UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-Q (Mark One) {x} QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended July 2, 1999 OR { } TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from _________ to _________ Commission File Number 000-05083 SAUCONY, INC. (Exact name of registrant as specified in its charter) Massachusetts 04-1465840 (State or other jurisdiction of (I.R.S. employer identification number) incorporation or organization) 13 Centennial Drive, Peabody, MA 01960 (Address of principal executive offices) 978-532-9000 (Registrant's telephone number, including area code) 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 [ ] Class Outstanding as of August 6, 1999 Class A Common Stock-$.33 1/3 Par Value 2,680,527 Class B Common Stock-$.33 1/3 Par Value 3,656,639 --------- 6,337,166 SAUCONY, INC. AND SUBSIDIARIES INDEX PART I. FINANCIAL INFORMATION Item 1. Financial Statements Condensed Consolidated Balance Sheets as of July 2, 1999 and January 1, 1999 3 Condensed Consolidated Statements of Income for the thirteen weeks and twenty-six weeks ended July 2, 1999 and July 3, 1998 4 Condensed Consolidated Statements of Stockholders' Equity for the twenty-six weeks ended July 2, 1999 and July 3, 1998 5 Condensed Consolidated Statements of Cash Flows for the twenty-six weeks ended July 2, 1999 and July 3, 1998 6-7 Notes to Condensed Consolidated Financial Statements - July 2, 1999 8-10 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations 11-16 Item 3. Quantitative and Qualitative Disclosure About Market Risk 16 PART II. OTHER INFORMATION Item 4. Submission of Matters to a Vote of Security Holders 17 Item 5. Stockholder Proposals for the 2000 Annual Meeting of Stockholders 17 Item 6. Exhibits and Reports on Form 8-K 18 Signature 19 SAUCONY, INC. AND SUBSIDIARIES Condensed Consolidated Balance Sheets (Unaudited) (in thousands) ASSETS July 2, January 1, 1999 1999 Current assets: Cash and cash equivalents $ 2,364 $ 5,495 Marketable securities 208 179 Accounts receivable, net 32,723 19,473 Inventories 29,325 31,072 Prepaid expenses and other current assets 3,683 2,923 --------- ---------- Total current assets 68,303 59,142 --------- ---------- Property, plant and equipment, net 8,111 8,123 --------- ---------- Other assets 2,393 2,614 --------- ---------- Total assets $ 78,807 $ 69,879 ========= ========== LIABILITIES AND STOCKHOLDERS' EQUITY Current liabilities: Notes payable $ 10,814 $ 7,568 Current maturities of long term debt 371 324 Accounts payable 4,550 6,244 Accrued expenses and other current liabilities 6,213 4,704 --------- ---------- Total current liabilities 21,948 18,840 --------- ---------- Long-term obligations: Long-term debt 451 559 Deferred income taxes 1,837 1,851 Other long-term obligations 164 157 --------- ---------- Total long-term obligations 2,452 2,567 --------- ---------- Minority interest in consolidated subsidiaries 274 222 --------- ---------- Stockholders' equity: Common stock, $.33 1/3 par value 2,211 2,178 Additional paid-in capital 16,539 15,921 Retained earnings 37,950 32,360 Accumulated translation (889) (528) ---------- ----------- Total 55,811 49,931 Less: Common stock held in treasury, at cost (1,665) (1,665) Unearned compensation (13) (16) ---------- ----------- 54,133 48,250 --------- ---------- Total liabilities and stockholders' equity $ 78,807 $ 69,879 ========= ========== See notes to condensed consolidated financial statements SAUCONY, INC. AND SUBSIDIARIES Condensed Consolidated Statements of Income For the Thirteen Weeks and Twenty-Six Weeks Ended July 2, 1999 and July 3, 1998 (Unaudited) (in thousands, except per share data) Thirteen Thirteen Twenty-Six Twenty-Six Weeks Weeks Weeks Weeks Ended Ended Ended Ended July 2, July 3, July 2, July 3, 1999 1998 1999 1998 Net sales $ 37,706 $ 26,562 $ 80,112 $ 56,186 Other revenue 74 158 282 200 --------- --------- --------- -------- Total revenue 37,780 26,720 80,394 56,386 --------- --------- --------- -------- Costs and expenses Cost of sales 23,569 16,480 50,554 36,131 Selling expenses 5,908 4,779 11,341 9,202 General and administrative expenses 4,246 4,070 8,554 7,580 --------- --------- --------- -------- Total costs and expenses 33,723 25,329 70,449 52,913 --------- --------- --------- -------- Operating income 4,057 1,391 9,945 3,473 Non-operating income (expense) Interest, net (246) (175) (392) (385) Foreign currency (11) (57) 15 (68) Other 13 9 37 43 --------- --------- --------- -------- Income