Item 1. BUSINESS
General
Sola International Inc., a Delaware corporation, designs, manufactures and distributes a broad range of plastic and glass eyeglass lenses. Sola's business commenced operations in 1960. Sola International Inc. acquired the Sola business unit (the "Predecessor Business") of Pilkington plc ("Pilkington") on December 1, 1993 (the "Acquisition"). In March 1995, Sola completed its initial public offering (the "IPO"). On June 19, 1996 Sola acquired substantially all of the worldwide ophthalmic business (the "AO" and "AO Acquisition") of American Optical Corporation ("AOC"). On July 2, 1996 the Company acquired Neolens, Inc. ("Neolens"), a manufacturer of polycarbonate eyeglass lenses. Sola has manufacturing and distribution sites in three major regions -- North America, Europe, and Rest of World (comprising primarily Australia, Asia and South America). Unless the context otherwise requires, all references to the "Company" or "Sola" herein refer to Sola International Inc. and its consolidated subsidiaries. The Company's fiscal year ends on March 31 of each year. The fiscal years ended March 31, 1998, March 31, 1997 and March 31, 1996 are referred to herein as "fiscal 1998", "fiscal 1997" and "fiscal 1996", respectively.
Products
The Company produces plastic and glass eyeglass lenses. The Company's lens products are differentiated by type of vision correction, lens design, lens material and coatings applied to the lens. The Company's lenses include single vision lenses (lenses which have a constant corrective power at all points); multifocal lenses (lenses which have more than one corrective power, including bifocal lenses, which have two distinct areas of different corrective power, and progressive lenses, which have a continuous gradient of different corrective power); and plano lenses (lenses which have no corrective power and are primarily used for sunglasses).
Although the Company's lenses are manufactured in both glass and plastic, plastic lenses currently account for approximately 90% of the Company's net lens sales. Approximately 52% of ophthalmic lens sales generated by plastic lenses are accounted for by conventional hard resin plastics, with the remainder derived from advanced lens materials such as thinner and lighter plastics and plastic photochromics. These more advanced materials have accounted for a growing percentage of the Company's sales both by volume and revenue. Sola manufactures and markets several advanced thinner and lighter plastic lens materials, including Spectralite(R), Finalite 1.6(TM) and polycarbonate. Spectralite(R) and Finalite 1.6(TM) are proprietary materials developed by Sola's research and development operation. Raw materials used in the manufacture of these products are available from a number of chemical suppliers. Polycarbonate is another thin and light material with greater impact resistance. To further improve the thinness and lightness of its lenses, the Company has increasingly employed aspheric and atoric designs (i.e., lenses that achieve comparable optical performance with a thinner cross section). The Company also sells plastic photochromic lenses, which require processing by a third party. The technology for such processing is currently proprietary to such third party.
The Company also manufactures and sells glass lenses, primarily in North America and Europe. These lenses are manufactured in plants located in the United States, Mexico and France. The Company's strategy for the glass lens market is to focus on high value-added product categories, such as glass progressive and higher index glass lenses. Since the Company is primarily focused on plastic lenses, glass lenses represent a small and decreasing portion of the Company's sales. The Company sells virtually no glass lenses in South America and non-Japan Asia, markets where glass is still the predominant material for eyeglass lenses.
The Company produces a variety of lens coatings, which primarily provide scratch resistance and anti-reflection properties. The penetration of coated lenses varies significantly from market to market.
The Company has recently introduced a number of new products and has a number of products in development that are intended to maintain and increase the Company's operating margins. For example, the Company has developed and successfully marketed proprietary progressive lenses (including Percepta(R) and VIP Gold(R)), which incorporate more complex design features than standard products and therefore attract an above average gross profit per pair. During fiscal 1998 Sola's proprietary Matrix(R) delivery system was installed at an increasing number of sites in the U.S. and foreign locations. This system, which creates finished prescriptions by bonding together thin lens wafers in a desktop laminating console, allows the rapid delivery of lenses with anti-reflective coating and potentially other high margin add-ons. The Company from time to time may also market products or technologies of third parties to broaden its product range pursuant to contractual relationships with such third parties.
Marketing and Sales
The Company develops and manages its marketing strategy on a decentralized basis and has sales offices in 20 countries across its three regions. The Company differentiates its products from those of its competitors through lens design, lens materials and coatings formulations. In response to customer demand, the Company's strategy is focused on providing a wide range of quality products on short notice. In developing markets, particularly in non-Japan Asia and Latin America, the Company seeks to expand its market share by increasing local production, attempting to develop brand recognition for its products and marketing to customers the advantage of higher value-added products, all of which are intended to help the Company compete on the basis of quality and service rather than price.
Distribution
In order to meet customer demand for delivery of a broad range of products within a short time, the Company has established a widespread distribution network, which is managed on a regional basis. The Company operates 52 major distribution centers located in 20 countries, covering all of its three regions.
The Company utilizes three primary distribution channels for its products. Lenses with corrective power are distributed (i) through a wholesale channel to wholesale distributors or to independent processing laboratories that process the Company's lenses and then resell them to retail outlets and practitioners for resale to consumers, (ii) through a retail channel to chains, superoptical retail stores (retail outlets with on-site lens processing capability) and other retailers (including "buying groups" consisting of a number of retailers acting together to purchase lenses) who sell the lenses to consumers and (iii) in certain markets in Asia and Europe, direct to eyecare practitioners through the Company's processing laboratories. Plano lenses are sold primarily to manufacturers of sunglasses. In English speaking markets (the United States, Australia and the United Kingdom), a significant percentage of the Company's sales is to large retail chains and superoptical retail stores. In most other markets, those retail-oriented channels are less significant, hence, the Company's sales are primarily oriented toward independent wholesale processing laboratories, as well as eyecare practitioners served by Company-owned labs.
Customers
During fiscal 1998, the Company's ten largest customers accounted for approximately 19.6% of net sales and the Company's largest customer accounted for 5.7% of net sales. During fiscal 1998, 7 of the Company's 10 largest customers were located in North America and accounted for approximately 15.7% of net sales in the aggregate.
One of the company's largest competitors, Essilor International, is extensively vertically integrated into wholesale laboratories, both in the United States and other parts of the world. Sola has sold and continues to sell its products to these Essilor laboratories.
International Operations
The Company operates manufacturing and distribution sites in all major regions of the world--North America (including Mexico), Europe, and Rest of World (comprising primarily Australia, Asia and South America)--and derived approximately half of its net sales in fiscal 1998 from the sale of products outside the United States. See Note 15 of Notes to Consolidated Financial Statements included elsewhere herein. As a result, a significant portion of the Company's sales and operations are subject to certain risks, including adverse developments in the foreign political and economic environment, exchange rates, tariffs and other trade barriers, staffing and managing foreign operations and potentially adverse tax consequences. Although the Company and its predecessors have been successfully conducting business outside of the United States since its inception in 1960, there can be no assurance that any of these factors will not have a material adverse effect on the Company's financial condition or results of operations in the future.
Manufacturing Operations
The Company has 20 manufacturing facilities located in its three major regions, including 18 lens manufacturing facilities. The Company has sought to make each operating region self-sufficient in the production of core products, while manufacturing both high-volume plano lenses and newer, low-volume and more complex products in fewer locations. More centralized manufacturing is pursued where appropriate in order to maximize production efficiencies or maintain strict quality controls and research and development support. For the location and principal operations of these facilities, see "Properties".
The principal materials used by the Company in the production of eyeglass lenses are hard resins (a commodity plastic used in most plastic lenses), glass, specialized chemicals used in many higher index plastic lenses and monomers mixed by the Company in the production of Spectralite(R). The Company believes that these materials are currently available from a variety of sources and that the materials necessary to produce the Company's coatings are readily available from a number of potential sources. In order to reduce materials costs, the Company coordinates centrally the purchasing of new materals (including monomers) and has negotiated more favorable purchasing arrangements with its principal suppliers on an annual basis.
Research and Development
The Company has invested and continues to invest heavily in research and development in order to continually develop new and innovative products and to improve the efficiency of its manufacturing process. At March 31, 1998, there were approximately 184 employees involved in the Company's research and development efforts. The Company's research and development expenditures for fiscal 1998, 1997 and 1996 were $18.3 million, $17.5 million (excluding the non-recurring $9.5 million in-process research and development non-cash charge associated with the AO Acquisition in fiscal 1997) and $13.3 million, respectively, representing 3.3%, 3.6% and 3.4% of net sales for each of those years. The Company has its own research and development centers in Petaluma, California, Southbridge, Massachusetts, and Adelaide, Australia. A small process automation group is attached to the manufacturing operation in Wexford, Ireland. The Company's research and development focuses on the design and development of innovative, value-added products, on new materials with superior characteristics, on technology that will deliver products to the market more efficiently, and on technologies to improve productivity in the manufacture of existing products. Recent research and development programs include the successful development of the Spectralite(R) thin and light lens material, the development of Spectralite(R) with photochromic capabilities, Percepta(R) progressive design, Access and Continurim enhanced near vision lens designs, and ultra tough multi coat ("UTMC") and other coatings. Sola's proprietary Matrix(R) delivery system which creates finished prescriptions by bonding together thin lens wafers in a desktop laminating console, allows the rapid delivery of lenses with anti-reflection coating and potentially other high margin add-ons. This system is being installed at an increasing number of sites in the U.S. and foreign locations.
Competition
The eyeglass lens and coating industry is highly competitive. The Company competes principally on the basis of customer service, the quality and breadth of product offerings, and price. The Company believes that among its largest global competitors are Essilor International and Hoya Corporation. The eyeglass lens and coating industry is characterized by price competition, which can be severe in certain markets, particularly for high volume, standard products. Sola attempts, to the extent possible, to counter competition on the basis of price by focusing on providing a rapid response to orders, maintaining high fill rates, developing differentiated new products, and educating processing laboratories and eyecare practitioners on the benefits of Sola lenses and coatings. There can be no assurance, however, that the Company's competitors will not develop products or services that are more effective or less expensive than the Company's products or which could render certain of the Company's products less competitive. Since recently-developed products comprise a substantial portion of the Company's sales, the Company's performance is dependent upon its continuing ability to develop and market new products. Some of the Company's competitors have significantly greater financial resources than the Company to fund expansion and research and development. Within a particular market, certain of the Company's competitors may enjoy a "home-country" advantage over foreign competition. In addition, in certain markets (primarily Europe), the Company also faces competition from a number of its principal competitors which are vertically integrated with processing centers to a greater extent than the Company, enabling them to customize prescription lenses. This limits the number of independent lens processing customers to which the Company can market its products.
In addition to direct competition with other manufacturers of eyeglass lenses, the Company competes indirectly with manufacturers of contact lenses and providers of medical procedures for the correction of visual impairment. Contact lenses and eyeglasses are not, however, perfect substitutes because of the difficulty of developing progressive or bifocal contact lenses for presbyopia and the tendency of contact lens wearers to also own eyeglasses. Current medical vision corrective procedures also are ineffective in correcting presbyopia and many patients who have undergone medical vision correction still require eyeglasses, although the prescription required may be weaker. The Company therefore believes that such indirect competition will not have a material adverse effect on the Company's business in the foreseeable future.
Patents, Trademarks & Licenses
The Company seeks to protect its intellectual property throughout the world. As of March 31, 1998, the Company had filed (or applied for) patents for 54 discrete inventions or technologies. Many of the Company's patents have been filed in multiple countries, and they include 46 patents (or patent applications) filed in the United States. The Company has been granted 250 trademarks in various countries, representing rights to 65 discrete names. These include 47 trademarks granted in the United States. A further 25 tradenames are under application. The Company does not believe that it is dependent on any particular patent, trade secret or similar intellectual property and, in light of its manufacturing, marketing and distribution strengths, believes that the loss of any individual trademark, trade secret or patent would not have a material adverse effect on its results of operations or financial condition.
As a result of the AO Acquisition and the ongoing research and development within that company, Sola acquired an additional portfolio of patents and patent applications. Upon consolidation within the overall portfolio and after taking account of the expiration of older patents, intellectual property protection will be maintained over an additional 16 discrete inventions and technologies, within the United States and multiple other countries. An additional trademark portfolio was similarly acquired. This includes a total of 66 discrete names, representing a total of 313 trademarks in multiple countries of which 66 are granted in the United States.
Employees
As of March 31, 1998, the Company had approximately 7,800 employees throughout the world. The majority of the Company's employees are not represented by labor unions. Labor relations are considered to be good and there have been no significant labor disputes in the past ten years.
Environmental Matters
The Company (together with the industry in which it operates) is subject to United States and foreign environmental laws and regulations concerning emissions to the air, waste water discharges and the generation, handling, storage, transportation and disposal of hazardous wastes, and to other federal, state and foreign laws and regulations. The Company believes that it possesses all material permits and licenses necessary for the continuing operation of its business and believes that its operations are in substantial compliance with the terms of all applicable environmental laws. It is impossible to predict accurately what effect these laws and regulations will have on the Company in the future.
Environmental laws and regulations vary among countries in which the Company operates. During fiscal 1992, the Company adopted an environmental policy which includes an environmental auditing process designed to evaluate and assist operating regions in their environmental compliance efforts.
The Company's manufacturing processes generally utilize non-hazardous chemicals where feasible. Certain processes, including those for cleaning lenses and mold assemblies, and abrasion resistant and anti-reflection coating of lenses, use a variety of volatile and other hazardous substances. Company developments in manufacturing methods, alternative non-solvent cleaning processes and waste reduction have been successful in reducing the use of these chemicals and/or emissions and environmental damage from these processes. Programs to eliminate use of chlorinated hydrocarbons and chlorofluorocarbons ("CFC's") in manufacturing processes have also been developed and the current use of these substances in the Company's North American operations is minimal.
Since 1988 the Company has operated a ground water remediation system at its Petaluma, California manufacturing facility in accordance with a consent order issued by the U.S. Environmental Protection Agency ("EPA") under the Comprehensive Environmental Response, Compensation and Liability Act of 1980. The system is designed to remediate a pre-1982 release of hazardous substances. Analytical results indicate that contamination levels have decreased significantly over the past few years. In March 1997 the EPA consented to the Company curtailing clean-up activities for a six month period which ended in September. The Company continued to monitor contamination levels during the curtailment period. During the quarter ended December 31, 1997 a report on contamination levels, and the impact of curtailed activities, was submitted to the EPA, and such report is currently under review. The report indicates no significant impact on the site from the curtailed activities, and the EPA has consented to continued curtailment of activities until such time as they have concluded their review of the report. The Company expects continued reduction of clean-up activities due to relatively low levels of contamination existing at the site.
Late in fiscal 1996, the Company was requested by the Missouri Department of Natural Resources ("MDNR") to conduct a removal action at a disposal site near Eldon, Missouri known as the Coburn Optical Industries Dump site, which was allegedly used by a predecessor to the Company for disposal of waste water sludge containing lead from 1974 to 1986. The MDNR has indicated that it considers the removal action at this site to be a low priority. Nonetheless, the Company agreed to undertake the requested removal action pursuant to the MDNR's Voluntary Cleanup Program. The Company completed its clean-up program during fiscal 1998 and the MDNR issued a no further action letter in March 1998.
It is possible that the Company may be involved in other similar investigations and actions under state, federal or foreign law in the future. Based on currently available information, the Company does
not believe that its share of costs, either at the existing sites or at any future sites, is likely to result in a liability that will have a material adverse effect on its results of operations or financial condition.
It is the Company's policy to meet or exceed all applicable environmental, health and safety laws and regulations. The complexity and continuing evolution of environmental regulation (including certain programs for which implementing regulations have not yet been finalized) preclude precise estimation of future environmental expenditures.
In connection with the Acquisition, Pilkington has agreed to indemnify the Company with respect to environmental losses based upon or resulting from certain existing facts, events, conditions, matters or issues, for (i) 50% of such losses to the extent such losses exceed $1 million but are less than or equal to $5 million, and (ii) 100% of such losses in excess of $5 million.
See Note 14 of Notes to Consolidated Financial Statements included elsewhere herein.
Item 2.
Item 2. PROPERTIES
A portion of the Company's research and development activities, its corporate headquarters and certain manufacturing and distribution operations are located near major earthquake faults. The ultimate impact on the Company is unknown, but operating results could be materially affected in the event of a major earthquake. The Company is predominantly self-insured for losses and interruptions caused by earthquakes.
For further information concerning the Company's leased properties, see Note 13 of Notes to Consolidated Financial Statements included elsewhere herein. The Company's operating leases have expirations ranging from 1998 to 2012. The Company does not anticipate any difficulties in renewing or replacing such leases as they expire; however, there can be no assurances that the Company will be able to renew or replace such leases. The Company believes that its manufacturing capacity is sufficient for its current needs.
Item 3.
Item 3. LEGAL PROCEEDINGS
In addition to the proceedings described under "Business - Environmental Matters", the Company is involved in routine litigation incidental to its business, none of which it believes will have a material adverse effect on its results of operations or financial condition. See Note 14 of Notes to Consolidated Financial Statements included elsewhere herein.
Item 4.
Item 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted to a vote of the security holders of the Company during the last quarter of fiscal 1998.
PART II
Item 5.
Item 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
On May 29, 1998, the closing price per share of the Company's Common Stock on the New York Stock Exchange was $39 9/16. As of May 29, 1998, there were 408 holders of record of the Company's Common Stock, which excludes beneficial owners of Common Stock held in "street name".
Since the Acquisition, the Company has not declared or paid any cash dividends on its Common Stock. The Company's credit agreement, among the Company, the lenders named therein and The Bank of America National Trust and Savings Association, for itself and as agent for a syndicate of other financial institutions, dated June 1996 as amended (the "Amended Agreement"), generally restricts, subject to certain exceptions, the payment of dividends, distributions and other payments. The Company does not anticipate paying any cash dividends in the foreseeable future and intends to retain future earnings for the development and expansion of its business. Subject to such restrictions, any future determination to pay dividends will be at the discretion of the Company's Board of Directors and subject to certain limitations under the General Corporation Law of the State of Delaware and will depend upon the Company's results of operations, financial condition, other contractual restrictions and factors deemed relevant by the Board of Directors.
Item 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Overview
The following discussion of the Company's financial condition and results of operations should be read in conjunction with the Company's consolidated financial statements and notes thereto included elsewhere in this Form 10-K. The financial statements for the year ended March 31, 1997 reflect the consolidated operations of the Company after accounting for the acquisition ("AO Acquisition") of substantially all of the worldwide ophthalmic business ("AO") of American Optical Corporation ("AOC") on June 19, 1996 (see Note 1 of Notes to Consolidated Financial Statements), using the purchase method of accounting. Operating results for fiscal 1997 subsequent to the AO Acquisition include non-recurring, non-cash charges relating to the write-off of in-process research and development projects ($9.5 million) and amortization associated with an inventory write-up to fair value ($7.2 million), both of which were recorded in connection with the AO Acquisition. The years ended March 31, 1998, 1997 and 1996 are referred to herein as fiscal 1998, fiscal 1997 and fiscal 1996, respectively.
