FORM 10-Q UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, DC. 20549 QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITES AND EXCHANGE ACT OF 1934 For the quarterly period ended September 30, 1999 Commission File Numbers: 333-32385-05 and 333-32385 HEDSTROM HOLDINGS, INC. HEDSTROM CORPORATION (Exact name of registrant as specified in its charter) Delaware 51-0329830 Delaware 51-0329829 (State or other jurisdiction (IRS Employer of incorporation Identification or organization) Number) 585 Slawin Court, Mount Prospect, Illinois 60056 (Address of principal executive offices, including zip code) (847) 803- 9200 (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 At November 11, 1999, there were outstanding: (i) 36,142,883 shares of the Common Stock, par value $.01 per share, of Hedstrom Holdings, Inc., (ii) 31,520,000 shares of the Non-Voting Common Stock, par value $.01 per share, of Hedstrom Holdings, Inc. and (iii) 10 shares of the Common Stock, par value $.01 per share, of Hedstrom Corporation. HEDSTROM HOLDINGS, INC. HEDSTROM CORPORATION FORM 10-Q FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 1999 TABLE OF CONTENTS Page Number PART I FINANCIAL INFORMATION Item 1. Financial Statements Consolidated Balance Sheets As of September 30, 1999 and December 31, 1998 Consolidated Income Statements Three months ended September 30, 1999 and 1998 Nine months ended September 30, 1999 and 1998 Consolidated Statements of Cash Flows Nine months ended September 30, 1999 and 1998 Consolidated Statement of Stockholders' Equity As of and for the nine months ended September 30, 1999 Notes to Consolidated Financial Statements Item 2. Management's Discussion and Analysis of Results of Operations and Financial Condition PART II OTHER INFORMATION Item 1. Legal Proceedings Item 6. Exhibits and Reports on Form 8-K Signature HEDSTROM HOLDINGS, INC. AND SUBSIDIARY CONSOLIDATED BALANCE SHEETS (In thousands, except share data) September 30, December 31, 1999 1998 ------------- ------------ (unaudited) ASSETS CURRENT ASSETS: Cash and cash equivalents $ 13,569 $ 4,334 Trade accounts receivable, net of allowance for doubtful accounts 51,106 69,522 Taxes receivable 6,745 6,745 Inventories 74,897 53,722 Deferred income taxes 6,016 6,016 Prepaid expenses and other current assets 5,729 4,130 -------- -------- TOTAL CURRENT ASSETS 158,062 144,469 -------- -------- PROPERTY, PLANT AND EQUIPMENT, at cost, net of accumulated depreciation 48,337 48,102 -------- -------- OTHER ASSETS: Deferred charges, net of accumulated amortization 12,598 14,795 Goodwill, net of accumulated amortization 185,562 186,826 Deferred income taxes 740 1,575 -------- -------- TOTAL OTHER ASSETS 198,900 203,196 -------- -------- TOTAL ASSETS $405,299 $395,767 ======== ======== HEDSTROM HOLDINGS, INC. AND SUBSIDIARY CONSOLIDATED BALANCE SHEETS (In thousands, except share data) September 30, December 31, 1999 1998 ------------- ------------ (unaudited) LIABILITIES AND STOCKHOLDERS' EQUITY CURRENT LIABILITIES: Revolving line of credit $ 53,950 $ 34,920 Current portion of long-term debt and capital leases 14,132 11,905 Accounts payable 25,512 20,709 Accrued expenses 18,241 22,970 -------- -------- TOTAL CURRENT LIABILITIES 111,835 90,504 -------- -------- LONG-TERM DEBT: Senior Subordinated Notes 110,000 110,000 Senior Discount Notes 29,284 26,584 Term Loans 111,275 123,736 Notes payable to related parties 2,500 2,500 Capital leases 1,324 1,690 Other 1,538 2,154 -------- -------- TOTAL LONG-TERM DEBT 255,921 266,664 -------- -------- STOCKHOLDERS' EQUITY: Preferred stock, $0.01 par value, 10,000,000 shares authorized, no shares issued and outstanding - - Common stock, $0.01 par value, 100,000,000 shares authorized, 36,142,883 and 36,142,883 shares issued and outstanding, respectively 361 361 Non-voting common stock, $0.01 par value, 40,000,000 shares authorized, 31,520,000 and 31,520,000 issued and outstanding, respectively 315 315 Additional paid-in capital 51,553 51,553 Accumulated other comprehensive loss 568 (2,616) Accumulated deficit (15,254) (11,014) -------- -------- TOTAL STOCKHOLDERS' EQUITY 37,543 38,599 -------- -------- TOTAL LIABILITIES AND STOCKHOLDERS' $405,299 $395,767 ======== ======== The accompanying notes to consolidated financial statements are an integral part of these statements. HEDSTROM HOLDINGS, INC. AND SUBSIDIARY CONSOLIDATED INCOME STATEMENTS (In thousands, except per share data) (Unaudited) For the three months ended September 30, --------------------------------------- 1999 1998 ---- ---- Net sales $56,936 $64,353 Cost of sales 40,661 40,809 ------- ------- Gross profit 16,275 23,544 Selling, general and administrative expense 18,832 15,383 ------- ------- Operating income (2,557) 8,161 Interest expense 9,022 7,896 ------- ------- Income (loss) before income taxes (11,579) 265 Income tax (benefit) expense (4,747) 115 ------- ------- Net income (loss) $(6,832) $ 150 ======= ======= Basic earnings (loss) per share: Net income (loss) per share ($0.10) $0.00 Weighted average number of common shares outstanding (in thousands) 67,633 67,663 Diluted earnings (loss) per share: Net income (loss) per share ($0.10) $0.00 Weighted average number of common shares outstanding (in thousands) 67,663 68,968 The accompanying notes to consolidated financial statements are an integral part of these statements. HEDSTROM HOLDINGS, INC. AND SUBSIDIARY CONSOLIDATED INCOME STATEMENTS (In thousands, except per share data) (Unaudited) For the nine months ended September 30, --------------------------------------- 1999 1998 ---- ---- Net sales $247,923 $226,014 Cost of sales 175,410 157,325 -------- -------- Gross profit 72,513 68,689 Selling, general and administrative expense 53,627 46,072 -------- -------- Operating income 18,886 22,617 Interest expense 26,073 23,377 -------- -------- Income (loss) before income taxes (7,187) (760) Income tax (benefit) expense (2,947) (312) -------- -------- Net income (loss) $ (4,240) $ (448) -------- -------- Basic earnings (loss) per share: Net income (loss) per share ($0.06) ($0.01) Weighted average number of common shares outstanding (in thousands) 67,633 67,663 Diluted earnings (loss) per share: Net income (loss) per share ($0.06) ($0.01) Weighted average number of common shares outstanding (in thousands) 67,663 67,663 The accompanying notes to consolidated financial statements are an integral part of these statements. HEDSTROM HOLDINGS, INC. AND SUBSIDIARY CONSOLIDATED STATEMENTS OF CASH FLOWS (In thousands) (Unaudited) For the nine months ended September 30, -------------------------------------- 1999 1998 ---- ---- Cash flows from operating activities: Net (loss) $ (4,240) $ (448) Adjustments to reconcile net (loss) to net cash provided by operating activities: Depreciation of property, plant and equipment and amortization of goodwill 10,007 9,572 Amortization of deferred financing fees 5,387 5,333 Deferred income tax benefit 835 (44) Changes in current assets and current liabilities, net of acquisitions: Accounts receivable 21,138 19,591 Inventories (21,175) (10,892) Prepaid expenses and other current assets (1,599) 172 Accounts payable 4,803 (1,678) Accrued expenses (7,620) (8,435) -------- ------- Net cash provided by operating activities 7,536 13,171 -------- ------- Cash flows from investing activities: Acquisitions