1 UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-Q (Mark One) [ X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934. For the quarterly period ended October 3, 1998 Commission File No. 0-21404 ------- SAFETY 1ST, INC. (Exact Name of Registrant as specified in its Charter) Massachusetts 04-2836423 (State or other jurisdiction (I.R.S. Employer of incorporation or organization) Identification Number) 210 Boylston Street Chestnut Hill, Massachusetts 02167 (Address of principal executive (Zip Code) offices) Registrant's telephone number, including area code: (617) 964-7744 Indicate by check mark whether the Registrant (1) has filed all reports to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes X No ----- ----- The aggregate number of Registrant's shares outstanding on October 31, 1998 was 7,231,122 shares of Common Stock, $.01 par value. 2 SAFETY 1ST, INC. INDEX PART I - FINANCIAL INFORMATION ITEM 1. FINANCIAL STATEMENTS CONDENSED BALANCE SHEETS AS OF OCTOBER 3, 1998 AND JANUARY 3, 1998 (Unaudited) 3 CONDENSED STATEMENTS OF OPERATIONS FOR THE THREE MONTHS ENDED OCTOBER 3, 1998 AND SEPTEMBER 27, 1997 (Unaudited) 5 CONDENSED STATEMENTS OF OPERATIONS FOR THE NINE MONTHS ENDED OCTOBER 3, 1998 AND SEPTEMBER 27, 1997 (Unaudited) 6 STATEMENTS OF CASH FLOWS FOR THE NINE MONTHS ENDED OCTOBER 3, 1998 AND SEPTEMBER 27, 1997 (Unaudited) 7 NOTES TO CONDENSED FINANCIAL STATEMENTS (Unaudited) 8 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (Unaudited) 9 PART II - OTHER INFORMATION ITEM 1. LEGAL PROCEEDINGS 11 ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K 12 SIGNATURES 13 2 3 PART 1 - FINANCIAL INFORMATION ITEM 1 - FINANCIAL STATEMENTS SAFETY 1ST, INC. CONDENSED BALANCE SHEETS (UNAUDITED) (IN THOUSANDS) ASSETS OCTOBER 3, 1998 JANUARY 3, 1998 --------------- --------------- CURRENT ASSETS Cash $ 446 $ 839 Accounts receivable, less allowance for doubtful accounts of $900, and $1,700, respectively 29,958 23,411 Inventory 15,710 16,372 Prepaid expenses and other current assets 3,235 1,190 Deferred income taxes 3,300 3,300 ------- ------- TOTAL CURRENT ASSETS 52,649 45,112 ------- ------- PROPERTY AND EQUIPMENT, net of accumulated depreciation of $4,900, and $3,900, respectively 14,183 12,666 ------- ------- OTHER ASSETS Mold deposits $ 1,821 $ 1,568 Software systems in process 5,228 5,006 Goodwill, net of amortization of $780 and $561 respectively 6,340 6,546 Deferred income taxes 6,433 6,300 Patents and trademarks, net of amortization of $541 and $464, respectively 631 634 Other assets 1,522 1,701 ------- ------- TOTAL OTHER ASSETS 21,975 21,755 ------- ------- $88,807 $79,533 ======= ======= 3 4 SAFETY 1ST, INC. CONDENSED BALANCE SHEETS - CONTINUED (IN THOUSANDS EXCEPT SHARE DATA) (UNAUDITED) LIABILITIES AND STOCKHOLDERS' EQUITY: OCTOBER 3, 1998 JANUARY 3, 1998 --------------- --------------- CURRENT LIABILITIES Revolving credit facility $ 30,178 $ 25,427 Accounts payable and accrued expenses 17,518 14,685 Current portion of long-term debt 2,706 3,763 -------- -------- TOTAL CURRENT LIABILITIES 50,402 43,875 Long-term debt 7,434 8,855 -------- -------- TOTAL LIABILITIES 57,836 52,730 -------- -------- REDEEMABLE PREFERRED STOCK 17,466 15,839 STOCKHOLDERS' EQUITY Common stock, $0.01 par value, 15,000,000 shares authorized, 7,231,122 and 7,187,288 issued at October 3, 1998 and January 3, 1998, respectively 72 72 Additional paid-in capital 40,524 40,242 Accumulated deficit (27,091) (29,350) -------- -------- TOTAL STOCKHOLDERS' EQUITY 13,505 10,964 -------- -------- $ 88,807 $ 79,533 ======== ======== Note: The Condensed Balance Sheet at January 3, 1998 has been derived from the audited financial statements at that date. The accompanying notes are an integral part of these Condensed Financial Statements. 4 5 SAFETY 1ST, INC. CONDENSED STATEMENTS OF OPERATIONS (IN THOUSANDS) (UNAUDITED) THREE MONTHS ENDED OCTOBER 3, 1998 SEPTEMBER 27, 1997 --------------- ----------------- Net Sales $32,442 $26,446 Cost of Sales 20,035 15,411 ------- ------- GROSS PROFIT 12,407 11,035 Selling general and administrative expenses 9,785 8,573 ------- ------- OPERATING INCOME 2,622 2,462 Interest expense 1,066 1,101 ------- ------- INCOME BEFORE INCOME TAXES 1,556 1,361 Income tax expense (benefit) -- (1,496) ------- ------- Net Income 1,556 2,857 Dividends and accretion on redeemable preferred stock 560 478 ------- ------- Net income available to common shareholders $ 996 $ 2,379 ======= ======= Basic earnings per common share $ 0.14 $ 0.33 ======= ======= Diluted earnings per common share $ 0.12 $ 0.29 ======= ======= Shares used to compute basic earnings per common share 7,231 7,187 ======= ======= Shares used to compute diluted earnings per common share 8,510 8,088 ======= ======= The accompanying notes are an integral part of these Condensed Financial Statements. 