before income taxes and minority interest 3,813 1,168 9,605 3,063 Provision for income taxes 1,543 494 3,973 1,392 Minority interest in income of consolidated subsidiaries 13 1 42 24 --------- --------- --------- -------- Net income $ 2,257 $ 673 $ 5,590 $ 1,647 ========= ========= ========= ======== Per share amounts: Earnings per common share - basic: $ 0.36 $ 0.11 $ 0.90 $ 0.26 ========== ========== ========== ========= Earnings per common share - diluted: $ 0.34 $ 0.11 $ 0.86 $ 0.26 ========== ========== ========== ========= Weighted average common shares and equivalents outstanding 6,625 6,342 6,512 6,348 ========= ========= ========= ======== Cash dividends per share of common stock 0 0 0 0 ========= ========= ========= ======== See notes to condensed consolidated financial statements SAUCONY, INC. AND SUBSIDIARIES Consolidated Statements of Stockholders' Equity For the Twenty-Six Weeks Ended July 2, 1999 and July 3, 1998 (in thousands, except share data) Common Stock Paid-in Retained Class A Class B Capital Earnings Balance, January 2, 1998 $ 902 $ 1,248 $ 15,652 $ 28,781 Issuance of 25,500 shares of common stock upon exercise of stock options 0 8 77 0 Amortization of unearned compensation 0 0 0 0 Net income 0 0 0 1,647 Foreign currency translation adjustments 0 0 0 0 --------- --------- --------- -------- Balance, July 3, 1998 $ 902 $ 1,256 $ 15,729 $ 30,428 ========= ========= ========= ======== Balance, January 1, 1999 $ 902 $ 1,276 $ 15,921 $ 32,360 Issuance of 100,274 shares of common stock upon exercise of stock options 0 33 333 0 Amortization of unearned compensation 0 0 0 0 Tax benefit related to stock options 0 0 261 0 Issuance of non-qualified stock options 0 0 24 0 Net income 0 0 0 5,590 Foreign currency translation adjustments 0 0 0 0 --------- --------- --------- -------- Balance, July 2, 1999 $ 902 $ 1,309 $ 16,539 $ 37,950 ========= ========= ========= ======== Total Treasury Stock Unearned Accumulated Stockholders' Shares Amount Compensation Translation Equity Balance, January 2, 1998 198,400 $ (1,054) $ (40) $ (417) $ 45,072 Issuance of 25,500 shares of common stock upon exercise of stock options 0 0 0 0 85 Amortization of unearned compensation 0 0 16 0 16 Net income 0 0 0 0 1,647 Foreign currency translation adjustments 0 0 0 (216) (216) -------- --------- ------- ------- ---------- Balance, July 3, 1998 198,400 $ (1,054) $ (24) $ (633) $ 46,604 ======== ========== ======== ======= ========= Balance, January 1, 1999 305,400 $ (1,665) $ (16) $ (528) $ 48,250 Issuance of 100,274 shares of common stock upon exercise of stock options 0 0 0 0 366 Amortization of unearned compensation 0 0 3 0 3 Tax benefit related to stock options 0 0 0 0 261 Issuance of non-qualified stock options 0 0 0 0 24 Net income 0 0 0 0 5,590 Foreign currency translation adjustments 0 0 0 (361) (361) -------- --------- ------- ------- ---------- Balance, July 2, 1999 305,400 $ (1,665) $ (13) $ (889) $ 54,133 ======== ========== ======== ======= ========= See notes to condensed consolidated financial statements SAUCONY, INC. AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS FOR THE TWENTY-SIX WEEKS ENDED JULY 2, 1999 AND JULY 3, 1998 INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS (in thousands) (Unaudited) July 2, July 3, 1999 1998 Cash flows from operating activities: Net income $ 5,590 $ 1,647 -------- --------- Adjustment to reconcile net income to net cash provided (used) by operating activities: Depreciation and amortization 935 843 Provision for bad debts and discounts 2,791 2,685 Deferred income tax benefit (370) (222) Other 104 194 Changes in operating assets and liabilities, net of effects of acquisitions, dispositions and foreign currency adjustments: Decrease (increase) in assets: Marketable securities (29) (39) Accounts receivable (16,070) (6,632) Inventories 1,223 (835) Prepaid expenses and other current assets (343) 440 Increase (decrease) in liabilities: Accounts payable (1,605) (439) Accrued expenses 1,795 1,975 -------- --------- Total adjustments (11,569) (2,030) --------- ---------- Net cash used by operating activities (5,979) (383) --------- ---------- Cash flows from investing activities: Purchases of property, plant and equipment (673) (499) Increase in deferred charges, deposits and other (28) (180) Proceeds from sale of equipment 3 15 Payments for business acquisitions 0 (579) -------- ---------- Net cash used by investing activities (698) (1,243) --------- ---------- Cash flows from