ITEM 1. BUSINESS
GENERAL
French Fragrances, Inc. (the "Company") is a manufacturer, distributor and marketer of prestige fragrances and related cosmetic products predominantly in the United States and principally to mass-market retailers. The Company has established itself as a distribution source for more than 160 fragrance brands through brand ownership and exclusive distribution arrangements, as well as through nonexclusive direct purchase relationships and other sources. The brands distributed by the Company include approximately 40 for which it has exclusive marketing and distribution rights, including the Geoffrey Beene brands of Grey Flannel, Eau de Grey Flannel and Bowling Green, the Halston brands of Halston, Catalyst, Z-14 and 1-12, and the brands Colors of Benetton, Hot and Cold, Ombre Rose, Lapidus, Faconnable, Salvador Dali, Dalissime, Laguna, Cafe and Watt (collectively, the "Controlled Brands") and over 120 other brands that are distributed by the Company on a non-exclusive basis (the "Distributed Brands"). The Company distributes its products to more than 31,000 separate retail locations in the United States, including department stores such as J.C. Penney, Sears, Macy's, Dayton Hudson and Nordstrom's, mass merchants such as Wal-Mart, Target, T.J. Maxx and K-Mart, drug stores such as CVS, Eckerd Drugs, Walgreens, Rite Aid and American Stores and independent fragrance, cosmetic and other stores such as Cosmetic Center, Ulta 3, Sharper Image and Syms. In fiscal 1998, sales to mass merchants, drug stores, independent fragrance, cosmetic and other stores (collectively, "mass-market retailers") constituted approximately 86% of net sales, sales to department stores constituted approximately 9% of net sales and the balance of the Company's sales was comprised of international sales.
Over the past five years, the Company (including FFI prior to the Merger (as defined below)) has emerged as a leading prestige fragrance marketer by (i) providing mass-market retailers a wide selection and reliable source of prestige products, (ii) increasing and diversifying the Company's market penetration by growing its distribution base to more than 31,000 separate retail locations, (iii) consummating several acquisitions of Controlled Brands, (iv) enhancing the overall performance of its Controlled Brands through the Company's marketing and distribution expertise, and (v) expanding the selection and distribution of the Distributed Brands through new manufacturer relationships and other
sources. As a result, the Company's net sales have grown to approximately $215.5 million for fiscal 1998 from approximately $33.9 million for fiscal 1993. Over the same period, the Company's EBITDA (as defined in Item 6 "Selected Financial Data") increased to $36.2 million from approximately $2.0 million.
The Company was known as Suave Shoe Corporation until the November 30, 1995 merger of a privately-held Florida corporation named French Fragrances, Inc. ("FFI") with and into the Company (the "Merger"). See Note 2 to the Notes to Consolidated Financial Statements. The Company was incorporated in Florida in 1960 and, until January 1995, manufactured and imported casual, athletic and leisure footwear. The footwear operations were discontinued in January 1995 by prior management of the Company following declining sales of shoe products, primarily as a result of increased competition from foreign shoe manufacturers.
FFI was organized in 1992 and had been a distributor of prestige fragrances and related cosmetic products since its inception. FFI experienced rapid growth as a distributor of prestige fragrances to the United States mass market and was searching for a large facility to accommodate its growing operations. Through the Merger with the Company, management of FFI was able to acquire the Company's Miami Lakes facility (the "Miami Lakes Facility") and have FFI become a publicly-held company. Following the Merger, the Company, as the surviving corporation in the Merger, changed its name to "French Fragrances, Inc." In addition, following the Merger, FFI's management became the management of the Company and the Company's business operations have consisted entirely of the business previously conducted by FFI, which is the manufacture, distribution and marketing of prestige fragrances and related cosmetic products.
