ITEM 1. BUSINESS
Apparel Ventures, Inc. , a Delaware corporation ("AVI" or the "Company"), was incorporated on April 20, 1994 and is headquartered in Gardena, California. As of June 30, 1999, AVI was a wholly-owned subsidiary of AVI Holdings, Inc. ("AVI Holdings"). On August 11, 1999 in a series of transactions the Company completed a comprehensive financial restructuring whereby the senior and junior noteholders in AVI Holdings and the preferred and common stockholders in AVI Holdings converted their ownership interests into new common stock of AVI Holdings. Subsequently AVI Holdings was merged into AVI whereby the new AVI Holdings common stock holders received 25% of the AVI stock on a fully diluted basis. Simultaneously new investors purchased from AVI $8.75 million of 10% subordinated debentures due July 31, 2004. Interest on these subordinated debentures is due semi-annually on April 30 and October 31 of each year. These subordinated debentures have detachable warrants having a nominal exercise price which may be exercised for 75% of the stock of AVI. Approximately $7.8 million of the proceeds from the new subordinated debentures was used by AVI to retire $34.85 million of AVI Senior Notes.
AVI designs, manufactures and markets branded women's swimwear. The Company offers seven proprietary branded lines catering to the children and pre-teen (age 7 to 13), Junior (age 14 to 30 years) and Missy (age 30 and over) categories, distributed through major department stores and specialty retail stores nationwide. By using multiple brand lines, AVI is able to achieve the broadest possible coverage of the women's swimwear market.
PRODUCT LINE
The Company's current product line offerings by its U.S. Division are as follows:
SASSAFRAS GROUP
The Sassafras Group, focusing on the junior market (ages 14 to 30) and the missy market (ages 30 and over), is currently comprised of five major branded product lines, as described below.
SASSAFRAS. Introduced in 1976, Sassafras has been successfully positioned as both fashionable and practical swimwear appealing to younger women with an eye for value. Sassafras offers approximately 90 styles, with most featuring full derriere coverage and padded bra tops. Featured cover-ups include matching sarongs. Priced at retail around $58, management believes that Sassafras' innovative design and high quality fabrication provide one of the best price/value relationships in the junior market. Sassafras is distributed primarily through department stores, national chain stores and specialty stores.
SESSA. Introduced in 1991, Sessa has been designed to bridge the junior and missy segments of the contemporary swim market by focusing on the fashion conscious baby boomer who seeks support and coverage while maintaining a forward style. Sessa targets ages 25 to 50 and is priced at retail between $55 and $90. Sessa offers approximately 140 styles featuring a multitude of textures and patterns in its one and two piece styles. Sessa's extensive cover-up and beachwear collection features pareaus, dresses, boy shorts, oversize shirts , shorts and skirts at retail prices ranging from $32 to $79. Sessa is primarily distributed through department stores, catalog accounts and specialty stores.
CITRUS. Introduced in 1987, Citrus swimwear is designed to focus on the active, surf, fashion forward juniors aged 13 to 28, and is priced at retail between $44 and $72. Citrus offers approximately 140 styles with each featuring sporty v-neck tanks, halter boy shorts, sport bras or triangle tops, with vivid colors in graphic prints and textures. Shapely padding and functional lingerie strap underwire styles characterize the Citrus two piece tops. Cover-ups include hot pants, sundresses and board shorts. A junior separates collection is offered annually, sized extra small to large in novelty textures and prints, and features full, moderate and surfer cut bottoms, as well as D cups. Citrus is distributed primarily through department stores and specialty stores.
TOO HOT. Reintroduced in 1998, Too Hot is designed to focus on the "surfer girl", aged 14 to 26, and is priced at retail between $50 and $74. Too Hot offers approximately 60 styles, mostly two piece designs, including "cami" tops, sport bras, triangles and the hot trend "Tankinis". The Too Hot color story is a retro Hawaiian one that appeals to the customer who wants a unique look for herself. Too Hot is primarily distributed through swim and specialty stores.
NAUTICA. The Nautica license was acquired in June 1996. The initial controlled release was very successful. The 1999 lines take the Nautica brand into two directions. The first direction is Nautica collections, a brand concept with all American styling and attitude targeted at affluent customers who identify with designer merchandise. The second direction is athletic attitude, featuring color blocking and clear suits with piping and binding features. Retail prices range from $40 to $100. Nautica separates were introduced in the summer of 1998 and have been very attractive at retail. Nautica is distributed through a selective group of department, swim and specialty stores.
LA BLANCA GROUP
The La Blanca Group, focusing on the Missy market (ages 25 and over), the Junior market (ages 14 to 25) and the children and pre-teen market (ages 7 to 13) is comprised of the following product lines:
LA BLANCA. Introduced in 1981, La Blanca is AVI's largest selling line and is a leader in the Missy market. La Blanca offers approximately 100 styles between swimwear and cover-ups and is particularly well known for its innovative styling and excellent fit. Priced at retail between $65 and $100, management believes La Blanca's high quality fabrics and suit construction provide a price/value relationship which is superior to any of La Blanca's competitors. La Blanca's sales of two piece suits is approximately 40% of its total net sales. This has lead to developing a La Blanca separates line introduced for Cruise 1999 season. The most innovative addition is La Blanca Curva, introduced in August 1998, offering bra sized swimwear which management believes will increase the sales as the consumer is responding to fit enhancement. La Blanca is distributed primarily through department stores, national chains and specialty stores.
STUDIO LA BLANCA. Introduced for the 1995 Cruise Season, Studio La Blanca is a fashion leader in the "contemporary Junior" market, appealing to the sophisticated junior as well as the missy customer with a young attitude. Retail prices range from $40 to $80. Primarily a two piece business, Studio addresses the demand from the younger market for separates and the ability to buy a different size top than bottom. Studio is distributed through department stores, national chains and specialty stores.
ELISABETH STEWART. AVI acquired the Elisabeth Stewart Label in April, 1994. This line gives the Company a presence in the market niche serving the more mature customer. The merchandising approach is typically more conservative and features "figure control" design with matching cover-ups. Retail prices $60 to $90 are similar to other branded products.
OCEAN PACIFIC. AVI acquired the Ocean Pacific or OP label through a licensing agreement signed in February 1997. OP produces swimwear and beachwear for the junior and kids market. Ocean Pacific is designed with the California beach style in mind. The line has been upgraded from past offerings by using textured fabrics and print fabrications that give the product a more "rich" feeling. The fit is conservative and will appeal to the junior customer who wants a clean covered look. The children's fit has remained consistent from years past and focuses on the customer who is in and out of the water all day long. It is distributed primarily through department stores, national chain stores and specialty stores.
PRIVATE LABEL. The Company sells specially designed and manufactured products for retail customers such as as Wal*Mart, JC Penney, Sears, and others. Entry into this segment of the market provides the Company with balance to its heavy focus on the branded business.