Results of Operations
Net Sales
Net sales were $547.7 million in fiscal 1998, $488.7 million in fiscal 1997, and $387.7 million in fiscal 1996, reflecting a growth of 12.1% from fiscal 1997 to fiscal 1998 and 26.0% from fiscal 1996 to fiscal 1997. Using constant exchange rates, the percentage increase from fiscal 1997 to fiscal 1998 was 16.6%, and from fiscal 1996 to fiscal 1997 was 25.6%. The AO Acquisition, with nine months of AO net sales, amounting to $64.4 million, included in fiscal 1997 net sales, had a significant impact on the net sales growth from fiscal 1996 to fiscal 1997. Higher priced product growth has contributed to the Company's net sales growth in fiscal 1997 and fiscal 1998, led by the growth of Spectralite(R), plastic photochromic and polycarbonate products, offset in part by price and volume erosion in net sales of lower priced products. Higher priced products accounted for approximately 66% of net lens sales in fiscal 1998 compared to 61% in fiscal 1997 and 57% in fiscal 1996. Increased marketing and customer service efforts have also contributed to the growth in other higher priced products. Net sales increases by region from fiscal 1997 to 1998 were as follows: North America 20.1%, Europe 7.1% and Rest of World 1.3%. Net sales increases in major market areas from fiscal 1996 to 1997 were as follows: North America 22.7%, Europe 40.6% and Rest of World 15.9%. At constant exchange rates, net sales increases from fiscal 1997 to fiscal 1998 were: North America 20.1%, Europe 16.0% and Rest of World 6.8%, and from fiscal 1996 to fiscal 1997 were: North America 22.9%, Europe 42.2% and Rest of World 12.1%.
Gross Profit and Gross Margin
Gross profit totaled $258.1 million in fiscal 1998, $231.4 million, as adjusted, in fiscal 1997 and $185.7 million in fiscal 1996, reflecting growths of 11.5% from fiscal 1997 to fiscal 1998 and 24.6% from fiscal 1996 to fiscal 1997. Gross profit as a percentage of net sales ("gross margin") in fiscal 1998, fiscal 1997, as adjusted and fiscal 1996, were 47.1%, 47.3%, and 47.9%, respectively. The gross margin has decreased in fiscal 1998 and fiscal 1997, as AO traditionally operates at lower gross margins than Sola on a stand alone basis. In addition, the Company continues to incur manufacturing start up costs in its
new finished polycarbonate manufacturing operation acquired when the Company purchased Neolens, Inc. in July 1996, and ramp up costs associated with new product offerings, such as Matrix, the Company's new anti-reflective coating delivery system. Offsetting in part the aforementioned reductions, has been a continued shift towards higher value added products, and continued benefits from the Company's cost reduction program. During fiscal 1996 the Company benefited from reduced manufacturing costs at its Mexican facility arising from the weakness of the Mexican Peso, and from the Company's cost reduction program. The Company continues to experience price competition, which can be severe in certain markets, particularly for standard products.
Operating Expenses
Operating expenses totaled $165.4 million in fiscal 1998, $157.3 million, as adjusted, in fiscal 1997 and $125.0 million in fiscal 1996 reflecting increases of 5.1% from fiscal 1997 to fiscal 1998 and 25.9% from fiscal 1996 to fiscal 1997. Research and development expenses for fiscal 1998, 1997 and 1996 represent 3.3%, 3.6% and 3.4%, respectively, of annual net sales, reflecting the Company's continued commitment to research and development of new products, materials and processes. Because research and development expenditure in AO as a percentage of net sales is lower than that of Sola on a stand alone basis, the current lower ratio of research and development expenses to net sales can be expected for the combined company in the future. The lower charge to research and development expenses in fiscal 1996 arose primarily from the transfer of a new product out of research and development and into production. Selling and marketing expenses were 17.2%, 18.9% and 17.1% of net sales in fiscal 1998, 1997 and 1996, respectively. During the fourth quarter of fiscal 1997 the Company introduced a new progressive lens design, Percepta(R), with a worldwide launch. Significant marketing expenditures associated with this launch were incurred primarily in the last two quarters of the 1997 fiscal year resulting in higher sales and marketing expenses as a percentage of net sales in fiscal 1997. As a percentage of net sales, general and administrative expenses in fiscal 1998, fiscal 1997 and fiscal 1996 were 9.7%, 9.7% and 11.7%, respectively. The higher percentage in fiscal 1996 compared to fiscal 1998 and fiscal 1997 was primarily due to higher performance based management bonuses in fiscal 1996 and higher provisions for doubtful accounts in South America and Asia.
Operating Income
Operating income for fiscal 1998 totaled $92.7 million, an increase of $18.6 million over fiscal 1997 operating income, as adjusted, of $74.1 million, or 25.2%. Operating income for fiscal 1997 totaled $74.1 million, as adjusted, an increase of $13.3 million over fiscal 1996 operating income of $60.8 million, or 21.9%.
Net Interest Expense
Net interest expense totaled $16.8 million for fiscal 1998, $15.9 million for fiscal 1997 and $12.1 million for fiscal 1996. Interest expense was higher in fiscal 1998 than fiscal 1997, primarily due to a full year of higher indebtedness to fund the acquisitions of AO and Neolens in June and July of 1996, offset in part by lower interest rates on the Company's revolving line of credit, and the repurchase of its 9 5/8% senior subordinated notes in December 1997. Interest expense was higher in fiscal 1997 than fiscal 1996 also due to the AO and Neolens acquisitions, offset by the lower interest rate under the Company's new bank credit facility and the reduction of debt from the proceeds of the equity public offering. Simultaneously with the AO Acquisition, the Company entered into a new bank credit facility with The Bank of America National Trust and Savings Association, for itself and as agent for a syndicate of other financial institutions (see "--Liquidity and Capital Resources"). In July 1996, the Company issued 2.32 million shares of common stock in a public offering for which it received net proceeds of approximately $62.8 million.
Provision for Income Taxes
The Company's combined state, federal and foreign tax rate was approximately 33.4% for fiscal 1998 compared to 28.5% for fiscal 1997, as adjusted, and 28.0% for fiscal 1996. The utilization of
United States valuation allowances, arising in fiscal 1994, were the primary reasons for the lower income tax rates in fiscal 1997 and fiscal 1996. The Company has deferred tax assets on its balance sheet as of March 31, 1998 amounting to approximately $16.0 million. The ultimate utilization of these deferred tax assets is dependent on the Company's ability to generate taxable income in the future.
Extraordinary Item
During fiscal 1998 the Company repurchased all of its remaining 9 5/8% Senior Subordinated Notes due 2003, and during fiscal 1996 the Company repurchased approximately $19.9 million principal amount at maturity of the Senior Subordinated notes. As a result of the repurchases the Company recorded extraordinary charges of $5.9 million for fiscal 1998, and $0.9 million for fiscal 1996, in each case resulting from the write-off of unamortized debt issuance costs and premium over accreted value, net of tax. The 1998 repurchase was funded by borrowings under the Company's credit agreement and the 1996 repurchase was partly funded by borrowings under the Company's prior credit agreement and partly from cash arising from the IPO.
Net Income
Net income for fiscal 1998 totaled $45.2 million compared to $41.8 million, as adjusted, for fiscal 1997 and $33.6 million for fiscal 1996, increases of $3.4 million and $8.2 million, respectively. The growth in net income from fiscal 1997, as adjusted, to fiscal 1998 was 8.1% and from fiscal 1996 to fiscal 1997, as adjusted, was 24.0%. If the extraordinary items in fiscal 1998 and fiscal 1996 are excluded, the growth from fiscal 1997, as adjusted, to fiscal 1998, and from fiscal 1996 to fiscal 1997, as adjusted, would have been 22.3% and 20.7%, respectively.
Liquidity and Capital Resources
The following analysis of the Company's cash flow statement reflects the historical results of the Company which have not been adjusted for the AO Acquisition.
Operating activities generated $20.9 million in cash in fiscal 1998 compared with $32.4 million in fiscal 1997 and $30.8 million in fiscal 1996. Significantly improved net income in fiscal 1998 was more than offset by increases in inventories and accounts receivable. During fiscal 1998 the Company decided to take advantage of prompt pay discounts offered by suppliers in the United States resulting in accounts payable not increasing in line with the increases in the business. Improved net income in fiscal 1997, after adding back one time non-recurring non-cash charges associated with the AO Acquisition, was offset in part by increases in inventories and accounts receivable. Accounts payable in fiscal 1997 increased in line with inventory growth.
During fiscal 1998 inventories as a percentage of net sales grew to 31.0% from 28.4% in the prior year. The increase in inventories is primarily a result of building inventories to support new product launches, growth in higher priced products as a percentage of net sales and therefore of inventories, and the projected overall increase in the business. During fiscal 1997 inventories as a percentage of net sales grew to 28.4% (27.2% if a full year's net sales for AO are used) from 26.0% in the prior year. The growth in inventory levels resulted from the introduction and regional spread of new products, resulting in both finished goods inventory growth and increased mold inventory requirements. The primary increase was caused by increases in inventories and molds to support the worldwide launch of a new progressive lens design, Percepta(R), in the fourth quarter of fiscal 1997. Accounts receivable as a percentage of net sales increased to 22.0% in fiscal 1998 compared to 21.5% a year ago. Accounts receivable as a percentage of net sales increased to 21.5% (20.5% if a full year's net sales for AO are used) in fiscal 1997 compared to 19.3% for fiscal 1996.
During fiscal 1998 net cash expended on investing activities amounted to $41.2 million, primarily being capital expenditures. The most significant capital expenditures, primarily on additional production capacity, were made in the United States, Mexico, Brazil, China, Venezuela and Australia. During fiscal 1997 net cash expended on investing activities amounted to $154.8 million. On June 19, 1996, the
Company acquired substantially all of the worldwide ophthalmic business of AOC for cash consideration of $103.6 million (together with the assumption of certain liabilities) (the "AO Acquisition"). The AO Acquisition was funded primarily through borrowings under the Company's then existing credit agreement, which borrowings were subsequently repaid in part with the proceeds from the equity public offering during July 1996. On July 2, 1996 the Company acquired Neolens, Inc. ("Neolens"), a Florida corporation for cash consideration of approximately $15.5 million, including the assumption of Neolens debt ("Neolens Acquisition"). The Neolens Acquisition was funded through borrowings under the Company's then existing credit agreement. During fiscal 1997, the Company spent approximately $30.0 million on capital expenditures primarily in the United States, Mexico, China and Brazil. The capital expenditures in fiscal 1997 were primarily to add production capacity. During fiscal 1996 net cash expended on investing activities was primarily for capital expenditures and increasing the Company's investment in its Venezuela joint venture. The capital expenditures in fiscal 1996 related mainly to expansion of production capacity to accommodate higher volumes and the introduction of new products. During fiscal 1996 the Company increased its investment in its Venezuela joint venture, Sola de Venezuela Industria Optica, C.A. ("Sola Venezuela"), from 45% to 100%. The purchase price amounted to approximately $3.6 million and was paid in cash. Management anticipates capital expenditures of $40 million to $45 million annually over the next several years, of which approximately $5 million annually is viewed as discretionary.
Financing activities generated $32.3 million in fiscal 1998, primarily from additional borrowings under the Amended Agreement and exercise of stock options by employees. In the third quarter of fiscal 1998 the Company repurchased all of its remaining 9 5/8% Senior Subordinated Notes due 2003. The notes repurchase was funded by borrowings under the Amended Agreement. In conjunction with the repurchase of its Senior Subordinated Notes the Company amended its bank credit agreement with The Bank of America National Trust and Savings Association, for itself and as agent for a syndicate of other financial institutions ("Amended Agreement"). The Amended Agreement increased the Company's multicurrency revolving facility from $180 million to $300 million. Borrowings are divided into two tranches. Tranche A permits borrowings up to $30 million in either U.S. dollars or foreign currencies, to be used for working capital and consummating certain permitted acquisitions. Tranche B permits borrowings of up to $270 million and can be used for working capital purposes, refinancing the term loans under the existing bank credit agreement, repurchasing the Company's Senior Subordinated Notes, and consummating certain permitted acquisitions. The Tranche A Facility matures on October 31, 2000 and the Tranche B Facility matures on May 31, 2001. Among other things the Amended Agreement changed certain financial covenants, removed the requirement for foreign subsidiary guarantees under the Tranche A facility, increased the basket for incurring other unsecured indebtedness to $150 million, and deleted the term facility portion.
Borrowings under the Tranche A and Tranche B revolvers (other than swing line loans, which may only be Base Rate loans) may be made as Base Rate Loans or LIBO Rate Loans. Base Rate Loans bear interest at rates per annum equal to the higher of (a) 0.50% per annum above the latest Federal Funds Rate, or (b) the Bank of America Reference Rate. LIBO Rate Loans bear interest at a rate per annum equal to the sum of the LIBO Rate and a margin varying from 0.450% to 0.750% based on the Company's leverage ratio. Fixed rate borrowings in foreign currencies bear interest at rates per annum equal to the referenced currency's local IBOR plus a margin varying from 0.450% to 0.750% based on the Company's leverage ratio. Local currency Base Rate Loans are also available at a spread similar to US Base Rate Loans described above.
During the fourth quarter of fiscal 1998 the Company issued 6 7/8% Senior Notes ("Notes") due 2008, for which the Company received approximately $98.5 million net proceeds, after discounts and issuance expenses. Net proceeds were used to pay down borrowings under the Amended Agreement. The Notes are unsecured senior obligations of the Company, limited to $100 million aggregate principal amount at maturity, and will mature on March 15, 2008. The Notes will be redeemable, as a whole or from time to time in part, at the option of the Company on any date at a redemption price equal to the aggregate principal amount plus a make whole premium.
Financing activities generated $125.3 million in fiscal 1997. During July 1996 the Company sold 2,320,000 additional shares of common stock at $28.625 per share through a public offering. The net proceeds from this offer, were approximately $62.8 million. The Company used such net proceeds to repay indebtedness which it incurred under its then existing bank credit agreement. Simultaneously with the closing of the AO Acquisition, the Company entered into a bank credit agreement with The Bank of America National Trust and Savings Association, for itself and as agent for a syndicate of other financial institutions, covering an aggregate amount of $180 million.
Financing activities were an outflow of $4.7 million in fiscal 1996. During the three months ended June 1995 the Company repurchased approximately $19.9 million principal amount at maturity of its 9 5/8% Senior Subordinated Notes due 2003. The repurchase was partly funded by borrowings under the prior credit agreement and partly from excess cash arising from the IPO.
The Company's foreign subsidiaries maintain local credit facilities to provide credit for overdraft, working capital and some fixed asset investment purposes. As of March 31, 1998, the Company's total credit available under such facilities was approximately $29.9 million, of which $10.1 million had been utilized.
The Company continues to have significant liquidity requirements. In addition to working capital needs and capital expenditures, the Company has substantial cash requirements for debt service. The Company expects that the Amended Agreement and other overseas credit facilities, together with cash on hand and internally generated funds, if available as anticipated, will provide sufficient capital resources to finance the Company's operations, fund anticipated capital expenditures, and meet interest requirements on its debt, including the Notes, for the foreseeable future. As the Company's debt matures, the Company may need to refinance such debt. There can be no assurance that such debt can be refinanced on terms acceptable to the Company.
Currency Exchange Rates
As a result of the Company's worldwide operations, currency exchange rate fluctuations tend to affect the Company's results of operations and financial position. The two principal effects of currency exchange rates on the Company's results of operations and financial position are (i) translation adjustments for subsidiaries where the local currency is the functional currency and (ii) translation adjustments for subsidiaries in hyper-inflationary countries. Translation adjustments for functional local currencies have been made to shareholders' equity. For the fiscal years ended March 31, 1998, 1997 and 1996 such translation adjustments were approximately $(10.0) million, $(3.8) million, $(1.6) million, respectively.
During fiscal 1996 the Company benefited from reduced manufacturing costs at its Mexican facility arising from the weakness of the Mexican Peso. For translation adjustments of the Company's subsidiaries operating in hyper-inflationary countries, until recently primarily Brazil, the functional currency is determined to be the U.S. dollar, and therefore all translation adjustments are reflected in the Company's Statements of Operations. Commencing with the fourth quarter of fiscal 1997 the Company's operations in Mexico have been accounted for as hyper-inflationary economies. In hyper-inflationary environments, the Company generally protects margins by methods which include increasing prices monthly at a rate appropriate to cover anticipated inflation, compounding interest charges on sales invoices daily and holding cash balances in U.S. dollar denominated accounts where possible.
Because a majority of the Company's debt is U.S. dollar denominated, the Company may hedge against certain currency fluctuations by entering into currency swaps (however certain currencies, such as the Brazilian Real, cannot be hedged), although no such swaps had been entered into as of March 31, 1998. As of March 31, 1998 certain of the Company's foreign subsidiaries had entered into forward contracts for intercompany purchase commitments in amounts other than their home currency. The carrying amount of the forward contracts approximates fair value, which has been estimated based on current exchange rates. For further financial data of the Company's performance by region, see Note 15 of Notes to Consolidated Financial Statements.
Seasonality
The Company's business is somewhat seasonal, with third quarter results generally weaker than the other three quarters as a result of lower sales during the holiday season, and fourth quarter results generally the strongest.
Inflation
Inflation continues to affect the cost of the goods and services used by the Company. The competitive environment in many markets limits the Company's ability to recover higher costs through increased selling prices, and the Company is subject to price erosion in many of its standard product lines. The Company seeks to mitigate the adverse effects of inflation through cost containment and productivity and manufacturing process improvements. For a description of the effects of inflation on the Company's reported revenues and profits and the measures taken by the Company in response to inflationary conditions, see--"Currency Exchange Rates" above.
Year 2000
The Company has developed preliminary plans to address the possible exposures related to the impact on its computer systems of the Year 2000. Key financial, information and operational systems have been assessed and plans have been developed to address systems modifications required by December 31, 1999. Based on work to date, and assuming that project plans, which continue to evolve, can be implemented as planned, management believes the financial impact of making the required systems changes will not be material to the Company's consolidated financial position, results of operations or cash flows.
The Company is also in the preliminary stages of assessing the possible effects on the Company's operations of the Year 2000 readiness of key suppliers and customers. The Company's reliance on suppliers and customers and therefore on the proper functioning of their information systems and software, means that failure to address Year 2000 issues could have a material impact on the Company's operations and financial results; however, the potential impact and related costs are not known at this time.