RECENT DEVELOPMENTS
ACQUISITION OF THE ASSETS OF J.P. FRAGRANCES, INC. In March 1998, the Company acquired (the "JPF Acquisition") certain assets of J.P. Fragrances, Inc.("JPF"), including inventory, returns, contract rights, accounts receivable, books and records, fixed assets (including furniture and warehouse materials and equipment), claims, intangible rights (including non-compete agreements) and goodwill (collectively, the "Acquired Assets"). The Company also assumed certain trade and other payables of JPF, but did not assume any of JPF's facility leases. Prior to the JPF Acquisition, JPF was a distributor of prestige fragrances in the United States. During its fiscal year ended December 31, 1997, JPF had net sales of $89.5 million, a significant portion of which consisted of sales of prestige fragrances to retailers. The JPF Acquisition is expected to increase the selection and market share of prestige fragrance products the Company offers to its retail customers. The purchase price, which will be adjusted based on JPF's balance sheet on the closing date of the JPF Acquisition and the invoice support relating to a certain account receivable, was financed from available cash from operations, the Company's revolving credit facility with Fleet National Bank ("Fleet") and a subordinated debenture in the principal amount of $3 million (the "JPF Debenture"). The JPF Debenture is non-interest bearing, with the principal amount being payable in three equal annual installments and if certain conditions relating to the fragrance business of JPF (the "JPF Business") are achieved by the Company, including achieving certain gross profit thresholds from the JPF Business. See Item 7 "Management's Discussion and Analysis of Financial Condition and Results of Operations - Liquidity and Capital Resources."
BUSINESS STRATEGY
The Company's objective is to maintain and enhance its position as a leading marketer of prestige fragrances and related cosmetic products, principally to mass-market retailers. The Company's strategy to achieve this objective includes the following:
ACQUIRE CONTROL OF ADDITIONAL PRESTIGE BRANDS. The Company continues to focus on acquiring ownership of, or exclusive distribution rights to, classic prestige fragrance brands that enjoy established consumer loyalty. These exclusive control positions allow the Company to actively manage the brand so as to enhance the brand's prestige value in the market and at the same time implement strategies intended to increase the brand's overall long-term profit contribution. In fiscal 1996, the Company acquired from Sanofi Beaute, Inc. ("Sanofi"), a long-term license to manufacture and distribute worldwide the Geoffrey Beene fragrance brands, including Grey Flannel and Bowling Green, and obtained the exclusive United States distribution rights for the Galenic Elancyl skin care products and the Benetton fragrance and cosmetic brands, including Colors of Benetton, Hot and Cold and Tribu. In fiscal 1997, the Company completed the purchase of the Halston fragrance brands, including Halston, Catalyst, Z-14 and 1-12 and acquired the principal assets of Fragrance Marketing Group, Inc. ("FMG"), including exclusive United States distribution rights to Ombre Rose, Faconnable, Balenciaga, Lapidus and several other brands. In May 1997, the Company acquired the remaining 50.01% of the common stock of Fine Fragrances, Inc. ("Fine Fragrances"), that it did not already own (the "Fine Fragrances Acquisition"). Fine Fragrances had been the exclusive distributor in North America of fragrances manufactured by COFCI, S.A. ("COFCI"), including Salvador Dali, Salvador, Laguna, Dalissime, Dalimix, Cafe, Taxi and Watt. After the Fine Fragrances Acquisition, the Company became the distributor of these brands under new ten-year exclusive distribution agreements with COFCI. Management believes that the Company's strong market position and reputation in the prestige fragrance industry have assisted the Company in acquiring ownership or control of prestige fragrance brands, particularly when, as with the Geoffrey Beene and Halston brands, the Company has already served as a direct distributor of the brand. Although the Company is currently exploring additional acquisition opportunities for prestige fragrance brands, the Company has no current agreements or commitments for any additional acquisitions of Controlled Brands, and there is, accordingly, no assurance that the Company will be able to complete any future acquisitions.
FURTHER EXPAND DIRECT DISTRIBUTION. The Company intends to continue to expand its distribution business and increase its sales to mass-market retailers by: (i) increasing the number of prestige brands it distributes; (ii) increasing the number of manufacturers for which it serves as a direct distributor; (iii) expanding its customer base to include additional mass-market retailers not presently served by the Company; and (iv) developing and implementing innovative marketing and merchandizing programs targeted to improve the sell-through of its customers, especially within the mass market. Management believes that the Company's ability to further expand its distribution business is enhanced by the competitive position it has already achieved. In particular, the Company's broad selection of prestige fragrances, its market presence as an established distributor to a large number of mass-market stores and its value-added service capabilities, combined with management's long-standing relationships with a
number of leading manufacturers and retailers, are considered by management to be important to the Company's continued success and growth. The Company also believes that, as a direct distributor of many classic prestige fragrances, it has the ability to offer mass-market retailers a more predictable and reliable source of supply of products than can be offered by other secondary sources for such fragrances with which the Company competes. The JPF Acquisition is expected to increase the number of manufacturers for which the Company serves as a direct distributor and the selection of Distributed Brands available on a continuous basis for its retail customers. The Company does not intend to open retail stores or otherwise engage in retail sales.
