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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 SEPTEMBER 30, 1998.
OR
/ / TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM ______________ TO ______________
COMMISSION FILE NUMBER: 0-23379
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I.C. ISAACS & COMPANY, INC.
(Exact name of Registrant as specified in its Charter)
DELAWARE 52-1377061
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
3840 BANK STREET 21224-2522
BALTIMORE, MARYLAND (Zip Code)
(Address of principal executive offices)
(410) 342-8200
(Registrant's telephone number, including area code)
NONE
(Former name, former address and former
fiscal year--if changed since last report)
------------------------
Indicate by check mark whether the Registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
Registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes /X/ No / /
As of September 30, 1998, 7,282,200 shares of common stock ("Common Stock")
of the Registrant were outstanding.
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PART I--FINANCIAL INFORMATION
I.C. ISAACS & COMPANY, INC.
CONSOLIDATED BALANCE SHEETS
ITEM 1. FINANCIAL STATEMENTS.
DECEMBER 31, SEPTEMBER 30,
1997 1998
------------- -------------
ASSETS
Current
Cash, including temporary investments of $6,512,455 and $712,000................. $ 7,422,067 $ 1,538,945
Accounts receivable, less allowance for doubtful accounts of $1,185,000 and
$1,350,000..................................................................... 23,020,077 23,240,726
Inventories (Note 1)............................................................. 23,936,226 26,656,582
Refundable income taxes (Note 4)................................................. -- 1,694,703
Prepaid expenses and other....................................................... 1,768,792 2,623,484
------------- -------------
Total current assets......................................................... 56,147,162 55,754,440
Property, plant and equipment, at cost, less accumulated depreciation and
amortization..................................................................... 2,678,688 3,388,419
Trademark, less accumulated amortization of $187,500 and $1,031,250
(Note 7)......................................................................... 11,062,500 10,218,750
Goodwill, less accumulated amortization of $863,505 and $1,348,126................. 1,788,595 1,303,915
Deferred income taxes (Note 4)..................................................... 1,505,000 1,505,000
Other assets....................................................................... 260,776 768,223
------------- -------------
$ 73,442,721 $ 72,938,747
------------- -------------
------------- -------------
LIABILITIES AND STOCKHOLDERS' EQUITY
Current
Checks issued against future deposits.............................................. $ -- $ 1,748,008
Current maturities of revolving line of credit (Note 2)............................ -- 3,314,359
Current maturities of capital lease obligations.................................... 172,515 182,619
Accounts payable................................................................... 6,967,488 5,984,744
Accrued expenses and other current liabilities (Note 3)............................ 1,979,364 2,451,042
Accrued compensation............................................................... 235,309 255,596
Income taxes payable (Note 4)...................................................... 156,000 --
------------- -------------
Total current liabilities.................................................... 9,510,676 13,936,368
------------- -------------
Long-term debt
Note payable....................................................................... 11,250,000 11,250,000
Capital lease obligations.......................................................... 186,122 46,632
------------- -------------
Total long-term debt......................................................... $ 11,436,122 $ 11,296,632
------------- -------------
Commitments and Contingencies (Note 7)
Stockholders' Equity (Notes 5 and 6)
Preferred stock; $.0001 par value; 5,000,000 shares authorized, none outstanding... -- --
Common stock; $.0001 par value; 50,000,000 shares authorized, 7,824,699 and
8,344,699 shares issued; 7,800,000 and 7,282,200 shares outstanding.............. 782 834
Additional paid-in capital......................................................... 34,120,190 38,924,998
Retained earnings.................................................................. 18,389,819 11,239,945
Treasury stock, at cost (24,699 and 1,062,499 shares).............................. (14,868) (2,460,030)
------------- -------------
Total stockholders' equity................................................... 52,495,923 47,705,747
------------- -------------
$ 73,442,721 $ 72,938,747
------------- -------------
------------- -------------
See accompanying notes to consolidated financial statements.
1
I.C. ISAACS & COMPANY, INC.
CONSOLIDATED STATEMENTS OF INCOME
THREE MONTHS ENDED SEPTEMBER NINE MONTHS ENDED
30, SEPTEMBER 30,
---------------------------- -----------------------------
1997 1998 1997 1998
------------- ------------- -------------- -------------
Net Sales.......................................... $ 49,536,995 $ 32,890,127 $ 127,246,549 $ 93,995,412
Cost of Sales...................................... 33,655,600 26,969,140 85,676,570 71,298,925
------------- ------------- -------------- -------------
Gross profit....................................... 15,881,395 5,920,987 41,569,979 22,696,487
------------- ------------- -------------- -------------
Operating Expenses
Selling.......................................... 4,174,980 4,725,073 12,153,727 13,390,127
License fees (Note 7)............................ 2,275,639 1,735,999 5,926,964 4,973,487
Distribution and shipping........................ 1,246,156 1,000,318 3,223,690 3,022,785
General and administrative....................... 1,993,755 2,672,428 5,369,729 7,616,117
Recovery of legal fees........................... -- -- (117,435) --
Provision for plant closing (Note 7)............. -- -- -- 226,326
------------- ------------- -------------- -------------
Total operating expenses..................... 9,690,530 10,133,818 26,556,675 29,228,842
------------- ------------- -------------- -------------
Operating Income (Loss)............................ 6,190,865 (4,212,831) 15,013,304 (6,532,355)
------------- ------------- -------------- -------------
Other Income (Expense)
Interest, net.................................... (696,947) (489,198) (1,619,198) (1,033,002)
Other, net....................................... 6,074 (68,663) 28,272 261,484
------------- ------------- -------------- -------------
Total other income (expense)....................... (690,873) (557,861) (1,590,926) (771,518)
------------- ------------- -------------- -------------
Income (loss) before minority interest and income
taxes............................................ 5,499,992 (4,770,692) 13,422,378 (7,303,873)
Minority interest.................................. (54,959) -- (134,226) --
------------- ------------- -------------- -------------
Income (loss) before income taxes.................. 5,445,033 (4,770,692) 13,288,152 (7,303,873)
Income tax benefit................................. -- -- -- 154,000
------------- ------------- -------------- -------------
Net Income (Loss).................................. $ 5,445,033 $ (4,770,692) $ 13,288,152 $ (7,149,873)
------------- ------------- -------------- -------------
------------- ------------- -------------- -------------
Basic and diluted earnings (loss) per share........ $ 1.36 $ (0.62) $ 3.32 $ (0.88)
Weighted average shares outstanding................ 4,000,000 7,733,214 4,000,000 8,080,994
------------- ------------- -------------- -------------
------------- ------------- -------------- -------------
Proforma financial information:
Income before income taxes, as presented......... $ 5,445,033 $ -- $ 13,288,152 $ --
Pro forma provision for income taxes............. 2,232,000 -- 5,448,000 --
------------- ------------- -------------- -------------
Pro forma net income............................. $ 3,213,033 $ -- $ 7,840,152 $ --
------------- ------------- -------------- -------------
------------- ------------- -------------- -------------
Pro forma basic and diluted earnings per share... $ 0.65 $ -- $ 1.59 $ --
Weighted average shares outstanding.............. 4,930,000 -- 4,930,000 --
------------- ------------- -------------- -------------
------------- ------------- -------------- -------------
See accompanying notes to consolidated financial statements.
