ITEM 1. BUSINESS
Introduction
I.C. Isaacs & Company, Inc., together with its predecessors and subsidiaries, including I.C. Isaacs & Company L.P., and Isaacs Design, Inc. (collectively the "Company") is a designer and marketer of branded jeanswear and sportswear. Founded in 1913, the Company offers collections of men's and women's jeanswear and sportswear under the Marithe and Francois Girbaud designer brand ("Girbaud brand" or "Girbaud branded") in the United States, Puerto Rico and Canada. The Girbaud brand is an internationally recognized designer label with a distinct European influence. The Company has positioned its Girbaud branded line with a broad assortment of products, styles and fabrications reflecting a contemporary European look. The Company markets a full collection of men's jeanswear and sportswear under the Girbaud brand, including a broad array of bottoms, tops and outerwear. In August 1998, the Company introduced a women's sportswear collection under the Girbaud brand, which also includes a wide assortment of bottoms, tops and outerwear. Sales of Girbaud branded products accounted for all of the Company's net sales in 2003 and 2002.
Products
The Company's jeanswear and sportswear collections under the Girbaud brand include a broad range of product offerings for young men and women, including a variety of tops, bottoms and outerwear. These collections are targeted to consumers who are seeking quality, fashionable products at competitive prices. Girbaud is an internationally recognized designer brand. The Company markets innovative European-inspired men's and women's jeanswear and sportswear collections under the Girbaud label. The Girbaud collections include full lines of bottoms consisting of jeans and casual pants in a variety of fabrications, including denim, stretch denim, cotton twill and nylon, cotton t-shirts, polo shirts, knit and woven tops, sweaters, outerwear and leather sportswear. Reflecting contemporary European design, each of these collections is characterized by innovative styling and fabrication and is targeted to consumers ages 16 to 50. Estimated retail prices range from $24 to $30 for t-shirts, $50 to $90 for tops and bottoms, $60 to $90 for sweaters and $80 to $300 for outerwear.
Customers and Sales
The Company's products are sold in over 2,300 specialty stores, specialty store chains and department stores. The Company uses both sales representatives and distributors for the sale of its products. Sales representatives include employees of the Company as well as independent contractors. Each of the Company's non-employee sales representatives has an agreement with the Company pursuant to which the sales representative serves as the sales representative of specified products of the Company within a specified territory. The Company does not have long-term contracts with any of its customers. Instead, its customers purchase the Company's products pursuant to purchase orders and are under no obligation to continue to purchase the Company's products.
The Company began marketing men's sportswear under the Girbaud brand in February 1998 and introduced a women's sportswear collection under the Girbaud brand in the second quarter of 1998. The Company's Girbaud men's products are sold to approximately 1,600 stores in the United States and Puerto Rico, including major department stores such as Macy's East, Macy's West, Dillard's, Burdines, Dayton Hudson, Saks, Inc, and Carson Pirie Scott, and many prominent specialty stores such as The Lark. The Company's Girbaud women's line is sold to more than 1,100 stores. None of the Company's customers accounted for 10% or more of sales in 2003 or 2002. The Company's Girbaud brand products are sold and marketed domestically under the direction of a 12 person sales force headquartered in New York.
Design and Merchandising
The Company's designers and merchandisers are provided with the Girbaud collections from Europe twice a year and they collaborate with Marithe and Francois Girbaud and their staff in the development of the Company's Girbaud product lines for sale in the United States. Merchandisers also regularly meet with sales management to gain additional market insight and further refine the products to be consistent with the needs of each of the Company's markets. The Company's in-house design and product development is carried out by merchandising departments in New York. Many of the Company's products are developed using computer-aided design equipment, which allows designers to view and easily modify images of a new design. The Company currently has 8 people on the design staff in New York City. Design expenditures were approximately $1.4 million in 2003 and $1.2 million in 2002.
Advertising and Marketing
The Company communicates and reinforces the brand and image of its Girbaud products through creative and innovative advertising and marketing efforts. The Company's advertising and marketing strategies are directed by its New York sales office and developed in collaboration with advertising agencies and with Girbaud's European offices and Paris advertising agency. The Company's advertising strategy is geared toward its youthful and contemporary consumers, whose lifestyles are influenced by music, sports and fashion. Its advertising campaigns have evolved from trade magazines to a wide variety of media, including billboards, fashion magazines, radio and special events. In 2003, the Company continued to utilize advertising media to promote its products, but did so at a substantially reduced levels of spending. The Company's advertising expenditures were approximately $0.6 million, or 0.9% of net sales, in 2003 and $2.0 million, or 2.9% of net sales, in 2002.
Product Sourcing
General
All of the manufacturing and sourcing of the Company's products in 2003 were done by domestic and foreign independent contractors. Each of the Company's independent contractors and independent buying agents has an agreement with the Company pursuant to which it performs manufacturing or purchasing services for the Company on a non-exclusive basis. The Company evaluates its contractors frequently and believes that there are a number of manufacturers capable of producing products that meet the Company's quality standards. The Company's production requirements account for all or a significant portion of many of its contractors' production capacity. The Company has the ability to terminate its arrangements with each of its contractors at any time. A change in suppliers, however, could cause a delay in manufacturing and a possible loss of sales which could adversely affect operating results.
Asia
Virtually all of the Company's sportswear products other than t-shirts are produced by approximately 17 different manufacturers in six countries in Asia. During 2003, three of the Company's Asian contractors accounted for approximately 33%, 10% and 7% of the Company's total unit production in 2003. The Company has well established relationships with many of its contractors, although it does not have written agreements with them. The Company retains independent buying agents in various countries in Asia to assist in selecting and overseeing independent manufacturers, sourcing fabric, trim and other materials and monitoring quotas. Independent buying agents also perform quality control functions on behalf of the Company, including inspecting materials and manufactured products prior to accepting delivery. The sourcing and merchandising staffs in the Company's New York offices oversee Asian fabric and product development, apparel manufacturing, price negotiation and quality control, as well as the research and development of new Asian sources of supply. Asian production represented approximately 62% of the Company's total unit production in 2003. Purchasing from Asian contractors requires the Company to estimate sales and issue purchase orders for inventory well in advance of receiving firm orders from its customers. A risk to the Company is that its estimates may differ from actual orders. If this happens, the Company may miss
sales because it did not order enough, or it may have to sell excess inventory at reduced prices.
The Company seeks to achieve the most efficient means for the timely delivery of its high quality products. With rare exceptions, the Company does not purchase fabrics but instead negotiates a finished garment price from its contractors in Asia. The contractor must then purchase the approved fabric as part of the package. All of the Company's products manufactured abroad are paid for in United States dollars. Accordingly, the Company does not engage in any currency hedging transactions.
United States and Mexico
To take advantage of the shorter production time associated with T-shirt products, the Company purchases substantially all of its T-shirt blanks from a supplier in Mexico. This supplier maintains T-shirt blanks at its location and provides both full service packaging services for finished T-shirts and also drop ships T-shirt blanks directly to various independent contractors within the United States to be screen printed, embroidered or both, before being sent to the Company as a finished product to fulfill orders. T-shirt production represented approximately 39% of the Company's total unit production in 2003. During 2003, two of the Company's domestic contractors accounted for approximately 30% and 7% of the Company's total unit production in 2003.
Warehousing and Distribution
The Company services its United States customers utilizing a 70,000 square foot Company-owned and operated distribution center in Milford, Delaware. The Company has established a computerized "Warehouse Management System" with real-time internal tracking information and the ability to provide its customers with electronically transmitted "Advance Shipping Notices." The accuracy of shipments is increased by the ability to scan coded garments at the packing operation. This process also provides for computerized routing and customer invoicing. The vast majority of shipments are handled by UPS, common carriers or parcel post.
Quality Control
The Company's quality control program is designed to ensure that all of the Company's products meet its high quality standards. Visits are made by the Company's agents and product development staff to outside contractors to ensure compliance with the Company's quality standards. Audits are also performed by quality control personnel at the Milford, Delaware distribution center on all categories of incoming merchandise.
All garments produced for the Company in Asia must be produced in accordance with the Company's specifications. The Company's import quality control program is designed to ensure that the Company's products meet its high quality standards. The Company monitors the quality of fabrics prior to the production of garments and inspects prototypes of products before production runs are commenced. In some cases, the Company requires its agents or manufacturers to submit fabric to an independent outside laboratory for testing prior to production. The Company requires each agent to perform both in-line and final quality control checks during and after production before the garments leave the contractor. Personnel from the Company's New York office also visit Asia to conduct these inspections.
Backlog and Seasonality
The Company's business is impacted by the general seasonal trends that are characteristic of the apparel and retail industries. In the Company's segment of the apparel industry, sales are generally higher in the first and third quarters. The Company generally receives orders for its products three to five months prior to the time the products are delivered to the stores. As of December 31, 2003, the Company had an order backlog of approximately $18.3 million, compared to approximately $10.5 million of such orders as of December 31, 2002. The backlog of orders at any given time is affected by a number of factors, including seasonality, weather conditions, scheduling of manufacturing
and shipment of products. All such orders are subject to cancellation for reasons such as late delivery.
Licenses and Other Rights Agreements
Girbaud
In November 1997, the Company entered into an exclusive license agreement (the "Girbaud Men's Agreement") with Girbaud Design, Inc. and its affiliate Wurzburg Holding S.A. ("Wurzburg") to manufacture and market men's jeanswear, casualwear and outerwear under the Girbaud brand and certain related trademarks (the "Girbaud Marks") in all channels of distribution in the United States, including Puerto Rico and the U.S. Virgin Islands. In March 1998, the Girbaud Men's Agreement was amended and restated to include active influenced sportswear as a licensed product category and to name Latitude Licensing Corp. as the licensor (the "Licensor"). Also in March 1998, the Company entered into an exclusive license agreement (the "Girbaud Women's Agreement" and, together with the Girbaud Men's Agreement, the "Girbaud Agreements") with the Licensor to manufacture and market women's jeanswear, casualwear and outerwear, including active influenced sportswear, under the Girbaud Marks in all channels of distribution in the United States, including Puerto Rico and the U.S. Virgin Islands. The Girbaud Agreements include the right to manufacture the licensed products in a number of foreign countries, and both had initial terms of two years.
