SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-KSB
[X] Annual Report Pursuant to Section 13 or 15(d) of
the Securities Exchange Act of 1934
For the fiscal year ended December 31, 1997 Commission file number 0-15414
OR
[ ] Transition report pursuant to section 13 or 15(d) of
the Securities Exchange Act of 1934
For the transition period from _____ to ______
ALOETTE COSMETICS, INC.
(Exact name of registrant as specified in its charter)
Pennsylvania 23-2056003
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
1301 Wright's Lane East, West Chester, PA 19380
(Address of principal executive offices) (Zip Code)
(610) 692-0600
(Registrant's telephone number, including area code)
NONE
(Securities registered pursuant to Section 12(b) of the Act)
Common Stock, no par value
(Securities registered pursuant to Section 12(g) of the Act)
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 periods 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 ____.
Transitional Small Business Disclosure Format Yes ____ No X
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405, of Regulations S-B is not contained herein, and will not be contained, to
the best of registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-KSB or any
amendment to this Form 10-KSB. [X]
Registrant's total revenues for its most recent fiscal year........$10,024,226
The aggregate market value of the 1,215,082 shares of voting stock held by
nonaffiliates of the registrant at the closing stock price of $3.50 as of March
25, 1998, was $4,252,787.
Common Stock outstanding as of March 25, 1998: 2,104,253
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the following documents are incorporated by reference in this Report
on Form 10-KSB:
1) Information set forth in Part III of this report is incorporated by
reference to the Registrants 1998 Proxy Statement.
TABLE OF CONTENTS
Part I Page
- ------ ----
Item 1. Business 1
2. Properties 7
3. Legal Proceedings 7
4. Submission of Matters to a Vote of Security Holders 7
Part II
5. Market for the Registrant's Common Equity 8
and Related Stockholder Matters
6.(i) Selected Consolidated Financial Data 9
(ii) Management's Discussion and Analysis of Results 10
of Operations and Financial Condition
7. Financial Statements and Supplementary Data 15
8. Changes in and Disagreements with Accountants on 15
Accounting and Financial Disclosure
Part III
9. Directors and Executive Officers of the Registrant 16
10. Executive Compensation 16
11. Security Ownership of Certain Beneficial 16
Owners and Management
12. Certain Relationships and Related Transactions 16
Part IV
13. Exhibits, Financial Statement Schedules 16
and Reports on Form 8-K
CAUTIONARY STATEMENT FOR PURPOSES OF THE SAFE HARBOR
PROVISIONS OF THE PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995
This report contains certain "forward-looking" statements. The Company
desires to take advantage of the "safe harbor" provisions of the Private
Securities Litigation Reform Act of 1995 and is including this statement for the
express purpose of availing itself of the protections of such safe harbor with
respect to all such forward-looking statements. Examples of forward looking
statements contained herein can be identified by the use of forward-looking
terminology such as "believes," "expects," "anticipates," "estimates," "intends"
and similar expressions. In addition, forward-looking statements are identified
by strategies that involve risks and uncertainties. The Company's ability to
predict any such occurrences or the effect of other events on the Company's
operations is inherently uncertain. Therefore, the Company wishes to caution
each reader of this report to carefully consider the specific factors discussed
with such forward looking statements, as such factors could affect the ability
of the Company to achieve its objectives and may cause actual results to differ
materially from those expressed herein.
ALOETTE COSMETICS, INC.
PART I
ITEM 1. BUSINESS
Aloette Cosmetics, Inc.
Aloette Cosmetics, Inc. was incorporated in 1977 under the laws of the
Commonwealth of Pennsylvania and is primarily engaged in the distribution of
aloe vera-based skin care products, cosmetics and other personal care products.
As used herein, "the Company" includes the operations of Aloette Cosmetics, Inc.
and its wholly-owned subsidiaries. The Company markets its products through its
domestic and foreign franchises, and distributors. As of December 31, 1997, 79
franchises were located in the United States and Canada.
During the period from January 1990 through June 1995, the Company also
manufactured products for sale to its franchises as well as other health and
beauty aid products for sale to third parties. On June 15, 1995 the Company
consummated the sale of substantially all of the assets of its manufacturing
operations in Texas for cash of approximately $2.1 million. The sale included
the facility, inventory and equipment. In connection with the sale, the Company
entered into a five-year supply agreement with the buyer to purchase inventory
at prices competitive in the industry. As a result of the sale of the
manufacturing operations, the Company recorded a pre-tax charge of $3.8 million
in 1995 (see Item 6 and Note 19 to the Consolidated Financial Statements). Sales
from the manufacturing operations were approximately $1.2 million through the
date of sale in 1995. The net loss from normal operations for the corresponding
period was $478,000.
Products
The majority of the Company's revenues are derived from sales to its
franchises of approximately 120 aloe vera-based skin care products, makeup,
fragrance and cosmetic accessory products marketed exclusively under the trade
name "Aloette". A common ingredient in the Aloette skin care line is the gel
from the plant popularly known as aloe vera. The Company's Aloette skin care
items are grouped according to individual skin type and are designed to be used
in a daily regimen. Aloette's glamour products include liquid foundations,
pressed powders, powder blushes, powder eyeshadows, eye pencils, mascaras,
lipsticks, hair care items and sun-care products. Fragrance items include a
Caribe line, a bath set and men's and women's colognes. The Company also sells
promotional and support items to its franchises, including business supplies,
product samples and sales and recruiting materials. For the year ended December
31, 1997, approximately 85% of the Company's total revenues were generated from
Aloette product sales.
Set forth below is certain information concerning the sales of each
product group for each of the Company's last three years.
1997 1996 1995
---- ---- ----
Net Net Net
Product % of Product % of Product % of
Sales Total Sales Total Sales Total
Skin care $4,771,191 56% $5,664,802 58% $6,634,538 59%
Glamour (makeup
and accessories) 1,873,420 22% 2,317,142 23% 2,538,164 22%
Fragrances 551,636 7% 209,782 2% 273,434 2%
Promotional and
support items 1,308,440 15% 1,654,292 17% 1,900,260 17%
---------- ---- ---------- ---- ----------- ----
Total $8,504,687 100% $9,846,018 100% $11,346,396 100%
========== ==== ========== ==== =========== ====
Marketing
Products marketed under the Aloette name are not sold in retail stores
and are primarily available through Aloette's domestic and foreign franchises
who recruit and train Beauty Consultants who utilize sales techniques developed
by the Company. Beauty Consultants are not required to purchase, maintain
inventories of or deliver products; instead, the Company sells its products to
franchises who maintain inventories at levels sufficient to meet anticipated
orders from customers.
Beauty Consultants hold Shows principally in the homes of a host or
hostess where they present the Company's products, instruct guests concerning
the use of such products as part of a daily beauty program and obtain product
orders. Franchises are responsible for shipping the products that are ordered to
hostesses, who in turn arrange for guests to receive their orders. Beauty
Consultants also obtain reorders from customers and sell Aloette products
through individual consultations. Non-show orders are shipped by franchises
directly to customers. For the years 1996 and 1995 non-show orders comprised
approximately 45% of retail sales, compared to 46% in 1997.
Franchising
In North America, the Company presently markets its Aloette products
primarily through a franchise system. In order to become a franchisee, an
applicant must enter into a franchise agreement with the Company and pay a
franchise fee. The fee is $20,000 payable upon execution, however financing of
the fee is available on approved credit. The franchise agreement requires that a
franchise make an initial inventory purchase of approximately $6,000 to $7,500
and that the franchisee have an adequate amount of working capital at the start
of its operations.
Under the franchise agreement, the Company grants specific rights and a
license to operate a franchise in a specific territory, which generally contains
approximately 750,000 people in the U.S. and 500,000 people in Canada. Sales
generated outside the franchise's territory may be subject to certain
unrestricted fees. In addition, the right to market in a specified territory can
be rescinded in the event the franchise fails to achieve sales quotas at various
anniversary dates of the agreement. This is relatively consistent with the
Company's original franchise philosophy prior to 1993, when the Company
developed certain Territorial Subdivision, Multi-Unit Development and Master
Franchise strategies. Under these strategies, franchises were established with
approximately 100,000 or more in population.
Historically, franchises have often been granted in those territories
with the most concentrated population bases. As of December 31, 1997, the
Company had a total of 48 franchises operating in the United States and 31
franchises operating in Canada. The Company continues to grant new franchises in
existing open territories and focuses on improving the productivity of its
existing franchises. The Company believes that improved productivity from
existing franchises will foster an increased demand for new franchises in the
future. The Company expects any expansion into international markets to be
primarily through the granting of international distributorship and license
agreements (see Business - International Operations).
When a franchise relationship is established, the Company provides the
franchisee with sales and operations manuals that describe the guidelines and
specifications that govern Aloette's prescribed franchise method of conducting
business. In addition, the franchisee is provided two to four days of training
by experienced Company personnel at the franchise location. Following training,
a Company employee makes periodic site visits to provide additional training and
review certain aspects of the franchisee's business in relation to the Company's
standards. Each franchise is required to submit various reports to the Company
including a monthly summary of operations and annual financial statements. The
Company also holds meetings of franchisees to provide information concerning the
Company and its products.
The franchise agreement requires franchises to pay the Company a
monthly royalty fee of five percent of the franchise's gross sales. For the year
ended December 31, 1997, approximately 15% of the Company's total revenues were
derived from these royalty fees.
In addition, franchisees are obligated to pay their pro rata portion of
the cost of incentive, promotional and motivational campaigns, contests and an
annual Seminar for Beauty Consultants organized by the Company. The expenses
recorded by the Company with respect to the above programs are net of any
reimbursements received from the franchisees.
2
The franchise agreement provides for an initial term of five years and
is renewable for an additional five-year term upon execution of the then-current
franchise agreement. Franchise agreements which were renewed during 1996 and
1997 provided for a ten-year term, with an additional renewal term of five years
upon execution of the then-current franchise agreement. There is no fee for
renewal. In order to renew, the franchisee must be in compliance with all terms
of the franchise agreement, including being current in all financial obligations
to the Company and must have met certain sales goals. The franchise agreement
may be terminated by the franchisee upon fulfilling all of its financial and
contractual obligations. The Company may not terminate a franchise except for
cause, (as defined in the franchise agreement), including the franchisee's
failure to comply with the franchise agreement. The Company retains a right of
first refusal on the sale of any franchise and has the right to review the
qualifications of the proposed transferee. In addition, upon the transfer of a
franchise, the franchisee must pay the Company a transfer fee equal to ten
percent of the sale price not to be less than $6,500 and not to exceed $25,000.
Revenues from franchise purchase fees and transfer fees constituted less than
approximately 0.5% of the Company's total revenues in the three years ended
December 31, 1997.
In 1993, the Company modified the franchise system to include the
Territorial Subdivision. The Territorial Subdivision strategy will continue to
be offered in certain situations and is intended to create the opportunity for
the Company to allow the transfer of undeveloped markets within existing
franchise territories ("Subdividers") to third-parties. If an existing
franchisee subdivides to a third-party and that third-party begins its franchise
with staff from the existing franchise, the third-party is required to negotiate
and pay a "going concern value" related to the staff's previous sales levels to
the existing franchisee in order to obtain approval for the subdivision from the
Company. The Company is solely responsible for granting franchise licenses,
monitoring and enforcing compliance to the franchise system, collecting
royalties and product payables and the collection and analysis of franchise
data.
The Company also incurs certain costs and expenses relating to the sale
of franchises. Included in these costs are breakaway fees which are provided to
existing franchisees as a result of a Beauty Consultant purchasing a franchise
from the Company. These breakaway fees, provided to the existing franchises in
the form of product credits, are calculated based on 10% of the new franchises
gross sales for a one year period.
