2.98, which approximates 90% of the closing price on the Company's common stock for the previous 20 business days. Pursuant to this agreement the parties entered into a registration rights agreement dated August 31, 1999, which grants the affiliated company demand registration rights. The Company recorded an extraordinary loss of approximately $314,000 which will be taken to income in the third quarter of fiscal year 1999. On September 28, 1999, perfumania.com, inc., a wholly-owned subsidiary of the Company, made an initial public offering of its common stock representing approximately 47% of the common stock outstanding following the offering. perfumania.com, inc. offered 3,500,000 shares of its common stock, which included 1,000,000 shares held by the Company. The offering raised approximately $24.5 million. The net proceeds of the offering will be used for working capital and other general corporate purposes and also repayment of any outstanding indebtedness to the Company as well as reduction of the outstanding balance in the Company's line of credit. 44 45 PERFUMANIA, INC. SCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS AND RESERVES
ADDITIONS ---------------------------------------------------------------------------- BALANCE AT CHARGED TO CHARGED TO BALANCE BEGINNING COSTS AND OTHER AT END OF PERIOD EXPENSE ACCOUNTS DEDUCTIONS OF PERIOD ------------ ----------- ---------- ----------- ----------- FOR THE YEAR ENDED FEBRUARY 1, 1997: Accounts receivable $ 472,804 $ 500,000 $ -- $ (724,418)(1) $ 248,386 Inventory 750,000 190,000 -- -- 940,000 FOR THE YEAR ENDED JANUARY 31, 1998: Accounts receivable 248,386 1,730,000 -- (1,273,432)(1) 704,954 Inventory 940,000 1,810,000 -- -- 2,750,000 Self insurance -- 297,710 187,449(2) (146,937)(3) 338,222 Deferred tax asset valuation allowance -- 3,405,000 -- -- 3,405,000 FOR THE YEAR ENDED JANUARY 30, 1999: Accounts receivable 704,954 -- -- -- 704,954 Inventory 2,750,000 3,764,665 -- (2,351,414)(4) 4,163,251 Self insurance 338,222 1,295,410 541,484(2) (1,654,491)(3) 520,625 Deferred tax asset valuation allowance 3,405,000 9,335,142 -- -- 12,740,142
- ------------------------- (1) Represents amounts written off against accounts receivable. (2) Represents employee contributions. (3) Represents benefit/premium payments. (4) Represents amounts written off against inventory. 45 46 ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURES None. 46 47 PART III. ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT DIRECTORS AND EXECUTIVE OFFICERS Our directors and executive officers are as follows:
NAME AGE POSITION - ------------------------------------ --- ------------------------------------------------- Ilia Lekach......................... 50 Chairman of the Board and Chief Executive Officer Jerome Falic........................ 35 President and Vice Chairman of the Board Marc Finer.......................... 37 President of the Retail Division and Director Donovan Chin........................ 32 Chief Financial Officer, Secretary and Director Claire Fair......................... 39 Vice President of Human Resources Robert Pliskin(1)(2)(3)............. 75 Director Carole Ann Taylor(1)(2)(3).......... 53 Director Horatio Groisman, M.D.(2)(3)........ 46 Director
- ----------------- (1) Member of Audit Committee. (2) Member of Compensation Committee. (3) Member of Stock Option Committee. ILIA LEKACH is a co-founder of Perfumania and was Perfumania's Chief Executive Officer and Chairman of the Board since its incorporation in 1988 until his resignation in April 1994. Mr. Lekach was re-appointed the Perfumania's Chief Executive Officer and Chairman of the Board on October 28, 1998. He is also Chairman of the Board and Chief Executive Officer of Parlux Fragrances, Inc., a publicly traded manufacturer of fragrance and related products. In August 1996, Mr. Lekach became an officer and director with L. Luria & Son, Inc., a publicly traded specialty discount retailer. On August 13, 1997, L. Luria & Son, Inc., filed for relief under Chapter 11 of the Bankruptcy Code and has since been liquidated. See "Certain Relationships and Related Transactions." JEROME FALIC was appointed President on October 28, 1998. Mr. Falic has been a Vice President of Perfumania since Perfumania's inception and a director of Perfumania since August 1994. Mr. Falic was appointed Perfumania's Vice Chairman of the Board in September 1994. MARC FINER has been the President of Perfumania's Retail Division since March 1994 and a director since August 1994. Mr. Finer was the President of Parfums Expresso, Inc. and