IMPROVE BRAND PERFORMANCE THROUGH FOCUSED MARKETING. The Company seeks to utilize its marketing expertise and its extensive distribution network to successfully position, or reposition, its brands in the market place to enhance their value. Such strategies typically include managing sales volumes, channels of distribution, pricing, advertising and promotions, packaging and gift set design, international marketing and other factors in a manner intended to best position the brand in each of its different distribution channels. The Company also implemented a policy of product differentiation among distribution channels to enhance the brand's prestige image.
STRENGTHEN AND EXPAND RELATIONSHIPS WITH RETAILERS THROUGH PROVIDING VALUE ADDED SERVICES. The Company continues to increase the number of retail locations to which it distributes its products and currently serves more than 31,000 separate retail locations. The Company attributes its growing distribution network to its ability to provide retailers with a consistent supply of product as well as its ability to provide retailers, especially mass-market retailers, with a level of service typically not provided by its competitors. For example, in many cases, the Company's sales and marketing professionals work closely with major retailers to act as category managers by, among other things, (i) developing merchandising programs that are designed to improve sales and profitability and that are specific to the customers' business and marketing strategies, (ii) creating regularly planned promotional campaigns and in-store displays designed to increase sales, and (iii) designing model stock assortments and planograms for the effective layout of customers' fragrance and cosmetics departments. The Company believes that the provision of such services both creates a partnership between the Company and the retailer and increases the absolute amount of the Company's products sold through such retailers.
DEVELOP LOW-RISK BRAND LINE EXTENSIONS. The Company's strategy is to opportunistically capitalize on existing brand awareness by introducing product line extensions, rather than launching new fragrance brands. Since the costs of developing a product line extension generally are not material to the Company, the Company's brand extension strategy can provide a significant increase in profitability to the Company with limited capital risk. For example, in response to requests from retailers, the Company introduced into a limited market Eau de Grey Flannel, as an extension to the Geoffrey Beene brand Grey Flannel, which is positioned as a lighter fragrance targeted to a more contemporary market. Based on the success of Eau de Grey Flannel, the Company is planning to introduce in the summer of 1998 more contemporary version extensions to the Halston brands Halston Ladies and Z-14. In addition, the Company is also planning the introduction of a women's fragrance for the Geoffrey Beene line for the fall of 1998. There can be no assurance as to the timing, occurrence or ultimate success of any new product introductions.
EXPLOIT OPERATING LEVERAGE TO FURTHER ENHANCE PROFITABILITY. The Company recently completed an upgrade of the Miami Lakes Facility intended to increase significantly its distribution capacity and enhance operational efficiency. As a result of this upgrade, the Company believes it will be able to increase the volume of product distributed without a commensurate increase in operating costs. Since its sales are characterized by a relatively large number of orders (approximately 130,400 in fiscal 1998) with a relatively low average order size (approximately $1,690 in fiscal 1998), the Company believes that by increasing the average order size through the introduction of additional brands or increasing the volume of existing brands sold to existing customers, it can further enhance its operating margins. The Company also recently completed the installation of a new management information system which, among other things, is expected to improve forecasting, purchasing and order tracking capabilities, as well as providing Year 2000 compliance.
INDUSTRY OVERVIEW
According to the United States Department of Commerce, fragrance and related product sales in the United States were approximately $6 billion in 1996. The United States market for fragrances and related products continues to grow moderately. The growth is generally attributed to new product introductions appealing to a broader segment of the market, population growth, increasing numbers of mature consumers and product innovation such as special sizes and new product formulations.
Fragrance products in the United States are generally distributed through two channels of distribution: (i) the prestige market, which includes department stores; and (ii) the mass market, which includes mass-market retailers, food and drug stores, independent fragrance, cosmetic and other stores and direct selling firms including house-to-house and home television shopping companies. Management of the Company believes that the market has experienced a significant shift in the purchasing habits of consumers away from higher priced department stores to mass-market retailers. Management also believes that this trend is indicative of an increasing desire among U.S. consumers to acquire prestige fragrance products at the best value. Nevertheless, management believes that successful launching and continued marketing support of a brand in the prestige distribution channel is essential to establish and maintain the brand's prestige status and marketability in the mass market.
Management believes there are a number of significant trends currently impacting the mass-market segment that it expects should contribute to its continued growth, including: (i) increasing acceptance of self-service shopping; (ii) increasing desire by retailers to purchase more efficiently and to buy more products from fewer vendors; (iii) sustained, and in some instances, increasing demand for classic prestige fragrances; and (iv) more upscale images communicated by mass merchandisers in their advertising.