Set forth below is certain information concerning the number of
franchise agreements entered into and terminated in North America for each of
the Company's last three years:
1997 1996 1995
---- ---- ----
Franchises at beginning of year 83 91 88
New Franchise agreements 4 12 (a) 9
Terminated/consolidated
franchise territories ( 8) (20)(a) ( 6)
-- -- --
Franchises at end of year 79 83 91
== == ==
(a) Includes two Canadian franchises that terminated in 1996 and which were
re-opened as Company-owned franchises.
At December 31, 1997, the Company had a total of 48 franchises in the
United States which were located in the following geographic regions: 10 in the
Northeast; 19 in the South; 11 in the Midwest; and 8 in the West. At December
31, 1997, the Company had a total of 31 Canadian franchises which were located
in the following provinces: 18 in Ontario; 2 in Quebec; 3 in Alberta; 3 in
British Columbia and 5 in other Canadian provinces.
International Operations
In countries other than the United States and Canada, the Company
grants Distributorship and License Agreements (the "Agreement") which provide
for either the exclusive or non-exclusive distribution rights for Aloette
products within a particular foreign country or market, including the right to
sublicense in accordance with the Aloette franchise system. The purchase fees
charged by the Company for the Agreements are negotiated and depend, in part,
upon the size of the potential market. The purchase fees for existing Agreements
have ranged from $0 to $110,000.
3
In 1997, net product sales generated by Aloette Canada represented 40%
of the Company's total. Net product sales to non-affiliate international
franchises and distributors for 1997, 1996 and 1995 were approximately .04%, 1%,
and 3%, respectively, of the Company's total net product sales.
Under an Agreement, the distributor is required to purchase all
products from the Company and is granted the right to distribute Aloette
products using any method of marketing and distribution approved by the Company,
including, without limitation, methods present in the Aloette marketing system
or any derivation thereof such as home show, direct retail, duty free shops and
direct response television. To reduce risk to the Company, generally all
purchases by the distributor must be prepaid or collateralized by an irrevocable
letter of credit. In addition, title to the goods passes to the distributor when
product is shipped from the Company's facilities in North America. The Company
retains all rights, title and interest in the Aloette trade name and any Aloette
trademarks. The distributor is responsible for all marketing, promotional and
advertising costs and expenses incurred in the territories governed by the
agreement. All advertising is subject to the Company's approval. The distributor
is required to pay royalty payments which generally have approximated 2.25% of
all retail sales or 14% of net product sales. In the event of an approved
subdivision the distributor must remit 10% of fees collected on the initial
grant, renewal and transfer of rights.
The term of the Agreement generally covers an initial period ranging
from five to ten years with an automatic five-year renewal if certain criteria
have been met. The distributor has the right to terminate the Agreement after
the initial term; the Company may terminate the Agreement in whole or in part at
any time for non-compliance, including the failure to attain certain sales
criteria. Except for an approved subdivision, the distributor does not have the
right to sell, transfer, or assign rights under the agreement and is generally
subject to a five-year non-compete clause upon termination.
In January 1996, the Company converted the existing franchise
agreements in Australia into Distributorship and Licensing Agreements granting
the non-exclusive right to market and distribute Aloette products in their
respective countries. Each of the Agreements, which require royalty payments
based on a percentage of net product sales, is effective for an initial term of
five years with an automatic five-year renewal if the distributor is in
compliance with the agreement including the attainment of certain sales goals.
As of December 31, 1997 there were three distributors in Australia.
In February 1994, the Company entered into a Distributorship and
Licensing Agreement granting the exclusive right to market and distribute
Aloette products in the Company's new packaging design in Taiwan. The agreement,
which requires the payment of monthly royalty payments based on a percentage of
net product sales, is effective for an initial term of five years and is
eligible for an automatic five-year renewal if the distributor is in compliance
with the agreement including the attainment of certain sales goals.
In February 1992, the Company entered into a licensing agreement (the
"Initial Licensing Agreement") with Alover Cosmetics GmbH ("Alover") granting
the exclusive right to conduct Aloette business within the following countries:
Austria, Bulgaria, Czechoslovakia, the Federal Republic of Germany, Hungary,
Poland and Romania. John E. Defibaugh, a director, former officer and the
husband of Patricia J. Defibaugh, the Company's Chairman and Chief Executive
Officer, owns approximately 50% of the shares of Alover. The Initial Licensing
Agreement required the payment of an initial licensing fee of $110,000 and gave
Alover the right to utilize the Company's trademarks and the exclusive right to
manufacture Aloette products based on "know-how" and expertise provided by the
Company. The Initial Licensing Agreement was amended in February 1994 to exclude
the right to manufacture products and to require the purchase of all products
from the Company. In addition, the required monthly royalty payments, which
under the original agreement ranged from 2% to 5% of retail sales based on
certain sales goals and were subject to a minimum annual payment provision, were
amended to be 2.25% of all retail sales. The agreement expired in February 1997.
In 1991, the Company entered into a national license agreement granting
the exclusive right to distribute the Company's products in the Netherlands. The
licensee is required to pay to the Company a monthly royalty fee based on the
retail sales of Aloette products in the licensed territory. The agreement is for
an initial term of five years and is renewable by the licensee for two
successive five-year terms if the licensee is in compliance with the agreement,
including the attainment of certain sales goals. The agreement, which expired in
November 1996, is currently being extended on a month to month basis. Currently
the licensee is subject to the same restrictive covenant as a distributor.
4
Aloette's international operations are subject to certain risks
inherent to conducting business outside of the United States. The Company's
Canadian operations are subject to fluctuations in currency rates while its
operations in Australia are also subject to risks related to import regulations.
In its recent Distribution and License Agreements, the Company has taken
measures to minimize the risks associated with doing business outside the United
States by requiring payment in United States currency and establishing terms
that are designed to minimize the Company's responsibility with regard to
exporting products for sale in foreign markets.
Suppliers
The Company currently purchases raw materials, consisting chiefly of
essential oils, chemicals, containers and packaging components from various
domestic and international suppliers. In addition, gel from the aloe vera plant
is an important ingredient in the Company's skin care products and is purchased
by its suppliers from several sources. The Company believes that its suppliers
can obtain sufficient aloe vera to manufacture and supply its products.
Prior to June 1995, the majority of Aloette's skin care and glamour
products were produced at the Company's manufacturing facility in Texas. On June
15, 1995, the Company sold this facility as part of a sale of assets, for $2.1
million. The Company entered into a five-year purchasing agreement with the
buyer at prices competitive in the industry. Many of the Company's skin care and
glamour products are being manufactured under this agreement; however, the
Company does utilize other manufacturers from time to time.
The Company continually engages in research and development activities
to improve its existing products and to develop new products. Such activities
did not require material expenditures in fiscal year 1997 and the Company
expects this trend to continue during fiscal 1998.
Distribution
The Company's products are shipped directly from the manufacturers to
Company-owned warehouse facilities. As of December 31, 1997, the Company's
warehouses were located in: West Chester, Pennsylvania (the "West Chester
Warehouse"); and Concord, Ontario, Canada (the "Canadian Warehouse"). (see
Business-Properties)
Currently the West Chester Warehouse generally maintains an approximate
160 day supply of products, promotional and support items for shipments to all
domestic franchises and customers. The Canadian Warehouse maintains an
approximate 210 day supply of inventory for shipments to all Canadian franchises
and customers.
Aloette products are shipped by the Company from its distribution
centers to franchises who are obligated to pay for such products within thirty
days of the invoice date. Franchises either ship products directly to the
customer or, in the case of a Show, to the hostess or host two weeks from the
date of the Show. All shipments made directly to hostesses, hosts or customers
must be paid for in full either prior to, or upon delivery. Products are also
shipped by the Company from its distribution centers to international
distributors that are obligated to prepay or pay for such products by letter of
credit.
Competition
The cosmetics industry is a highly competitive market which is subject
to changing consumer preferences and demands. There are many companies which
sell cosmetics by means of Shows, on a door-to-door basis, by direct response
(i.e. mail order, telephone, television, etc.) or in retail stores. All of these
companies compete with the Company. Many of these competitors are substantially
larger than the Company in terms of sales and distributors and have
substantially greater financial resources and experience.
The Company's competition arises from both domestic and foreign
sources. Two of the better known direct marketing cosmetics companies which
compete with the Company's Aloette products are Mary Kay Cosmetics, Inc., which
sells cosmetics directly to its beauty consultants who, subsequently, market
them to customers and Avon Products, Inc., which historically has primarily
utilized the door-to-door selling technique. Both of these companies are
substantially larger than the Company. The market in which the Company
participates is highly competitive in price, service and quality. The Company
believes that its continued success will depend on its ability to remain
competitive in these areas.
In the marketing of Aloette products, price is a significant
competitive factor. Due to the Company's direct sales and franchise marketing
methods, the Company has been able to price its products at levels which are
substantially lower than those for products which the Company believes to be of
comparable quality.
5
Regulation
The Company is subject to regulation by the Food and Drug
Administration ("FDA") and the Alcohol and Tax Unit of the Treasury Department.
The Company's franchise sales practices, franchise agreements and advertising
and general sales practices are subject to regulation by the Federal Trade
Commission. In addition, the Company's operations are subject to numerous
federal, state and local laws related to the sale of franchises and the
labeling, content and packaging of its products.
Each of the foreign jurisdictions in which the Company markets its
products imposes regulatory requirements on the labeling and content of such
products, as well as the sale of franchises. The Company believes that its
products, franchise practices and methods of distribution are in compliance with
all such foreign and domestic laws and regulations.
Certain of the Company's suppliers are also subject to regulation by
the FDA. The Company has no reason to believe that such suppliers are not in
compliance with requirements set by the FDA.
Environmental Matters
The Company does not believe that compliance with federal, state or
local provisions which have been enacted or adopted regulating the discharge of
materials into the environment or otherwise relating to the protection of the
environment will have a material effect on its capital expenditures, earnings or
competitive position.
Trademarks and Patents
The Company's trademark "Aloette", issued in May 1988, has a
twenty-year life and is subject to renewal. The Company has registered the
Aloette trademark in the United States, Canada and certain foreign countries.
The Company has also registered its logo, which is in the form of a lark, in the
United States and Canada. The trademark "lark" logo, issued in 1985, has a
twenty-year life and is also subject to renewal.
Customers
The Company extends 30-day payment terms to its franchises for
purchases of "Aloette" products and supplies. The Company's franchises offer
customers the right to exchange merchandise. Historically, the amounts of such
returns have been minimal. The Company does not accept product returns from its
franchises or offer warranties on its products except in the case of
manufacturing defects. Historically, such amounts have not been material.
The Company sells to two franchises in Canada; Aloette of Montreal and
Aloette of Quebec City, that have common ownership. Sales to these franchises
were approximately 12%, 13% and 9% of revenues in 1997, 1996 and 1995,
respectively.
Employees
As of December 31, 1997, the Company employed 31 people who were
involved with the Company's franchise and distribution business.
The Aloette franchisees are independent business owners and not
employees of the Company. Similarly, the Beauty Consultants are independent
contractors of the franchisees and are neither employees nor involved in a
contractual relationship with the Company.
None of the Company's employees are represented by a labor organization
and the Company is not a party to any collective bargaining agreement. The
Company has never been subject to an employee strike or work stoppage and
considers its employee relations to be good.
6
Insurance
The Company presently maintains product liability insurance at a level
which management believes is sufficient. However, because of the risks inherent
in selling cosmetics, it is possible that the Company could be held liable in
future litigation for amounts in excess of its product liability insurance
coverage. A judgment against the Company for an amount exceeding its liability
insurance coverage could have a material adverse effect upon the Company. If a
product liability claim were asserted and the product in question was acquired
from an independent supplier, the Company might be able to proceed against such
supplier. However, the success of any such proceeding could be affected by
product alterations by the Company, the insolvency of such supplier or other
uncertainties.
ITEM 2. PROPERTIES
The 25,000 square foot corporate headquarters located in West Chester,
Pennsylvania is owned by the Company. Approximately 10,000 square feet is used
for office space and 15,000 square feet is used for warehousing and shipping. In
June 1996, the Company sold a 3,700 square foot office condominium located near
its headquarters.