FOREIGN OPERATIONS - APPAREL VENTURES EUROPA AND AVI DE MEXICO
In 1992, in order to have the ability to manufacture and sell product in the European Economic Community ("EEC"), the Company purchased 79% of the capital stock of a small manufacturing operation in Portugal, which it renamed Apparel Ventures Europa - Textil, LDA ("AVE"). Management of AVE owns the remaining 21% of AVE's stock. Upon acquiring AVE, management of the Company realized that the implementation of a comprehensive strategy required for creative development, manufacturing and sales for the EEC would take three to five years. AVE currently manufactures the product lines "Citrus" and "Too Hot Brazil" for the European market. AVE also sells specially designed and manufactured products for Marks & Spencer. AVE accounted for $4.7 million (excluding intercompany sales) of net sales for the fiscal year ended June 30, 1999.
During fiscal 1997, the Company established an operating company in Cuernavaca, Mexico. The wholly-owned subsidiary's name is AVI De Mexico, S.A. De C.V. Under NAFTA rules, this company produces swimwear and coverups primarily for the U.S. market.
GROUP NET SALES AND GROSS PROFIT
The table below illustrates a breakdown of the net sales and gross profit for each of the Company's three U.S. Division/Groups and AVE for each of the last three fiscal years.
DESIGN AND MANUFACTURING
The Company's product lines have been well-received in the marketplace due to AVI's innovative combinations of color, fabric, style and pattern, as well as heavy emphasis on proper fit. Input into the design process is obtained from close contact with department and specialty store buyers as well as customer responses to designs offered in "Early Cruise" lines two to three months before the major selling season. AVI schedules its design process to ensure that it has a full complement available for the "Early Cruise" season, as this season affords AVI with an opportunity to revise its production schedule depending on the success of each particular style.
AVI purchases the majority of its textile inputs from American manufacturers of nylon Lycra spandex-based knitted fabric. The Company's major suppliers include Guilford Mills, Inc., S. Edwards and Tricot Liesse. The Company does not believe it is reliant on any one supplier.
AVI is able to maintain control over the manufacturing process while achieving a degree of flexibility to respond to market changes. All of AVI's cutting is performed in-house at its Gardena, California facility. Two Company operated facilities in South Gate and Norwalk, California fulfill approximately 25% of AVI's sewing requirements. These plants manufacture the Company's labels and products exclusively. AVI currently subcontracts outside contractors the remaining 75% of its sewing requirements, of which approximately 50% is subcontracted to local Los Angeles area contractors and 50% to Mexico contractors (including AVI De Mexico). AVI maintains control over the quality of the garments at all sewing facilities through its quality control staff who approve all cuts at the sewing site and re-check garments at the Company's distribution centers. All plants have been moved to an 11-month production cycle to minimize the impact of seasonality. This is achieved through various cut-up and Private Label programs which help absorb the fixed overhead during otherwise non productive periods.
The Company believes that long term it must increase its lower cost Mexican production capacity. At June 30, 1999 the Company had 170 operators in Mexico.
DISTRIBUTION AND SALES
AVI sells its products through all major distribution channels. AVI's brands are sold through prestige department stores such as Saks, Bloomingdales, Lord & Taylor and Nordstrom, and traditional department stores such as Dillards, Macy's and Robinson May and specialty stores such as Everything But Water and California Sunshine. AVI sells branded close-out merchandise to MARMAXX Group and Ross. AVI sells Private Label products to Wal*Mart, JC Penney and Sears. AVI's top ten customers accounted for approximately 53% of gross sales and no single customer for more than 10% of AVI's gross sales in fiscal 1999.
Although AVI's design process targets the ultimate consumer, in order to optimize the distribution of AVI's products, the Company's marketing process targets the specific buyer characteristics of each distribution channel. In particular, department store buyers and national chain store buyers tend to focus on items such as pricing and product availability. As a result, AVI provides these buyers with significant guidance in style selection. Conversely, local specialty store buyers tend to be much more design conscious, and AVI must instead concentrate its marketing efforts on coordinating product delivery and payment schedules.
Because of the seasonal nature of the swimwear industry, significant functions in the design and selling process typically occur on a well-defined time schedule. The following schedule illustrates this pattern for the product lines developed for a Cruise Season.
Function Time Frame - ---------------------------------- ------------------------- Line Development November to July Marketing July to May Manufacturing and Sales August to June
These time parameters reflect the peak activity for a given function. Based on the results of the nationwide Early Cruise Season, during which buyers make their selections for the season from the full range of product lines offered by the industry, swimsuit manufacturers modify production schedules in order to accommodate the expected demand for their products during Cruise. Manufacturing occurs between August and May and peak shipping occurs between November and June.
In order to optimize its product offerings, AVI takes full advantage of the "Early Cruise" season by providing test product lines and working closely with buyers to obtain feedback for the Cruise season. AVI encourages early ordering by specialty stores, offering dating programs that allow up to 102 days for payment at the start of the season. AVI offers an exchange program where AVI takes back slow moving products in exchange for more popular selling products. During the past three years, returns and allowances have averaged 8.2% of gross sales.
AVI maintains national showrooms in Los Angeles and New York which are staffed by a total of four clerical and eight employed salespeople. AVI covers other major markets by utilizing independent sales representatives from 10 different organizations. These independent sales representatives are paid a commission based on a fixed percentage of net sales, with lower rates established for off-price or promotional sales. In addition, two officers of the Company and two sales principals of each brand Group play an active role in developing customer relationships and managing certain house accounts. The most extensive marketing effort occurs at tradeshows, where the Company's products are showcased along with competitors' merchandise. Major tradeshows occur in Florida, New York and Los Angeles, usually from July through October.
FACTORING
The Company currently factors substantially all of its accounts receivable with the CIT Group. Under the factoring agreement, the factor purchases substantially all of the Company's accounts receivable and assumes substantially all credit risks with respect to such accounts for a factoring charge negotiated as a percentage of the invoice amount assigned. The Company employs eight employees who are responsible for following up on adjustments claimed by customers on chargebacks prepared by the factor.
COMPETITION
The women's swimwear segment of the apparel industry is highly competitive and fragmented. The Company must remain competitive in the areas of style, quality, brand recognition, price and customer service. The Company competes with numerous apparel manufacturers, including companies marketing predominantly swimwear, companies marketing a full line of apparel and others which, unlike the Company, have become vertically integrated by expanding into retail distribution. Many of the Company's competitors have greater financial resources than the Company.
In general the branded women's swimwear business is dominated by AVI, Jantzen (a division of VF Corp.), Beach Patrol ( a privately held company ), and Authentic Fitness, Inc. The balance of the industry is characterized by small companies with sales of less than $10 million.
Foreign competition has not historically been a significant factor in swimsuit manufacturing for three major reasons: (i) material, rather than labor, is the highest cost component in swimsuits, (ii) foreign producers have historically been unable to fit the consumer as well as domestic producers who retain control over the manufacturing process and (iii) domestic manufacturers can provide shorter delivery and reorder lead times.
EMPLOYEES
During the peak season from July through April, the production headcount increases from approximately 400 to 775. None of the Company's domestic workforce is unionized, and employee relations are considered to be good. The employee count as of June 30, 1999 was as follows:
TRADEMARKS AND LICENSING AGREEMENTS
Company owned brands are protected by trademark registration or similar protection in the United States and most other markets where the related products are sold. These trademark rights are enforced and protected by litigation against infringement as necessary. The Company has also granted licenses to other parties to manufacture products under the Company's trademarks in product categories and/or geographic areas in which the Company does not operate.