Stock Ownership by a Former Licensor
Prior to 2002, the Company issued to a former licensor of the Company an aggregate of 3.3 million shares of Series A Convertible Preferred Stock, par value $.0001 per share, of the Company (the "Preferred Stock") and 666,667 shares of the Company's common stock. Except as required by law, the Preferred Stock was not entitled to vote on any matters, and had a liquidation preference of $1.00 per share plus any declared but unpaid dividends. The Preferred Stock also provided for certain redemption rights to the Company and certain conversion rights to the holder of the Preferred Stock. Prior to 2002, the Company also issued to this former licensor a subordinated secured promissory note of the Company in the principal amount of $7.2 million, with principal and interest at an annual rate of 8% payable in varying installments through December 2006 (the "Original Note").
Girbaud Transaction
On May 6, 2002, Textile Investment International S.A. ("Textile"), an affiliate of the Licensor, acquired the Preferred Stock, the 666,667 shares of common stock and the Original Note from the former licensor. Pursuant to the terms of a Framework Agreement entered into on May 14, 2002 by the Company, Textile, the Licensor and Wurzburg (the "Framework Agreement"), the Company:
-- amended the terms of the Preferred Stock so that the Preferred Stock became immediately convertible, but only into common stock of the Company. In November 2002, Textile converted all the Preferred Stock into 3.3 million shares of common stock of the Company,
-- granted Textile warrants to purchase 500,000 shares of the Company's Common Stock for $0.75 per share,
-- entered into a Stockholders' Agreement with Textile establishing certain terms and conditions regarding the acquisition and disposition of the Company's securities as well as certain corporate governance matters, and
-- amended the Girbaud Agreements to
-- add an additional option for the Company to extend the term by four additional years through 2011 and
-- provide for the payment to the Licensor of consulting fees of $125,000 per agreement for calendar year 2002, and $150,000 per agreement for each remaining calendar year under the term of each agreement (the "Consultants' Fees").
As a result of those transactions, Textile and Wurzburg (which owns 500,000 shares of the Company's common stock) own approximately 40% of the Company's common stock and, as the Company's largest stockholders, they may designate five of the nine nominees for election as directors of the Company.
The Company's business is dependent upon its use of the Girbaud brand names and images, which are in turn dependent upon the existence and continuation of certain licenses as described below.
Girbaud Domestic Licenses
Unless extended in accordance with the options added to the Girbaud Agreements pursuant to the Framework Agreement, the terms of the Girbaud Agreements will expire at the end of 2007. The Girbaud Agreements generally allow the Company to use the Girbaud Marks on apparel designed by or for the Company or based on designs and styles previously associated with the Girbaud brand, subject to quality control by the Licensor over the final designs of the products, marketing and advertising material and manufacturing premises. The Girbaud Agreements provide that they may be terminated by the Licensor upon the occurrence of certain events, including, but not limited to, a breach by the Company of certain obligations under the agreements that remain uncured following certain specified grace periods.
Under the Girbaud Men's Agreement as amended the Company is required to make royalty payments to the Licensor in an amount equal to 6.25% of the Company's net sales of regular licensed merchandise and 3.0% in the case of certain irregular and closeout licensed merchandise. The Company is obligated to pay the greater of actual royalties earned or minimum guaranteed annual royalties of $3,000,000 through 2007. On a monthly basis during the term, the Company is obligated to pay 8.3% of the minimum guaranteed royalties for that year. On a quarterly basis during the term, the Company is required to pay the amount that the actual royalties exceed the total minimum guaranteed royalties for that quarter. The Company is required to spend the greater of an amount equal to 3% of Girbaud men's net sales or $500,000 in advertising and related expenses promoting the men's Girbaud brand products in each year through the term of the Girbaud men's agreement.
Under the Girbaud Women's Agreement as amended, the Company is required to make royalty payments to the Licensor in an amount equal to 6.25% of net sales of regular licensed merchandise and 3.0% of certain irregular and closeout licensed merchandise. The Company is obligated to pay the greater of actual royalties earned or minimum guaranteed annual royalties of $1,500,000 through 2007. On a monthly basis during the term, the Company is obligated to pay 8.3% of the minimum guaranteed royalties for that year. On a yearly basis, the Company is required to pay the amount that the actual royalties exceed the total minimum guaranteed royalties for that year.
The Company is required to spend the greater of an amount equal to 3% of Girbaud women's net sales or $400,000 in advertising and related expenses promoting the women's Girbaud brand products in each year through the term of the Girbaud Women's Agreement. In addition, over the term of the Girbaud Women's Agreement the Company is required to contribute $190,000 per year to the Licensor's advertising and promotional expenditures for the Girbaud brand.
The Girbaud Women's Agreement initially required the Company to open a Girbaud flagship store for the sale of the Company's Girbaud men's and women's lines and other Girbaud licensed merchandise in New York City by the end of 1998. In December 1998, the Girbaud Women's Agreement was amended to defer this requirement for one year and to provide that the Company would spend an additional $1.8 million on enhanced sales and marketing in 1999. In August, 1999, the Company issued 500,000 shares of restricted common stock to the Licensor (which was subsequently transferred to Wurzburg) in connection with an amendment of the Girbaud Women's Agreement to further defer the obligation to open a Girbaud retail store. Under the new agreement, if the Company had not signed a lease agreement for a Girbaud retail store by July 31, 2002, it would become obligated to pay the Licensor an additional $500,000 in royalties. During 2001, the Company decided not to sign a lease agreement for a Girbaud retail
store and paid $175,000 of this royalty, the remainder of which was paid by July 31, 2002. The entire amount was expensed in the fourth quarter of 2001.
The Company is obligated to pay a minimum of $6.1 million during 2004 in the form of minimum royalty payments, fashion show and advertising and promotional expenses pursuant to the Girbaud license agreements. In 2004, the Company expects that substantially all of its net sales will come from apparel associated with the Girbaud licenses.
Credit Control
The Company manages its own credit and collection functions and has never used a factoring service or outside credit insurance. The Company sells to approximately 2,300 accounts throughout the United States and Puerto Rico. All of the functions necessary to service this large volume of accounts are handled by the Company's in-house credit department in Baltimore, Maryland. The Company extends credit to its customers. Accordingly, the Company may have significant risk in collecting accounts receivable from its customers. The Company has credit policies and procedures which it uses to minimize exposure to credit losses. The Company currently employs three people in its credit department and believes that managing its own credit gives it unique flexibility as to which customers the Company should sell and how much business it should do with each. The Company obtains and periodically updates information regarding the financial condition and credit histories of customers. The Company's collection personnel evaluate this information and, if appropriate, establish a line of credit. Credit personnel track payment activity for each customer using customized computer software and directly contact customers with receivable balances outstanding beyond 30 days. If these collection efforts are unsuccessful, the Company may discontinue merchandise shipments until the outstanding balance is paid. Ultimately, the Company may engage an outside collection organization to collect past due accounts. Timely contact with customers has been effective in minimizing the Company's credit losses. In 2003 and 2002, the Company's credit losses were $0.3 million and $0.5 million, respectively and the Company's actual credit losses as a percentage of net sales were 0.5% and 0.7%, respectively.
Competition
The apparel industry is highly competitive and fragmented and is subject to rapidly changing consumer demands and preferences. The Company believes that its continued success depends in large part upon its ability to anticipate, gauge and respond to changing consumer demands and fashion trends in a timely manner and upon the continued appeal to consumers of the Girbaud brand. The Company competes with numerous apparel brands and distributors (including Diesel, Enyce, Ecko, Rocawear and Sean John). Many of the Company's competitors have greater financial resources than the Company. Although the level and nature of competition differ among its product categories, the Company believes that it competes on the basis of its brand image, quality of design and value pricing. The Company continued to experience intense competition in 2003 from many established and new competitors at both the specialty store and department store channels of distribution.
Management Information Systems
The Company believes that advanced information processing is essential to maintaining its competitive position. The Company's systems provide, among other things, comprehensive order processing, production, accounting and management information for the marketing, selling, production, retailing and distribution functions of the Company's business. The Company's software programs allow it to track, among other things, orders, production schedules, inventory and sales of its products. The programs include centralized management information systems, which provide the various operating departments with financial, sales, inventory and distribution related information. Via electronic data interchange, the Company is able to ship orders, from inventory on hand, to certain customers within 24 to 72 hours from the time of order receipt.
Employees
As of March 26, 2004, the Company had approximately 100 full-time employees. The Company is not a party to any labor agreements, and none of its employees are represented by a labor union. The Company considers its relationship with its employees to be good and has not experienced any material interruption of its operations due to labor disputes. The Company also engaged the services of Peter J Rizzo as its Chief Executive Officer in December 2003, and the services of Jesse de la Rama as its Vice President of Merchandise & Retail Development in March 2004.
Environmental Matters
The Company is subject to federal, state and local laws, regulations and ordinances that (i) govern activities or operations that may have adverse environmental effects (such as emissions to air, discharges to water, and the generation, handling, storage and disposal of solid and hazardous wastes) or (ii) impose liability for the costs of clean up or other remediation of contaminated property, including damages from spills, disposals or other releases of hazardous substances or wastes, in certain circumstances without regard to fault. Certain of the Company's operations routinely involve the handling of chemicals and waste, some of which are or may become regulated as hazardous substances. The Company has not incurred any significant expenditures or liabilities for environmental matters. Although the Company believes that its environmental obligations will not have a material adverse effect on its financial condition or results of operations, environmental compliance matters are subject to inherent risks and uncertainties.
ITEM 2.
ITEM 2. PROPERTIES
Certain information concerning the Company's principal facilities is set forth below:
The Company believes that its existing facilities are well maintained and in good operating condition. See "ITEM 1. Business--Warehousing and Distribution".
ITEM 3.
ITEM 3. LEGAL PROCEEDINGS
The Company is not presently a party to any litigation.
ITEM 4.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
During the fourth quarter of 2003, there were no matters submitted to a vote of the Company's stockholders.
PART II
ITEM 5.
ITEM 5. MARKET FOR THE COMPANY'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
The market for the Company's common stock is not an exchange but is the OTC Bulletin Board, an established quotation service regulated by the National Association of Securities Dealers. As of March 26, 2004, the Company had approximately 1,000 holders of record of its common stock.
Shares of the Company's common stock are traded on the OTC Bulletin Board under the ticker symbol "ISAC.OB". The reported last sale price of the common stock on the OTC Bulletin Board on March 29, 2004 was $0.74. The table below sets forth, for the periods indicated, the high and low bid prices of the Company's common stock for the periods indicated, as quoted by the OTC Bulletin Board Research Service. Such quotations reflect inter-dealer prices, without retail markup, markdown or commission, and may not represent actual transactions.:
The Company anticipates that all earnings of the Company will be retained for the foreseeable future for use in the operation of the Company's business. Any future determination as to the payment of dividends will be at the discretion of the Company's Board of Directors and will depend upon the Company's results of operations, financial condition, restrictions in the Company's credit facilities and other factors deemed relevant by the Board of Directors.