2
I.C. ISAACS & COMPANY, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
NINE MONTHS ENDED
SEPTEMBER 30,
------------------------------
1997 1998
-------------- --------------
Operating Activities
Net income (loss)............................................................... $ 13,288,152 $ (7,149,873)
Adjustments to reconcile net income to net cash provided by operating activities
Provision for doubtful accounts............................................... 1,251,425 1,229,952
Write off of accounts receivable.............................................. (791,425) (1,064,952)
Provision for sales returns and discounts..................................... 8,122,576 4,509,674
Sales returns and discounts................................................... (8,529,067) (4,549,674)
Depreciation and amortization................................................. 759,513 2,099,021
Minority interest............................................................. 134,226 --
Compensation expense on stock options......................................... -- 30,000
Other......................................................................... 174,150 (2,506)
(Increase) decrease in assets
Accounts receivable......................................................... (16,582,108) (343,144)
Inventories................................................................. (8,435,026) (2,720,356)
Refundable income taxes..................................................... -- (1,694,703)
Prepaid expenses and other.................................................. (335,082) (854,692)
Other assets................................................................ (43,624) (12,705)
Increase (decrease) in liabilities
Accounts payable............................................................ (83,214) (982,744)
Accrued expenses and other current liabilities.............................. 1,467,020 471,678
Accrued compensation........................................................ 132,799 20,287
Income taxes payable........................................................ -- (156,000)
-------------- --------------
Cash used in operating activities................................................. (9,469,685) (11,170,737)
-------------- --------------
Investing Activities
Capital expenditures............................................................ (780,495) (1,375,064)
Acquisition of Girbaud license.................................................. -- (600,000)
-------------- --------------
Cash used in investing activities................................................. (780,495) (1,975,064)
-------------- --------------
Financing Activities
Checks issued against future deposits........................................... 2,182,744 1,748,008
Issuance of common stock........................................................ -- 4,774,860
Stockholder distributions....................................................... (6,498,629) --
Principal proceeds from debt.................................................... 15,968,866 3,314,359
Principal payments on debt...................................................... (328,030) (129,386)
Deferred financing costs........................................................ (521,035) --
Purchase of treasury stock...................................................... -- (2,445,162)
-------------- --------------
Cash provided by financing activities............................................. 10,803,916 7,262,679
-------------- --------------
Increase (decrease) in cash and cash equivalents.................................. 553,736 (5,883,122)
Cash and Cash Equivalents, at beginning of period................................. 938,799 7,422,067
-------------- --------------
Cash and Cash Equivalents, at end of period....................................... $ 1,492,535 $ 1,538,945
-------------- --------------
-------------- --------------
See accompanying notes to consolidated financial statements.
3
I.C. ISAACS & COMPANY, INC.
SUMMARY OF ACCOUNTING POLICIES
BASIS OF PRESENTATION
The consolidated financial statements include the accounts of I. C. Isaacs &
Company, Inc. ("ICI"), I.C. Isaacs Europe, S.L. ("Isaacs Europe"), I.C. Isaacs &
Company, L.P. (the "Partnership"), Isaacs Design, Inc. ("Design") and I. C.
Isaacs Far East (collectively, the "Company"). ICI operates as the general
partner of the Partnership and has a 99.0% ownership interest. The limited
partner, with a 1.0% ownership interest was an individual. The Company accounted
for the limited partner's ownership interest as a minority interest in the
accompanying consolidated financial statements. In connection with the initial
public offering of its common stock, ICI purchased the limited partnership
interest, at book value, from the limited partner. The Company established
Isaacs Europe in July 1996 as the exclusive licensee of Beverly Hills Polo
Club-Registered Trademark- sportswear in Europe. Isaacs Europe did not have any
significant revenue or expenses in 1997 or 1998. All intercompany balances and
transactions have been eliminated. Also, ICI terminated its Subchapter S
corporation status on December 22, 1997, and became subject to federal, state
and local income taxes.
BUSINESS DESCRIPTION
The Company, which operates in one business segment, designs, manufactures
and markets full lines of sportswear for young men, women and boys under the
BOSS-Registered Trademark- brand in the United States and Puerto Rico and for
men and women under the Beverly Hills Polo Club-Registered Trademark- brand in
the United States, Puerto Rico and Europe. In May 1998, the Company entered into
an exclusive license agreement to manufacture and market boys sportswear under
the Beverly Hills Polo Club-Registered Trademark- brand in the United States and
Puerto Rico. The Company intends to begin marketing boys sportswear under the
Beverly Hills Polo Club-Registered Trademark- brand in the first half of 1999.
In February 1998, the Company began offering collections of men's sportswear
under the Girbaud-Registered Trademark- brand in the United States and Puerto
Rico. The Company began marketing women's sportswear under the
Girbaud-Registered Trademark- brand in the second quarter of 1998 for delivery
during the 1998 holiday season. The Company also manufactures and markets
women's sportswear under various other Company-owned brand names as well as
under third-party private labels.
INTERIM FINANCIAL INFORMATION
In the opinion of management, the interim financial information as of
September 30, 1998 and for the nine months ended September 30, 1997 and 1998
contains all adjustments, consisting only of normal recurring adjustments,
necessary for a fair presentation of the results for such periods. Results for
interim periods are not necessarily indicative of results to be expected for an
entire year.
RISKS AND UNCERTAINTIES
The apparel industry is highly competitive. The Company competes primarily
with larger, well capitalized companies which may seek to increase market share
through price reductions. The risk to the Company is that such a strategy may
ultimately lead to reduced profit margins. In the past several years, many of
the Company's competitors have switched much of their apparel manufacturing from
the United States to foreign locations such as Mexico, the Dominican Republic
and throughout Asia. As competitors lower production costs it gives them greater
flexibility to alter prices. Over the last several years, the Company has
switched a significant portion of its production to contractors outside the
United States to reduce costs. Management believes that it will continue this
strategy for the foreseeable future.
4
I.C. ISAACS & COMPANY, INC.
SUMMARY OF ACCOUNTING POLICIES (CONTINUED)
The Company faces other risks inherent in the apparel industry. These risks
include changes in fashion trends and related consumer acceptance and the
continuing consolidation in the retail segment of the apparel industry. The
Company's ability, or inability, to manage these risk factors could influence
future financial and operating results.
USE OF ESTIMATES
The preparation of financial statements in accordance with generally
accepted accounting principles requires management to make certain estimates and
assumptions, particularly regarding valuation of accounts receivable and
inventory, recognition of liabilities and disclosure of contingent assets and
liabilities at the date of the financial statements. Actual results could differ
from those estimates.
CONCENTRATION OF CREDIT RISK
Financial instruments which potentially expose the Company to concentrations
of credit risk consist primarily of trade accounts receivable. The Company's
customer base is not concentrated in any specific geographic region, but is
concentrated in the retail industry. For the nine months ended September 30,
1997 and 1998, sales to one customer were 14.6% and 25.1%, respectively. The
significant customer was the same during both periods. The Company establishes
an allowance for doubtful accounts based upon factors surrounding the credit
risk of specific customers, historical trends and other information.
The Company is also subject to concentrations of credit risk with respect to
its cash and cash equivalents, which it minimizes by placing these funds with
high-quality institutions.
The Company is exposed to credit losses in the event of nonperformance by
the counterparties to the letter of credit agreements, but it does not expect
any financial institutions to fail to meet their obligation given their high
credit rating.