In February 1997, the Company entered into a license agreement with Ocean Pacific Apparel Corp. for the design, manufacture and marketing of children's, pre-teen and junior's swimwear and related cover-ups, special make-up goods and tee-shirts under the "Ocean Pacific" and "OP" brand names. The agreement covers the U.S. and its territories and is valid for a term up to and including June 30, 2000 and provides for the payment of certain minimum royalty and advertising payments based on net sales for each agreement year. Ocean Pacific Apparel Corp. has the right to approve design specification of products bearing the licensed trademark.
In June 1996, the Company entered into a license agreement with Nautica Apparel, Inc. for the design, manufacture and marketing of women's swimwear and related cover-ups under the "Nautica" brand name. The agreement covers the U.S. and its territories and is valid for a term up to and including June 30, 2000 and provides for the payment of certain minimum royalty and advertising payments based on net sales for each agreement year. Nautica Apparel, Inc. has the right to approve design specifications of products bearing the licensed trademark.
Minimum annual royalty payments under these licensing agreements are approximately $436,000 for the year ending June 30, 2000.
Management believes that loss of any license would not have a material adverse effect on the Company.
BACKLOG
Backlog represents booked unshipped customer orders which, although terminable without penalty, are believed by the Company to be firm. Because of the seasonality of the Company's business , the Company's backlog varies over the course of the year. Backlog usually peaks in December and January. At January 31, 1999 the Company's backlog was approximately $33.7 million. The backlog at September 17, 1999 was $23.9 million compared to $19.7 million at September 18, 1998. See also "Seasonality" below.
SEASONALITY
The Company's business is highly seasonal. In fiscal 1999, approximately 74% of the Company's gross sales were generated in the second half of its fiscal year. The Company expects this pattern to continue in its current and subsequent fiscal years. This seasonality and the relatively long lead times required to design and manufacture new products have led to the development of this standard selling cycle. The Company operates with a deficit in cash flow from operations (seasonal working capital requirements) for the first nine months of each fiscal year.
CAUTIONARY STATEMENT ON FORWARD-LOOKING STATEMENTS
Certain statements included in Item 1 - "Business", Item 3 - "Legal Proceedings" and Item 7 - "Management's Discussion and Analysis of Financial Condition and Results of Operations" are "forward-looking statements" within the meaning of the federal securities laws. This includes any statements concerning plans and objectives of management relating to the Company's operations or economic performance, and assumptions related thereto.
These forward-looking statements are made based on management's expectations and beliefs concerning future events impacting the Company and therefore involve a number of risks and uncertainties. Management cautions that forward-looking statements are not guarantees and that actual results could differ materially from those expressed or implied in the forward looking statements.
Important factors that could cause the actual results of operations or financial condition of the Company to differ include, but are not necessarily limited to, the overall level of consumer spending for swimwear; changes in trends in the swimwear industry market in which the Company competes; actions of competitors that may impact the Company's business; and the impact of unforeseen economic changes in the markets where the Company competes, such as changes in interest rates, currency exchange rates, recession and other external economic and political factors over which the Company has no control.
ITEM 2.
ITEM 2. PROPERTIES
The following is a summary of all Company operated facilities:
The Company believes that the existing facilities are in good condition. On December 31, 1999 the lease on the 312 E. Rosecrans Ave. building expires. The Company could not negotiate for an extended term at a reasonable rental rate which forced the Company to find other facilities. On September 13, 1999 the Company executed a lease on a 100,000 sq. ft. building which has approximately 70,000 sq. ft. of warehouse and 30,000 sq. ft. of office space. The Company will consolidate the two finished goods warehouses and its administrative staff in this building. The lease has a favorable lease rate for a period of 7 years with a 7 year option to renew at COLA. The Company will vacate the 312 E. Rosecrans building and close one of the other buildings in Gardena, California.
The Company owns substantially all of the equipment used in all of its facilities.
ITEM 3.
ITEM 3. LEGAL PROCEEDINGS
The Company is from time to time involved in routine litigation. No litigation in which the Company is presently involved is material to its financial position or results of operations.
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 fourth quarter of the fiscal year ended June 30, 1999.
PART II
ITEM 5.
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
There is no established public trading market for the Company's common stock.
ITEM 6.
ITEM 6. SELECTED FINANCIAL DATA ($ IN MILLIONS)
The following table presents selected consolidated historical financial data of the Company.
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(1) This includes the cost of certain real estate acquired pursuant to the acquisition of the Company's business in 1994 (the "Acquisition") and the allocation of excess purchase price in the Acquisition to equipment.
(2) For purposes of calculating the ratio of earnings to fixed charges, "earnings" represent income before income taxes plus fixed charges, and "fixed charges" consist of interest expense.
(3) The Company has included information concerning EBITDA and EBITA because it understands that such information is used by certain investors as measures of the Company's operating performance. EBITDA and EBITA should not be considered as alternatives to, or more meaningful than, income from operations or cash flow (as determined in accordance with generally accepted accounting principles) as measures of the Company's operating performance. EBITDA and EBITA do not necessarily indicate whether cash flows have been or will be sufficient to fund cash needs. Furthermore, EBITDA and EBITA presented herein may not be comparable to similarly titled measures of other companies because of variations of the "adjustments" that might exist in the computations.
Other measures of performance, including the Net Sales Growth, Gross Margin, and EBITDA and EBITA margins and ratios to net interest expense, are presented as additional information which management considers relevant to the performance of the Company. The measures of Sales Growth and Gross Margin are customarily considered key indicators of performance within the apparel industry, and the EBITDA and EBITA margins and ratios are relevant to investors in debt instruments. Management believes this additional information is relevant to an investor's understanding of the Company's performance since it is believed such information is used to measure performance of other companies in the apparel industry and those which are significantly debt financed.
(*) In fiscal 1996, the Company recorded an extraordinary item of $0.3 million related to the write-off of deferred debt issue costs and bond discount due to the repurchase of $4.0 million of Senior Notes.
(4) Capital expenditures includes $1,310,000 in capitalized building cost under capital lease obligation (AVI De Mexico).
ITEM 7.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following tables also set forth information with respect to the percentage relationship to net sales of certain items of the consolidated statements of operations of the Company for the years ended June 30, 1997, 1998 & 1999.
FISCAL 1999 VS. 1998
NET SALES
The Company's net sales for fiscal 1999 increased by $.9 million or 1.1% as compared to fiscal 1998. This increase was due primarily to a $5.8 million increase in Nautica sales, a $1.7 million increase in private label sales a $.8 million increase in Sessa sales and a $.4 million increase in AV Europe sales. These increases were offset by a $2.5 million decrease in Sassafras sales, a $1.1 million decrease in La Blanca sales, a $3.6 million decrease in Studio sales and a $.6 million decrease in Ocean Pacific sales. The increase in net sales for Nautica was the result of improved designs and increased distribution of the brand. The increase in private label sales was due primarily to a new private label program for Mervyns. The decrease in La Blanca, Studio and Ocean Pacific was due to a less than enthusiastic reception for the designs and our interim strategy to cut off production to minimize end of season closeout merchandise and customer markdown allowances.