On May 15, 1997, the Board of Directors of the Company and the Company's stockholders adopted the 1997 Omnibus Stock Plan (the "Plan"). The purpose of the Plan is to promote the long-term growth and profitability of the Company by providing key people with incentives to improve stockholder value and contribute to the growth and financial success of the Company, and by enabling the Company to attract, retain and reward the best-available persons for positions of substantial responsibility. The maximum number of shares of Common Stock that could be issued with respect to awards granted under the Plan was 500,000. The Company's stockholders approved an increase in the shares of Common Stock that may be issued with respect to awards granted under the Plan to an aggregate of 1.1 million shares, at the 1999 annual meeting of stockholders, approved an additional increase to an aggregate of 1.6 million shares at the 2002 annual meeting of stockholders and approved an additional increase to an aggregate of 2.2 million shares at the 2003 annual meeting of stockholders. The Plan is administered by the Compensation Committee of the Board of Directors. Participation in the Plan is open to all employees, officers, directors and consultants of the Company or any of its affiliates, as may be selected by the Compensation Committee from time to time. The Plan allows for stock options, stock appreciation rights, stock awards, phantom stock awards and performance awards to be granted. The Compensation Committee will determine the prices, vesting schedules, expiration dates and other material conditions upon which such awards may be exercised. Through December 31, 2003, the Company had granted stock options under the Plan exercisable upon vesting for an aggregate of 2,070,250 stock options. The weighted average exercise price of such options is $1.08 per share. Through December 31, 2003, none of those stock options had been exercised. The issuance of such stock options was exempt from the registration requirements of the Securities Act of 1933, as amended, pursuant to Section 4(2) thereunder. The Company previously filed a Registration Statement on Form S-8 (the "Form S-8") to register shares of Common Stock issuable pursuant to awards granted under the Plan.
On May 6, 2002, Textile acquired the Preferred Stock, 666,667 shares of common stock and the Original Note from a former licensor. In December 2002, Textile converted all the Preferred Stock into 3.3 million shares of Common Stock of the Company. See, "Business - Licenses and Other Rights Agreements - Girbaud Transaction. In September 2002, the Company, pursuant to the terms of the Framework Agreement, granted Textile warrants to purchase 500,000 shares of the Company's Common Stock for $0.75 per share. The warrants were valued using the Black-Scholes option-pricing model and recorded as a preferred stock dividend at the time of issuance.
ITEM 6.
ITEM 6. SELECTED FINANCIAL DATA
The selected financial data set forth below and on the following page have been derived from the consolidated financial statements of the Company and the related notes thereto. The statement of operations data for the years ended December 31, 2003, 2002 and 2001 and the balance sheet data as of December 31, 2003 and 2002 are derived from the consolidated financial statements of the Company which have been audited by BDO Seidman, LLP, independent certified public accountants, included elsewhere herein. The statement of operations data for the years ended December 31, 2000 and 1999 and the balance sheet data as of December 31, 2001, 2000 and 1999 are derived from the consolidated financial statements of the Company, which have been audited but are not contained herein. The following selected financial data should be read in conjunction with the Company's consolidated financial statements and the related notes thereto and "Management's Discussion and Analysis of Financial Condition and Results of Operations," which are included elsewhere herein.
ITEM 7.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following discussion and analysis should be read in conjunction with the "Selected Financial Data" and the Company's consolidated financial statements and the related notes thereto, which are included elsewhere herein.
Overview
Over the past several years, the Company has shifted its focus from various brands to the Girbaud brand exclusively. In 2000, the Company terminated its license for use of the BOSS brand and it did not renew its Beverly Hills Polo Club licensing agreements in the United States and Puerto Rico when those licenses expired on December 31, 2001. During 2003 and 2002, the Company focused all of its resources on the Girbaud men's and women's lines. The Company's brand-driven market strategy has been evidenced by the increase of licensed, branded apparel as a percentage of the Company's net sales. In 2003 and 2002, all of the Company's net sales were from the Girbaud brand. This compares to 84.9%, 8.6% and 2.4% of net sales for the Girbaud, Beverly Hills Polo Club and BOSS brands in 2001 respectively.
Significant Accounting Policies and Estimates
The Company's significant accounting policies are more fully described in its Summary of Accounting Policies set forth in the Company's consolidated financial statements and the notes thereto which accompany this report. The preparation of financial statements in conformity with accounting principles generally accepted within the United States requires management to make estimates and assumptions in certain circumstances that affect amounts reported in the accompanying financial statements and related notes. In preparing these financial statements, management has made its best estimates and judgments of certain amounts included in the financial statements, giving due consideration to materiality. The Company does not believe there is a great likelihood that materially different amounts would be reported related to the accounting policies described below; however, application of these accounting policies involves the exercise of judgments and the use of assumptions as to future uncertainties and, as a result, actual results could differ from these estimates.
The Company evaluates the adequacy of its allowance for doubtful accounts at the end of each quarter. In performing this evaluation, the Company analyzes the payment history of its significant past due accounts, subsequent cash collections on these accounts and comparative accounts receivable aging statistics. Based on this information, along with consideration of the general strength of the economy, the Company develops what it considers to be a reasonable estimate of the uncollectible amounts included in accounts receivable. This estimate involves significant judgement by the management of the Company. Actual uncollectible amounts may differ from the Company's estimate.
The Company estimates inventory markdowns based on customer orders sold below its inventory cost that will be shipped in the following period and estimates an amount for similar unsold inventory at period end. The Company analyzes recent sales and gross margins on unsold inventory in further estimating inventory markdowns. These specific markdowns are reflected in cost of sales and the related gross margins at the conclusion of the appropriate selling season. This estimate involves significant judgement by the management of the Company. Actual gross margins on sales of excess inventory may differ from the Company's estimate.
Year Ended December 31, 2003 Compared to Year Ended December 31, 2002
Net Sales.
Net sales increased 0.6% to $66.2 million in 2003 from $65.8 million in 2002. Whereas net sales did not significantly change in 2003 compared to 2002, net sales trended up towards the second half of 2003 compared to the second half of 2002. Net sales were $16.5 million, $16.2 million, $16.4 million and $17.1 million in the first, second, third and fourth quarters of 2003 respectively compared to $20.2 million, $17.0 million $16.3 million and $12.3 million for the same quarters of 2002 respectively. Net sales of Girbaud men's sportswear increased $1.0 million or 1.8% to $57.2 million. Net sales of Girbaud women's sportswear decreased $0.6 million or 6.3% to $9.0 million.
Gross Profit.
Gross profit decreased 6.2% to $22.5 million in 2003 from $24.0 million in 2002. Gross profit as a percentage of net sales decreased to 34.0% from 36.5% over the same period. The decrease in gross profit resulted from sales to off-price retailers at reduced selling prices and an increase in air freight costs affecting gross profit margins in 2003. In an effort to decrease the inventory level and to generate cash for first quarter 2003 working capital needs, the Company generated significant sales early in 2003 to a mass retailer at gross profit margins significantly below the margins on goods that are sold to department and specialty stores. To properly reflect inventory at its net realizable value at the end of the prior year, the Company had an inventory writedown of $1.8 million at December 31, 2002. Accordingly, this generated minimal gross profit associated with these sales to the mass retailer in the first quarter of 2003. The Company's inventory writedown at the end of 2003 was $0.3 million. To help identify inventory shortages as well as excess inventory, the Company monitors inventory levels by product category on a weekly basis. Personnel look at recent sales data and order backlog to help identify slow moving inventory items. Further, sales managers continually discuss product turnover and sales forecasts with sales personnel to aid in identifying product shortages and overages. Based on the information available, the Company believes the inventory writedowns were appropriate at December 31, 2003 and 2002, respectively.
Selling, Distribution, General and Administrative Expenses.
Selling, distribution, general and administrative ("SG&A") expenses decreased 19.3% to $18.8 million in 2003 from $23.3 million in 2002. As a percentage of net sales, SG&A expenses decreased to 28.3% from 35.4% over the same period due to overall reduced expenses. Selling expenses decreased 17.4% to $11.4 million from $13.8 million mainly due to decreases in advertising expense and in commission expense. Distribution and shipping expenses decreased 12.5% to $2.1 million in 2003 from $2.4 million in 2002 due to efficiencies and cost reductions achieved at the Company's distribution center. General and
administrative expenses decreased 22.4% to $5.2 million in 2003 from $6.7 million in 2002 due to decreases in professional, consulting and other fees associated with the 2002 Framework Agreement as well as a decrease in salaries. There was no provision for severance in 2003 compared to $0.4 million in 2002.
License Fees.
License fees decreased 16.0% to $4.2 million in 2003 from $5.0 million in 2002. As a percentage of net sales, license fees decreased to 6.3% from 7.6%. The decrease in license fees as a percentage of net sales was primarily due to the $0.5 million reduction of the 2003 minimum royalty payments (see below). The Company is obligated to pay the greater of actual royalties earned on net sales of the men's and women's Girbaud product offering or minimum guaranteed annual royalties through 2007 of $3,000,000 for men's and $1,500,000 for women's. In February 2003, Latitude and the Company agreed to reduce the 2003 minimum guaranteed annual royalty payments by $450,000. See Management's Discussion and Analysis of Financial Condition and Results of Operations - Liquidity and Capital Resources - Credit Facilities.
Operating Loss.
Operating loss decreased to $0.4 million in 2003 from $4.3 million in 2002. This improvement is due to a decrease in operating expenses offset slightly by a decrease in gross profit in 2003.
Interest Expense.
Interest expense increased 42.9% to $1.0 million in 2003 from $0.7 million in 2002 as a result of increased borrowings on the revolving line of credit as well as an increase in the interest rate charged by the lender during 2003. Interest income earned in 2003 and 2002 was insignificant.
Income Taxes.
The Company has estimated its annual effective tax rate at 0% based on its estimate of pre-tax loss for 2003. As of December 31, 2003, the Company had net operating loss carryforwards of approximately $45.6 million, which begin to expire in 2013, for income tax reporting purposes for which no income tax benefit has been recorded due to the uncertainty over the level of future taxable income.