5 6 SAFETY 1ST, INC. CONDENSED STATEMENTS OF OPERATIONS (IN THOUSANDS) (UNAUDITED) NINE MONTHS ENDED OCTOBER 3, 1998 SEPTEMBER 27, 1997 --------------- ------------------ Net Sales $96,330 $79,844 Cost of Sales 58,691 47,516 ------- ------- GROSS PROFIT 37,639 32,328 Selling general and administrative expenses 29,513 25,364 ------- ------- OPERATING INCOME 8,126 6,964 Interest expense 3,023 3,364 ------- ------- INCOME BEFORE INCOME TAXES 5,103 3,600 Income tax expense (benefit) 1,217 (668) ------- ------- Net Income 3,886 4,268 Dividends and accretion on redeemable preferred stock 1,627 478 ------- ------- Net income available to common shareholders $ 2,259 $ 3,790 ======= ======= Basic earnings per common share $ 0.31 $ 0.53 ======= ======= Diluted earnings per common share $ 0.26 $ 0.50 ======= ======= Shares used to compute basic earnings per common share 7,214 7,187 ======= ======= Shares used to compute diluted earnings per common share 8,649 7,614 ======= ======= The accompanying notes are an integral part of these Condensed Financial Statements. 6 7 SAFETY 1ST, INC. STATEMENTS OF CASH FLOWS (IN THOUSANDS) (UNAUDITED) NINE MONTHS ENDED OCTOBER 3, 1998 SEPTEMBER 27, 1997 ---------------- ------------------ CASH FLOWS FROM OPERATING ACTIVITIES: Net Income $3,885 $ 4,268 Adjusted to Reconcile Net Income to Net Cash provided by (used in) operating activities: Depreciation 3,037 2,413 Amortization 583 354 ------ ------- NET CASH PROVIDED BY OPERATING ACTIVITIES BEFORE CHANGES IN ASSETS AND LIABILITIES: 7,505 7,035 Changes on Assets and Liabilities: (Increase) Decrease in: Accounts receivable (6,547) (6,144) Inventory 662 (456) Prepaid expenses and other assets (3,253) (938) Tax refund receivable -- 5,027 Increase (Decrease) in: Accounts Payable and accrued expenses 3,835 (9,968) ------ ------- NET CASH PROVIDED BY (USED IN) OPERATING ACTIVITIES 2,202 (5,444) ------ ------- CASH FLOWS USED IN INVESTING ACTIVITIES: Acquisitions of property and equipment (4,224) (2,148) Increase in software system in process (223) (2,345) Acquisition of patents and trademarks (74) (51) ------ ------- NET CASH USED IN INVESTING ACTIVITIES (4,521) (4,544) ------ ------- CASH FLOW PROVIDED BY FINANCING ACTIVITIES: Net borrowing from (repayment of) revolving credit facility 4,751 (13,640) Proceeds from (repayment of) long-term debt (1,875) 12,500 Proceeds from issuance of redeemable preferred stock -- 15,000 Refinancing fees -- (2,350) Proceeds from exercised Stock Options 283 59 Repayment of notes payable (825) (1,176) Other (408) 250 ------ ------- NET CASH PROVIDED BY FINANCING ACTIVITIES 1,926 10,643 ------ ------- Net (Decrease) Increase in cash (393) 655 Cash and Cash Equivalents - Beginning of period 839 509 ------ ------- CASH AND CASH EQUIVALENTS - END OF PERIOD $ 446 $ 1,164 ------ ------- SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION: Cash paid during the period for Interest $2,846 $ 3,242 ====== ======= The accompanying notes are an integral part of these Condensed Financial Statements 7 8 SAFETY 1ST, INC. NOTES TO CONDENSED FINANCIAL STATEMENTS (Unaudited) NOTE 1. BASIS OF PRESENTATION The Company is a developer, marketer and distributor of child safety and child care, convenience, activity and home security products. The accompanying unaudited condensed financial statements of the Company have been prepared pursuant to the rules and regulations of the Securities and Exchange Commission ("SEC") and, in the opinion of the management, reflect all adjustments (consisting of only normal recurring adjustments) necessary to present fairly the financial position, results of operations and cash flows for the periods presented. Certain information and footnote disclosures included in financial statements prepared in accordance with generally accepted accounting principles have been condensed or omitted. These condensed financial statements should be read in conjunction with the audited financial statements and notes thereto included in the financial statements filed as part of the Company's Annual Report on Form 10-K filed for the year ended January 3, 1998. The results of the operations for the nine months ended October 3, 1998 are not necessarily indicative of the operating results for the full year. 8 9 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS. Statement of Forward-Looking Information: The Company may occasionally make forward-looking statements and estimates, such as forecasts and projections of the Company's future performance or statements of management's plans and objectives. These forward-looking statements may be contained in SEC filings, Annual Reports to Shareholders, Press Releases and oral statements, among others, made by the Company. Actual results could differ materially from those in such forward-looking statements. Therefore, no assurances can be given that the results in such forward-looking statements will be achieved. Important factors that could cause the Company's actual results