Manufacturers of prestige fragrances have historically restricted their direct sales in the United States primarily to prestige department stores and specialty stores. As a result, mass-market retailers have traditionally obtained prestige products from secondary sources. Historically, the secondary sources available to the mass market have been limited to (i) direct distributors such as the Company, which principally receives products directly from perfume manufacturers, and (ii)
distributors of prestige products manufactured by, or distributed to, foreign sources for foreign distribution which are diverted to the United States market ("Diverted Sources"). Under existing court decisions, there are variations in the extent to which trademark and copyright laws or customs regulations may restrict the importation of trademarked or copyrighted fragrance products through Diverted Sources without the consent of the trademark or copyright owner. From time to time, the Company may take advantage of favorable buying opportunities and purchase limited amounts of fragrance products from sources which may purchase from Diverted Sources. There can be no assurance that these sources of product will be available in the future or that the Company may not become the subject of legal action arising from its buying activities with respect to these products. To date, the Company has not been the subject of any such legal action.
PRODUCTS
The Company sells prestige fragrances and related cosmetics products, including perfume, cologne, eau de toilette, body spray, men's cologne and after-shave, and gift sets. Each fragrance is distributed in a variety of sizes and packaging arrangements. In addition, each fragrance line may be complemented by body products, such as soaps, deodorants, body lotions, cremes and dusting powders. The Company's products generally retail at prices ranging from $20 to $100 per item.
The Company currently stocks approximately 60 Halston and Geoffrey Beene brand name items which it manufactures and approximately 240 brand name items of other Controlled Brands which it purchases from fragrance manufacturers. The Company currently stocks, in addition to its Controlled Brand products, more than 800 different brand name items purchased from various fragrance manufacturers and other sources. The Company seeks to continue to expand its base of direct purchase relationships with fragrance manufacturers.
The Company uses third party contract manufacturers in the United States and Europe to obtain substantially all of the raw materials, components and packaging products and for the manufacture of finished products relating to the Halston and Geoffrey Beene fragrance products. The Company currently obtains its materials for these products from a limited number of manufacturers and other suppliers. Management of the Company believes that its relationships with these manufacturers are good, and that there are sufficient alternatives should one or more of these manufacturers become unavailable. Distributed Brand products are supplied to the Company in finished goods form and are generally acquired directly from major international fragrance manufacturers, as well as from other sources.
Except as to Controlled Brand products, the Company, as is customary in the industry, generally does not have long-term or exclusive contracts with manufacturers or suppliers. Purchases from manufacturers or suppliers that do not have exclusive distribution contracts with the Company are generally made pursuant to purchase orders. The Company's ten largest suppliers of Distributed Brands accounted for approximately 81% of the Company's cost of sales for the fiscal year ended January 31, 1998. The loss of, or a significant adverse change in, the relationship between the Company and any of its major suppliers could have a material adverse effect on the Company's business, financial condition and results of operations.
LICENSING AND EXCLUSIVE DISTRIBUTION AGREEMENTS
Except for its Halston, Geoffrey Beene and COFCI products, substantially all of the Company's products are covered by trademarks owned by others. Management does not believe that its business, other than with respect to the Halston, Geoffrey Beene and COFCI fragrance products, is dependent upon any particular trademark, license or similar property. Management believes that the Halston trademarks, the Geoffrey Beene license and trademarks and the COFCI license and trademarks are important to its business.
HALSTON. In March 1996, the Company, directly and through its subsidiary Halston Parfums, Inc. ("Halston Parfums"), acquired from Halston Borghese, Inc. ("Halston Borghese") and its affiliates certain assets, including the trademark registrations in the United States and trademark registrations and applications in numerous other countries for the Halston fragrance brands, including Halston, Catalyst, Z-14 and 1-12 (the "Halston Acquisition"). See Note 2 to the Notes to Consolidated Financial Statements. The Company (and FFI since 1993) had been a direct distributor of the Halston brands in the United States, which has been the primary market for the Halston fragrance products. The Company also has patent registrations in the United States for bottle designs associated with certain of the Halston fragrance products.