GOODWILL
The Company has recorded goodwill based on the excess of purchase price over
net assets acquired. The Company analyzes the operating income of the women's
Company-owned and private label lines in relation to the goodwill amortization
on a quarterly basis for evidence of impairment. During the third quarter,
management determined that the reduction in sales had significantly impacted the
operating income of the women's Company-owned and private label lines and that
an impairment of the goodwill has occurred. In response, management has recorded
a one-time write down of $435,000 and has reduced the life of the goodwill 40
years to 20 years. Effective October 1, 1998, the remaining goodwill will be
amortized over 63 months. Management will continue to analyze the profitability
of the women's private label lines on a quarterly basis for any additional
impairment.
INCOME TAXES
The Company accounts for income taxes in accordance with Statement of
Financial Accounting Standards No. 109, Accounting for Income Taxes ("SFAS
109"). Under SFAS 109, deferred taxes are determined using the liability method
which requires the recognition of deferred tax assets and liabilities based on
differences between financial statement and income tax basis using presently
enacted tax rates.
EARNINGS PER SHARE
Pro forma earnings per share for the period ended September 30, 1997 are
based on pro forma net income and the weighted average number of shares of
common stock outstanding (4,000,000) adjusted to include the number of shares
(930,000) sold by the Company which would be necessary to fund the distribution
of $9.3 million of previously earned but undistributed Subchapter S corporation
earnings.
5
I.C. ISAACS & COMPANY, INC.
SUMMARY OF ACCOUNTING POLICIES (CONTINUED)
In March 1997, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 128, Earnings Per Share ("SFAS 128"). SFAS
128 provides a different method of calculating earnings per share than is
currently used in APB Opinion 15. SFAS 128 provides for the calculation of basic
and diluted earnings per share. Basic earnings per share includes no dilution
and is computed by dividing income available to common stockholders by the
weighted average number of common shares outstanding for the period. Diluted
earnings per share reflects the potential dilution of securities that could
share in the earnings of an entity, similar to existing fully diluted earnings
per share. As required by the policies of the Securities and Exchange
Commission, the Company treated the shares sold to fund the S Corporation
Distribution as outstanding prior to the initial public offering completed in
December 1997. There is no difference in basic and diluted earnings per share.
RECENT ACCOUNTING PRONOUNCEMENTS
In October 1995, the Financial Accounting Standards Board issued Statement
of Financial Accounting Standards No. 123, "Accounting for Stock-Based
Compensation" ("SFAS 123"). SFAS 123 will begin to affect the Company in fiscal
1998 with the granting of stock options to employees and director's under the
1997 Omnibus Stock Plan. The Company will adopt only the disclosure provisions
of SFAS 123 and account for stock-based compensation using the intrinsic value
method set forth in APB Opinion 25. The Company recorded compensation expense in
September 1998 related to stock options granted to non-employee directors.
Statement of Financial Accounting Standards No. 130, "Reporting
Comprehensive Income" ("SFAS 130"), establishes standards for reporting and
display of comprehensive income, its components and accumulated balances.
Comprehensive income is defined to include all changes in equity except those
resulting from investments by owners and distributions to owners. Among other
disclosures, SFAS 130 requires that all items that are required to be recognized
under current accounting standards as components of comprehensive income be
reported in a financial statement that is displayed with the same prominence as
other financial statements. The Company adopted SFAS 130 during the first
quarter of 1998 and has no items of comprehensive income to report.
In February 1998, the Financial Accounting Standards Board issued Statement
of Financial Accounting Standards No. 132, "Employers Disclosures about Pensions
and Other Postretirement Benefits" ("SFAS 132"). SFAS 132 revised employers'
disclosures about pension and other postretirement benefit plans but does not
change measurement or recognition of those plans. Also, SFAS 132 requires
additional information on changes in the benefit obligations and fair values of
plan assets. Presently, the Company does not offer postretirement benefits.
Adoption of SFAS 132 will not have an effect on reported financial and operating
results. The Company will provide the required additional information in the
financial statements for the year ending December 31, 1998.
In June 1998, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 133, "Accounting for Derivative Instruments"
("SFAS 133"). SFAS 133 establishes accounting and reporting standards for
derivative instruments and for hedging activities. SFAS 133 requires that an
entity recognize all derivatives as either assets or liabilities and measure
those instruments at fair market value. Under certain circumstances, a portion
of the derivative's gain or loss is initially reported as a component of other
comprehensive income and subsequently reclassified into income when the
transaction affects earnings. For a derivative not designated as a hedging
instrument, the gain or loss is recognized in income in the period of change.
The Company will be required to adopt SFAS 133 by January 1, 2000. Presently,
the Company does not use derivative instruments either in hedging activities or
as investments. Accordingly, the Company believes that adoption of SFAS 133 will
have no material impact on its financial position or results of operations.
6
I.C. ISAACS & COMPANY, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. INVENTORIES
Inventories consist of the following:
DECEMBER 31, SEPTEMBER 30,
1997 1998
------------- -------------
Raw Materials.................................................. $ 4,742,653 $ 4,560,545
Work-in-process................................................ 1,864,569 2,228,358
Finished Goods................................................. 17,329,004 19,867,679
------------- -------------
$ 23,936,226 $ 26,656,582
------------- -------------
------------- -------------
2. LONG-TERM DEBT
In May 1998, the Company amended the revolving line of credit and letter of
credit agreement. The amended agreement provides that the Company may borrow up
to 85.0%, formerly 80.0%, of the net eligible accounts receivable and a portion
of imported inventory, as defined in the financing agreement. Borrowings under
the revolving line of credit may not exceed $30.0 million including outstanding
letters of credit which are limited to $12.0 million, formerly $8.0 million, and
bear interest at the lender's prime rate of interest less 0.25%. The amended
agreement expires on June 30, 1999.
3. ACCRUED EXPENSES
Accrued expenses consist of the following:
DECEMBER 31, SEPTEMBER 30,
1997 1998
------------ -------------
Royalties....................................................... $ 901,925 $ 1,423,880
Accrued professional fees....................................... 150,000 50,000
Payable to salesmen............................................. 127,634 110,820
Payroll tax withholdings........................................ 139,214 176,910
Customer credit balances........................................ 240,530 150,336
Property taxes.................................................. 136,700 128,938
Accrued interest................................................ 174,401 192,124
Other........................................................... 108,960 218,034
------------ -------------
$1,979,364 $ 2,451,042
------------ -------------
------------ -------------
4. INCOME TAXES
The Company recorded an income tax benefit in the quarter ended June 30,
1998 to reflect partial reversal of the income tax provision recorded in the
quarter ended March 31, 1998 and to recognize a tax benefit for the carryback of
net operating losses to recover income taxes paid during 1997. The Company does
not expect to record any additional provision or benefit for income taxes during
the fourth quarter of 1998.
5. STOCKHOLDERS' EQUITY
In June 1998, the Company's Board of Directors authorized a stock repurchase
program. Under this program the Company may repurchase up to $4.0 million of its
common stock. As of September 30, 1998, the Company had purchased 1,037,800
shares at a cost of $2,445,162.
6. STOCK OPTIONS
In May 1997, ICI adopted the 1997 Omnibus Stock Plan. Under the 1997 Omnibus
Stock Plan, ICI may grant qualified and nonqualified stock options, stock
appreciation rights, restricted stock or performance awards, payable in cash or
shares of common stock, to selected employees. The 1997 Omnibus Stock Plan will
be administered by the Board of Directors. The Company has reserved 500,000
shares of common
7
I.C. ISAACS & COMPANY, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
6. STOCK OPTIONS (CONTINUED)
stock for issuance under the 1997 Omnibus Stock Plan. In August 1998 the Company
granted options to purchase 351,000 shares of the Company's common stock at an
exercise price of $2.125 per share. The shares will become fully vested on the
second anniversary of the grant date.
