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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D) OF
THE SECURITIES EXCHANGE ACT OF 1934
FOR THE FISCAL YEAR ENDED COMMISSION FILE NO. 0-23379
DECEMBER 31, 1998
I.C. ISAACS & COMPANY, INC.
(Exact name of registrant as specified in charter)
DELAWARE 52-1377061
(State or other jurisdiction of (IRS employer
incorporation or organization) identification no.)
3840 BANK STREET, BALTIMORE, MARYLAND 21224-2522
(Address of principal executive office) (Zip code)
Registrant's telephone number, including area code: (410) 342-8200
Securities Registered Pursuant to Section 12(b) of the Act:
NONE
Securities Registered Pursuant to Section 12(g) of the Act:
Title of Class:
COMMON STOCK, $.001 PAR VALUE PER SHARE
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 ___
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of Registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K [X].
As of March 26, 1999, the aggregate market value of the outstanding shares
of the Registrant's Common Stock held by non-affiliates was approximately
$8,477,750 based on the average closing price of the Common Stock as reported by
the Nasdaq National Market on March 26, 1999. Determination of affiliate status
for this purpose is not a determination of affiliate status for any other
purpose.
As of March 26, 1999, 6,782,200 shares of Common Stock were outstanding.
DOCUMENT INCORPORATED BY REFERENCE
Specified portions of the definitive Proxy Statement for the 1999 Annual Meeting
of Stockholders of I.C. Isaacs & Company, Inc. to be held on June 3, 1999 are
incorporated by reference into Part III hereof.
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I.C. ISAACS & COMPANY, INC.
FORM 10-K
TABLE OF CONTENTS
PAGE
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PART I
ITEM 1. BUSINESS................................................................................ 1
ITEM 2. PROPERTIES.............................................................................. 17
ITEM 3. LEGAL PROCEEDINGS....................................................................... 17
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS..................................... 17
PART II
ITEM 5. MARKET FOR THE COMPANY'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS.................. 18
ITEM 6. SELECTED FINANCIAL DATA................................................................. 19
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS... 20
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA............................................. 28
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE.... 28
PART III
*ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE COMPANY......................................... 29
*ITEM 11. EXECUTIVE COMPENSATION.................................................................. 29
*ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.......................... 29
*ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.......................................... 29
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K........................ 29
SIGNATURES........................................................................................... 34
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* Incorporated by reference from the Registrant's definitive Proxy Statement
for the 1999 Annual Meeting of Stockholders to be held June 3, 1999. The
Proxy Statement will be filed not later than 120 days after the end of the
fiscal year covered by this Annual Report on Form 10-K.
"BOSS-Registered Trademark-," "Lord Isaacs-Registered Trademark-," "I. C.
Isaacs-Registered Trademark-," "Pizzazz-Registered Trademark-" and "I.G.
Design-Registered Trademark-" are trademarks of the Company. All other
trademarks or service marks, including "Girbaud-Registered Trademark-" and
"Marithe and Francois Girbaud-Registered Trademark-" (collectively, "Girbaud")
and "Beverly Hills Polo Club-Registered Trademark-" appearing in this Annual
Report on Form 10-K are the property of their respective owners and are not the
property of the Company.
IMPORTANT INFORMATION REGARDING FORWARD-LOOKING STATEMENTS
THIS ANNUAL REPORT ON FORM 10-K 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
STATEMENTS REGARDING THE INTENT, BELIEF OR CURRENT EXPECTATIONS OF THE COMPANY
AND ITS MANAGEMENT, INCLUDING INDICATIONS REGARDING THE STRENGTH OF UPCOMING
COLLECTIONS AND THE COMPANY'S EXPECTATIONS FOR 1999, STATEMENTS REGARDING
ANTICIPATED COST SAVINGS, ANTICIPATED WORKING CAPITAL NEEDS, AND DISCLOSURES
REGARDING THE COMPANY'S YEAR 2000 READINESS, EXPENDITURES AND PLANS. WORDS SUCH
AS "BELIEVES," "ANTICIPATES," "EXPECTS," "INTENDS," "PLANS," AND SIMILAR
EXPRESSIONS ARE INTENDED TO IDENTIFY FORWARD-LOOKING STATEMENTS BUT ARE NOT THE
EXCLUSIVE MEANS OF IDENTIFYING SUCH STATEMENTS. SUCH STATEMENTS ARE
FORWARD-LOOKING STATEMENTS WHICH 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 OR ITS AGREEMENTS FOR USE OF THE BOSS, BEVERLY HILLS
POLO CLUB AND GIRBAUD 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 ANNUAL REPORT ON FORM 10-K, WHETHER AS A RESULT OF
NEW INFORMATION, FUTURE EVENTS OR CIRCUMSTANCES OR OTHERWISE.
PART I
ITEM 1. BUSINESS
INTRODUCTION
I.C. Isaacs & Company, Inc. (together with its predecessors, subsidiaries
and affiliated companies, including I.C. Isaacs & Company L.P., the "Company")
is a designer, manufacturer and marketer of branded sportswear. Founded in 1913,
the Company has assembled a portfolio of brands that addresses distinct fashion
segments resulting in a diverse customer base. The Company offers full lines of
sportswear for young men and boys under the BOSS brand in the United States and
Puerto Rico and sportswear for men and boys under the Beverly Hills Polo Club
brand in the United States, Puerto Rico and Europe. The Company offers broad
collections of men's and women's sportswear under the Girbaud designer brand in
the United States and Puerto Rico. Through a focused strategy of providing
fashionable, branded merchandise at value prices, the Company has emerged as a
significant fashion source for youthful and contemporary consumers who purchase
jeanswear and sportswear through specialty and department stores. The Company
also offers women's pants and jeans under various other Company-owned brand
names as well as under third-party private labels for sale to major chain stores
and catalogs.
The Company manufactures and markets certain sportswear under the BOSS brand
for sale at specified price points in the United States and Puerto Rico, subject
to a concurrent use agreement. The Company has positioned the BOSS line to
appeal to consumers who desire a fresh, urban, fashion-forward look. The BOSS
collection has been expanded from an initial line of denim products to a full
array of sportswear consisting of jeans, tee shirts, sweatshirts, shorts, knit
and woven shirts and outerwear, many of which are characterized by innovative
design, creative graphics and bold uses of color. The Company also markets a
juniors' sportswear line under the BOSS brand for young women, which includes
denim products, tee shirts and active sportswear. Net sales of BOSS sportswear
accounted for 73.4% and 74.6% of the Company's net sales in 1998 and 1997,
respectively.
The Company manufactures and markets certain sportswear under the Beverly
Hills Polo Club brand in the United States, Puerto Rico and Europe under an
exclusive license. The Company targets men and boys who desire updated
traditional sportswear at competitive prices. To reach a broader demographic
customer base, the Beverly Hills Polo Club collection combines contemporary
design details and innovative fabrics with classic American sportswear styling.
The Beverly Hills Polo Club collection consists primarily of cotton clothing,
including jeans, pants, shorts, knit and woven shirts and outerwear, targeting
the active, image-conscious consumer. The Company's Beverly Hills Polo Club line
was introduced in the spring of 1994. Net sales of Beverly Hills Polo Club
sportswear accounted for 14.6%, and 15.8% of the Company's net sales in 1998 and
1997, respectively.
In November 1997, the Company acquired an exclusive license to manufacture
and market certain men's sportswear under the Girbaud brand in the United States
and Puerto Rico. In March 1998, the Company acquired an exclusive license to
manufacture and market certain women's sportswear under the Girbaud brand in the
United States and Puerto Rico. In November 1998, both licenses were expanded to
include selected countries in Central and South America and the Caribbean. The
Girbaud brand is an internationally recognized designer sportswear label with a
distinct European influence. By targeting customers who desire contemporary,
international fashion, the Girbaud brand has enabled the Company to address
another consumer segment with its branded product portfolio. The Company has
positioned the Girbaud line with a broad assortment of products, styles and
fabrications reflecting a contemporary European look. In February 1998, the
Company began marketing a full collection of men's jeanswear and sportswear
under the Girbaud brand including a broad array of bottoms, tops and outerwear.
In August 1998, the Company introduced a women's sportswear collection under the
Girbaud brand including bottoms, tops and outerwear. Net sales of Girbaud
sportswear accounted for 4.1% of the Company's sales in 1998.
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The Company also manufactures and markets a limited number of pants and
jeans styles for women under its own "I.C. Isaacs," "Lord Isaacs" and "Pizzazz"
brand names and under third-party private labels for sale to major chain stores
and catalogs. Net sales of these labels accounted for 7.8% and 9.5% of the
Company's net sales in 1998 and 1997, respectively.
RECENT EVENTS
The Company 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. In addition, other brands such as DKNY and Nautica have
recently improved the jeanswear segments of their product lines, and a number of
new companies, such as FUBU, have emerged with competing products targeted at
the urban young men's market. In November 1998, the Company announced a
restructuring plan designed to address this increasingly competitive environment
for young men's jeanswear. Under the restructuring plan the Company has
positioned and merchandized its Girbaud line of sportswear to offer jeanswear
and sportswear products that are truly innovative and 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 more
consistent with market trends and to present the product lines to the market in
a timely manner. In addition, the Company has focused its resources on those
product lines with the greatest profit potential, and has made significant
expense reductions. In connection with these activities, the Company recorded a
$1.1 million charge in the third quarter of 1998 related to the write down of
inventory and goodwill and an additional charge of $0.3 million in the fourth
quarter related to the closure of the Company's Carthage, Mississippi
manufacturing facility. Key elements of the restructuring plan include the
following:
- The Company has drastically reduced or eliminated several product lines or
categories that were not profitable or did not have near-term profit
potential. As a result of these initiatives, the Company's focus will be
streamlined towards the BOSS young men's, juniors' and boys', Beverly
Hills Polo Club men's and boys' and Girbaud men's and women's sportswear
lines.
- With the exception of continuing its basic jeans and pants models for sale
to major chain stores and catalogs, the Company has discontinued
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.
- The Company has discontinued its line of women's sportswear manufactured
under the Beverly Hills Polo Club label and focused its energy on
designing and marketing its Beverly Hills Polo Club men's and boy's
collections.
- In addition to eliminating its Beverly Hills Polo Club women's line, the
Company has significantly reduced and modified its European men's line
under the Beverly Hills Polo Club label. In January 1999, the Company
presented a collection designed to be more reflective of current trends in
the European marketplace.
- The Company has amended certain of its licensing agreements with the
licensor of the Beverly Hills Polo Club brand name to provide for the
elimination of international royalties for the remainder of 1999 and a
substantial reduction in international royalties in 2000.
- The BOSS juniors' line has been substantially reduced and is more focused
on core price point products with greater volume potential, such as jeans
and tee-shirts.