financing activities: Net short-term borrowings 3,642 2,143 Repayment of long-term debt and capital lease obligations (221) (2,178) Issuances of common stock 366 85 -------- --------- Net cash provided by financing activities 3,787 50 -------- --------- Effect of exchange rate changes on cash and cash equivalents (241) (39) --------- ---------- Net decrease in cash and cash equivalents (3,131) (1,615) Cash and equivalents at beginning of period 5,495 4,432 -------- --------- Cash and equivalents at end of period $ 2,364 $ 2,817 ======== ========= Supplemental disclosure of cash flow information: Cash paid during the period for: Income taxes, net of refunds $ 4,277 $ 218 ======== ========= Interest $ 343 $ 413 ======== ========= Non-cash investing and financing activities: Property purchased under capital leases $ 160 $ 0 ======== ========= See notes to condensed consolidated financial statements SAUCONY, INC. NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS JULY 2, 1999 (Unaudited) NOTE 1 - BASIS OF PRESENTATION The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with the instructions to Form 10-Q and, therefore, do not include all information and footnotes necessary for a fair presentation of financial position, results of operations and cash flows in conformity with generally accepted accounting principles. In the opinion of management, all adjustments (consisting solely of normal recurring adjustments) necessary for a fair presentation have been included. These interim consolidated financial statements should be read in conjunction with the audited consolidated financial statements and the notes, thereto, included in the Company's Annual Report on Form 10-K, as filed with the Securities and Exchange Commission, for the year ended January 1, 1999. Operating results for twenty-six weeks ended July 2, 1999, are not necessarily indicative of the results for the entire year. NOTE 2 - RECLASSIFICATION Certain items in prior years Consolidated Financial Statements have been reclassified to conform to the 1999 presentation. NOTE 3 - INVENTORIES Inventories at July 2, 1999 and January 1, 1999 consisted of the following (in thousands): July 2, January 1, 1999 1999 Finished goods $ 23,109 $ 24,194 Work in progress 1,124 834 Raw materials 5,092 6,044 ----------- ----------- $ 29,325 $ 31,072 =========== =========== NOTE 4 - EARNINGS PER SHARE (Unaudited) (in thousands, except per share amounts) Thirteen Weeks Ended Thirteen Weeks Ended July 2, 1999 July 3, 1998 --------------------------- -------------------------- Earnings Earnings Earnings Earnings per per per per Common Common Common Common Share - Share - Share - Share - Basic Diluted Basic Diluted Net income available for common shares and assumed conversions $ 2,257 $ 2,257 $ 673 $ 673 ========== ========= ========== ========== Weighted-average common shares outstanding 6,264 6,264 6,262 6,262 Effect of dilutive securities: Employee stock options 0 361 0 80 ---------- --------- ---------- ---------- Weighted-average common shares and equivalents outstanding 6,264 6,625 6,262 6,342 ========== ========= ========== ========== Earnings per share $ 0.36 $ 0.34 $ 0.11 $ 0.11 ========== ========= ========= ========== Twenty-Six Weeks Ended Twenty-Six Weeks Ended July 2, 1999 July 3, 1998 --------------------------- -------------------------- Earnings Earnings Earnings Earnings per per per per Common Common Common Common Share - Share - Share - Share - Basic Diluted Basic Diluted Net income available for common shares and assumed conversions $ 5,590 $ 5,590 $ 1,647 $ 1,647 ========== ========= ========== ========== Weighted-average common shares outstanding 6,246 6,246 6,267 6,267 Effect of dilutive securities: Employee stock options 0 266 0 81 ---------- --------- ---------- ---------- Weighted-average common shares and equivalents outstanding 6,246 6,512 6,267 6,348 ========== ========= ========== ========== Earnings per share $ 0.90 $ 0.86 $ 0.26 $ 0.26 ========== ========= ========= ========== NOTE 5 - STATEMENT OF COMPREHENSIVE INCOME (in thousands) Thirteen Thirteen Twenty-Six Twenty-Six Weeks Weeks Weeks Weeks Ended Ended Ended Ended July 2, 1999 July 3, 1998 July 2, 1999 July 3, 1998 ------------ ------------ ------------ ------------ Net income $ 2,257 $ 673 $ 5,590 $ 1,647 Other comprehensive income: Foreign currency translation adjustment (175) (184) (361) (216) = Income tax benefit related to other comprehensive expense (19) (74) (154) (86) ----------- ---------- ----------- -----------= Other