Parfums D'Arte, wholesale distributors of fragrances in Puerto Rico, from their inception in August 1986 until March 1994. DONOVAN CHIN was appointed Chief Financial Officer and Secretary of Perfumania in February of 1999. Prior to this appointment, Mr. Chin served as Corporate Controller of Perfumania from May 1995 to February 1999 and Assistant Corporate Controller from May 1993 to May 1995. Previously, Mr. Chin was employed by Price Waterhouse LLP in its Miami audit practice. CLAIRE FAIR was appointed Vice President of Human Resources in August 1996. From November 1993 to August 1996, she served as Perfumania's Director of Human Resources. Previously, she was the Director of Employee Relations with Sterling, Inc. 47 48 ROBERT PLISKIN was appointed a director of Perfumania in October 1991. Mr. Pliskin served as President of Longines Wittnauer Watch Company from 1971 to 1980 when he became President of the Seiko Time Corporation, a position he held until 1987. In 1987 he became the President of Hattori Corporation of America, a distributor of watches and clocks, until his retirement in 1993. Mr. Pliskin is a member of our Audit, Compensation and Stock Option Committees. CAROLE ANN TAYLOR was appointed a director of Perfumania in June 1993. From 1987 to 1998, Ms. Taylor was the owner and president of the Bayside Company Store, a retail souvenir and logo store at Bayside Marketplace in Miami, Florida. During this time she has also been a partner of the Jardin Bresilien Restaurant also located at the Bayside Marketplace. Currently, Ms. Taylor is the owner of Miami To Go, Inc., a retail and wholesale logo and souvenir merchandising and silkscreening company. She is also a partner at Miami Airport Duty Free Joint Venture with Greyhound Leisure Services which owns and operates the 19 duty free stores at Miami International Airport. She serves as director of the Miami-Dade Chamber of Commerce, the Greater Miami Convention & Visitors Bureau and the Miami Film Festival. Ms. Taylor is a member of our Audit, Compensation and Stock Option Committees. DR. HORATIO GROISMAN was appointed a Director of Perfumania in March 1999. Dr. Groisman has been a practicing physician since 1981, specializing in head and neck surgery, and currently has offices in Miami, Aventura and Hollywood, Florida. Dr. Groisman is a member of our Compensation and Stock Option Committees. Perfumania's officers are elected annually by the Board of Directors and serve at the discretion of the Board. Perfumania's directors hold office until the next annual meeting of shareholders and until their successors have been duly elected and qualified. SECTION 16(A) BENEFICIAL OWNERSHIP REPORTING COMPLIANCE Section 16(a) of the Securities Exchange Act of 1934 requires the Company's directors and executive officers, and persons who own more than 10 percent of the Company's Common Stock, to file with the Securities and Exchange Commission (the "SEC") initial reports of ownership and reports of changes in ownership of Common Stock. Officers, directors and greater than 10 percent shareholders are required by SEC regulation to furnish the Company with copies of all Section 16(a) forms they file. To the Company's knowledge, based solely on review of the copies of such reports furnished to the Company and written representations that no other reports were required, during the fiscal year ended January 30, 1999, all Section 16(a) filing requirements applicable to its officers, directors and greater than 10 percent beneficial owners were complied with except that one report relating to one transaction was filed late by each Jerome Falic and Robert Pliskin, respectively and two reports representing two transactions for Claire Fair have not been filed as of May 28, 1999. On October 28, 1999, the Company repriced the outstanding options issued under the Company's 1991 Stock Option Plan. As of May 28, 1999 each of the following individuals has not met the filing requirement with respect to those options which were cancelled in connection with the repricing: Ilia Lekach, Jerome Falic, Marc Finer, Claire Fair, Simon Falic, Ron Friedman, Robert Pliskin, and Carole A. Taylor. 48 49 ITEM 11. EXECUTIVE COMPENSATION The following table sets forth compensation awarded to, earned by or paid to (a) our Chief Executive Officer, (b) each of the three other highly compensated executive officers of Perfumania who were serving as executive officers at the end of the last completed fiscal year, other than the Chief Executive Officer, whose compensation exceeded $100,000 at the end of the last fiscal year (collectively, the "Named Executive Officers"), for services rendered to Perfumania during fiscal year 1998, 1997 and 1996, and (c) those individuals for whom disclosures would have been provided but for the fact that the individual was not serving as an executive officer of Perfumania at the end of the last fiscal year. SUMMARY COMPENSATION TABLE