of property, plant and equipment (6,115) (7,305) Acquisition of ERO, Inc. - (3,037) Acquisition of Backyard Products Ltd. - (16,805) Other acquisitions - (3,579) -------- ------- Net cash used for investing activities (6,115) (30,726) -------- ------- HEDSTROM HOLDINGS, INC. AND SUBSIDIARY CONSOLIDATED STATEMENTS OF CASH FLOWS (In thousands) (Unaudited) For the nine months ended September 30, -------------------------------------- 1999 1998 ---- ---- Cash flows from financing activities: Proceeds from Term Loans - 30,000 Principal payments on Term Loans (9,699) (7,249) Borrowings on Revolving Credit Facility, net 19,030 (11,900) Other (1,517) (594) -------- ------- Net cash provided by financing activities 7,814 10,257 -------- ------- Net increase (decrease) in cash and cash equivalents 9,235 (7,298) Cash and cash equivalents: Beginning of period 4,334 10,844 -------- ------- End of period $ 13,569 $ 3,546 ======== ======= The accompanying notes to consolidated financial statements are an integral part of these statements. HEDSTROM HOLDINGS, INC. AND SUBSIDIARY CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY (In thousands, except shares) (Unaudited) Common Stock Accumulated -------------- Additional Other Par Paid-In Comprehensive Accumulated Shares Value Capital Losses Deficit Total --------------------------------------------------------- -------- Balance at December 31, 1998 67,662,883 $676 $51,553 $(2,616) $(11,014) $38,599 Foreign currency translation adjustment - - - 3,184 - 3,184 Net income - - - - (4,240) (4,240) -------- Comprehensive income - - - - - (1,056) --------------------------------------------------------- -------- Balance at September 30, 1999 67,662,883 $676 $51,553 $ 568 $(15,254) $37,543 =================================================================== The accompanying notes to consolidated financial statements are an integral part of these statements. HEDSTROM HOLDINGS, INC. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (unaudited) NOTE 1 - PRINCIPLES OF CONSOLIDATION: The accompanying interim consolidated financial statements include the accounts of Hedstrom Holdings, Inc. (Holdings) and its wholly owned subsidiary, Hedstrom Corporation (Hedstrom, and together with Holdings, the Company). These financial statements are unaudited but, in the opinion of management, contain all adjustments, consisting only of normal recurring adjustments, necessary to present fairly the financial condition, results of operations and cash flows of the Company. Certain prior period amounts have been reclassified to conform with the current period presentation. All intercompany balances and transactions have been eliminated in consolidation. The interim consolidated financial statements should be read in conjunction with the consolidated financial statements and notes thereto contained in the Company's Annual Report on Form 10-K for the year ended December 31, 1998 as filed with the Securities and Exchange Commission. The results of operations for the three months and nine months ended September 30, 1999 are not necessarily indicative of the results to be expected for the entire fiscal year. NOTE 2 - INVENTORIES: Inventories at September 30, 1999 and December 31, 1998 consist of the following (in thousands): September 30, December 31, 1999 1998 ------------ ----------- Raw materials $25,564 $21,421 Work-in-process 11,564 9,013 Finished goods 37,769 23,288 ------- ------- $74,897 $53,722 ======= ======= NOTE 3 - DEBT: Debt consists of the following (in thousands): September 30, December 31, 1999 1998 ------------ ----------- Senior Subordinated Notes $110,000 $110,000 Term Loans 124,459 134,158 Revolving Credit Facility 53,950 34,920 Senior Discount Notes 29,284 26,584 Other 6,310 7,827 -------- -------- $324,003 $313,489 ======== ======== Senior Subordinated Notes The $110.0 million Senior Subordinated Notes bear interest at 10% per annum, payable on June 1 and December 1 of each year. The Senior Subordinated Notes mature on June 1, 2007. Except as set forth below, the Senior Subordinated Notes are not redeemable at the option of the Company prior to June 1, 2002. On and after such date, the Senior Subordinated Notes are redeemable, at the Company's option, in whole or in part, at the following redemption prices (expressed in percentages of principal amount), plus accrued and unpaid interest to the redemption date: if redeemed during the 12-month period commencing on June 1 of the years set forth below: Redemption Period Price ------ ---------- 2002 105.000 2003 103.333 2004 101.667 2005 and thereafter 100.000 In addition, at any time and from time to time prior to June 1, 2000, the Company may redeem in the aggregate up to $44.0 million principal amount of Senior Subordinated Notes with the proceeds of one or more equity offerings so long as there is a public market at the time of such redemption (provided that the equity offering is an offering by Holdings, a portion of the net cash proceeds thereof equal to the amount required to redeem any such Senior Subordinated Notes is contributed to the equity capital of the Company), at a redemption price (expressed as a percentage of principal amount) of 110%, plus accrued and unpaid interest, if any, to the redemption date; provided, however, that at least $66.0 million aggregate principal amount of the Senior Subordinated Notes remains outstanding after each such redemption. The Senior Subordinated Notes are unsecured senior subordinated obligations of the Company and are unconditionally and fully guaranteed (jointly and severally) on a senior basis by Holdings and on a senior subordinated basis by each domestic subsidiary of the Company. The Senior Subordinated Notes are subordinated to all senior indebtedness (as defined) of the Company and rank pari passu in right of payment with all senior subordinated indebtedness (as defined) of the Company. The Senior Subordinated Notes Indenture contains certain covenants that, among other things, limit (i) the incurrence of additional indebtedness by the Company and its restricted subsidiaries (as defined), (ii) the payment of dividends and other restricted payments by the Company and its restricted subsidiaries, (iii) distributions from restricted subsidiaries, (iv) asset sales, (v) transactions with affiliates, (vi) sales or issuances of restricted subsidiary capital stock and (vii) mergers and consolidations. Term Loans and Revolving Credit Facility The Senior Credit Facilities consist of (a) the six-year $75.0 million Tranche A Senior Secured Term Loan Facility; (b) the eight- year $65.0 million Tranche B Senior Secured Term Loan Facility; and (c) the Senior Secured Revolving Credit Facility providing for revolving loans to the Company and the issuance of letters of credit for the account of the Company in an aggregate principal and stated amount at any time not to exceed $70.0 million. Borrowings under the Revolving Credit Facility are available based upon a borrowing base equal to the sum of 85% of eligible accounts receivable and 50% of eligible inventory. The obligations of the Company under the Senior Credit Facilities are unconditionally, fully and irrevocably guaranteed (jointly and severally) by Holdings and each of the Company's direct or indirect domestic subsidiaries (collectively, the Senior