The Company's Canadian office is located in Concord, Ontario where the
Company owns a 17,500 square foot building. Approximately 7,500 square feet is
used for office space and 10,000 square feet is used for warehousing and
shipping.
The Company believes that its current facilities are adequate to meet
its present needs.
ITEM 3. LEGAL PROCEEDINGS
On or about May 27, 1994, an action was filed against the Company in
the Eastern District of Pennsylvania under the caption, Slaven et al. v. Aloette
Cosmetics, Inc. et al., alleging, among other things, breach of contract and
warranty and fraud against the Company and an officer and seeking compensatory
and punitive damages in excess of $1,000,000 plus court costs and attorney's
fees. The Company filed answers and counterclaims in these actions. In March
1995, the counts alleging breach of covenant of good faith and fair dealing and
abandonment of trademark were dismissed without prejudice based upon
insufficient pleadings. The Company settled this matter successfully on February
25, 1997. The terms of the settlement did not have a material effect on the
Company's consolidated results of operations.
On November 11, 1994, the Company filed an action in the High Court of
New Zealand under the caption, Aloette Cosmetics, Inc. of Delaware, et al. v.
Billisa Holdings Ltd., et al., alleging, among other things, that the defendants
failed to pay for products supplied and failed to pay management fees. The
Company requested an injunction requiring the defendants to turn over documents
and inventory and to cease operating as a franchise. On December 19, 1994, the
Court granted the Company's request for an injunction. The defendants filed
answers and counterclaims in these actions seeking compensatory and punitive
damages in excess of approximately $5 million plus court costs and attorneys'
fees. The counterclaim alleged, among other things, breach of express and
implied terms of contract, breach of fiduciary obligations, breach of section 9
of the Fair Trading Act of 1988 and undue influence. The Company settled this
matter successfully on March 6, 1997. The terms of the settlement did not have a
material effect on the Company's consolidated results of operations.
In addition, from time to time, the Company is a defendant in
litigation arising in the normal course of business. Management and legal
counsel do not believe that any settlement resulting from such litigation will
have a material adverse effect on the Company's consolidated financial position
or results of operations.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
Not applicable.
7
PART II
Item 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
The Company's common stock is traded in the over-the-counter market
under the symbol "ALET" and is quoted on the NASDAQ National Market System. The
following table sets forth, for the periods indicated, the high and low market
prices for the Company's common stock.
STOCK PRICE RANGE
1997 1996
--------------------- ----------------------
Quarter Ended High Low High Low
------------- ---- ---- ---- ---
December 31 $3 1/4 $2 1 /2 $4 1/8 $2 3/4
September 30 3 1/4 2 9/16 4 5/8 3 5/8
June 30 3 1/4 2 5 /8 5 1/8 3 3/4
March 31 3 1/4 2 7 /8 5 1/2 2 1/4
The Company had 2,104,253 shares of no par value stock outstanding at
December 31, 1997. The approximate number of shareholders of record at March 25,
1998 was 1,067.
The Company has not paid dividends since 1993. Under the Company's
financing agreement with its lender, effective December 31, 1996 through 1998,
the Company is prohibited from paying dividends.
8
Item 6 (i) SELECTED CONSOLIDATED FINANCIAL DATA
The following selected financial data has been derived from the Company's
consolidated financial statements. The information set forth below should be
read in conjunction with the Company's Consolidated Financial Statements, the
related notes and other financial information appearing elsewhere herein and
Management's Discussion and Analysis of Results of Operations and Financial
Condition.
SELECTED CONSOLIDATED FINANCIAL DATA
(in thousands, except per share data)
- --------------------------------------------------------------------------------------
Year ended December 31 1997(1) 1996 1995(2) 1994 1993
- ---------------------- ------- ---- ------- ----- ----
INCOME STATEMENT DATA:
Net product sales ...................... $ 8,505 $ 9,846 $ 11,346 $ 14,861 $ 15,555
Revenue from franchise operations ...... 1,488 1,728 1,853 2,032 2,296
Sales of franchises .................... 31 47 65 210 216
-------- -------- -------- -------- --------
Total revenues ......................... $ 10,024 $ 11,621 $ 13,264 $ 17,103 $ 18,067
======== ======== ======== ======== ========
Cost of product sales .................. $ 5,075 $ 5,920 $ 8,021 $ 10,821 $ 10,088
Selling, general and administrative .... $ 4,022 $ 4,448 $ 5,712 $ 7,975 $ 7,958
Loss on sale of assets of
manufacturing operations ............ - - $ 3,800 - -
Total costs and expenses ............... $ 9,122 $ 10,509 $ 17,596 $ 18,818 $ 18,076
Net income (loss) ...................... $ 738 $ 920 $ (4,126) $ (1,541) $ ( 180)
Basic net income (loss) per common share $ .35 $ .43 $ (1.91) $ ( .71) $ ( .08)
Net income (loss) per common share
assuming dilution ................ $ .34 $ .42 $ (1.91) $ ( .71) $ ( .08)
Cash dividends declared
per common share (3) .............. - - - - $ .16
Weighted average shares outstanding .... 2,127 2,157 2,157 2,157 2,157
1997 1996 1995 1994 1993
-------- -------- -------- -------- --------
BALANCE SHEET DATA:
Working capital ........................ $ 7,384 $ 6,744 $ 4,488 $ 5,252 $ 9,772
Total assets ........................... $ 11,880 $ 12,675 $ 12,194 $ 24,382 $ 25,522
Long-term debt ......................... $ 956 $ 1,557 $ 1,968 $ 2,676 $ 5,478
Shareholders' equity ................... $ 8,814 $ 8,378 $ 7,475 $ 11,526 $ 13,444
(1) The Company purchased 53,000 shares of common stock in 1997 under a previously announced stock repurchase program.
(2) Includes a $3.8 million pre-tax charge for the loss on the sale of certain assets of its manufacturing operations.
(3) The Company suspended its quarterly dividend in the third quarter of 1993.
9
Item 6 (ii) MANAGEMENT'S DISCUSSION AND ANALYSIS
OF RESULTS OF OPERATIONS AND
FINANCIAL CONDITION
RESULTS OF OPERATIONS
1997 versus 1996
Net Sales and Earnings. The Company recorded net income of $738,000, or
$.35 per share, for the fiscal year ended December 31, 1997. In comparison, for
the fiscal year ended December 31, 1996, net income was $920,000, or $.43 per
share. Operating income was $902,000 and $1.1 million for the years ended
December 31, 1997 and 1996, respectively. While the Company continued to benefit
from reductions in costs and expenses, operating income was negatively impacted
by the decline in revenues discussed below.
Total revenues for the twelve months ended December 31, 1997 were
approximately $10.0 million compared to $11.6 million in 1996; a decrease of
$1.6 million or 14%. Net product sales were $8.5 million through December 31,
1997 versus $9.8 million for the year ended 1996. The $1.3 million decrease in
net product sales was the result of declining sales primarily at the Domestic
and Canadian subsidiaries. Sales declined 9% in the Domestic subsidiary and 18%
in the Canadian subsidiary.
Historically, the Company has introduced several new products each
year. In prior years any increase in sales volume related to the new products
was offset by discontinued products. In 1997, the Company's product line was
increased to 120 products from approximately 110 in 1996. Most of the new
products were part of the new "Caribe line" which replaced two colognes. As a
result, sales of the fragrance product line increased approximately $342,000, or
163%, to $552,000 in 1997 compared to $210,000 in 1996. In 1998, the Company
plans to continue to expand its product line in an attempt to increase net
product sales in North America.
The Company did not implement an across the board price increase in
1997 or 1996 and has no intention to do so in 1998. Rather, the Company will
review prices on a product-by-product basis.
Revenues from franchise operations (the royalty received from Aloette
franchises based on their retail sales) was $1.5 million for the year ended
December 31, 1997, compared to $1.7 million in 1996. This decrease corresponds
to the 14% decrease in retail sales.
Retail sales - sales from franchises to their customer - were
approximately $31.9 million in fiscal year 1997 compared to $37.3 million in
fiscal year 1996. In the U.S., retail sales decreased $2.3 million, or 11%, to
$18.5 million in 1997 from $20.8 million in 1996. In Canada, retail sales
decreased approximately $2.7 million, or 17%, to $13.3 million in 1997 from
$16.0 million in 1996. Approximately 1% of the change in retail sales at the
Canadian franchises was a result of exchange rate fluctuations. However, the
decline in retail sales was primarily attributable to (i) a reduction of the
Company's independent sales force (Beauty Consultants and Managers) which
negatively impacts the franchises productivity and (ii) the termination of
certain franchises which were not operating in compliance with the Company's
franchise agreements or operating procedures. The Company is implementing
certain strategies, discussed below, in an attempt to reverse the current trend
in retail sales. The Company cannot provide any assurances that it will be
successful in altering the trend in retail sales, and thus revenues. In
addition, during the fourth quarter of 1997, the Company engaged a financial
advisor to assist it in exploring strategic alternatives available to the
Company. The work of such advisor is ongoing.
In an effort to promote recruiting of new Beauty Consultants and
Managers, and thus improve franchise productivity, in the fourth quarter of
1997, the Company introduced a new recruiting video and brochure. The Company
intends to introduce additional materials and incentives in 1998.
In addition to the continuing support the Company provides to
franchisees in order to improve their productivity, the Company intends to
continue to promote the franchise opportunity in open territories as well as
explore other methods to accelerate the development of specific geographic
areas. The number of franchises in North America dropped from 83 in 1996 to 79
in 1997. Even though the Company was successful in starting 4 new franchises in
1997 and 12 new franchises in 1996, the Company terminated or consolidated 28
franchises during the same period. Generally it takes a new franchise several
years to reach the retail sales levels maintained by an established franchise.
10
Cost of Product Sales. The cost of product sales as a percentage of net
product sales was 60% for each of the years ended December 31, 1997 and 1996.
Although management will continue to explore methods to improve margins by
continuing to negotiate discounts with certain suppliers and increase controls
in purchasing, it is expected that this percentage will remain relatively
constant in 1998.
For the year ended December 31, 1997, the cost of product sales was
$5.1 million compared to $5.9 for 1996. The 14% decrease is a result of lower
net product sales.
Selling, General and Administrative Expenses. For the twelve months
ended December 31, 1997 and 1996, total selling, general and administrative
expenses were $4.0 million and $4.4 million, respectively. The decrease resulted
from continued cost reduction initiatives in 1997 and lawsuit expenses incurred
in 1996. The cost reduction initiatives included more efficient staff levels,
lower office expenses and limited use of consultants. Although management will
continue to evaluate additional areas for expense reductions, further
expenditures and investments to alter the current revenue trend are being
considered.
Sales of Franchises. The costs associated with the sales of franchises
decreased $115,000, or 82%, to $26,000 at December 31, 1997. The decrease
resulted from a reduction in breakaway credits given to existing franchises as a
result of a Beauty Consultant purchasing a franchise from the Company. A new
Franchise Breakaway program implemented in 1995 awarded product credits for a
one year period to existing franchises as a result of a Beauty Consultant
purchasing a franchise from the Company. At this time costs associated with the
sales of franchises in 1998 are expected to be minimal.
Other Income, Net. For the twelve months of 1997, the Company recorded
net other income of $59,000 compared to net other income of $47,000 in 1996. The
$12,000 increase is primarily attributable to a decrease in interest expense due
to the lower outstanding debt balance in 1997.
Income Tax. In 1997, the Company recorded a $223,000 provision for
income taxes for its 1997 fiscal year compared to a $238,000 provision for its
1996 fiscal year.