ANNUAL COMPENSATION LONG-TERM COMPENSATION ------------------------- ------------------------------- NO. OF OTHER ANNUAL SECURITIES NAME AND FISCAL COMPENSATION UNDERLYING OTHER ANNUAL PRINCIPAL POSITION YEAR SALARY ($) BONUS ($) ($) (1) OPTIONS COMPENSATION ($) - --------------------- ------ ---------- --------- ------------ ---------- ---------------- Ilia Lekach (2) 1998 0 0 500,000(3) 775,000(8) 0 Chairman of the Board and Chief Executive Officer Jerome Falic (4) 1998 259,034 0 0 334,500(8) 0 President and Vice 1997 246,700 0 0 0 0 Chairman of the Board 1996 236,250 61,000 0 0 0 Marc Finer 1998 200,401 0 0 60,000(8) 0 President, Retail 1997 183,912 0 0 50,000 0 Division 1996 169,962 22,500 0 0 0 Claire Fair 1998 116,855 0 0 26,500(8) 0 Vice President of 1997 114,980 0 0 15,000 0 Human Resources 1996 85,809 0 0 3,000 0 Simon Falic (5) 1998 316,598 0 0 154,500(8) 1,303,588(6) 1997 304,813 0 0 0 0 1996 287,163 75,000 0 0 0 Ron A. Friedman (7) 1998 228,981 0 0 429,000(8) 826,232(6) 1997 246,700 0 0 0 0 1996 236,250 61,000 0 0 0
- ------------- (1) The column for "Other Annual Compensation" does not include any amounts for executive perquisites and any other personal benefits, such as the cost of automobiles, life insurance and disability insurance because the aggregate dollar amount per executive is less than 10% of his annual salary and bonus. (2) Ilia Lekach was re-appointed Chief Executive Officer and Chairman of the Board on October 28, 1998. (3) Amount reported represents consulting fees paid to Ilia Lekach during fiscal 1998 prior to his employment by Perfumania. Signing bonus for services rendered in fiscal 1998. (4) Jerome Falic was appointed as President following the resignation of Simon Falic on January 29, 1999. (5) Simon Falic resigned on January 29, 1999, at which time he served as President, Chief Financial Officer, Chief Operating Officer, Treasurer and Secretary. (6) Represents severance payments in accordance with individual separation agreements with each receiving the amount indicated over a 36-month term. (7) Mr. Friedman resigned on October 28, 1998 as Chief Financial Officer, Chief Operating Officer, Treasurer and Secretary. (8) Includes options repriced effective October 28, 1998 in the following amounts: Ilia Lekach (375,000); Jerome Falic (100,000); Mark Finer (60,000); Claire Fair (21,500), Simon Falic (100,000); and Ron Friedman (429,000). 49 50 OPTION GRANTS DURING FISCAL YEAR 1998 The following table sets forth certain information concerning grants of stock options made during fiscal year 1998 to the Named Executive Officers and the two individuals for whom disclosures would have been provided but for the fact that the individuals were not serving as an executive officer of Perfumania at the end of the last fiscal year.
INDIVIDUAL OPTION GRANTS IN FISCAL YEAR 1998 ---------------------------------------------------------------------------------------------------- % OF TOTAL OPTIONS POTENTIAL REALIZABLE VALUE AT NUMBER GRANTED TO ASSUMED ANNUAL RATES OF STOCK OF OPTIONS EMPLOYEES IN EXERCISE PRICE EXPIRATION PRICE APPRECIATION FOR OPTION TERM NAME GRANTED (1) FISCAL 1998 (4) PER SHARE DATE 5% (1) 10% (1) - ------------------ ------------ --------------- -------------- ---------- ----------------------------------- Ilia Lekach 400,000 21% $0.41 2008 $ 117,938 $ 260,760 375,000(2) 20% $0.50 2008 $ 103,156 $ 298,125 Jerome Falic 34,500(3) 4% $0.50 2008 $ 10,850 $ 27,428 200,000 25% $0.41 2008 $ 51,578 $ 130,380 100,000(2) 5% $0.50 2008 $ 31,450 $ 79,500 Marc Finer 60,000(2) 3% $0.50 2008 $ 18,870 $ 47,700 Claire Fair 5,000(3) * $0.50 2008 $ 1,573 $ 3,975 21,500(2) 1% $0.50 2008 $ 6,762 $ 17,093 Simon Falic 54,500(3) 3% $0.50 2008 $ 71,140 $ 43,328 100,000(2) 13% $0.50 2008 $ 31,450 $ 79,500 Ron Friedman 54,000 3% $0.50 2008 $ 16,983 $ 42,930 375,000 19% $0.50 2008 $ 117,938 $ 298,125