Credit Facilities Guarantors). In addition, the Senior Credit Facilities are secured by first priority or equivalent security interests in (i) all the capital stock of, or other equity interests in, each direct or indirect domestic subsidiary of the Company and 65% of the capital stock of, or other equity interests in, each direct foreign subsidiary of the Company, or any of its domestic subsidiaries and (ii) all tangible and intangible assets (including, without limitation, intellectual property and owned real property) of the Company and the Senior Credit Facilities Guarantors. On September 30, 1999, the Company amended the Senior Credit Facility. The amendment allows for less restrictive covenants. In addition, the amendment allows, at Hedstrom's option, the interest rates per annum applicable to the Senior Credit Facilities to be either (i) the Eurocurrency Rate (as defined) plus 3.5% in the case of the Tranche A Term Loan Facility and the Revolving Credit Facility or 4.0% in the case of the Tranche B Term Loan Facility or (ii) the Alternate Base Rate (as defined) plus 2.5% in the case of the Tranche A Term Loan Facility and the Revolving Credit Facility or 3.0% in the case of the Tranche B Term Loan Facility. The Alternate Base Rate is the highest of (a) Credit Suisse First Boston's Prime Rate (as defined) or (b) the federal funds effective rate from time to time plus 0.5%. The applicable margin in respect of the Tranche A Term Loan Facility and the Revolving Credit Facility will be adjusted from time to time by amounts to be agreed upon based on the achievement of certain performance targets to be determined. The Senior Credit Facilities contain a number of significant covenants that, among other things, restrict the ability of the Company to dispose of assets, incur additional indebtedness, repay other indebtedness or amend debt instruments, pay dividends, create liens on assets, make investments or acquisitions, engage in mergers or consolidations, make capital expenditures, or engage in certain transactions with affiliates. In addition, under the Senior Credit Facilities, the Company is required to comply with specified interest coverage and maximum leverage ratios. At September 30, 1999, the Company was in compliance with all of the amended restrictive covenants contained in the Senior Credit Facilities. Senior Discount Notes Holdings received $25.0 million of gross proceeds from the issuance of 44,612 units consisting of the Discount Notes described below and 2,705,896 shares of Holdings common stock. Of the $25.0 million in gross proceeds, $3.4 million ($1.25 per share) was allocated to the common stock, based upon management's estimate of fair market value, and $21.6 million was allocated to the Discount Notes. The Discount Notes are unsecured obligations of Holdings and have an aggregate principle amount at maturity of $44.6 million, representing a yield to maturity of 12%. No cash interest will accrue on the Discount Notes prior to June 1, 2002. Thereafter, cash interest will be payable on June 1 and December 1 of each year, commencing December 1, 2002. The Discount Notes mature on June 1, 2009. Except as set forth below, the Discount Notes are not redeemable at the option of Holdings prior to June 1, 2002. On and after such date, the Discount Notes are redeemable at Holdings' option, in whole or in part, at the following redemption prices (expressed in percentages of principal amount at maturity), plus accrued and unpaid interest to the redemption date: if redeemed during the 12-month period commencing on June 1 of the years set forth below: Redemption Period Price ------ ---------- 2002 106.000 2003 104.000 2004 102.000 2005 and thereafter 100.000 In addition, at any time and from time to time prior to June 1, 2000, Holdings may redeem in the aggregate up to 40% of the accreted value of the Discount Notes with the proceeds of one or more equity offerings by Holdings so long as there is a public market at the time of such redemption, at a redemption price (expressed as a percentage of accreted value on the redemption date) of 112%, plus accrued and unpaid interest, if any, to the redemption date; provided, however, that at least $26.8 million aggregate principal amount at maturity of the Discount Notes remains outstanding after each such redemption. At any time on or prior to June 1, 2002, the Discount Notes may also be redeemed as a whole at the option of Holdings upon the occurrence of a change of control (as defined) at a redemption price equal to 100% of the accreted value thereof plus the applicable premium, and accrued and unpaid interest, if any, to the date of redemption. The Discount Notes Indenture contains certain covenants that, among other things, limit (i) the incurrence of additional indebtedness by Holdings and its restricted subsidiaries (as defined), (ii) the payment of dividends and other restricted payments by Holdings and its restricted subsidiaries, (iii) distributions from restricted subsidiaries, (iv) asset sales, (v) transactions with affiliates, (vi) sales or issuances of restricted subsidiary capital stock and (vii) mergers and consolidations. Other Debt Other debt consists of a $2.5 million Holdings note payable to the previous owners of Holdings as well as various other mortgages, capital leases and equipment loans. The $2.5 million note payable bears interest at 10% per annum and is payable at the earlier of April 30, 2002, or when the Company has met certain cash flow levels. The mortgages and equipment loans have varying interest rates and maturities. NOTE 4 - SEGMENT INFORMATION: Effective January 1, 1998, the Company adopted SFAS No. 131, Disclosure About Segments of an Enterprise and Related Information. SFAS 131 requires companies to identify their operating segments based upon the internal financial information reported to the company's chief operating decision maker. The Company's operating decision maker is its Chief Executive Officer (CEO). Financial information reported to the CEO reflects five business segments: the Bedford Division, the Ashland Division, the ERO Division, the Montreal Division and the International Division. The CEO evaluates performance of each segment based upon the operating earnings (loss) of each segment. The Company develops, manufactures and sells a variety of children's leisure and activity products. The Bedford Division principally manufactures and markets in the United States and Canada outdoor gym sets, wood gym kits and slides, spring horses, trampolines and gym accessories. The Ashland Division principally manufactures and markets in the United States a wide variety of children's playballs and ball pit products. The Montreal Division principally manufactures and markets children's products including arts and crafts, game tables, certain other children's bulk play products such as play kitchens and battery-operated ride-on vehicles. In addition, this division includes a broad line of school supplies featuring popular licensed characters. The ERO Division produces the Slumber Shoppe line of products including products such as indoor sleeping bags and play tents featuring popular licensed characters, a water sports line of products including flotation jackets, masks, fins, goggles and snorkels. Additionally the division produces licensed