Information Relating to Forward-Looking Statements
This Form 10-K of the Company includes forward-looking statements within the meaning of Section 21E of the Securities Exchange Act of 1934, including statements regarding, among other items, (i) the Company's development of new products, including, among others, Percepta, Spectralite, Access and Matrix, (ii) the availability of raw materials for the Company's products, the costs of product introductions, and trends in sales growth (including growth related to new products), (iii) anticipated trends in the Company's business environment, including competitive and pricing pressures, (iv) the Company's ability to continue to control costs and maintain adequate standards of customer service and product quality (v) future income tax rates and capital expenditures and working capital requirements and (vi) statements regarding the adequacy of the Company's planning for the Year 2000 computer programming issues. These forward looking statements reflect the Company's current views with respect to future events and financial performance. The words "believe", "expect", "anticipate" and similar expressions identify forward-looking statements. Readers are cautioned not to place undue reliance on these forward-looking statements, which speak only as of their dates. The Company undertakes no obligation to publicly update or revise any forward-looking statements, whether as a result of new information, future events or otherwise. Actual results could differ materially from the forward-looking statements as a result of various factors including the "Factors Affecting Future Operating Results" included in Exhibit 99.1 of the Company's Form 10-K for the fiscal year ended March 31, 1998 and the factors described in "Business--Environmental Matters."
Item 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The financial statements required by this item are set forth on pages, and through and the related financial statement schedule is set forth on page S-1.
Item 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
Not applicable.
PART III
Item 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The principal occupations and positions for at least the past five years of each of the directors and executive officers of the Company are as follows (references to the Company include its predecessors):
Irving S. Shapiro has been Chairman of the Board of the Company since December 1994. Mr. Shapiro is Of Counsel to Skadden, Arps, Slate, Meagher & Flom LLP. He was Chairman and Chief Executive Officer of E.I. du Pont de Nemours and Company from 1974 to 1981. He is Chairman of the Board of Marvin & Palmer Associates, Inc., and is a director of J.P. Morgan Florida Federal Savings Bank, Pediatric Services of America Inc., and Gliatech, Inc.
Douglas D. Danforth has been a director of the Company since December 1994. He was Chairman and Chief Executive Officer of Westinghouse Electric Corporation from 1983 to 1987. He is a director of Daltile Inc.
Hamish Maxwell has been a director of the Company since December 1994. Mr. Maxwell was Chairman of the Executive Committee of the Board of Directors of Philip Morris Companies Inc. from September 1991 through April 1995 and was Chairman and Chief Executive Officer of such company from 1984 to 1991. He is a director of Bankers Trust Company, Bankers Trust New York Corporation and Chairman of WPP Group plc.
Maurice J. Cunniffe has been a director of the Company since December, 1996. He is Chairman and Chief Executive Officer of American Optical Corporation, a company of which he has been sole shareholder since 1982.
Jackson L. Schultz has been a director of the Company since November 1995. Mr. Schultz joined Wells Fargo Bank in 1970, retiring in 1990 as Senior Vice President responsible for Public and Governmental Affairs.
A. William Hamill has been a director of the Company since December, 1996. Mr. Hamill is Executive Vice President and Chief Financial Officer of Union Camp Corporation, which he joined in 1996. From 1993 through 1996, he was a partner in SCI Investors Inc. and a director of Custom Papers Group Inc. From 1991 to 1993, he was Senior Vice President and Chief Financial Officer of Specialty Coatings International Inc.. From 1975 through 1990, Mr. Hamill was with Morgan Stanley & Co. Incorporated, where he was a Managing Director.
John E. Heine has served as Chief Executive Officer and President of the Company since November 1981 and served as Chairman of the Board of the Company from September 1993 to December 1994. Mr. Heine joined the Company in 1981 as Managing Director of Sola International Holdings, Ltd. and previously held general management positions with Southern Farmers Holdings, Ltd. in Adelaide and H.J. Heinz in Melbourne, Australia.
James H. Cox was appointed Executive Vice President in December 1996, Assistant Secretary and Assistant Treasurer of the Company in September 1993 and President of Sola Optical USA, the Company's North American eyeglass lens business in 1991. He joined the Company as Vice President, Manufacturing in 1985. Mr. Cox was formerly Executive Vice President of Operations with Bausch & Lomb's Consumer Products Division.
Steven M. Neil was appointed Executive Vice President, Finance, Chief Financial Officer, Secretary and Treasurer in October 1997. Prior to joining Sola, Mr. Neil was Vice President-Finance, Treasurer and Chief Financial Officer of Perrigo Company from May 1995 to September 1997. He also served as President of Perrigo International, Inc. from July 1996. Mr. Neil served as Vice President-Controller of Perrigo Company from January 1993 to May 1995. Prior to that time he served as Controller and Chief Accounting Officer with Applied Magnetics Corporation, where he also served in other positions of increasing responsibility since 1983. He is a member of the Board of Directors of Intelligent Solutions, Inc.
Stephen J. Lee was appointed Vice President, Human Resources of the Company in 1988 and was formerly Director of Personnel for Pilkington's Ophthalmic and Insulation Divisions. Mr. Lee joined the Pilkington Group in 1974.
Barry J. Packham joined the Company as Vice President, Manufacturing Development in February 1993. Mr. Packham was Managing Director of Ceramic Fuel Cells Ltd., a research and development joint venture consortium in Melbourne, Australia, from 1991 to 1993 and formerly held manufacturing and general management positions with Kodak and Leigh-Mardon Pty. Ltd.
John J. Bastian has served as Regional Director, Australia since 1987. Mr. Bastian joined the Company in 1983 as Group General Manager, Marketing in Sola International Holdings, South Australia following a six-year career with PA Management Consultants.
Theodore Gioia has served as Vice President, Strategic Planning since 1992. Mr. Gioia joined the Company as Director of Strategic Planning in 1989, having sold the start-up recording company he founded in 1987. Mr. Gioia was previously a consultant with McKinsey & Company and the Boston Consulting Group.
Adrian P. Walker joined the Company as Regional Director, Asia in November 1996. Mr. Walker held a number of general management positions with subsidiaries of BTR plc. from March 1980 to November 1996. He was most recently General Manager of ACI Laminates and Insulations, based in Melbourne, Australia from July 1995 to October 1996. From August 1992 to July 1995 he was Managing Director of Dunlop Slazenger (Far East), in Malaysia, and from April 1985 to July 1992 was General Manager, Serck Services (Gulf) Ltd., in the United Arab Emirates.
Mark T. Mackenzie was appointed Regional Director, Europe in April 1994. Mr. Mackenzie served as Group Marketing Director of Tarkett Pegulan AG, and as General Manager of the Residential Flooring Division, based in Germany. He formerly held marketing and sales positions with Gillette, L'Oreal and Cadbury Schweppes.
Alan S. Vaughan was appointed Vice President, Worldwide Rx Operations in June 1994, having previously served as European Manufacturing and Technical Director. Mr. Vaughan joined the Company in 1978 as Managing Director of Sola ADC Lenses in Ireland. He was previously Director of Operations with Johnson & Johnson (Ireland).
Item 11. EXECUTIVE COMPENSATION
Incorporated by reference to the material included under the caption "Compensation of Executive Officers" in the Company's proxy statement for the fiscal year ended March 31, 1998.
Item 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
Incorporated by reference to the material included under the caption "Security Ownership of Certain Beneficial Owners and Managers" in the Company's proxy statement for the fiscal year ended March 31, 1998.
Item 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Incorporated by reference to the material included under the caption "Certain Transactions" in the Company's proxy statement for the fiscal year ended March 31, 1998.
PART IV
Item 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
(a) Documents Filed as Part of this Report:
1. Financial Statements. See Index to Consolidated Financial Statements and Financial Statement Schedules included on page.
2. Financial Statement Schedules. See "Schedule II - Valuation and Qualifying Accounts" included on page S-1.
Schedules other than those listed above have been omitted since they are either not required, not applicable or the information is otherwise included.
3. List of Exhibits. See Index of Exhibits included on page E-1.
(b) Reports on Form 8-K:
The Company filed a report on Form 8-K, dated February 17, 1998 to report the Company's adoption of FAS 128, Earnings per Share, for its fiscal quarter ended December 31, 1997, and restating certain earnings per share information previously presented in the Company's Securities Exchange Act filings.
SIGNATURES
Pursuant to the requirements of Section 13 or Section 15(d) of the Securities Exchange Act of 1934, as amended, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
SOLA INTERNATIONAL INC. (Registrant)
Date: June 15th, 1998 By: /s/Steven M. Neil ------------------ Steven M. Neil Executive Vice President, Finance, Chief Financial Officer, Secretary and Treasurer
SOLA INTERNATIONAL INC.
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
Page ---- Report of Ernst & Young LLP, Independent Auditors....................... Consolidated Balance Sheets as of March 31, 1998 and 1997............... Consolidated Statements of Income for the years ended March 31, 1998, 1997 and 1996......................................................... Consolidated Statements of Shareholders' Equity for the years ended March 31, 1998, 1997 and 1996......................................... Consolidated Statements of Cash Flows for the years ended March 31, 1998, 1997 and 1996........................................ Notes to Consolidated Financial Statements.............................. Quarterly Financial Data (unaudited).................................... Financial Statement Schedule............................................ S-1
Report of Ernst & Young LLP, Independent Auditors
Board of Directors and Shareholders
Sola International Inc.
We have audited the accompanying consolidated balance sheets of Sola International Inc. as of March 31, 1998 and 1997, and the related consolidated statements of income, shareholders' equity, and cash flows for each of the three years in the period ended March 31, 1998. Our audits also included the financial statement schedule listed in the index at item 14(a). These consolidated financial statements and schedule are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements and schedule based on our audits.
We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of Sola International Inc. as of March 31, 1998 and 1997, and the consolidated results of its operations and its cash flows for each of the three years in the period ended March 31, 1998, in conformity with generally accepted accounting principles. Also, in our opinion, the related financial statement schedule, when considered in relation to the basic financial statements taken as a whole, presents fairly in all material respects the information set forth therein.
/s/Ernst & Young LLP
Palo Alto, California May 6, 1998
Cumulative Foreign Currency Total Translation Shareholders' Adjustments Equity --------- --------- Balances, March 31, 1995 .......................... $ 5,636 $ 159,443 17 shares of $0.01 par value common stock issued under stock option plans ................. 59 Repayment of Equity participation loans ........... 674 Cumulative translation adjustments ................ (1,611) (1,611) Net income ........................................ 33,676 --------- --------- Balances, March 31, 1996 .......................... 4,025 192,241
Public Offering of 2.320 shares of $0.01 par value common stock, net of offering expenses .... 62,765 146 shares of $0.01 par value common stock issued under stock option plans ................. 1,749 Tax benefit from exercise of stock options ........ 266 Repayment of Equity participation loans ........... 151 Cumulative translation adjustments ................ (3,771) (3,771) Net income ........................................ 30,897 --------- --------- Balances, March 31, 1997 .......................... 254 284,298
460 shares of $0.01 par value common stock issued under stock option plans ................. 5,334 Tax benefit from exercise of stock options ........ 2,191 Repayment of Equity participation loans ........... 40 Cumulative translation adjustments ................ (9,994) (9,994) Net income ........................................ 45,153 --------- --------- Balances, March 31, 1998 .......................... $ (9,740) $ 327,022 ========= =========
The accompanying notes are integral part of these financial statements.
SOLA INTERNATIONAL INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. Business and Basis of Presentation
Sola International Inc. ("Company") designs, manufactures and distributes a broad range of eyeglass lenses, primarily focusing on the fast growing plastic lens segment of the global market. The Company operates in one business segment.
In June 1996, the Company acquired substantially all of the worldwide ophthalmic business ("AO") of American Optical Corporation for cash consideration of $103.6 million (together with the assumption of certain liabilities) (the "AO Acquisition"). The AO Acquisition was accounted for under the purchase method of accounting as of the closing date. The total purchase price of $110.2 million (including acquisition costs of $6.5 million) exceeded the historical book value of the net assets acquired and such excess was allocated to the assets and liabilities based on their estimated fair values as of the AO Acquisition date, including in-process research and development ($9.5 million) with no alternative future use. Independent appraisals were utilized for determining the amounts assigned to certain purchased assets including property, plant and equipment and in-process research and development.
In July 1996 the Company acquired control of Neolens, Inc. ("Neolens"), a Florida corporation that manufactured polycarbonate eyeglass lenses and was a supplier to the Company. The Company acquired Neolens for cash consideration of approximately $15.5 million, including the assumption of Neolens debt (the "Neolens Acquisition") and was accounted for under the purchase method of accounting as of the closing date. The total purchase price of $16.8 million (including acquisition costs of $1.3 million) included $17.6 million allocated to goodwill and other intangible assets. Results of Neolens prior to acquisition were not material to the Company's consolidated results of operations.
On October 5, 1995 the Company increased its investment in its Venezuela joint venture, Sola de Venezuela Industria Optica, C.A. ("Sola Venezuela"), from 45% to 80%, and in March 1996, the Company exercised its option to acquire the remaining 20% of the shares in Sola Venezuela. The purchase price for all the shares, including the 20% option, and acquisition expenses, amounted to approximately $3.6 million and was paid in cash. In addition to the cash purchase price of the final 20% of Sola Venezuela, Sola will pay a contingent payment based on the growth in the net income of Sola Venezuela in fiscal 1998 over the net income of Sola Venezuela in fiscal 1995, and such payment is not anticipated to be significant. The acquisition has been accounted for under the purchase method of accounting.
The accompanying consolidated financial statements of the Company have been prepared in accordance with U.S. generally accepted accounting principles. The Company's fiscal 1997 financial statements presented herein include the results of operations and cash flows of the AO business for the nine months and ten days ended March 31, 1997 and the results of operations and cash flows of the Neolens business for the nine months ended March 31, 1997 subsequent to their respective acquisitions.
2. Summary of Significant Accounting Policies
Principles of Consolidation:
The consolidated financial statements include the accounts of the Company and its wholly-owned and controlled foreign subsidiaries. All significant transactions between the entities have been eliminated.
SOLA INTERNATIONAL INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
2. Summary of Significant Accounting Policies - (Continued)
Cash and Cash Equivalents:
Cash equivalents consist primarily of short-term investments with an original maturity of three months or less, carried at cost which approximates market value.
Inventories:
Inventories are stated at the lower of cost (first-in, first-out) or market.
Property, Plant and Equipment:
Property, plant and equipment are stated at cost and are depreciated on a straight-line basis over the estimated useful lives of the related assets (buildings--15 to 50 years; plant and office equipment--2 to 10 years). Leasehold improvements and leased equipment are amortized over the lesser of their useful lives or the remaining term of the related leases.
Impact of recently issued accounting standards:
In June 1997, the FASB released Statement of Financial Accounting Standards No. 130, "Reporting Comprehensive Income" ("FAS 130"). FAS 130 establishes standards for the reporting and display of comprehensive income and its components in a full set of general purpose financial statements and is effective for fiscal years beginning after December 15, 1997. The Company is currently evaluating the impact of the application of the new rules on the Company's consolidated financial statements.
In June 1997, the FASB released Statement of Financial Accounting Standards No. 131, "Disclosures about Segments of an Enterprise and Related Information" ("FAS 131"). FAS 131 will change the way companies report selected segment information in annual financial statements and also requires those companies to report selected segment information in interim financial reports to shareholders. FAS 131 is effective for fiscal years beginning after December 15, 1997. The Company is currently evaluating the impact of the application of the new rules on the Company's consolidated financial statements.
Intangible Assets:
Intangible assets, including trademarks, patents and licenses, are stated at cost and amortized on a straight-line basis over their estimated useful lives of 2 to 17 years. Legal costs incurred by the Company in successfully defending its patents are capitalized to patent costs and amortized over the remaining life of the patent. Goodwill is amortized over 40 years. As of March 31, 1998 and 1997 accumulated amortization was $17.9 million and $12.4 million, respectively.
Debt issuance costs are being amortized to interest expense over the respective lives of the debt instruments which range from five to ten years. As of March 31, 1998 and 1997, accumulated amortization was $0.4 million and $1.5 million, respectively. As a result of repurchasing the Company's 9 5/8% Senior Subordinated Notes in fiscal 1998 and 1996 (see Note 8), the Company wrote off $1.5 million and $0.4 million, respectively, of debt issuance costs reflected on the statement of income, together with the premium over accreted value, as an extraordinary item, net of tax.
SOLA INTERNATIONAL INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
2. Summary of Significant Accounting Policies - (Continued)
Foreign Currency Translation:
The assets and liabilities and revenue and expense accounts of the Company's foreign subsidiaries operating in non-highly inflationary economies have been translated using the exchange rate at the balance sheet date and the weighted average exchange rate for the period, respectively.
The net effect of the translation of the accounts of the Company's subsidiaries has been included in equity as cumulative foreign currency translation adjustments. Adjustments that arise from exchange rate changes on transactions denominated in a currency other than the local currency are included in income as incurred and are not material.
The Company has operations in Brazil, a hyper-inflationary country until recently, for which the functional currency is the U.S. dollar. Commencing with the fourth quarter of fiscal 1997 the Company's operations in Mexico have been accounted for as hyper-inflationary economies. All translation and transaction adjustments are included in determining net income.
Revenue Recognition:
Sales and related cost of sales are recognized upon shipment of product. The Company's principal customers are wholesale distributors and processing laboratories, retail chains, superoptical retail stores, independent eyecare practitioners and sunglass manufacturers. No individual customer accounts for more than 10% of net sales. The Company generally does not require collateral from its customers, but performs on-going credit evaluations of its customers.
Advertising and Promotion Costs:
The Company's policy is to expense advertising and promotion costs as they are incurred. The Company's advertising and promotion expenses were approximately $12.3 million, $12.5 million, and $9.4 million for fiscal 1998, 1997, 1996, respectively.
Income Taxes:
The accompanying financial statements of the Company reflect the provisions of FASB 109. Investment tax credits and research and development credits are accounted for by the flow-through method.
Reclassifications:
Certain prior year items have been reclassified to conform with the current year's presentation. These reclassifications had no impact on total assets or net income.
Use of Estimates:
The preparation of the financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. Actual results could differ from those estimates.
SOLA INTERNATIONAL INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
2. Summary of Significant Accounting Policies - (Continued)
Concentration of Credit Risks:
Cash and cash equivalents are invested in deposits with major banks in the United States and in countries where subsidiaries operate. Deposits in these banks may exceed the amount of insurance provided on such deposits. The Company has not experienced any losses on its deposits of cash and cash equivalents.