- The Company has significantly cut the number of styles and SKUs offered in
its continuing branded sportswear lines to reduce product development
costs, selling expenses and inventory exposure.
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- The Company's Carthage, Mississippi manufacturing plant--which was largely
responsible for the production of women's pants and jeans--was closed in
February 1999. A portion of the production in this facility has been
transferred to the remaining Company-owned plant in Raleigh, Mississippi,
as well as to independent contractors in Mexico.
- The Company's advertising budget has been reduced to reflect the decrease
in lines; 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 to support growth of the Girbaud
brand, which includes a full print media campaign as well as billboards,
buses and special events.
PRODUCTS
The Company's sportswear collections under the BOSS, Beverly Hills Polo Club
and Girbaud brands provide a broad range of product offerings for young men,
women and boys including a variety of tops, bottoms and outerwear. While these
brands reflect a distinct image and style, each is targeted to consumers who are
seeking high quality, fashionable products at competitive prices. The Company
also manufactures and markets a limited number of styles of women's pants and
jeans under its own "I.C. Isaacs," "Lord Isaacs" and "Pizzazz" brand names as
well as under third-party private labels.
BOSS PRODUCTS
The BOSS brand is a full sportswear line characterized by innovative
fabrication and creative graphics. BOSS products appeal to young men, young
women and boys who want a fresh, fashion-forward look with an urban attitude at
a competitive price. As the line has expanded and matured, the demographics of
BOSS customers have expanded beyond their urban base to include
fashion-conscious young consumers across the United States. Over the past
several years, the Company has placed increased emphasis on expansion of the
top's segment, and it anticipates that this segment will continue to be the
fastest growing category of products in the BOSS collection.
BOTTOMS
The Company's BOSS products began as a line of high-quality jeans and other
denim casual wear. The bottoms line currently consists of a wide variety of
denim jeans in a broad array of colors, designs and styles together with
corduroy and twill pants. Many of the BOSS jeans feature elements such as unique
pocket treatments, innovative trim and embroidered logos. The Company maintains
its own washing facilities, which allow it to create a variety of washes for its
denim products. The Company has identified an underserved niche in the young
men's market for fashion jeans at moderate price points as compared with many
designer jeans, which retail for $60 and up per pair. The estimated retail price
for the Company's jeans is between $35 and $50 per pair.
TOPS AND OUTERWEAR
The BOSS young men's line includes a variety of tops, tee shirts and
outerwear. The BOSS tops collection consists of a range of products including
cotton tee shirts, polo shirts, cotton pique shirts, novelty knit tops and
fleece sweatshirts. These products utilize unique combinations of textured
polyester fabrications, as well as a broad array of appliqued logos and
innovative graphics. The styling of many of the BOSS tops is influenced by
sports clothing and uniforms and conveys an energetic, youthful attitude. The
Company's outerwear line includes a variety of products including nylon jackets
and downfilled parkas. The estimated retail prices range from $19 to $22 for tee
shirts, $30 to $55 for tops and $50 to $100 for outerwear products.
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BOYS', YOUTH AND JUNIORS' (YOUNG WOMEN)
The Company complements its BOSS young men's line with BOSS boys' and youth
lines, which are targeted to appeal to boys ages 4 to 7 and youth ages 8 to 16.
The BOSS boys' and youth product lines are substantially similar to the young
men's line and include jeans, tee shirts, tops, sweatshirts and outerwear.
Because the boys' market is more price conscious, some of the styles use less
expensive fabrication and design detail. The boys' and youth lines typically
sell at retail prices approximately 10% to 20% below the young men's line.
The BOSS juniors' line is the female counterpart to the BOSS young men's
line and is targeted to appeal to fashion-conscious girls and women ages 16 to
25. The estimated retail prices for the juniors' line range from $15 to $20 for
tee shirts, $25 to $50 for tops, $30 to $45 for jeans and $30 to $75 for
outerwear.
BEVERLY HILLS POLO CLUB PRODUCTS
The Beverly Hills Polo Club sportswear products are positioned to be an
updated traditional sportswear brand. The products combine contemporary design
details and innovative fabric with classic American styling. With a broader
demographic appeal than the BOSS brand, Beverly Hills Polo Club products are
targeted to appeal to consumers 16 years and older. Today, the Beverly Hills
Polo Club name and accompanying horse and rider logo symbolize quality,
traditional sportswear at competitive prices.
TOPS AND OUTERWEAR
The Company has merchandised the Beverly Hills Polo Club line to place more
emphasis on tops, including a full line of tee shirts, polo shirts, rugby
shirts, denim shirts and sweatshirts made primarily in cotton fabrics such as
pique, jersey and jersey fleece. While classic in styling, the tops line is
distinguished by innovative use of design, embroidery and fabric detail. The
collections also include more contemporary styles and a broader array of novelty
fabrics as well as product offerings such as woven shirts and outerwear,
including jackets and downfilled parkas. Estimated retail prices range from $19
to $22 for tee shirts, $30 to $60 for tops and $60 to $120 for outerwear.
BOTTOMS
While the primary focus of the Beverly Hills Polo Club line has been on
tops, the collection also includes a full line of bottoms consisting of denim
jeans, twill pants and corduroy casual pants. While somewhat more conservative
in styling compared to the BOSS line, the Beverly Hills Polo Club bottoms line
combines classic styling with unique trim, embroidery and pocket treatments.
Estimated retail prices for jeans and casual pants range from $40 to $55 per
pair.
GIRBAUD PRODUCTS
The Girbaud brand is an internationally recognized designer sportswear
label. The Company has launched innovative European-inspired men's and women's
sportswear collections under the Girbaud label. The Girbaud collections include
full lines of bottoms consisting of jeans and casual pants in a variety of
fabrications, including denim, stretch denim, cotton twill and nylon, cotton tee
shirts, polo shirts, knit and woven tops, sweaters and outerwear. Reflecting
contemporary European design, each of these collections is characterized by
innovative styling and fabrication and is targeted to consumers ages 16 to 50.
Estimated retail prices range from $20 to $25 for tee shirts, $50 to $75 for
tops and bottoms, $60 to $90 for sweaters and $80 to $200 for outerwear
products.
COMPANY-OWNED AND THIRD-PARTY PRIVATE LABEL PRODUCTS
The Company also produces a limited number of pants and jean styles for
women under its own brands, including "I.C. Isaacs," "Lord Isaacs" and
"Pizzazz," as well as under customers' private labels for
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sale to major chain stores and catalogs. These brands focus on pull-on elastic
waist pants and jeans. These pants are designed to appeal to more mature women
looking for basic styling at value prices. The Company offers pants in a variety
of fits, including missy, petite and large sizes. Estimated retail prices range
from $15 to $24.
CUSTOMERS AND SALES
The Company's products are sold in over 3,500 specialty stores, specialty
store chains and department stores. The Company uses both sales representatives
and distributors for the sale of its products. Sales representatives include
employees of the Company as well as independent contractors. Each of the
Company's distributors and non-employee sales representatives has an agreement
with the Company pursuant to which the distributor or sales representative
serves as the exclusive distributor or sales representative of specified
products of the Company within a specified territory. The Company does not have
long-term contracts with any of its customers. Instead, its customers purchase
the Company's products pursuant to purchase orders and are under no obligation
to continue to purchase the Company's products.
The Company's BOSS products are sold throughout the United States and Puerto
Rico in over 2,500 specialty stores and specialty store chains. Substantially
all of the Company's net revenues are attributable to domestic sales. The
Company's newest level of distribution is to department stores, and its single
largest customer in 1998 was J.C. Penney Company, Inc., which accounted for
26.2% of net sales. No other customer of the Company accounted for 10.0% or more
of net sales in 1998. The Company's BOSS products are sold and marketed under
the direction of its national sales office headquartered in New York. In
addition to executive selling based in New York and Dallas, the Company has 19
commissioned BOSS sales representatives who work out of regional showrooms
throughout the United States and Puerto Rico. The Company considers its
professional sales force to be one of its major assets and one of the principal
reasons why it has been successful in establishing relationships with department
stores and thousands of specialty stores and specialty store chains.
The Company's Beverly Hills Polo Club sportswear is sold in the United
States, Puerto Rico and Europe to over 2,000 specialty stores, specialty store
chains and department stores, such as J.C. Penney Company Inc. and Peebles. The
Company's Beverly Hills Polo Club products are sold and marketed under the
direction of its national sales offices in New York. In addition to executive
selling based in New York and Dallas, the Company has a sales force consisting
of 15 Beverly Hills Polo Club sales representatives.
The Company's Beverly Hills Polo Club sportswear has recently begun to be
sold throughout Europe through wholesale distributors, all of whom buy products
directly from the Company. The Company currently has wholesale distribution
arrangements with distributors in Belgium, Finland, France, Greece, Italy,
Luxembourg, the Netherlands, Norway, Portugal, Switzerland, Austria and Germany.
Under these arrangements, the distributors purchase goods from the Company's
Spanish subsidiary in United States dollars under irrevocable letters of credit
or by prepayment, thereby minimizing the Company's credit risk. The Company has
established three franchise stores in Spain.
The Company began marketing men's sportswear under the Girbaud brand in
February 1998 and introduced a women's sportswear collection under the Girbaud
brand in the second quarter of 1998. The Company's Girbaud products are being
sold to more than 800 stores in the United States and Puerto Rico, including
major department stores such as Nordstroms, Bloomingdales, Macy's East, Macy's
West and Dayton Hudson, and many prominent speciality stores such as Fred Segal
Santa Monica and The Atrium in New York. The Company's Girbaud brand products
are sold and marketed domestically under the direction of a 9-person sales force
headquartered in New York and in Central and South America and the Caribbean by
agreement with a third-party distributor.
The Company-owned branded products and the Company's third-party private
label products are sold under the direction of the sales headquarters in New
York. The products are distributed to department
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stores such as Sears Roebuck and Co.; mass merchandisers and discounters such as
Hills Department Store Company and Ames Department Stores, Inc.; and catalogs
such as National Wholesale Co., Inc. and Arizona Mail Order Company, Inc.
DESIGN AND MERCHANDISING
The Company's designers and merchandisers travel around the world to monitor
emerging fashion trends and search for styling inspiration and fabrics. These
sources, together with new styling and graphics developed by the Company's
designers, serve as the primary creative influences for the Company's product
lines. In addition, designers and merchandisers regularly meet with sales
management to gain additional market insight and further refine the products to
be consistent with the needs of each of the Company's markets. The Company's
in-house design and product development is carried out by merchandising
departments in New York. Many of the Company's products are developed using
computer-aided design equipment, which allows designers to view and easily
modify images of a new design. From 1994 to 1998, the Company's design staff
grew from 6 to 20 people. The Company currently has 16 people on the design
staff in New York City. Design expenditures incurred were approximately $3.0
million in 1998. The Company estimates that design expenditures in 1999 will be
approximately the same.