room decorations for young children, consisting principally of stick-on and peel-off wall decorations. The International Division produces and distributes gym sets, and other products, manufactured by domestic divisions, outside of the United States. For the Three Months For the Nine Months Ended September 30, Ended September 30, ------------------- ------------------ 1999 1998 1999 1998 (Dollars in thousands) ---- ---- ---- ---- Bedford Division Net revenues $9,511 $11,388 $117,211 $93,385 Operating earnings (4,740) (1,814) 13,047 8,745 Identifiable assets 44,492 47,249 44,492 47,249 Ashland Division Net revenues 7,515 6,304 30,526 30,612 Operating earnings (65) (723) 3,206 2,307 Identifiable assets 22,031 20,628 22,031 20,628 ERO Division Net revenues 20,018 20,157 48,179 45,674 Operating earnings 3,450 6,715 6,772 9,278 Identifiable assets 46,818 39,633 46,818 39,633 Montreal Division Net revenues 15,787 23,295 32,058 39,270 Operating earnings 212 5,238 (2,850) 3,233 Identifiable assets 76,160 66,822 76,160 66,822 International Division Net revenues 4,105 3,209 19,949 17,073 Operating earnings (1,414) (1,255) (1,289) (946) Identifiable assets 10,152 8,303 10,152 8,303 Corporate, other non- segments and Intercompany Eliminations Identifiable assets 205,646 213,132 205,646 213,132 Consolidated totals from continuing operations Net revenues 56,936 64,353 247,923 226,014 Operating earnings (2,557) 8,161 18,886 22,617 Identifiable assets 405,299 395,767 405,299 395,767 NOTE 5 - RECENTLY ADOPTED ACCOUNTING PRONOUNCEMENTS: The Financial Accounting Standards Board has issued SFAS No. 133, Accounting for Derivative and Similar Financial Instruments For Hedging Activities. This pronouncement revises the accounting for derivative financial instruments. It requires entities to recognize all derivatives as either assets or liabilities in the balance sheet and measure those instruments at fair value. The adoption of this statement is required for fiscal years beginning after June 15, 1999. The Company has entered into interest rate swap agreements to hedge exposure to variable interest rate debt. The Company will recognize these derivatives at fair value in its financial statements if these agreements are outstanding as of January 1, 2000. The adoption of this pronouncement is not expected to have a significant impact on the Company's financial position or results of operations. The Financial Accounting Standards Board has issued SFAS No. 134 Accounting For Mortgage-Backed Securities. SFAS No. 134 will have no effect on the financial condition or results of operations of the Company. NOTE 6 - SUBSIDIARY GUARANTORS / NONGUARANTORS FINANCIAL INFORMATION: The following is financial information pertaining to Hedstrom and its subsidiary guarantors and subsidiary nonguarantors (with respect to the Senior Subordinated Notes and the Senior Credit Facilities) for the periods in which they are included in Holding's accompanying consolidated financial statements. HEDSTROM CORPORATION AND SUBSIDIARIES CONSOLIDATING BALANCE SHEETS (In thousands) At September 30, 1999 At December 31, 1998 ------------------------------------------ ----------------------------------------------- Hedstrom Hedstrom Hedstrom Subsidiary Hedstrom Subsidiary Subsidiary Non- Adjustment Total Subsidiary Non- Adjustments/ Total Assets Guarantor guarantor Eliminations Hedstrom Guarantors guarantors Eliminations Hedstrom ========================== ========== ========= ============ ======== ========== ========== ============ ======== Current assets: Cash and cash equivalents $ 12,988 $ 581 $ - $ 13,569 $ 1,839 $ 2,495 $ - $ 4,334 Accounts receivable, net 41,651 9,455 - 51,106 59,193 10,329 - 69,522 Taxes receivable 6,095 650 - 6,745 6,095 650 - 6,745 Inventories 47,244 27,709 (56) 74,897 40,742 13,036 (56) 53,722 Deferred income taxes(c) 6,016 - - 6,016 6,016 - - 6,016 Prepaid expenses and other current assets 5,004 725 - 5,729 3,849 281 - 4,130 -------- ------- -------- -------- -------- -------- -------- -------- Total current assets 118,998 39,120 (56) 158,062 117,734 26,791 (56) 144,469 -------- ------- -------- -------- -------- -------- -------- -------- Property, plant, and equipment, net 29,985 18,352 - 48,337 31,361 16,741 - 48,102 -------- ------- -------- -------- -------- -------- -------- -------- Other assets: Investment in and advances to Nonguarantor Subsidiaries 63,821 - (63,821) - 56,190 - (56,190) - Deferred charges, net 11,816 - - 11,816 13,857 - - 13,857 Goodwill, net 165,529 20,033 - 185,562 165,835 20,991 - 186,826 Deferred income taxes 1,201 (2,555) - (1,354) 1,092 (1,611) - (519) -------- ------- -------- -------- -------- -------- -------- -------- Total other assets 242,367 17,478 (63,821) 196,024 236,974 19,380 (56,190) 200,164 -------- ------- -------- -------- -------- -------- -------- -------- Total assets $391,350 $74,950 $(63,877) $404,423 $386,069 $ 62,912 $(56,246) $392,735 ======== ======= ======== ======== ======== ======== ======== ======== HEDSTROM CORPORATION AND SUBSIDIARIES CONSOLIDATING BALANCE SHEETS (In thousands) At September 30, 1999 At December 31, 1998 ------------------------------------------ ----------------------------------------------- Hedstrom Hedstrom Hedstrom Subsidiary Hedstrom Subsidiary Subsidiary Non- Adjustment Total Subsidiary Non- Adjustments/ Total Guarantor guarantor Eliminations Hedstrom Guarantors guarantors Eliminations Hedstrom ========== ========= ============ ======== ========== ========== ============ ======== Liabilities and stockholders' equity ========================== Current liabilities: Revolving line of credit $ 53,950 $ - $ - $53,950 $ 34,920 $ - $ - $ 34,920 Current portion of long term debt and capital leases 13,692 440 - 14,132 11,417 488 - 11,905 Advances from Guarantor Subidiaries - 46,722 (46,722) - - 39,091 (39,091) - Accounts payable (c) 17,652 7,860 - 25,512 17,170 3,539 - 20,709 Accrued expenses 17,274 1,775 (23) 19,026 20,520 2,198 (23) 22,695 -------- ------- -------- -------- -------- ------- -------- -------- Total current liabilities 102,568 56,797 (46,745) 112,620 84,027 45,316 (39,114) 90,229 -------- ------- -------- -------- -------- ------- -------- -------- Senior Subordinated Notes 110,000 - - 110,000 110,000 - - 110,000 Term Loans 111,275 - - 111,275 123,736 - - 123,736 Capital leases 1,324 - - 1,324 1,690 - - 1,690 Other 1,367 171 - 1,538 1,667 487 - 2,154 -------- ------- -------- -------- -------- ------- -------- -------- Total long-term debt(a) 223,966 171 - 224,137 237,093 487 - 237,580 -------- ------- -------- -------- -------- ------- -------- -------- Total liabilities 326,534 56,968 (46,745) 336,757 321,120 45,803 (39,114) 327,809 -------- ------- -------- -------- -------- ------- -------- -------- Total stockholder's equity (deficit)(b) 64,816 17,982 (17,132) 65,666 64,949 17,109 (17,132) 64,926 -------- ------- -------- -------- -------- ------- -------- -------- Total liabilities and stockholders' equity $391,350 $74,950 $(63,877) $402,423 $386,069 $62,912 $(56,246) $392,735 ======== ======= ======== ======== ======== ======= ======== ======== CONSOLIDATING INCOME STATEMENTS (In thousands) Three Months Ended September 30, 1999 Three Months Ended September 30, 1998 ------------------------------------------- ----------------------------------------------- Hedstrom