Financial Instruments With Off-Balance-Sheet Risk:
The Company is a party to financial instruments with off-balance-sheet risk in the normal course of business to reduce its exposure to market and interest rate risk. Gains and losses due to rate fluctuations on such transactions are recognized currently. Cash flows related to these gains and losses are reported as operating or financing activities in the accompanying consolidated statements of cash flows. As of March 31, 1998, certain of the Company's foreign subsidiaries had entered into forward contracts for intercompany purchase commitments, which are not significant, in amounts other than their home currency. The carrying amount of the foreign exchange contracts approximates fair value, which has been estimated based on current exchange rates. The forward exchange contracts generally have varying maturities up to 9 months. Unless noted otherwise, the Company does not require collateral or other security to support financial instruments with credit risk.
Earnings (Loss) Per Share:
In 1997, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 128, "Earnings per Share" ("FAS 128"). FAS 128 replaced the previously reported primary and fully diluted earnings per share with basic and diluted earnings per share. Unlike primary earnings per share, basic earnings per share excludes any dilutive effects of options, warrants, and convertible securities. Diluted earnings per share is very similar to the previously reported fully diluted earnings per share. All earnings per share amounts for all included periods have been presented, and where necessary, restated to conform to the FAS 128 requirements.
SOLA INTERNATIONAL INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
2. Summary of Significant Accounting Policies - (Continued)
The following table sets forth the computation of basic and diluted earnings per share for the fiscal years ended March 31, 1998, 1997 and 1996 (in thousands, except per share data):
Year Ended March 31, ------------------------------- 1998 1997 1996 -------- -------- -------- Numerator: Income before extraordinary item ............ $ 51,092 $ 30,897 $ 34,588 Extraordinary item, loss on repurchase of senior subordinated notes, net of tax ..... (5,939) -- (912) -------- -------- -------- Net income ............................... $ 45,153 $ 30,897 $ 33,676 ======== ======== ======== Denominator: Denominator for basic earnings per share- Weighted average common shares outstanding............................. 24,400 23,561 21,785
Effect of dilutive securities: Employee stock options.................. 1,147 1,298 1,159 Denominator for diluted earnings per share- -------- -------- -------- Weighted average common shares and dilutive securities outstanding......... 25,547 24,859 22,944 ======== ======== ======== Basic earnings (loss) per share: Income before extraordinary item............. $ 2.09 $ 1.31 $ 1.59 Extraordinary item........................... (0.24) -- (0.04) -------- -------- -------- Net income................................ $ 1.85 $ 1.31 $ 1.55 ======== ======== ======== Diluted earnings (loss) per share: Income before extraordinary item............. $ 2.00 $ 1.24 $ 1.51 Extraordinary item........................... (0.23) -- (0.04) -------- -------- -------- Net income................................ $ 1.77 $ 1.24 $ 1.47 ======== ======== ========
SOLA INTERNATIONAL INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
3. Inventories
March 31, ---------------------------- 1998 1997 -------- -------- (in thousands)
Raw materials .......................... $ 16,714 $ 17,505 Work in progress ....................... 6,872 6,948 Finished goods ......................... 104,966 76,936 Molds .................................. 41,204 37,245 -------- -------- $169,756 $138,634 ======== ========
Molds comprise mainly finished goods for use by manufacturing affiliates in the manufacture of spectacle lenses.
4. Property, Plant and Equipment
March 31, --------------------- 1998 1997 -------- -------- (in thousands)
Land, buildings and leasehold improvements ........... $ 40,467 $ 29,749 Machinery and office equipment ....................... 136,218 115,943 Equipment under capital leases ....................... 593 259 -------- -------- 177,278 145,951 Less accumulated depreciation and amortization ....... 44,500 35,474 -------- -------- $132,778 $110,477 ======== ========
Depreciation expense for fiscal 1998, 1997 and 1996 was $14.3 million, $13.3 million and $11.1 million, respectively.
5. Notes Payable to Banks
Notes payable to banks at March 31, 1998 represent borrowings generally denominated in foreign currencies under several foreign credit agreements with lenders at interest rates ranging from 1.63% to 8.63%, and 24.0% for Brazilian Real based borrowings. The Brazilian Real based borrowings were $351,000 at March 31, 1998. The weighted average interest rates as of March 31, 1998 and 1997 were 8.06% and 8.68%, respectively. As of March 31, 1998, the Company had total unused lines of credit amounting to $19.8 million and was in compliance with minimum net worth requirements of agreements with certain foreign banks.
SOLA INTERNATIONAL INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
6. Long-Term Debt
March 31, --------- ---- (in thousands)
Uncollateralized term loans, interest rates varying from 4.75% to 10.0% at March 31, 1998, principal and interest payable through December 2008 ......................... $ 3,939
Loans collateralized by equipment and other assets, interest rates varying from 3.92% to 7.85% at March 31, 1998, principal and interest payable through March 2001 ..................................................... 246
Other........................................................... 110 ------- 4,295 Less current portion (included in other current liabilities).... 2,505 ------- Long-term debt, less current portion............................ $ 1,790 =======
Aggregate annual maturities of long-term debt over the next five years and thereafter are as follows:
Period Ending March 31, (in thousands) ----------------------- 1999......................................................... $2,505 2000......................................................... 678 2001......................................................... 262 2002......................................................... 191 2003......................................................... 182 Thereafter................................................... 477
The Company believes that as of March 31, 1998, the fair value of its long-term debt approximates the carrying value of those obligations. The fair value of the Company's long-term debt is estimated based on quoted market prices for similar issues with the same interest rates that would be available to the Company for similar debt obligations.
7. Bank Credit Agreement
In conjunction with the repurchase of its Senior Subordinated Notes (see Note 8) the Company amended its bank credit agreement with The Bank of America National Trust and Savings Association, for itself and as agent for a syndicate of other financial institutions ("Amended Agreement"). The Amended Agreement increased the Company's multicurrency revolving facility from $180 million to $300 million. Borrowings are divided into two tranches. Tranche A permits borrowings up to $30 million in either U.S. dollars or foreign currencies, to be used for working capital and consummating certain permitted acquisitions. Tranche B permits borrowings of up to $270 million and can be used for working capital purposes, refinancing the term loans under the existing bank credit agreement, repurchasing the Company's Senior Subordinated Notes, outstanding letters of credit ($2.5 million as of March 31, 1998) and consummating certain permitted acquisitions. The Tranche A Facility matures on October 31, 2000 and the Tranche B Facility matures on May 31, 2001. In addition, the Amended Agreement changed certain financial covenants, removed the requirement for foreign subsidiary guarantees under the
SOLA INTERNATIONAL INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
7. Bank Credit Agreement - (Continued)
Tranche A facility, increased the basket for incurring other unsecured indebtedness to $150 million, and deleted the term facility portion.
Borrowings under the Tranche A and Tranche B revolvers (other than swing line loans, which may only be Base Rate loans) may be made as Base Rate Loans or LIBO Rate Loans. Base Rate Loans bear interest at rates per annum equal to the higher of (a) 0.50% per annum above the latest Federal Funds Rate, or (b) the Bank of America Reference Rate. LIBO Rate Loans bear interest at a rate per annum equal to the sum of the LIBO Rate and a margin varying from 0.450% to 0.750% based on the Company's leverage ratio. Fixed rate borrowings in foreign currencies bear interest at rates per annum equal to the referenced currency's local IBOR plus a margin varying from 0.450% to 0.750% based on the Company's leverage ratio. Local currency Base Rate Loans are also available at a spread similar to US Base Rate Loans described above.
The Amended Agreement contains a number of covenants, including, among others, covenants restricting the Company and its subsidiaries with respect to the incurrence of indebtedness (including contingent obligations), the creation of liens, the making of certain investments and loans, engaging in unrelated businesses, transactions with affiliates, the consummation of certain transactions such as sales of substantial assets, mergers or consolidations, margin stock purchases and other transactions. The Amended Agreement also restricts the ability of the Company and its subsidiaries to make restricted payments in the nature of, among other things, (i) declaring, making or paying dividends or other distributions in excess of prescribed levels and (ii) purchasing, redeeming or retiring shares of the Company's capital stock in excess of prescribed levels. The Company and its subsidiaries are also required to comply with certain financial tests and maintain certain financial ratios.
8. Senior Subordinated Notes
The Company's 6 7/8% Senior Notes ("Notes") were issued under an indenture dated March 19, 1998, among the Company and State Street Bank and Trust Company of California, N.A., as Trustee (the "Indenture"). The Notes are unsecured senior obligations of the Company, limited to $100 million aggregate principal amount at maturity, and will mature on March 15, 2008. Interest on the notes is payable semiannually on March 15 and September 15 of each year, commencing September 15, 1998.
The Notes will be redeemable, as a whole or from time to time in part, at the option of the Company on any date (a "Redemption Date") at a redemption price equal to the greater of (i) 100% of the principal amount of the Notes to be redeemed or (ii) the sum of the present values of the Remaining Scheduled Payments (as defined) thereon discounted to such Redemption Date on a semiannual basis at the Treasury Rate (as defined) plus 20 basis points, plus in either case accrued interest (as defined).
The Notes rank pari passu to all other Senior Indebtedness, as defined in the Indenture, of the Company. The Company believes that as of March 31, 1998, the fair value of its Senior Subordinated Notes approximates the carrying value of those obligations.
During fiscal 1998 the Company repurchased all of its 9 5/8% Senior Subordinated Notes due 2003. As a result of the purchase the Company recorded an extraordinary charge of $5.9 million for fiscal 1998 resulting from the write-off of unamortized debt issuance costs and premium over accreted value, net of tax of $3.8 million. The repurchase was funded by borrowings under the Amended Agreement.
SOLA INTERNATIONAL INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
9. Common Stock
Common Stock
The Company has entered into loan agreements with certain members of the Company's management to enable them to invest in the Company's common stock. As of March 31, 1998 and 1997, loans amounting to $0.2 million and $0.3 million, respectively, which bear interest at 7.5% per annum, payable quarterly, and mature on December 1, 1998, were outstanding under this plan. These loans are secured by the common stock and have been reflected as a reduction in shareholders' equity on the consolidated balance sheets.
Stock Options
The Company has elected to follow Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees" ("APB 25") and related interpretations in accounting for its employee stock options because, as discussed below, the alternative fair value accounting provided for under FASB Statement No. 123, "Accounting for Stock-Based Compensation" ("FAS 123") requires use of option valuation models that were not developed for use in valuing employee stock options. Under APB 25, because the exercise price of the Company's employee stock options equals the market price of the underlying stock on the date of grant, no compensation expense is recognized.
On February 23, 1995 all outstanding stock options under the previous corporate structure were assumed by the Company and converted into options to acquire shares of the Company's Common Stock, with the number of shares subject to such option and exercise price thereof adjusted appropriately (the "Existing Option Plan"). The Existing Option Plan has been amended to provide that no new options will be granted thereunder.
The Company adopted the Sola International Inc. Stock Option Plan (the "International Plan"), effective February 15, 1995. On August 16, 1996 the shareholders of the Company ratified an increase of 500,000 to the number of options available for issuance under the International Plan. The maximum number of shares of Common Stock with respect to which options may be granted under the International Plan is 1,355,868 shares plus, subject to the requirement of rule 16b-3 of the Securities Exchange Act of 1934, if applicable, the number of shares of Common Stock subject to existing options under the Existing Option Plan, which expire or terminate without exercise for any reason, which number of shares underlying Existing Options shall not exceed 1,645,219. Under the International Plan certain key employees, and non employee directors and/or creditors of the Company and its subsidiaries and affiliates (each an "Optionee") are eligible to receive non-qualified stock options (the "International Options") to acquire shares of common stock of the Company. International Options granted to an Optionee are evidenced by an agreement between the Optionee and the Company which contains terms not inconsistent with the International Plan which the committee appointed to administer the International Plan, deemed necessary or desirable (the "International Option Agreement").
Pursuant to the Existing Option Plan and the International Plan ("Plans"), unless otherwise set forth in an Existing Option Agreement or an International Option Agreement, 20% of the Options granted to an Optionee vest on the date of grant, with an additional 20% vesting on each successive one-year anniversary of the date of grant. Options not previously vested become fully vested in the event of a sale or other disposition of 80% or more of the outstanding capital stock or substantially all of the assets of the Company, or upon a Merger or consolidation of the Company and its subsidiaries and affiliates unless the merger or consolidation is one in which the Company is the surviving corporation or one in which control of the Company and its subsidiaries and affiliates does not change (a "Termination Event").
SOLA INTERNATIONAL INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
9. Common Stock - (Continued)
However, Existing Options which are not exercised on or prior to a Termination Event lapse upon the closing of a Termination Event. All non-vested Options of an Optionee lapse upon such Optionee's termination of employment for any reason. An Optionee's vested Options lapse 45 days after termination of such Optionee's employment with the Company and its subsidiaries and affiliates for any reason other than death or disability, in which case such options terminate 180 days after such termination; provided, however, that such options lapse immediately in the event an Optionee's employment with the Company and its subsidiaries and affiliates is terminated for cause.
Pro Forma Disclosures
Pro Forma information regarding net income and earnings per share is required by FAS 123, and has been determined as if the Company had accounted for its employee stock options under the fair value method of that Statement. The fair value for these options was estimated at the date of grant using a Black-Scholes option pricing model with the following assumptions: risk-free interest rates of 5.67%, 6.67% and 6.67%, no dividend yield, volatility factors of the expected market price of the Company's common stock of .373, .389 and .389, and a weighted-average expected life of the option of 4 years, for fiscal 1998, 1997 and 1996, respectively.
The Black-Scholes option valuation model was developed for use in estimating the fair value of traded options which have no vesting restrictions and are fully transferable. In addition, option valuation models require the input of highly subjective assumptions including the expected stock price volatility. Because the Company's employee stock options have characteristics significantly different from those of traded options, and because changes in the subjective input assumptions can materially affect the fair value estimate, in management's opinion, the existing models do not necessarily provide a reliable single measure of the fair value of its employee stock options.
For purposes of pro forma disclosures, the estimated fair value of the options is amortized to expense over the options' vesting period. The Company's pro forma information follows (in thousands, except for earnings per share information):
Year Ended March 31, --------------------------------- 1998 1997 1996 ------- ------- ------- Pro forma net income .................... $44,157 $30,312 $33,603 Pro forma earnings per share: Basic........................... $ 1.81 $ 1.29 $ 1.54 Diluted......................... $ 1.73 $ 1.22 $ 1.46
The pro forma effect on net income during the phase-in period of FAS 123 may not be representative of the effects on pro forma net income in future periods.
SOLA INTERNATIONAL INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
9. Common Stock - (Continued)
Option Activity
Options exercisable as of March 31, 1996 and March 31, 1997 in thousands were 1,119 and 1,486, respectively. Options available for grant as of March 31, 1996, 1997 and 1998 in thousands were 257, 409 and 149, respectively. Exercise prices for options granted during fiscal 1998 ranged from $29.81 to $41.44. The weighted-average remaining contractual life of those options is four years.
10. Defined Contribution Plans
The Company sponsors several defined contribution plans covering substantially all U.S. and U.K. employees. The plans provide for limited Company matching of participants' contributions. Contributions to all defined contribution plans charged to operations were $1.2 million, $1.0 million and $0.9 million for fiscal 1998, 1997 and 1996, respectively.
11. Defined Benefit Retirement Plans
The Company participates in a defined benefit pension plan ("Domestic Pension Plan") covering substantially all full-time domestic employees. Benefit payments under the plan are based principally on
SOLA INTERNATIONAL INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
11. Defined Benefit Retirement Plans - (Continued)
employee compensation during the last five or ten year period prior to retirement and/or length of service. New employees are eligible to participate in the plan within one year of employment and are vested after five years of service. The Company's policy is to fund such amounts as are necessary, on an actuarial basis, to provide for the plan's current service costs and the plan's prior service costs over their amortization periods.
The Company also participates in a contributory defined benefit pension plan covering certain Australian employees ("International Pension Plan"). Benefits are generally based on length of service and on employee compensation during the last three years of service prior to retirement. The Company's policy is to fund such amounts as are necessary, on an actuarial basis, to provide for the plan's current service costs and the plan's prior service costs over their amortization periods.
The following table provides information on the status of the Domestic Pension Plan and the International Pension Plan.
SOLA INTERNATIONAL INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
11. Defined Benefit Retirement Plans - (Continued)
The significant actuarial assumptions for the following tables, as of the period-end measurement dates, are as follows:
Year Ended March 31, ------------------ 1998 1997 1996 ---- ---- ---- Domestic Pension Plan: Discount rate .................................. 6.35% 7.35% 7.0% Expected long-term rate of return on plan assets 8.0% 8.0% 8.0% Rate of increase in future compensation levels ....................................... 5.0% 5.0% 5.0% International Pension Plan: Discount rate .................................. 6.5% 7.5% 8.0% Expected long-term rate of return on plan assets 7.5% 8.0% 8.5% Rate of increase in future compensation levels ....................................... 4.0% 5.0% 5.5%
The change in the actuarial assumptions for fiscal 1998, 1997 and 1996 have not had a significant effect on the funded status of the Domestic or International Pension Plans.
At March 31, 1998, the Domestic Pension Plan and International Pension Plan assets include cash equivalents, fixed income securities and common stock.
SOLA INTERNATIONAL INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
11. Defined Benefit Retirement Plans - (Continued)
SOLA INTERNATIONAL INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
12. Income Taxes
The domestic and foreign components of income before provision for income taxes, minority interest and extraordinary item are as follows:
Year Ended March 31, ----------------------------------------- 1998 1997 1996 ------- ------- ------- (in thousands) Domestic .................... $42,918 $14,351 $27,158 Foreign ..................... 33,034 27,035 21,454 ------- ------- ------- $75,952 $41,386 $48,612 ======= ======= =======
The components of the provision for income taxes are as follows:
Year Ended March 31, -------------------------------- 1998 1997 1996 -------- -------- -------- (in thousands) Current: Federal and State ........................ $ 9,082 $ 6,142 $ 3,756 Foreign .................................. 8,006 7,178 8,210 Deferred: Federal and State ........................ 7,808 1,720 9,181 Foreign .................................. 4,891 1,534 1,134 Valuation allowance adjustment ............. (4,418) (9,837) (9,858) Tax benefit allocated to reduction of goodwill ................................. -- 4,000 1,200 -------- -------- -------- $ 25,369 $ 10,737 $ 13,623 ======== ======== ========
During fiscal 1998 and 1997, the Company recognized certain tax benefits related to stock option plans in the amount of $2.2 million and $0.3 million, respectively. Such benefits were recorded as a reduction of income taxes payable and an increase in additional paid-in capital.