7. COMMITMENTS AND CONTINGENCIES
In November 1997 and as further amended in March 1998, the Company entered
into an exclusive license agreement with Girbaud Design, Inc. and its affiliate
to manufacture and market men's jeanswear, casual wear, outerwear and active
influenced sportswear under the Girbaud-Registered Trademark- brand and certain
related trademarks in the United States, Puerto Rico and the U.S. Virgin
Islands. The agreement has an initial term of two years and may be extended at
the option of the Company for up to a total of ten years. Under the agreement
the Company is required to make payments to the licensor in an amount equal to
6.25% of net sales of regular licensed merchandise and 3.0% of certain irregular
and closeout licensed merchandise. Payments are subject to guaranteed minimum
annual royalties as follows:
1998............................................................ $1,200,000
1999............................................................ $1,500,000
Beginning with the first quarter of 1998, the Company became obligated to
pay the greater of actual royalties earned or the minimum guaranteed royalties
for that year. The Company is required to spend at least $350,000 in advertising
for the men's Girbaud-Registered Trademark- brand in 1998 and $500,000 each year
thereafter while the agreement is in effect.
In March 1998, the Company entered into an exclusive license agreement with
Girbaud Design, Inc. and its affiliate to manufacture and market women's
jeanswear, casual wear and active influenced sportswear under the
Girbaud-Registered Trademark- brand and certain related trademarks in the United
States, Puerto Rico and the U.S. Virgin Islands. The agreement has an initial
term of two years and may be extended at the option of the Company for up to a
total of ten years. The Company paid an initial license fee of $600,000. Under
the agreement, the Company is required to make payments to the licensor in an
amount equal to 6.25% of net sales of regular licensed merchandise and 3.0% of
certain irregular and closeout licensed merchandise. Payments are subject to
guaranteed minimum annual royalties as follows:
1999.............................................................. $ 700,000
2000.............................................................. $ 800,000
Beginning with the first quarter of 1999, the Company is obligated to pay
the greater of actual royalties earned or the minimum guaranteed royalties for
that year. The Company is required to spend at least $550,000 in advertising for
the women's Girbaud-Registered Trademark- brand in 1998 and $400,000 each year
thereafter while the agreement is in effect. In addition, while the agreement is
in effect the Company is required to pay $190,000 per year to the licensor for
advertising and promotional expenditures related to the
Girbaud-Registered Trademark- brand.
In May 1998, the Company entered into a license agreement with BHPC
Marketing, Inc., to manufacture and market boy's knitted and woven shirts,
cotton pants, jeanswear, shorts, swimwear and outerwear under the Beverly Hills
Polo Club-Registered Trademark- brand in the United States and Puerto Rico. The
initial term of the agreement is three years, commencing January 1, 1999, with
renewal options for a total of six years. Under the agreement the Company is
required to make payments to the licensor in an amount equal to 5.0% of net
sales. Payments are subject to guaranteed minimum annual royalties as follows:
1999.............................................................. $ 50,000
2000.............................................................. $ 75,000
2001.............................................................. $ 100,000
8
7. COMMITMENTS AND CONTINGENCIES (CONTINUED)
In November 1998, the Company announced that it intends to close its
Carthage, Mississippi manufacturing facility which will result in a charge of
approximately $300,000 against earnings in the fourth quarter of 1998. A portion
of the production in this facility, the majority of which is ladies pants under
the Company's private label, will be transferred to the remaining Company-owned
plant in Raleigh, Missippi, as well as to independent contractor facilities in
Mexico.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS.
IMPORTANT INFORMATION REGARDING FORWARD-LOOKING STATEMENTS
This Quarterly Report on Form 10-Q contains forward-looking statements
within the meaning of Section 27A of the Securities Act of 1933, as amended, and
Section 21E of the Securities Exchange Act of 1934, as amended. Those statements
include indications regarding the intent, belief or current expectations of the
Company and its management, including indications regarding the strength of
upcoming collections, statements regarding anticipated cost savings and
disclosures regarding the Company's year 2000 readiness, expenditures and plans.
Such statements are subject to a variety of risks and uncertainties, many of
which are beyond the Company's control, which could cause actual results to
differ materially from those contemplated in such forward-looking statements,
including in particular the risks and uncertainties described under "Risk
Factors" in the Company's Prospectus which include, among other things, (i)
changes in the marketplace for the Company's products, including customer
tastes, (ii) the introduction of new products or pricing changes by the
Company's competitors, (iii) changes in the economy, and (iv) termination of one
or more of its agreements for use of the BOSS-Registered Trademark-, Beverly
Hills Polo Club-Registered Trademark- and Girbaud-Registered Trademark- brand
names and images in the manufacture and sale of the Company's products. Existing
and prospective investors are cautioned not to place undue reliance on these
forward-looking statements, which speak only as of the date hereof. The Company
undertakes no obligation to update or revise the information contained in this
Quarterly Report on Form 10-Q, whether as a result of new information, future
events or circumstances or otherwise.
RESTRUCTURING PLAN
The Company has experienced increased competition in 1998 from a number of
competitors, including the Tommy Jeans division of Tommy Hilfiger and the Polo
Jeans division of Polo Ralph Lauren, at both the department store and specialty
store channels of distribution. The Company believes that both Tommy Jeans and
Polo Jeans have undertaken strategies that include massive consumer advertising,
and the addition of sales efforts directed at specialty stores as a way to
expand distribution. Other brands such as DKNY and Nautica have recently
improved the jeanswear segments of their product lines. In addition, a number of
new companies have emerged with competing products targeted at the urban young
men's market. The Company has taken a series of steps to address this
increasingly competitive environment for young men's jeanswear. First, the
Company has positioned and merchandized its Girbaud-Registered Trademark- line
of sportswear to offer jeanswear and sportswear products that are distinctive
from a styling perspective. Second, the Company has restructured and expanded
its BOSS young men's merchandising staff in an effort to develop product lines
that are consistent with market trends and to present such lines to the market
in a timely manner. In addition, the Company is implementing a restructuring
plan designed to focus resources on the product lines with the greatest profit
potential, in conjunction with significant expense reductions. In addition to
the $1.1 million charge taken during the third quarter, the Company expects to
take an additional charge of approximately $0.3 million in the fourth quarter
relating to the closing of the Company's Carthage, Mississippi plant. The
Company anticipates annual costs savings in the range of approximately $3
million to $4 million as a result of the restructuring. Key elements of the plan
are as follows:
- The Company will drastically reduce or eliminate product lines that
are not currently profitable or do not have near-term profit
potential. As a result of these initiatives, the Company's focus will
be streamlined towards BOSS young men's, juniors and boy's, Beverly
Hills Polo Club men's and boy's and Girbaud men's and women's
sportswear lines.
9
- With the exception of continuing its basic jeans and pants models
for sale to major chain stores and catalogs, the Company will
discontinue production of women's sportswear manufactured under its
own brand names and under third party private labels. This
initiative is consistent with the Company's overall shift towards
brand-driven products. Net sales of women's Company-owned brands
and third party private label lines totaled $2.2 million for the
three months ended September 30, 1998.
- The Company will discontinue its line of women's sportswear
manufactured under the Beverly Hills Polo Club label in the U.S.
and Europe and focus its energy on designing and marketing its
Beverly Hills Polo Club men's and boy's collections. Net sales of
Beverly Hills Polo Club women's sportswear totaled $0.5 million for
the three months ended September 30, 1998.