Hedstrom Hedstrom Subsidiary Hedstrom Subsidiary Subsidiary Non- Adjustments/ Total Subsidiary Non- Adjustments/ Total Statement of Operations Guarantor guarantor Eliminations Hedstrom Guarantors guarantors Eliminations Hedstrom ======================= ========= ========= ============ ======== ========== ========== ============ ======== Net sales $52,459 $19,511 $(15,034) $56,936 $59,524 $18,112 $(13,283) $ 64,353 Cost of sales 43,351 12,344 (15,034) 40,661 41,033 13,048 (13,272) 40,809 ------- ------- -------- ------- ------- ------- -------- -------- Gross profit (loss) 9,108 7,167 - 16,275 18,491 5,064 (11) 23,544 Selling, general and administrative expense 15,491 3,341 - 18,832 12,519 2,864 - 15,383 ------- ------- -------- ------- ------- ------- -------- -------- Operating income (loss) (6,383) 3,826 - (2,557) 5,972 2,200 (11) 8,161 Interest expense (c) 7,388 610 - 7,998 6,239 684 - 6,923 ------- ------- -------- ------- ------- ------- -------- -------- Income (loss) before income taxes (13,771) 3,216 - (10,555) (267) 1,516 (11) 1,238 Income tax provision (benefit) (c) (5,645) 1,318 - (4,327) (114) 633 (4) 515 ------- ------- -------- ------- ------- ------- -------- -------- Net income (loss) $(8,126) $ 1,898 $ - $(6,228) $ (153) $ 883 $ (7) $ 723 ======= ======= ======== ======= ======= ======= ======== ======== CONSOLIDATING INCOME STATEMENTS (In thousands) Nine Months Ended September 30, 1999 Nine Months Ended September 30, 1998 ------------------------------------------- ----------------------------------------------- Hedstrom Hedstrom Hedstrom Subsidiary Hedstrom Subsidiary Subsidiary Non- Adjustments/ Total Subsidiary Non- Adjustments/ Total Statement of Operations Guarantor guarantor Eliminations Hedstrom Guarantors guarantors Eliminations Hedstrom ======================= ========= ========= ============ ======== ========== ========== ============ ======== Net sales $235,669 $39,459 $(27,205) $247,923 $215,798 $33,717 $(23,501) $226,014 Cost of sales 175,612 27,003 (27,205) 175,410 156,143 24,733 (23,551) 157,325 -------- ------- -------- -------- -------- ------- -------- -------- Gross profit (loss) 60,057 12,456 - 72,513 59,655 8,984 50 68,689 Selling, general and administrative expense 45,021 8,606 - 53,627 39,007 7,065 - 46,072 -------- ------- -------- -------- -------- ------- -------- -------- Operating income (loss) 15,036 3,850 - 18,886 20,648 1,919 50 22,617 Interest expense (c) 21,395 1,635 - 23,030 18,699 1,867 - 20,566 -------- ------- -------- -------- -------- ------- -------- -------- Income (loss) before income taxes (6,359) 2,215 - (4,144) 1,949 52 50 2,051 Income tax provision (benefit) (c) (2,608) 908 - (1,700) 692 128 21 841 -------- ------- -------- -------- -------- ------- -------- -------- Net income (loss) $ (3,751) $ 1,307 $ - $ (2,444) $ 1,257 $ (76) $ 29 $ 1,210 ======= ======= ======== ======== ======== ======= ======== ======== HEDSTROM CORPORATION AND SUBSIDIARIES CONSOLIDATING STATEMENTS OF CASH FLOWS (In thousands) Nine Months Ended September 30, 1999 Nine Months Ended September 30, 1998 ------------------------------------ ------------------------------------------- Hedstrom Hedstrom Hedstrom Subsidiary Hedstrom Subsidiary Subsidiary Non- Adustments/ Total Subsidiary Non- Adjustments/ Total Guarantor guarantor Eliminations Hedstrom guarantor guarantor Eliminations Hedstrom ========= ========= ============ ======== ========= ========== ============ ======== Cash flows from operating activities: Net income (loss)(c) $ (3,751) $ 1,307 $ - $ (2,444) $ 1,257 $ (76) $ 29 $ 1,210 Adjustments to reconcile net income (loss) to net cash (used for) provided by operating activities: Depreciation of property, plant and equipment and amortization of goodwill and deferreds 10,275 2,263 - 12,538 10,277 2,004 - 12,281 Deferred income tax provision (c) (109) 944 - 835 (44) - - (44) Changes in current assets and current liabilities, net of acquisitions: Accounts receivable 20,264 874 - 21,138 20,992 (1,401) - 19,591 Inventories (6,502) (14,673) - (21,175) (2,351) (8,341) (200) (10,892) Prepaid expenses and other current assets (1,155) (444) - (1,599) 20 152 - 172 Accounts payable 482 4,321 - 4,803 (3,168) 1,490 - (1,678) Accrued expenses (6,137) (423) - (6,560) (10,517) 2,877 171 (7,469) Other - - - - - - - - -------- ------- ----- -------- -------- ------ ---- -------- Net cash (used for) provided by operating activities 13,367 (5,831) - 7,536 16,466 (3,295) - 13,171 -------- ------- ----- -------- -------- ------ ---- -------- Cash flows from investing activities: Acquisitions of property plant and equipment (3,108) (3,007) - (6,115) (5,409) (1,896) - (7,305) Acquisition of ERO, Inc. - - - (3,037) - - (3,037) Other Acquisition - - - - (16,805) (3,500) - (20,305) -------- ------- ----- -------- -------- ------ ---- --------- Net cash used for investing activities (3,108) (3,007) - (6,115) (25,251) (5,396) - (30,647) -------- ------- ----- -------- -------- ------ ---- --------- HEDSTROM CORPORATION AND SUBSIDIARIES CONSOLIDATING STATEMENTS OF CASH FLOWS (In thousands) Nine Months Ended September 30, 1999 Nine Months Ended September 30, 1998 ------------------------------------ ------------------------------------------- Hedstrom Hedstrom Hedstrom Subsidiary Hedstrom Subsidiary Subsidiary Non- Adustments/ Total Subsidiary Non- Adjustments/ Total Guarantor guarantor Eliminations Hedstrom guarantor guarantor Eliminations Hedstrom ========= ========= ============ ======== ========= ========== ============ ======== Cash flows from financing activities: Net proceeds from issuance of new term loans $ - $ - $ - $ - $30,000 $ - $ - $ 30,000 Principal payments on term loans (9,699) - - (9,699) (7,249) - - (7,249) Borrowings on new revolving line of credit 19,030 - - 19,030 (11,900) - - (11,900) Advances to/(from) Nonguarantor subsidiaries (7,631) 7,631 - - (9,099) 9,099 - - Other (810) (707) - (1,517) (10) (663) - (673) -------- ------ ----- -------- -------- ------ ---- -------- Net cash (used for) provided by financing activities 890 6,924 - 7,814 1,742 8,436 - 10,178 -------- ------ ----- -------- -------- ------ ---- -------- Net increase (decrease) in cash and cash equivalents 11,149 (1,914) - 9,235 (7,043) (255) - (7,298) Cash and cash equivalents: Beginning of period 1,839 2,495 - 4,334 8,984 1,860 - 10,844 -------- ------ ----- -------- -------- ------ ---- -------- End of period $ 12,988 $ 581 $ - $ 13,569 $ 1,941 $1,605 $ - $ 3,546 ======== ====== ===== ======== ======== ====== ==== ======== Each of the Subsidiary Guarantors is a wholly-owned subsidiary of Hedstrom and has fully and unconditionally guaranteed the Senior Subordinated Notes on a joint and several basis. The Company has not presented separate financial statements and other disclosures concerning each subsidiary Guarantor because management has determined that such information is not material to investors. The column "Total Hedstrom" represents the consolidated financial statements of Hedstrom and its subsidiaries. Hedstrom Corporation is Holdings' only direct subsidiary. The primary differences between the consolidated amounts of Hedstrom Corporation and the consolidated amounts included in the accompanying consolidated financial statements of Holdings are as follows: (a) Hedstrom Corporation's Long-Term Debt does not include a $2.5 million note payable issued by Holdings in connection withe its 1995 recapitalization, and the issuance of Senior Discount Notes valued at $29.3 million at September 30, 1999. (b) Hedstrom Corporation's stockholder's equity includes Holdings' stockholders equity plus $21.6 million in proceeds from the issuance of Senior Discount Notes, which proceeds were contributed as equity by Holdings to Hedstrom Corporation less the interest, net of taxes, accrued thereon and, as of both September 30, 1999 and December 31, 1997, the $2.5 million note payable described in (a) above less the interest, net of taxes, accrued thereon. (c) Accounts payable, Interest expense and deferred income taxes do not reflect the accrued interest, interest expense and the deferred tax benefit of accrued interest on the obligations discussed in (a) above. ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF The following discussion of the Company's results of operations and financial condition should be read in conjunction with the consolidated financial statements of the Company and the notes thereto contained herein, as well as included in the Company's Annual Report on Form 10-K for the year ended December 31, 1998 as filed with the Securities and Exchange Commission. This Quarterly Report on Form 10-Q contains forward-looking statements within the meaning of Section 21E of the Securities Exchange Act of 1934, as amended, which are subject to risks and uncertainties that could cause actual results to differ materially from those expressed or implied in such statements. These risks, which are further detailed below as well as included in the Registration Statement on Form S-1 of the Company and Hedstrom as filed with the Securities and Exchange Commission (File Nos. 333-32385-05 and 333-32385), include, but are not limited to, the Company's recent net losses, substantial leverage and debt service, financing restrictions and covenants, reliance on key customers, dependence on key licenses and obtaining new licenses, raw materials prices and product liability risks. In addition, such forward-looking statements are necessarily dependent upon assumptions, estimates and dates that may be incorrect or imprecise and involve known and unknown risks, uncertainties and other factors. Accordingly, any forward-looking statements included herein do not purport to be predictions of future events or circumstances and may not be realized. Forward-looking statements can be identified by, among other things, the use of forward - looking terminology such as believes, expects, may, will, should, seeks, pro-forma, anticipates or intends or the negative of any thereof, or other variations or comparable terminology, or by discussions of strategy or intentions. Given these uncertainties, undue reliance should not be placed on any forward-looking statements. The Company disclaims any obligation to update any such factors or to publicly announce the results of any revisions to any of the forward-looking statements contained herein to reflect future events or developments. The following table sets forth net sales and operating profit for each of Hedstrom's operating divisions for the periods indicated (amounts in thousands): Three months Nine months Ended Ended September 30, September 30, 1999 1998 1999 1998 ---- ---- ---- ---- Net sales Bedford Division $ 9.5 $11.4 $117.2 $93.4 Ashland Division 7.5 6.3 30.5 30.6 International Division 4.1 3.2 19.9 17.0 Montreal Division 15.8 23.3 32.1 39.3 ERO Division 20.0 20.2 48.2 45.7 ----- ----- ------ ------ Total net sales $56.9 $64.4 $247.9 $226.0 ===== ===== ====== ====== Operating profit: Bedford Division $(4.8) $(1.8) $ 13.0 $ 8.7 Ashland Division (0.2) (0.7) 3.2 2.3 International Division (1.4) (1.3) (1.2) (1.0) Montreal Division 0.3 5.3 (2.9) 3.3 ERO Division 3.5 6.7 6.8 9.3 ----- ----- ----- ------ Total gross profit $(2.6) $ 8.2 $18.9 $ 22.6 ===== ===== ===== ====== Net Sales. Net sales for the third quarter ended September 30, 1999 decreased to $56.9 million from $64.4 million for the comparable prior quarter, a decrease of $7.5 million. The decrease was attributable to decreased sales at the Montreal, Bedford, and ERO Divisions. Net sales at the Montreal Division decreased $7.5 million for the third quarter of 1999 versus the prior year comparable quarter. This decrease was due to the lower than anticipated sales of new Expressways! branded products and a shifting of orders from major retailers, relating to game tables, to the fourth quarter of the year. This decrease was partially offset by the increase in power rider cars, as a result of the introduction of new licensed products. Net sales at the Bedford Division decreased $1.9 million versus the prior year comparable quarter due to lower demand for trampolines, and sports related products. This decrease in net sales at the Bedford Division was partially offset by the increase in sales of wood gym sets achieved through Backyard Products Limited, a manufacturer of wood gym sets acquired in August 1998. In addition, net sales at the ERO Division decreased by approximately $0.2 million as decreased demand for Slumber Shoppe and Coral products were only partially offset by increased demand for Priss Prints products. The aforementioned decreases in net sales were partially offset by higher net sales at the Ashland, and International Divisions. The Ashland Division net sales increased by $1.2 million to $7.5 million for the quarter ended September 30, 1999, from $6.3 million for the prior year's comparable quarter, due to increased demand for Hops, decorated, undecorated, and premium licensed play balls. The International Division's net sales for the third quarter ended September 30, 1999, increased by $0.9 million versus the prior year comparable period as a result of greater market penetration. Net sales for the nine months ended September 30, 1999 versus the nine months ended September 30, 1998, increased to $247.9 million from $ 226.0 million an increase of $21.9 million. The increase was attributable to the Bedford, International, and ERO divisions. Net sales at the Bedford Division increased to $117.2 million for the nine months ended September 30, 1999, versus $93.4 million for the comparable period in 1998. The increase was as a result of sales of wood gym sets achieved through the acquisition of Backyard Products Limited. In addition, slightly lower sales of metal gym sets, wood gym kits and sports related products were partially offset by higher sales of trampolines. The net sales of the International Division increased to $19.9 million for the first nine months of 1999 from $17.0 million in the comparable period of 1998 as a result of favorable exchange rates and market penetration. The ERO Division's net sales increased $2.5 million to $48.2 million for the nine months ending September 30, 1999, from $45.7 million for the prior year's comparable period. The increase in net sales was primarily a result of higher demand for Slumber Shoppe products resulting mainly from the movie release of Star Wars _ Episode I. The ERO Division increase in net sales was partially offset by a decrease in net sales of Coral products, due to a decrease in listings of Swim and Dive products at major retailers. The aforementioned increases in net sales were