SOLA INTERNATIONAL INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
12. Income Taxes - (Continued)
A reconciliation between income tax provisions computed at the U.S. federal statutory rate and the effective rate reflected in the statements of income is as follows:
Year Ended March 31, ---------------------- 1998 1997 1996 ---- ---- ---- Provision at statutory rate ........................ 35.0% 35.0% 35.0% State tax provision, net of federal effect ......... 3.5 4.0 3.6 Valuation allowance ................................ (5.8) (23.8) (15.2) Tax benefit allocated to reduction of goodwill ..... -- 9.7 2.5 Income of foreign subsidiaries at differing statutory rates ................................. (1.3) (2.4) 9.3 Tax benefit from NOL utilization ................... -- -- (5.7) Other .............................................. 2.0 3.4 (1.5) ---- ---- ---- 33.4% 25.9% 28.0% ==== ==== ====
The tax effects of temporary differences that give rise to significant portions of the deferred tax assets and deferred tax liabilities are presented below:
March 31, ----------------- 1998 1997 ------- ------- (in thousands) Deferred tax assets: Accounts receivable, principally due to allowances for doubtful accounts ...................................... $ 2,064 $ 2,249 Inventories, principally due to reserves ................. 3,191 3,591 Property, plant and equipment, principally due to differences in depreciation ............................ 4,874 5,868 Accruals for employee benefits ........................... 8,322 8,904 In-process research and development ...................... 12,281 13,225 Other assets ............................................. 3,610 4,746 Net operating losses ..................................... 9,188 11,221 ------- ------- Total gross deferred tax assets .......................... 43,530 49,804 Less valuation allowance ................................. 9,801 14,219 ------- ------- Net deferred tax assets .................................. $33,729 $35,585 ======= ======= Deferred tax liabilities: Property, plant and equipment, principally due to differences in depreciation ............................ $12,102 $ 9,262 Inventories .............................................. 2,752 2,641 Amortization of goodwill ................................. 5,653 3,999 Unremitted income of foreign subsidiaries ................ 3,834 2,700 Other .................................................... 4,071 3,385 ------- ------- Net deferred tax liabilities ............................. $28,412 $21,987 ======= ======= Net deferred tax assets less net deferred tax liabilities ............................................ $ 5,317 $13,598 ======= =======
SOLA INTERNATIONAL INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
12. Income Taxes - (Continued)
In fiscal 1997 a valuation allowance of $8.6 million was established against deferred tax assets acquired in the AO Acquisition. Movements in the valuation allowances in fiscal 1998, 1997 and 1996 relate primarily to realization of NOL's or changes in the Company's evaluation of the realizability of deferred tax assets.
For tax purposes, the Company's foreign subsidiaries, at March 31, 1998, had net operating loss carryforwards of $32.9 million. Of this amount, $31.0 million does not expire, and $1.9 million expires between 2002 and 2007. The deferred tax assets reflected in the Company's accounts as of March 31, 1998 before valuation allowances reflect these NOL's.
The Company has not provided for U.S. federal income and foreign withholding taxes on $21 million of non-U.S. subsidiaries' undistributed earnings as of March 31, 1998 because such earnings are intended to be reinvested indefinitely. Upon distribution of those earnings in the form of dividends or otherwise, the Company would be subject to U.S. income taxes (subject to an adjustment for foreign tax credits). Determination of the amount of unrecognized deferred U.S. income tax liability is not practicable because of the complexities associated with its hypothetical calculation.
13. Commitments
The Company leases certain warehouse and office facilities, office equipment and automobiles under non cancelable operating leases which expire in 1998 through 2012. The Company is responsible for taxes, insurance and maintenance expenses related to the leased facilities. Under the terms of certain lease agreements, the leases may be extended, at the Company's option, and certain of the leases provide for adjustments of the minimum monthly rent.
Future minimum annual lease payments under the leases are as follows:
Period Ending March 31, - ----------------------- (in thousands) 1999.......................................................... $4,774 2000.......................................................... 3,909 2001.......................................................... 2,730 2002.......................................................... 2,540 2003.......................................................... 2,563 Thereafter.................................................... 5,449
Rent expense for fiscal 1998, 1997, and 1996 was $7.8 million, $5.6 million and $5.4 million, respectively.
14. Contingencies
The Company is subject to environmental laws and regulations concerning emissions to the air, discharges to surface and subsurface waters and the generation, handling, storage, transportation, treatment and disposal of waste materials.
SOLA INTERNATIONAL INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
14. Contingencies - (Continued)
The Company is currently participating in a remediation program of one of its manufacturing facilities under the Comprehensive Environmental Response, Compensation and Liability Act and the Superfund Amendments and Reauthorization Act of 1986. In March 1997 the U.S. Environmental Protection Agency ("EPA") consented to the Company curtailing clean-up activities for a six month period which ended in September. The Company continued to monitor contamination levels during the curtailment period. During the quarter ended December 31, 1997 a report on contamination levels, and the impact of curtailed activities, was submitted to the EPA, and such report is currently under review. The report indicates no significant impact on the site from the curtailed activities, and the EPA has consented to continued curtailment of activities until such time as they have concluded their review of the report. The Company expects continued reduction of clean-up activities due to relatively low levels of contamination existing at the site.
The Company is also involved in other investigations of environmental contamination at several U.S. sites. Some clean-up activities have been conducted and investigations are continuing to determine future remedial requirements, if any.
Under the terms of the sale agreement with Pilkington plc ("Pilkington"), for the purchase of the Sola business in December 1993 ("Acquisition"), Pilkington has indemnified the Company with regard to expenditures subsequent to the Acquisition for certain environmental matters relating to circumstances existing at the time of the Acquisition. Under the terms of the indemnification, the Company is responsible for the first $1 million spent on such environmental matters, Pilkington and the Company share equally the cost of any further expenditures between $1 million and $5 million, and Pilkington retains full liability for any expenditures in excess of $5 million.
In the ordinary course of business, various legal actions and claims pending have been filed against the Company. While it is reasonably possible that such contingencies may result in a cost greater than that provided for in the financial statements, it is the opinion of management that the ultimate liability, if any, with respect to these matters, will not materially affect the consolidated operations or financial position of the Company.
SOLA INTERNATIONAL INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
15. Worldwide Operations
The Company operates in the ophthalmic industry in the design and manufacture of eyeglass lenses.
Internal sales represent intercompany sales between regions at a mark-up from cost; the elimination of any profit arising from such sales is reflected in eliminations in determining operating income.
For fiscal 1998, 1997 and 1996, the corporate headquarters costs of $9.7 million, $6.9 million and $7.7 million, respectively, are included in the North American geographic area.
SOLA INTERNATIONAL INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
16. Pro Forma Data
The following pro forma data, as restated for the adoption of FAS 128, was prepared to illustrate the estimated effect of the AO Acquisition and the financing related thereto, as if the Acquisition had occurred as of the beginning of each period presented:
Year Ended March 31, --------------------------- 1997 1996 --------- ----------- Net sales .................................... $ 507,713 $ 475,274 ========= ===========
Income before extraordinary item ............. $ 41,968 $ 42,093 ========= ===========
Net income ................................... $ 41,968 $ 41,181 ========= ===========
Earnings per share - basic: Income before extraordinary item ........... $ 1.72 $ 1.75 ========= ===========
Net income ................................. $ 1.72 $ 1.71 ========= ===========
Earnings per share - diluted: Income before extraordinary item ........... $ 1.64 $ 1.67 ========= ===========
Net income ................................. $ 1.64 $ 1.63 ========= ===========
These pro forma results of operations have been prepared for comparison purposes only, and do not purport to be indicative of what the results would have been had the AO Acquisition occurred at the beginning of each period presented. As a result of the AO Acquisition the Company has incurred two non-recurring charges during fiscal 1997: (i) a $7.2 million charge to cost of sales for the amortization associated with an inventory write-up to fair value during the six months ended September 30, 1996; and (ii) a $9.5 million charge for the write-off of in-process research and development all of which was recorded in the quarter ended June 30, 1996. These charges, and the related provision for tax thereon, have been excluded from the pro forma results as they are non-recurring. The pro forma data above does not include pro forma adjustments for the Neolens Acquisition as the results of Neolens prior to acquisition were not material to the Company's consolidated results of operations.
SOLA INTERNATIONAL INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
SOLA INTERNATIONAL INC.
QUARTERLY FINANCIAL DATA (in thousands, except per share data) (unaudited)
Quarter Ended ----------------------------------------- June 30, Sept. 30, Dec. 31, March 31, 1996 1996 1996 1997 -------- -------- -------- -------- Net sales .......................... $109,536 $128,194 $119,721 $131,238 Gross profit ....................... 51,487 53,109 57,124 62,434 Operating income ................... 6,082 13,975 15,261 22,029 Net income ......................... 2,162 6,969 7,840 13,926 Earnings per share - basic (1): Net income ....................... 0.10 0.29 0.32 0.57 Earnings per share - diluted (1): Net income ....................... 0.09 0.27 0.31 0.55
(1) As restated for the adoption of FAS 128.
S-1
E-4
Item 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Overview
The following discussion of the Company's financial condition and results of operations should be read in conjunction with the Company's consolidated financial statements and notes thereto included elsewhere in this Form 10-K. The financial statements for the year ended March 31, 1997 reflect the consolidated operations of the Company after accounting for the acquisition ("AO Acquisition") of substantially all of the worldwide ophthalmic business ("AO") of American Optical Corporation ("AOC") on June 19, 1996 (see Note 1 of Notes to Consolidated Financial Statements), using the purchase method of accounting. Operating results for fiscal 1997 subsequent to the AO Acquisition include non-recurring, non-cash charges relating to the write-off of in-process research and development projects ($9.5 million) and amortization associated with an inventory write-up to fair value ($7.2 million), both of which were recorded in connection with the AO Acquisition. The years ended March 31, 1998, 1997 and 1996 are referred to herein as fiscal 1998, fiscal 1997 and fiscal 1996, respectively.
Results of Operations
Net Sales
Net sales were $547.7 million in fiscal 1998, $488.7 million in fiscal 1997, and $387.7 million in fiscal 1996, reflecting a growth of 12.1% from fiscal 1997 to fiscal 1998 and 26.0% from fiscal 1996 to fiscal 1997. Using constant exchange rates, the percentage increase from fiscal 1997 to fiscal 1998 was 16.6%, and from fiscal 1996 to fiscal 1997 was 25.6%. The AO Acquisition, with nine months of AO net sales, amounting to $64.4 million, included in fiscal 1997 net sales, had a significant impact on the net sales growth from fiscal 1996 to fiscal 1997. Higher priced product growth has contributed to the Company's net sales growth in fiscal 1997 and fiscal 1998, led by the growth of Spectralite(R), plastic photochromic and polycarbonate products, offset in part by price and volume erosion in net sales of lower priced products. Higher priced products accounted for approximately 66% of net lens sales in fiscal 1998 compared to 61% in fiscal 1997 and 57% in fiscal 1996. Increased marketing and customer service efforts have also contributed to the growth in other higher priced products. Net sales increases by region from fiscal 1997 to 1998 were as follows: North America 20.1%, Europe 7.1% and Rest of World 1.3%. Net sales increases in major market areas from fiscal 1996 to 1997 were as follows: North America 22.7%, Europe 40.6% and Rest of World 15.9%. At constant exchange rates, net sales increases from fiscal 1997 to fiscal 1998 were: North America 20.1%, Europe 16.0% and Rest of World 6.8%, and from fiscal 1996 to fiscal 1997 were: North America 22.9%, Europe 42.2% and Rest of World 12.1%.
Gross Profit and Gross Margin
Gross profit totaled $258.1 million in fiscal 1998, $231.4 million, as adjusted, in fiscal 1997 and $185.7 million in fiscal 1996, reflecting growths of 11.5% from fiscal 1997 to fiscal 1998 and 24.6% from fiscal 1996 to fiscal 1997. Gross profit as a percentage of net sales ("gross margin") in fiscal 1998, fiscal 1997, as adjusted and fiscal 1996, were 47.1%, 47.3%, and 47.9%, respectively. The gross margin has decreased in fiscal 1998 and fiscal 1997, as AO traditionally operates at lower gross margins than Sola on a stand alone basis. In addition, the Company continues to incur manufacturing start up costs in its
new finished polycarbonate manufacturing operation acquired when the Company purchased Neolens, Inc. in July 1996, and ramp up costs associated with new product offerings, such as Matrix, the Company's new anti-reflective coating delivery system. Offsetting in part the aforementioned reductions, has been a continued shift towards higher value added products, and continued benefits from the Company's cost reduction program. During fiscal 1996 the Company benefited from reduced manufacturing costs at its Mexican facility arising from the weakness of the Mexican Peso, and from the Company's cost reduction program. The Company continues to experience price competition, which can be severe in certain markets, particularly for standard products.
Operating Expenses
Operating expenses totaled $165.4 million in fiscal 1998, $157.3 million, as adjusted, in fiscal 1997 and $125.0 million in fiscal 1996 reflecting increases of 5.1% from fiscal 1997 to fiscal 1998 and 25.9% from fiscal 1996 to fiscal 1997. Research and development expenses for fiscal 1998, 1997 and 1996 represent 3.3%, 3.6% and 3.4%, respectively, of annual net sales, reflecting the Company's continued commitment to research and development of new products, materials and processes. Because research and development expenditure in AO as a percentage of net sales is lower than that of Sola on a stand alone basis, the current lower ratio of research and development expenses to net sales can be expected for the combined company in the future. The lower charge to research and development expenses in fiscal 1996 arose primarily from the transfer of a new product out of research and development and into production. Selling and marketing expenses were 17.2%, 18.9% and 17.1% of net sales in fiscal 1998, 1997 and 1996, respectively. During the fourth quarter of fiscal 1997 the Company introduced a new progressive lens design, Percepta(R), with a worldwide launch. Significant marketing expenditures associated with this launch were incurred primarily in the last two quarters of the 1997 fiscal year resulting in higher sales and marketing expenses as a percentage of net sales in fiscal 1997. As a percentage of net sales, general and administrative expenses in fiscal 1998, fiscal 1997 and fiscal 1996 were 9.7%, 9.7% and 11.7%, respectively. The higher percentage in fiscal 1996 compared to fiscal 1998 and fiscal 1997 was primarily due to higher performance based management bonuses in fiscal 1996 and higher provisions for doubtful accounts in South America and Asia.
Operating Income
Operating income for fiscal 1998 totaled $92.7 million, an increase of $18.6 million over fiscal 1997 operating income, as adjusted, of $74.1 million, or 25.2%. Operating income for fiscal 1997 totaled $74.1 million, as adjusted, an increase of $13.3 million over fiscal 1996 operating income of $60.8 million, or 21.9%.
Net Interest Expense
Net interest expense totaled $16.8 million for fiscal 1998, $15.9 million for fiscal 1997 and $12.1 million for fiscal 1996. Interest expense was higher in fiscal 1998 than fiscal 1997, primarily due to a full year of higher indebtedness to fund the acquisitions of AO and Neolens in June and July of 1996, offset in part by lower interest rates on the Company's revolving line of credit, and the repurchase of its 9 5/8% senior subordinated notes in December 1997. Interest expense was higher in fiscal 1997 than fiscal 1996 also due to the AO and Neolens acquisitions, offset by the lower interest rate under the Company's new bank credit facility and the reduction of debt from the proceeds of the equity public offering. Simultaneously with the AO Acquisition, the Company entered into a new bank credit facility with The Bank of America National Trust and Savings Association, for itself and as agent for a syndicate of other financial institutions (see "--Liquidity and Capital Resources"). In July 1996, the Company issued 2.32 million shares of common stock in a public offering for which it received net proceeds of approximately $62.8 million.
Provision for Income Taxes
The Company's combined state, federal and foreign tax rate was approximately 33.4% for fiscal 1998 compared to 28.5% for fiscal 1997, as adjusted, and 28.0% for fiscal 1996. The utilization of
United States valuation allowances, arising in fiscal 1994, were the primary reasons for the lower income tax rates in fiscal 1997 and fiscal 1996. The Company has deferred tax assets on its balance sheet as of March 31, 1998 amounting to approximately $16.0 million. The ultimate utilization of these deferred tax assets is dependent on the Company's ability to generate taxable income in the future.
Extraordinary Item
During fiscal 1998 the Company repurchased all of its remaining 9 5/8% Senior Subordinated Notes due 2003, and during fiscal 1996 the Company repurchased approximately $19.9 million principal amount at maturity of the Senior Subordinated notes. As a result of the repurchases the Company recorded extraordinary charges of $5.9 million for fiscal 1998, and $0.9 million for fiscal 1996, in each case resulting from the write-off of unamortized debt issuance costs and premium over accreted value, net of tax. The 1998 repurchase was funded by borrowings under the Company's credit agreement and the 1996 repurchase was partly funded by borrowings under the Company's prior credit agreement and partly from cash arising from the IPO.
Net Income
Net income for fiscal 1998 totaled $45.2 million compared to $41.8 million, as adjusted, for fiscal 1997 and $33.6 million for fiscal 1996, increases of $3.4 million and $8.2 million, respectively. The growth in net income from fiscal 1997, as adjusted, to fiscal 1998 was 8.1% and from fiscal 1996 to fiscal 1997, as adjusted, was 24.0%. If the extraordinary items in fiscal 1998 and fiscal 1996 are excluded, the growth from fiscal 1997, as adjusted, to fiscal 1998, and from fiscal 1996 to fiscal 1997, as adjusted, would have been 22.3% and 20.7%, respectively.
Liquidity and Capital Resources
The following analysis of the Company's cash flow statement reflects the historical results of the Company which have not been adjusted for the AO Acquisition.
Operating activities generated $20.9 million in cash in fiscal 1998 compared with $32.4 million in fiscal 1997 and $30.8 million in fiscal 1996. Significantly improved net income in fiscal 1998 was more than offset by increases in inventories and accounts receivable. During fiscal 1998 the Company decided to take advantage of prompt pay discounts offered by suppliers in the United States resulting in accounts payable not increasing in line with the increases in the business. Improved net income in fiscal 1997, after adding back one time non-recurring non-cash charges associated with the AO Acquisition, was offset in part by increases in inventories and accounts receivable. Accounts payable in fiscal 1997 increased in line with inventory growth.