GROSS PROFIT
Gross profit for fiscal 1999 increased $1.7 million or 6.7%, and increased as a percent of net sales from 32.9% to 34.7% in fiscal 1999. Gross profit on branded merchandise increased from 34.9% of net sales in fiscal 1998 to 36.4% of net sales in fiscal 1999. This increase in gross profit, as a percent of net sales was primarily in the Sassafras Group, where the gross profit increased significantly for the house brands. Gross profit for the Sassafras group house brands increased from 23% in fiscal 1998 to 36.7% in fiscal 1999. As compared to last year the improvement is directly attributable to improved design, production planning and delivery. The gross profit for the house branded lines for the La Blanca Group decreased from 39.5% in fiscal 1998 to 34.4% in fiscal 1999 as the result of the poor performance of La Blanca and Studio.
OPERATING EXPENSES
Operating expenses for fiscal 1999 increased $.4 million or 2.0%, and increased as a percent of net sales from 28.9% in fiscal 1998 to 29.1% in fiscal 1999. This increase in operating expenses is due to: increased selling expense of $.3 million; increased distribution expense of $0.1 million; and increased general and administrative expense of $.2 million, offset by reduced design expense of $.2 million. The increase in selling expense is primarily due to license and co-operative advertising. The increase in distribution is primarily due to increased wages as a result of the minimum wage increase and additional expense to make merchandise floor-ready for the customer. The increase in general and administrative expense is due to consulting fees which had been had been waived in the prior year.
OTHER INCOME (EXPENSE)
Other expenses for fiscal 1999 were $.6 million higher than in fiscal 1998 due primarily to increased interest expense on the working capital loan of $0.5 million and increased royalty expense for the Nautica and Ocean Pacific licenses of $.3 million, increased other miscellaneous expense of $.1 million and reduced royalty income $.1 million, offset by reduced bondholder consent fee expense of $.4 million.
INCOME TAX PROVISION (BENEFIT) AND NET LOSS
Net loss before income taxes was $(3.6) million in fiscal 1999 compared to $(4.2) million in fiscal 1998. The $.6 million improvement in net loss reflects the (i) improved gross margin of $1.7 million, offset by increased operating and other expenses of $1.1 million.
The Company's effective income tax benefit for fiscal 1999 was (2.8)% of pre tax loss compared to income tax provision rate of 71.1% in fiscal 1998. In fiscal 1998 the Company recorded a valuation allowance of $4,359,000 to account for uncertainties related to the Company's possible decreased use of deferred tax assets to shelter future income, resulting in additional income tax expense for the fiscal year. The benefit differs from statutory rates primarily because of increases in the aforementioned valuation allowance.. Management periodically reviews the factors and may change the amount of valuation allowance as facts and circumstances dictate. The Federal and state net operating loss carryforwards amount to approximately $15,895,000 and $7,499,000 respectively, as of June 30, 1999. Unused net operating loss carryforwards expire between fiscal 2009 and 2013.
FISCAL 1998 VS. 1997
NET SALES
The Company's net sales for fiscal 1998 increased by $10.1 million or 15.2% as compared to fiscal 1997. This increase was due primarily to the increase in the sale of licensed merchandise totaling $12.1 million, increased private label sales for mass merchants of $4.1 million, increased La Blanca and Studio La Blanca sales of $3.6 million, increased AVE sales of $0.9 million, offset by a decrease in the Sassafras Group branded merchandise sales of $7.3 million and a decrease in prior season and other merchandise sales of $3.3 million. The increase in net sales for the La Blanca labels was due to improved designs, improved product performance at retail, as a result of improved marketing and sales efforts. The decrease in net sales for the Sassafras Group was due primarily to the late start in product development for the cruise 1998 season which resulted in late production and delivery to the customer.
GROSS PROFIT
Gross profit for fiscal 1998 increased $0.5 million or 2.2%, but decreased as a percent of net sales, from 37.1% to 32.9% in fiscal 1998. Gross profit on branded merchandise decreased from 39.0% of net sales in fiscal 1997 to 34.9% of net sales in fiscal 1998. This decrease in gross profit, as a percent of net sales was totally in the Sassafras Group, where the gross margin decreased from 39.8% in fiscal 1997 to 27.0% in fiscal 1998. This deterioration was due primarily to the late delivery and poor reception of the Sassafras, Sessa, Citrus and Too Hot brands which resulted in larger discounts being given to move merchandise. The gross profit for the branded lines in the La Blanca Group increased from 37.8% in in fiscal 1997 to 39.1% in fiscal 1998.
OPERATING EXPENSES
Operating expenses for fiscal 1998 increased $2.6 million or 13.4%, but decreased as a percent of net sales from 29.3% in fiscal 1997 to 28.9% in fiscal 1998. This increase in operating expenses is primarily due to: increased design expense of $0.5 million; increased selling expense of $1.8 million; increased distribution expense of $0.5 million, offset by decreased general and administrative expense of $0.3 million. The increase in design expense is primarily due to the increased amortization of fiscal 1998 design and sample expenses . The increase in selling expense is primarily due to increased commissions of $0.2 million, increased advertising expense of $0.4 million, relating to payments on licensed products, increased co-op advertising expense on branded merchandise of $0.5 million and increased amortization expense of fiscal 1998 sample cost deferred in the prior year. The decrease in general and administrative expense is attributable primarily to reduced bonus accrual of $0.4 million, Jordan consulting fees of $0.2 million waived for fiscal 1998, offset by increased management information system expense of $0.2 relating to Year 2000 compliance and increased factor fees of $0.1 million due to increased sales.
OTHER INCOME (EXPENSE)
Other expenses for fiscal 1998 were $1.0 million higher than in fiscal 1997 due primarily to increased interest expense on the working capital loan of $0.4 million and increased royalty expense for the newly acquired Nautica and Ocean Pacific licenses of $0.7 million and bondholder consent fee of $0.4 million, offset by reduced litigation settlement expense of $0.4 million and reduced foreign exchange loss of $0.1 million.
INCOME TAX PROVISION (BENEFIT) AND NET LOSS
Net loss before income taxes was $(4.2) million in fiscal 1998 compared to $(1.2) million in fiscal 1997. The $3.0 million increase in net loss reflects the (i) increase in operating expenses of $2.6 million, (ii) increased other expenses of $0.9 million( mainly due to royalty expense and increased interest expense), offset by increase in gross profit margin of $0.5 million.
The Company's effective income tax provision rate for fiscal 1998 was 71.1% compared to income tax benefit rate of (32.1)% in fiscal 1997. In fiscal 1998 the Company recorded a valuation allowance of $4,359,000 to account for uncertainties related to the Company's possible decreased use of deferred tax assets to shelter future income, resulting in additional income tax expense for the fiscal year. Management periodically reviews the factors and may change the amount of valuation allowance as facts and circumstances dictate. The Federal and state net operating loss carryforwards amount to approximately $13,400,000 and $6,400,00 respectively, as of June 30, 1998. Unused net operating loss carryforwards expire between fiscal 2009 and 2013.