GEOFFREY BEENE. In March 1995, FFI, directly and through its subsidiary, G.B. Parfums, Inc. ("G.B. Parfums"), acquired certain assets from Sanofi, including an exclusive worldwide license with Geoffrey Beene, Inc. to manufacture and sell Geoffrey Beene fragrance and related products, including the Grey Flannel, Bowling Green and Chance brands (the "Geoffrey Beene Acquisition"). See Note 2 to the Notes to Consolidated Financial Statements. FFI had been a direct distributor since 1989 of the Geoffrey Beene brands in the United States, which has been the primary market for the Geoffrey Beene brand products. The Company and G.B. Parfums have trademark registrations and applications in the United States and in numerous other countries for these brands. The license agreement has an initial term of 30 years from February 1995, subject to automatic extensions for successive ten-year periods unless earlier terminated by G.B. Parfums in accordance with the agreement. In addition to certain consulting and other payments required to be made by G.B. Parfums, G.B. Parfums is obligated to pay royalties based on 3% of net sales of Geoffrey Beene fragrance products, which royalty payments decrease if Mr. Geoffrey Beene ceases to design apparel in the field of high fashion using his own name.
COFCI. Since 1990, Fine Fragrances has had agreements with COFCI for the exclusive distribution in the United States and Canada of
fragrances and related cosmetic products, including the Salvador Dali, Laguna, Salvador, Dalissime, Dalimix, Cafe, Taxi and Watt brands. Following the Fine Fragrances Acquisition in May 1997, these agreements were assigned to the Company. The agreements expire in April 2007, subject to earlier termination by COFCI if the Company were to cease to purchase certain minimum levels of product.
GALENIC ELANCYL. In October 1995, FFI entered into a five year agreement (which is automatically renewable for successive three year terms unless either party gives written notice prior to the applicable term) with Pierre Fabre Dermo Cosmetique, a large French skin care manufacturer, pursuant to which the Company serves as the exclusive distributor in the United States of the Galenic Elancyl skin care products.
BENETTON. In December 1995, the Company entered into agreement with S.A.B., USA Corp., with an initial term through December 1, 2000 (which is automatically renewable for successive three year terms unless either party gives written notice prior to the applicable term) pursuant to which the Company serves as the exclusive distributor in the United States of the Benetton fragrance lines, including the Colors of Benetton, Hot and Cold and Tribu brands.
FACONNABLE. In May 1996, in connection with the acquisition of the principal assets of FMG (the "FMG Acquisition"), the Company acquired a distribution agreement with Fairtrade Sarl having an initial term through June 1999, pursuant to which the Company serves as the exclusive distributor in the United States of the Faconnable fragrance line, including the Faconnable and Face a Face brands. See Note 2 to the Notes to Consolidated Financial Statements. The distribution agreement automatically renews for two successive five-year terms unless the Company terminates the agreement at the end of the initial term.
LAPIDUS. In May 1996, in connection with the FMG Acquisition, the Company acquired a distribution agreement with Les Parfums Ted Lapidus, S.A. having an initial term through June 1999, pursuant to which the Company serves as the exclusive distributor in the United States of the Lapidus, Fantasme and Creation fragrance lines. The distribution agreement automatically renews for two successive five-year terms unless the Company terminates the agreement at the end of the initial term.
OMBRE ROSE. In May 1996, in connection with the FMG Acquisition, the Company acquired a distribution agreement with Inter Parfums, S.A. with a minimum term through December 31, 2003, pursuant to which the Company serves as the exclusive distributor in the United States of the Ombre Rose and Ombre D'or fragrance lines.
OTHERS. In May 1996, in connection with the FMG Acquisition, the Company acquired a number of distribution agreements pursuant to which the Company serves as the exclusive distributor in the United States of additional prestige fragrance brands, including Balenciaga Pour Homme, Chevignon, Rumba, Le Dix, Prelude and One Man Show. These agreements generally extend through 1998 or 1999 and are generally automatically renewable for successive five-year terms unless either party gives written notice prior to the end of the applicable term.
MARKETING AND SALES
In the United States and Canada, the Company has established its own sales and marketing staff, and also utilizes independent sales representatives. As a result of the Halston Acquisition and the FMG Acquisition, the Company significantly increased its sales and marketing force. As of April 9, 1998, the Company's sales and marketing force consisted of approximately 35 sales and marketing employees and approximately 44 independent sales representatives and 19 market specialists that focus on the retail sell through of the Company's brands in specific areas of the United States. In general, each sales employee and representative is assigned sales responsibility for a customer or territory. The Company's sales and marketing employees and representatives routinely visit retailers to assist in the merchandising, layout and stocking of selling areas. As a result of the increased use of electronic data interchange ("EDI") by the Company's customers, which reduces the administrative time and costs associated with processing orders, the Company has refocused its sales and marketing force to increase the promotion of in-store sales.