Year Ended December 31, 2002 Compared to Year Ended December 31, 2001
Net Sales.
Net sales decreased 20.0% to $65.8 million in 2002 from $82.3 million in 2001. The Company believes that the decrease was primarily due to the discontinuance of the BOSS, Beverly Hills Polo Club and Company-owned and private label brands, net sales of which represented $12.4 million in 2001, the sluggish retail environment and a weaker than anticipated consumer response to the Girbaud fall product offering. Net sales of Girbaud men's sportswear decreased $1.7 million or 2.9% to $56.2 million. Net sales of Girbaud women's sportswear decreased $2.5 million or 20.7% to $9.6 million. The Company is positioning the women's Girbaud collection as two separate collections, one for streetwear and the other as a contemporary line. While this positioning has had a negative impact on 2002 sales, the Company believes this repositioning will improve future growth of the line.
Gross Profit.
Gross profit decreased 11.8% to $24.0 million in 2002 from $27.2 million in 2001. Gross profit as a percentage of net sales increased to 36.5% from 33.0% over the same period. The increase in gross profit as a percentage of net sales was primarily due to the sales of Girbaud jeanswear and sportswear at higher margins in 2002 compared to 2001 net sales that included sales of the discontinued product lines of BOSS and Beverly Hills Polo Club sportswear. In an
effort to decrease the inventory level and to generate cash for first quarter working capital needs, the Company generated significant sales early in 2003 to a mass retailer at gross profit margins significantly below the margins on goods that are sold to department and specialty stores. To properly reflect inventory at its net realizable value, the Company had an inventory writedown of $1.8 million at December 31, 2002, compared to an inventory writedown of $0.3 million at December 31, 2001, which adversely affected the overall gross margin in 2002. To help identify inventory shortages as well as excess inventory, the Company monitors inventory levels by product category on a weekly basis. Personnel look at recent sales data and order backlog to help identify slow moving inventory items. Further, sales managers continually discuss product turnover and sales forecasts with sales personnel to aid in identifying product shortages and overages. Based on the information available, the Company believes the inventory writedowns were appropriate at December 31, 2002 and 2001, respectively.
Selling, Distribution, General and Administrative Expenses.
Selling, distribution, general and administrative ("SG&A") expenses increased 2.6% to $23.3 million in 2002 from $22.7 million in 2001. As a percentage of net sales, SG&A expenses increased to 35.4% from 27.6% over the same period due to reduced net sales levels, higher selling expenses and general and administrative expenses offset by lower distribution and shipping expenses. Selling expenses increased 11.3% to $13.8 million from $12.4 million due to increases in consulting fees associated with the Framework Agreement, sample purchases and merchandise allowances for chargebacks offset by a decrease in commission expense associated with reduced net sales levels. Distribution and shipping expenses decreased 20.0% to $2.4 million in 2002 from $3.0 million in 2001 due to decreased personnel at the Company's distribution facility to correspond with the decrease in merchandise shipments as a result of decreased sales. General and administrative expenses increased 1.5% to $6.7 million in 2002 from $6.6 million in 2001 due to increases in professional, consulting and other fees associated with the Framework Agreement offset by a decrease in salaries and bad debt expense. The provision for severance decreased 42.9% in 2002 to $0.4 million from $0.7 million in 2001.
License Fees.
License fees decreased 3.8% to $5.0 million in 2002 from $5.2 million in 2001. As a percentage of net sales, license fees increased to 7.6% from 6.3%. The increase in license fees as a percentage of net sales is primarily due to the decrease in net sales levels of the women's Girbaud line without a corresponding decrease in minimum guaranteed annual royalties of $1,500,000 in 2002. The Company is obligated to pay the greater of actual royalties earned on net sales of the women's Girbaud product offering or minimum guaranteed annual royalties of $1,500,000 through 2007.
Operating Loss.
Operating loss increased to $4.3 million in 2002 from $0.7 million in 2001. This deterioration is due to a decrease in net sales and the related gross profit coupled with an increase in certain operating expenses.
Interest Expense.
Interest expense decreased 46.2% to $0.7 million in 2002 from $1.3 million in 2001 as a result of lower borrowings on the revolving line of credit during the first half of 2002. Interest income earned in 2002 and 2001 was insignificant.
Income Taxes.
The Company has estimated its annual effective tax rate at 0% based on its estimate of pre-tax loss for 2002. As of December 31, 2002, the Company has net operating loss carryforwards of approximately $45.2 million, which begin to expire in 2013, for income tax reporting purposes for which no income tax benefit has been recorded due to the uncertainty over the level of future taxable income.
Liquidity and Capital Resources
The Company has relied primarily on asset based borrowings, trade credit and internally generated funds to finance its operations. During 2003, the Company increased its accounts receivable $1.6 million while inventory decreased $2.5 during this same period. Accounts payable and accrued liabilities increased $0.6 million during 2003. Cash and cash equivalents held by the Company increased to $0.8 million at December 31, 2003 compared to $0.6 million at December 31, 2002 while its working capital decreased to $4.6 million at December 31, 2003 from $6.2 million at December 31, 2002. A decrease in demand for the Company's products could have a material adverse effect on the Company's working capital.
Operating Cash Flow.
Cash provided by operations totaled $1.3 million in 2003 compared to cash used in operations of $5.0 million in 2002. Positive operating cash flow in 2003 was due primarily to a decrease in inventory and an increase in liabilities partially offset by the net loss and an increase in accounts receivable. Cash provided by investing activities during 2003 was insignificant, totaling $0.1 million. Cash used in financing activities totaled $1.2 million in 2003 resulting primarily from the pay down of the revolving line of credit and decrease in checks issued against future deposits.
Inventories decreased $2.5 million from December 31, 2002 to December 31, 2003, compared to an increase of $1.4 million from December 31, 2001 to December 31, 2002. The decrease in 2003 was partially the result of the Company's efforts to reduce unsold inventory to more manageable levels. In 2003, the Company also eliminated the need to carry T-shirt blank raw material inventory by switching to a vendor in Mexico whom drop ships T-shirt blanks directly to screen printers or embroidery contractors as requested by the Company . The increase in 2002 was the result of purchasing inventory for sales that did not materialize in the fall of 2002, which was a result of the sluggish retail environment and a weaker than anticipated consumer response to the Company's fall product offering. To properly reflect unsold inventory at its net realizable value, the Company had an inventory valuation allowance of $1.8 million at December 31, 2002, compared to $0.3 million at December 31, 2003.
Credit Facilities
The Company has an asset-based revolving line of credit (the "Credit Agreement") with Congress Financial Corporation ("Congress"). In December 2002 and again in March and November 2003, the Credit Agreement was amended to extend the term through December 31, 2004, to modify the minimum levels of working capital and tangible net worth the Company is required to maintain and to modify the rate of interest on borrowings under the Credit Agreement. The amended Credit Agreement provides that the Company may borrow up to 80.0% of net eligible accounts receivable and a portion of inventory, as defined in the Credit Agreement. Borrowings under the Credit Agreement may not exceed $20.0 million including outstanding letters of credit which are limited to $6.0 million from May 1 to September 30 of each year and $4.0 million for the remainder of each year, and bear interest at Congress' prime rate of interest plus 2.25% (effectively 6.30% at December 31, 2003). Outstanding letters of credit approximated $1.4 million at December 31, 2003. In connection with amending the Credit Agreement in December 2002, the Company had agreed to pay Congress a financing fee of $250,000, one half of which was paid at the time of closing and the other half was paid by the Company in February 2003. This financing fee is being amortized over 24 months which began in January 2003. In connection with amending the Credit Agreement in March 2003, the Company paid Congress a financing fee of $75,000. This financing fee was amortized over the remaining months of 2003. In connection with amending the Credit Agreement in November 2003, the Company paid Congress a financing fee of $50,000 which was expensed at the time of payment. In connection with the Company's efforts to obtain these waivers, and to comply with its covenants, the Licensor and the Company agreed, in February and November 2003 to:
-- defer the December 2002 and January 2003 royalty payments of $250,000 each under the Girbaud Men's Agreement to October and November 2003 respectively. Both these deferred October and November 2003 royalty payments of $250,000 each were further deferred to May and June 2004 respectively;
-- defer the December 2002 royalty payment of $125,000 under the Girbaud Women's Agreement to October 2003. This royalty payment was further deferred to May 2004;
-- reduce the 2003 minimum guaranteed annual royalty payments by $450,000 to $1,050,000 by paying $25,000 in each of the months of April and May, 2003; $125,000 in each of the months of June, July, August, September, October and December, 2003; and $250,000 in November 2003. One half of the November royalty payment of $250,000, or $125,000 was further deferred to June 2004.
-- defer payment of approximately $94,000 of Consultants' Fees which became due in December 2002 under the Girbaud Men's and Women's Agreements and pay $30,000 of that amount in February 2003 and the balance in August 2003; and
-- reduce the Consultants' Fees payable in 2003 from $300,000 to $100,000 and waive payment of approximately $97,000 that the Company owed for samples provided by Girbaud.
The Company extends credit to its customers. Accordingly, the Company may have significant risk in collecting accounts receivable from its customers. The Company has credit policies and procedures which it uses to minimize exposure to credit losses. The Company's collection personnel regularly contact customers with receivable balances outstanding beyond 30 days to expedite collection. If these collection efforts are unsuccessful, the Company may discontinue merchandise shipments until the outstanding balance is paid. Ultimately, the Company may engage an outside collection organization to collect past due accounts. Timely contact with customers has been effective in minimizing its credit losses. In 2003 and 2002, the Company's credit losses were $0.3 million and $0.5 million, respectively and the Company's actual credit losses as a percentage of net sales were 0.5% and 0.7%, respectively.
The Company has the following contractual obligations and commercial commitments as of December 31, 2003:
(*) Adjusted to account for the deferrals, reductions and waivers of the Consultants' Fees, royalty and other payment obligations mentioned above
(**)At December 31, 2003, the Company had $4.2 million of borrowings under its revolving line of credit and outstanding letters of credit of approximately $1.4 million under the Credit Agreement.
The Company believes that current levels of cash and cash equivalents ($0.8 million at December 31, 2003) together with cash from operations and funds available under its Credit Agreement, will be sufficient to meet its capital requirements for the next 12 months.
Inflation
The Company does not believe that the relatively moderate rates of inflation experienced in the United States over the last year have had a significant effect on its net sales or profitability. Although higher rates of inflation have been experienced in a number of foreign countries in which the Company's products are manufactured, the Company does not believe that they have had a material effect on the Company's net sales or profitability.