1996 versus 1995
Net Sales and Earnings. The Company recorded net income of $920,000, or
$.43 per share, for the fiscal year ended December 31, 1996 compared to a net
loss of $4.1 million, or $1.91 per share, in 1995. Operating income for the
fiscal year ended 1996 was $1.1 million versus an operating loss of $4.3 million
for the fiscal year ended 1995. The $5.4 million increase in operating income
was attributable to improved product margin and lower administrative expenses,
combined with the sale of certain assets of the manufacturing operations in June
1995, which resulted in a $3.8 million charge against income in 1995, and the
elimination of losses incurred by the manufacturing operations through the date
of the sale.
Total revenues for 1996 were $11.6 million compared to $13.3 million in
1995. Net product sales decreased substantially due to the loss of revenues
generated by the manufacturing operations to $9.8 million for the twelve months
ended December 31, 1996 versus $11.3 million in 1995, a decrease of 13%, or $1.5
million. Net product sales of the manufacturing operations generated from the
sales of health and beauty products, private-label and contract manufacturing
services were $1.2 million in 1995 through the date of its sale. Excluding the
sales generated by the manufacturing operations in 1995 described above, total
net product sales decreased 3% from fiscal 1995 to 1996. While net product sales
at the Company's North American subsidiaries decreased only slightly, sales to
the Company's international distributors decreased $183,000, or 62% to $114,000
in 1996 compared to $297,000 in 1995.
Revenues from franchise operations (the royalty fee received from
Aloette franchises based on their retail sales) decreased 8% to $1.7 million in
1996 from $1.85 million in 1995. The decline in revenue from franchise
operations directly corresponds to the decline in year-to-date retail sales --
sales from franchises to their customers -- which totaled approximately $37.5
million in 1996 versus $40.3 million in 1995, a decrease of $3 million, or 7.5%.
11
Cost of Product Sales. Year-to-date cost of product sales as a
percentage of net product sales decreased to 60% for 1996 versus 71% in 1995 and
from $8.0 million to $5.9 million. The decrease was primarily due to the sale of
certain assets of the manufacturing operations and the elimination of its
associated high overhead costs in the latter half of 1995.
Selling, General and Administrative Expenses. Total selling, general
and administrative costs of $4.4 million in 1996 decreased $1.3 million, or 22%,
from $5.7 million for the 1995 fiscal year. The decrease in expenses was
predominantly a result of cost reduction initiatives taken in prior periods and
the elimination of expenses from the manufacturing operations.
Loss on Sale of Manufacturing Operations. As described above, on June
15, 1995, the Company consummated the sale of certain assets of its
manufacturing operations in Texas for cash of approximately $2.1 million. The
sale included the facility, inventory and equipment. As a result of the sale of
the manufacturing operations, the Company recorded a charge of $3.8 million in
1995. The Company recorded no such expense in 1996. In connection with the sale,
the Company entered into a five-year supply agreement with the buyer to purchase
inventory at prices competitive in the industry.
Sales of Franchises. The costs associated with the sales of franchises
increased to $141,000 in 1996 from $62,000 in 1995. This increase was primarily
due to the implementation of a new Franchise Breakaway program in 1995.
Other Income (Expense), Net. For 1996, the Company recorded net other
income of $46,500 compared to net other expense of $294,500 in 1995. A decrease
in interest expense due to the lower outstanding debt balance in 1996 and an
increase in interest income resulting from the increase in cash and cash
equivalents contributed to such a favorable change.
Income Taxes. In 1996, the Company recorded a $238,000 provision for
income taxes compared to a tax benefit of $500,000 recorded in 1995, which
resulted from the net losses from its domestic subsidiaries.
ASSETS
Cash and cash equivalents increased approximately $330,000 to $4.6
million at December 31, 1997. Continued positive cash flows from operations,
including reductions in inventories, was the primary factor for the increase.
Net cash provided by operations was approximately $1.0 million in 1997 and $3.6
million in 1996. Inventories decreased 6% to $2.6 million at December 31, 1997
from the December 31, 1996 level of approximately $2.7 million. Cash and cash
equivalents was the largest segment of total assets at December 31, 1997,
amounting to 38%.
LIABILITIES AND SHAREHOLDERS' EQUITY
Total liabilities decreased approximately $1.2 million to $3.1 million
at December 31, 1997 from $4.3 million at December 31, 1996. The decrease was
attributable to payments made to (i) reduce outstanding debt, offset by the
increase in deferred interest related to the Company's subordinated debt (see
Notes 5 and 18 to the Consolidated Financial Statements) and (ii) for accrued
foreign withholding tax payments.
Treasury stock increased to $8.9 million at December 31, 1997 from $8.8
million at December 31, 1996 due to the purchase of 53,000 shares of the
Company's common stock under the stock repurchase program.
12
LIQUIDITY AND CAPITAL RESOURCES
During 1997, the Company's financial position strengthened moderately
due to the Company's positive earnings and inventory reductions. At December 31,
1997, the Company held approximately $4.6 million in cash and cash equivalents
and had no outstanding borrowings under the line of credit. As described above,
cash and cash equivalents increased approximately $330,000. Outstanding debt
decreased $600,000 as a result of the Company's using cash proceeds from normal
operations to repay outstanding loans. However, deferred interest related to the
Company's subordinated debt increased approximately $130,000 which was charged
to interest expense. Such deferred interest is required to be paid once the
principal of the subordinated debt is paid in full. At December 31, 1997, the
amount of the subordinated debt was $1,555,720 compared to $2,155,720 at
December 31, 1996.
Working capital increased to $7.4 million at December 31, 1997 from
$6.7 million at December 31, 1996. The increase in cash and cash equivalents and
the decrease in accrued expenses were the predominant factors in the favorable
increase in working capital.
On January 4, 1996, the Company entered into an agreement with PNC
Bank, N.A. providing for a revolving line of credit with a maximum commitment
amount of $1 million, expiring December 31, 1996. Effective as of December 31,
1996, the term of the revolving credit facility was extended through December
31, 1998, and continues to be collateralized by substantially all of the
Company's assets. Under the agreement interest will be variable and calculated
on a 360 day basis, based upon the bank's prime rate and payable monthly.
The agreement contains, among other covenants, provisions which require
the Company to maintain certain financial ratios, including minimum tangible net
worth, fixed charge coverage, debt to equity and current ratios. The agreement
also restricts the payment of dividends and imposes restrictions on additional
indebtedness and capital expenditures. A facility fee and all expenses incurred
by the lender are also payable by the Company. The Company was in compliance
with all such covenants at December 31, 1997. Although there can be no
assurances, management believes based on the Company's current operating plan,
that it will be able to comply with such covenants through the agreement
expiration date.
Year 2000 compliance programs and information systems are already
incorporated into the Company's current accounting system. Management expects no
additional costs that will have a material adverse effect on the financial
position, results of operations or liquidity of the Company.
The Company has not paid dividends since 1993. In addition, the
financing agreement described above prohibits payments of dividends.
In 1990, the Board of Directors authorized a stock repurchase program
to purchase up to 150,000 shares of the Company's common stock in the open
market. In April 1997, the Company announced an increase in the number of shares
available for repurchase to 500,000 shares of the Company's common stock. There
is no fixed purchase period and all purchases are made at the Board's
discretion. Prior to 1997 an aggregate of 80,000 shares have been repurchased.
During 1997 the Company repurchased an additional 53,000 shares of common stock.
Management believes that its working capital and available line of
credit will be sufficient to cover normal and expected cash flow needs,
including planned capital spending, for at least the next two years.
INFLATION
The impact of inflation and changing prices on the Company's business
has been minimal. Historically, the Company has been able to increase its prices
to minimize the effect of increases in costs of materials.
13
FOREIGN CURRENCY TRANSLATION
Although the Company takes measures to minimize unfavorable currency
translation effects, it is subject to currency exchange fluctuations primarily
as a result of its Canadian operations.
PROSPECTIVE ACCOUNTING CHANGES
In June 1997, the Financial Accounting Standards Board issued SFAS No.
130, "Reporting Comprehensive Income" (SFAS 130), which is effective for years
beginning after December 15, 1997. This statement establishes standards for the
reporting and display of comprehensive income and its components. Comprehensive
income is defined to include all changes in equity during a period except those
resulting from investments by owners and distributions to owners. The Company
will adopt SFAS 130 and begin reporting of comprehensive income in 1998.
In June 1997, the Financial Accounting Standards Board issued SFAS No.
131, "Disclosures about Segments of an Enterprise and Related Information" (SFAS
131), which is effective for years beginning after December 15, 1997. This
statement establishes standards for the reporting and display of financial and
descriptive information about the Company's reportable operating segments.
Operating segments are defined as the components of and enterprise about which
separate financial information is available that is evaluated regularly by the
chief operating decision maker in deciding how to allocate resources and in
assessing performance. The Company will adopt SFAS 131 and begin segment
reporting in 1998.
SEASONALITY
The Company's sales and profitability are generally lower during the
first and third quarters of each year.
14
Item 7. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS PAGE
AND SUPPLEMENTARY DATA
Report of Independent Accountants F-1
Financial Statements:
Consolidated Balance Sheets as of
December 31, 1997 and 1996 F-2
Consolidated Statements of Operations for the
years ended December 31, 1997, 1996 and 1995 F-3
Consolidated Statements of Shareholders'
Equity for the years ended
December 31, 1997, 1996 and 1995 F-4
Consolidated Statements of Cash Flows for the
years ended December 31, 1997, 1996
and 1995 F-5
Notes to Consolidated Financial Statements F-6 - F-17
Item 8. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS
ON ACCOUNTING AND FINANCIAL DISCLOSURE
Not applicable.
15
REPORT OF INDEPENDENT ACCOUNTANTS
To the Shareholders
of Aloette Cosmetics, Inc.
We have audited the consolidated financial statements and the financial
statement schedule of Aloette Cosmetics, Inc. and Subsidiaries listed in Item 13
of this Form 10-KSB. These financial statements and the financial statement
schedule are the responsibility of the Company's management. Our responsibility
is to express an opinion on these financial statements and the financial
statement schedule based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the consolidated financial position of Aloette Cosmetics,
Inc. and Subsidiaries as of December 31, 1997 and 1996, and the consolidated
results of their operations and their cash flows for each of the three years in
the period ended December 31, 1997, in conformity with generally accepted
accounting principles. In addition, in our opinion, the financial statement
schedule referred to above, when considered in relation to the basic financial
statements taken as a whole, presents fairly, in all material respects, the
information required to be included therein.
Coopers & Lybrand L.L.P.
2400 Eleven Penn Center
Philadelphia, Pennsylvania
February 13, 1998
F-1
ALOETTE COSMETICS, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
December 31, 1997 and 1996
ASSETS 1997 1996
---- ----
Current assets:
Cash and cash equivalents $ 4,571,344 $ 4,238,182
Accounts receivable, less allowance
of $153,000 and $142,000, respectively 818,437 814,000
Current portion of notes receivable, less
allowance of $37,000 and $170,000, respectively 198,597 197,759
Inventories 2,571,754 2,723,916
Prepaid expenses and other current assets 187,831 567,543
Deferred income taxes 346,000 229,500
----------- -----------
Total current assets 8,693,963 8,770,900
Cost in excess of net assets acquired, net 400,318 450,358
Notes receivable, less current portion 186,840 460,089
Property, plant and equipment, net 2,284,608 2,627,868
Other assets 314,146 366,126
----------- -----------
Total assets $11,879,875 $12,675,341
=========== ===========
LIABILITIES AND SHAREHOLDERS' EQUITY
LIABILITIES
Current liabilities:
Current maturities of long-term debt $ 600,000 $ 604,261
Accounts payable 139,390 357,404
Accrued expenses 426,588 792,189
Accrued compensation and benefits 47,990 187,021
Current portion, deferred franchise fee revenue 95,726 85,981
----------- -----------
Total current liabilities 1,309,694 2,026,856
Deferred income taxes 145,000 152,000
Deferred interest 602,371 474,216
Long-term debt, less current maturities 955,720 1,556,707
Deferred franchise fee revenue, less current portion 52,689 87,773
----------- -----------
Total liabilities 3,065,474 4,297,552
----------- -----------
Commitments and contingencies
SHAREHOLDERS' EQUITY
Common stock, no par value, 20,000,000 shares
authorized, 2,963,134 shares issued and
outstanding as of December 31, 1997 and 1996 25,000 25,000
Additional paid-in capital 7,415,808 7,457,292
Unearned ESOP shares - (71,250)
Cumulative currency translation adjustments (1,289,947) (1,122,944)
Retained earnings 11,588,328 10,850,817
Less: Common stock in treasury, at cost, 858,881 and
805,881 shares in 1997 and 1996, respectively (8,924,788) (8,761,126)
----------- -----------
Total shareholders' equity 8,814,401 8,377,789
----------- -----------
Total liabilities and shareholders' equity $11,879,875 $12,675,341
=========== ===========
The accompanying notes are an integral part of the consolidated
financial statements.