comprehensive income, net of tax (156) (110) (207) (130) ----------- ---------- ----------- ----------- Comprehensive income $ 2,101 $ 563 $ 5,383 $ 1,517 ========== ========= ========== ========== NOTE 6 - OPERATING SEGMENT DATA The Company's operating segments are organized based on the nature of products and consist of the Saucony Segment and Other Products Segment. The determination of the reportable segments for the thirteen and twenty-six weeks ended July 2, 1999 and July 3, 1998, as well as the basis of measurement of segment profit or loss, is consistent with the segment reporting disclosed in the Company's Annual Report on Form 10-K as filed for the fiscal year ended January 2, 1999. (in thousands) Thirteen Thirteen Twenty-Six Twenty-Six Weeks Weeks Weeks Weeks Ended Ended Ended Ended July 2, 1999 July 3, 1998 July 2, 1999 July 3, 1998 Revenues: Saucony $ 32,606 $ 21,778 $ 70,433 $ 47,662 Other products 5,174 4,942 9,961 8,724 ---------- --------- ---------- ---------- $ 37,780 $ 26,720 $ 80,394 $ 56,386 ========== ========= ========== ========== Income (loss) before income taxes: Saucony $ 4,169 $ 2,078 $ 10,234 $ 4,258 Other products (356) (910) (629) (1,195) ----------- ---------- ----------- ----------- $ 3,813 $ 1,168 $ 9,605 $ 3,063 ========== ========= ========== ========== ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Highlights The following table sets forth the comparison, as a percent change and in absolute dollars, of certain items in the consolidated statement of earnings for the thirteen and twenty-six weeks ended July 2, 1999 and July 3, 1998 and, for the periods indicated, the percentage of certain items in the consolidated statement of earnings relative to net sales. Percent Change Increase (Decrease) Thirteen Twenty-Six Weeks Weeks Net sales 42.0% 42.6% Gross profit 40.2 47.4 Selling, general and administrative 14.7 18.5 $ Change (in thousands) Thirteen Twenty-Six Weeks Weeks Operating income $ 2,666 $ 6,472 Income before tax and minority interest 2,645 6,542 Net income 1,584 3,943 Percent of Net Sales Thirteen Twenty-Six Weeks Weeks ----- ----- 1999 1998 1999 1998 ---- ---- ---- ---- Gross margin 37.5% 38.0% 36.9% 35.7% Selling, general and administrative 27.0 33.3 24.8 29.9 Operating income 10.8 5.2 12.4 6.2 Income before tax and minority interest 10.1 4.4 12.0 5.5 Net income 6.0 2.5 7.0 2.9 The following table sets forth net sales (in thousands) and percentages of net sales of the Company's product lines in the thirteen and twenty-six weeks ended July 2, 1999 and July 3, 1998, respectively: Thirteen Weeks Ended July 2, 1999 and July 3, 1998 1999 1998 ---------------------- ---------------------- $ % $ % - - - - Saucony $ 32,578 86.4% $ 21,624 81.4% Other products 5,128 13.6% 4,938 18.6% ---------- --------- ---------- --------- Total $ 37,706 100.0% $ 26,562 100.0% ========== ========= ========== ========= Twenty-Six Weeks Ended July 2, 1999 and July 3, 1998 1999 1998 ---------------------- ---------------------- $ % $ % - - - - Saucony $ 70,253 87.7% $ 47,475 84.5% Other products 9,859 12.3% 8,711 15.5% ---------- --------- ---------- --------- Total $ 80,112 100.0% $ 56,186 100.0% ========== ========= ========== ========= Thirteen Weeks Ended July 2, 1999 Compared to Thirteen Weeks Ended July 3, 1998 Consolidated Net Sales Net sales increased 42% to $37,706,000 in the thirteen weeks ended July 2, 1999 from $26,562,000 in the thirteen weeks ended July 3, 1998. The impact of foreign exchange rate changes in the thirteen weeks ended July 2, 1999 was negligible. Saucony Brand Segment Worldwide net sales of branded Saucony footwear and apparel increased 51% to $32,578,000 in the thirteen weeks ended July 2, 1999 from $21,624,000 in the thirteen weeks ended July 3, 1998, primarily due to an 86% unit volume growth in the footwear category. Overall average sell prices declined 23% in the thirteen weeks ended July 2, 1999 due to a higher proportion of more moderately-priced Originals footwear in the Company's domestic product mix. Domestic net sales increased 67% to $28,705,000 due primarily to increased unit volumes and higher average unit sell prices for Saucony's Originals (introduced in the second quarter of 1998). International net sales decreased 13% to $3,873,000 due primarily to the discontinuance of operations in Australia, which was offset in part by increased distributor unit volume and increased unit volumes recorded by the Company in Canada