to differ from those contained in such forward-looking statements include, among others, those factors set forth in Exhibit 99 to the Company's Annual Report on Form 10-K for the year ended January 3, 1998, and incorporated herein by reference. Results of Operations (all $ amounts in thousands): Three Months Ended October 3, 1998 and September 27, 1997 Net sales for the three months ended October 3, 1998 increased by $5,996, or 22.7%, to approximately $32,442 from $26,446 in the comparable period of 1997. The increase is primarily attributable to an increase in sales domestically by $5,841, as the Company's continuing product line carried forward from 1997 increased by 14%. Gross profit for the three months ended October 3, 1998 was $12,407, or 38.2% of net sales, as compared to $11,035, or 41.7%, for the three months ended September 27, 1997. Gross profit percentage was impacted by the following factors: (i) devaluation of the Canadian dollar, which increases cost of goods sold for the Canadian subsidiary since all inventory purchases are made in U.S. dollars; (ii) unusually high number of returns due to the Company's toy replacement program for the Bounce `N Ride Buggy product; and (iii) higher mix of bulk products sold, which generally carry a lower gross margin than peg products. Selling, general and administrative expenses increased by $1,212 to $9,785, or 30.2% of net sales, for the three months ended October 3, 1998 from $8,573, or 32.4% of net sales, for the comparable period in 1997. This increase is primarily attributable to an increase in selling related expenses caused by the sales increase as well as an increase in payroll and payroll related costs. The improvement as a percentage of sales is due to the leveraging of the existing fixed cost structure over a larger sales base. As a result of the above factors, operating income for the three months ended October 3, 1998 was $2,622. Operating income for the comparable period in 1997 was $2,462. Interest expense decreased to $1,066 for the three months ended October 3, 1998 from $1,101 for the three months ended September 27, 1997 due to lower average debt balances in 1998 versus the prior year. The Company recorded an income tax provision of $0 for the three months ended October 3, 1998 due to the recognition of approximately $500 of deferred tax benefit related to the reduction in the valuation allowance, as management believes it is more likely than not that the deferred tax assets on the balance sheet will be realized through the generation of future taxable income. In the third quarter of 1997, the Company reduced the valuation allowance by $2 million based on a similar analysis of projected future income under the "more likely than not" criteria. 9 10 Nine Months Ended October 3, 1998 and September 27, 1997 Net sales for the nine months ended October 3, 1998 increased by $16,486, or 20.6%, to $96,330 from $79,844 in comparable period in 1997. The increase is primarily attributable to an increase in sales domestically by $12,996, and internationally by $3,490. New product sales were $16,230 for the nine months ended October 3, 1998 versus $11,775 in the prior comparable period. Gross profit for the nine months ended October 3, 1998 was $37,639, or 39.1% of net sales, versus $32,328 or 40.5% for the comparable period in 1997. The decrease in the percentage is primarily due to the same factors noted for the three months ended October 3, 1998. Selling, general and administrative expenses were $29,513, or 30.6% of net sales, for the nine months ended October 3, 1998. For the comparable period ending 1997, selling, general and administrative expenses were $25,364, or 31.8%, of net sales, an increase of $4,149. As a result of the above factors, operating income was $8,126 for the nine months ended October 3, 1998 versus an operating income of $6,964 during the same period in 1997. Interest expense decreased from $3,364 for the nine months ended September 27, 1997 to $3,023 for the same period in 1998 due to lower average debt balances in 1998 versus the prior year. LIQUIDITY AND CAPITAL RESOURCES (ALL $ AMOUNTS IN THOUSANDS) The Company's primary capital requirements are for working capital and capital expenditures. The Company's capital needs are provided by availability under the Company's term loan and revolving credit facilities (including a revolving credit facility in the UK completed during the third quarter), as well as through internally generated funds. Net cash provided by operations increased to $2,202 for the nine months ended October 3, 1998 versus net cash used in operations of $5,444 for the nine months ended September 27, 1997. The primary cause of the increase was more efficient working capital management, as inventory turns and days sales outstanding improved versus the prior year. Net cash used in investing activities was $4,521 due to the purchase of property