The Company's senior sales and marketing personnel support the efforts of its sales employees and representatives by working with the merchandise managers, lead buyers and marketing departments of its major retailers to develop advertising and promotional plans tailored to these customers' retail needs. The Company's sales and marketing personnel frequently work with customers to (i) assist in the development of merchandising and promotional programs and budgets for specific products or selling seasons, (ii) design model schematic planograms for the budgeting of the customer's fragrance and cosmetics departments, (iii) identify trends in consumer preferences and (iv) conduct training programs for the retailers' sales personnel.
The Company nationally advertises its Controlled Brand products directly in leading men's and women's print media, through radio advertising in key markets and through cooperative advertising in association with major retailers. The Company also promotes products through the use of gift-with-purchase programs, sales personnel incentive commissions and purchase-with-purchase programs.
It has been an industry practice for businesses that market fragrances and cosmetics to prestige department stores to provide the department stores with rights to return merchandise. The Company limits return rights to certain promotional items offered in its Halston, Geoffrey Beene and Galenic Elancyl lines to prestige department stores. The Company generally does not offer any other return rights and seeks to limit sales of such promotional products to each retailer to volumes that can be sold through to the retailer's customer base. The Company establishes reserves and provides allowances for returns of such products at the time of sale. As a percentage of gross sales (net sales plus returns, reserves and allowances), returns were approximately 1.8%, 1.9% and 2.6%, respectively, for the fiscal years ended January 31, 1996, 1997 and 1998. To date, the Company's returns have not exceeded its returns reserves and allowances, although there can be no assurance that such reserves and allowances will be adequate in the future.
Marketing and sales activities outside the United States and Canada relate primarily to Geoffrey Beene and Halston products and are conducted
through arrangements with independent distributors. The Company's export sales department coordinates the Company's relationship with various international fragrance distributors and assists them in developing promotional campaigns and marketing budgets for individual foreign markets. Revenues related to export sales were not material during any of the last three fiscal years.
DISTRIBUTION
The Company distributes its products to more than 31,000 separate retail locations in the United States, including department stores such as J.C. Penney, Sears, Macy's, Dayton Hudson and Nordstrom's, mass merchants such as Wal-Mart, Target, T.J. Maxx and K-Mart, drug stores such as CVS, Eckerd Drugs, Walgreens and Drug Emporium and independent fragrance, cosmetic and other stores such as Cosmetic Center, Ulta 3, Sharper Image and Syms. In addition, with respect to the Halston and Geoffrey Beene fragrance products, the Company distributes these products worldwide.
A majority of the Company's customers require rapid shipment of products. Because the Company generally attempts to fill orders within two days from the receipt of a purchase order, and because all orders are subject to cancellation without penalty by the customer until shipment, management does not consider backlog to be a significant indication of future sales activities. All orders are packaged by the Company and most merchandise is shipped to customers by common carriers. In addition, to expedite delivery, the Company addresses its individual customer needs by offering its customers U.P.C. coding, advance price ticketing, case packing, drop ship programs (direct to store), shrink-wrap, electronic service/anti-theft tagging and EDI capabilities. As an example of the importance of these services to retailers, approximately 78% of the Company's purchase orders in fiscal 1998 were received by EDI.
As is customary in the fragrance industry, the Company does not have long-term or exclusive contracts with any of its customers. Sales to customers are generally made pursuant to purchase orders. The Company believes that its continuing relationships with its customers are based upon its ability to provide a wide selection and reliable source of prestige fragrance products as well as its ability to provide value-added services to its customers, especially mass-market retailers. The Company's ten largest customers accounted for approximately 38% of net sales for the fiscal year ended January 31, 1998. No single customer accounted for more than 10% of net sales for the same period. The loss of, or a significant adverse change in, the relationship between the Company and any of its key customers could have a material adverse effect on the Company's business, financial condition and results of operations.
SEASONALITY
The Company generally has significantly higher sales in the second half of the calendar year as a result of increased demand by retailers in anticipation of, and during, the holiday season. For example, in fiscal 1998, 67% of the Company's net sales were made during the second half of the fiscal year.