and Western Europe. Other Products Segment Net sales of Other Products increased 4% to $5,128,000 in the thirteen weeks ended July 2, 1999 from $4,938,000 in the thirteen weeks ended July 3, 1998, reflecting revenue growth in both bicycle and related products, increased domestic and international sales of the Company's Hind apparel brand and, to a lesser extent, increased sales at the Company's factory outlet stores, offset in part by lower international sales of non-Saucony brands due to the cessation of operations in Australia in July 1998. The growth in bicycle and related products revenue is due in large measure to the growth in the Merlin business and the acquisition of Real Design in August 1998. Cost and Expenses The Company's gross profit increased 40% to $14,137,000 in the thirteen weeks ended July 2, 1999 from $10,082,000 in the thirteen weeks ended July 3, 1998 due to higher domestic unit volumes. The Company's gross margin decreased to 37.5% in the thirteen weeks ended July 2, 1999 from 38.0% in the thirteen weeks ended July 3, 1998 due to inefficiencies in domestic manufacturing operations. Selling, general and administrative expenses increased to $10,154,000, or 27.0% of net sales, in the thirteen weeks ended July 2, 1999 from $8,849,000, or 33.3% of net sales, in the thirteen weeks ended July 3, 1998. Selling expenses increased $1,129,000 in the thirteen weeks ended July 2, 1999 due to increased domestic spending for print media, athlete and event sponsorship and co-operative advertising, as well as increased sales commissions and payroll and related expenses. General and administrative expenses increased $176,000 in the thirteen weeks ended July 2, 1999 due to increased staffing, performance-based compensation, increased bad debt expense, increased administrative cost to sustain the growth of the Hind apparel and bicycle division, offset in part by reduced international administrative spending as a result of the cessation of operations in Australia in July 1998. Net interest expense increased 41% to $246,000 in the thirteen weeks ended July 2, 1999 from $175,000 in the thirteen weeks ended July 3, 1998 due to increased borrowings against the Company's domestic credit facility to finance working capital requirements. Income Before Tax (in thousands) 1999 1998 ---- ---- Segment Saucony Brand $ 4,169 $ 2,078 Other Products (356) (910) ---------- --------- Consolidated $ 3,813 $ 1,168 ========= ======== Consolidated income before tax increased to $3,813,000 in the thirteen weeks ended July 2, 1999 from $1,168,000 in the thirteen weeks ended July 3, 1998 due primarily to increased domestic Saucony Brand income and the improved financial performance of Hind apparel. Income Taxes The provision for income taxes increased to $1,543,000 in the thirteen weeks ended July 2, 1999 from $494,000 in the thirteen weeks ended July 3, 1998, due primarily to increased domestic pre-tax income. The effective tax rate decreased to 40.5% in the thirteen weeks ended July 2, 1999 from 42.3% in the thirteen weeks ended July 3, 1998 due primarily to a shift in the composition of domestic and foreign pre-tax earnings. Net Income Net income increased to $2,257,000 in the thirteen weeks ended July 2, 1999 from $673,000 in the thirteen weeks ended July 3, 1998. Diluted earnings per share increased to $0.34 in the thirteen weeks ended July 2, 1999 compared to $0.11 in the thirteen weeks ended July 3, 1998. Twenty-Six Weeks Ended July 2, 1999 Compared to Twenty-Six Weeks Ended July 3, 1998 Consolidated Net Sales Net sales increased 43% to $80,112,000 in the twenty-six weeks ended July 2, 1999 from $56,186,000 in the twenty-six weeks ended July 3, 1998. The impact of foreign exchange rate changes in the twenty-six weeks ended July 2, 1999 was negligible. Saucony Brand Segment Worldwide net sales of branded Saucony footwear and apparel increased 48% to $70,253,000 in the twenty-six weeks ended July 2, 1999 from $47,475,000 in the twenty-six weeks ended July 3, 1998, primarily due to an 84% unit volume growth in the footwear category. Overall average sell prices declined 26% in the twenty-six weeks ended July 2, 1999 due to a higher proportion of more moderately-priced Originals in the Company's domestic product mix. Domestic net sales increased 70% to $61,348,000 due primarily to increased unit volumes for Saucony's core technical footwear models and Originals (introduced in the second quarter of 1998). International net sales decreased 