Recent Accounting Pronouncements
In December 2003, the FASB issued a revision to SFAS No. 132, Employers' Disclosures about Pensions and Other Postretirement Benefits". This statement does not change the measurement or recognition aspects for pensions and other postretirement benefit plans; however, it does revise employee disclosures to include more information about the plan assets, obligations to pay benefits and funding obligations. SFAS 132, as revised, is generally effective for financial statements with fiscal years ending after December 15, 2003. Certain additional disclosure applicable to foreign defined benefit plans are effective for fiscal years ending after June 15th, 2004. The Company has adopted the required provisions of SFAS No. 132, as revised.
In May 2003, the FASB issued SFAS No.150, "Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity," SFAS No. 150 clarifies the definition of a liability as currently defined in FASB Concepts Statement No. 6, "Elements of Financial Statements, " as well as other planned revisions. This statement requires a financial instrument that embodies an obligation of an issuer to be classified as a liability, In addition, the statement establishes standards for the initial and subsequent measurement of these financial instruments and disclosure requirements. SFAS 150 is effective for financial instruments entered into or modified after May 31, 2003 and for all other matters, is effective at the first interim period beginning after June 15, 2003. The adoption of SFASD 150 did not have a material effect on the Company's financial position or results of operations.
In April 2003, the FASB issued SFAS No.149," Amendment of Statement 133 on Derivative Instruments and Hedging Activities," SFAS No. 149 amends SFAS No. 133 for decisions made by the FASB's Derivatives Implementation Group, other FASB projects dealing with financial instruments, and in response to implementation issues raised in relation to the application of the definition of a derivative. This statement is generally effective for contracts entered into or modified after June 30, 2003 and for hedging relationships designed after June 30, 2003. The adoption of SFAS 149 did not have material effect on the Company's financial
position or results of operations.
In January 2003, the FASB issued Interpretation ("FIN") No. 46, "Consolidation of Variable Interest Entities" and in December 2003, a revised interpretation was issued (FIN No.46, as revised). In general, a variable interest entity ("VIE") is a corporation, partnership, trust, or any other legal structure used for business purposes that either does not have equity investors with voting rights or has equity investors that do not provide sufficient financial resources for the entity to support its activities. FIN 46, as revised, requires a VIE to be consolidated by a company if that company is designated as the primary beneficiary. The interpretation applies to VIEs created after January 31, 2003, and for all financial statements issued after December 15, 2003 for VIEs in which an enterprise held a variable interest that it acquired before February 1, 2003. The adoption of FIN 46, as revised, did not have a material effect on the Company's financial position or results of operations,
In December 2002, the FASB issued SFAS No.148, "Accounting for Stock-Based Compensation--Transition and Disclosure.' This statement amends SFAS No. 123,"Accounting for Stock-Based Compensation," to provide alternative methods of transition for a voluntary change to the fair value based method of accounting for stock-based employee compensations. In addition, SFAS 148 amends the disclosure requirements of SFAS 123 to require prominent disclosures in both annual and interim financial statements about the method of accounting for stock-based employee compensation and the effect of the method used on reported results. The Company adopted the disclosure provisions of this standard.
In November 2002, the FASB issued Interpretation No. 45, Guarantor's Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others"' ("FIN 45"). FIN 45 addresses the disclosures to be made by a guarantor in its interim and annual financial statements about its obligations under guarantees, The disclosure requirements in this Interpretation are effective for financial statements of interim or annual periods ending after December 15, 2002. The adoption of FIN 45 did not have a material effect on the Company's financial position or results of operations.
ITEM 7A.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The Company's principal market risk results from changes in floating interest rates on short-term debt. The Company does not use interest rate swap agreements to mitigate the risk of adverse changes in the prime interest rate. However, the impact of a 100 basis point change in interest rates affecting the Company's short-term debt would not be material to the net loss, cash flow or working capital. The Company does not hold long-term interest sensitive assets and therefore is not exposed to interest rate fluctuations for its assets. The Company does not hold or purchase any derivative financial instruments for trading purposes.
ITEM 8.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The consolidated financial statements of the Company and the report of independent certified public accountants thereon are set forth on pages through hereof.
ITEM 9.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
None.
ITEM 9A.
ITEM 9A. CONTROLS AND PROCEDURES
The Company maintains disclosure controls and procedures that are designed
-- to ensure that information required to be disclosed in the Company's Exchange Act reports
-- is recorded, processed, summarized and reported within the time periods specified in the SEC's rules and forms,
-- is accumulated and communicated to the Company's management, including the Company's Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure.
-- with the objective of providing reasonable assurance that
-- the Company's transactions are properly authorized;
-- the Company's assets are safeguarded against unauthorized or improper use; and
-- the Company's transactions are properly recorded and reported, all to permit the preparation of the Company's financial statements in conformity with generally accepted accounting principles.
In designing and evaluating the Company's disclosure controls and procedures, the Company's management recognized that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives, and that management must apply its judgment in evaluating the cost-benefit relationship of possible controls and procedures.
As of the end of the period, the Company conducted an evaluation, under the supervision and with the participation of the Company's management, including the Company's Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of the Company's disclosure controls and procedures. Among other matters, the Company sought in the Company's evaluation to determine whether there were any significant deficiencies or material weaknesses in the Company's disclosure controls and procedures, or whether the Company had identified any acts of fraud involving personnel who have a significant role in the implementation of those controls and procedures.
Based upon that evaluation, the Company's CEO and CFO have concluded that, subject to the limitations described above, the Company's disclosure controls and procedures are effective to ensure that material information relating to the Company and its consolidated subsidiary is made known to management, including the CEO and CFO, particularly during the period when the Company's periodic reports are being prepared, and that the Company's disclosure controls and procedures are effective to provide reasonable assurance that the Company's financial statements are fairly presented in conformity with generally accepted accounting principles.
There have been no significant changes in the Company's disclosure controls and procedures or in other factors that could significantly affect them during the fourth quarter of 2003.
PART III
ITEM 10.
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE COMPANY
The information appearing in the Company's Definitive Proxy Statement prepared in connection with the 2004 Annual Meeting of Stockholders (the "Proxy Statement") under the captions "Proposal 1: Election of Directors", "Principal Executive Officers of the Company Who Are Not Also Directors", "Section 16(a) Beneficial Ownership Reporting Compliance", "Board Committees and Meetings" and "Code of Ethics" are incorporated herein by reference. The Proxy Statement will be filed not later than 120 days after the end of the fiscal year covered by this annual report on Form 10-K.
ITEM 11.
ITEM 11. EXECUTIVE COMPENSATION
The information appearing in the Proxy Statement under the caption "Executive Compensation" is incorporated herein by reference.
ITEM 12.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The information appearing in the Proxy Statement under the caption "Security Ownership Of Certain Beneficial Owners And Management" and "Securities Authorized for Issuance Under Equity Compensation Plans" are incorporated herein by reference.
ITEM 13.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information appearing in the Proxy Statement under the caption "Certain Relationships And Related Transactions" is incorporated herein by reference.
ITEM 14.
ITEM 14. PRINCIPAL ACCOUNTING FEES AND SERVICES
The information appearing in the Proxy Statement under the caption "Principal Accounting Fees and Services" is incorporated herein by reference.
PART IV
ITEM 15.
ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
(a)1. Financial Statements. The following financial statements, related notes and the Report of Independent Certified Public Accountants, are included in response to Item 8 hereof:
(a)2. Financial Statements Schedules. The following is a list of all financial statements schedules filed herewith:
Schedule II-Valuation and Qualifying Accounts
Schedules other than those listed above have been omitted because they are not required or are not applicable, or the required information has been included in the Consolidated Financial Statements or the Notes thereto.
(a)3. Exhibits (numbered in accordance with Item 601 of Regulation S-K). The following is a list of Exhibits filed herewith:
3.06 Certificate of Amendment of the Company's Amended and Restated Certificate of Incorporation (a copy of which was filed with the Commission on August 14, 2003 as Exhibit 3.06 to the Company's Quarterly Report on Form 10-Q, and is hereby incorporated herein by this reference).
4.04 Amended and Restated Omnibus Stock Plan as in effect on June 30, 2003 (a copy of which was filed with the Commission on August 14, 2003 as Exhibit 4.04 to the Company's Quarterly Report on Form 10-Q, and is hereby incorporated herein by this reference).
10.112 Employment Agreement dated the 31st day of March, 2003 between I.C. Isaacs & Company, L.P. and Robert Conologue (a copy of which was filed with the Commission on May 15, 2003 as Exhibit 10.112 to the Company's Quarterly Report on Form 10-Q, and is hereby incorporated herein by this reference).
10.113 Employment Agreement dated the 15th day of February, 2003 between I.C. Isaacs & Company, L.P. and Sandra Finkelstein (a copy of which was filed with the Commission on May 15, 2003 as Exhibit 10.113 to the Company's Quarterly Report on Form 10-Q, and is hereby incorporated herein by this reference).
10.114 Amendment dated as of May 15th, 2003 to the Amended and Restated Employment Agreement between I.C. Isaacs & Company, L.P. and Daniel J. Gladstone Employment Agreement dated the 15th day of February, 2003 between I.C. Isaacs & Company, L.P. and Sandra Finkelstein (a copy of
which was filed with the Commission on May 15, 2003 as Exhibit 10.114 to the Company's Quarterly Report on Form 10-Q, and is hereby incorporated herein by this reference).
10.115 Amendment dated as of March 31st, 2003 to the Amended and Restated Employment Agreement between I.C. Isaacs & Company, L.P. and Eugene C. Wielespki (a copy of which was filed with the Commission on May 15, 2003 as Exhibit 10.115 to the Company's Quarterly Report on Form 10-Q, and is hereby incorporated herein by this reference).
10.116 Consulting Agreement made as of the 31st day of March 31st, 2003 between I.C. Isaacs & Company, L.P. and Societe de Finance et d'Investissement, SA (a copy of which was filed with the Commission on May 15, 2003 as Exhibit 10.116 to the Company's Quarterly Report on Form 10-Q, and is hereby incorporated herein by this reference).
10.117 Amendment No. 2 and Waiver to Amendment and Restated Loan and Security Agreement, dated November 12, 2003, by and between I. C. Isaacs & Company L.P. and Congress Financial Corporation (a copy of which was filed with the Commission on November 14, 2003 as Exhibit 10.112 to the Company's Quarterly Report on Form 10-Q, and is hereby incorporated herein by this reference).