ADVERTISING AND MARKETING
The Company prides itself on its ability to efficiently utilize its
advertising budget. Although the Company increased its expenditures on
advertising to approximately $5.7 million or 5.0% of net sales in 1998, this is
still a relatively modest amount as compared with some of its competitors. In
1997 and 1998, the Company's expenditures for advertising and marketing
activities totaled $3.9 million and $5.7 million, respectively.
The Company aggressively communicates and reinforces the brand and image of
its BOSS, Beverly Hills Polo Club and Girbaud products through creative and
innovative advertising and marketing efforts. The Company's advertising and
marketing strategies are directed by its national sales offices and developed in
collaboration with its advertising agencies and, in the case of Girbaud, with
the Girbaud Paris office. The Company's advertising strategy is geared towards
its youthful consumers, whose lifestyles are influenced by music, sports and
fashion. The Company has been advertising the BOSS brand since 1992, the Beverly
Hills Polo Club brand since 1994 and the Girbaud brand since 1998. Its
advertising campaigns have evolved from trade magazines to a wide variety of
media, including billboards, television, fashion magazines and professional
sports endorsements.
Print advertisements for the BOSS brand appear in SOURCE, SLAM, SPORTSWEAR
INTERNATIONAL, XXL and URBAN LATINO magazines, while television advertisements
appear on MTV: Music Television, and the Madison Square Garden (MSG) Network.
Advertisements for the BOSS brand also appear on a variety of outdoor
advertising media, including billboards and bus stops. Print advertisements for
the Beverly Hills Polo Club brand are targeted to appeal to a broader
demographic base and appear in magazines such as GQ AND POV. Television
advertisements for the Beverly Hills Polo Club brand have appeared on the Fox
Sports Network and MSG. The Company is a sponsor of selected professional
basketball teams, including the New York Knicks and New Jersey Nets, and Beverly
Hills Polo Club was a sponsor of the NCAA Basketball Tournaments and the PGA
Tour. The Company's products can be seen on some of today's most visible sports
and music celebrities, whose attitude and image are captured by the BOSS and
Beverly Hills Polo Club brands. Recognizing that point of sale advertising is
highly effective, the Company also provides an array of in-store signage and
product videos for both BOSS and Beverly Hills Polo Club products.
To increase consumer awareness of the Girbaud brand in the United States,
the Company has begun a multifaceted marketing campaign which includes print
advertisement in magazines such as ELLE, VIBE, DETOUR, DETAILS and INTERVIEW
magazines. The campaign also includes outdoor advertising, including billboard
and signage on New York City buses, point of sale materials and promotions, and
celebrity wardrobing. As a first tier designer brand, Girbaud also presents
international runway shows as well as appearing in major trade shows.
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MANUFACTURING AND PRODUCT SOURCING
GENERAL
The Company believes that its flexible manufacturing and sourcing
capabilities enable it to effectively control the timing, quality and pricing of
products while providing customers with increased value. The Company uses its
own facilities as well as both domestic and foreign contractors for the
production of its products. During 1998, approximately 16.5% of the Company's
purchases of raw materials, labor and finished goods for its apparel were made
in Mexico; approximately 32.9% were made in Asia; approximately 29.3% were made
at third-party facilities in the United States; and the balance was made at the
Company's facilities in the United States. Approximately 78.7% of the Company's
manufacturing and sourcing in 1998 was done by third parties, all through
arrangements with independent contractors. Each of the Company's independent
contractors and independent buying agents has an agreement with the Company
pursuant to which they perform manufacturing or purchasing services for the
Company on a non-exclusive basis. The Company evaluates its contractors
frequently and believes that there are a number of manufacturers capable of
producing products that meet the Company's quality standards. The Company
represents all or a significant portion of many of its contractors' production
and has the ability to terminate its arrangements with any of its contractors at
any time.
UNITED STATES AND MEXICO
Until the second quarter of 1998, the Company operated three manufacturing
facilities in Mississippi. In 1998, the Company produced approximately 40% of
its bottoms (slacks, jeans, shorts and skirts) in these facilities. 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 quarter ended March 31, 1998. The production in this facility, the majority
of which was jeans, was transferred to a third party independent contractors'
facilities in Mexico. The actual expenses incurred in connection with the
closure were not significantly different than the reserve provided by the
Company in the first quarter. In the first quarter of 1999, the Company closed
its Carthage, Mississippi manufacturing facility. This closure resulted in a
charge of $0.3 million against earnings in the quarter ended December 31, 1998.
The production in this facility, the majority of which was ladies' pants and
jeans under the Company's private labels, was transferred to the remaining
Company-owned plant in Raleigh, Mississippi, as well as to independent
contractors in Mexico. The Company's remaining facility in Raleigh, Mississippi
employs approximately 230 people.
The Company utilizes five contractors in the United States and three
contractors in Mexico. The majority of the Company's U.S. and Mexico production
is of bottoms and tee shirts. The Company safeguards its manufacturing capacity
by utilizing contractors in both the United States and Mexico to produce the
same product lines. The Company has established ongoing relationships with all
of these contractors but is not bound by written agreements to continue to do
business with any of them. The Company also uses a variety of contractors in
both the United States and Mexico as needed for value added functions such as
embroidery, screen printing and laundering. Seasonal fluctuations in production
requirements are accommodated by adjusting contracted quantities, while
maintaining more consistent levels of production in the Company-operated
facility. All contractors in the United States and Mexico are selected and
managed by the Company's manufacturing staff in Mississippi and Mexico.
The Company uses a variety of raw materials, principally consisting of woven
fabrics including denim, cotton and various trim items. While the Company must
make commitments for a significant portion of its fabric purchases in advance of
sales, the Company's risk is reduced because a substantial portion of the
Company's products are sewn in basic denim which is widely available.
ASIA
In addition to the Company's domestic and Mexican pant and tee shirt
production facilities, the balance of the Company's sportswear products is
produced by approximately 30 different manufacturers in
7
10 countries. Virtually all of the Company's products other than pants and tee
shirts are produced in Asia, but none of the Asian contractors engaged by the
Company accounted for more than 10.0% of the Company's total production in 1998.
The Company has well established relationships with many of its contractors,
although it does not have written agreements with them. The Company retains
independent buying agents in various countries in Asia to assist in selecting
and overseeing independent manufacturers, sourcing fabric, trim and other
materials and monitoring quotas. Independent buying agents also perform quality
control functions on behalf of the Company, including inspecting materials and
manufactured products prior to accepting delivery. The sourcing and
merchandising staffs in the Company's New York offices oversee all aspects of
Asian fabric and product development, apparel manufacturing, price negotiation
and quality control, as well as the research and development of new Asian
sources of supply.
The Company seeks to achieve the most efficient means for the timely
delivery of its high quality products. With rare exceptions, the Company does
not purchase fabrics but instead negotiates a finished garment price from its
contractors. The contractor must then purchase the approved fabric as part of
the package. Orders are generally placed after the Company has received customer
orders, and delivery of finished goods to customers generally occurs 90 to 150
days after placement of the order. All of the Company's products manufactured
abroad are paid for in United States dollars. Accordingly, the Company does not
engage in any currency hedging transactions. During the last several years, the
percentage of the Company's products produced in Asia has increased
dramatically, and this trend is likely to continue in the future.
WAREHOUSING AND DISTRIBUTION
The Company services its United States customers and intends to service its
Central and South American and Caribbean customers utilizing a 70,000 square
foot Company-owned and operated distribution center in Milford, Delaware. The
Company has established a computerized "Warehouse Management System" with
real-time internal tracking information and the ability to provide its customers
with electronically transmitted "Advance Shipping Notices." The accuracy of
shipments is increased by the ability to scan coded garments at the packing
operation. This process also provides for computerized routing and customer
invoicing. The vast majority of shipments are handled by UPS, common carriers or
parcel post. The Company previously determined, based on prior years' sales
levels, that its distribution requirements could be better met by consolidating
its warehousing and distribution functions into a new 150,000 square foot
facility in Milford, Delaware. As a result of an overall decline in sales and
demand, the Company has decided to delay the construction of the new
distribution center for the foreseeable future. The Company does not intend to
dispose of its current distribution center. The Company also has a warehouse in
Carthage, Mississippi.
The Company currently services its European customers through a contractual
arrangement with a distribution center in Barcelona, Spain, where the Company
maintains its European headquarters.
QUALITY CONTROL
The Company's quality control program is designed to ensure that all of the
Company's products meet its high quality standards. The quality of piece goods
is monitored prior to garments being produced, and prototypes of each product
are inspected and approved before production runs are commenced.
The goods produced by the Company-operated facility, as well as by United
States and Mexican contractors, undergo continual audits by quality personnel
during production. The quality control efforts of the Company-operated facility
are directed and coordinated by the Company's Quality Control Manager located in
Mississippi. Frequent visits are made by the Quality Control Manager and other
support staff to all outside contractors to ensure compliance with the Company's
rigorous quality standards. Audits are also performed by quality personnel at
the Milford, Delaware distribution center on all categories of incoming
merchandise. The Company employs a full-time staff of 6 persons dedicated to the
quality control efforts of its United States and Mexican production.
8
All garments produced for the Company in Asia must be produced in accordance
with the Company's specifications. The Company's import quality control program
is designed to ensure that all of the Company's products meet its high quality
standards. The Company monitors the quality of fabrics prior to the production
of garments and inspects prototypes of products before production runs are
commenced. In many cases, the Company requires its agents or manufacturers to
submit fabric to an independent outside laboratory for testing prior to
production. The Company requires each agent to perform both in-line and final
quality control checks during and after production before the garments leave the
contractor. Personnel from the Company's New York office also visit Asia to
conduct inspections.
BACKLOG AND 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 in the first and third
quarters. The Company generally receives orders for its products three to five
months prior to the time the products are delivered to the stores. As of
December 31, 1998, the Company had unfilled orders of approximately $27.0
million, compared to approximately $46.0 million of such orders as of December
31, 1997. The Company expects to fill substantially all of these orders in 1999.
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. During 1998, increased competition and continued
sluggishness in the retail apparel market contributed to the decrease in
backlog. All such orders are subject to cancellation for causes such as late
delivery. Accordingly, a comparison of backlogs of orders from period to period
is not necessarily meaningful and may not be indicative of eventual actual
shipments.
LICENSES AND OTHER RIGHTS AGREEMENTS
The Company's business is heavily dependent upon its use of the BOSS,
Beverly Hills Polo Club and Girbaud brand names and images, which are in turn
dependent upon the existence and continuation of certain licenses and other
rights agreements as described below.