21% to $8,905,000 due primarily to the discontinuance of operations in Australia and decreased distributor unit volumes, offset in part by increased unit volumes recorded by the Company in Canada and Western Europe. Other Products Segment Net sales of Other Products increased 13% to $9,859,000 in the twenty-six weeks ended July 2, 1999 from $8,711,000 in the twenty-six weeks ended July 3, 1998, reflecting revenue growth in both bicycle and related products, increased domestic and international sales of the Company's Hind apparel brand and, to a lesser extent, increased sales at the Company's factory outlet stores, offset in part by lower international sales due to the cessation of operation in Australia in July 1998. The growth in bicycles and related products revenue is due in large measure to the growth in the Merlin business and the acquisition of Real Design in August 1998. Cost and Expenses The Company's gross profit increased 47% to $29,558,000 in the twenty-six weeks ended July 2, 1999 from $20,055,000 in the twenty-six weeks ended July 3, 1998 due to higher domestic unit volumes. The Company's gross margin improved to 36.9% in the twenty-six weeks ended July 2, 1999 from 35.7% in the twenty-six weeks ended July 3, 1998 due to lower levels of product returns and markdowns and a change in the product mix compared to the prior comparable period. Selling, general and administrative expenses increased to $19,895,000, or 24.8% of net sales, in the twenty-six weeks ended July 2, 1999 from $16,782,000, or 29.9% of net sales, in the twenty-six weeks ended July 3, 1998. Selling expenses increased $2,139,000 in the twenty-six weeks ended July 2, 1999 due to increased domestic spending for print media, athlete and event sponsorship, co-operative advertising, as well as increased sales commissions and payroll and related expenses. General and administrative expenses increased $974,000 in the twenty-six weeks ended July 2, 1999 due to increased staffing, performance-based compensation, increased bad debt expense, increased administrative cost to sustain the growth of the Hind apparel and bicycle division, offset in part by reduced international administrative spending as a result of the cessation of operations in Australia in July 1998. Net interest expense increased 2% to $392,000 in the twenty-six weeks ended July 2, 1999 from $385,000 in the twenty-six weeks ended July 3, 1998 due to increased borrowing under the Company's domestic credit facility to finance working capital requirements, which was largely offset by lower debt levels resulting from the paydown of the Company's senior notes payable in the second quarter of 1998. Income Before Tax (in thousands) 1999 1998 ---- ---- Segment Saucony Brand $ 10,234 $ 4,258 Other Products (629) (1,195) ---------- --------- Consolidated $ 9,605 $ 3,063 ========= ======== Consolidated income before tax increased to $9,605,000 in the twenty-six weeks ended July 2, 1999 from $3,063,000 in the twenty-six weeks ended July 3, 1998 due primarily to increased domestic Saucony Brand income and the improved financial performance of Hind apparel. Income Taxes The provision for income taxes increased to $3,973,000 in the twenty-six weeks ended July 2, 1999 from $1,392,000 in the twenty-six weeks ended July 3, 1998, due primarily to increased domestic pre-tax income. The effective tax rate decreased to 41.4% in the twenty-six weeks ended July 2, 1999 from 45.4% in the twenty-six weeks ended July 3, 1998 due primarily to a deferred tax valuation allowance recorded in the twenty-six weeks ended July 3, 1998, relating to foreign operating losses that were not expected to be realized. Net Income Net income increased to $5,590,000 in the twenty-six weeks ended July 2, 1999 from $1,647,000 in the twenty-six weeks ended July 3, 1998. Diluted earnings per share increased to $0.86 in the twenty-six weeks ended July 2, 1999 compared to $0.26 in the twenty-six weeks ended July 3, 1998. Liquidity and Capital Resources As of July 2, 1999 the Company's cash and cash equivalents totaled $2,364,000, a decrease of $3,131,000 from January 1, 1999. The decrease is due primarily to an increase in accounts receivable of $13,279,000, net of the provision for bad debts and discounts, partially offset by an increase in accrued liabilities of $1,795,000 and an increase in borrowings against the Company's domestic and foreign credit facilities of $3,642,000. The increase in accounts receivable is due to increased net sales