10.118 Amendment No. 8, dated October 29, 2003 to the Trademark License and Technical Assistance Agreement for Women's Collections between Latitude Licensing Corp. and I.C. Isaacs & Company L.P. (a copy of which was filed with the Commission on November 14, 2003 as Exhibit 10.113 to the Company's Quarterly Report on Form 10-Q, and is hereby incorporated herein by this reference).
10.119 Amendment No. 6, dated October 29, 2003 to the Trademark License and Technical Assistance Agreement dated the 1st day of November 1997 by and between Latitude Licensing Corp. and I.C. Isaacs & Company L.P. (a copy of which was filed with the Commission on November 14, 2003 as Exhibit 10.114 to the Company's Quarterly Report on Form 10-Q, and is hereby incorporated herein by this reference).
23.1 Consent of BDO Seidman, LLP
31.1 Certification Pursuant to Section 302 of the Sarbanes-Oxley Act of
31.2 Certification Pursuant to Section 302 of the Sarbanes-Oxley Act of
32.1 Certification Pursuant to Section 1350 of chapter 63 of Title 18 of the United States Code
(b) Reports on Form 8-K:
On November 12, 2003, the Company furnished a Current Report on Form 8-K under Item 12 -- Disclosure of Results of Operations and Financial Condition, containing a press release in which it announced its financial results for the quarter ended September 30, 2003.
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.
I.C. ISAACS & COMPANY , INC. (REGISTRANT)
By: /s/ Peter J. Rizzo ----------------------------------------------------------- Peter J. Rizzo Chief Executive Officer Date: March 29, 2004
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.
Signature Title Date
/s/ Peter J. Rizzo Chief (Principal) Executive Officer, March 29, 2004 ------------------- Director Peter J. Rizzo
/s/ Robert J. Conologue Chief Operating Officer, Chief March 29, 2004 ------------------- (Principal) Financial Officer, Director Robert J. Conologue
/s/ Staffan Ahrenberg Chairman of the Board March 29, 2004 ------------------- Staffan Ahrenberg
/s/ Daniel J. Gladstone President March 29, 2004 ------------------- Daniel J. Gladstone
/s/ Olivier Bachellerie Director March 29, 2004 ------------------- Olivier Bachellerie
/s/ Rene Faltz Director March 29, 2004 ------------------- Rene Faltz
/s/ Neal J. Fox Director March 29, 2004 ------------------- Neal J. Fox
/s/ Jon Hechler Director March 29, 2004 ------------------- Jon Hechler
/s/ Roland Loubet Director March 29, 2004 ------------------- Roland Loubet
/s/ Robert S. Stec Director March 29, 2004 ------------------- Robert S. Stec
Report of Independent Certified Public Accountants
To the Board of Directors and Stockholders I.C. Isaacs & Company, Inc.
We have audited the accompanying consolidated balance sheets of I.C. Isaacs & Company, Inc. and subsidiaries as of December 31, 2003 and 2002 and the related consolidated statements of operations, stockholders' equity and cash flows for each of the three years in the period ended December 31, 2003. 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 auditing standards generally accepted in the United States of America. 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 financial position of I.C. Isaacs & Company, Inc. and subsidiaries at December 31, 2003 and 2002 and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2003 in conformity with accounting principles generally accepted in the United States of America.
BDO SEIDMAN, LLP
Bethesda, Maryland March 15, 2004
I.C. Isaacs & Company, Inc. Consolidated Balance Sheets
See accompanying summary of accounting policies and notes to consolidated financial statements.
I.C. Isaacs & Company, Inc. Consolidated Statements of Operations
See accompanying summary of accounting policies and notes to consolidated financial statements.
I.C. Isaacs & Company, Inc. Consolidated Statements of Stockholders' Equity
See accompanying summary of accounting policies and notes to consolidated financial statements.
I.C. Isaacs & Company, Inc. Consolidated Statements of Cash Flows
See accompanying summary of accounting policies and notes to consolidated financial statements.
I.C. Isaacs & Company, Inc. Summary of Accounting Policies
Basis of Presentation
The consolidated financial statements include the accounts of I. C. Isaacs & Company, Inc. ("ICI"), I.C. Isaacs Europe, S.L. ("Isaacs Europe"), I.C. Isaacs & Company, L.P. (the "Partnership"), Isaacs Design, Inc. ("Design") and I.C. Isaacs Far East Ltd. (collectively the "Company"). The Company sold the common stock of Isaacs Europe, SL in December 2001. I.C. Isaacs Far East Ltd. did not have any significant revenue or expenses in 2003, 2002 and 2001. All intercompany balances and transactions have been eliminated.
Business Description
The Company, which operates in one business segment, is a designer and marketer of branded jeanswear and sportswear. The Company offers collections of jeanswear and sportswear for men and women under the Marithe and Francois Girbaud brand ("Girbaud brand") in the United States, Puerto Rico and Canada. The Girbaud brand is an internationally recognized designer label with a distinct European influence. The Company has positioned its Girbaud brand line with a broad assortment of products, styles and fabrications reflecting a contemporary European look. The Company markets a full collection of men's and women's jeanswear and sportswear under the Girbaud brand, including a broad array of bottoms, tops and outerwear.
Risks and Uncertainties
The apparel industry is highly competitive. The Company competes with many companies, including larger, well capitalized companies which have sought to increase market share through massive consumer advertising and price reductions. The Company continues to experience increased competition from many established and new competitors at both the department store and specialty store channels of distribution. The Company continues to redesign its jeanswear and sportswear lines in an effort to be competitive and compatible with changing consumer tastes. Also, the Company has developed and implemented marketing initiatives to promote its Girbaud brand. A risk to the Company is that such a strategy may lead to continued pressure on profit margins. In the past several years, many of the Company's competitors have switched much of their apparel manufacturing from the United States to foreign locations such as Mexico, the Dominican Republic and throughout Asia. As competitors lower production costs, it gives them greater flexibility to lower prices. Over the last several years, the Company also switched its production to contractors outside the United States to reduce costs. Since 2001, the Company has imported substantially all of its inventory, excluding t-shirts, as finished goods from contractors in Asia. This shift in purchasing requires the Company to estimate sales and issue purchase orders for inventory well in advance of receiving firm orders from its customers. A risk to the Company is that its sales estimates may differ from actual orders. If this happens, the Company may miss sales because it did not order enough inventory, or it may have to sell excess inventory at reduced prices. The Company faces other risks inherent in the apparel industry. These risks include changes in fashion trends and related consumer acceptance and the continuing consolidation in the retail segment of the apparel industry. The Company's ability, or inability, to manage these risk factors could influence future financial and operating results.
Use of Estimates
The preparation of financial statements in accordance with generally accepted accounting principles requires management to make certain estimates and assumptions, particularly regarding valuation of accounts receivable and inventory, recognition of liabilities and disclosure of contingent assets and liabilities at the date of the financial statements. Actual results could differ from those estimates.
Concentration of Credit Risk
Financial instruments which potentially expose the Company to concentrations of credit risk consist primarily of trade accounts receivable. The Company's customer base is not concentrated in any specific geographic region, but is concentrated in the retail industry. For the years ended December 31, 2003, 2002 and 2001, sales to one customer were $5,155,655, $5,302,278 and $4,361,417. These amounts constitute 7.8%, 8.1% and 5.3% of total sales, respectively. The Company establishes an allowance for doubtful accounts based upon factors surrounding the credit risk of specific customers, historical trends and other information. The Company's actual credit losses as a percentage of net sales were 0.3%, 0.8% and 1.2% for the years ended December 31, 2003, 2002 and 2001, respectively.
The Company is also subject to concentrations of credit risk with respect to its cash and cash equivalents, which it minimizes by placing these funds with high-quality institutions. The Company is exposed to credit losses in the event of nonperformance by the counterparties to letter of credit agreements, but it does not expect any financial institutions to fail to meet their obligation given their high credit rating.
Inventories
Inventories are stated at the lower of cost or market. Cost is determined by the first-in, first-out (FIFO) method.
Property, Plant and Equipment
Property, plant and equipment are stated at cost. Depreciation is computed over the estimated useful lives of the assets by both straight-line and accelerated methods. Leasehold improvements are amortized using the straight-line method over the life of the lease.
Trademark and Licenses
Included in trademark and licenses is the cost of certain licenses which allow the Company to produce and market certain branded apparel. The Company capitalized the cost of obtaining the trademark and licenses, with the cost being amortized on a straight-line basis over the initial term of the trademark or license. The Company accrues royalty expense related to the licenses at the greater of the specified percentage of sales or the minimum guaranteed royalty set forth in the license agreements.
Asset Impairment
The Company periodically evaluates the carrying value of long-lived assets when events and circumstances warrant such a review. The carrying value of a long-lived asset is considered impaired when the anticipated undiscounted cash flow from such asset is separately identifiable and is less than the carrying value. In that event, a loss is recognized based on the amount by which the carrying value exceeds the fair market value of the long-lived asset. Fair market value is determined primarily using the anticipated cash flows discounted at a rate commensurate with the risk involved.
Stock Options
The Company has adopted the disclosure-only provisions of Statement of Financial Accounting Standards No. 123, "Accounting for Stock Based Compensation" ("SFAS 123"), but applies, and plans to continue applying, the intrinsic value method set forth in Accounting Principles Board Opinion No. 25 for stock options granted to employees. The Company expenses the fair value of stock options granted to nonemployees. If the Company had elected to recognize compensation expense based on the fair value at the grant dates, consistent with the method prescribed by SFAS No. 123, net loss per share would have been changed to the pro forma amount indicated below.
For stock options granted to employees, the Company has estimated the fair value of each option granted using the Black-Scholes option pricing model with
the following assumptions: risk-free interest rate of 4.03, 3.96% and 5.93%, expected volatility of 75%, 75% and 75%, expected option life of 5, 9 and 4.5 years and no dividend payment expected for 2003, 2002 and 2001, respectively. Using these assumptions, the fair value of the stock options granted is $0..53, $0.47 and $0.39 for 2003, 2002 and 2001, respectively. There were no adjustments made in calculating the fair value to account for vesting provisions or for non-transferability or risk of forfeiture. The weighted average remaining life for options outstanding at December 31, 2003 is 6 years.