- In addition to eliminating its Beverly Hills Polo Club women's
line, the Company will significantly reduce and modify its European
men's line under the Beverly Hills Polo Club label. In January and
February 1999, the Company will present a collection designed to be
reflective of current trends in the European marketplace.
- Going forward, the BOSS juniors line will be substantially reduced
and will be more focused on core price point products with greater
volume potential, such as jeans and tee-shirts. Net sales of BOSS
juniors sportswear totaled $1.5 million for the three months ended
September 30, 1998.
- The Company has substantially cut the number of styles and SKUs
offered in its continuing branded sportswear lines to reduce product
development costs, selling expenses and inventory exposure.
- The Company's Carthage, Mississippi manufacturing plant--which is
largely responsible for the production of women's pants and
jeans--will be closed by the end of January. A portion of the
production in this facility will be transferred to the remaining
Company-owned plant in Raleigh, Mississippi, as well as to independent
contractors in Mexico. The Company estimates annual cost savings of
between $0.4 million to $0.7 million as a result of this closure.
- The Company's advertising budget will be reduced to reflect the
decrease in lines and more dollars will be allocated towards special
events and point-of-sale advertising and promotions. The Company
believes that this type of exposure provides the greatest benefit for
its expenditures. There will be no reduction in the advertising budget
to support growth of the Girbaud brand which includes a full print
campaign including bill boards and buses.
10
RESULTS OF OPERATIONS
The following tables set forth, for the periods indicated, the Company's net
sales categorized by brand and product category and the percentage relationship
to net sales of certain items in the Company's consolidated financial statements
for the periods indicated:
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
-------------------- ---------------------
1997 1998 1997 1998
--------- --------- ---------- ---------
(IN THOUSANDS)
MEN'S (1)
BOSS Bottoms................................... $ 13,209 $ 9,762 $ 42,284 $ $27,544
BOSS Tops...................................... 18,050 8,720 37,497 28,406
BOSS Boys...................................... 4,062 4,870 10,833 11,708
Men's BHPC..................................... 7,762 3,698 19,584 11,873
Girbaud Men's.................................. -- 1,613 -- 2,415
Men's Other.................................... 33 40 83 90
--------- --------- ---------- ---------
Men's net sales.............................. 43,116 28,703 110,281 82,036
--------- --------- ---------- ---------
WOMEN'S (1)
BOSS Juniors................................... 1,250 1,465 3,204 3,419
Women's BHPC................................... 309 518 1,128 922
Women's Other (2).............................. 4,862 2,204 12,634 7,618
--------- --------- ---------- ---------
Women's net sales............................ 6,421 4,187 16,966 11,959
--------- --------- ---------- ---------
Total net sales............................ $ 49,537 $ 32,890 $ 127,247 $ 93,995
--------- --------- ---------- ---------
--------- --------- ---------- ---------
- - ------------------------
(1) The net sales totals incorporate product returns allocated in proportion to
gross sales.
(2) Includes Company-owned brands and third-party private labels.
NINE MONTHS
ENDED
SEPTEMBER 30
--------------------
1997 1998
--------- ---------
Net sales.................................................................... 100.0% 100.0%
Cost of sales................................................................ 67.3 75.9
--------- ---------
Gross profit................................................................. 32.7 24.1
Selling expenses............................................................. 9.6 14.2
License fees................................................................. 4.7 5.3
Distribution and shipping expenses........................................... 2.5 3.2
General and administrative expenses.......................................... 4.1 8.3
--------- ---------
Operating income............................................................. 11.8% (6.9)%
--------- ---------
--------- ---------
11
THREE MONTHS ENDED SEPTEMBER 30, 1998 COMPARED TO THREE MONTHS ENDED SEPTEMBER
30, 1997
NET SALES.
Net sales decreased 33.5% to $32.9 million in the three months ended
September 30, 1998 from $49.5 million in the three months ended September 30,
1997. The decrease was primarily due to increased competition coupled with a
softer retail market and compounded by the delay in the introduction of the Fall
men's lines. Net sales of BOSS-Registered Trademark- sportswear decreased $11.8
million or 32.2% to $24.8 million due to increased competition and the delay in
merchandise introduction. Net sales of the BOSS tops segment were $8.7 million
in the three months ended September 30, 1998 versus $18.0 million for the three
months ended September 30, 1997. Net sales of Beverly Hills Polo
Club-Registered Trademark- sportswear decreased $3.9 million or 48.1% to $4.2
million due to increased competition coupled with a softer retail market and
compounded by the delay in the introduction of the Fall men's lines. The delay
in introducing the Fall 1998 product lines also adversely impacted sales of
Beverly Hills Polo Club sportswear.
The reason for the delay in the introduction of the Fall 1998 men's line was
that the creative quality of the styles which had been developed to present to
the market were not, in the Company's judgment, consistent with current fashion
trends in the market segment. Consequently, the Company delayed further
presentation of the Fall 1998 men's line for several weeks while the line was
reworked to add designs intended to better match market expectations. This delay
contributed to reduced net sales of the Company's young men's sportwear. The
Company does not expect the adverse impact of the delay in introduction of the
Fall 1998 men's line to extend beyond December 1998. In addition, all of the
Company's product lines for the Spring 1999 season have been presented to the
market on schedule.
Net sales for the new Girbaud sportswear were $1.6 million for the three
months ended September 30, 1998. The Company began to recognize revenue from
shipments of Girbaud men's sportswear in the second quarter of 1998. The Company
will begin to ship Girbaud sportswear for women in the fourth quarter of 1998.
Sales of Company-owned brands and third party private label sportswear decreased
55.1% to $2.2 million for the three months ended September 30, 1998. The
decrease in net sales of Company-owned brands and third party private label
sportswear was the result of the Company's decision to move to a more brand
oriented, market-driven Company. In May 1998, the Company entered into an
exclusive license agreement to manufacture and market boy's sportswear under the
Beverly Hills Polo Club brand in the United States and Puerto Rico. The Company
intends to begin shipping boy's sportswear under the Beverly Hills Polo Club
brand in the first half of 1999.
GROSS PROFIT.
Gross profit decreased 62.9% to $5.9 million in the three months ended
September 30, 1998 from $15.9 million in the three months ended September 30,
1997. Gross profit as a percentage of net sales decreased from 32.1% to 17.9%
over the same period. The decrease in gross profit was primarily due to the
reduction in net sales coupled with excess capacity at its manufacturing
facilities due to the reduction in customer orders. In addition, the Company
recorded an inventory valuation allowance of $2.3 million. The Company monitors
inventory levels, by product category, weekly to help identify inventory
shortages as well as excess inventory. Personnel look at recent sales data and
order backlog to help identify slow moving inventory items. Further, the sales
managers continually discuss product turnover and sales forecasts with sales
personnel to aid in identifying product shortages and overages. Based on the
information available, the Company believes the inventory valuation provision is
appropriate at September 30, 1998.
SELLING, DISTRIBUTION, GENERAL AND ADMINISTRATIVE EXPENSES.