of the Company's Saucony, Hind and bicycle products in the twenty-six weeks ended July 2, 1999. The Company's days sales outstanding for its accounts receivable remained constant at 74 days in the twenty-six weeks ended July 2, 1999 as compared to July 3, 1998. Inventories decreased $1,223,000 in the twenty-six weeks ended July 2, 1999 due to the management of domestic inventory levels. As a consequence of the improved inventory management and the velocity of Originals, the Company's inventory turns ratio increased to 3.4 turns in the twenty-six weeks ended July 2, 1999 from 3.0 turns in the twenty-six weeks ended July 3, 1998. For the twenty-six weeks ended July 2, 1999, the Company used $5,979,000 of net cash from operating activities, expended $673,000 to acquire capital assets, and expended $221,000 to reduce long-term debt and received $366,000 from the issuance of common stock in connection with the exercise of employee stock options. Principal factors (other than net income, accounts receivable, provision for bad debts and discounts and inventory) affecting the operating cash flows in the twenty-six weeks ended July 2, 1999 were, a decrease of $1,605,000 in accounts payable (due to decreased inventory levels), an increase of $1,795,000 in accrued expenses (due to increased variable selling and administrative expenses associated with a higher level net sales) and an increase of $343,000 in prepaid expenses (due to an increase in advance payments for advertising and inventory). The liquidity of the Company is contingent upon a number of factors, principally the Company's future operating results. Management believes that the Company's current cash and cash equivalents, credit facilities and internally generated funds are adequate to meet its working capital requirements and to fund its capital investments needs and debt service payments. Year 2000 The Company views its exposure to the Year 2000 problem in three areas: (i) internal computer systems used to manage the Company's business, (ii) microprocessors and other electronic devices included as components of equipment used by the Company ("embedded chips") and (iii) computer systems used by suppliers and customers of the Company. The Company's plan, under the coordination of the Vice President Information Systems, is to resolve its internal Year 2000 problems following sequential phases of evaluation, updating and testing and to pursue Year 2000 compliance awareness and supporting documentation from key suppliers and customers. In the evaluation phase, the Company reviews the applicable system to identify Year 2000 problems and determines the necessary remediation steps. The updating and testing phases involve the implementation and testing, respectively, of Year 2000 remediation measures. Based on the evaluation of its exposure for the Year 2000 problem, the Company has modified or replaced portions of its software, computer and other equipment systems. The Company has incurred costs of approximately $20,000 in fiscal 1998 and expects to incur additional costs of $100,000 to $150,000 in fiscal 1999 related to the Year 2000 modifications. To date, the Company has evaluated substantially all of its internal computer systems and embedded chips and has completed the majority of necessary upgrades. The Company expects that full evaluation, updating and testing will be completed during the fourth quarter of fiscal 1999. The Company has interviewed key suppliers to determine their capability to continue providing goods and services. Based on responses from over 80% of those surveyed, the Company believes that its suppliers are unlikely to disrupt inventory agreements due to a Year 2000 problem. Nevertheless, the Company continues to expand its understanding of the Year 2000 problems of its significant business partners based on ongoing surveys and interviews and this process will continue throughout 1999. Contingency plans for supply disruptions are being formulated and are expected to be completed in the third quarter of 1999. The Company has also interviewed key customers and all those who utilize Electronic Data Interface (EDI) as the principal means of placing orders. The responses received indicate that most customers are in the process of developing or executing remediation plans to address Year 2000 problems. The Company believes that customers present a potential Year 2000 business risk because of the Company's limited ability to influence their actions or