Revenue Recognition
Sales are recognized upon shipment of products. Allowances for estimated returns are provided when sales are recorded. In accordance with EITF 00-10, shipping and handling fees billed to customers are classified in net sales in the consolidated statements of operations. Shipping and handling costs incurred are classified in distribution and shipping in the consolidated statements of operations.
Advertising Costs
Advertising costs, included in selling expenses, are expensed as incurred and were $559,966, $1,975,405 and $1,767,647 for the years ended December 31, 2003, 2002 and 2001 respectively.
Cash Equivalents
For purposes of the statements of cash flows, all temporary investments purchased with a maturity of three months or less are considered to be cash equivalents.
Income Taxes
The Company accounts for income taxes in accordance with Statement of Financial Accounting Standards No. 109, "Accounting for Income Taxes" ("SFAS 109"). Under SFAS 109, deferred taxes are determined using the liability method which requires the recognition of deferred tax assets and liabilities based on differences between the financial statement and the income tax basis using presently enacted tax rates.
Fair Value of Financial Instruments
Financial instruments of the company include cash and cash equivalents, accounts receivable, short-term investments and long and short-term debt. Fair
values of cash and cash equivalents, accounts receivable, short-term investments and short-term debt approximate cost due to the short period of time to maturity. Based upon the current borrowing rates available to the Company, estimated fair values of long-term debt approximate their recorded amounts.
Loss Per Share
Loss per share is based on the weighted average number of shares of common stock and dilutive common stock equivalents outstanding. Basic loss per share includes no dilution and is computed by dividing income available to common shareholders by the weighted average number of common shares outstanding for the period. Diluted loss per share reflects the potential dilution of securities that could share in the earnings of an entity. Basic and diluted earnings per share are the same during 2003, 2002 and 2001 because the impact of dilutive securities is anti-dilutive. There were outstanding employee stock options of 2,070,250, 1,306,250 and 1,086,250 and outstanding warrants of 500,000, 500,000 and 0 at December 31, 2003, 2002 and 2001, respectively. These stock options and warrants were excluded from the computation of loss per share as their inclusion would have been anti-dilutive.
Comprehensive Income
The Company has adopted the provisions of Statement No. 130, "Reporting Comprehensive Income". The Company has no items of comprehensive income to report.
Recent Accounting Pronouncements
In December 2003, the FASB issued a revision to SFAS No. 132, Employers' Disclosures about Pensions and Other Postretirement Benefits". This statement does not change the measurement or recognition aspects for pensions and other postretirement benefit plans; however, it does revise employee disclosures to include more information about the plan assets, obligations to pay benefits and funding obligations. SFAS 132, as revised, is generally effective for financial statements with fiscal years ending after December 15, 2003. Certain additional disclosure applicable to foreign defined benefit plans are effective for fiscal years ending after June 15th, 2004. The Company has adopted the required provisions of SFAS No. 132, as revised.
In May 2003, the FASB issued SFAS No.150, "Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity," SFAS No. 150 clarifies the definition of a liability as currently defined in FASB Concepts Statement No. 6, "Elements of Financial Statements, " as well as other planned revisions. This statement requires a financial instrument that embodies an obligation of an issuer to be classified as a liability, In addition, the statement establishes standards for the initial and subsequent measurement of these financial instruments and disclosure requirements. SFAS 150 is effective for financial instruments entered into or modified after May 31, 2003 and for all other matters, is effective at the first interim period beginning after June 15, 2003. The adoption of SFASD 150 did not have a material effect on the Company's financial position or results of operations.
In April 2003, the FASB issued SFAS No.149," Amendment of Statement 133 on Derivative Instruments and Hedging Activities," SFAS No. 149 amends SFAS No. 133 for decisions made by the FASB's Derivatives Implementation Group, other FASB projects dealing with financial instruments, and in response to implementation issues raised in relation to the application of the definition of a derivative. This statement is generally effective for contracts entered into or modified after June 30, 2003 and for hedging relationships designed after June 30, 2003. The adoption of SFAS 149 did not have material effect on the Company's financial position or results of operations.
In January 2003, the FASB issued Interpretation ("FIN") No. 46, "Consolidation of Variable Interest Entities" and in December 2003, a revised interpretation was issued (FIN No.46, as revised). In general, a variable interest entity ("VIE") is a corporation, partnership, trust, or any other legal structure used for business purposes that either does not have equity investors
with voting rights or has equity investors that do not provide sufficient financial resources for the entity to support its activities. FIN 46, As revised, requires a VIE to be consolidated by a company if that company is designated as the primary beneficiary. The interpretation applies to VIEs created after January 31, 2003, and for all financial statements issued after December 15, 2003 for VIEs in which an enterprise held a variable interest that it acquired before February 1, 2003. The adoption of Fin 46, as revised, did not have a material effect on the Company's financial position or results of operations,
In December 2002, the FASB issued SFAS No.148, "Accounting for Stock-Based Compensation--Transition and Disclosure.' This statement amends SFAS No. 123,"Accounting for Stock-Based Compensation," to provide alternative methods of transition for a voluntary change to the fair value based method of accounting for stock-based employee compensations. In addition, SFAS 148 amends the disclosure requirements of SFAS 123 to require prominent disclosures in both annual and interim financial statements about the method of accounting for stock-based employee compensation and the effect of the method used on reported results. The Company adopted the disclosure provisions of this standard.
In November 2002, the FASB issued Interpretation No. 45, Guarantor's Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others"' ("FIN 45"). FIN 45 addresses the disclosures to be made by a guarantor in its interim and annual financial statements about its obligations under guarantees, The disclosure requirements in this Interpretation are effective for financial statements of interim or annual periods ending after December 15, 2002. The adoption of FIN 45 did not have a material effect on the Company's financial position or results of operations.
I.C. Isaacs & Company, Inc. Notes to Consolidated Financial Statements
1. Inventories
2. Property, Plant and Equipment
Depreciation expense for 2003, 2002 and 2001 totaled $501,953, $804,000 and $686,670 respectively.
3. Long-term Debt
(a) The Company has an asset-based revolving line of credit (the "Credit Agreement") with Congress Financial Corporation ("Congress"). In December 2002 and again in March and November 2003, the Credit Agreement was amended to extend the term through December 31, 2004, to modify the minimum levels of working capital and tangible net worth the Company is required to
maintain and to modify the rate of interest on borrowings under the Credit Agreement. The amended Credit Agreement provides that the Company may borrow up to 80.0% of net eligible accounts receivable and a portion of inventory, as defined in the Credit Agreement. Borrowings under the Credit Agreement may not exceed $20.0 million including outstanding letters of credit which are limited to $6.0 million from May 1 to September 30 of each year and $4.0 million for the remainder of each year, and bear interest at the lender's prime rate of interest plus 2.25% (effectively 6.30% at December 31, 2003). Outstanding letters of credit approximated $1.4 million at December 31, 2003. In connection with amending the Credit Agreement in December 2002, the Company had agreed to pay Congress a financing fee of $250,000, one half of which was paid at the time of closing and the other half was paid by the Company in February 2003. This financing fee is being amortized over 24 months beginning January 2003. In connection with amending the Credit Agreement in March 2003, the Company paid Congress a financing fee of $75,000. This financing fee was amortized over the remaining months of 2003. In connection with amending the Credit Agreement in November 2003, the Company paid Congress a financing fee of $50,000, which was expensed at the time it was paid. The Company is currently in compliance with the working capital and tangible net worth covenants, however, there can be no assurances that the Company will not be in violation of these covenants during 2004 or thereafter. Average short-term borrowings and the related interest rates are as follows:
------------------------------------ Year Ended December 31, ------------------------------------ 2003 2002 ---------------- ----------------
Borrowings under revolving line of credit $ 4,224,285 $ 5,030,453 Weighted average interest rate 6.30% 5.60% Maximum month-end balance during year $ 7,836,492 $ 5,451,316 Average month-end balance during year $ 5,956,376 $ 2,464,754
(b) On May 6, 2002, Textile Investment International S.A. ("Textile"), an affiliate of the licensor to the Company of the Girbaud brand, acquired a note payable issued by the Company from a former licensor. On May 21, 2002, Textile exchanged this note for an amended and restated note (the "Replacement Note"), which deferred the original note's principal payments and extended the maturity date until 2007. The Replacement Note is subordinated to the rights of Congress under the Agreement. Due to certain availability requirements of the Credit Agreement not being met, the December 2002 and the March, June, September and December 2003 Replacement Note payments were not required to be made. Under the Replacement Note, the fact that these payments were not paid does not put the Replacement Note in default. The Replacement Note has been classified as current or long-term based upon the scheduled quarterly payments as detailed per the Replacement Note agreement. In addition, the scheduled quarterly payments not made above have been classified as current.
At December 31, 2003, long-term debt maturities are as follows:
2004 $ 2,013,977 2005 1,352,203 2006 1,465,263 2007 1,726,465 ---------------- $ 6,557,908 ================
4. Accrued Expenses
5. Income Taxes
Deferred income taxes reflect the net effects of temporary differences between the carrying amounts of assets and liabilities for financial and income tax reporting purposes. The Company has net operating loss carry forwards for income tax reporting purposes of approximately $45,163,000 for which no income tax benefit has been recorded due to the uncertainty over the generation of taxable income in 2004 and thereafter. These net operating loss carryforwards begin to expire in 2013.
6. Stockholders' Equity
In June 1998, the Company's Board of Directors authorized a stock repurchase program. The Company currently holds 1,176,709 of common stock shares in its treasury at a cost of $2,322,871.
On May 6, 2002, Textile acquired from a former licensor of the Company 3.3 million shares of the Company's Series A Convertible Preferred Stock (the "Preferred Stock"), 666,667 shares of the Company's Common Stock and a subordinated secured promissory note issued by the Company to this former licensor in March 2001 in the original principal amount of $7.2 million (the "Note"). The Preferred Stock held by the former licensor was to become convertible into either 3.3 million shares of Common Stock of the Company or a $3.3 million promissory note of the Company in 2003. Pursuant to the terms of the Framework Agreement entered into on May 14, 2002 (the "Framework Agreement"), between the Company, Textile and Textile affiliates Latitude Licensing Corp. ("Latitude") and Wurzburg Holding S.A. ("Wurzburg"), the Company amended the terms of the Preferred Stock so that the Preferred Stock was immediately convertible, but only into Common Stock of the Company. In November 2002, Textile converted all of the Preferred Stock into 3.3 million shares of Common Stock of the Company.