- --------------- * Indicates that amount is less than 1%. (1) In accordance with the rules of the Securities and Exchange Commission, the potential realizable values for such options shown in the table presented above are based on assumed rates of stock price appreciation of 5% and 10% compounded annually from the date the options were granted to their expiration date. These assumed rates of appreciation do not represent the Company's estimate or projection of the appreciation of shares of common stock of the Company. (2) The indicated options were initially granted prior to fiscal 1998 and were subject to the Company's repricing effective October 28, 1998. Pursuant to repricing, these options were cancelled and reissued with an exercise price of $0.50. (3) The indicated options were granted during fiscal 1998 prior to the repricing and were subject to the Company's repricing. Pursuant to repricing, these options were cancelled and reissued with an exercise price of $0.50. (4) Total stock option grants during fiscal 1998 were 1,926,750 of which 1,130,600 represents options cancelled and subsequently re-granted as part of the repricing. 50 51 AGGREGATED OPTION EXERCISES IN LAST FISCAL YEAR AND FISCAL YEAR-END OPTION VALUES The following table sets forth certain information concerning option exercises in fiscal year 1998 and the number of unexercised stock options held by the Named Executive Officers and the two individuals for whom disclosure would have been provided but for the fact that the individuals were not serving as executive officers of Perfumania at the end of the last fiscal year.
NUMBER OF VALUE OF UNEXERCISED NUMBER OF UNEXERCISED OPTIONS AT IN-THE-MONEY OPTIONS SHARES ACQUIRED VALUE FISCAL YEAR-END (#) AT FISCAL YEAR-END ($) NAME ON EXERCISE REALIZED EXERCISABLE/UNEXERCISABLE EXERCISABLE/UNEXERCISABLE - ---------------------------- --------------- --------- ------------------------- ------------------------- Ilia Lekach................. -- -- 775,000/0 $ 8,061,938/0 Jerome Falic................ -- -- 334,500/0 $ 2,439,386/0 Marc Finer.................. 33,000 $ 120,375 27,000/0 $ 280,868/0 Claire Fair................. 9,500 $ 97,532 9,500/7,500 $98,824/78,019 Simon Falic................. -- -- 154,500/0 $ 1,607,186/0 Ron A. Friedman............. 429,000 $ 175,890 -- --
LONG-TERM INCENTIVE AND PENSION PLANS The Company does not have any long-term incentive or pension plans. DIRECTOR COMPENSATION Perfumania pays each nonemployee director a $6,500 annual retainer and reimburses directors for expenses relating to their activities as directors of Perfumania. In addition, nonemployee directors are eligible to receive stock options under the Directors Stock Option Plan. When a person is elected as a director of Perfumania, pursuant to the terms of the Director Stock Option Plan, the director is automatically granted an option to purchase 2,000 shares of common stock and upon the directors re-election he is granted an option to purchase 4,000 shares of common stock, with the exercise price in both instances equal to the fair market value of the common stock on the date of grant. EMPLOYMENT AGREEMENTS Effective February 1, 1999, Perfumania entered into 3-year employment agreements with Ilia Lekach and Jerome Falic. The employment agreements provide for annual salaries of $400,000 and $318,347, respectively, subject to cost-of-living increases, or 5% if higher. The employment agreements provide that Mr. Lekach and Mr. Falic will continue to receive their annual salary until the expiration of the term of their employment agreements if their employment is terminated by Perfumania for any reason other than death, disability or cause (as defined in the employment agreements). The agreements contain a performance bonus plan which provides for additional compensation and grant of stock options, if Perfumania meets certain net income levels. The employment agreements also prohibit the employees from directly or indirectly competing with Perfumania during the term of their employment and for one year after termination of employment except in the case of termination of employment by Perfumania without cause. Effective August 1996, Perfumania entered into a 3-year employment agreement with Marc Finer and Claire Fair. The employment agreements provide for an annual salary of $175,000 and $100,000, respectively, subject to cost-of-living increases, or 5% if higher. The agreements provide that Mr. Finer and Ms. Fair will continue to receive their salary until the expiration of the term of the employment agreement if his employment is terminated by Perfumania for any reason other than death, disability or cause (as defined in the employment agreements). There is a performance bonus plan in the agreement, which provides for additional compensation and 51 52 a grant of stock options, if Perfumania meets certain net income levels. The employment agreements also prohibit them from directly