MANAGEMENT INFORMATION SYSTEMS
The Company's management information system provides on-line, real-time, fully integrated information for its sales, purchasing, warehouse and financial departments. The order entry portion of the system is designed around EDI to provide enhanced turnaround and reduced opportunity for errors in orders and invoicing for both the Company and its customers. The system forms the basis for a number of the value-added services that the Company provides to its customers, including inventory replenishment, customer billing, sales analysis, product availability and pricing information, and expedited order processing. In order to accommodate its rapid growth, the Company recently completed the installation of a new management information system which, among other things, is expected to improve forecasting, purchasing and order tracking capabilities, as well as providing Year 2000 compliance. At January 31, 1998, the Company had incurred approximately $1.8 million of costs for the implementation of the new system. Because the Year 2000 compliance feature was a part of the new system which the Company installed and is in the process of being tested, no specific costs were allocated to resolve the Year 2000 compliance issue. The Company is in the process of initiating formal communications with all of its significant suppliers and large customers to determine the extent to which the Company is vulnerable to those third parties' failure to remedy their own Year 2000 issues. Although management of the Company does not anticipate any problems, there can be no assurance that the systems of other companies on which the Company's systems rely will be converted on time or that a failure to convert by another company or a conversion that is incompatible with the Company's systems would not have a material adverse effect on the Company. The Company intends to continue to enhance its management information systems on an ongoing basis, to provide improved service to the Company's customers through quicker response times in shipments, customer service and sales information, and to provide the Company's management the ability to identify opportunities for increased efficiencies and cost savings.
COMPETITION
The fragrance industry is highly competitive and at times subject to rapidly changing consumer preferences and industry trends. The Company competes with other distributors, Diverted Sources, manufacturers of mass-market fragrances and other manufacturers of prestige fragrances. Competition is generally a function of assortment and continuity of merchandise selection, price, timely delivery and level of in-store customer support. The Company believes that it competes primarily on the basis of (i) its established relationships with its fragrance manufacturer suppliers and, in particular, its ability to offer mass-market retailers a reliable, direct supply of prestige fragrances and related cosmetic products at competitive prices, and (ii) its emphasis on providing value-added customer services to its mass-market retailers. There are products which are better known than the products produced for or distributed by the Company. Many of the Company's competitors are substantially larger and more diversified, and have substantially greater financial and marketing resources, than the Company, as well as greater name recognition and the ability to develop and market products similar to and competitive with those distributed by the Company.
EMPLOYEES
The Company has an employee leasing agreement with The Vincam Group, Inc. ("Vincam"), pursuant to which Vincam is the employer of record and assumes all payroll obligations and certain employee benefits administration with respect to the full-time personnel of the Company, while allowing the Company to retain management control of these persons. References herein to "employees" or "personnel" of the Company include individuals whose services are leased. As of April 9, 1998, the Company leased the services of approximately 190 full-time employees. None of the Company's employees are covered by a collective bargaining agreement, and the Company believes that its relationship with its employees is satisfactory. The Company also uses the services of independent contractors in various capacities, including sales representatives and information systems personnel. The Company also contracts with a temporary personnel agency for temporary or seasonal labor.
EXECUTIVE OFFICERS OF THE COMPANY
The following table sets forth information, as of April 9, 1998, with respect to each person who is an executive officer of the Company, as indicated below:
Name Age Position - --------------------- --- ------------------------------------- Rafael Kravec 66 Chairman of the Board E. Scott Beattie 39 President and Chief Executive Officer Gretchen Goslin 37 Vice President - Marketing Oscar E. Marina 38 Vice President, General Counsel and Secretary William J. Mueller 51 Vice President - Operations, Chief Financial Officer and Treasurer
All officers are elected annually by the Board of Directors (the "Board") and serve at the discretion of the Board. The business experience, principal occupations and employment as well as the periods of service of each of the executive officers of the Company during the last five years are set forth below.
Rafael Kravec has served as Chairman of the Board since April 1997 and as a director from the Merger until April 1997. Mr. Kravec served as Chief Executive Officer and as a director of the Company from the Merger until April 1997. Mr. Kravec served as President and Chief Executive Officer and a director of FFI from its formation in July 1992 until the consummation of the Merger. Mr. Kravec has also served as President and Chief Executive Officer and a director of (i) G.B. Parfums since its formation in March 1995, (ii) Halston Parfums since its formation in March 1996, (iii) Fine Fragrances since March 1990, (iv) FRM Services, Inc. ("FRM"), a wholly-owned subsidiary of the Company, since December 1996, and (v) National Trading Manufacturing, Inc. ("National Trading"), a company controlled by Mr. Kravec since 1981.