F-2
ALOETTE COSMETICS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
for the years ended December 31, 1997, 1996 and 1995
1997 1996 1995
---- ---- ----
Revenues:
Net product sales $ 8,504,687 $ 9,846,018 $11,346,396
Revenue from franchise operations 1,488,313 1,728,336 1,852,892
Sales of franchises 31,226 46,589 64,695
----------- ----------- -----------
10,024,226 11,620,943 13,263,983
Costs and expenses:
Cost of product sales 5,074,664 5,920,258 8,021,329
Selling, general and administrative 4,021,656 4,447,678 5,712,170
Loss on sale of assets
manufacturing operations - - 3,800,000
Sales of franchises 25,900 141,170 62,059
----------- ----------- -----------
9,122,220 10,509,106 17,595,558
----------- ----------- -----------
Operating income (loss) 902,006 1,111,837 (4,331,575)
Other income (expense), net 58,505 46,533 (294,540)
----------- ----------- -----------
Income (loss) before income taxes 960,511 1,158,370 (4,626,115)
Provision (benefit) for income taxes 223,000 238,000 (500,000)
----------- ----------- -----------
Net income (loss) $ 737,511 $ 920,370 $(4,126,115)
=========== =========== ===========
Per common share data:
Basic earnings (loss) (note 16) $ .35 $ .43 $ (1.91)
=========== =========== ===========
Earnings (loss) assuming dilution (note 16) $ .34 $ .42 $ (1.91)
=========== =========== ===========
Dividends $ - $ - $ -
=========== =========== ===========
Weighted average shares outstanding 2,126,675 2,157,253 2,157,253
=========== =========== ===========
The accompanying notes are an integral part of the consolidated
financial statements.
F-3
ALOETTE COSMETICS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
for the years ended December 31, 1997, 1996 and 1995
Additional Currency
Common Stock Issued Paid-In Translation Retained Treasury Stock
Shares Amount Capital ESOP Adjustments Earnings Shares Cost
------ ------ ------- ------ ----------- -------- ------ ----
Balance, December 31, 1994 2,963,134 $25,000 $7,538,995 $(213,750) $(1,119,249) $14,056,562 805,881 $(8,761,126)
Allocation of ESOP shares (49,260) 71,250
Currency translation adjustment 53,131
Net loss (4,126,115)
--------- ------- ---------- --------- ----------- ----------- ------- ----------
Balance, December 31, 1995 2,963,134 25,000 7,489,735 (142,500) (1,066,118) 9,930,447 805,881 (8,761,126)
Allocation of ESOP shares (32,443) 71,250
Currency translation adjustment (56,825)
Net income 920,370
--------- ------- ---------- --------- ----------- ----------- ------- -----------
Balance, December 31, 1996 2,963,134 25,000 7,457,292 (71,250) (1,122,943) 10,850,817 805,881 (8,761,126)
Allocation of ESOP shares (41,484) 71,250
Purchase of Treasury Stock 53,000 (163,662)
Currency translation adjustment (167,004)
Net loss 737,511
--------- ------- ---------- --------- ----------- ----------- ------- -----------
Balance, December 31, 1997 2,963,134 $25,000 $7,415,808 $ 0 $(1,289,947) $11,588,328 858,881 $(8,924,788)
========= ======= ========== ========= =========== =========== ======= ===========
The accompanying notes are an integral part of the consolidated
financial statements.
F-4
ALOETTE COSMETICS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
for the years ended December 31, 1997, 1996 and 1995
1997 1996 1995
---- ---- ----
Cash flows from operating activities:
Net income (loss) $ 737,511 $ 920,370 $(4,126,115)
Adjustments to reconcile net income (loss) to cash
provided by (used in) operating activities:
Depreciation & amortization 468,337 670,152 635,852
ESOP expense 29,766 38,808 21,992
Provision for doubtful accounts and notes receivable 88,323 133,408 356,470
(Gain) loss on sale of property, plant and equipment - 43,085 (31,093)
Loss on sale of assets of manufacturing operations - - 3,800,000
Deferred interest 128,155 173,220 -
Deferred income taxes (123,500) 25,000 (584,000)
Franchise fee revenue (15,226) (25,589) (54,471)
Other (931) 3,678 4,809
Changes in operating assets and liabilities,
net of effects from disposition of assets:
(Increase) decrease in receivables (91,513) 159,122 1,000,388
Decrease in inventories 99,728 934,853 667,239
Decrease in prepaids and other current assets 189,841 387,854 297,113
Increase (decrease) in accounts payable and accrued
expenses (507,877) 165,718 (657,104)
----------- ---------- ----------
Net cash provided by operating activities 1,002,614 3,629,679 1,331,080
----------- ---------- ----------
Cash flows from investing activities:
Proceeds of notes receivable, net 239,360 198,164 281,274
Proceeds from sale of property, plant and equipment 1,701 186,488 296,846
Purchase of property, plant and equipment (28,467) (92,760) (26,304)
Proceeds for sale of the manufacturing operations - - 2,097,210
(Increase) decrease in other assets (42,906) 33,494 140,995
----------- ---------- ----------
Net cash provided by investing activities 169,688 325,386 2,790,021
----------- ---------- ----------
Cash flows from financing activities:
(Repayment) proceeds of notes payable, net - - (4,385,000)
Purchase of Treasury Stock (163,662) - -
Payment of long-term debt (605,248) (715,012) (2,602,171)
----------- ---------- ----------
Net cash (used in) financing activities (768,910) (715,012) (6,987,171)
Effect of exchange rate changes on cash (70,230) (25,985) (72,011)
----------- ---------- ----------
Net increase (decrease) in cash and cash equivalents 333,162 3,214,068 (2,938,081)
Cash & cash equivalents at beginning of year 4,238,182 1,024,114 3,962,195
----------- ---------- ----------
Cash & cash equivalents at end of year $ 4,571,344 $4,238,182 $ 1,024,114
=========== ========== ===========
The accompanying notes are an integral part of the consolidated
financial statements.
F-5
ALOETTE COSMETICS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. Summary of Significant Accounting Policies:
Basis of Presentations:
The consolidated financial statements include the accounts of the
Company and its wholly-owned subsidiaries. All significant intercompany balances
and transactions have been eliminated in consolidation.
Use of Estimates in the Preparation of Financial Statements:
Financial statement preparation requires management to make estimates
and assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingencies at the date of the financial statements and the
reported amounts of net sales and expenses during the reported period.
Differences from those estimates are recorded in the period they become known.
Fair Value of Financial Instruments:
The Company maintains financial instruments which include cash and cash
equivalents, notes receivable and long term debt. The carrying values of these
financial instruments approximate fair value.
Concentration of Risk:
Financial instruments which potentially subject the Company to
concentration of credit risk consist of cash, investments and trade and note
receivables. The Company's investments consisted primarily of low risk
investments such as certificates of deposit, municipal bonds and government
securities and by policy, are not heavily concentrated in any individual
security or any one financial institution. The Company's cash accounts are
primarily maintained with two financial institutions. A substantial portion of
trade and notes receivable are due from the Company's franchisees. The Company
will generally file UCC statements (in U.S.) and General Security Agreements (in
Canada) in order to obtain a priority position in the franchisees' personal
property. Certain of the notes are also collateralized by real estate and other
assets of the franchise.
Gel from the aloe vera plant is an important ingredient in the
Company's skin care products and is purchased by the Company's suppliers from
several sources. The Company believes that its suppliers can obtain sufficient
aloe vera to manufacture and supply its products. In addition, the majority of
the Company's skin care and glamour products are manufactured by two
manufacturers. However, the Company maintains substantially all of its product
formulas and does business with several manufacturers capable of manufacturing
these products if the present manufacturers are unable. Hence the Company
believes that there is no vulnerability of risk.
Cash and Cash Equivalents:
The Company considers all highly liquid investments with maturities of
three months or less to be cash equivalents for purposes of the consolidated
statement of cash flows.
Inventories:
Inventories are valued at the lower of cost or market. Cost has been
determined using the first-in, first-out method.
F-6
1. Summary of Significant Accounting Policies, continued:
Property, Plant and Equipment and Depreciation:
Property, plant and equipment are recorded at cost. Depreciation is
computed principally utilizing the straight-line method and the double declining
balance method over the estimated useful lives of the assets. Upon sale or
retirement, the cost and related accumulated depreciation are removed from the
accounts and resulting gains or losses are reflected in income. A summary of
estimated lives is as follows:
Buildings 20-25 years
Equipment 5-7 years
Building Improvements 15 years
Accounting for the Impairment and Sale of Long-Lived Assets:
Effective January 1, 1996, the Company adopted Statement of Financial
Accounting Standards No. 121, "Accounting for the Impairment of Long-Lived
Assets and for Long Lived Assets to be Disposed of" (SFAS No. 121). The
provisions of SFAS No. 121 require the Company to review its long-lived assets
for impairment on an exception basis whenever events or changes in circumstances
indicate that the carrying amount of the assets may not be recoverable through
future cash flows. If it is determined that an impairment loss has occurred
based on expected cash flows, then the loss is recognized in the income
statement. The adoption of SFAS No. 121 did not have a material effect on the
Company's consolidated financial statements.
Cost in Excess of Net Assets Acquired:
Cost in excess of net assets acquired relates to certain acquisitions
and franchise repurchases. Amortization of cost in excess of net assets acquired
is computed using the straight-line method over a 20-year period. The Company's
policy is to record any impairment loss against the net unamortized cost in
excess of net assets acquired in the period when it is determined that the
carrying amount of the asset may not be recoverable. An evaluation is made at
each balance sheet date and it is based on such factors as the occurrence of a
significant event, a significant change in the environment in which the business
operates or if the expected future net cash flows would become less than the
carrying amount of the asset. As of December 31, 1997 and 1996, accumulated
amortization was $600,480 and $550,440, respectively.
Other Assets:
The Company traded inventory no longer sold to its franchises for
credits toward the purchase of goods and services used principally for
promotions, sales and other business activities. These barter credits were
recorded in other assets based on the fair value of the assets to be exchanged.
The asset is relieved and the barter credit is capitalized or expensed when the
goods or services are received or used.
Sales of Franchises:
The Company grants franchises in exchange for an initial franchise fee.
The fee is deferred and recognized into income over the period when all material
services, including sales and technical support, or conditions relating to the
sale of the franchise have been substantially performed. Administrative costs
associated with such sales are expensed as incurred.
Under the current franchise agreement amended in 1995, payment of the
franchise fee is normally due upon granting the franchise; however, financing
may be available with approved credit. Under the current financing arrangements
of various franchise agreements, a portion of the franchise fee is due upon
granting of the franchise with the balance due in installments over a two to
five-year period. The franchise agreement provides that the franchisee may
terminate the agreement upon fulfilling all of its financial and contractual
obligations; however, the franchise fees paid to the Company through the date of
termination are nonrefundable.