or indirectly competing with Perfumania during the term of their employment and for one year after termination of employment except in the case of termination of employment by Perfumania without cause. SEPARATION AGREEMENTS Upon his resignation, Mr. Simon Falic entered into a separation agreement with Perfumania, pursuant to which we will make $1,303,588 in severance payments to him, subject to applicable withholding taxes, which is payable as follows: $300,000 in January 1999 and the balance payable in monthly installments of $26,529 during fiscal 1999, $27,855 during fiscal 2000 and $29,248 during fiscal 2001. Mr. Falic continues to receive health, dental and life insurance coverage, on the same basis as prior to his resignation for an additional 36 months. Upon his resignation, Mr. Friedman entered into a separation agreement with Perfumania pursuant to which we will make severance payments of $826,232, subject to applicable withholding taxes, payable as follows: $119,046 in January 1999 and the balance in monthly installments of $20,136 from February through October 1999 and $18,948 from November 1999 through November 2001. Mr. Friedman will continue to receive health, dental and life insurance coverage, on the same basis as prior to his resignation for an additional 36 months. Additionally, we shall convert the previously granted options into shares of common stock. HISTORICAL INFORMATION REGARDING REPRICING OF OPTIONS The following table sets forth information concerning the repricing of options held by Named Executive Officers of the Company. The table reflects all repricings of options in fiscal 1998.
LENGTH OF ORIGINAL OPTION MARKET PRICE TERM REMAINING NUMBER OF OF STOCK AT EXERCISE AT DATE OF OPTIONS TIME OF PRICE AT TIME NEW REPRICING OR REPRICED OR REPRICING OR OF REPRICING EXERCISE AMENDMENT NAME DATE AMENDED AMENDMENT OR AMENDMENT PRICE (IN YEARS) - ----------------------- -------- ------------ ------------ ------------- -------- --------------- Jerome Falic........... 10/27/98 100,000 $0.50 $ 2.75 $0.50 6.0 10/27/98 34,500 $0.50 $2.875 $0.50 9.33 ------- 134,500 Mark Finer............. 10/27/98 50,000 $0.50 $3.375 $0.50 8.6 10/27/98 10,000 $0.50 $ 3.00 $0.50 6.33 ------- 60,000 Claire Fair............ 10/27/98 26,500 $0.50 $ 2.75 $0.50 6.0 Simon Falic............ 10/27/98 100,000 $0.50 $ 2.75 $0.50 6.0 10/27/98 54,500 $0.50 $2.875 $0.50 9.33 ------- 154,500 Ron Friedman........... 10/27/98 175,000 $0.50 $ 2.75 $0.50 6.0 10/27/98 100,000 $0.50 $ 3.25 $0.50 7.25 10/27/98 100,000 $0.50 $ 3.50 $0.50 5.58 10/27/98 54,000 $0.50 $2.875 $0.50 9.33 ------- 429,000 Ilia Lekach............ 10/27/98 375,000 $0.50 $3.125 $0.50 5.4
52 53 COMPENSATION COMMITTEE OF THE BOARD OF DIRECTORS REPORT ON FISCAL 1998 OPTION REPRICINGS On October 28, 1998, the Compensation Committee approved a repricing of all outstanding stock options under the Company's Stock Option Plan and the Directors Stock Option Plan. All outstanding stock options were cancelled and each option holder was granted the same number of stock options at the fair market value of the Company's common stock on October 27, 1998, which was $0.50. No other terms of the stock options were amended. A total of 1,130,600 stock options were repriced as of this date, of which 842,500 were held by officers and directors of the Company. We approved the repricing because we believe that equity interests are a significant factor in the Company's ability to attract and retain key employees, and are critical to the Company's long-term goals. The stock options that were repriced had option prices ranging from $2.75 to $6.84. During fiscal year 1998, the market value of the Company's common stock had declined significantly, reaching a price as low as $0.41 in October 1998. This continued decline in the market price of the common stock was contrary to the incentive objectives of the stock option plans and in order not to negatively impact the Company's ability to retain key employees, the Compensation Committee approved this repricing of all outstanding stock options under both option plans. Robert Pliskin Carole Ann Taylor 53 54 ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT The following table sets forth, as of September 17, 1999, information with respect to the beneficial ownership of Perfumania's common stock by (i) each person known by Perfumania to beneficially own more than 5% of the outstanding shares of common stock, (ii) each director of Perfumania, (iii) each Named Executive Officer, and (iv) all directors and executive officers of Perfumania as a group.