and equipment, principally molds for new product introductions. During 1998, net cash provided by financing activities was $1,926, primarily related to borrowings from the Company's revolving credit facility of $4,751 offset by principal payments on the term loan of $1,875 and repayment of notes payable of $825 issued in connection with the 1996 acquisition of Orleans Juvenile Products, Inc. The Company believes that its cash, together with its borrowing availability will be sufficient to meet its operating and other cash requirements for the next twelve months. YEAR 2000 The Year 2000 problem is a result of computer programs being written using two digits (rather than four) to define the applicable year. Any of the Company's programs that have time-sentitive software may recognize a date using "00" as the year 1900 rather the year 2000. This could result in a major system failure or miscalculations. The Company presently believes that, with modifications to existing software and conversion to new software, the Year 2000 problem will not pose significant operational problems for the Company's computer systems as modified and converted. The Company is also developing contingency plans to address Year 2000 issues at customers and suppliers; at this time, the Company is still assessing the effect the Year 2000 issue will have on customers and suppliers, and therefore cannot fully determine the impact it will have. 10 11 PART II - OTHER INFORMATION ITEM 1. Legal Proceedings. On November 27, 1997, The Product Development Group, Inc. filed a complaint in Federal District Court in Massachusetts alleging that the Company had infringed two patents owned by the plaintiff by selling two of its child security gates. The complaint seeks injunctive relief and treble damages of an unspecified amount and attorney's fees. The Company disputes the charges of infringement and the validity of the patents and intends to defend the lawsuit vigorously. The case is presently in the discovery stage. On December 4, 1995, T.S.A. Plastic Molds, Inc. ("TSA") filed a lawsuit against the Company which alleged certain contract claims amounting to approximately $94,000 (Canadian funds) based on TSA's construction of two steel molds for the Company. In November of 1997, TSA amended its complaint to claim damages in excess of $500,000 (Canadian funds). The Company had filed a cross complaint against TSA claiming that TSA did not deliver the merchandise ordered by the Company to the Company's specifications. On August 11, 1998, the parties executed a Mutual Receipt, Release and Discharge under which the Company and TSA agreed to settle all disputes between the parties, and on September 1, 1998, the parties executed a Declaration of Settlement Out of Court. The amount of payment required to be made by the Company pursuant to the settlement is not material. The Company encounters personal injury litigation related to its products in the ordinary course of business. The Company maintains product liability insurance in amounts deemed adequate by the Company's management. The Company believes that there are no claims or litigation pending the outcome of which would be likely to have a material adverse effect on the financial position of the Company. 11 12 EXHIBIT INDEX Exhibit Description ------- ----------- 10.1 Fourth Amendment To Credit Agreement (dated as of July 30, 1997) among the Company and Safety Home Products Canada, Inc., as Borrowers, BT Commercial Corporation, as Lender and Agent, and Bankers Trust Company, as Issuing Bank, dated as of May 15, 1998. 10.2 Fifth Amendment To Credit Agreement (dated as of July 30, 1997) among the Company and Safety Home Products Canada, Inc., as Borrowers, BT Commercial Corporation, as Lender and Agent, and Bankers Trust Company, as Issuing Bank, dated as of July 4, 1998. 10.3 Loan Agreement dated as of 1st September, 1998 between Safety 1st (Europe) Limited, as Borrower, and BNY International Limited, as Lender. 10.4 Invoice Discounting Agreement dated as of 1st September, 1998 between Safety 1st (Europe) Limited and BNY International Limited. 10.5 Company's side letter dated July 24, 1998 to BNY International Limited waiving ownership claims in goods shipped to Safety 1st (Europe) Limited and proceeds therefrom. 11 Statement regarding Computation of Per Share Earnings. 27 Financial Data Schedule. 13 SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned hereunto duly authorized. SAFETY 1ST, INC. a Massachusetts corporation Date: November 16, 1998 By: /s/ Michael Lerner -------------------------------- Michael Lerner Chief Executive Officer (Principal Executive Officer) Date: November 16, 1998 By: /s/ Richard E. Wenz -------------------------------- Richard E. Wenz President and Chief Operating Officer Date: November 16, 1998 By: /s/ Joseph Driscoll -------------------------------- Joseph Driscoll Chief Financial Officer 13