The Company has also (i) granted Textile warrants to purchase 500,000 shares of the Company's Common Stock for $0.75 per share, (ii) entered into a Stockholders' Agreement with Textile establishing certain terms and conditions regarding the acquisition and disposition of the Company's securities as well as certain corporate governance matters, and (iii) amended the Girbaud licensing agreement for men's and women's apparel to add an additional option for the Company to extend the term by four additional years through 2011. The Company determined the aggregate value of these warrants on the date of grant to be approximately $596,000, based on the Black-Scholes valuation model, with the following weighted average assumptions: dividend yield of 0%, expected volatility of 75%, risk free interest rate of 3.59% and expected term of 9 years. This amount had been recorded as a preferred stock deemed dividend in the statements of operations and stockholders' equity.
7. Stock Options
In May 1997, the Company adopted the 1997 Omnibus Stock Plan (the "Plan"). Under the 1997 Omnibus Stock Plan, as amended in 1999, 2002 and 2003, the Company may grant qualified and nonqualified stock options, stock appreciation rights, restricted stock or performance awards, payable in cash or shares of common stock, to selected employees. The Company has reserved 2,200,000 shares of common stock for issuance under the 1997 Omnibus Stock Plan. Options vest at the end of the second year and expire 10 years from the date of grant and upon termination of employment.
The following table relates to options activity in 2001, 2002 and 2003 under the Plan:
A summary of stock options outstanding and exercisable as of December 31, 2003 is as follows:
8. Discontinued Operations
On December 20, 2001, the Board of Directors voted to sell all of the outstanding common stock of Isaacs Europe. Subsequently, the Company sold 100% of the outstanding common stock of Isaacs Europe to a management group of Isaacs Europe in exchange for repayment of $100,000 of intercompany debt and the assumption of liabilities.
The Company had concluded, from the inception of Isaacs Europe, that it did not meet the criteria for segment reporting under either Statement of Financial Accounting Standards No. 14 "Financial Reporting for Segments of a Business Enterprise" or Statement of Financial Accounting Standards No. 131 "Disclosures about Segments of an Enterprise and Related Information". However, in June 2001, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 144 "Accounting for the Impairment or Disposal of Long-Lived Assets" ("SFAS 144") which changed the criteria for reporting disposals as discontinued operations in the financial statements. The Company has reviewed the provisions of SFAS 144 and has determined that the sale of Isaacs Europe meets the two conditions necessary for presentation as discontinued operations. Those conditions are (a) the operations and cash flow of the component have been or will be eliminated from the ongoing operations of the entity as a result of the disposal transaction and (b) the entity will not have any significant continuing involvement in the operations of the component after the disposal transaction.
The sale of Isaacs Europe was effective on December 31, 2001. The Company recorded a loss from operations of Isaacs Europe of $1,309,610 for the year ended December 31, 2001. The Company recorded a loss on the sale of Isaacs Europe of $1,182,281. The loss on the sale of Isaacs Europe was not offset by the consideration of $100,000 as the ultimate collection of the amount was uncertain at the time of the transaction. Isaacs Europe subsequently ceased operations and the Company will not collect the consideration from the sale. Revenues from Isaacs Europe were insignificant since its inception.
9. Commitments and Contingencies
Operating Leases
The Company rents real and personal property under leases expiring at various dates through 2008. Certain of the leases stipulate payment of real estate taxes and other occupancy expenses. Minimum annual rental commitments under noncancellable operating leases in effect at December 31, 2003 are summarized as follows:
Licenses
Girbaud Men's Licensing Agreement
The Company has entered into an exclusive license agreement with Latitude to manufacture and market men's jeanswear, casual wear, outerwear and active influenced sportswear under the Girbaud brand and certain related trademarks in the United States, Puerto Rico, the U.S. Virgin Islands and Canada. In June 2002, the Company notified Latitude of its intention to extend the agreement through 2007. Under the agreement as amended, the Company is required to make royalty payments to the licensor in an amount equal to 6.25% of net sales or regular licensed merchandise and 3.0% of certain irregular and closeout licensed merchandise. The Company is obligated to pay the greater of actual royalties earned or minimum guaranteed annual royalties of $3,000,000 through 2007. In February 2003, Latitude and the Company agreed to defer the December 2002 and January 2003 royalty payments of $250,000 each to October and November 2003, respectively. In November of 2003, Latitude and the Company agreed that the $250,000 royalty payment that had been deferred from December 2002 to October 2003 would be further deferred to May 2004, and the $250,000 royalty payment that had been deferred from January 2003 to November 2003 would be further deferred to June 2004. The Company is required to spend the greater of an amount equal to 3% of Girbaud men's net sales or $500,000 in advertising and related expenses promoting the men's Girbaud brand products in each year through the term of the Girbaud men's agreement.
Girbaud Women's Licensing Agreement
The Company has entered into an exclusive license agreement with Latitude to manufacture and market women's jeanswear, casual wear, and active influenced sportswear under the Girbaud brand and certain related trademarks in the United States, Puerto Rico, and the U.S. Virgin Islands. In June 2002, the Company notified Latitude of its intention to extend the agreement through 2007. Under
the agreement as amended, the Company is required to make royalty payments to the licensor in an amount equal to 6.25% of net sales or regular licensed merchandise and 3.0% of certain irregular and closeout licensed merchandise. The Company is obligated to pay the greater of actual royalties earned or minimum guaranteed annual royalties of $1,500,000 through 2007. In February 2003, Latitude and the Company agreed to defer the December 2002 royalty payment of $125,000 to October 2003 and to reduce the 2003 minimum guaranteed royalty payments by $450,000 to $1,050,000. The Company will make no minimum royalty payments under this agreement from February to May 2003. In November of 2003, Latitude and the Company agreed that the $125,000 royalty payment that had been deferred from January 2003 to October 2003 would be further deferred to May 2004, and that one half of the $250,000 payment due in the month of November 2003 with respect to the minimum royalties to be paid in 2003 would be paid in that month and the $125,000 balance thereof shall be deferred to June 2004. The Company is required to spend the greater of an amount equal to 3% of Girbaud women's net sales or $400,000 in advertising and related expenses promoting the women's Girbaud brand products in each year through the term of the Girbaud women's agreement. In addition, while the agreement is in effect the Company is required to pay $190,000 per year to the licensor for advertising and promotional expenditures related to the Girbaud brand.
The Company has the following contractual obligations as of December 31, 2003:
Employment Agreements
Robert J. Arnot, former Chairman of the Board, Chief Executive Officer and President of the Company and Daniel Gladstone, President of the Girbaud Division of the Company, each entered into a consulting agreement with Latitude beginning May 17, 2002 and terminating on December 31, 2005 or when the consultant is no longer employed by the Company, whichever occurs first. Under the terms of the consulting agreements, each will serve on an advisory committee to assist in developing global strategy and a plan for the Marithe and Francois Girbaud brand and will attend regular meetings of the committee. If the committee is not established or is disbanded, each will be required to meet in Europe with representatives of Latitude from time to time. As compensation, each is to receive an annual consulting fee of $100,000, except for the year 2002, for which the consulting fee was to be $66,000. During 2002, Latitude paid Messrs. Arnot and Gladstone $44,000 each and the consulting agreements were terminated. While not paid by the Company, the Company concluded that consulting services performed by these two senior executives will ultimately benefit its operations and accordingly recorded the amounts received by these officers as consulting expense and contributed capital.
The Company is party to employment agreements with several officers which provide for specified levels of compensation and certain other benefits. The agreements also provide for severance payments from the termination date through the expiration date under certain circumstances.
In December 2002, Robert J Arnot and the Board of Directors agreed that he would not continue to serve as Chief Executive Officer and President. On February 3, 2003, Mr. Arnot resigned as a director, Chief Executive Officer and
President of the Company effective as of February 6, 2003. In connection with his resignation, Mr. Arnot agreed to terminate his employment agreement and enter into a separation agreement. The separation agreement provided that Mr. Arnot serve as a paid consultant to the Company between February 6, 2003 and May 2, 2003 and thereafter had received severance payments until December 15, 2003. The Company recognized severance expense of $400,000 in December 2002.
The Company engaged the services of Peter J Rizzo as its Chief Executive Officer in December 2003.
10. Retirement Plan
The Company sponsors a defined benefit pension plan that covers substantially all employees with more than one year of service. The Company's policy is to fund pension costs accrued. Contributions to the plan reflect benefits attributed to employees' service to date, as well as service expected to be earned in the future. The benefits are based on the number of years of service and the employee's compensation during the three consecutive complete years of service prior to or including the year of termination of employment. Plan assets consist primarily of common stocks, fixed income securities and cash. The latest available actuarial valuation is as of December 31, 2003. Pension expense for 2003, 2002 and 2001 was approximately $349,000, $244,000 and $190,000 respectively, and includes the following components:
With respect to the above table, the weighted average discount rate used to measure the projected benefit obligation and net prepaid periodic pension cost was 7.5% for 2003, 2002 and 2001; the rate of increase in future compensation levels is 3%; and the expected long-term rate of return on assets is 8%. The net prepaid periodic pension cost is included in other assets in the accompanying consolidated balance sheets.
11. Supplemental Disclosures of Cash Flow Information
Cash paid during the year for interest amounted to $499,166, $463,457 and $1,309,956 for 2003, 2002 and 2001, respectively.
1. Earnings (loss) per share calculations for each of the quarters are based on the weighted average shares outstanding for each period. The sum of the quarters may not necessarily be equal to the full year earnings per share amounts.
2. During the fourth quarter of 2002, the Company wrote down its inventory by approximately $1.8 million, which had the effect of increasing the net loss per share by $0.20.
Report of Independent Certified Public Accountants on Financial Statement Schedules
I.C. Isaacs & Company, Inc.
The audits referred to in our report to I.C. Isaacs & Company, Inc. dated March 15, 2004, which is contained in Item 8 of this Form 10-K, include the audit of the financial statement schedule listed in the accompanying index for each of the three years in the period ended December 31, 2003. This financial statement schedule is the responsibility of the Company's management. Our responsibility is to express an opinion on the financial statement schedule based on our audits.
In our opinion, such schedule presents fairly, in all material respects, the information set forth therein.
BDO SEIDMAN, LLP
Bethesda, Maryland March 15, 2004
SCHEDULE II I. C. Isaacs & Company, Inc. Valuation and Qualifying Accounts
(1) This amount includes a $90,000 reduction in the allowance for doubtful accounts due to the sale of the common stock of Isaacs Europe in the fourth quarter of 2001.