COMMON STOCK BENEFICIALLY OWNED ------------------------------------- NAME AND ADDRESS OF BENEFICIAL OWNER (1) SHARES PERCENT(8) - ------------------------------------------------------------------- ------------------- ---------- Ilia Lekach........................................................ 1,459,995 (2)(3)(4) 14.7% Simon Falic(5)..................................................... 683,050 (2)(4) 7.2% Rachmil Lekach..................................................... 675,125 (2)(4) 7.3% Jerome Falic....................................................... 923,230 (3)(4) 9.7% Marc Finer......................................................... 27,000 (4) * Claire Fair........................................................ 18,000 (4) * Robert Pliskin..................................................... 4,000 (4) * Carole A. Taylor................................................... 3,800 (4) * Donovan Chin....................................................... 9,500 (4) * Horatio Groisman, M.D.............................................. 2,000 (4) * Parlux Fragrances, Inc.(6)......................................... 1,512,406 16.5 All directors and executive officers as a group (8 persons)........ 2,447,525 (7) 23.7%
- ------------- * Less than 1%. (1) The address of each of the beneficial owners identified is 11701 NW 101st Road, Miami, Florida 33178 except as otherwise noted. (2) Ilia Lekach, Simon Falic and Rachmil Lekach jointly own with their spouses the shares set forth opposite their respective names. (3) Includes 12,300 shares of common stock owned by Pacific Investment Group, a corporation wholly owned by Mr. Lekach. (4) Includes shares of common stock issuable upon the exercise of stock options within 60 days of September 17, 1999 in the following amounts: Ilia Lekach (775,000); Rachmil Lekach (150,000); Simon Falic (334,500); Jerome Falic (334,500); Robert Pliskin (4,000); Marc Finer (27,000); Donovan Chin (9,500); Horatio Groisman, M.D. (2,000); Claire Fair (17,000); and Carole A. Taylor (3,800). (5) The address of Mr. Simon Falic is 150 Harbor Way, Bal Harbour, Florida 33154. (6) The address of Parlux is 3725 S.W. 30th Avenue, Ft. Lauderdale, Florida 33312. (7) Includes 1,172,800 shares of common stock issuable upon the exercise of stock options within 60 days of September 17, 1999. (8) Based on 9,156,434 shares outstanding on September 17, 1999. 54 55 ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS Relationship with Parlux. Parlux Fragrances, Inc. is a public company engaged in the manufacture of fragrances. Ilia Lekach, our Chairman of the Board and Chief Executive Officer, and one of our principal shareholders, is the Chairman of the Board of Parlux. During fiscal year 1998, 1997 and 1996 we purchased approximately $24.3, $21.4 and $30.7 million, respectively, of merchandise from Parlux, representing approximately 27%, 26% and 29%, respectively, of our total purchases. We believe that our purchases of merchandise from Parlux, were, except for credit terms, on terms no less favorable to us than could reasonably be obtained in arm's length transactions with independent third parties. On August 31, 1999, the Company entered into a stock purchase agreement with Parlux. The agreement calls for the transfer of 1,512,406 shares of the Company's treasury stock to Parlux in consideration for a partial reduction of the Company's outstanding trade indebtedness balance of approximately $4.5 million. The transfer price was based on a per share price of $2.98, which approximates 90% of the closing price on the Company's common stock for the previous 20 business days. Pursuant to this agreement the parties entered into a registration rights agreement dated August 31, 1999, which grants Parlux demand registration rights. Relationship with L. Luria & Son, Inc. L. Luria & Son, Inc. is a public company that was a specialty discount retailer selling a broad line of products. Ilia Lekach, our Chairman of the Board and Chief Executive Officer, and one of our principal shareholders, was the Chairman of the Board of Luria's. During fiscal year 1998, 1997 and 1996, we sold approximately $0, $2.0 and $2.5 million, respectively, of merchandise to Luria's, representing approximately 0%, 1% and 2%, respectively, of our total sales. We believe that our sales of merchandise to Luria's, were, except for credit terms, on terms no less favorable to us than could reasonably be obtained in arm's length transactions with independent third parties. During