During fiscal 1998 inventories as a percentage of net sales grew to 31.0% from 28.4% in the prior year. The increase in inventories is primarily a result of building inventories to support new product launches, growth in higher priced products as a percentage of net sales and therefore of inventories, and the projected overall increase in the business. During fiscal 1997 inventories as a percentage of net sales grew to 28.4% (27.2% if a full year's net sales for AO are used) from 26.0% in the prior year. The growth in inventory levels resulted from the introduction and regional spread of new products, resulting in both finished goods inventory growth and increased mold inventory requirements. The primary increase was caused by increases in inventories and molds to support the worldwide launch of a new progressive lens design, Percepta(R), in the fourth quarter of fiscal 1997. Accounts receivable as a percentage of net sales increased to 22.0% in fiscal 1998 compared to 21.5% a year ago. Accounts receivable as a percentage of net sales increased to 21.5% (20.5% if a full year's net sales for AO are used) in fiscal 1997 compared to 19.3% for fiscal 1996.
During fiscal 1998 net cash expended on investing activities amounted to $41.2 million, primarily being capital expenditures. The most significant capital expenditures, primarily on additional production capacity, were made in the United States, Mexico, Brazil, China, Venezuela and Australia. During fiscal 1997 net cash expended on investing activities amounted to $154.8 million. On June 19, 1996, the
Company acquired substantially all of the worldwide ophthalmic business of AOC for cash consideration of $103.6 million (together with the assumption of certain liabilities) (the "AO Acquisition"). The AO Acquisition was funded primarily through borrowings under the Company's then existing credit agreement, which borrowings were subsequently repaid in part with the proceeds from the equity public offering during July 1996. On July 2, 1996 the Company acquired Neolens, Inc. ("Neolens"), a Florida corporation for cash consideration of approximately $15.5 million, including the assumption of Neolens debt ("Neolens Acquisition"). The Neolens Acquisition was funded through borrowings under the Company's then existing credit agreement. During fiscal 1997, the Company spent approximately $30.0 million on capital expenditures primarily in the United States, Mexico, China and Brazil. The capital expenditures in fiscal 1997 were primarily to add production capacity. During fiscal 1996 net cash expended on investing activities was primarily for capital expenditures and increasing the Company's investment in its Venezuela joint venture. The capital expenditures in fiscal 1996 related mainly to expansion of production capacity to accommodate higher volumes and the introduction of new products. During fiscal 1996 the Company increased its investment in its Venezuela joint venture, Sola de Venezuela Industria Optica, C.A. ("Sola Venezuela"), from 45% to 100%. The purchase price amounted to approximately $3.6 million and was paid in cash. Management anticipates capital expenditures of $40 million to $45 million annually over the next several years, of which approximately $5 million annually is viewed as discretionary.
Financing activities generated $32.3 million in fiscal 1998, primarily from additional borrowings under the Amended Agreement and exercise of stock options by employees. In the third quarter of fiscal 1998 the Company repurchased all of its remaining 9 5/8% Senior Subordinated Notes due 2003. The notes repurchase was funded by borrowings under the Amended Agreement. In conjunction with the repurchase of its Senior Subordinated Notes the Company amended its bank credit agreement with The Bank of America National Trust and Savings Association, for itself and as agent for a syndicate of other financial institutions ("Amended Agreement"). The Amended Agreement increased the Company's multicurrency revolving facility from $180 million to $300 million. Borrowings are divided into two tranches. Tranche A permits borrowings up to $30 million in either U.S. dollars or foreign currencies, to be used for working capital and consummating certain permitted acquisitions. Tranche B permits borrowings of up to $270 million and can be used for working capital purposes, refinancing the term loans under the existing bank credit agreement, repurchasing the Company's Senior Subordinated Notes, and consummating certain permitted acquisitions. The Tranche A Facility matures on October 31, 2000 and the Tranche B Facility matures on May 31, 2001. Among other things the Amended Agreement changed certain financial covenants, removed the requirement for foreign subsidiary guarantees under the Tranche A facility, increased the basket for incurring other unsecured indebtedness to $150 million, and deleted the term facility portion.
Borrowings under the Tranche A and Tranche B revolvers (other than swing line loans, which may only be Base Rate loans) may be made as Base Rate Loans or LIBO Rate Loans. Base Rate Loans bear interest at rates per annum equal to the higher of (a) 0.50% per annum above the latest Federal Funds Rate, or (b) the Bank of America Reference Rate. LIBO Rate Loans bear interest at a rate per annum equal to the sum of the LIBO Rate and a margin varying from 0.450% to 0.750% based on the Company's leverage ratio. Fixed rate borrowings in foreign currencies bear interest at rates per annum equal to the referenced currency's local IBOR plus a margin varying from 0.450% to 0.750% based on the Company's leverage ratio. Local currency Base Rate Loans are also available at a spread similar to US Base Rate Loans described above.
During the fourth quarter of fiscal 1998 the Company issued 6 7/8% Senior Notes ("Notes") due 2008, for which the Company received approximately $98.5 million net proceeds, after discounts and issuance expenses. Net proceeds were used to pay down borrowings under the Amended Agreement. The Notes are unsecured senior obligations of the Company, limited to $100 million aggregate principal amount at maturity, and will mature on March 15, 2008. The Notes will be redeemable, as a whole or from time to time in part, at the option of the Company on any date at a redemption price equal to the aggregate principal amount plus a make whole premium.
Financing activities generated $125.3 million in fiscal 1997. During July 1996 the Company sold 2,320,000 additional shares of common stock at $28.625 per share through a public offering. The net proceeds from this offer, were approximately $62.8 million. The Company used such net proceeds to repay indebtedness which it incurred under its then existing bank credit agreement. Simultaneously with the closing of the AO Acquisition, the Company entered into a bank credit agreement with The Bank of America National Trust and Savings Association, for itself and as agent for a syndicate of other financial institutions, covering an aggregate amount of $180 million.
Financing activities were an outflow of $4.7 million in fiscal 1996. During the three months ended June 1995 the Company repurchased approximately $19.9 million principal amount at maturity of its 9 5/8% Senior Subordinated Notes due 2003. The repurchase was partly funded by borrowings under the prior credit agreement and partly from excess cash arising from the IPO.
The Company's foreign subsidiaries maintain local credit facilities to provide credit for overdraft, working capital and some fixed asset investment purposes. As of March 31, 1998, the Company's total credit available under such facilities was approximately $29.9 million, of which $10.1 million had been utilized.
The Company continues to have significant liquidity requirements. In addition to working capital needs and capital expenditures, the Company has substantial cash requirements for debt service. The Company expects that the Amended Agreement and other overseas credit facilities, together with cash on hand and internally generated funds, if available as anticipated, will provide sufficient capital resources to finance the Company's operations, fund anticipated capital expenditures, and meet interest requirements on its debt, including the Notes, for the foreseeable future. As the Company's debt matures, the Company may need to refinance such debt. There can be no assurance that such debt can be refinanced on terms acceptable to the Company.
Currency Exchange Rates
As a result of the Company's worldwide operations, currency exchange rate fluctuations tend to affect the Company's results of operations and financial position. The two principal effects of currency exchange rates on the Company's results of operations and financial position are (i) translation adjustments for subsidiaries where the local currency is the functional currency and (ii) translation adjustments for subsidiaries in hyper-inflationary countries. Translation adjustments for functional local currencies have been made to shareholders' equity. For the fiscal years ended March 31, 1998, 1997 and 1996 such translation adjustments were approximately $(10.0) million, $(3.8) million, $(1.6) million, respectively.
During fiscal 1996 the Company benefited from reduced manufacturing costs at its Mexican facility arising from the weakness of the Mexican Peso. For translation adjustments of the Company's subsidiaries operating in hyper-inflationary countries, until recently primarily Brazil, the functional currency is determined to be the U.S. dollar, and therefore all translation adjustments are reflected in the Company's Statements of Operations. Commencing with the fourth quarter of fiscal 1997 the Company's operations in Mexico have been accounted for as hyper-inflationary economies. In hyper-inflationary environments, the Company generally protects margins by methods which include increasing prices monthly at a rate appropriate to cover anticipated inflation, compounding interest charges on sales invoices daily and holding cash balances in U.S. dollar denominated accounts where possible.
Because a majority of the Company's debt is U.S. dollar denominated, the Company may hedge against certain currency fluctuations by entering into currency swaps (however certain currencies, such as the Brazilian Real, cannot be hedged), although no such swaps had been entered into as of March 31, 1998. As of March 31, 1998 certain of the Company's foreign subsidiaries had entered into forward contracts for intercompany purchase commitments in amounts other than their home currency. The carrying amount of the forward contracts approximates fair value, which has been estimated based on current exchange rates. For further financial data of the Company's performance by region, see Note 15 of Notes to Consolidated Financial Statements.
Seasonality
The Company's business is somewhat seasonal, with third quarter results generally weaker than the other three quarters as a result of lower sales during the holiday season, and fourth quarter results generally the strongest.
Inflation
Inflation continues to affect the cost of the goods and services used by the Company. The competitive environment in many markets limits the Company's ability to recover higher costs through increased selling prices, and the Company is subject to price erosion in many of its standard product lines. The Company seeks to mitigate the adverse effects of inflation through cost containment and productivity and manufacturing process improvements. For a description of the effects of inflation on the Company's reported revenues and profits and the measures taken by the Company in response to inflationary conditions, see--"Currency Exchange Rates" above.
Year 2000
The Company has developed preliminary plans to address the possible exposures related to the impact on its computer systems of the Year 2000. Key financial, information and operational systems have been assessed and plans have been developed to address systems modifications required by December 31, 1999. Based on work to date, and assuming that project plans, which continue to evolve, can be implemented as planned, management believes the financial impact of making the required systems changes will not be material to the Company's consolidated financial position, results of operations or cash flows.
The Company is also in the preliminary stages of assessing the possible effects on the Company's operations of the Year 2000 readiness of key suppliers and customers. The Company's reliance on suppliers and customers and therefore on the proper functioning of their information systems and software, means that failure to address Year 2000 issues could have a material impact on the Company's operations and financial results; however, the potential impact and related costs are not known at this time.
Information Relating to Forward-Looking Statements
This Form 10-K of the Company includes forward-looking statements within the meaning of Section 21E of the Securities Exchange Act of 1934, including statements regarding, among other items, (i) the Company's development of new products, including, among others, Percepta, Spectralite, Access and Matrix, (ii) the availability of raw materials for the Company's products, the costs of product introductions, and trends in sales growth (including growth related to new products), (iii) anticipated trends in the Company's business environment, including competitive and pricing pressures, (iv) the Company's ability to continue to control costs and maintain adequate standards of customer service and product quality (v) future income tax rates and capital expenditures and working capital requirements and (vi) statements regarding the adequacy of the Company's planning for the Year 2000 computer programming issues. These forward looking statements reflect the Company's current views with respect to future events and financial performance. The words "believe", "expect", "anticipate" and similar expressions identify forward-looking statements. Readers are cautioned not to place undue reliance on these forward-looking statements, which speak only as of their dates. The Company undertakes no obligation to publicly update or revise any forward-looking statements, whether as a result of new information, future events or otherwise. Actual results could differ materially from the forward-looking statements as a result of various factors including the "Factors Affecting Future Operating Results" included in Exhibit 99.1 of the Company's Form 10-K for the fiscal year ended March 31, 1998 and the factors described in "Business--Environmental Matters."
Item 8.
Item 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The financial statements required by this item are set forth on pages, and through and the related financial statement schedule is set forth on page S-1.
Item 9.
Item 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
Not applicable.
PART III
Item 10.
Item 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The principal occupations and positions for at least the past five years of each of the directors and executive officers of the Company are as follows (references to the Company include its predecessors):
Irving S. Shapiro has been Chairman of the Board of the Company since December 1994. Mr. Shapiro is Of Counsel to Skadden, Arps, Slate, Meagher & Flom LLP. He was Chairman and Chief Executive Officer of E.I. du Pont de Nemours and Company from 1974 to 1981. He is Chairman of the Board of Marvin & Palmer Associates, Inc., and is a director of J.P. Morgan Florida Federal Savings Bank, Pediatric Services of America Inc., and Gliatech, Inc.
Douglas D. Danforth has been a director of the Company since December 1994. He was Chairman and Chief Executive Officer of Westinghouse Electric Corporation from 1983 to 1987. He is a director of Daltile Inc.
Hamish Maxwell has been a director of the Company since December 1994. Mr. Maxwell was Chairman of the Executive Committee of the Board of Directors of Philip Morris Companies Inc. from September 1991 through April 1995 and was Chairman and Chief Executive Officer of such company from 1984 to 1991. He is a director of Bankers Trust Company, Bankers Trust New York Corporation and Chairman of WPP Group plc.
Maurice J. Cunniffe has been a director of the Company since December, 1996. He is Chairman and Chief Executive Officer of American Optical Corporation, a company of which he has been sole shareholder since 1982.
Jackson L. Schultz has been a director of the Company since November 1995. Mr. Schultz joined Wells Fargo Bank in 1970, retiring in 1990 as Senior Vice President responsible for Public and Governmental Affairs.
A. William Hamill has been a director of the Company since December, 1996. Mr. Hamill is Executive Vice President and Chief Financial Officer of Union Camp Corporation, which he joined in 1996. From 1993 through 1996, he was a partner in SCI Investors Inc. and a director of Custom Papers Group Inc. From 1991 to 1993, he was Senior Vice President and Chief Financial Officer of Specialty Coatings International Inc.. From 1975 through 1990, Mr. Hamill was with Morgan Stanley & Co. Incorporated, where he was a Managing Director.
John E. Heine has served as Chief Executive Officer and President of the Company since November 1981 and served as Chairman of the Board of the Company from September 1993 to December 1994. Mr. Heine joined the Company in 1981 as Managing Director of Sola International Holdings, Ltd. and previously held general management positions with Southern Farmers Holdings, Ltd. in Adelaide and H.J. Heinz in Melbourne, Australia.
James H. Cox was appointed Executive Vice President in December 1996, Assistant Secretary and Assistant Treasurer of the Company in September 1993 and President of Sola Optical USA, the Company's North American eyeglass lens business in 1991. He joined the Company as Vice President, Manufacturing in 1985. Mr. Cox was formerly Executive Vice President of Operations with Bausch & Lomb's Consumer Products Division.
Steven M. Neil was appointed Executive Vice President, Finance, Chief Financial Officer, Secretary and Treasurer in October 1997. Prior to joining Sola, Mr. Neil was Vice President-Finance, Treasurer and Chief Financial Officer of Perrigo Company from May 1995 to September 1997. He also served as President of Perrigo International, Inc. from July 1996. Mr. Neil served as Vice President-Controller of Perrigo Company from January 1993 to May 1995. Prior to that time he served as Controller and Chief Accounting Officer with Applied Magnetics Corporation, where he also served in other positions of increasing responsibility since 1983. He is a member of the Board of Directors of Intelligent Solutions, Inc.
Stephen J. Lee was appointed Vice President, Human Resources of the Company in 1988 and was formerly Director of Personnel for Pilkington's Ophthalmic and Insulation Divisions. Mr. Lee joined the Pilkington Group in 1974.
Barry J. Packham joined the Company as Vice President, Manufacturing Development in February 1993. Mr. Packham was Managing Director of Ceramic Fuel Cells Ltd., a research and development joint venture consortium in Melbourne, Australia, from 1991 to 1993 and formerly held manufacturing and general management positions with Kodak and Leigh-Mardon Pty. Ltd.
John J. Bastian has served as Regional Director, Australia since 1987. Mr. Bastian joined the Company in 1983 as Group General Manager, Marketing in Sola International Holdings, South Australia following a six-year career with PA Management Consultants.
Theodore Gioia has served as Vice President, Strategic Planning since 1992. Mr. Gioia joined the Company as Director of Strategic Planning in 1989, having sold the start-up recording company he founded in 1987. Mr. Gioia was previously a consultant with McKinsey & Company and the Boston Consulting Group.
Adrian P. Walker joined the Company as Regional Director, Asia in November 1996. Mr. Walker held a number of general management positions with subsidiaries of BTR plc. from March 1980 to November 1996. He was most recently General Manager of ACI Laminates and Insulations, based in Melbourne, Australia from July 1995 to October 1996. From August 1992 to July 1995 he was Managing Director of Dunlop Slazenger (Far East), in Malaysia, and from April 1985 to July 1992 was General Manager, Serck Services (Gulf) Ltd., in the United Arab Emirates.
Mark T. Mackenzie was appointed Regional Director, Europe in April 1994. Mr. Mackenzie served as Group Marketing Director of Tarkett Pegulan AG, and as General Manager of the Residential Flooring Division, based in Germany. He formerly held marketing and sales positions with Gillette, L'Oreal and Cadbury Schweppes.
Alan S. Vaughan was appointed Vice President, Worldwide Rx Operations in June 1994, having previously served as European Manufacturing and Technical Director. Mr. Vaughan joined the Company in 1978 as Managing Director of Sola ADC Lenses in Ireland. He was previously Director of Operations with Johnson & Johnson (Ireland).
Item 11.
Item 11. EXECUTIVE COMPENSATION
Incorporated by reference to the material included under the caption "Compensation of Executive Officers" in the Company's proxy statement for the fiscal year ended March 31, 1998.
Item 12.
Item 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
Incorporated by reference to the material included under the caption "Security Ownership of Certain Beneficial Owners and Managers" in the Company's proxy statement for the fiscal year ended March 31, 1998.
Item 13.
Item 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Incorporated by reference to the material included under the caption "Certain Transactions" in the Company's proxy statement for the fiscal year ended March 31, 1998.
PART IV
Item 14.
Item 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
(a) Documents Filed as Part of this Report:
1. Financial Statements. See Index to Consolidated Financial Statements and Financial Statement Schedules included on page.
2. Financial Statement Schedules. See "Schedule II - Valuation and Qualifying Accounts" included on page S-1.
Schedules other than those listed above have been omitted since they are either not required, not applicable or the information is otherwise included.
3. List of Exhibits. See Index of Exhibits included on page E-1.
(b) Reports on Form 8-K:
The Company filed a report on Form 8-K, dated February 17, 1998 to report the Company's adoption of FAS 128, Earnings per Share, for its fiscal quarter ended December 31, 1997, and restating certain earnings per share information previously presented in the Company's Securities Exchange Act filings.
SIGNATURES
Pursuant to the requirements of Section 13 or Section 15(d) of the Securities Exchange Act of 1934, as amended, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
SOLA INTERNATIONAL INC. (Registrant)
Date: June 15th, 1998 By: /s/Steven M. Neil ------------------ Steven M. Neil Executive Vice President, Finance, Chief Financial Officer, Secretary and Treasurer
SOLA INTERNATIONAL INC.