internal processes. The Company has determined the risks associated with the reasonably worst-case scenario. Except for the risks associated with customer readiness which are beyond the Company's control, there are manual backup and outsourcing opportunities readily available to support the Company's internal fulfillment systems. The foregoing discussion of the Company's Year 2000 readiness contains forward-looking statements and were derived using numerous assumptions. Despite the Company's belief that its Year 2000 program reduces the risk of an internal compliance failure and is taking an active approach to assess the readiness of its business partners, there can be no assurances that all parties will achieve timely Year 2000 compliance or that such noncompliance will not have a material adverse impact to the Company. ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK The Company has performed an analysis to assess the potential effect of reasonably possible near-term changes in inflation and foreign currency exchange rates. The effect of inflation on the Company's results of operations over the past three years has been minimal. The impact of currency fluctuation on the purchase of inventory by the Company from foreign suppliers has been minimal as the transactions were denominated in U.S. dollars. The Company, however, is subject to currency fluctuation risk with respect to the operating results of the Company's foreign subsidiaries and certain foreign currency-denominated payables. The Company has entered into certain forward foreign exchange contracts to minimize the transaction currency risk. PART II. OTHER INFORMATION Item 4. Submission of Matters to a Vote of Security-Holders At the 1999 Annual Meeting of Stockholders of the Company (the "Annual Meeting") held on May 20, 1999, the following matters were acted upon by the stockholders of the Company: 1. The election of John M. Connors, Jr., John H. Fisher, Phyllis H. Fisher, Charles A. Gottesman, Robert J. LeFort, Jr., and John J. Neuhauser as directors of the Company. 2. The ratification of the selection by the Board of Directors of PricewaterhouseCoopers LLP as the Company's independent auditors for the current 1999 fiscal year. The results of the voting on each of the matters presented to stockholders at the Annual Meeting are set forth below: Votes Votes Broker For Against Abstentions Non-votes 1. Election of Directors John M Connors, Jr. 2,487,616 -- 6,321 N.A. John H. Fisher 2,487,616 -- 6,321 N.A. Phyllis H. Fisher 2,487,616 -- 6,321 N.A. Charles A. Gottesman 2,487,616 -- 6,321 N.A. Robert J. LeFort, Jr. 2,487,616 -- 6,321 N.A. John. J. Neuhauser 2,487,616 -- 6,321 N.A. 2. Ratification of Independent Auditors 2,489,815 3,212 910 N.A. ITEM 5 - Stockholder Proposals for the 2000 Annual Meeting of Stockholders As set forth in the Company's proxy statement for its 1999 Annual Meeting of Stockholders, stockholder proposals submitted pursuant to Rule 14a-8 under the Securities and Exchange Act of 1934 (the "Exchange Act") for inclusion in the Company's proxy materials for its 2000 Annual Meeting of Stockholders must be received by the Company on or before December 31, 1999. In addition, in accordance with recent amendments to Rules 14a-4, 14a-5 and 14a-8 under the Exchange Act, written notice of stockholder proposals submitted outside the processes of Rule 14a-8 for consideration at the 2000 Annual Meeting of Stockholders must be received by the Company on or before March 22, 2000 in order to be considered timely for purposes of Rule 14a-4. The persons designated in the Company's proxy statement and management proxy card will be granted discretionary authority with respect to any stockholder proposal with respect to which the Company does not receive timely notice. ITEM 6. Exhibits and Reports on Form 8-K a. Exhibits 27.0 - Financial Data Schedule 99.1 - Certain Factors that May Effect Future Results, set out on pages 25-27 of the Company's Annual Report on Form 10-K for the period ended January 2, 1998. Such Form 10-K shall not be deemed to be filed except to the extent that portions thereof are expressly incorporated by reference herein. b. Reports on Form 8-K None. SIGNATURE Pursuant to the requirements of the Securities and Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. SAUCONY, INC. By: /s/ Terence P. Chin Terence P. Chin Senior Vice President Chief Financial Officer (Duly authorized officer and principal financial officer) Date: August 12, 1999