CAPITAL RESOURCES AND LIQUIDITY
The Company's working capital decreased from $12.3 million in fiscal 1998 to $12.0 million in fiscal 1999. The cash used by operations was ($10.7) million in 1998, compared with cash provided by operations of $4.2 million in fiscal 1999. The increase in cash provided from operations in fiscal 1999 compared to fiscal 1998 was primarily due to the reduced net loss and reduced inventory and accounts receivable levels.
In June, 1999 the Company notified its bank that for the period ended April 30, 1999 the Company was in default of certain of the covenants in the Loan Agreement. The bank notified the Company it wanted to protect its rights and would not waive the covenant violations. Further, the bank reduced the credit facility to $18 million, and eliminated the seasonal over advance and finished goods inventory availability of the Credit Facility. The bank reserved its rights under the agreement to further modify the lending arrangement if the April event of default was not cured or further events of default occur.
The line of credit contains covenants requiring the maintenance of minimum tangible net worth, fixed charge coverage ratios and other matters. For the year ended June 30, 1999 the Company failed to meet the minimum tangible net worth, fixed charge coverage ratio and minimum EBITDA requirement as defined by the credit agreement.
On August 11, 1999 in concert with the Company's financial restructuring the bank waived the covenant violations and reinstated virtually all of the provisions of the original Loan Agreement. The Company has a line of credit with the bank ("Credit Facility") which provides for advances and commercial letters of credit up to $32.0 million (see Note 7 in the accompanying financial statements incorporated herein by reference). The Credit Facility expires July 31, 2000.
For the year ended June 30, 1998 the Company failed to meet the fixed charge coverage ratio requirement under the indenture governing the Senior Notes. This violation was waived and an amendment modifying the indenture was approved by the bondholders. In connection with such waiver and amendment, the Company agreed to pay $360,000 to the Bondholders. This amount was accrued as of June 30, 1998, and is included in interest expense.
For the year ended June 30, 1999 the Company failed to meet the fixed charge coverage ratio requirement under the indenture governing the Senior Notes. On August 11, 1999 the indenture was amended to eliminate all restrictive and performance covenants. Subsequently, substantially all of the Senior Notes were retired by the Company at a discount. This action by the Company eliminated the fixed charge coverage default which existed at June 30, 1999.
At June 30, 1999 the Company had insufficient cash to meet its debt service requirements and operational cash flow needs to continue operations. This financial issue was remedied on August 11, 1999 with the complete financial restructuring. (See Note 1 to the accompanying financial statements)
Other than the Credit Facility, Subordinated Debenture which is due July 31, 2004 and the remaining $1.15 million of Senior Notes due December 31, 2000 the Company does not have any other substantial debt principal payment requirement.
Based on current levels of operations, anticipated growth and the effects of the restructuring, the Company expects that it will be able to meet all of its debt service requirements as well as its capital expenditure, and other cash requirements through the fiscal year ending June 30, 2000.
At June 30, 1999, the net collateral availability under the line of credit was approximately $4,600,000.
COMPUTER SYSTEMS
The Company has completely retrofitted the Management Information System used to run its operations. The inventory management, order entry, billing and credit and collection and financial systems have been rendered Y2K compliant. The Company is presently using these retrofitted programs to manage the information flow. The system has undergone independent third party testing, in conjunction with our customers, and has been certified Y2K compliant. The Company believes all of its internal systems, major vendor systems and major customer systems are Y2K compliant. However, there can be no assurance given that the Company will not experience interruptions in supply, production, or order fulfillment as the result of external Y2K problems.
ITEM 8
ITEM 8 - FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.
The Company's Consolidated Financial Statements and the report of Independent Auditors thereon and the Financial Statement Schedule listed in the accompanying Index to Financial Statements are hereby incorporated by reference.
ITEM 9
ITEM 9 - CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
None
PART III ----------------
ITEM 10
ITEM 10 - DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The following table sets forth information with respect to each of the Company's directors and executive officers. Each of the persons named below is elected to their respective office or offices annually.
ITEM 11
ITEM 11 - EXECUTIVE COMPENSATION
Summary Compensation Table - ---------------------------
The following table discloses aggregate compensation paid or accrued by the Company for the past three fiscal years to the Company's chief executive officer and to the other four most highly compensated executive officers serving in such capacities at the end of the 1999 fiscal year.
(*) Amount reflects bonus for fiscal 1996 paid in fiscal 1997.
(**) Amount reflects bonus for fiscal 1997 paid in fiscal 1998. There were no bonuses in fiscal 1998.
EMPLOYMENT AGREEMENTS
In connection with the 1994 Acquisition, the Company entered into an employment agreement with Mr. Goodman. The Employment Agreement provided that Mr. Goodman will be employed for a term of five years, although the Company has the right to terminate the Employment Agreement at any time upon payment of a severance amount equal to the employee's fixed annual compensation for a period of twelve months or eighteen months, depending upon when such termination occurs. Mr. Goodman's Employment Agreement expired on May 23, 1999 and was verbally renewed in August, 1999 effective July 1, 1999. The agreement is in process of documentation.
Mr. Goodman's Employment Agreement provides that he will receive fixed annual compensation plus performance-based incentive compensation. The fixed annual compensation for Mr. Goodman will be $282,000. Mr. Goodman will be eligible to participate in the incentive compensation plan to be determined at a later date. The agreement is for a period of three years with an option to renew at Mr. Goodman's request for an additional two years.
COMPENSATION OF DIRECTORS
Directors receive annual fees in the amount of $8,000, plus reimbursement for out-of-pocket expenses incurred in connection with the attendance at meetings. For fiscal year 1999 $56,000 in fees were accrued but not paid.
ITEM 12
ITEM 12 - SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The following chart reflects the beneficial ownership of the Company's common stock as of August 31, 1999, after giving effect to the financial restructuring of the Company pursuant to certain agreements dated August 11, 1999. The following table sets forth certain information with respect to the beneficial ownership of the Company by each person who owns more than 5% of the common stock currently issued and outstanding, each of the Company's directors, named executive officers and all of its directors and executive officers as a group. Except as otherwise noted below, the address of each person listed below is the Company's address. To the knowledge of the Company, all persons listed have sole voting and investment power with respect to their shares of common stock.
- ------------------------------------
* Calculated based on actual outstanding shares only as of August 31, 1999 of 209,356 without giving effect to unexercised common stock purchase warrants.
** Represents less than 1% of the outstanding.
(1) Includes currently exercisable warrants to acquire 209,464 shares of common stock issued in connection with the issuance to this person of 10% subordinated debentures.
(2) Includes currently exercisable warrants to acquire 218,571 shares of common stock issued in connection with the issuance to this person of 10% subordinated debentures.
(3) Includes currently exercisable warrants to acquire 20,946 shares of common stock issued in connection with the issuance to this person of 10% subordinated debentures.
(4) Includes currently exercisable warrants to acquire 36,984 shares of common stock issued in connection with the issuance to this person of 10% subordinated debentures.