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
Page ---- Report of Ernst & Young LLP, Independent Auditors....................... Consolidated Balance Sheets as of March 31, 1998 and 1997............... Consolidated Statements of Income for the years ended March 31, 1998, 1997 and 1996......................................................... Consolidated Statements of Shareholders' Equity for the years ended March 31, 1998, 1997 and 1996......................................... Consolidated Statements of Cash Flows for the years ended March 31, 1998, 1997 and 1996........................................ Notes to Consolidated Financial Statements.............................. Quarterly Financial Data (unaudited).................................... Financial Statement Schedule............................................ S-1
Report of Ernst & Young LLP, Independent Auditors
Board of Directors and Shareholders
Sola International Inc.
We have audited the accompanying consolidated balance sheets of Sola International Inc. as of March 31, 1998 and 1997, and the related consolidated statements of income, shareholders' equity, and cash flows for each of the three years in the period ended March 31, 1998. Our audits also included the financial statement schedule listed in the index at item 14(a). These consolidated financial statements and schedule are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements and schedule based on our audits.
We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of Sola International Inc. as of March 31, 1998 and 1997, and the consolidated results of its operations and its cash flows for each of the three years in the period ended March 31, 1998, in conformity with generally accepted accounting principles. Also, in our opinion, the related financial statement schedule, when considered in relation to the basic financial statements taken as a whole, presents fairly in all material respects the information set forth therein.
/s/Ernst & Young LLP
Palo Alto, California May 6, 1998
Cumulative Foreign Currency Total Translation Shareholders' Adjustments Equity --------- --------- Balances, March 31, 1995 .......................... $ 5,636 $ 159,443 17 shares of $0.01 par value common stock issued under stock option plans ................. 59 Repayment of Equity participation loans ........... 674 Cumulative translation adjustments ................ (1,611) (1,611) Net income ........................................ 33,676 --------- --------- Balances, March 31, 1996 .......................... 4,025 192,241
Public Offering of 2.320 shares of $0.01 par value common stock, net of offering expenses .... 62,765 146 shares of $0.01 par value common stock issued under stock option plans ................. 1,749 Tax benefit from exercise of stock options ........ 266 Repayment of Equity participation loans ........... 151 Cumulative translation adjustments ................ (3,771) (3,771) Net income ........................................ 30,897 --------- --------- Balances, March 31, 1997 .......................... 254 284,298
460 shares of $0.01 par value common stock issued under stock option plans ................. 5,334 Tax benefit from exercise of stock options ........ 2,191 Repayment of Equity participation loans ........... 40 Cumulative translation adjustments ................ (9,994) (9,994) Net income ........................................ 45,153 --------- --------- Balances, March 31, 1998 .......................... $ (9,740) $ 327,022 ========= =========
The accompanying notes are integral part of these financial statements.
SOLA INTERNATIONAL INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. Business and Basis of Presentation
Sola International Inc. ("Company") designs, manufactures and distributes a broad range of eyeglass lenses, primarily focusing on the fast growing plastic lens segment of the global market. The Company operates in one business segment.
In June 1996, the Company acquired substantially all of the worldwide ophthalmic business ("AO") of American Optical Corporation for cash consideration of $103.6 million (together with the assumption of certain liabilities) (the "AO Acquisition"). The AO Acquisition was accounted for under the purchase method of accounting as of the closing date. The total purchase price of $110.2 million (including acquisition costs of $6.5 million) exceeded the historical book value of the net assets acquired and such excess was allocated to the assets and liabilities based on their estimated fair values as of the AO Acquisition date, including in-process research and development ($9.5 million) with no alternative future use. Independent appraisals were utilized for determining the amounts assigned to certain purchased assets including property, plant and equipment and in-process research and development.
In July 1996 the Company acquired control of Neolens, Inc. ("Neolens"), a Florida corporation that manufactured polycarbonate eyeglass lenses and was a supplier to the Company. The Company acquired Neolens for cash consideration of approximately $15.5 million, including the assumption of Neolens debt (the "Neolens Acquisition") and was accounted for under the purchase method of accounting as of the closing date. The total purchase price of $16.8 million (including acquisition costs of $1.3 million) included $17.6 million allocated to goodwill and other intangible assets. Results of Neolens prior to acquisition were not material to the Company's consolidated results of operations.
On October 5, 1995 the Company increased its investment in its Venezuela joint venture, Sola de Venezuela Industria Optica, C.A. ("Sola Venezuela"), from 45% to 80%, and in March 1996, the Company exercised its option to acquire the remaining 20% of the shares in Sola Venezuela. The purchase price for all the shares, including the 20% option, and acquisition expenses, amounted to approximately $3.6 million and was paid in cash. In addition to the cash purchase price of the final 20% of Sola Venezuela, Sola will pay a contingent payment based on the growth in the net income of Sola Venezuela in fiscal 1998 over the net income of Sola Venezuela in fiscal 1995, and such payment is not anticipated to be significant. The acquisition has been accounted for under the purchase method of accounting.
The accompanying consolidated financial statements of the Company have been prepared in accordance with U.S. generally accepted accounting principles. The Company's fiscal 1997 financial statements presented herein include the results of operations and cash flows of the AO business for the nine months and ten days ended March 31, 1997 and the results of operations and cash flows of the Neolens business for the nine months ended March 31, 1997 subsequent to their respective acquisitions.
2. Summary of Significant Accounting Policies
Principles of Consolidation:
The consolidated financial statements include the accounts of the Company and its wholly-owned and controlled foreign subsidiaries. All significant transactions between the entities have been eliminated.
SOLA INTERNATIONAL INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
2. Summary of Significant Accounting Policies - (Continued)
Cash and Cash Equivalents:
Cash equivalents consist primarily of short-term investments with an original maturity of three months or less, carried at cost which approximates market value.
Inventories:
Inventories are stated at the lower of cost (first-in, first-out) or market.
Property, Plant and Equipment:
Property, plant and equipment are stated at cost and are depreciated on a straight-line basis over the estimated useful lives of the related assets (buildings--15 to 50 years; plant and office equipment--2 to 10 years). Leasehold improvements and leased equipment are amortized over the lesser of their useful lives or the remaining term of the related leases.
Impact of recently issued accounting standards:
In June 1997, the FASB released Statement of Financial Accounting Standards No. 130, "Reporting Comprehensive Income" ("FAS 130"). FAS 130 establishes standards for the reporting and display of comprehensive income and its components in a full set of general purpose financial statements and is effective for fiscal years beginning after December 15, 1997. The Company is currently evaluating the impact of the application of the new rules on the Company's consolidated financial statements.
In June 1997, the FASB released Statement of Financial Accounting Standards No. 131, "Disclosures about Segments of an Enterprise and Related Information" ("FAS 131"). FAS 131 will change the way companies report selected segment information in annual financial statements and also requires those companies to report selected segment information in interim financial reports to shareholders. FAS 131 is effective for fiscal years beginning after December 15, 1997. The Company is currently evaluating the impact of the application of the new rules on the Company's consolidated financial statements.
Intangible Assets:
Intangible assets, including trademarks, patents and licenses, are stated at cost and amortized on a straight-line basis over their estimated useful lives of 2 to 17 years. Legal costs incurred by the Company in successfully defending its patents are capitalized to patent costs and amortized over the remaining life of the patent. Goodwill is amortized over 40 years. As of March 31, 1998 and 1997 accumulated amortization was $17.9 million and $12.4 million, respectively.
Debt issuance costs are being amortized to interest expense over the respective lives of the debt instruments which range from five to ten years. As of March 31, 1998 and 1997, accumulated amortization was $0.4 million and $1.5 million, respectively. As a result of repurchasing the Company's 9 5/8% Senior Subordinated Notes in fiscal 1998 and 1996 (see Note 8), the Company wrote off $1.5 million and $0.4 million, respectively, of debt issuance costs reflected on the statement of income, together with the premium over accreted value, as an extraordinary item, net of tax.
SOLA INTERNATIONAL INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
2. Summary of Significant Accounting Policies - (Continued)
Foreign Currency Translation:
The assets and liabilities and revenue and expense accounts of the Company's foreign subsidiaries operating in non-highly inflationary economies have been translated using the exchange rate at the balance sheet date and the weighted average exchange rate for the period, respectively.
The net effect of the translation of the accounts of the Company's subsidiaries has been included in equity as cumulative foreign currency translation adjustments. Adjustments that arise from exchange rate changes on transactions denominated in a currency other than the local currency are included in income as incurred and are not material.
The Company has operations in Brazil, a hyper-inflationary country until recently, for which the functional currency is the U.S. dollar. Commencing with the fourth quarter of fiscal 1997 the Company's operations in Mexico have been accounted for as hyper-inflationary economies. All translation and transaction adjustments are included in determining net income.
Revenue Recognition:
Sales and related cost of sales are recognized upon shipment of product. The Company's principal customers are wholesale distributors and processing laboratories, retail chains, superoptical retail stores, independent eyecare practitioners and sunglass manufacturers. No individual customer accounts for more than 10% of net sales. The Company generally does not require collateral from its customers, but performs on-going credit evaluations of its customers.
Advertising and Promotion Costs:
The Company's policy is to expense advertising and promotion costs as they are incurred. The Company's advertising and promotion expenses were approximately $12.3 million, $12.5 million, and $9.4 million for fiscal 1998, 1997, 1996, respectively.
Income Taxes:
The accompanying financial statements of the Company reflect the provisions of FASB 109. Investment tax credits and research and development credits are accounted for by the flow-through method.
Reclassifications:
Certain prior year items have been reclassified to conform with the current year's presentation. These reclassifications had no impact on total assets or net income.
Use of Estimates:
The preparation of the financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. Actual results could differ from those estimates.
SOLA INTERNATIONAL INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
2. Summary of Significant Accounting Policies - (Continued)
Concentration of Credit Risks:
Cash and cash equivalents are invested in deposits with major banks in the United States and in countries where subsidiaries operate. Deposits in these banks may exceed the amount of insurance provided on such deposits. The Company has not experienced any losses on its deposits of cash and cash equivalents.
Financial Instruments With Off-Balance-Sheet Risk:
The Company is a party to financial instruments with off-balance-sheet risk in the normal course of business to reduce its exposure to market and interest rate risk. Gains and losses due to rate fluctuations on such transactions are recognized currently. Cash flows related to these gains and losses are reported as operating or financing activities in the accompanying consolidated statements of cash flows. As of March 31, 1998, certain of the Company's foreign subsidiaries had entered into forward contracts for intercompany purchase commitments, which are not significant, in amounts other than their home currency. The carrying amount of the foreign exchange contracts approximates fair value, which has been estimated based on current exchange rates. The forward exchange contracts generally have varying maturities up to 9 months. Unless noted otherwise, the Company does not require collateral or other security to support financial instruments with credit risk.
Earnings (Loss) Per Share:
In 1997, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 128, "Earnings per Share" ("FAS 128"). FAS 128 replaced the previously reported primary and fully diluted earnings per share with basic and diluted earnings per share. Unlike primary earnings per share, basic earnings per share excludes any dilutive effects of options, warrants, and convertible securities. Diluted earnings per share is very similar to the previously reported fully diluted earnings per share. All earnings per share amounts for all included periods have been presented, and where necessary, restated to conform to the FAS 128 requirements.
SOLA INTERNATIONAL INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
2. Summary of Significant Accounting Policies - (Continued)
The following table sets forth the computation of basic and diluted earnings per share for the fiscal years ended March 31, 1998, 1997 and 1996 (in thousands, except per share data):
Year Ended March 31, ------------------------------- 1998 1997 1996 -------- -------- -------- Numerator: Income before extraordinary item ............ $ 51,092 $ 30,897 $ 34,588 Extraordinary item, loss on repurchase of senior subordinated notes, net of tax ..... (5,939) -- (912) -------- -------- -------- Net income ............................... $ 45,153 $ 30,897 $ 33,676 ======== ======== ======== Denominator: Denominator for basic earnings per share- Weighted average common shares outstanding............................. 24,400 23,561 21,785
Effect of dilutive securities: Employee stock options.................. 1,147 1,298 1,159 Denominator for diluted earnings per share- -------- -------- -------- Weighted average common shares and dilutive securities outstanding......... 25,547 24,859 22,944 ======== ======== ======== Basic earnings (loss) per share: Income before extraordinary item............. $ 2.09 $ 1.31 $ 1.59 Extraordinary item........................... (0.24) -- (0.04) -------- -------- -------- Net income................................ $ 1.85 $ 1.31 $ 1.55 ======== ======== ======== Diluted earnings (loss) per share: Income before extraordinary item............. $ 2.00 $ 1.24 $ 1.51 Extraordinary item........................... (0.23) -- (0.04) -------- -------- -------- Net income................................ $ 1.77 $ 1.24 $ 1.47 ======== ======== ========
SOLA INTERNATIONAL INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
3. Inventories
March 31, ---------------------------- 1998 1997 -------- -------- (in thousands)
Raw materials .......................... $ 16,714 $ 17,505 Work in progress ....................... 6,872 6,948 Finished goods ......................... 104,966 76,936 Molds .................................. 41,204 37,245 -------- -------- $169,756 $138,634 ======== ========
Molds comprise mainly finished goods for use by manufacturing affiliates in the manufacture of spectacle lenses.
4. Property, Plant and Equipment
March 31, --------------------- 1998 1997 -------- -------- (in thousands)
Land, buildings and leasehold improvements ........... $ 40,467 $ 29,749 Machinery and office equipment ....................... 136,218 115,943 Equipment under capital leases ....................... 593 259 -------- -------- 177,278 145,951 Less accumulated depreciation and amortization ....... 44,500 35,474 -------- -------- $132,778 $110,477 ======== ========
Depreciation expense for fiscal 1998, 1997 and 1996 was $14.3 million, $13.3 million and $11.1 million, respectively.
5. Notes Payable to Banks
Notes payable to banks at March 31, 1998 represent borrowings generally denominated in foreign currencies under several foreign credit agreements with lenders at interest rates ranging from 1.63% to 8.63%, and 24.0% for Brazilian Real based borrowings. The Brazilian Real based borrowings were $351,000 at March 31, 1998. The weighted average interest rates as of March 31, 1998 and 1997 were 8.06% and 8.68%, respectively. As of March 31, 1998, the Company had total unused lines of credit amounting to $19.8 million and was in compliance with minimum net worth requirements of agreements with certain foreign banks.
SOLA INTERNATIONAL INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
6. Long-Term Debt
March 31, --------- ---- (in thousands)
Uncollateralized term loans, interest rates varying from 4.75% to 10.0% at March 31, 1998, principal and interest payable through December 2008 ......................... $ 3,939
Loans collateralized by equipment and other assets, interest rates varying from 3.92% to 7.85% at March 31, 1998, principal and interest payable through March 2001 ..................................................... 246
Other........................................................... 110 ------- 4,295 Less current portion (included in other current liabilities).... 2,505 ------- Long-term debt, less current portion............................ $ 1,790 =======
Aggregate annual maturities of long-term debt over the next five years and thereafter are as follows:
Period Ending March 31, (in thousands) ----------------------- 1999......................................................... $2,505 2000......................................................... 678 2001......................................................... 262 2002......................................................... 191 2003......................................................... 182 Thereafter................................................... 477
The Company believes that as of March 31, 1998, the fair value of its long-term debt approximates the carrying value of those obligations. The fair value of the Company's long-term debt is estimated based on quoted market prices for similar issues with the same interest rates that would be available to the Company for similar debt obligations.
7. Bank Credit Agreement
In conjunction with the repurchase of its Senior Subordinated Notes (see Note 8) the Company amended its bank credit agreement with The Bank of America National Trust and Savings Association, for itself and as agent for a syndicate of other financial institutions ("Amended Agreement"). The Amended Agreement increased the Company's multicurrency revolving facility from $180 million to $300 million. Borrowings are divided into two tranches. Tranche A permits borrowings up to $30 million in either U.S. dollars or foreign currencies, to be used for working capital and consummating certain permitted acquisitions. Tranche B permits borrowings of up to $270 million and can be used for working capital purposes, refinancing the term loans under the existing bank credit agreement, repurchasing the Company's Senior Subordinated Notes, outstanding letters of credit ($2.5 million as of March 31, 1998) and consummating certain permitted acquisitions. The Tranche A Facility matures on October 31, 2000 and the Tranche B Facility matures on May 31, 2001. In addition, the Amended Agreement changed certain financial covenants, removed the requirement for foreign subsidiary guarantees under the
SOLA INTERNATIONAL INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
7. Bank Credit Agreement - (Continued)
Tranche A facility, increased the basket for incurring other unsecured indebtedness to $150 million, and deleted the term facility portion.
Borrowings under the Tranche A and Tranche B revolvers (other than swing line loans, which may only be Base Rate loans) may be made as Base Rate Loans or LIBO Rate Loans. Base Rate Loans bear interest at rates per annum equal to the higher of (a) 0.50% per annum above the latest Federal Funds Rate, or (b) the Bank of America Reference Rate. LIBO Rate Loans bear interest at a rate per annum equal to the sum of the LIBO Rate and a margin varying from 0.450% to 0.750% based on the Company's leverage ratio. Fixed rate borrowings in foreign currencies bear interest at rates per annum equal to the referenced currency's local IBOR plus a margin varying from 0.450% to 0.750% based on the Company's leverage ratio. Local currency Base Rate Loans are also available at a spread similar to US Base Rate Loans described above.
The Amended Agreement contains a number of covenants, including, among others, covenants restricting the Company and its subsidiaries with respect to the incurrence of indebtedness (including contingent obligations), the creation of liens, the making of certain investments and loans, engaging in unrelated businesses, transactions with affiliates, the consummation of certain transactions such as sales of substantial assets, mergers or consolidations, margin stock purchases and other transactions. The Amended Agreement also restricts the ability of the Company and its subsidiaries to make restricted payments in the nature of, among other things, (i) declaring, making or paying dividends or other distributions in excess of prescribed levels and (ii) purchasing, redeeming or retiring shares of the Company's capital stock in excess of prescribed levels. The Company and its subsidiaries are also required to comply with certain financial tests and maintain certain financial ratios.
8. Senior Subordinated Notes
The Company's 6 7/8% Senior Notes ("Notes") were issued under an indenture dated March 19, 1998, among the Company and State Street Bank and Trust Company of California, N.A., as Trustee (the "Indenture"). The Notes are unsecured senior obligations of the Company, limited to $100 million aggregate principal amount at maturity, and will mature on March 15, 2008. Interest on the notes is payable semiannually on March 15 and September 15 of each year, commencing September 15, 1998.
The Notes will be redeemable, as a whole or from time to time in part, at the option of the Company on any date (a "Redemption Date") at a redemption price equal to the greater of (i) 100% of the principal amount of the Notes to be redeemed or (ii) the sum of the present values of the Remaining Scheduled Payments (as defined) thereon discounted to such Redemption Date on a semiannual basis at the Treasury Rate (as defined) plus 20 basis points, plus in either case accrued interest (as defined).