Selling, distribution, general and administrative expenses ("SG&A")
increased 12.2% to $8.4 million in the three months ended September 30, 1998
from $7.4 million in the three months ended September 30, 1997. As a percentage
of net sales, SG&A expenses increased to 25.3% from 14.9% over the same period
due to higher advertising expenditures and costs of merchandise samples offset
somewhat by lower commissions to the Company's salespersons. Advertising
expenditures increased $0.9 million to $1.5 million as the Company continued to
focus on enhancing the identity and image of its brands through increased media
exposure. Also, the Company is required to spend $0.9 million in advertising for
the women's and men's Girbaud brands in 1998. Distribution and shipping expenses
decreased $0.2 million
12
because of a reduction in personnel at its warehouse facility. General and
administrative expenses increased $0.7 million to $2.7 million due to a one time
write-off of Goodwill of $0.4 million as well as amortization of the BOSS
trademark, professional fees and year 2000 consulting expenses of $0.3 million,
$0.3 million and $0.2 million, respectively.
LICENSE FEES.
License fees decreased $0.6 million to $1.7 million in the three months
ended September 30, 1998 from $2.3 million in the three months ended September
30, 1997. As a percentage of net sales, license fees increased from 4.6% to
5.2%. The decrease in license fees was not in proportion to the decrease in net
sales due to the minimum royalties under the Girbaud men's license agreement.
OPERATING INCOME (LOSS).
Operating income (loss) decreased 168.0% to ($4.2) in the three months ended
September 30, 1998 from $6.2 million in the three months ended September 30,
1997. The decline was due to lower sales and gross profit and to a lesser extent
an increase in operating expenses.
INTEREST EXPENSE.
Interest expense decreased $0.3 million to $0.5 million in the three months
ended June 30, 1998. The Company repaid its asset-based line of credit with a
portion of the proceeds of its initial public offering completed in December
1997, but began to borrow significant amounts in the three months ended June 30,
1998. However, the Company incurred interest expense of $0.3 million related to
the $11.25 million note payable associated with its purchase of the BOSS
trademark in November 1997.
INCOME TAXES.
The Company did not record an income tax provision or benefit for the three
months ended September 30, 1998 due to the net loss for the period. The Company
provided a valuation allowance related to the deferred tax asset represented by
the net operating losses due to the uncertainty surrounding the amount of
taxable income to be generated in 1999.
NINE MONTHS ENDED SEPTEMBER 30, 1998 COMPARED TO NINE MONTHS ENDED SEPTEMBER 30,
1997
NET SALES.
Net sales decreased 26.1% to $94.0 million in the nine months ended
September 30, 1998 from $127.2 million in the nine months ended September 30,
1997. The decrease was primarily due to increased competition coupled with a
softer retail market and compounded by the delay in the introduction of the Fall
men's lines. Net sales of BOSS sportswear decreased $22.7 million or 24.2% to
$71.1 million due to continued softness in the men's jean segment plus the
impact of increased competition and the delay in merchandise introduction. Net
sales of the BOSS tops segment were $28.4 million in the nine months ended
September 30, 1998 versus $37.5 million for the nine months ended September 30,
1997. Net sales of Beverly Hills Polo Club sportswear decreased $7.9 million or
38.2% to $12.8 million. The delay in introducing the Fall 1998 product lines
also adversely impacted sales of Beverly Hills Polo Club sportswear. However,
the spring 1999 collections of BOSS and Beverly Hills Polo Club were presented
on time. While subsequent market response to both the BOSS and Beverly Hills
Polo Club lines has been encouraging, the Company believes the delay in
introduction of the Fall 1998 collections will continue to adversely impact
sales and overall productivity in the fourth quarter of 1998. Net sales for the
new Girbaud sportswear were $2.4 million for the nine months ended September 30,
1998. The Company began to recognize revenue from shipments of Girbaud men's
sportswear in the second quarter of 1998. The Company will begin to ship Girbaud
sportswear for women in the fourth quarter of 1998. The Company's private label
sales decreased 39.4% to $7.7 million for the nine months ended June 30, 1998.
In May 1998, the Company entered into an exclusive license agreement to
manufacture and market boy's sportswear under the Beverly Hills Polo Club brand
in the United States and Puerto Rico. The Company intends to begin shipping
boy's sportswear under the Beverly Hills Polo Club brand in the first half of
1999.
13
GROSS PROFIT.
Gross profit decreased 45.4% to $22.7 million in the nine months ended
September 30, 1998. Gross profit as a percentage of net sales decreased from
32.7% to 24.1% over the same period. The decrease in gross profit was primarily
due to the reduction in net sales coupled with excess capacity at its
manufacturing facilities due to the reduction in customer orders. In addition,
to reduce inventory levels, a significant amount of sales were made to a mass
retailer at gross profit margins significantly below the margins on goods that
are sold to specialty stores. This adversely affected the overall gross margin.
In addition, the Company recorded an inventory valuation allowance of $2.3
million. The Company monitors inventory levels, by product category, weekly to
help identify inventory shortages as well as excess inventory. Personnel look at
recent sales data and order backlog to help identify slow moving inventory
items. Further, the sales managers continually discuss product turnover and
sales forecasts with sales personnel to aid in identifying product shortages and
overages. Based on the information available, the Company believes the inventory
valuation provision is appropriate at September 30, 1998. The decline in gross
profit was offset somewhat by the continued shift of production of denim bottoms
from the United States to Mexico to take advantage of the lower labor and
overhead.
SELLING, DISTRIBUTION, GENERAL AND ADMINISTRATIVE EXPENSES.
SG&A increased 18.0% to $24.3 million in the nine months ended September 30,
1998 from $20.6 million in the nine months ended September 30, 1997. As a
percentage of net sales, SG&A expenses increased to 25.9% from 16.2% over the
same period due to higher advertising expenditures and costs of merchandise
samples offset somewhat by lower commissions to the Company's salespersons.
Advertising expenditures increased $1.7 million to $4.1 million as the Company
continued to focus on enhancing the identity and image of its brands through
increased media exposure. Also, the Company is required to spend $0.9 million in
advertising for the women's and men's Girbaud brands in 1998. Distribution and
shipping expenses decreased $0.2 million because of a reduction in overtime
wages, due to decreased additional temporary labor at its warehouse facility.
General and Administrative expenses increased $2.5 million to $7.8 million due
to amortization of the BOSS trademark, professional fees and year 2000
consulting expenses of $0.9 million, $0.4 million and $0.2 million,
respectively, and a $0.2 million loss provision for estimated costs associated
with closing the Newton, Mississippi manufacturing facility. The loss provision
relates primarily to severance pay for employees.
LICENSE FEES.
License fees decreased $0.9 million to $5.0 million in the nine months ended
September 30, 1998 from $5.9 million in the nine months ended September 30,
1997. As a percentage of net sales, license fees increased from 4.6% to 5.3%.
The decrease in license fees was not in proportion to the decrease in net sales
due to the minimum royalties under the Girbaud men's license agreement.
OPERATING INCOME (LOSS).
Operating income (loss) decreased 143.0% to ($6.5) million in the nine
months ended September 30, 1998 from $15.0 million in the nine months ended
September 30, 1997. The decline was due to lower sales and gross profit and to a
lesser extent an increase in operating expenses.
INTEREST EXPENSE.
Interest expense decreased $0.6 million to $1.0 million in the nine months
ended September 30, 1998. The Company repaid its asset-based line of credit with
a portion of the proceeds of its initial public offering completed in December
1997. Borrowings under the line of credit has been insignificant in the first
six months of 1998, however the Company began to borrow under the line of credit
in the third quarter and incurred $0.1 million in interest expense. In addition,
the Company incurred interest expense related to the $11.25 million note payable
associated with its purchase of the BOSS trademark in November 1997. This
expense of $0.8 million was offset somewhat by interest income of $0.2 million
earned on available cash. The Company invests its excess cash in short-term
investments.