BOSS TRADEMARK RIGHTS
In 1990, the Company obtained a license from Brookhurst, Inc. ("Brookhurst")
to use the registered trademark BOSS in the United States and Puerto Rico in
connection with certain items of sportswear for men and women. Brookhurst and
its predecessors had utilized the BOSS trademark since the late nineteenth
century.
In February 1993, the owner of the "HUGO BOSS" trademark filed suit against
the licensor of the "BOSS" trademark in the United States and several licensees,
including the Company. The complaint alleged trademark infringement related to
use of the "BOSS" and "HUGO BOSS" trademarks. However, the complaint did not
challenge the exclusive right of the Company to use the "BOSS" trademark in
connection with the manufacture and sale of certain clothing as set forth in its
exclusive license agreement. The Company executed certain agreements in November
1997 which resulted in the settlement (the "Settlement") of the BOSS trademark
litigation. As part of the Settlement, the Company borrowed $11.25 million 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").
As part of the Settlement, Brookhurst (i) sold its BOSS trademark rights
worldwide (excluding Mexico), goodwill and registrations to the Company, (ii)
assigned its rights with respect to the BOSS trademark under certain agreements
with third parties (the rights under (i) and (ii) above referred to collectively
as the "BOSS Trademark Rights") to the Company and (iii) agreed to cease using
the BOSS brand name and image (except for a limited sell-off of certain uniforms
and samples bearing the BOSS mark). As part of the Settlement, the Company sold
its foreign BOSS trademark rights and its rights under related agreements
acquired from Brookhurst (the "BOSS Foreign Trademark Rights") to Ambra, Inc., a
wholly-owned subsidiary of Hugo Boss AG ("Ambra"). Neither Hugo Boss nor Ambra
is affiliated with
9
Brookhurst or the Company. The Company also entered into a foreign manufacturing
rights agreement with Ambra (the "Foreign Rights Agreement") under which the
Company obtained a license to manufacture apparel in certain foreign countries
for sale in the United States using the BOSS brand name and image. The Company
retained its ownership of domestic BOSS Trademark Rights ("Domestic BOSS
Trademark Rights") subject to a concurrent use agreement with Hugo Boss (the
"Concurrent Use Agreement'). Subject to the terms of the Concurrent Use
Agreement, Hugo Boss retained the right to manufacture and market sportswear and
other products using the BOSS name. In the event Hugo Boss manufactures and
markets sportswear products which the Company is permitted to manufacture and
market under the Concurrent Use Agreement, Hugo Boss must sell such products at
or above specified wholesale price points in the United States and Puerto Rico,
which are generally higher than the price points of the Company. Although there
is some degree of overlap in the wholesale price points of the Company and Hugo
Boss under the Concurrent Use Agreement, the Company does not currently sell or
intend to sell BOSS brand sportswear within those overlapping price points and
does not anticipate any material adverse effect on the Company's financial
condition or results of operations if Hugo Boss were to manufacture and market
sportswear within those overlapping price points.
Under the agreements entered into in connection with the Settlement, the
Company's BOSS rights were expanded to allow broader product offerings and
additional Company control over styling, advertising and distribution. In
addition to the categories of apparel which the Company was permitted to
manufacture, distribute, market and sell under its previous license agreement
with Brookhurst, under the Settlement, the Company acquired the right to
manufacture, distribute, market and sell, within specified wholesale price
points, the following categories of apparel under the BOSS brand in a specified
microgramma style (the "BOSS Logotype"): swimwear, jogging suits, polo shirts
and belts (as parts of garments). The Company may use the BOSS trademark in
forms other than the BOSS Logotype with the prior approval of the other parties
to the agreements. The Company is prohibited from using the BOSS brand name or
image on footwear, formal and tailored clothing, leather clothing, body wear,
underwear, intimate apparel, loungewear, sleepwear and robes, clothing designed
for the primary purpose of engaging in skiing, tennis, motor sports, windsurfing
and any non-apparel items. The Concurrent Use Agreement sets forth specific
parameters governing the use by the Company of the BOSS Logotype with respect to
advertising, wholesale pricing points and the size, location, appearance, style
and coloring of the trademark on different product categories and advertising,
and generally requires that the Company use the phrase "BOSS by I.G. Design" on
its BOSS products. No material adverse effect on the Company's financial
condition or results of operations is expected as a result of the Concurrent Use
Agreement.
Under the Foreign Rights Agreement, the Company continues to have the right
to manufacture BOSS apparel in foreign countries, including those in which the
Company is currently manufacturing BOSS apparel and several additional
countries. No significant changes are anticipated with respect to the Company's
foreign manufacturing activities and therefore no material adverse effect on the
Company's financial condition or results of operations is expected. The Foreign
Rights Agreement will terminate on December 31, 2001, but may be extended, at
the Company's option, through December 31, 2007.
Under the Foreign Rights Agreement, the Company will pay annual royalties of
12.5%: (i) on the first $32.0 million of net sales attributable to apparel
manufactured in those foreign countries in which the Company currently
manufactures or will manufacture BOSS products ("Territory Net Sales") for each
of the first four years of the agreement; (ii) on the first $20.0 million in
Territory Net Sales for year five of the agreement; and (iii) on the first $16.0
million of Territory Net Sales in years six through ten of the agreement. The
base royalties on such amounts of Territory Net Sales would increase to as much
as 19.5% upon any prepayment of the Note. For the first four years of the
agreement, an aggregate additional royalty of 5.0% is payable annually on
Territory Net Sales from $84.0 million to approximately $105.3 million and an
aggregate additional royalty of 4.0% is payable annually on Territory Net Sales
of $158.0 million and up. Additional royalties in years five through ten of the
agreement increase for certain corresponding sales levels. The Company is
required (i) to generate minimum annual Territory Net Sales of at least $32.0
million for each of the first four years of the agreement, $20.0 million for the
fifth year of
10
the agreement and $16.0 million for each of years six through ten of the
agreement and (ii) to pay annual royalties on such sales based on the
percentages described above. The Company's Territory Net Sales for any given
year under the agreement must equal at least 95.0% of total net sales
attributable to BOSS apparel manufactured worldwide. To the extent that the
Company does not achieve the required Territory Net Sales, the Company will have
the right, in order to avoid termination of the agreement, to pay royalties as
if such Territory Net Sales had been achieved. In the event that the Company's
cumulative payment of royalties under the Foreign Rights Agreement and interest
paid under the Note exceed: (i) $16.0 million paid at any time during the first
four years of the agreement, (ii) $6.5 million paid at any time during years
five through seven of the agreement, (iii) $6.0 million paid at any time during
years eight through ten of the agreement, or (iv) $26.0 million paid at any time
during the entire term of the agreement, the requirement to generate minimum
annual Territory Net Sales, as described above, terminates and the Company shall
continue to pay royalties based on the percentages described above.
The Foreign Rights Agreement may be terminated by the licensor upon the
occurrence of certain events, including, but not limited to (i) a material
breach by the Company after expiration of the applicable grace period, (ii)
certain events of bankruptcy, insolvency or assignment for the benefit of all
creditors relating to the Company or the appointment of a receiver or trustee
for the Company (a "Bankruptcy Event"), (iii) certain specified changes in the
control of the ownership of the Company and (iv) certain uncured breaches by the
Company's foreign manufacturers of the terms of the agreements. In addition to
terminating the agreement, the licensor may require the Company to pay on an
accelerated basis all royalties due under certain sales assumptions through the
then current term of the agreement upon the occurrence of certain events,
including, but not limited to (i) the failure of the Company to pay royalties
when due or to meet certain minimum sales requirements, (ii) the failure of the
Company to manufacture products in certain foreign countries, (iii) the sale of
the licensed products outside the United States, (iv) certain attempts by the
Company to create or establish trademark rights in the word BOSS in its own name
anywhere outside of the United States, (v) the willful and material breach of
the agreement and (vi) the occurrence of a Bankruptcy Event. The Company's
rights to use the BOSS name will terminate upon exercise of the Option (as
hereinafter defined) or upon earlier termination of any of the other agreements.
Any termination of the Company's rights to use the BOSS name would have a
material adverse effect on the Company's financial condition and results of
operations.
Ambra holds an option dated November 5, 1997 to purchase the Domestic BOSS
Trademark Rights from the Company (the "Option") for an amount equal to the
original principal amount of the Note at any time between November 5, 2006 and
December 31, 2007 or earlier upon (i) certain breaches of the Concurrent Use
Agreement, (ii) an event of default under the Note or (iii) termination for any
reason of the Foreign Rights Agreement.
BEVERLY HILLS POLO CLUB LICENSES
Beverly Hills Polo Club Domestic Licenses
Since 1993, the Company has had an exclusive wholesale licensing agreement
(the "BHPC Agreement") with BHPC Marketing, Inc. for the manufacture and
promotion of certain men's sportswear bearing the registered trademark Beverly
Hills Polo Club with an accompanying horse and rider design (the "BHPC
Trademark") for sale to moderate or better department stores and specialty
stores in the United States and its possessions, including Puerto Rico. Under
the BHPC Agreement, the Company may sell up to 25.0% of its total volume to
warehouse clubs. The licenses generally allow the Company to use the BHPC
Trademark on sportswear designed by or for the Company, subject to a quality
approval process for marketing and advertising materials, manufacturing premises
and products bearing the trademark. Under the license, as amended through April
1997, the Company is required to make payments to the licensor in an amount
equal to 5.0% of the Company's net invoiced sales of licensed merchandise and to
spend an amount equal to 1.0% of net invoiced sales of such merchandise in
advertising for the licensed
11
products. Under the license, the Company pays a monthly royalty equal to the
greater of 8.3% of the guaranteed minimum annual royalty or the actual royalty
earned by the licensor in the preceding month.
Under the BHPC Agreement, the Company has been granted an exclusive license
to use the BHPC Trademark in connection with menswear fashions made of materials
other than silk in the following categories: denim sportswear, outerwear, knit
and woven shirts, knit and woven casual pants and shorts, sweaters, basic and
fashion fleece tops and bottoms, overalls and shortalls, knit tops (including
tee shirts and polo shirts), swimwear and warm-ups. The BHPC Agreement has a
three year term expiring December 31, 2001 and is renewable at the option of the
Company, provided the Company is not in breach thereof at the time renewal
notice is given, for a three-year period commencing January 1, 2000 through
December 31, 2004.
In 1998, the Company was subject to a guaranteed payment of $400,000.
Guaranteed minimum annual royalties and guaranteed annual net shipments for the
current term and the renewal term are equal to the greater of (i) 80.0% of the
immediately preceding contract year's actual royalties and net shipments or (ii)
the previous year's guaranteed minimum royalty and guaranteed net shipments.