partially offset by lower net sales at the Montreal Division. Net sales for the Montreal Division for the nine months ended September 30, 1999 decreased by $7.2 million to $32.1 million from $39.3 million for the prior year's comparable period. The decrease in net sales at the Montreal Division was due to the timing of placement of new Express Ways! branded products and a shifting of orders from major retailers relating to game tables to the fourth quarter of the year. The decrease in net sales at the Montreal Division was partially offset by increased net sales of Impact back to school products, due to new product introductions and new licenses. Net sales of the Ashland Division were relatively unchanged between 1999 and 1998. Gross Profit. Gross profit for the third quarter ended September 30, 1999, decreased by $7.2 million to $16.3 million as compared to $23.5 million for the quarter ended September 30, 1998. As a percentage of consolidated net sales, consolidated gross profit percentage decreased to 28.6% in the third quarter of 1999, from 36.6% for the quarter ended September 30, 1999. The decrease was due to lower gross profit margins at the Montreal, Bedford and ERO Divisions. The gross profit margin at the Montreal Division decreased to 37.3% for the quarter ended September 30, 1999 from 39.1% for the prior year comparable quarter. The Montreal Division's decrease was primarily due to unfavorable product sales mix and unfavorable manufacturing variances as a result of lower production volume as compared to the prior years third quarter. The Bedford Division's gross profit margin decreased to negative 6.3% for the quarter ended September 30, 1999, from 14.9% for the prior year's comparable quarter. The decrease in the Division's gross profit percentage was due to unfavorable product sales mix resulting from sales of trampolines, higher production employee fringe benefits, including medical costs and unfavorable manufacturing variances relating to the timing of the acquisition of Backyard Products Limited. Backyard Products Limited was acquired late in August, 1998. Due to the timing of the acquisition, the Company was not negatively impacted, in the prior year, by unfavorable manufacturing variances which usually occur during July and August as a result of low production volume. The gross profit margin at the ERO Division decreased to 47.0% for the three month ended September 30, 1999 from 54.0% for the comparable period ended September 30, 1998. The decrease in the ERO Division's gross profit percentage was a result of unfavorable material costs, unfavorable product sales mix and close out sales relating to water sports products. The aforementioned decreases were partially offset by increased gross profit margin at the Ashland Division. The Ashland Division's gross profit margin increased to 22.7% for the quarter ended September 30, 1999 from 19.0% for the prior year's comparable quarter. The increase at the Ashland Division was due to cost reduction programs that included reducing unauthorized customer deductions, overhead costs and material costs. Gross profit for the nine months ended September 30, 1999 increased by $3.8 million to $72.5 million as compared to $68.7 million for the nine months ended September 30, 1998 as a result of higher consolidated net sales. As a percentage of consolidated net sales, the consolidated gross profit percentage decreased slightly to 29.2% for the nine months ended September 30, 1999, from 30.4% for the nine months ended September 30, 1998. The decrease in consolidated gross profit percentage was mainly due to the lower gross margin percentages at the ERO and International Division's. The ERO Division's gross profit percentage decreased to 43.2% for the nine months ended September 30, 1999, from 46.0% for the prior year's comparable period while the International Division's gross profit percentage decreased to 17.6% from 22.4%. These decreases were mainly a result of unfavorable product sales mix as well as low margin close out sales of water sports products at the ERO Division. The decrease in the gross margin percentage at the ERO Division was partially offset by slightly higher gross profit margin percentages at the Company's other divisions. Selling general and administrative expenses increased $3.4 million to $18.8 million for the third quarter ended September 30, 1999, versus $15.4 million for the prior years third quarter. As a percentage of net sales, selling, general and administrative expenses increased to 33.0% from 23.9% for the quarter ended September 30, 1999. The increase was a result of lower sales volume to cover fixed expenses and product sales mix as consolidated net sales included a greater percentage of royalty bearing products as compared to the prior year. For the nine months ended September 30, 1999 selling, general and administrative expenses increased $7.5 million to $53.6 million from $46.1 million for the nine months ended September 30, 1998. As a percentage of net sales, selling, general and administrative expenses increased slightly to 21.6% from 20.4% for the nine months ended September 30, 1998. This increase was mainly a result of product sales mix as consolidated net sales included a greater percentage of royalty bearing products as compared to the prior year. Interest Expense. Interest expense for the three and nine months ended September 30, 1999, versus September 30, 1998 increased as a result of higher debt levels associated with greater working capital. Income Tax Expense. Holdings' effective income tax rate for the three months ended September 30, 1999, and the nine months ended September 30, 1999 and 1998 was 41.0%. Liquidity and Capital Resources of the Company Working Capital and Cash Flows Net cash provided by operating activities was $7.5 million for the nine months ended September 30, 1999 versus $13.2 million provided by operations for the prior year comparable period. The decrease was mainly a result of higher inventory levels. Net cash used for investing activities was $6.1 million, all relating to the acquisitions of property, plant and equipment. Net cash provided by financing activities for the nine months ended September 30, 1999, was $7.8 million resulting from $19.0 million of net proceeds on the Company's revolving loan to fund additional working capital requirements and meet debt service requirements partially offset by principal repayments of $9.7 million on the Company's term loans and $1.5 million of scheduled principal repayments on capital leases for the nine months ended September 30, 1999. Liquidity The Company's primary liquidity demands are for capital expenditures, term loan principal payments and for working capital needs. The Senior Credit Facilities impose an annual limit of $10.0 million on the Company's capital expenditures and investments (subject in any given year to a roll-over of up to $4.0 million of unused capital expenditure capacity from the previous year). The Senior Credit Facilities impose significant restrictions on the Company's ability to make dividend payments. The Company's primary sources of liquidity are cash flows from operations and borrowings under the Revolving Credit Facility. As of September 30, 1999, approximately $13.6 million was available to the Company (subject to borrowing base