14
OTHER INCOME.
The Company recognized $0.3 million of income in the nine months ended
September 30, 1998 related to a refund of excess premiums paid on its employee
health insurance plan. There was no comparable refund in 1997.
INCOME TAXES.
The Company recorded an income tax benefit of $.2 million in the first nine
months of 1998 to recognize a tax benefit for the carryback of net operating
losses to recover income taxes paid during 1997. The Company does not expect to
record any additional provision or benefit for income taxes during the final
quarter of 1998. The Company provided a valuation allowance related to the
deferred tax asset represented by the net operating losses due to the
uncertainty surrounding the amount of taxable income to be generated in 1999.
Prior to its initial public offering, the Company's earnings were not subject to
federal, state and local taxes since it elected to be treated as a Subchapter S
Corporation. The Company terminated its Subchapter S Corporation status in
December 1997.
LIQUIDITY AND CAPITAL RESOURCES
The Company has relied primarily on internally generated funds, trade credit
and asset based borrowings to finance its operations and expansion. The
Company's capital requirements primarily result from working capital needed to
support increases in inventory and accounts receivable. The Company's working
capital improved significantly during the first nine months of 1998 compared to
the first nine months of 1997, primarily due to receipt and utilization of the
net proceeds from its initial public offering in December 1997 and the exercise
of the over-allotment option in January 1998. As of September 30, 1998, the
Company had cash, including temporary investments of $1.5 million and working
capital of $41.9 million compared to $1.5 and $22.4 million, respectively as of
September 30, 1997.
OPERATING CASH FLOW.
Cash used by operations totaled $11.2 million for the first nine months of
1998 due to increases in accounts receivable, inventories and refundable income
taxes and a decrease in accounts payable offset somewhat by an increase in
accrued expenses and other current liabilities. Cash used for investing
activities for the first nine months of 1998 totaled $2.0 million and was used
primarily to purchase the land and initiate architectural work related to
construction of the new distribution center in Milford, Delaware, as well as the
purchase of machinery for the Company's factories and upgrading computer
equipment to help ensure year 2000 compliance. In addition, the Company paid an
initial fee of $0.6 million for the women's Girbaud license. Cash provided by
financing activities totaled $7.3 million for the first nine months of 1998,
resulting primarily from the exercise of the over-allotment option on its
initial public offering in January 1998 and borrowings under its revolving line
of credit offset by the purchase of treasury stock.
Inventory increased $2.7 million from December 31, 1997 to September 30,
1998, compared to $8.4 million from December 31, 1996 to September 30, 1997. The
increase in 1998 is due to the buildup of finished goods because of the decline
in sales of BOSS men's and Beverly Hills Polo Club sportswear as well as $1.8
million in inventory for the new Girbaud collection.
The increase in refundable income taxes results from the expected return of
estimated income taxes paid in the first quarter of 1998 and a refund of income
taxes paid in 1997. The refunds will result from the proposed carryback of net
operating losses to 1997 and the elimination of estimated tax payments due to
net operating losses in 1998.
Capital expenditures were $1.4 million for the first nine months of 1998
compared to $.8 million for the first nine months of 1997. The Company's capital
expenditures were primarily for the purchase of land and architectural fees
related to construction of the new distribution center in Milford, Delaware as
well as
15
the purchase of machinery for the Company's factories and upgrading computer
equipment to help ensure year 2000 compliance. In the second quarter, the
Company decided to delay the construction of the distribution center in Milford,
Delaware and the new construction timetable has not been finalized. The Company
does not intend to dispose of its current distribution center. The Company
expects to spend up to $0.5 million to upgrade its computer software programs to
ensure year 2000 compliance. The Company expects conversion of its primary
software programs to be completed in November 1998 with testing to follow in
early 1999. The Company purchased new versions of the two secondary software
programs which have been updated for year 2000 compliance. The Company has
expensed all consulting fees related to the year 2000 conversion. The Company
does not currently have commitments for any other capital expenditures in 1998.
However, as part of the Company's expanded relationship with Girbaud, in 1999
the Company intends to open a Girbaud flagship store in Manhattan, New York
City. The Company intends to lease the required space for the store. Currently,
the Company is still searching for a suitable site and cannot determine the
amount of capital expenditures that may be required to appropriately fixture the
store or, if it ultimately decided to do so, to construct the store. In addition
in March 1998 the Company paid an initial license fee of $0.6 million for the
women's Girbaud license.
In the second quarter of 1998, the Company closed its Newton, Mississippi
manufacturing facility. This closure resulted in a charge of $0.2 million
against earnings for the period ended September 30, 1998. The production in this
facility, the majority of which is jeans, was transferred to third party
independent contractors facilities in Mexico where the Company currently has
jeans manufactured. The Company anticipates annual cost savings in the range of
$0.3 million to $0.6 million after the transfer of production to Mexico as
result of lower labor and overhead costs. The actual expenses incurred were not
significantly different than the reserve provided by the Company in the first
quarter.
In November 1998, the Company announced that it intends to close its
Carthage, Mississippi manufacturing facility. This closure, which will occur in
the first quarter of 1999, will result in a charge of $0.3 million against
earnings in the fourth quarter of 1998. The production in this facility, the
majority of which is ladies pants and jeans under the Company's private label,
will be transferred to the remaining Company-owned plant in Raleigh,
Mississippi, as well as to independent contractors in Mexico. The Company
anticipates annual cost savings of between $0.4 million and $0.7 million after
the transfer of production as a result of lower labor and overhead costs.
As of September 30, 1998 the Company had $3.3 million in outstanding
borrowings under its revolving line of credit and term loan facility compared to
$23.0 million as of September 30, 1997.
CREDIT FACILITIES.
In May 1998, the Company amended the revolving line of credit and letter of
credit agreement with Congress Financial Corporation. The amended agreement
provides that the Company may borrow up to 85.0%, formerly 80.0%, of the net
eligible accounts receivable and a portion of imported inventory, as defined in
the financing agreement. Borrowings under the revolving line of credit may not
exceed $30.0 million (unchanged from the previous agreement) including
outstanding letters of credit which are limited to $12.0 million, formerly $8.0
million, and bear interest at the lender's prime rate of interest less 0.25%.
The amended agreement expires on June 30, 1999.
In November 1997, the Company borrowed $11.25 million from Ambra, Inc. to
finance the acquisition of certain BOSS trademark rights. This obligation is
evidenced by a secured limited recourse promissory note which matures on
December 31, 2007 (the "Note"). The Note bears interest at 10.0% per annum,
payable quarterly; principal is payable in full upon maturity of the note.
The Company extends credit to its customers. The Company has credit policies
and procedures which it uses to minimize exposure to credit losses. The
Company's collection personnel regularly contact customers with receivable
balances outstanding beyond 30 days to expedite collection. If these collection
efforts are unsuccessful, the Company may discontinue merchandise shipments
until the outstanding
16
balance is paid. Ultimately, the Company may engage an outside collection
organization to collect past due accounts. Timely contact with customers
collection personnel has been effective in reducing credit losses to an
immaterial amount. For the nine months ended September 30, 1997, and 1998, the
Company's credit losses were $0.8 million and $1.1 million, respectively. The
Company's actual credit losses as a percentage of net sales was 0.5% and 1.2%
respectively.
The Company believes that current levels of cash and cash equivalents ($1.5
million at September 30, 1998) together with cash from operations and existing
credit facilities, will be sufficient to meet its capital requirements for the
next 12 months.