The BHPC Agreement may be terminated by the licensor upon the occurrence of
certain events, including but not limited to the following: (i) a breach by the
Company of any obligation under the agreement that remains uncured within 30
days following the receipt of written notice of such breach, (ii) the Company
becomes insolvent, is the subject of a petition in bankruptcy or otherwise
enters into any composition with its creditors, including reorganization, or
(iii) the Company has committed three breaches of the agreement, in which case
no right to cure the breach is afforded to the Company.
During the term of the BHPC Agreement, the Company is prohibited from
manufacturing or otherwise distributing any merchandise under a brand name which
closely resembles the BHPC Trademark and from using on non-Beverly Hills Polo
Club products any graphic, style or design which closely resembles any items
supplied to the Company by the licensor. In addition, the rights of the Company
under the BHPC's Agreement are subject to the terms of a Settlement Agreement
and Consent Judgment between the licensor and Polo Fashions, Inc., which imposes
certain restrictions on the licensor's manner of use and advertising of the BHPC
Trademark, including a prohibition on the use of the words "Polo" and "Polo
Club" alone on any item of apparel. The Company believes that the BHPC
Trademark, as licensed to the Company, complies with those restrictions.
In April 1998, the Company entered into an exclusive license (the "BHPC
Boys' Agreement") to manufacture and market boys' sportwear, including knit and
woven shirts, cotton and cotton mixed pants (excluding tailored pants), jeans,
shorts, swim shorts and sports outerwear, under the Beverly Hills Polo Club
brand in the United States and Puerto Rico. Under the terms of the BHPC Boys'
Agreement, the Company must pay the licensor of the BHPC Trademark royalties
equal to 5% of net shipments by the Company of licensed products. The Company is
subject to guaranteed minimum annual royalties of $50,000 in 1999. The BHPC
Boys' Agreement has an initial term of three years, and is renewable at the
option of the Company, provided the Company is not in breach thereof at the time
the renewal notice is given, until December 31, 2004.
Beverly Hills Polo Club International Licenses
On August 15, 1996, I.C. Isaacs Europe, S.L., a Spanish limited corporation
and wholly-owned subsidiary of the Company, entered into retail and wholesale
license agreements (collectively, the "International Agreements") for use of the
BHPC Trademark in Europe. The International Agreements, as amended, provide
certain exclusive rights to use the BHPC Trademark in all countries in Europe
for an initial term of three years ending December 31, 1999, renewable at the
Company's option, provided the Company is not in breach thereof at the time the
renewal notice is given, through three consecutive extensions ending December
31, 2004. The International Agreements are subject to substantially the same
terms and conditions as the BHPC Agreements described above.
12
The international retail agreement (the "Retail Agreement") grants the
Company the right to use the BHPC Trademark in connection with the manufacture
and sale through authorized Beverly Hills Polo Club retail stores and franchise
stores in Europe of the following categories of products: (i) men's apparel,
including denim sportswear, outerwear, woven shirts, knit and woven casual pants
and shorts, sweaters, basic and fashion fleece tops and bottoms, overalls and
shortalls, knit tops (including tee shirts and polo shirts) swimwear and
warm-ups (excluding suits, ties, dress shirts, underwear, shoes, overcoats and
full length rainwear); (ii) women's apparel, including slacks, skirts, dresses,
sweaters, outerwear, blouses and jeans; and (iii) all other products licensed by
the Beverly Hills Polo Club licensor to other third parties (which must be
purchased by the Company from the authorized third-party licensees). Under the
Retail Agreement, the Company was required to pay the licensor royalties (the
"Initial Retail Royalties") equal to (i) 4.0% of the wholesale purchases by the
Company of Beverly Hills Polo Club products sold to Beverly Hills Polo Club
retail stores ("Wholesale Purchases") and (ii) 2.0% of retail sales of licensed
products by Beverly Hills Polo Club retail stores and was subject to guaranteed
minimum annual royalty payments of $30,000 in 1999 and guaranteed net shipment
volumes of $0.8 million in 1999. By amendment dated as of March 1, 1999 the
Retail Agreement was amended (the "Retail Amendment") to provide as follows: (i)
for the period beginning March 1, 1999 and ending December 31, 1999, no
royalties, guaranteed minimum annual royalties or guaranteed net shipment
volumes shall apply; (ii) for the period beginning January 1, 2000 and ending
December 31, 2000, the Company shall pay the licensor royalties equal to 3.0% of
Wholesale Purchases, and no guaranteed minimum annual royalties or guaranteed
net shipment volumes shall apply; and (iii) for any periods thereafter, the
Initial Retail Royalties shall apply and the Company shall be subject to the
guaranteed minimum annual royalties and guaranteed net shipment volumes, in
effect immediately prior to the date of the Retail Amendment.
The international wholesale agreement (the "Wholesale Agreement") grants the
Company the right to use the BHPC Trademark in connection with the manufacture
and sale at wholesale, for distribution to department stores and specialty
stores in Europe, of the following categories of products: (i) men's apparel,
including denim sportswear, outerwear, woven shirts, knit and woven casual pants
and shorts, sweaters, basic and fashion fleece tops and bottoms, overalls and
shortalls, knit tops (including tee shirts and polo shirts), swimwear and
warm-ups (excluding suits, ties, dress shirts, underwear, shoes, overcoats, and
full length rainwear); and (ii) women's apparel, including slacks, skirts,
dresses, sweaters, outerwear, blouses and jeans. Under the Wholesale Agreement,
the Company was required to pay the licensor royalties, (the "Initial Wholesale
Royalties") equal to 6.0% of net shipments by the Company of licensed products
directly to authorized Beverly Hills Polo Club distributors or to retail stores
("Net Shipments") and was subject to guaranteed minimum annual royalty payments
of $120,000 in 1999 and guaranteed net shipment volume of $4.0 million in 1999.
By amendment dated as of March 1, 1999, the Wholesale Agreement was amended (the
"Wholesale Amendment") to provide as follows: (i) for the period beginning March
1, 1999 and ending December 31, 1999, no royalties, guaranteed minimum annual
royalties or guaranteed net shipment volumes shall apply; (ii) for the period
beginning January 1, 2000 and ending December 31, 2000, the Company shall pay
royalties equal to 3.0% of Net Shipments and shall be subject to a guaranteed
minimum annual royalty payment of $60,000; and (iii) for any periods thereafter,
the Initial Wholesale Royalties shall apply and the Company shall be subject to
the guaranteed minimum annual royalties and guaranteed net shipment volumes in
effect immediately prior to the date of the Wholesale Amendment.
13
GIRBAUD LICENSES
GIRBAUD DOMESTIC LICENSES
In November 1997, the Company entered into an exclusive license agreement
(the "Girbaud Men's Agreement") with Girbaud Design, Inc. and its affiliate
Wurzburg Holding S.A. to manufacture and market men's jeanswear, casualwear and
outerwear under the Girbaud brand and certain related trademarks (the "Girbaud
Marks") in all channels of distribution in the United States, including Puerto
Rico and the U.S. Virgin Islands. In March 1998, the Girbaud Men's Agreement was
amended and restated to include active influenced sportswear as a licensed
product category and to name Latitude Licensing Corp. as the licensor (the
"Licensor"). Also in March 1998, the Company entered into an exclusive license
agreement (the "Girbaud Women's Agreement" and, together with the Girbaud Men's
Agreement, the "Girbaud Agreements") with the Licensor to manufacture and market
women's jeanswear, casualwear and outerwear, including active influenced
sportswear, under the Girbaud Marks in all channels of distribution in the
United States, including Puerto Rico and the U.S. Virgin Islands. The Girbaud
Agreements include the right to manufacture the licensed products in a number of
foreign countries, and both have initial terms of two years and may be extended
at the option of the Company for up to a total of ten years. The Girbaud
Agreements generally allow the Company to use the Girbaud Marks on apparel
designed by or for the Company or based on designs and styles previously
associated with the Girbaud brand, subject to quality control by the Licensor
over the final designs of the products, marketing and advertising material and
manufacturing premises. The Girbaud Agreements provide that they may be
terminated by the Licensor upon the occurrence of certain events, including, but
not limited to, a breach by the Company of any obligation under the agreement
that remains uncured following certain specified grace periods.
Under the Girbaud Men's Agreement the Company is required to make payments
to the Licensor in an amount equal to 6.25% of the Company's net sales of
regular licensed merchandise and 3.0% in the case of certain irregular and
closeout licensed merchandise. The Company is subject to guaranteed minimum
annual royalty payments of $1.5 million in 1999, $2.0 million in 2000, $2.5
million in 2001 and $3.0 million each year from 2002 through 2007. In 1998, the
Company was subject to minimum annual royalty payments of $1.2 million. On a
quarterly basis during the term, commencing with the first quarter of 1998, the
Company is obligated to pay the greater of (i) actual royalties earned by the
Licensor under the license or (ii) 8.3% of the minimum guaranteed royalties for
that year. The Company was required to spend at least $350,000 in advertising
men's Girbaud brand products in 1998 and is required to spend at least $500,000
in each subsequent year while the Girbaud Men's Agreement is in effect.
Under the Girbaud Women's Agreement the Company paid a one-time license
acquisition fee in the amount of $600,000 and is required to make payments to
the Licensor in an amount equal to 6.25% of the Company's net sales of regular
licensed merchandise and 3.0% in the case of certain irregular and closeout
licensed merchandise. The Company is subject to guaranteed minimum annual
royalty payments of $700,000 in 1999, $800,000 in 2000, $1.0 million in 2001 and
$1.5 million each year from 2002 through 2007. On a quarterly basis during the
term, commencing with the first quarter of 1999, the Company is obligated to pay
the greater of (i) actual royalties earned by the Licensor under the license or
(ii) 8.3% of the minimum guaranteed royalties for that year. The Company was
required to spend at least $550,000 in advertising women's Girbaud brand
products in 1998 and is required to spend at least $400,000 in each subsequent
year while the Girbaud Women's Agreement is in effect. In addition, over the
term of the Girbaud Women's Agreement the Company is required to contribute
$190,000 per year to the Licensor's advertising and promotional expenditures for
the Girbaud brand.
The Girbaud Women's Agreement initially required the Company to open a
Girbaud flagship store for the sale of the Company's Girbaud men's and women's
lines and other Girbaud licensed merchandise in New York City by the end of
1998. In December 1998, the Girbaud Women's Agreement was amended to defer this
requirement for one year and to provide that the Company would spend an
additional $1.8 million on enhanced sales and marketing in 1999.
14
In November 1998, the Company entered into amendments (the "Girbaud
Amendments") to the Girbaud Agreements allowing distribution through an approved
distributor in selected countries in Central and South America and the
Caribbean. The Girbaud Amendments are effective until November 12, 2001 or until
expiration of the Girbaud Agreements, whichever is earlier. In the event that
the Company does not achieve more than 75% of target sales levels in any Central
or South American or Caribbean country, its license to distribute Girbaud
products in that country will become non-exclusive effective starting the
following year.