(5) Includes currently exercisable warrants to acquire 36,984 shares of common stock issued in connection with the issuance to this person of 10% subordinated debentures.
(6) Includes the currently exercisable common stock purchase warrants described on notes (2) through (5) above.
ITEM 13
ITEM 13 - CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
MANAGEMENT AGREEMENT. In 1994 in connection with the consummation of the Acquisition and issuance of the Series A Notes, the Company and TJC Management Corporation ("TJC"), an affiliate of Jordan, entered into an agreement (the "Management Agreement") pursuant to which TJC or its designee provides management services to the Company upon consideration of the payment of certain fees, not to exceed $250,000 per annum, and reasonable out of pocket expenses. On August 11, 1999 the Company completed a comprehensive financial restructuring which included a renegotiated Management Agreement with TJC Management Corporation. Quarterly AVI will pay to TJC a fee of 3% of EBITDA based on the prior year's audited results. During fiscal year 1999 the Company accrued $.2 million of management fees which were not paid.
FINANCIAL RESTRUCTURING. On August 11, 1999 in a series of transactions the Company completed a comprehensive financial restructuring whereby the senior and junior noteholders in AVI Holdings and the preferred and common stockholders in AVI Holdings converted their ownership interests into new common stock of AVI Holdings. Subsequently AVI Holdings was merged into AVI whereby the new AVI Holdings common stock holders received 25% of the AVI stock on a fully diluted basis. Simultaneously new investors purchased from AVI $8.75 million of 10% subordinated debentures due July 31, 2004. Interest on these subordinated debentures is due semi-annually on April 30 and October 31 of each year. These subordinated debentures have detachable warrants having a nominal exercise price which may be exercised for 75% of the stock of AVI. Approximately $7.8 million of the proceeds from the new subordinated debentures was used by AVI to retire $34.85 million of AVI Senior Notes.
As a part of the restructuring, stockholders of AVI Holdings became direct common stockholders of the Company. These stockholders include Mr. Goodman, Chief Executive Officer and Chairman of the Board (28,203 shares representing approximately 13.5% of the currently issued and outstanding shares of the Company); John W. Jordan II, a director of the Company (824 shares representing less than 1% of the outstanding); David W. Zalaznick (214 shares representing less than 1% of the outstanding); John R. Lowden (433 shares representing less than 1% of the outstanding); Michael Lerner (18 shares representing less than 1% of the outstanding); and JZ Equity Partners (176,262 shares representing approximately 84% of the currently outstanding shares of the Company).
Certain of the Company's directors and executive officers, as well as the principal stockholder of the Company, JZ Equity Partners, participated in the 10% subordinated debenture offering. Specifically, Mr. Goodman invested $3 million, Messrs. John W. Jordan, II and David W. Zalaznick each invested $507,630, Mr. John R. Lowden invested $287,500 and JZ Equity Partners, invested $2,875,000. In connection with their acquisition of the debentures, each of these persons also acquired the detachable common stock purchase warrants described above.
Also on August 11, 1999 the Company and its new stockholders (including those named above) entered into a Stockholder Agreement pursuant to which the parties agreed to certain management arrangements, stock transfer restrictions and rights and other terms relating to the investors' rights as stockholders of the Company.
PART IV -------------
ITEM 14
ITEM 14 - EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
SUPPLEMENTAL INFORMATION TO BE FURNISHED WITH REPORTS FILED PURSUANT TO SECTION 15(d) OF THE ACT BY REGISTRANTS WHICH HAVE NOT REGISTERED SECURITIES PURSUANT TO SECTION 12 OF THE ACT.
The Company has not sent to its security holders any annual report or proxy materials with respect to its 1999 fiscal year or with respect to any annual meeting of its security holders.
SIGNATURES
Pursuant to the requirements of Section 13 or 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.
APPAREL VENTURES, INC.
/ s / MARVIN L. GOODMAN ------------------------------------------------ By : Marvin L. Goodman Chief Executive Officer and Chairman of the Board
Date: September 28, 1999 ------------------------------------------------
Pursuant to the requirements of the Securities Exchange Act of 1934, as amended, this report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated.
EXHIBIT INDEX -------------
The exhibits listed on this Exhibit Index are filed as part of this Form 10-K.
- ----------------------------- (*) (Incorporated by reference to the same number Exhibit to the Registrant's Registration Statement on Form S-4 (Registration No. 33-80570).
APPAREL VENTURES, INC. AND SUBSIDIARIES
INDEPENDENT AUDITORS' REPORT
AND
CONSOLIDATED FINANCIAL STATEMENTS JUNE 30, 1999 AND 1998
INDEPENDENT AUDITORS' REPORT
To the Board of Directors Apparel Ventures, Inc. and Subsidiaries
We have audited the accompanying consolidated balance sheet of Apparel Ventures, Inc., a wholly owned subsidiary of AVI Holdings, Inc., and Subsidiaries as of June 30, 1998 and 1999 and the consolidated statements of operations and other comprehensive income (loss), stockholder's equity (deficit), and cash flows for each of the years in the three year period ended June 30, 1999. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audits 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 financial position of Apparel Ventures, Inc. and Subsidiaries as of June 30, 1998 and 1999, and the results of their operations and cash flows for each of the years in the three year period ended June 30, 1999 in conformity with generally accepted accounting principles.
As discussed in Note 1 to the financial statements, on August 11, 1999 the Company completed a comprehensive debt and capital restructuring.
/S/ MOSS ADAMS LLP - ------------------- MOSS ADAMS LLP
Los Angeles, California September 10, 1999
APPAREL VENTURES, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEET
APPAREL VENTURES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF OPERATIONS AND OTHER COMPREHENSIVE INCOME (LOSS)
APPAREL VENTURES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF STOCKHOLDER'S EQUITY (DEFICIT) - --------------------------------------------------------------------------------
APPAREL VENTURES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF CASH FLOWS
APPAREL VENTURES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 1998 AND 1999
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NOTE 1 - OPERATIONS AND FINANCIAL CONDITION
OPERATIONS - The Company, a wholly owned subsidiary of AVI Holdings, Inc., is headquartered in Gardena, California and designs, manufactures and markets branded women's swimwear. The Company offers seven proprietary lines catering to the Junior and Missy categories distributed through major department stores and specialty retail stores nationwide and, through a subsidiary, throughout Europe.
DEBT AND CAPITAL RESTRUCTURE - On August 11, 1999 in a series of transactions, the Company completed the following comprehensive debt and capital restructuring:
Noteholders and preferred shareholders of the Company's parent, AVI Holdings, Inc., converted their interests into newly issued common stock of AVI Holdings, Inc. One holder of a note of approximately $63,000 elected not to convert such interest into common stock, and this debt was assumed by the Company. The common shareholders of AVI Holdings, Inc. then exchanged their shares of AVI Holdings, Inc. for all of the outstanding shares of the Company and the shares of AVI Holdings, Inc. were canceled.
Concurrent with the above transaction, certain investors of AVI Holdings, Inc. advanced $8,750,000 to the Company under subordinated notes bearing interest at 10% per annum. The proceeds were used to retire Series A senior notes (see below) and to provide working capital. Interest is payable semi-annually, and the notes are due July 31, 2004. The subordinated notes were issued with detachable warrants for the purchase of 75% of the common stock of the Company. The warrants may be exercised immediately, and permit the holder to purchase common shares of the Company for $.01 per share.