August 1997, Luria's filed for relief under Chapter 11 of the United States Bankruptcy Code. We are an unsecured creditor of Luria's and in fiscal year 1997 we wrote off receivables from Luria's in the amount of $1.2 million. We have been characterized as an insider as defined by the United States Bankruptcy Code, in the liquidating plan of reorganization filed on April 6, 1998 by Luria's in the United States Bankruptcy Court, Southern District of Florida. In August 1998, the committee of unsecured creditors in Luria's bankruptcy proceedings filed a complaint with the United States Bankruptcy Court, Southern District of Florida, to recover substantial funds from us. The complaint alleges that Luria's made preference payments, as defined by the Bankruptcy Court, to us and seeks recovery of said preference payments, as well as the disallowment of any and all claims of us against Luria's until full payment of the preference payments have been made. In July 1999, we agreed with the committee of unsecured creditors to settle all claims held by Luria's against us for the sum of $1.2 million, payable over the next nine months according to a repayment schedule. This settlement is subject to the approval of the Bankruptcy Court. The full amount of the settlement was accrued for in our financial statements for the year ending January 30, 1999 and January 31, 1998. Related Party Indebtedness. From time to time we have borrowed money for working capital purposes from our principal shareholders and executive officers and members of their immediate families. The highest aggregate amounts of our indebtedness to such persons during fiscal year 1998, 1997 and 1996, respectively, amount outstanding at the end of fiscal year 1998, 1997 and 1996, respectively, the maturity date of such indebtedness and the interest rate payable by us at the end of fiscal year 1998, 1997 and 1996, respectively, were as set forth in the following table:
HIGHEST AMOUNT AMOUNT OUTSTANDING OUTSTANDING AT FISCAL DURING FISCAL FISCAL YEAR MATURITY ANNUAL YEAR YEAR END DATE INTEREST RATE ------ -------------- -------------- ----------------- ------------- Israel Friedman(1) 1998 $356,352 $0 November 1998 Prime plus 2% 1997 786,483 304,483 Payable on Demand Prime plus 2% 1996 770,000 770,000 Payable on Demand 15%
- ----------------- (1) Father of Ron A. Friedman, our previous Chief Financial Officer, Chief Operating Officer and Secretary. As of the end of fiscal year 1998, 1997 and 1996, Ilia Lekach was indebted to us pursuant to an unsecured note, in the amount of $457,243, $457,243 and $417,763, respectively, issued in connection with his purchase of a 55 56 condominium from us in October 1991. The note accrues interest at the rate of 9.5% and matures on December 31, 2000. Prior to becoming employed as our Chief Executive Officer effective February 1, 1999, Ilia Lekach provided consulting services to us. The total consulting fees paid to him during fiscal year 1998 was $500,000. No consulting fees were paid to Mr. Lekach in fiscal 1997 or fiscal 1996. 56 57 PART IV. ITEM 14. EXHIBITS, FINANCIAL STATEMENTS, SCHEDULES AND REPORTS ON FORM 8-K. (a) The following documents are filed as part of this report: (1) Financial Statements An index to financial statements for the fiscal years ended January 30, 1999, January 31, 1998 and February 1, 1997 appears on page 23. (2) Financial Statement Schedule The following statement schedule for the fiscal years ended January 30, 1999, January 31, 1998 and February 1, 1997 are submitted herewith:
ITEM FORM 10-K NUMBER PAGE --------- Schedule II - Valuation and Qualifying Accounts and Reserves...................................... 52
All other financial schedules are omitted because they are not applicable, or the required information is otherwise shown in the financial statements or notes thereto. (3) Exhibits
PAGE NUMBER OR INCORPORATED BY REFERENCE EXHIBIT DESCRIPTION FROM ------- ---------------------------------------------------------------------------------------------- --------------- 3.1 Amended and Restated Articles of Incorporation (1) 3.2 Bylaws (2) 4.1 Warrant Agreement between the Company and Josephthal, Lyon & Ross Incorporated (3) 10.1 Executive Compensation Plans and Arrangements (5) (a) Employment Agreement, dated as of February 1, 1995, between the Company and Simon Falic (b) Employment Agreement, dated as of February 1, 1995, between the Company and Jerome Falic (c) Employment Agreement, dated as of February 1, 1995, between the Company and Ron Friedman (d) Consulting Agreement, dated as of January 1, 1994, between the Company and Rachmil Lekach (e) Consulting Agreement, dated as of May 2, 1995, between the Company and Ilia Lekach 10.3 Amendments to the Loan and Security Agreements between the Company and LaSalle (5) National Bank dated July 29, 1994, and September 30, 1994