CREDIT CONTROL
The Company manages its own credit and collection functions and has never
used a factoring service or outside credit insurance. The Company sells to
approximately 3,500 accounts throughout the United States and Puerto Rico. All
of the functions necessary to service this large volume of accounts are handled
by the Company's in-house credit department in Baltimore, Maryland. The Company
extends credit to its customers. Accordingly, the Company may have significant
risk in collecting accounts receivable from its customers. The Company has
credit policies and procedures which it uses to minimize exposure to credit
losses. The Company currently employs six people in its credit department and
believes that managing its own credit gives it unique flexibility as to which
customers the Company should sell and how much business it should do with each.
The Company obtains and periodically updates information regarding the financial
condition and credit histories of customers. The Company's collection personnel
evaluate this information and, if appropriate, establish a line of credit.
Credit personnel track payment activity for each customer using customized
computer software and directly contact customers with receivable balances
outstanding beyond 30 days. If these collection efforts are unsuccessful, the
Company may discontinue merchandise shipments until the outstanding balance is
paid. Ultimately, the Company may engage an outside collection organization to
collect past due accounts. Timely contact with customers has been effective in
reducing credit losses to an immaterial amount. In 1997, and 1998, the Company's
credit losses were $1.2 million and $1.4 million, respectively. The Company's
actual credit losses as a percentage of net sales was 0.7% and 1.2%,
respectively.
COMPETITION
The apparel industry is highly competitive and fragmented and is subject to
rapidly changing consumer demands and preferences. The Company believes that its
continued success depends in large part upon its ability to anticipate, gauge
and respond to changing consumer demands and fashion trends in a timely manner
and upon the continued appeal to consumers of the BOSS, Beverly Hills Polo Club
and Girbaud brands. The Company competes with numerous apparel brands and
distributors (including Calvin Klein, DKNY, Guess?, Mecca, Phat Farm, Polo
Jeans, Tommy Jeans, and Nautica). Many of the Company's competitors have greater
financial resources than the Company. Although the level and nature of
competition differ among its product categories, the Company believes that it
competes on the basis of its brand image, quality of design and value pricing.
The Company 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 such as FUBU have emerged with competing products targeted at the
urban young men's market. For a discussion of the steps the Company has taken to
address this increasingly competitive environment, see "--Recent Events." Under
the Concurrent Use Agreement, the BHPC Agreements and the Girbaud Agreements,
certain third parties have retained the right to produce, distribute, advertise
and sell, and to authorize others to produce, distribute, advertise and sell
certain garments that are similar to some of the Company's products, including,
in the case of the BOSS brand, similar garments using the BOSS name at generally
higher
15
wholesale price points. Any such production, distribution, advertisement or sale
of such garments by such licensor or another authorized party could have a
material adverse effect on the Company's financial condition or results of
operations.
MANAGEMENT INFORMATION SYSTEMS
The Company believes that advanced information processing is essential to
maintaining its competitive position. The Company is currently upgrading systems
to be year 2000 compliant and to allow areas of the business to be more
pro-active to customer requirements, to improve internal communication flow, to
increase process efficiency and to support management decisions. For a
discussion of the Company's year 2000 compliance and expenditures, see "ITEM 7.
Management's Discussion and Analysis of Financial Condition and Results of
Operations--Year 2000 Compliance and Expenditures." The Company's systems
provide, among other things, comprehensive order processing, production,
accounting and management information for the marketing, selling, manufacturing,
retailing and distribution functions of the Company's business. The Company's
software program allows it to track, among other things, orders, manufacturing
schedules, inventory and sales of its products. The program includes centralized
management information systems, which provide the various operating departments
with financial, sales, inventory and distribution related information. Via
electronic data interchange, the Company is able to ship orders to certain
customers within 24 to 72 hours from the time of order receipt.
EMPLOYEES
The Company believes that its employees are one of its most valuable
resources. As of March 31, 1999, the Company had approximately 450 full-time
employees. The Company is not a party to any labor agreements, and none of its
employees is represented by a labor union. The Company considers its
relationship with its employees to be good and has not experienced any material
interruption of its operations due to labor disputes.
ENVIRONMENTAL MATTERS
The Company is subject to federal, state and local laws, regulations and
ordinances that (i) govern activities or operations that may have adverse
environmental effects (such as emissions to air, discharges to water, and the
generation, handling, storage and disposal of solid and hazardous wastes) or
(ii) impose liability for the costs of clean up or other remediation of
contaminated property, including damages from spills, disposals or other
releases of hazardous substances or wastes, in certain circumstances without
regard to fault. Certain of the Company's operations routinely involve the
handling of chemicals and waste, some of which are or may become regulated as
hazardous substances. The Company has not incurred any significant expenditures
or liabilities for environmental matters. Although the Company believes that its
environmental obligations will not have a material adverse effect on its
financial condition or results of operations, environmental compliance matters
are subject to inherent risks and uncertainties.
16
ITEM 2. PROPERTIES
Certain information concerning the Company's principal facilities is set
forth below:
APPROXIMATE AREA
LEASED OR IN
LOCATION OWNED USE SQUARE FEET
- ----------------------------------------- ----------- ----------------------------------------- ----------------
Baltimore, MD............................ Owned Administrative Headquarters and Office 40,000
Facilities
New York, NY............................. Leased Sales, Merchandising, Marketing and 10,100
Sourcing Headquarters
Barcelona, Spain......................... Leased European Headquarters 2,000
Milford, DE.............................. Owned Distribution Center 70,000
Carthage, MS............................. Leased Warehouse 110,000
Newton, MS............................... Leased Subleased to third party 101,000
Raleigh, MS.............................. Leased Manufacturing Plant 90,000
The Company also has regional sales offices, all of which are leased, in the
following cities: Atlanta, Georgia; Dallas, Texas; Miami, Florida; Seattle,
Washington; Los Angeles, California; Philadelphia, Pennsylvania; Boston,
Massachusetts; Minneapolis, Minnesota; Charlotte, North Carolina; and Santurce,
Puerto Rico. The Company believes that its existing facilities are well
maintained and in good operating condition. The Company previously determined,
based on prior years' sales levels, that its distribution requirements could be
better met by consolidating its warehousing and distribution functions into a
new 150,000 square foot facility in Milford, Delaware. As a result of an overall
decline in sales and demand, the Company has decided to delay the construction
of the new distribution center for the foreseeable future. The Company does not
intend to dispose of its current distribution center. See "ITEM 1. Business--
Warehousing and Distribution" and Note 7 of Notes to Consolidated Financial
Statements for further information.
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. The production in this facility, the majority of which is
jeans, was transferred to a third party independent contractors' facilities in
Mexico. The Company has subleased the facility to a third party and is currently
in negotiations to assign the lease to a third party.
In the first quarter of 1999, the Company closed its Carthage, Mississippi
manufacturing facility. This closure, resulted in a charge of $0.3 million
against earnings for the quarter ended December 31, 1998. The production in this
facility, the majority of which is ladies' pants and jeans under the Company's
private labels, was transferred to the remaining Company-owned plant in Raleigh,
Mississippi, as well as to independent contractors in Mexico. The Company now
uses the Carthage facility as a warehouse.
ITEM 3. LEGAL PROCEEDINGS
From time to time the Company is a party to various claims, complaints and
other legal actions that have arisen in the ordinary course of business. The
Company is not presently aware of any such legal proceedings which, in the
aggregate, it believes would have a material adverse effect on the Company's
financial condition or results of operations.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
During the fourth quarter of 1998, there were no matters submitted to a vote
of the Company's stockholders.
17
PART II
ITEM 5. MARKET FOR THE COMPANY'S COMMON EQUITY AND RELATED
STOCKHOLDER MATTERS
The market for the Company's Common Stock is not an exchange but is
established by the National Association of Securities Dealers' Automated
Quotation System. As of March 26, 1999, the Company had approximately 40 holders
of record of the Company's Common Stock.
The Company's Common Stock trades on the Nasdaq National Market under the
Symbol "ISAC." The reported last sale price of the Common Stock on the Nasdaq
National Market on March 26, 1999 was $1.25. The following table sets forth for
the periods indicated the high and low closing sale prices for the Common Stock
reported by the Nasdaq National Market:
1998 1997
-------------------- ---------------------
QUARTER ENDED HIGH LOW HIGH LOW
- ---------------------------------------------------------------------- --------- --------- ---------- ---------
March 31.............................................................. $ 11.375 $ 6.875 -- --
June 30............................................................... $ 7.00 $ 2.50 -- --
September 30.......................................................... $ 3.375 $ 1.875 -- --
December 31........................................................... $ 2.50 $ 1.0625 $ 10.1875 $ 10.00
Since November 1998, the Company's Common Stock has been closing at prices
between $1.0312 and $2.4375. In order to maintain its listing on the Nasdaq
National Market, a stock must have a minimum bid price of $1.00. There can be no
assurances that the Company's Common Stock will maintain a minimum bid price of
$1.00 or more in the future or that it will not be delisted from the Nasdaq
National Market.
The Company anticipates that all earnings of the Company will be retained
for the foreseeable future for use in the operation of the Company's business.
Any future determination as to the payment of dividends will be at the
discretion of the Company's Board of Directors and will depend upon the
Company's results of operations, financial condition, restrictions in the
Company's credit facilities and other factors deemed relevant by the Board of
Directors.
On May 15, 1997, the Board of Directors of the Company and the Company's
stockholders adopted the 1997 Omnibus Stock Plan (the "Plan"). The purpose of
the Plan is to promote the long-term growth and profitability of the Company by
providing key people with incentives to improve stockholder value and contribute
to the growth and financial success of the Company, and by enabling the Company
to attract, retain and reward the best-available persons for positions of
substantial responsibility. The maximum number of shares of Common Stock that
may be issued with respect to awards granted under the Plan is 500,000. The
Board of Directors has approved an increase in the shares of Common Stock that
may be issued with respect to awards granted under the Plan to an aggregate of
1.1 million shares. This increase is subject to approval by the Company's
stockholders at the 1999 annual meeting of stockholders (the "Annual Meeting").
The Plan is administered by the Compensation Committee of the Board of
Directors. Participation in the Plan will be open to all employees, officers,
directors and consultants of the Company or any of its affiliates, as may be
selected by the Compensation Committee from time to time. The Plan allows for
stock options, stock appreciation rights, stock awards, phantom stock awards and
performance awards to be granted. The Compensation Committee will determine the
prices, vesting schedules, expiration dates and other material conditions upon
which such awards may be exercised. Through December 31, 1998, the Company had
granted stock options under the Plan exercisable upon vesting for an aggregate
of 346,000 stock options. The weighted average exercise price of such options is
$2.125 per share. Through December 31, 1998, none of those stock options had
been exercised. The issuance of such stock options was exempt from the
registration requirements of the Securities Act of 1933, as amended, pursuant to
Section 4(2) thereunder. The Company previously filed a Registration Statement
on Form S-8 (the "Form S-8") to register shares of Common Stock issuable
pursuant to awards granted under the Plan. The Company intends to file a post
effective amendment to the Form S-8 after following the Annual Meeting if
stockholders vote to approve the increase in the shares of Common Stock that may
be issued
18
with respect to awards granted under the Plan as described above. The purpose of
the post effective amendment will be to register the additional shares of Common
Stock issuable pursuant to awards granted under the Plan.