The Notes rank pari passu to all other Senior Indebtedness, as defined in the Indenture, of the Company. The Company believes that as of March 31, 1998, the fair value of its Senior Subordinated Notes approximates the carrying value of those obligations.
During fiscal 1998 the Company repurchased all of its 9 5/8% Senior Subordinated Notes due 2003. As a result of the purchase the Company recorded an extraordinary charge of $5.9 million for fiscal 1998 resulting from the write-off of unamortized debt issuance costs and premium over accreted value, net of tax of $3.8 million. The repurchase was funded by borrowings under the Amended Agreement.
SOLA INTERNATIONAL INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
9. Common Stock
Common Stock
The Company has entered into loan agreements with certain members of the Company's management to enable them to invest in the Company's common stock. As of March 31, 1998 and 1997, loans amounting to $0.2 million and $0.3 million, respectively, which bear interest at 7.5% per annum, payable quarterly, and mature on December 1, 1998, were outstanding under this plan. These loans are secured by the common stock and have been reflected as a reduction in shareholders' equity on the consolidated balance sheets.
Stock Options
The Company has elected to follow Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees" ("APB 25") and related interpretations in accounting for its employee stock options because, as discussed below, the alternative fair value accounting provided for under FASB Statement No. 123, "Accounting for Stock-Based Compensation" ("FAS 123") requires use of option valuation models that were not developed for use in valuing employee stock options. Under APB 25, because the exercise price of the Company's employee stock options equals the market price of the underlying stock on the date of grant, no compensation expense is recognized.
On February 23, 1995 all outstanding stock options under the previous corporate structure were assumed by the Company and converted into options to acquire shares of the Company's Common Stock, with the number of shares subject to such option and exercise price thereof adjusted appropriately (the "Existing Option Plan"). The Existing Option Plan has been amended to provide that no new options will be granted thereunder.
The Company adopted the Sola International Inc. Stock Option Plan (the "International Plan"), effective February 15, 1995. On August 16, 1996 the shareholders of the Company ratified an increase of 500,000 to the number of options available for issuance under the International Plan. The maximum number of shares of Common Stock with respect to which options may be granted under the International Plan is 1,355,868 shares plus, subject to the requirement of rule 16b-3 of the Securities Exchange Act of 1934, if applicable, the number of shares of Common Stock subject to existing options under the Existing Option Plan, which expire or terminate without exercise for any reason, which number of shares underlying Existing Options shall not exceed 1,645,219. Under the International Plan certain key employees, and non employee directors and/or creditors of the Company and its subsidiaries and affiliates (each an "Optionee") are eligible to receive non-qualified stock options (the "International Options") to acquire shares of common stock of the Company. International Options granted to an Optionee are evidenced by an agreement between the Optionee and the Company which contains terms not inconsistent with the International Plan which the committee appointed to administer the International Plan, deemed necessary or desirable (the "International Option Agreement").
Pursuant to the Existing Option Plan and the International Plan ("Plans"), unless otherwise set forth in an Existing Option Agreement or an International Option Agreement, 20% of the Options granted to an Optionee vest on the date of grant, with an additional 20% vesting on each successive one-year anniversary of the date of grant. Options not previously vested become fully vested in the event of a sale or other disposition of 80% or more of the outstanding capital stock or substantially all of the assets of the Company, or upon a Merger or consolidation of the Company and its subsidiaries and affiliates unless the merger or consolidation is one in which the Company is the surviving corporation or one in which control of the Company and its subsidiaries and affiliates does not change (a "Termination Event").
SOLA INTERNATIONAL INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
9. Common Stock - (Continued)
However, Existing Options which are not exercised on or prior to a Termination Event lapse upon the closing of a Termination Event. All non-vested Options of an Optionee lapse upon such Optionee's termination of employment for any reason. An Optionee's vested Options lapse 45 days after termination of such Optionee's employment with the Company and its subsidiaries and affiliates for any reason other than death or disability, in which case such options terminate 180 days after such termination; provided, however, that such options lapse immediately in the event an Optionee's employment with the Company and its subsidiaries and affiliates is terminated for cause.
Pro Forma Disclosures
Pro Forma information regarding net income and earnings per share is required by FAS 123, and has been determined as if the Company had accounted for its employee stock options under the fair value method of that Statement. The fair value for these options was estimated at the date of grant using a Black-Scholes option pricing model with the following assumptions: risk-free interest rates of 5.67%, 6.67% and 6.67%, no dividend yield, volatility factors of the expected market price of the Company's common stock of .373, .389 and .389, and a weighted-average expected life of the option of 4 years, for fiscal 1998, 1997 and 1996, respectively.
The Black-Scholes option valuation model was developed for use in estimating the fair value of traded options which have no vesting restrictions and are fully transferable. In addition, option valuation models require the input of highly subjective assumptions including the expected stock price volatility. Because the Company's employee stock options have characteristics significantly different from those of traded options, and because changes in the subjective input assumptions can materially affect the fair value estimate, in management's opinion, the existing models do not necessarily provide a reliable single measure of the fair value of its employee stock options.
For purposes of pro forma disclosures, the estimated fair value of the options is amortized to expense over the options' vesting period. The Company's pro forma information follows (in thousands, except for earnings per share information):
Year Ended March 31, --------------------------------- 1998 1997 1996 ------- ------- ------- Pro forma net income .................... $44,157 $30,312 $33,603 Pro forma earnings per share: Basic........................... $ 1.81 $ 1.29 $ 1.54 Diluted......................... $ 1.73 $ 1.22 $ 1.46
The pro forma effect on net income during the phase-in period of FAS 123 may not be representative of the effects on pro forma net income in future periods.
SOLA INTERNATIONAL INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
9. Common Stock - (Continued)
Option Activity
Options exercisable as of March 31, 1996 and March 31, 1997 in thousands were 1,119 and 1,486, respectively. Options available for grant as of March 31, 1996, 1997 and 1998 in thousands were 257, 409 and 149, respectively. Exercise prices for options granted during fiscal 1998 ranged from $29.81 to $41.44. The weighted-average remaining contractual life of those options is four years.
10. Defined Contribution Plans
The Company sponsors several defined contribution plans covering substantially all U.S. and U.K. employees. The plans provide for limited Company matching of participants' contributions. Contributions to all defined contribution plans charged to operations were $1.2 million, $1.0 million and $0.9 million for fiscal 1998, 1997 and 1996, respectively.
11. Defined Benefit Retirement Plans
The Company participates in a defined benefit pension plan ("Domestic Pension Plan") covering substantially all full-time domestic employees. Benefit payments under the plan are based principally on
SOLA INTERNATIONAL INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
11. Defined Benefit Retirement Plans - (Continued)
employee compensation during the last five or ten year period prior to retirement and/or length of service. New employees are eligible to participate in the plan within one year of employment and are vested after five years of service. The Company's policy is to fund such amounts as are necessary, on an actuarial basis, to provide for the plan's current service costs and the plan's prior service costs over their amortization periods.
The Company also participates in a contributory defined benefit pension plan covering certain Australian employees ("International Pension Plan"). Benefits are generally based on length of service and on employee compensation during the last three years of service prior to retirement. The Company's policy is to fund such amounts as are necessary, on an actuarial basis, to provide for the plan's current service costs and the plan's prior service costs over their amortization periods.
The following table provides information on the status of the Domestic Pension Plan and the International Pension Plan.
SOLA INTERNATIONAL INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
11. Defined Benefit Retirement Plans - (Continued)
The significant actuarial assumptions for the following tables, as of the period-end measurement dates, are as follows:
Year Ended March 31, ------------------ 1998 1997 1996 ---- ---- ---- Domestic Pension Plan: Discount rate .................................. 6.35% 7.35% 7.0% Expected long-term rate of return on plan assets 8.0% 8.0% 8.0% Rate of increase in future compensation levels ....................................... 5.0% 5.0% 5.0% International Pension Plan: Discount rate .................................. 6.5% 7.5% 8.0% Expected long-term rate of return on plan assets 7.5% 8.0% 8.5% Rate of increase in future compensation levels ....................................... 4.0% 5.0% 5.5%
The change in the actuarial assumptions for fiscal 1998, 1997 and 1996 have not had a significant effect on the funded status of the Domestic or International Pension Plans.
At March 31, 1998, the Domestic Pension Plan and International Pension Plan assets include cash equivalents, fixed income securities and common stock.
SOLA INTERNATIONAL INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
11. Defined Benefit Retirement Plans - (Continued)
SOLA INTERNATIONAL INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
12. Income Taxes
The domestic and foreign components of income before provision for income taxes, minority interest and extraordinary item are as follows:
Year Ended March 31, ----------------------------------------- 1998 1997 1996 ------- ------- ------- (in thousands) Domestic .................... $42,918 $14,351 $27,158 Foreign ..................... 33,034 27,035 21,454 ------- ------- ------- $75,952 $41,386 $48,612 ======= ======= =======
The components of the provision for income taxes are as follows:
Year Ended March 31, -------------------------------- 1998 1997 1996 -------- -------- -------- (in thousands) Current: Federal and State ........................ $ 9,082 $ 6,142 $ 3,756 Foreign .................................. 8,006 7,178 8,210 Deferred: Federal and State ........................ 7,808 1,720 9,181 Foreign .................................. 4,891 1,534 1,134 Valuation allowance adjustment ............. (4,418) (9,837) (9,858) Tax benefit allocated to reduction of goodwill ................................. -- 4,000 1,200 -------- -------- -------- $ 25,369 $ 10,737 $ 13,623 ======== ======== ========
During fiscal 1998 and 1997, the Company recognized certain tax benefits related to stock option plans in the amount of $2.2 million and $0.3 million, respectively. Such benefits were recorded as a reduction of income taxes payable and an increase in additional paid-in capital.
SOLA INTERNATIONAL INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
12. Income Taxes - (Continued)
A reconciliation between income tax provisions computed at the U.S. federal statutory rate and the effective rate reflected in the statements of income is as follows:
Year Ended March 31, ---------------------- 1998 1997 1996 ---- ---- ---- Provision at statutory rate ........................ 35.0% 35.0% 35.0% State tax provision, net of federal effect ......... 3.5 4.0 3.6 Valuation allowance ................................ (5.8) (23.8) (15.2) Tax benefit allocated to reduction of goodwill ..... -- 9.7 2.5 Income of foreign subsidiaries at differing statutory rates ................................. (1.3) (2.4) 9.3 Tax benefit from NOL utilization ................... -- -- (5.7) Other .............................................. 2.0 3.4 (1.5) ---- ---- ---- 33.4% 25.9% 28.0% ==== ==== ====
The tax effects of temporary differences that give rise to significant portions of the deferred tax assets and deferred tax liabilities are presented below:
March 31, ----------------- 1998 1997 ------- ------- (in thousands) Deferred tax assets: Accounts receivable, principally due to allowances for doubtful accounts ...................................... $ 2,064 $ 2,249 Inventories, principally due to reserves ................. 3,191 3,591 Property, plant and equipment, principally due to differences in depreciation ............................ 4,874 5,868 Accruals for employee benefits ........................... 8,322 8,904 In-process research and development ...................... 12,281 13,225 Other assets ............................................. 3,610 4,746 Net operating losses ..................................... 9,188 11,221 ------- ------- Total gross deferred tax assets .......................... 43,530 49,804 Less valuation allowance ................................. 9,801 14,219 ------- ------- Net deferred tax assets .................................. $33,729 $35,585 ======= ======= Deferred tax liabilities: Property, plant and equipment, principally due to differences in depreciation ............................ $12,102 $ 9,262 Inventories .............................................. 2,752 2,641 Amortization of goodwill ................................. 5,653 3,999 Unremitted income of foreign subsidiaries ................ 3,834 2,700 Other .................................................... 4,071 3,385 ------- ------- Net deferred tax liabilities ............................. $28,412 $21,987 ======= ======= Net deferred tax assets less net deferred tax liabilities ............................................ $ 5,317 $13,598 ======= =======
SOLA INTERNATIONAL INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
12. Income Taxes - (Continued)
In fiscal 1997 a valuation allowance of $8.6 million was established against deferred tax assets acquired in the AO Acquisition. Movements in the valuation allowances in fiscal 1998, 1997 and 1996 relate primarily to realization of NOL's or changes in the Company's evaluation of the realizability of deferred tax assets.
For tax purposes, the Company's foreign subsidiaries, at March 31, 1998, had net operating loss carryforwards of $32.9 million. Of this amount, $31.0 million does not expire, and $1.9 million expires between 2002 and 2007. The deferred tax assets reflected in the Company's accounts as of March 31, 1998 before valuation allowances reflect these NOL's.
The Company has not provided for U.S. federal income and foreign withholding taxes on $21 million of non-U.S. subsidiaries' undistributed earnings as of March 31, 1998 because such earnings are intended to be reinvested indefinitely. Upon distribution of those earnings in the form of dividends or otherwise, the Company would be subject to U.S. income taxes (subject to an adjustment for foreign tax credits). Determination of the amount of unrecognized deferred U.S. income tax liability is not practicable because of the complexities associated with its hypothetical calculation.
13. Commitments
The Company leases certain warehouse and office facilities, office equipment and automobiles under non cancelable operating leases which expire in 1998 through 2012. The Company is responsible for taxes, insurance and maintenance expenses related to the leased facilities. Under the terms of certain lease agreements, the leases may be extended, at the Company's option, and certain of the leases provide for adjustments of the minimum monthly rent.
Future minimum annual lease payments under the leases are as follows:
Period Ending March 31, - ----------------------- (in thousands) 1999.......................................................... $4,774 2000.......................................................... 3,909 2001.......................................................... 2,730 2002.......................................................... 2,540 2003.......................................................... 2,563 Thereafter.................................................... 5,449
Rent expense for fiscal 1998, 1997, and 1996 was $7.8 million, $5.6 million and $5.4 million, respectively.
14. Contingencies
The Company is subject to environmental laws and regulations concerning emissions to the air, discharges to surface and subsurface waters and the generation, handling, storage, transportation, treatment and disposal of waste materials.
SOLA INTERNATIONAL INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
14. Contingencies - (Continued)
The Company is currently participating in a remediation program of one of its manufacturing facilities under the Comprehensive Environmental Response, Compensation and Liability Act and the Superfund Amendments and Reauthorization Act of 1986. In March 1997 the U.S. Environmental Protection Agency ("EPA") consented to the Company curtailing clean-up activities for a six month period which ended in September. The Company continued to monitor contamination levels during the curtailment period. During the quarter ended December 31, 1997 a report on contamination levels, and the impact of curtailed activities, was submitted to the EPA, and such report is currently under review. The report indicates no significant impact on the site from the curtailed activities, and the EPA has consented to continued curtailment of activities until such time as they have concluded their review of the report. The Company expects continued reduction of clean-up activities due to relatively low levels of contamination existing at the site.
The Company is also involved in other investigations of environmental contamination at several U.S. sites. Some clean-up activities have been conducted and investigations are continuing to determine future remedial requirements, if any.
Under the terms of the sale agreement with Pilkington plc ("Pilkington"), for the purchase of the Sola business in December 1993 ("Acquisition"), Pilkington has indemnified the Company with regard to expenditures subsequent to the Acquisition for certain environmental matters relating to circumstances existing at the time of the Acquisition. Under the terms of the indemnification, the Company is responsible for the first $1 million spent on such environmental matters, Pilkington and the Company share equally the cost of any further expenditures between $1 million and $5 million, and Pilkington retains full liability for any expenditures in excess of $5 million.
In the ordinary course of business, various legal actions and claims pending have been filed against the Company. While it is reasonably possible that such contingencies may result in a cost greater than that provided for in the financial statements, it is the opinion of management that the ultimate liability, if any, with respect to these matters, will not materially affect the consolidated operations or financial position of the Company.
SOLA INTERNATIONAL INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
15. Worldwide Operations
The Company operates in the ophthalmic industry in the design and manufacture of eyeglass lenses.
Internal sales represent intercompany sales between regions at a mark-up from cost; the elimination of any profit arising from such sales is reflected in eliminations in determining operating income.
For fiscal 1998, 1997 and 1996, the corporate headquarters costs of $9.7 million, $6.9 million and $7.7 million, respectively, are included in the North American geographic area.
SOLA INTERNATIONAL INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
16. Pro Forma Data
The following pro forma data, as restated for the adoption of FAS 128, was prepared to illustrate the estimated effect of the AO Acquisition and the financing related thereto, as if the Acquisition had occurred as of the beginning of each period presented:
Year Ended March 31, --------------------------- 1997 1996 --------- ----------- Net sales .................................... $ 507,713 $ 475,274 ========= ===========
Income before extraordinary item ............. $ 41,968 $ 42,093 ========= ===========
Net income ................................... $ 41,968 $ 41,181 ========= ===========
Earnings per share - basic: Income before extraordinary item ........... $ 1.72 $ 1.75 ========= ===========
Net income ................................. $ 1.72 $ 1.71 ========= ===========
Earnings per share - diluted: Income before extraordinary item ........... $ 1.64 $ 1.67 ========= ===========
Net income ................................. $ 1.64 $ 1.63 ========= ===========
These pro forma results of operations have been prepared for comparison purposes only, and do not purport to be indicative of what the results would have been had the AO Acquisition occurred at the beginning of each period presented. As a result of the AO Acquisition the Company has incurred two non-recurring charges during fiscal 1997: (i) a $7.2 million charge to cost of sales for the amortization associated with an inventory write-up to fair value during the six months ended September 30, 1996; and (ii) a $9.5 million charge for the write-off of in-process research and development all of which was recorded in the quarter ended June 30, 1996. These charges, and the related provision for tax thereon, have been excluded from the pro forma results as they are non-recurring. The pro forma data above does not include pro forma adjustments for the Neolens Acquisition as the results of Neolens prior to acquisition were not material to the Company's consolidated results of operations.
SOLA INTERNATIONAL INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
SOLA INTERNATIONAL INC.
QUARTERLY FINANCIAL DATA (in thousands, except per share data) (unaudited)
Quarter Ended ----------------------------------------- June 30, Sept. 30, Dec. 31, March 31, 1996 1996 1996 1997 -------- -------- -------- -------- Net sales .......................... $109,536 $128,194 $119,721 $131,238 Gross profit ....................... 51,487 53,109 57,124 62,434 Operating income ................... 6,082 13,975 15,261 22,029 Net income ......................... 2,162 6,969 7,840 13,926 Earnings per share - basic (1): Net income ....................... 0.10 0.29 0.32 0.57 Earnings per share - diluted (1): Net income ....................... 0.09 0.27 0.31 0.55
(1) As restated for the adoption of FAS 128.
S-1
E-4