As a result of an agreement in connection with the Company's tender offer to repurchase Series A senior notes at a discount, Series A senior notes with a face value of $34,850,000 were retired for $7,754,000 ($222.50 per $1,000 face value). Holders of the remaining $1,150,000 Series A senior notes elected to not accept the tender offer. In conjunction with this debt restructure, the bond debenture was substantially modified to eliminate financial covenants, conditions and restrictions.
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APPAREL VENTURES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 1998 AND 1999
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NOTE 1 - OPERATIONS AND FINANCIAL CONDITION (Continued)
The proforma effect of these transactions on June 30, 1999 balance sheet is as follows:
(a) Proceeds from subordinated debt from shareholders. Value of detachable warrants estimated to be $7,000.
(b) Retirement of senior notes payable and related gain recognition.
(c) Estimated administrative fees associated with restructure transaction.
(d) Merger of AVI Holdings, Inc. with the Company.
(e) Write off of deferred debt issue costs and organization costs.
(f) Write off interest accrued on senior notes.
(g) Estimated tax effect of capital restructuring.
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APPAREL VENTURES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 1998 AND 1999
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NOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
PRINCIPLES OF CONSOLIDATION - The consolidated financial statements include the accounts of the Company, its 79%-owned Portuguese subsidiary, Apparel Ventures Europa-Textil, LDA, and its wholly owned subsidiary, AVI de Mexico, S.A. de C.V. Significant intercompany accounts and transactions are eliminated in consolidation.
REVENUE RECOGNITION - Revenue is recognized when shipment of product occurs. An estimate for returns and allowances is recorded against gross sales amounts to arrive at net sales.
INVENTORIES - Inventories are stated at the lower of cost, determined on a first-in, first-out basis, or market.
DEPRECIATION AND AMORTIZATION - Depreciation and amortization of property and equipment is provided using straight-line and accelerated methods over estimated useful lives, ranging from 3 to 30 years. Amortization of goodwill and organization costs is provided over 40 years on the straight-line method. Deferred financing costs are amortized on the straight-line method over 60 to 78 months.
Long-lived assets such as property and equipment, goodwill, and trademarks are recorded at cost, less accumulated depreciation and amortization. As of June 30, 1999 management considers the stated value of long-lived assets to be recoverable.
ADVERTISING COSTS - Advertising costs are expensed in the period incurred. Advertising expense was approximately $1,420,000, $2,421,000, and $2,729,000 for the years ended June 30, 1997, 1998, and 1999, respectively.
INCOME TAXES - Income taxes are accounted for using an asset and liability method. Under this method, deferred Federal and state income tax assets and liabilities are provided for temporary differences between the financial reporting basis and the tax reporting basis of the Company's assets and liabilities. Income taxes are further explained in Note 10.
DEFERRED CHARGES - Deferred charges primarily consist of costs incurred for the design changes of swimsuit styles to be produced and sold in the upcoming year. The costs are deferred and are charged against the period benefited, on the basis of unit sales to total unit sales expected for the next season.
INTEREST EXPENSE - Interest expense includes amortization of the related deferred loan costs over the term of the loan. In conjunction with the debt restructuring indicated in Note 1, all deferred loan costs were written off subsequent to June 30, 1999.
STATEMENT OF CASH FLOWS - For purposes of cash flows, all highly liquid investments purchased with an original maturity of three months or less are considered to be cash equivalents.
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APPAREL VENTURES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 1998 AND 1999
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NOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
CONCENTRATION OF CREDIT RISK - The Company sells its branded products through all major retail distribution channels, with the exception of the mass merchandise segment. The Company currently factors substantially all of its accounts receivable and uses the factor for credit administration and cash collection purposes. Under its factoring agreement, the factor purchases trade accounts receivable and assumes substantially all credit risks. The Company is responsible for following up on adjustments claimed by customers. Management believes there are no significant concentrations of credit risk. There is one customer balance included in non-factored accounts receivable totaling approximately $1.1 million.
TRANSLATION OF FOREIGN CURRENCIES - Cumulative translation adjustments, which arise from consolidating Portuguese and Mexican operations, are included in stockholder's equity.
USE OF ESTIMATES - The preparation of 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.
RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS - During 1999 the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standard (SFAS) No. 133 ("Accounting for Derivative instruments and Hedging Activities"), SFAS No. 134 ("Accounting for Mortgage Backed Securities"), and SFAS No. 137 ("Accounting for Derivative Instruments and Hedging Activities"). All of these standards are effective for fiscal years beginning after June 30, 1999. Management believes these pronouncements will not have a material effect on the Company's financial statements.
NOTE 3 - SUBSIDIARIES
The Company has a 79% stock ownership in Apparel Ventures Europa-Textil, LDA. The excess of the purchase price paid over the estimated fair value of the net assets acquired (approximately $126,000) has been recorded as goodwill and is being amortized over 40 years.
The Company's wholly-owned subsidiary in Mexico, AVI de Mexico, S.A. de C.V. (AVIM), was formed in fiscal 1997 and began full production in fiscal 1999.
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APPAREL VENTURES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 1998 AND 1999
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NOTE 4 - DUE FROM FACTOR
Due from factor consists of the following as of June 30:
NOTE 5 - INVENTORIES
Inventories consist of the following as of June 30:
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APPAREL VENTURES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 1998 AND 1999
- --------------------------------------------------------------------------------
NOTE 6 - PROPERTY AND EQUIPMENT
The components of property and equipment as of June 30 are:
NOTE 7 - LINE OF CREDIT AND NOTES PAYABLE
The Company has a revolving credit agreement with a bank which provides for advances and commercial letters of credit of up to $32 million through July 31, 2000. The line of credit has sublimits of $3 million for commercial letters of credit. Borrowings are limited to a predetermined percentage of eligible factored accounts receivable, select non-factored customer accounts receivable, eligible finished goods inventory, and certain real estate owned by the Company, plus a seasonal overadvance of $2.5 million during September and increasing to $4.5 million from October to March 15 of each year, the amount of which is tied to bookings and finished goods inventory. Interest on base borrowings is charged at the bank's prime rate plus .5%, however, borrowings may be fixed, at management's discretion, for periods of 30 to 180 days at LIBOR plus 2.75%. Interest on seasonal overadvances is charged at the bank's prime rate plus 1.5%, however, borrowings may be fixed, at management's discretion, for periods of 30 to 180 days at LIBOR plus 3.75%.The line is collateralized by receivables, finished goods inventories, and general intangibles. As of June 30, 1999 the Company had $567,000 in outstanding letters of credit. Maximum and average amounts outstanding during the year ended June 30, 1999 were $33,071,000 and $20,044,000, respectively. The weighted average interest rate, including bank fees, during the year ended June 30, 1999 was 8.89%.
The credit agreement included a $2,450,000 term loan which was retired on September 24, 1998. The Company's president contributed $2,450,000 cash to AVI Holdings, Inc. in exchange for class D preferred stock. Concurrently, AVI Holdings, Inc. contributed $2,450,000 to the Company which was used to retire the term loan.