F-7
1. Summary of Significant Accounting Policies, continued:
Revenue from Franchise Operations:
Revenue from franchise operations consists of monthly royalty fees from
franchisees based on a percentage of franchise retail sales. Royalty fees are
recognized as earned.
Foreign Currency Translation:
Assets and liabilities in foreign currencies are translated into U.S.
dollars at the rate of exchange prevailing at the balance sheet date. Revenues
and expenses are translated at the average rate of exchange for the period. The
cumulative translation adjustments are recorded as a separate component of
stockholders' equity. Gains and losses on foreign currency transactions are
included in the determination of net income. Such amounts were not material for
1997, 1996 and 1995.
Income Taxes:
Deferred income taxes are recognized for all temporary differences
between the tax and financial reporting bases of the Company's assets and
liabilities based on enacted tax laws and statutory tax rates applicable to the
periods in which the differences are expected to affect taxable income. Deferred
tax assets are reduced by a valuation allowance in the period when, based on the
weight of available evidence, it is more likely than not that some portion or
all of the deferred tax asset will not be realized.
Income (Loss) Per Common Share:
Effective January 1, 1997, the Company adopted Statement of Financial
Accounting Standards No. 128, "Earnings Per Share" (SFAS No. 128). The
provisions of SFAS No. 128 establishes standards for computing and presenting
earnings per share (EPS) and requires the Company to restate all prior-period
EPS data presented (see Note 16). The adoption of SFAS No. 128 did not have a
material effect on the Company's consolidated financial statements. Income
(loss) per common share is based on the weighted average number of shares
outstanding during each period. The dilutive effect of common stock options and
warrants is not material.
Prospective Accounting Changes:
In June 1997, the Financial Accounting Standards Board issued SFAS No.
130, "Reporting Comprehensive Income" (SFAS 130), which is effective for years
beginning after December 15, 1997. This statement establishes standards for the
reporting and display of comprehensive income and its components. Comprehensive
income is defined to include all changes in equity during a period except those
resulting from investments by owners and distributions to owners. The Company
will adopt SFAS 130 and begin reporting of comprehensive income in 1998.
In June 1997, the Financial Accounting Standards Board issued SFAS No.
131, "Disclosures about Segments of an Enterprise and Related Information" (SFAS
131), which is effective for years beginning after December 15, 1997. This
statement establishes standards for the reporting and display of financial and
descriptive information about the Company's reportable operating segments.
Operating segments are defined as the components of and enterprise about which
separate financial information is available that is evaluated regularly by the
chief operating decision maker in deciding how to allocate resources and in
assessing performance. The Company will adopt SFAS 131 and begin segment
reporting in 1998.
F-8
2. Inventories:
At December 31, 1997 and 1996, inventories consisted of the following:
1997 1996
---- ----
Finished goods $1,888,930 $1,930,947
Work in progress - 4,645
Raw materials 682,824 788,324
---------- ----------
$2,571,754 $2,723,916
========== ==========
The inventory amounts are presented net of an inventory valuation
allowance of $324,000 in 1997 and $624,000 in 1996.
3. Property, Plant and Equipment:
At December 31, 1997 and 1996, property, plant and equipment consisted
of the following:
1997 1996
---- ----
Land $ 777,764 $ 787,791
Buildings 2,170,609 2,198,080
Equipment 1,486,057 1,711,404
---------- ----------
4,434,430 4,697,275
Accumulated depreciation 2,149,822 2,069,407
---------- ----------
$2,284,608 $2,627,868
========== ==========
Depreciation expense for 1997, 1996 and 1995 was $342,342, $491,353,
and $406,096, respectively. Depreciation expense includes the amortization of
capital lease assets. Accumulated depreciation as of December 31, 1996 and 1995
included accumulated amortization relating to assets held under a capital lease
of $268,444 and $185,846, respectively (see Note 10).
All real property, fixtures and improvements, owned by the Company, are
pledged as collateral under the financing agreement dated January 4, 1996 and
extended through 1998 (see Note 4).
4. Notes Payable, Banks:
On January 4, 1996 the Company entered into an agreement with the bank
providing for a revolving line of credit with a maximum commitment amount of $1
million, expiring December 31, 1996. Effective as of December 31, 1996, the term
of the revolving credit facility was extended through December 31, 1998, and
continues to be collateralized by substantially all of the Company's assets.
Under the agreement interest will be variable and calculated on a 360 day basis,
based upon the bank's prime rate and payable monthly.
The agreement contains among other covenants, provisions which require
the Company to maintain certain financial ratios, including minimum tangible net
worth, fixed charge coverage, debt to equity and current ratios. The agreement
also restricts the payment of dividends and imposes restrictions on additional
indebtedness and capital expenditures. A facility fee and all expenses incurred
by the lender are also payable by the Company. The Company was in compliance
with these covenants at December 31, 1997. No borrowings were made against the
bank note payable throughout 1997, hence, the Company did not record any
interest expense as a result of the agreement.
F-9
5. Long-term Debt:
At December 31, 1997 and 1996, long-term debt consisted of the
following:
1997 1996
---- ----
Subordinated note payable to a director and
former officer related to the purchase of
777,881 shares of the Company's common
stock, due in monthly payments of $50,000
through July 2000, bearing interest at 7%
payable quarterly (Note 18) $1,555,720 $2,155,720
Other - 5,248
---------- ----------
1,555,720 2,160,968
Less current maturities 600,000 604,261
---------- ----------
$ 955,720 $1,556,707
========== ==========
Annual maturities of long-term debt during the next three years and
thereafter are as follows:
1998 $ 600,000
1999 600,000
2000 355,720
Thereafter -
----------
$1,555,720
==========
In April 1996, the Company reached an agreement with a director,
shareholder and former officer to restructure the payment terms of a
Subordinated Note held by such person. The new terms provided for interest to
accrue on the unpaid balance at the rate of 7%, with an initial payment of
$200,000 and monthly principal payments of $50,000 which began in May 1996.
Interest payments will be deferred until all principal has been paid in full.
Upon repayment of principal, monthly payments of $50,000 will continue until all
deferred interest has been paid in full. It is expected that the deferred
interest will be paid in full by November 2001. In accordance with the new
terms, during 1996 the Company reclassified approximately $300,000 of interest
accrued as of December 31, 1995 as deferred interest. Due to the deferral of
interest, the effective annual interest rate based on the agreed upon terms
without any consideration for prepayments of principal or interest, is estimated
to be approximately 5%. Prior to the restructuring the agreement required annual
payments of $393,674 through 2001 bearing interest at 9.25% payable quarterly.
The restructuring had no material impact on the current consolidated results of
operations.
6. Employee Stock Ownership Plan:
Substantially all domestic employees of Aloette Cosmetics, Inc. are
covered under the Aloette Employee Stock Ownership Plan (ESOP) and Trust. The
ESOP is non-contributory and there is no past service liability in connection
with the plan.
In 1993, the Company purchased 50,000 shares at a price of $7.125 per
share for its Employee Stock Ownership Plan and Trust. In accordance with the
plan, 10,000 shares per year were allocated to eligible employees at December
31, 1997, 1996 and 1995. At December 31, 1997 there were no unearned shares.
The Company's expenses for the plan were approximately $30,000, $38,800
and $22,000 for each of the years ended December 31, 1997, 1996 and 1995.
Subsequent contributions to the Plan are at the Board's discretion.
F-10
7. Stock Options and Warrants:
In July 1994, the shareholders approved an amended and restated
Incentive Stock Option Plan which permits the granting of options to purchase
900,000 shares of common stock to officers, key employees, non-employee
directors, independent contractors and consultants. Options are granted at a
purchase price equal to the fair market value of the stock at the date of grant.
The plan is administered by the Compensation Committee of the Board of
Directors. The Committee also determines the option exercise period of each
Stock Option; however, the exercise period shall not exceed ten years from the
date of grant. Unexercised options expire ten years after the date of grant or
upon termination of employment.
1997 1996 1995
Weighted Avg Weighted Avg
Shares Exercise Price Shares Exercise Price Shares
------------------------------ ------------------------------ -----------------
Outstanding at beginning of year 349,000 $3.25 349,000 $3.25 517,500
Options Granted -0- -0- 34,000
Options Exercised -0- -0- -0-
Options Forfeited -0- -0- -0-
Options Canceled -0- -0- (202,500)
------- ------- -------
Outstanding at end of year 349,000 $3.25 349,000 $3.25 349,000
======= ======= =======
Exercisable at end of year 264,753 $3.25 180,503 $3.24 103,753
Option price range per share $1.75 to $3.38 $1.75 to $3.38 $1.75 to $3.38
In June 1993, the shareholders approved an Amended and Restated Stock
Warrant Plan for Directors allowing an aggregate of 100,000 shares to be
granted. Under this plan, upon his/her election or appointment, each outside
director is granted 1,000 warrants for each year of the term to which such
Director was elected or appointed. The warrants, which vest in increments of
1,000 on each successive anniversary date of the grant provided the director has
served through that anniversary date, are exercisable at a price equal to the
closing price of a share of the Company's common stock as of the last business
day immediately preceding the date of such Director's election or appointment
and expire six (6) years from the date of grant, or if the Director does not
fulfill his/her appointment.
1997 1996 1995
Weighted Avg Weighted Avg
Shares Exercise Price Shares Exercise Price Shares
------------------------------ ------------------------------- -----------------
Outstanding at beginning of year 31,000 $ 7.28 34,000 $ 9.79 44,000
Warrants Granted 8,000 $ 2.72 3,000 $ 3.75 3,000
Warrants Exercised -0- -0- -0-
Warrants Forfeited -0- -0- -0-
Warrants Canceled (7,000) $11.25 (6,000) $19.75 (13,000)
------ ------ ------
Outstanding at end of year 32,000 $ 5.27 31,000 $ 7.28 34,000
====== ====== ======
Exercisable at end of year 23,000 $ 5.99 26,000 $ 7.77 28,000
Warrant price range per share $2.25 to $9.00 $2.25 to $11.25 $2.25 to $19.75
Aloette adopted the disclosure-only option under Financial Accounting
Standards Board Statement of Financial Accounting Statement No. 123, "Accounting
for Stock-Based Compensation" (SFAS No. 123). Accordingly, the Company has not
recognized any compensation cost related to options or warrants. The Company
calculated compensation cost as required and determined that the application of
SFAS No. 123 would not result in a significant difference from reported net
income and earnings per share.
F-11
7. Stock Options and Warrants, continued:
The following table summarizes information about stock options and warrants
outstanding at December 31, 1997.