57 58
PAGE NUMBER OR INCORPORATED BY REFERENCE EXHIBIT DESCRIPTION FROM ------- ---------------------------------------------------------------------------------------------- --------------- 10.4 Amendments to the Loan and Security Agreements between the Company and LaSalle (6) National Bank dated March 29, 1996 10.5 1991 Stock Option Plan, as amended (6) 10.6 1992 Directors Stock Option Plan, as amended (6) 10.7 Regulation S 5% Convertible Debentures Agreement (6) 10.8 Regulation S Stock Subscription Agreement (6) 10.9 Amendments to the Loan and Security Agreements between LaSalle National Bank dated (7) April 16, 1997 21.1 Subsidiaries of the Registrant (6) 23.1 Consent of PricewaterhouseCoopers LLP (9) 27.1 Financial Data Schedule (for SEC use only) (9)
(1) Incorporated by reference to the exhibit of the same description filed with the Company's 1993 Form 10-K (filed April 28, 1994). (2) Incorporated by reference to the exhibit of the same description filed with the Company's Registration Statement on Form S-1 (No. 33-46833). (3) Incorporated by reference to the exhibit of the same description filed with the Company's Registration Statement on Form S-1 (No. 33-43556). (4) Incorporated by reference to the exhibit of the same description filed with the Company's Registration Statement on Form S-8 (filed October 13, 1994). (5) Incorporated by reference to the exhibit of the same description filed with the Company's 1994 Form 10-K (filed April 20, 1995). (6) Incorporated by reference to the exhibit of the same description filed with the Company's 1995 Form 10-K (filed April 26, 1996). (7) Incorporated by reference to the exhibit of the same description filed with the Company's 1996 Form 10-K (filed May 2, 1997) (8) Incorporated by reference to the exhibit of the same description filed with the Company's 1997 Form 10-K (filed May , 1998) (9) Filed herewith. (b) Reports on Form 8-K None. 58 59 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. October 7, 1999 PERFUMANIA, INC. By: /s/ ILIA LEKACH ---------------------------------- Ilia Lekach, Chairman of the Board and Chief Executive Officer 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 registrant and in the capacities and on the dates indicated.
SIGNATURE TITLE DATE - ----------------------------------- ------------------------- ---------------- /s/ ILIA LEKACH Chairman of the Board and October 7, 1999 - ----------------------------------- Chief Executive Officer Ilia Lekach /s/ JEROME FALIC President and Vice Chairman October 7, 1999 - ----------------------------------- of the Board Jerome Falic /s/ DONOVAN CHIN Chief Financial Officer October 7, 1999 - ----------------------------------- and Director Donovan Chin /s/ MARC FINER President of the Retail Division October 7, 1999 - ----------------------------------- and Director Marc Finer /s/ ROBERT PLISKIN Director October 7, 1999 - ----------------------------------- Robert Pliskin /s/ CAROLE ANN TAYLOR Director October 7, 1999 - ----------------------------------- Carole Ann Taylor /s/ HORACIO GROISMAN, M.D. Director October 7, 1999 - ----------------------------------- Horacio Groisman, M.D.
59 EX-23.1 2 CONSENT OF PRICEWATERHOUSECOOPERS LLP 1 Exhibit 23.1 CONSENT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS We hereby consent to the incorporation by reference in the Registration Statement on Form S-8 (No. 333-60061) of Perfumania, Inc. of our report dated April 29, 1999, except for the fourth paragraph of Note 2 and second paragraph of Note 8 as to which the date is July 14, 1999, relating to the financial statements and financial statement schedules, which appears in this Amendment No. 2 to Form 10-K. PricewaterhouseCoopers LLP Miami, Florida October 8, 1999 EX-27.1 3 FINANCIAL DATA SCHEDULE
5 1 US DOLLARS YEAR JAN-30-1999 FEB-01-1998 JAN-30-1999 1 1,745,603 0 4,813,801 704,954 53,880,132 69,217,070 37,194,943 14,014,481 95,129,376 73,051,781 0 0 0 86,145 17,635,912 95,129,376 175,255,633 175,255,633 110,638,432 110,638,432 78,017,385 0 4,960,851 (17,637,092) 1,337,406 (18,974,498) 0 0 0 (18,974,498) (2.85) (2.85)
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