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APPAREL VENTURES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 1998 AND 1999
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NOTE 7 - LINE OF CREDIT AND NOTES PAYABLE (Continued)
The line of credit contains covenants requiring the maintenance of a minimum tangible net worth, fixed charge coverage ratios and other matters. For the year ended June 30, 1999 the Company failed to satisfy the fixed charge coverage ratio, minimum EBITDA, and the minimum tangible net worth covenants as required by the credit agreement. The violations have been waived by the bank for fiscal 1999.
NOTE 8 - ACCRUED LIABILITIES
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APPAREL VENTURES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 1998 AND 1999
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NOTE 9 - OTHER LONG-TERM OBLIGATIONS (Continued)
Minimum payments under other long-term obligations, including interest, and long term debt for future years ending June 30 are:
The assets under capital lease consist of a building and computer equipment with an aggregate cost of $1,139,000 and accumulated depreciation of $39,000 as of June 30, 1999.
NOTE 10 - SENIOR NOTES PAYABLE
Series A Senior Notes are due December 31, 2000 and bear interest of 12.25%, payable July 1 and January 1 each year. As part of the indenture, the bondholders received stock warrants allowing them to purchase 10% of the outstanding shares of the Parent Company's common stock at $.01 per share. The notes were issued at a discount of $800,000, which is being amortized over the term of the notes to yield a constant interest rate of 12.7%. As of June 30, 1999, $36 million principal amount of bonds remain outstanding net of $213,000 unamortized discount.
As indicated in Note 1, on August 11, 1999 $34,850,000 of the Series A senior notes were retired for $7,754,000, and all related warrants were canceled. Following the transaction, $1,150,000 principal amount of Series A senior notes remain outstanding, bearing interest and payable as indicated above.
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APPAREL VENTURES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 1998 AND 1999
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NOTE 11 - INCOME TAXES
Deferred income taxes reflect the tax effect of temporary differences between the financial reporting and tax reporting bases of assets and liabilities. The income tax expense (benefit) for the years ended June 30, 1997, 1998, and 1999 is summarized as follows:
The primary differences between the income tax expense (benefit) computed at the U.S. statutory corporate income tax rate and the effective income tax rate for the years ended June 30, 1997, 1998 and 1999 are as follows:
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APPAREL VENTURES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 1998 AND 1999
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NOTE 11 - INCOME TAXES (Continued)
At June 30, 1998 and 1999, net deferred tax assets (liabilities) are comprised of the following:
Federal and state net operating loss carryforwards amount to approximately $15,895,000 and $7,499,000 respectively, as of June 30, 1999. As a result of the debt restructuring referred to in Note 1, these loss carryforwards will be reduced in proportion to the debt forgiveness income that is non-taxable as a result of the Company's insolvency, as defined by the Internal Revenue Code. The net operating losses are anticipated to be substantially eliminated by non-taxable debt forgiveness income in fiscal 2000. Therefore, the deferred tax asset for these loss carryforwards continues to be reserved as of June 30, 1999.
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APPAREL VENTURES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 1998 AND 1999
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NOTE 12 - ROYALTIES AND LICENSE AGREEMENTS
ROYALTY INCOME - The Company licenses various trademarks to entities for the design, manufacture, and distribution of products within the United States and foreign territories. The agreements generally provide for the receipt of royalties based on a percent of net sales, subject to minimum royalty requirements. Included in accounts receivable are $38,000 and $106,000 due from the licensees at June 30, 1998 and 1999, respectively. Royalty income recognized under these agreements amounted to $214,000, $205,000 and $152,000 for the years ended June 30, 1997, 1998 and 1999, respectively.
ROYALTY EXPENSE - During fiscal 1997, the Company began licensing various trademarks from entities for the design and manufacture of branded products within the United States. The agreements generally provide for payment of royalties based on a percentage of net sales, subject to a minimum royalty requirement. For the years ended June 30, 1997, 1998, and 1999, royalty expenses related to these licensing agreements were approximately $122,000, $799,000, and $1,092,000, respectively. Minimum annual royalty payments are approximately $833,000 for the year ending June 30, 2000.
NOTE 13 - LEASE COMMITMENTS
The Company leases its office, showrooms and warehouse facilities under various operating leases expiring from December 1999 through March 2005. Rent expense for the years ended June 30, 1997, 1998 and 1999 amounted to $1,003,000, $1,070,000 and $1,044,000, respectively.
Minimum payments required under non-cancelable operating leases with terms in excess of one year are as follows:
On December 31, 1999 the lease of a finished goods warehouse expires. The Company could not negotiate for an extended term at a reasonable rental rate which prompted the Company to find other facilities. In September 1999, the Company executed a lease on a new building which has approximately 70,000 sq. ft. of warehouse and 30,000 sq. ft. of office space. The Company will close one of its other facilities in Gardena, California and consolidate the two finished goods warehouses and its administrative staff in this new building. The lease has a term of seven years with a seven year option to renew with a cost of living price adjustment. The new lease requires annual payments of $542,000.
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APPAREL VENTURES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 1998 AND 1999
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NOTE 14 - FAIR VALUE OF FINANCIAL INSTRUMENTS
The Company believes the carrying amount of the following financial instruments approximates their current fair value: cash, receivables, accounts payable, line of credit, and notes payable. The fair value amounts have been estimated by the Company considering the nature of the instrument and applicable market information.
As indicated by a restructuring of debt on August 11, 1999 (Note 1), the fair value of senior notes payable is less than the carrying value as of June 30, 1999. The difference between the carrying cost and the fair value will be recognized as a gain in fiscal 2000 upon the retirement of the senior notes on August 11, 1999.
NOTE 15 - OPERATING SEGMENTS
The Company's products comprise a single operating segment. Sales are made to a large number of customers primarily throughout the United States and Europe. No single customer accounted for 10% or more of total sales for 1997, 1998 or 1999.
NOTE 16 - QUARTERLY FINANCIAL DATA (UNAUDITED)
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SUPPLEMENTAL INFORMATION - -------------------------------------------------------------------------------
REPORT OF INDEPENDENT ACCOUNTANTS ON FINANCIAL STATEMENT SCHEDULE
To the Board of Directors Apparel Ventures, Inc. and Subsidiaries
Our audits of the consolidated financial statements of Apparel Ventures, Inc. and Subsidiaries referred to in our report dated September 10, 1999 appearing in item 8 in this Annual Report on Form 10-K also included an audit of the financial statement schedule listed in item 14(a)(2) of Form 10-K. In our opinion, this financial statement schedule presents fairly, in all material respects, the information set forth therein when read in conjunction with the related consolidated financial statements.
/S/MOSS ADAMS LLP - ------------------ MOSS ADAMS LLP
Los Angeles, California September 10, 1999
- ------------------------------------------------------------------------------- S-1
APPAREL VENTURES, INC. AND SUBSIDIARIES
SCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS
YEAR ENDED JUNE 30, 1997, 1998 AND 1999
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- ------------------------------------------------------------------------------- S-2