YEAR 2000 COMPLIANCE AND EXPENDITURES
The Company has determined that it will be required to modify or replace
portions of its information technology systems, both hardware and software, so
that they will properly recognize and utilize dates beyond December 31, 1999
(the "Year 2000 issue"). As a result, the Company has developed a plan to review
and, as appropriate, modify or replace the software (and replace some hardware)
in its computer systems. The Company presently believes that with modifications
to existing software, conversions to new software and replacement of some
hardware, the Year 2000 issue will be satisfactorily resolved in its own
systems. The Company has established an internal auditing process to tract and
verify the results of its plan and tests. Management believes the Company is
currently on schedule to substantially complete the renovation, validation and
implementation phases of its plan with respect to its mission-critical systems
by January 1999. The Company is also working with key external parties with whom
it has important financial and operational relationships, including banks,
utilities and other vendors and third party payors, to assess the remediation
efforts made by these parties with respect to their own systems and to determine
the extent to which such systems are vulnerable to the Year 2000 issue. The
Company has not yet received sufficient information from these parties about
their remediation plans to predict the outcome of their efforts. The Company is
also developing a contingency plan that is expected to address financial and
operational problems that might arise on and around January 1, 2000. This
contingency plan would include identifying back-up processes that do not rely on
computers whenever possible. The Company has incurred and expects to continue to
incur expenses allocable to internal staff, as well as costs for outside
consultants, and computer systems' remediation and replacement in order to
achieve Year 2000 compliance. The Company expects conversion of its primary
software programs to be completed in November 1998 with testing to follow in
early 1999. The Company currently estimates that these costs will total
approximately $0.5 million, the majority of which will have been incurred by the
end of 1998. The costs of the Year 2000 program and the date on which the
Company plans to complete Year 2000 modifications are based on current
estimates, which reflect numerous assumptions about future events, including the
continued availability of certain resources, the timing and effectiveness of
third-party remediation plans and other factors. The Company can give no
assurance that these estimates will be achieved, and actual results could differ
materially from the Company's plans. Specific factors that might cause such
material differences include, but are not limited to, the availability and cost
of personnel trained in this area, the ability to locate and correct relevant
computer source codes and embedded technology, the results of internal and
external testing and the timelessness and the effectiveness of remediation
efforts of third parties.
If the modifications and conversions referred to above are not made or are
not completed on a timely basis, the Year 2000 issue could have a material
adverse effect on the Company's business, financial condition and results of
operations. Moreover, even if these changes are successful, failure of third
parties to which the Company is financially or operationally linked to address
their own system problems could have a material adverse effect on the Company.
SEASONALITY
The Company's business is impacted by the general seasonal trends that are
characteristic of the apparel and retail industries. In the Company's segment of
the apparel industry, sales are generally higher
17
in the first and third quarters. Historically, the Company has taken greater
markdowns in the second and fourth quarters. The Company generally receives
orders for its products three to five months prior to the time the products are
delivered to stores. As of September 30, 1998, the Company had unfilled orders
of approximately $29 million, compared to approximately $45 million of such
orders as of September 30, 1997. The backlog of orders at any given time is
affected by a number of factors, including seasonality, weather conditions,
scheduling of manufacturing and shipment of products. As the timing of the
shipment of products may vary from year to year, the results for any particular
quarter may not be indicative of the results for the full year.
IMPACT OF RECENT ACCOUNTING PRONOUNCEMENTS
In October 1995, the Financial Accounting Standards Board issued Statement
of Financial Accounting Standards No. 123, "Accounting for Stock-Based
Compensation" ("SFAS 123"). SFAS 123 will begin to affect the Company in fiscal
1998 with the granting of stock options to employees and directors under the
1997 Omnibus Stock Plan. The Company will adopt only the disclosure provisions
of SFAS 123 and account for stock-based compensation using the intrinsic value
method set forth in APB Opinion 25. The Company recorded compensation expense in
September 1998 related to stock options granted to non-employee directors.
Statement of Financial Accounting Standards No. 130, "Reporting
Comprehensive Income" ("SFAS 130"), establishes standards for reporting and
display of comprehensive income, its components and accumulated balances.
Comprehensive income is defined to include all changes in equity except those
resulting from investments by owners and distributions to owners. Among other
disclosures, SFAS 130 requires that all items that are required to be recognized
under current accounting standards as components of comprehensive income be
reported in a financial statement that is displayed with the same prominence as
other financial statements. The Company adopted SFAS 130 during the first
quarter of 1998 and has no items of comprehensive income to report.
In February 1998, the Financial Accounting Standards Board issued Statement
of Financial Accounting Standards No. 132, "Employers Disclosures about Pensions
and Other Postretirement Benefits" ("SFAS 132"). SFAS 132 revised employers'
disclosures about pension and other postretirement benefit plans but does not
change measurement or recognition of those plans. Also, SFAS 132 requires
additional information on changes in the benefit obligations and fair values of
plan assets. Presently, ICI does not offer postretirement benefits. Adoption of
SFAS 132 will not have an effect on reported financial and operating results.
The Company will provide the required additional information in the financial
statements for the year ending December 31, 1998.
In June 1998, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 133, "Accounting for Derivative Instruments"
("SFAS 133"). SFAS 133 establishes accounting and reporting standards for
derivative instruments and for hedging activities. SFAS 133 requires that an
entity recognize all derivatives as either assets or liabilities and measure
those instruments at fair market value. Under certain circumstances, a portion
of the derivative's gain or loss is initially reported as component of other
comprehensive income and subsequently reclassified into income when the
transaction affects earnings. For a derivative not designated as hedging
instrument, the gain or loss is recognized in income in the period of change.
The Company will be required to adopt SFAS 133 by January 1, 2000. Presently,
the Company does not use derivative instruments either in hedging activities or
as investments. Accordingly, the Company believes that adoption of FASB 133 will
have no material impact on its financial position or results of operations.
18
PART II--OTHER INFORMATION
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K.
(a) Exhibits.
Exhibit 10.35 Amendment by and between BHPC Marketing, Inc. and I. C. Isaacs
& Company, L.P. dated October 21, 1998 relating to the
Exclusive Domestic License Agreement dated December 14, 1995
Exhibit 10.36 Letter Agreement by and between BHPC Marketing, Inc. and I. C.
Isaacs & Company, L.P. dated October 21, 1998 relating to the
Exclusive Domestic License Agreement for Women's BHPC
sportswear dated June 1, 1993
(b) Reports on Form 8-K.
None
19
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 thereunto duly authorized.
I.C. ISAACS & COMPANY, INC.
By: /s/ ROBERT J. ARNOT
-----------------------------------------
Robert J. Arnot
CHAIRMAN OF THE BOARD AND
CHIEF EXECUTIVE OFFICER
Dated: November 11, 1998
Pursuant to the requirements of the Securities Exchange Act of 1934, this
Report has been signed below by the following persons on behalf of the
Registrant and in the capacities and on the dates indicated.
NAME CAPACITY DATE
- - ------------------------------ --------------------------- -------------------
Chairman of the Board,
/s/ ROBERT J. ARNOT Chief Executive Officer
- - ------------------------------ and Director (Principal November 11, 1998
Robert J. Arnot Executive Officer)
Vice President and Chief
/s/ EUGENE C. WIELEPSKI Financial Officer and
- - ------------------------------ Director (Principal November 11, 1998
Eugene C. Wielepski Financial and Accounting
Officer)
20