Outstanding Exercisable
------------------------------------------------- --------------------------------
Exercise Average Average Average
Price Range Shares Life Exercise Price Shares Exercise Price
----------- ------ ---- -------------- ------ --------------
$0.00 - $1.97 10,000 7.8 $1.75 10,000 $1.75
$1.98 - $3.95 353,000 6.1 $3.28 260,753 $3.29
$5.93 - $7.90 12,000 2.5 $6.25 11,000 $6.25
$7.91 - $9.86 6,000 .4 $9.00 6,000 $9.00
------- -------
Total 381,000 5.9 $3.42 287,753 $3.46
======= =======
8. Income Taxes:
Income (loss) before provision (benefit) for income taxes consists of the
following:
1997 1996 1995
---- ---- ----
Domestic $1,084,868 $1,338,145 $(3,966,286)
Foreign (124,357) (179,775) (659,829)
----------- ---------- -----------
$ 960,511 $1,158,370 $(4,626,115)
=========== ========== ===========
At December 31, 1997, 1996 and 1995, the provision (benefit) for income taxes
consists of the following:
Current 1997 1996 1995
---- ---- ----
Federal $ 280,000 $ 202,000 $ 84,000
Foreign 66,500 11,000 -
---------- ----------- -----------
346,500 213,000 84,000
---------- ----------- -----------
Deferred:
Federal (62,000) 25,000 (584,000)
Foreign (61,500) - -
---------- ----------- -----------
(123,500) 25,000 (584,000)
---------- ----------- -----------
Total $ 223,000 $ 238,000 $ (500,000)
========== =========== ===========
A reconciliation of the statutory federal income tax (benefit) to the effective
tax is as follows:
1997 1996 1995
---- ---- ----
Statutory income tax (benefit) $ 327,000 $ 394,000 $(1,573,000)
Utilization of foreign tax credits (230,000) (444,000) (1,638,000)
Utilization of N.O.L. carryforward - (57,000) -
Tax effect of foreign dividend 33,000 242,000 2,394,000
Goodwill amortization 17,000 17,000 17,000
Foreign subsidiary losses not
utilized by the consolidated group 37,000 69,000 224,000
Other 39,000 17,000 76,000
---------- ---------- ---------
$ 223,000 $ 238,000 $(500,000)
========== ========== =========
F-12
8. Income Taxes, continued:
The tax effects of the primary temporary differences between values
recorded for assets and liabilities for financial reporting purposes and values
utilized for measurement in accordance with tax laws giving rise to the
Company's deferred tax assets and liabilities are as follows:
1997 1996
DEFERRED INCOME TAXES ASSET LIABILITY ASSET LIABILITY
--------------------- ----------------------------- ------------------------------
Depreciation $ 54,000 $ - $ - $ 22,000
Inventories 90,000 - 168,500 -
Net operating loss carryforward 480,000 - 481,000 -
Foreign tax credit carryforward 1,693,000 - 1,776,000 -
Other 57,000 145,000 61,000 130,000
---------- --------- ----------- --------
2,374,000 145,000 2,486,500 152,000
Valuation allowance 2,028,000 - 2,257,000 -
---------- --------- ----------- --------
$ 346,000 $ 145,000 $ 229,500 $152,000
========== ========= =========== ========
Applicable U.S. income and foreign withholding taxes have not been
provided on approximately $2.8 million of undistributed earnings of foreign
subsidiaries as it is the Company's intention to permanently reinvest these
earnings or to repatriate such earnings in a tax-free manner.
Certain foreign subsidiaries have available net operating loss
carryforwards of approximately $1.1 million which for the most part have an
unlimited carryforward life. In addition, a domestic subsidiary has available a
net operation loss carryforward of approximately $117,000 for state tax purposes
which expires in years 1998 through 1999. The Company has foreign tax credit
carryforwards in the U.S. of approximately $1.69 million expiring in 2000
through 2002. As of December 31, 1997, the Company did not believe that it was
more likely than not that it would generate sufficient foreign and state income,
and U.S. sourced income within the appropriate period to utilize all the net
operating loss carryforwards and the foreign tax credits, respectively.
9. Employee Benefits:
Effective January 1, 1992, the Company implemented a Profit Sharing and
Section 401(k) Salary Deferral Plan and Trust covering all domestic employees of
Aloette Cosmetics, Inc. All accounts in the previous pension plan and profit
sharing plan were fully vested and were merged into the Profit Sharing and
Section 401(k) Plan. The plans were determined to be tax-qualified pursuant to
an IRS determination letter dated October 30, 1995.
Aloette Canada has a defined contribution pension plan for all
employees with at least one year of service. Under the terms of the plan,
Aloette Canada contributes an amount dependent upon the employee's compensation
ranging from 2% to 10% with a maximum contribution of $15,500 Canadian dollars
per employee.
The Company has a supplemental benefits plan pursuant to which the
Company maintains non-funded accounts for designated officers and employees.
Accounts in the supplemental plan increase each year based on a growth factor.
The amounts expensed for these plans in 1997, 1996 and 1995 were
$55,140, $59,883 and $58,554, respectively.
F-13
10. Leases:
Capital Leases
In 1993, the Company entered into a lease agreement for computer and
related equipment totaling $419,000. The capital lease extended through 1996 and
was payable in quarterly installments of $33,746 including interest at 4.5%. The
lease was bought out in December 1996. There were no leases in 1997.
Rent
Total rent expense was $12,225, $1,369 and $16,457 in 1997, 1996
and 1995, respectively.
11. Litigation:
On or about May 27, 1994, an action was filed against the Company in
the Eastern District of Pennsylvania under the caption, Slaven et al. v. Aloette
Cosmetics, Inc. et al., alleging, among other things, breach of contract and
warranty and fraud against the Company and an officer and seeking compensatory
and punitive damages in excess of $1,000,000 plus court costs and attorney's
fees. The Company filed answers and counterclaims in these actions. In March
1995, the counts alleging breach of covenant of good faith and fair dealing and
abandonment of trademark were dismissed without prejudice based upon
insufficient pleadings. The Company settled this matter successfully on February
25, 1997. The terms of the settlement did not have a material effect on the
Company's consolidated results of operations.
On November 11, 1994, the Company filed an action in the High Court of
New Zealand under the caption, Aloette Cosmetics, Inc. of Delaware, et al. v.
Billisa Holdings Ltd., et al., alleging, among other things, that the defendants
failed to pay for products supplied and failed to pay management fees. The
Company requested an injunction requiring the defendants to turn over documents
and inventory and to cease operating as a franchise. On December 19, 1994, the
Court granted the Company's request for an injunction. The defendants filed
answers and counterclaims in these actions seeking compensatory and punitive
damages in excess of approximately $5 million plus court costs and attorneys'
fees. The counterclaim alleged, among other things, breach of express and
implied terms of contract, breach of fiduciary obligations, breach of section 9
of the Fair Trading Act of 1988 and undue influence. The Company settled this
matter successfully on March 6, 1997. The terms of the settlement did not have a
material effect on the Company's consolidated results of operations.
In addition, from time to time, the Company is a defendant in
litigation arising in the normal course of business. Management and legal
counsel do not believe that any settlement resulting from such litigation will
have a material adverse effect on the Company's consolidated financial position
or results of operations.
12. Related Parties:
A former director of the Company is affiliated with a product packaging
company. Purchases from this company during 1997, 1996 and 1995 were $131,382,
$137,531 and $201,171, respectively.
In February 1992, the Company entered into a franchise and license
agreement with a limited liability company of the Federal Republic of Germany,
Alover Cosmetics GmbH ("Alover") for exclusive right to use the trade name,
trademarks and marketing and product know-how of the Company in certain European
countries. Alover has paid $110,000 to the Company as payment for the initial
license fee. A director and former officer of the Company and the husband of the
Chairman of the Board beneficially owns 50% of the shares of outstanding stock
of Alover. The agreement expired in February 1997 (see Notes 5 and 18 for
description of additional related party disclosures).
From time to time, the Company enters into consulting agreements with
directors on an "as needed" basis. Total fees expended under these agreements
were $29,167 for 1997, $51,900 for 1996 and $49,100 for 1995. Note that in
November 1995, a director, who is also the husband of the Chairman of the Board,
entered into a one year consulting agreement with the Company. The agreement,
which expired in November 1996, was extended on a monthly basis through July
1997.
F-14
13. Business Segment and Export Data:
The Company's revenues are derived principally from the sale of
cosmetics and health and beauty aid products in one business segment. The
Company's financial information relating to domestic and foreign operations is
as follows:
1997 1996 1995
Revenues:
Domestic $ 5,989,936 $ 6,642,885 $ 8,151,622
International(1) 4,034,290 4,978,058 5,112,361
----------- ----------- -----------
$10,024,226 $11,620,943 $13,263,983
=========== =========== ===========
Identifiable assets:
Domestic $ 6,733,565 $ 7,139,963 $ 7,238,708
International(1) 5,146,310 5,535,378 4,954,799
----------- ----------- -----------
$11,879,875 $12,675,341 $12,193,507
=========== =========== ===========
Operating income (loss):
Domestic $ 1,144,845 $ 1,342,071 $(3,559,126)
International (1) (242,839) (230,234) (772,449)
----------- ----------- -----------
$ 902,006 $ 1,111,837 $(4,331,575)
=========== =========== ============
(1) Aloette Canada accounts for substantially all of the international
sales and identifiable assets.
Of the total domestic identifiable assets, receivables totaled $630,611
in 1997, $664,593 in 1996 and $689,724 in 1995.
Of the total international assets, total receivables due from Canadian
customers totaled $523,739 in 1997, $741,737 in 1996 and $1,176,042 in
1995.
Two franchises under common ownership by two individuals accounted for
approximately 12%, 13% and 9% of total revenues in 1997, 1996 and 1995,
respectively.
14. Supplemental Cash Flow Information:
Noncash investing and financing activities:
In the year ending December 31, 1997, the Company granted one franchise
for a note receivable of $20,000. During 1996 and 1995, the Company sold and
financed resales of several franchise territories for franchise notes receivable
of $362,000 and $191,000, respectively.
In March 1996, the Company repurchased one of its Canadian franchises,
consisting of three potential franchise territories, as satisfaction of a note
receivable of approximately $160,000. One franchise territory is being operated
by the Company; one territory was resold for a note receivable and cash of
approximately $110,000; and the Company expects that the third territory will
eventually be sold. For the period from its acquisition through December 31,
1997, the Company operated franchise's net product sales and net earnings did
not significantly affect consolidated results from operations. No franchises
were repurchased as satisfaction of a note receivable in 1997.
Cash paid during the year for interest and income taxes was as follows:
1997 1996 1995
---- ---- ----
Interest $ 3,650 $ 26,201 $260,940
Income taxes $170,478 $477,110 $206,456
F-15
During 1996, the Company reclassified approximately $300,000 of
interest accrued as of December 31, 1995 as deferred interest in accordance with
the Subordinated Note (see Notes 5 and 18).
As of December 31, 1995, the Company had recorded $300,000 of barter
credits, which are included in other assets. During 1996, the Company utilized
$104,000 of these credits, with $50,000 representing noncash transactions as
opposed to $12,000 in 1997.
15. Other Income (Expense), Net:
The following table includes the components of other income (expense),
net:
1997 1996 1995
---- ---- ----
Interest income $ 189,134 $ 239,741 $ 109,682
Interest expense (131,805) (199,853) (487,279)
Other income, net 1,176 6,645 83,057
--------- --------- ---------
$ 58,505 $ 46,533 $(294,540)
========= ========= =========
16. Earnings Per Share Information
1997 1996 1995
Basic Diluted Basic Diluted Basic Diluted
------------------------ ------------------------ ---------------------------
Net Earnings Available to common
Shareholders $ 737,511 $ 737,511 $ 920,370 $ 920,370 $(4,126,115) $(4,126,115)
Average equivalent shares:
Shares of Aloette common stock
Outstanding 2,126,675 2,126,675 2,157,253 2,157,253 2,157,253 2,157,253
Employee compensation-related
shares, including warrants and
options - 11,370 - 55,528 - 468
----------- ---------- ---------- ---------- ------------- -------------
Total average equivalent shares 2,126,675 2,138,045 2,157,253 2,212,781 2,157,253 2.157,721
Net earnings per share $ .35 $ .34 $ .43 $ .42 $ (1.91) $ (1.91)
=========== ========== ========== ========== ============= =============
17. Stock Repurchase Plan:
In 1990, the Company authorized a stock repurchase program to purchase
up to 150,000 shares of the Company's common stock in the open market from time
to time. As of December 31, 1996, 80,000 shares had been purchased under the
plan. Of that, 50,000 shares were for the Company's Employee Stock Ownership
Plan.
In 1997, the Board of Directors of the Company approved an increase in
the number of shares available for purchase to 500,000 shares of the Company's
common stock. During 1997, 53,000 shares of common stock were purchased and are
currently being held as Treasury Stock.
F-16
18. Treasury Stock Purchase:
On April 16, 1991, the Company purchased 777,881 of its common stock
from John E. Defibaugh, Director and former President and Chief Operating
Officer, for consideration of $8.4 million or approximately $10.85 per share,
plus acquisition costs. Upon consummation, the Company paid Mr. Defibaugh $3.0
million of the original purchase price in cash financed through borrowings under
a bank line of credit and issued a subordinated note payable for the remaining
portion. The Company made a lump-sum payment of $1.5 million in April 1992. The
terms of the note were restructured in January 1996. The note is currently
payable in $50,000 monthly installments with interest at 7%. All interest is
being deferred until the principal is paid in full. No interest payments have
been made since October 1994. Interest expense related to this obligation for
1997, 1996 and 1995 was $128,000, $173,000 and $255,000, respectively.