ITEM 6. SELECTED FINANCIAL DATA
The selected financial data set forth below have been derived from the
consolidated financial statements of the Company and the related notes thereto.
The statement of income data for the years ended December 31, 1996, 1997 and
1998 and the balance sheet data as of December 31, 1997 and 1998 are derived
from the consolidated financial statements of the Company which have been
audited by BDO Seidman, LLP, independent certified public accountants, included
elsewhere herein. The statement of income data for the years ended December 31,
1994 and 1995 and the balance sheet data as of December 31, 1994, 1995 and 1996
are derived from the consolidated financial statements of the Company, which
have been audited but are not contained herein. The following selected financial
data should be read in conjunction with the Company's consolidated financial
statements and the related notes thereto and "Management's Discussion and
Analysis of Financial Condition and Results of Operations," which are included
elsewhere herein.
YEAR ENDED DECEMBER 31,
--------------------------------------------------------
1994 1995 1996 1997 1998
--------- --------- ---------- ---------- ----------
(IN THOUSANDS EXCEPT PER SHARE DATA)
STATEMENT OF INCOME DATA:
Net sales........................................................ $ 85,298 $ 93,271 $ 118,655 $ 161,446 $ 113,721
Cost of sales.................................................... 62,216 68,530 84,421 109,694 90,661
--------- --------- ---------- ---------- ----------
Gross profit................................................... 23,082 24,741 34,234 51,752 23,060
Selling expenses................................................. 7,462 8,927 11,898 16,236 16,983
License fees..................................................... 3,012 3,174 4,817 7,577 6,020
Distribution and shipping expenses............................... 2,046 2,379 2,669 4,307 3,900
General and administrative expenses.............................. 5,813 5,787 6,243 7,546 9,999
Provision for plant closings..................................... -- -- -- -- 526
Recovery of legal fees........................................... -- -- (718) (117) --
--------- --------- ---------- ---------- ----------
Operating income (loss)........................................ 4,749 4,474 9,325 16,203 (14,368)
Interest, net.................................................... 1,191 1,247 1,365 2,372 1,455
Other income (expense) (1)....................................... 1,235 (3) 85 3 381
Minority interest................................................ (53) (33) (82) (135) --
--------- --------- ---------- ---------- ----------
Income (loss) before extraordinary item and income taxes......... 4,740 3,191 7,963 13,699 (15,442)
Extraordinary item (2)........................................... 389 -- -- -- --
--------- --------- ---------- ---------- ----------
Income (loss) before income taxes................................ 5,129 3,191 7,963 13,699 (15,442)
Income tax (expense)/benefit..................................... -- -- -- 1,349 (1,351)
--------- --------- ---------- ---------- ----------
Net income (loss).............................................. $ 5,129 $ 3,191 $ 7,963 $ 15,048 $ (16,793)
--------- --------- ---------- ---------- ----------
--------- --------- ---------- ---------- ----------
Basic and diluted net income (loss) per share (3)................ $ 1.29 $ 0.80 $ 1.99 $ 3.68 $ (2.15)
--------- --------- ---------- ---------- ----------
--------- --------- ---------- ---------- ----------
Weighted average common shares outstanding....................... 3,988 3,988 4,000 4,094 7,810
PRO FORMA STATEMENT OF INCOME DATA:
Income before income taxes....................................... 5,129 3,191 7,963 13,699
Income tax provision (4)......................................... 2,103 1,308 3,265 5,617
--------- --------- ---------- ----------
Net income..................................................... $ 3,026 $ 1,883 $ 4,698 $ 8,082
--------- --------- ---------- ----------
--------- --------- ---------- ----------
Basic and diluted net income per share........................... $ 0.95 $ 1.62
---------- ----------
---------- ----------
Weighted average common shares outstanding....................... 4,930 5,001
19
AS OF DECEMBER 31,
-----------------------------------------------------
1994 1995 1996 1997 1998
--------- --------- --------- --------- ---------
(IN THOUSANDS)
BALANCE SHEET DATA:
Working capital............................................ $ 10,035 $ 10,807 $ 16,274 $ 45,940 $ 31,577
Total assets............................................... 30,103 31,764 37,257 73,443 59,046
Total debt................................................. 8,798 8,645 7,796 11,609 13,848
Stockholders' equity....................................... 14,428 14,645 19,393 52,496 37,313
- ------------------------
(1) Includes income from settlement of license disputes of $1.2 million in 1994.
(2) In connection with the early extinguishment of certain debt, the Company
recorded an extraordinary gain of $0.4 million in 1994.
(3) Historical earnings per share does not reflect a provision for income taxes
as the Company had been taxed as an S corporation for the years ended
December 31, 1994, 1995, 1996 and the majority of 1997.
(4) Reflects pro forma provision for income taxes as if the Company had been
taxed as a C corporation for the years ended December 31, 1994, 1995, 1996
and 1997.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
The following discussion and analysis should be read in conjunction with the
"Selected Financial Data" and the Company's consolidated financial statements
and the related notes thereto, which are included elsewhere herein.
OVERVIEW
During its first 77 years, the Company became one of the leading
manufacturers of pants, trousers and jeans in the United States. The Company was
able to utilize its fabric sourcing and manufacturing expertise to build a well
known franchise in the men's and women's bottoms segment of the apparel
industry. In this period, the Company's marketing efforts were typically driven
by its manufacturing capabilities, and branding was limited to Company-owned
brands and third-party private labels.
In the late 1980's, management made a decision to change the Company's
marketing focus from a manufacturing-driven to a brand-driven strategy. This
fundamental shift within the Company reflected senior management's belief that
the American sportswear market would be dominated by recognized brands with
clearly established images. Management also concluded that increasing market
share would go to those companies that were market-driven and able to service
their customers with diversified manufacturing and sourcing capabilities.
Recognizing its strength in bottoms manufacturing, in 1990 the Company entered
into a license agreement for the exclusive use of the BOSS brand name on men's
denim apparel and on all types of juniors' sportswear for the young women's
market. In 1994, the Company expanded its license agreement to include use of
the BOSS brand name on men's, women's, boys' and youth sportswear in the United
States and Puerto Rico. In 1997, the Company's rights to manufacture and market
BOSS sportswear were further expanded to allow broader product offerings and
significant Company control over styling, advertising and distribution. In the
fall of 1993, the Company entered into license agreements for the use of the
Beverly Hills Polo Club brand name on men's sportswear in the United States and
Puerto Rico. License rights were expanded to include Europe in 1996.
In November 1997, the Company acquired an exclusive license to manufacture
and market certain men's sportswear under the Girbaud brand in the United States
and Puerto Rico. Over the last ten years, the Girbaud brand was manufactured and
marketed in the United States under license by VF Corp. The Girbaud brand is an
internationally recognized designer sportswear label with a distinct European
influence. By targeting men who desire contemporary international fashion, the
Girbaud brand enables the Company to address another consumer segment within its
branded product portfolio. The Company has positioned the Girbaud men's line
with a broader assortment of products, styles and fabrications reflecting a
contemporary European look. The Company began marketing a fall men's collection
under the Girbaud brand in February 1998. In March 1998, the Company entered
into an exclusive license agreement to manufacture and market certain women's
sportswear under the Girbaud brand in the United States and
20
Puerto Rico. The Company began marketing women's sportswear under the Girbaud
brand in the second quarter of 1998. The Company has positioned the Girbaud
women's line with a broad assortment of contemporary sportswear products, styles
and fabrications. The Company paid an initial license fee of $600,000. Under the
Girbaud men's license agreement, the Company is required to spend at least
$350,000 in advertising for the men's Girbaud brand in 1998 and at least
$500,000 each year thereafter while the agreement is in effect. Under the
Girbaud women's license agreement, the Company is required to spend at least
$550,000 in advertising for the women's Girbaud brand in 1998 and at least
$400,000 each year thereafter while the agreement is in effect. In addition, the
Company is required to contribute $190,000 per year to the licensor's
advertising and promotional expenditures for the Girbaud brand. In December 1998
the Girbaud women's license agreement was amended to provide that the Company
would spend an additional $1.8 million in sales and marketing of the brand in
1999. Minimum royalty payments began in the first quarter of 1998. In November
1998, the Company entered into an exclusive license agreement to manufacture and
market certain men's and women's sportwear under the Girbaud brand in selected
countries in Central and South America and in the Carribean. See "ITEM
1. Business--Licenses and Other Rights Agreements."
The Company also manufactures and markets a limited number of pants and
jeans styles for women under its own "I.C. Isaacs," "Lord Isaacs" and "Pizzazz"
brand names and under third-party private labels for sale to major chain stores
and catalogs. The Company intends to continue to manufacture and market these
pants and jeans for the foreseeable future. See "ITEM 1. Business--Licenses and
Other Rights Agreements."
Over the past several years, the Company has completed its strategic
repositioning from a manufacturing-driven company to a marketing and
brand-driven company. Through a focused strategy of providing fashionable,
branded merchandise at value prices, the Company has emerged as a significant
fashion influence for youthful and contemporary consumers who purchase
sportswear through specialty and department stores. The Company's brand-driven
market strategy is evidenced by the increase of licensed, branded apparel as a
percentage of the Company's net sales. In 1998, the BOSS, Beverly Hills Polo
Club and Girbaud brands comprised 73.4%, 14.6% and 4.1% of net sales,
respectively. Concurrently with this strategy, the Company has also shifted its
product mix from predominately bottoms to a full array of sportswear, including
tops and outerwear. The Company has also expanded its branded lines to include
sportswear for boys, youth and juniors. Historically, the Company has recognized
markdowns for specific unsold inventory in the second and fourth quarters. These
specific markdowns are reflected in cost of sales and the related gross margins
at the conclusion of the appropriate selling season.