limitations) from cash on hand and available borrowings under the Revolving Credit Facility. Management believes that cash generated from operations, together with borrowings under the Revolving Credit Facility and cash on hand, will be sufficient to meet the Company's working capital and capital expenditures needs for the foreseeable future. Interest payments on the Senior Subordinated Notes and interest and principal payments under the Senior Credit Facilities represent significant cash requirements for the Company. The Senior Subordinated Notes require semiannual interest payments of $5.5 million. Borrowings under the Senior Credit Facilities bear interest at floating rates and require interest payments on varying dates depending on the interest rate option selected by the Company. Outstanding borrowings under the Senior Credit Facilities consisted of $121.0 million under the Term Loan Facilities, comprised of $57.5million of Tranche A Term Loans maturing in 2003 and $63.5 million of Tranche B Term Loans maturing in 2005. The Senior Credit Facilities also include a $70 million Revolving Credit Facility. As of September 30, 1999, a balance of $54.0 million was outstanding under the Revolving Credit Facility. On September 30, 1999, the Company entered into its Fifth Amendment to the Senior Credit Facility. The Fifth Amendment, among other things, provided for less restrictive financial covenants for the third and fourth quarters of 1999. As of the date hereof, management believes the Company may not be able to meet the fourth quarter financial covenants set forth in the Fifth Amendment. Accordingly, the Company intends to begin negotiations with the bank group to amend the financial ratio covenants for the period ending December 31, 1999 as well as for the year 2000. Although the Company anticipates that it will be able to obtain amendments to the Senior Credit Facility, there can be no assurance that the Company will be able to obtain such amendments. Year 2000 Date Conversion The Company relies on a significant number of computer programs and computer technologies (collectively, IT) and non-IT Systems for its key operations, including product design, finance and various administrative functions. In July of 1997 the Company began an impact assessment of the Year 2000 on its business systems and ability to provide product, information, and services to its business partners before, during and after the Year 2000. As a result of this assessment the Company adopted a two phase plan to attain Year 2000 compliance. Phase I of the Company's Year 2000 compliance plan addresses its mainframe business systems which need to be converted to handle Year 2000 dates. Phase II addresses computer hardware, stand-alone systems, and embedded systems which may need to be upgraded by the end of 1999. Conversion of Phase I data bases and programs was completed in July 1998. The systems testing phase was completed in the first quarter of 1999, and the Company installed the converted business system in April, 1999. Assessment of all computer hardware, stand-alone systems, communications hardware and software which may require replacement or upgrade by January 2000 is now complete. The Company has identified all systems which it believes are not Year 2000 compliant. Remediation of these systems will take place throughout 1999. In addition, the Company is evaluating the Year 2000 readiness of its key vendors to ensure that its ability to produce and deliver products is not materially impacted. As this evaluation is completed, the Company will decide what further actions, if any, are appropriate. The Company anticipates that its total Year 2000 compliance costs will approximate $1.0 million. The Company believes that it has sufficient funds available through its existing credit facilities to address the Year 2000 costs. These costs will include software, hardware and consulting expenses which are being expensed as incurred. The Company believes its current worse case scenario would be the inability of suppliers to deliver key raw materials. The Company is currently devising contingency plans which could among other things include carrying excess stock of key raw materials such as steel at December 31, 1999. Although the Company is confident that the Year 2000 issues are manageable and will be dealt with in a timely fashion, this conclusion is forward looking and involves uncertainty and risks. The ultimate result may be impacted by a variety of factors such as, but not limited to, the ability to successfully remediate existing IT systems, the failure to identify problems associated with non-IT systems and problems associated with supplier or customer information systems, any of which could have a material adverse effect on the Company's ability to successfully address Year 2000 issues. PART II - OTHER INFORMATION Item 1. Legal Proceedings The Company is currently involved in several lawsuits arising in the ordinary course of business. The Company maintains insurance covering such liability, and does not believe that the outcome of any such lawsuits will have a material adverse effect on the Company's financial condition. Item 6. Exhibits and Reports on Form 8-K a) Exhibits (1) 2.1 - Agreement and Plan of Merger, dated as of April 10, 1997, among Hedstrom Corporation, HC Acquisition Corp. and ERO, Inc. (1) 3.1 - Restated Certificate of Incorporation of Hedstrom Holdings, Inc., as filed with the Secretary of State of the State of Delaware on October 27, 1995. (1) 3.2 Certificate of Amendment of Restated Certificate of Incorporation of Hedstrom Holdings, Inc., as filed with the Secretary of State of the State of Delaware on June 6, 1997. (1) 3.3 - Restated Bylaws of Hedstrom Holdings, Inc. (1) 3.4 - Certificate of Incorporation of New Hedstrom Corp., as filed with the Secretary of State of the State of Delaware on November 20, 1990. (1) 3.5 - Certificate of Amendment of the Certificate of Incorporation of New Hedstrom Corp., as filed with the Secretary of State of the State of Delaware on January 14, 1991. (1) 3.6 - By-Laws of Hedstrom Corporation. (1) 4.1 - Indenture, dated as of June 1, 1997, among Hedstrom Corporation, Hedstrom Holdings, Inc., the Subsidiary Guarantors identified on the signature pages thereto and IBJ Schroder Bank & Trust Company, as Trustee. (1) 4.2 - Form of Senior Subordinated Note. (1) 4.3 - Form of New Senior Subordinated Note. (1) 4.4 - Indenture, dated as of June 1, 1997, among Hedstrom Holdings, Inc. and United States Trust Company of New York, as Trustee. (1) 4.5 - Form of Discount Note. 10.1 - Amendment Number Five dated September 30, 1999 to the Credit Agreement, dated as of June 12, 1997, among Hedstrom Corporation, Hedstrom Holdings, Inc., the finacial institutions party thereto and Credit Suisse First Boston, as agent. 11.1 - Computation of Earnings Per Share. 27.1 - Financial Data Schedule. b) Reports on Form 8-K The registrant has not filed any reports on Form 8-K during the quarter. SIGNATURES Pursuant to the requirements of the Securities and Exchange Act of 1934, the registrants have duly caused this report to be signed on their behalf by the undersigned thereunto duly authorized. Date: November 11, 1999 HEDSTROM HOLDINGS, INC. HEDSTROM CORPORATION /s/ David F. Crowley David F.Crowley Chief Financial Officer