19. Sale of Assets of the Manufacturing Operations:
On June 15, 1995, the Company finalized the sale of certain assets of
its manufacturing operations in Texas for cash of approximately $2.1 million.
The sale included the facility, inventory and equipment. As a result of the sale
of these assets, the Company recorded a charge of $3.8 million in 1995. In
connection with the sale, the Company entered into a five-year supply agreement
to purchase inventory at prices competitive in the industry.
Sales from the manufacturing operations were approximately $1.2 million
for the twelve months ended December 31, 1995. The net loss from normal
operations for the corresponding period was $478,000.
F-17
PART III
Item 9. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The information required under this item is incorporated by reference
to the Registrant's 1998 Proxy Statement.
Item 10. EXECUTIVE COMPENSATION
The information required under this item is incorporated by reference
to the Registrant's 1998 Proxy Statement.
Item 11. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The information required under this item is incorporated by reference
to the Registrant's 1998 Proxy Statement.
Item 12. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information required under this item is incorporated by reference
to the Registrant's 1998 Proxy Statement.
PART IV
Item 13. EXHIBITS, FINANCIAL STATEMENTS, FINANCIAL
STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
(a) Documents filed as part of this Report:
1. CONSOLIDATED FINANCIAL STATEMENTS:
Report of Independent Accountants
Consolidated Balance Sheets as of December 31, 1997 and 1996
Consolidated Statements of Operations for the Years Ended
December 31, 1997, 1996 and 1995
Consolidated Statements of Changes in Shareholders' Equity for
the Years Ended December 31,1997, 1996 and 1995
Consolidated Statements of Cash Flows for the Years Ended
December 31, 1997, 1996 and 1995
Notes to Consolidated Financial Statements
16
2. CONSOLIDATED FINANCIAL STATEMENT SCHEDULES:
Schedule II - Valuation and Qualifying Accounts
All other schedules not listed above have been omitted because they are
not applicable or are not required, or because the required information is
included in the consolidated financial statements or notes thereto.
(b) Reports on Form 8-K:
None.
(c) Exhibits:
3(i) Articles of Incorporation, as amended (incorporated by
reference to Exhibit 3.1 to Form 10-K dated March 28, 1988,
File No. 0-15414)
3(ii) By-laws of Registrant, as amended (incorporated by reference
to Exhibit 3.2 to Form 10-K dated March 28, 1988,
File No. 0-15414)
4.1 Form of Stock Certificate for Shares of Common Stock
(incorporated by reference to Exhibit 4.1 to Amendment No. 4
to Form S-1 Registration Statement dated June 24, 1986,
File No. 33-4918)
9. Not applicable
10.1 Incentive Stock Option Plan, as amended, of Aloette Cosmetics,
Inc. (incorporated by reference to the 1994 Proxy Statement)
10.2 Employee Stock Ownership Plan, as amended, of
Aloette Cosmetics, Inc. (incorporated by reference to
Exhibit 10.2 of Form 10-KSB dated March 30, 1994,
File No. 0-15414)
10.3 Form of Franchise Agreement for the United States effective
through June 1993, as amended (incorporated by reference to
Exhibit 10.3 to Form S-3 Registration Statement dated
September 22, 1989, File No. 33-30544)
10.4 Form of Franchise Agreement for Canada, effective through
June 1993, as amended (incorporated by reference to
Exhibit 10.30 to Form S-3 Registration
Statement dated June 24, 1986, File No. 33-4918)
10.5 Form of Distributorship and License Agreement, with attached
Exhibit A listing all such agreements (incorporated by
reference to Exhibit 10.5 of Form 10-KSB dated March 30, 1994,
File No. 0-15414)
10.6 Form of Aloette Cosmetics, Inc. Consultant Agreement
(incorporated by reference to Exhibit 10.22 to Amendment No. 4
to Form S-1 Registration Statement dated June 24, 1986,
File No. 33-4918)
10.7 Form of Indemnification Agreement, by and between Aloette
Cosmetics, Inc. and Officers and Directors (incorporated by
reference to Exhibit 10.30 to Form 10-K dated March 28, 1988,
File No. 0-15414)
10.8 Director's Stock Warrant Plan (incorporated by reference to
the 1993 Proxy Statement)
10.9 Employment Agreement, dated April 1, 1993, by and between
Patricia J. Defibaugh and Aloette Cosmetics, Inc.
(incorporated by reference to Exhibit 10.13 of Form 10-KSB
dated March 31, 1995, File No. 0-15414)
17
10.10 Severance Protection Agreement, dated April 1, 1993, by and
between Patricia J. Defibaugh and Aloette Cosmetics, Inc.
(incorporated by reference to Exhibit 10.14 of Form 10-KSB
dated March 31, 1995, File No. 0-15414)
10.11 Share Purchase Agreement dated April 26, 1992, between
John E. Defibaugh and Aloette Cosmetics, Inc. for the
purchase of 777,881 shares of the Company's common stock
(incorporated by reference to Exhibit 10.23 to Form 10-K
dated March 28, 1992, File No. 0-15414)
10.12 Subordinated Promissory Note dated April 26, 1992, between
John E. Defibaugh and Aloette Cosmetics, Inc.
(incorporated by reference to Exhibit 10.24 to Form 10-K
dated March 28, 1992, File No. 0-15414)
10.13 Profit Sharing and Section 401(k) Salary Deferred Plan, as
amended, of Aloette Cosmetics, Inc. and Superior Products
Company dated February 5, 1992 (incorporated by reference to
Exhibit 10.17 of Form 10-KSB dated March 30, 1994, File No.
0-15414)
10.14 Form of Multi-Unit Development Agreement for Canada, with
attached Exhibit B listing all such agreements (incorporated
by reference to Exhibit 10.23 of Form 10-KSB dated March 30,
1994, File No. 0-15414)
10.15 Form of Franchise Agreement for Canada, effective July 1993,
as amended (incorporated by reference to Exhibit 10.25 of
Form 10-KSB dated March 30, 1994, File No. 0-15414)
10.16 Asset purchase agreement, by and between Aloette Cosmetics of
Canada, Inc. and Aloette Cosmetiques De Quebec, Inc.
(incorporated by reference to Exhibit 10.24 of Form 10-KSB
dated March 31, 1995, File No. 0-15414)
10.17 Form of Franchise Agreement effective September 1995
(incorporated by reference to Exhibit 10.25 of Form 10-KSB
dated March 26, 1996, File No. 0-15414)
10.18 Consulting agreement dated November 14, 1995, by and between
Aloette Cosmetics, Inc. and Subsidiaries and John E. Defibaugh
(incorporated by reference to Exhibit 10.26 of Form 10-KSB
dated March 26, 1996, File No. 0-15414)
10.19 Loan Agreement dated January 4, 1996, by and between PNC Bank,
N.A. and Aloette Cosmetics, Inc. and Subsidiaries
(incorporated by reference to Exhibit 10.27 of Form 10-KSB
dated March 26, 1996, File No. 0-15414)
10.20 Line of Credit Note dated January 4, 1996, by and between PNC
Bank, N.A. and Aloette Cosmetics, Inc. and Subsidiaries
(incorporated by reference to Exhibit 10.28 of Form 10-KSB
dated March 26, 1996, File No. 0-15414)
10.21 Security Agreement dated January 4, 1996, by and between PNC
Bank, N.A. and Aloette Cosmetics, Inc. and Subsidiaries
(incorporated by reference to Exhibit 10.29 of Form 10-KSB
dated March 26, 1996, File No. 0-15414)
10.22 Open-end Mortgage and Security Agreement dated January 4,
1996, by and between PNC Bank, and Aloette Cosmetics, Inc.
(incorporated by reference to Exhibit 10.29 of Form 10-KSB
dated March 26, 1996, File No. 0-15414)
10.23 Agreement of Sale dated June 7, 1996 to sell the two
condominiums in Pennsylvania, by and between Aloette
Cosmetics, Inc. and Architectural Alliance (incorporated by
reference to Exhibit 10.27 of Form 10-KSB dated March 27,
1997, File No. 0-15414)
18
10.24 Amendment to Subordinated Promissory Note dated
April 26, 1992, by and between John E. Defibaugh and Aloette
Cosmetics, Inc. dated April , 1996 (incorporated by reference
to Exhibit 10.28 of Form 10-KSB dated March 27, 1997
File No. 0-15414)
10.25 Amendment to Loan Agreement dated January 4, 1996, by and
between PNC Bank, N.A. and Aloette Cosmetics, Inc. and
Subsidiaries effective as of December 31, 1996
(incorporated by reference to Exhibit 10.29 of
Form 10-KSB dated March 27, 1997 File No. 0-15414)
10.26 Amendment to Line of Credit Note dated January 4, 1996, by
and between PNC Bank, N.A. and Aloette Cosmetics, Inc. and
Subsidiaries effective as of December 31, 1996
(incorporated by reference to Exhibit 10.30 of Form 10-KSB
dated March 27, 1997 File No. 0-15414)
21. Subsidiaries of the Registrant
23. Consent of Coopers & Lybrand L.L.P., independent accountants
27. Financial Data Schedule
99. None
19
ALOETTE COSMETICS, INC. AND SUBSIDIARIES
SCHEDULE II: VALUATION AND QUALIFYING ACCOUNTS
Column A Column B Column C Column D Column E
-------- -------- -------- -------- --------
Additions
Balance at Charged to Charged to Other Change Balance at
Beginning Costs and Other Accounts Add (Deduct) End
of Year Expenses (Describe) (Describe) (1) of Year
--------------------------------------------------------------------------------------------------------------------
Allowance for doubtful
accounts - product:
1997 $142,000 76,000 (65,000) $153,000
1996 110,000 67,000 (35,000) 142,000
1995 125,000 95,000 (110,000) 110,000
Allowance for doubtful
accounts - franchise
notes receivable:
1997 $170,000 18,000 (151,000) $ 37,000
1996 270,000 97,000 (197,000) 170,000
1995 15,000 367,000 (112,000) 270,000
Reserve for obsolete
inventory:
1997 $624,000 9,000 (309,000) $324,000
1996 677,000 95,000 (148,000) 624,000
1995 638,000 364,000 (325,000) 677,000
(1) Uncollectible accounts written off or inventories disposed of.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized.
ALOETTE COSMETICS, INC.
/s/ Patricia J. Defibaugh /s/ Jean M. Lewis
- -------------------------------------------- -----------------
Patricia J. Defibaugh Jean M. Lewis
President and Chief Operating Officer Vice President of Finance (Principal
Financial and Accounting Officer)
Date: March 30, 1998 Date: March 30, 1998
- --------------------------------------------- ------------------------
Pursuant to the requirements of the Securities Exchange Act of 1934,
this report has been signed by the following persons on behalf of the registrant
in the capacities and on the dates indicated:
Signature Title Date
--------- ----- ----
/s/ Patricia J. Defibaugh Chairman and Director March 30, 1998
- --------------------------------------
Patricia J. Defibaugh
/s/ Robert B. Throm Director March 30, 1998
- --------------------------------------
Robert B. Throm
/s/ John E. Defibaugh Director March 30, 1998
- --------------------------------------
John E. Defibaugh
/s/ William Albertus, Sr. Director March 30, 1998
- --------------------------------------
William Albertus, Sr.
/s/ Mark J. DeNino Director March 30, 1998
- --------------------------------------
Mark J. DeNino
EXHIBIT INDEX
PAGE NO. IN SEQUENTIAL
EXHIBIT NO. NUMBERING SYSTEM
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21
23
27