RESULTS OF OPERATIONS
The following table sets forth, for the periods indicated, the percentage
relationship to net sales of certain items in the Company's consolidated
statements of income for the periods shown below:
YEAR ENDED DECEMBER 31,
-----------------------------------
1996(1) 1997(1) 1998
----------- ----------- ---------
Net sales.................................................................... 100.0% 100.0% 100.0%
Cost of sales................................................................ 71.1 67.9 79.7
----- ----- ---------
Gross profit................................................................. 28.9 32.1 20.3
Selling expenses............................................................. 10.0 10.1 14.9
License fees................................................................. 4.1 4.7 5.3
Distribution and shipping expenses........................................... 2.2 2.7 3.4
General and administrative expenses.......................................... 4.7 4.6 9.3
----- ----- ---------
Operating income (loss)...................................................... 7.9% 10.0% (12.6)%
----- ----- ---------
----- ----- ---------
- ------------------------
(1) General and administrative expenses have been reduced to reflect the receipt
in 1996 and 1997 of approximately $0.7 million and $0.1 million,
respectively, related to an agreement with the Company's insurance carrier
to reimburse it for legal fees associated with litigation billed in prior
years.
21
YEAR ENDED DECEMBER 31, 1998 COMPARED TO YEAR ENDED DECEMBER 31, 1997
NET SALES.
Net sales decreased 29.6% to $113.7 million in 1998 from $161.4 million in
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
1998 Boss and Beverly Hills Polo Club men's lines. Net sales of BOSS sportswear
decreased $37.0 million or 30.7% to $83.4 million. Net sales of the BOSS tops
segment were $32.7 million in 1998 versus $48.1 million in 1997. Net sales of
Beverly Hills Polo Club sportswear decreased $8.9 million or 34.9% to $16.6
million. The spring 1999 BOSS and Beverly Hills Polo Club collections were
presented on time. Net sales of Girbaud sportswear were $4.7 million in 1998.
The Company began to recognize revenue from shipments of Girbaud men's
sportswear in the second quarter of 1998 and from shipments of Girbaud
sportswear for women in the fourth quarter of 1998. The Company's sales of
Company-owned brands and private label brands decreased 41.8% to $9.0 million in
1998. In April 1998, the Company entered into an exclusive license agreement to
manufacture and market boys' sportswear under the Beverly Hills Polo Club brand
in the United States and Puerto Rico. In November 1998, the Company entered into
exclusive international license agreements to manufacture and market men's and
women's sportswear under the Girbaud brand in selected countries in Central and
South America and in the Caribbean.
GROSS PROFIT.
Gross profit decreased 55.4% to $23.1 million in 1998 from $51.8 million in
1997. Gross profit as a percentage of net sales decreased from 32.1% to 20.3%
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 in 1998 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 $5.5
million in 1998 to properly reflect unsold inventory at net realizable value.
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 was appropriate at December 31, 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.
Selling, distribution, general and administrative ("SG&A") expenses
increased 10.4% to $31.4 million in 1998 from $28.0 million in 1997. As a
percentage of net sales, SG&A expenses increased to 27.6% from 17.4% over the
same period due to lower net sales coupled with higher advertising expenditures
and costs of merchandise samples offset somewhat by lower commissions to the
Company's salespersons. Advertising expenditures increased $1.8 million to $5.7
million as the Company continued to focus on enhancing the identity and image of
its brands through increased media exposure. The increase in advertising was
primarily due to advertising for the Girbaud brand in 1998. Distribution and
shipping expenses decreased $0.4 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 $10.0 million due
to amortization of the BOSS trademark, a one-time write-off of goodwill,
professional fees, directors and officers insurance and year 2000 consulting
expenses of $1.1 million, $0.4 million, $0.4 million, $0.3 million and $0.2
million, respectively, and $0.2 million and $0.3 million loss provisions for
estimated costs
22
associated with closing the Newton, Mississippi and Carthage, Mississippi
manufacturing facilities. The loss provisions relate primarily to severance pay
for employees.
LICENSE FEES.
License fees decreased $1.6 million to $6.0 million in 1998 from $7.6
million in 1997. As a percentage of net sales, license fees increased from 4.7%
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 188.9% to ($14.4) million in 1998 from
$16.2 million in 1997. The decline was due to lower net sales and reduced gross
profit margin percentage and, to a lesser extent, an increase in operating
expenses, as explained above.
INTEREST EXPENSE.
Interest expense decreased $0.9 million to $1.5 million in 1998. The Company
repaid the outstanding balance of its asset-based revolving line of credit with
a portion of the proceeds of its initial public offering completed in December
1997. Borrowings under the line of credit were insignificant in the first six
months of 1998, however the Company began to borrow under the line of credit in
the third and fourth quarters and incurred $0.2 million in interest expense in
1998. In addition, the Company incurred interest expense of $1.1 million related
to the $11.25 million note payable associated with its purchase of the BOSS
trademark in November 1997. This expense of $1.1 million was offset somewhat by
interest income of $0.3 million earned on available cash. The Company invests
its excess cash in short-term investments.
INCOME TAXES.
The Company recorded an income tax benefit of $0.2 million in 1998 to
recognize a tax benefit for the carryback of net operating losses to recover
income taxes paid during 1997. The Company wrote off a deferred tax asset of
$1.5 million during the fourth quarter of 1998 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 because it elected to be treated as a Subchapter S
Corporation. The Company terminated its Subchapter S Corporation status in
December 1997.
YEAR ENDED DECEMBER 31, 1997 COMPARED TO YEAR ENDED DECEMBER 31, 1996
NET SALES. Net sales increased 36.0% to $161.4 million in 1997 from $118.7
million in 1996. Substantially all of this increase was due to higher volume
shipments of BOSS and Beverly Hills Polo Club sportswear. Net sales of BOSS
sportswear increased $34.3 million or 39.8% to $120.4 million primarily driven
by strong growth in the men's tops, boys' and youth segments. Net sales of the
BOSS tops segment were $48.1 million in 1997 versus $29.3 million in 1996. Net
sales of Beverly Hills Polo Club sportswear increased $11.3 million or 79.0% to
$25.6 million over the same period, primarily driven by strong growth in the
men's business. The increases in net sales were partially offset by weaker than
expected performance in the fourth quarter of 1997 principally attributable to
sluggishness in the retail apparel market, primarily at the specialty store
level. International sales were insignificant in 1997.
GROSS PROFIT. Gross Profit increased 51.5% to $51.8 million in 1997 from
$34.2 million in 1996. Gross profit as a percentage of net sales increased to
32.1% in 1997 from 28.9% in 1996. The increase in gross profit was due in part
to the expansion of the BOSS tops product line, which typically carries a higher
gross margin than the bottoms product line. In addition, the tops line had
improved gross margins due to reduced costs on imported tops resulting from
volume purchase discounts. Also, the continued shift of production of denim
bottoms from the United States to Mexico and the accompanying decrease in labor
and overhead costs contributed to the improved gross margin. The Company's
improved gross margin was
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also a result of increased sales of products at full margin, particularly in the
first quarter, offset somewhat by markdowns taken in the second quarter related
to unsold spring and summer goods.
SELLING, DISTRIBUTION, GENERAL AND ADMINISTRATIVE EXPENSES. SG&A expenses
increased 39.3% to $28.0 million in 1997 from $20.1 million in 1996. As a
percentage of net sales, SG&A expenses increased to 17.4% from 16.9% in 1996 as
the Company continued to increase investment in its organizational structure and
personnel to support growth and expanded advertising. Selling expenses increased
$4.3 million to $16.2 million in 1997 as a result of higher commissions to the
Company's salespersons and higher advertising expenditures which increased $1.4
million to $3.9 million as the Company continued to focus on enhancing the
identity and image of its brands through increased media exposure. Distribution
and shipping expenses increased $1.6 million to $4.3 million due to higher unit
shipments and increased overtime costs. The Company opted to incur additional
overtime wages rather than adding personnel to process the increase in unit
shipments. General and administrative expenses increased $1.3 million to $7.5
million due to salary increases for existing employees and salaries and costs
associated with the hiring of new management and administrative personnel.
LICENSE FEES. License fees increased $2.8 million to $7.6 million in 1997
from $4.8 million in 1996. As a percentage of net sales, license fees increased
to 4.7% from 4.1%. This increase was due to greater sales growth of non-denim
branded products, which have higher royalty rates than other branded products.
The Company believes that its license fees will increase as the percentage of
net sales of branded products increases.
OPERATING INCOME. Operating income increased 74.2% to $16.2 million or
10.0% of net sales in 1997, from $9.3 million or 7.9% of net sales in 1996. This
increase resulted primarily from the increase in net sales and gross profit
margins.
INTEREST EXPENSE. Interest expense increased $1.0 million to $2.4 million
in 1997 due to an increase in working capital borrowing requirements. In 1997
the average debt balance was $17.1 million, with an average effective interest
rate of 9.5%. In 1996, the average debt balance was $9.8 million with an average
effective interest rate of 9.25%.
INCOME TAXES. The Company recorded a net income tax benefit of $1.3 million
in the fourth quarter of 1997. Prior to its initial public offering, the
Company's earnings were not subject to federal, state and local income taxes. In
connection with its initial public offering, the Company became subject to such
taxes, and as a result, recorded a deferred tax asset and a corresponding tax
benefit of approximately $1.5 million in conjunction with termination of its
Subchapter S Corporation status in December 1997. This income tax benefit was
offset somewhat by a current provision for income taxes of $0.2 million which
was recorded for the period December 23, 1997 to December 31, 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 decreased significantly during 1998 compared to 1997, primarily due to
the 1998 net loss and purchases of treasury stock partially offset by the
issuance of Company stock upon the exercise of the over-allotment option in
January 1998. As of December 31, 1998, the Company had cash, including temporary
investments of $1.3 million and working capital of $31.6 million compared to
$7.4 million and $45.9 million, respectively as of December 31, 1997.
OPERATING CASH FLOW.
Cash used in operations totaled $9.3 million in 1998, an increase of $7.7
million from December 31, 1997 to December 31, 1998, due to the net loss offset
by decreases in accounts receivable, inventories, and
24
accounts payable offset somewhat by increases in refundable income taxes and
other assets. Cash used for investing activities in 1998 totaled $1.9 million
and was used primarily to purchase the land and initiate the 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 $5.1 million in 1998, resulting
primarily from the issuance of stock upon the exercise of the over-allotment
option in January 1998 and borrowings under its revolving line of credit
partially offset by the purchase of treasury stock.
Inventory decreased $0.8 million from December 31, 1997 to December 31,
1998, compared to an increase of $9.8 million from December 31, 1996 to December
31, 1997. The change in 1998 was due to an increase in the quantity of finished
goods offset, (in part due to continued production for sales that never
materialized), by a $5.5 million inventory valuation allowance related to slow
moving inventory. The increase in inventories was due to a decline in sales of
BOSS men's and Beverly Hills Polo Club sportswear as well as inventory for the
new Girbaud collections.
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 $1.5 million in 1998 compared to $1.1 million in
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 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. 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. Conversion of its primary software programs was completed in
November 1998 and testing occurred in the first quarter of 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 1999. 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. The production in this facility, the majority of which was