E. Scott Beattie has served as President and Chief Executive Officer of the Company since February 1998 and has been a director of the Company since the Merger. From April 1997 to February 1998, Mr. Beattie served as President and Chief Operating Officer of the Company, and from November 1995 until April 1997, Mr. Beattie served as Vice Chairman of the Board and Assistant Secretary of the Company (positions he held with FFI from January
1995 until the consummation of the Merger). From September 1989 to September 1997, Mr. Beattie served as President of E.S.B. Consultants, Inc. ("ESB"), a financial and management consulting firm that until September 1997 was controlled by Mr. Beattie. ESB provided consulting services to the Company from 1992 until 1997. Mr. Beattie has also served as Executive Vice President of Bedford Capital Corporation ("Bedford"), a Toronto, Canada based firm that is engaged in the business of providing merchant banking services through two private pools of capital to middle-market companies, since March 1995 and as Vice President of Bedford from September 1989 to March 1995. Mr. Beattie is a director of Bedford, Bedford Capital Financial Corporation, which is the parent company of Bedford and trades on the Toronto Stock Exchange, Cash Converters, Inc., a specialty retailer, and Janna Systems Inc., an applications software company.
Gretchen Goslin has served as Vice President - Marketing of the Company since the Merger. Ms. Goslin served as Vice President - Marketing of FFI from May 1993 until the consummation of the Merger. From August 1991 to May 1993, Ms. Goslin was Vice President - Marketing of Cosmyl Corporation, a cosmetics company.
Oscar E. Marina has served as Vice President, General Counsel and Secretary of the Company and Fine Fragrances since March 1996. Mr. Marina has also served as Vice President, General Counsel and Secretary of G.B. Parfums and Halston Parfums since March 1997 and Secretary of G.B. Parfums and Halston Parfums since March 1996. Mr. Marina has served as a director and Assistant Secretary of FRM since December 1996. From October 1988 until March 1996, Mr. Marina was an attorney with the law firm of Steel Hector & Davis LLP in Miami, becoming a partner of the firm in January 1995.
William J. Mueller has served as Vice President - Operations, Chief Financial Officer and Treasurer of the Company since the Merger. Mr. Mueller served as Vice President - Operations, Chief Financial Officer and Treasurer of FFI from April 1993 until the consummation of the Merger. Mr. Mueller has also served as Vice President - Finance and Chief Financial Officer of Fine Fragrances since April 1993 and Treasurer of G.B. Parfums and Halston Parfums since March 1996. Mr. Mueller is a certified public accountant.
ITEM 2.
ITEM 2. PROPERTIES
The Company's corporate headquarters and distribution center is at the Miami Lakes Facility located at 14100 N.W. 60th Avenue, Miami Lakes, Florida 33014 in a building owned by the Company on a tract of land comprising approximately 13 acres. The Miami Lakes Facility contains approximately 200,000 square feet of assembly, distribution, shipping and storage space and approximately 30,000 square feet of office space. In 1996, the Company issued a mortgage on the Miami Lakes Facility in the amount of $6 million. See Note 2 to the Notes to Consolidated Financial Statements. The Company has completed an upgrade of the Miami Lakes Facility, which included a comprehensive re-racking of the warehouse area and the installation of a computerized pick/sortation system that is expected to improve the rate of orders filled and represent a savings in labor costs. The Company is planning to expand its racked warehouse area and to rack its shipping area by the summer of 1998. The Company also leases from National Trading a 59,000 square foot building in Miami, Florida (the "National Trading Facility"), which had housed the Company's distribution facilities prior to the Merger. See Notes 1 and 9 to the Notes to Consolidated Financial Statements. The Company is continuing to occupy the National Trading Facility as a warehouse, but National Trading and the Company are pursuing a potential sale or lease of the National Trading Facility to a third party, which would discharge the Company from its lease obligation. There is no assurance that any such sale will be consummated. See "Management's Discussion and Analysis of Financial Condition and Results of Operations - Liquidity and Capital Resources."
ITEM 3.
ITEM 3. LEGAL PROCEEDINGS
The Company is a party to a number of pending legal actions, proceedings and claims. While any litigation contains an element of uncertainty, management of the company believes, based upon the advice of counsel, that the outcome of such actions, proceedings or claims, pending or known to be threatened, will not have a material adverse affect on the Company's consolidated financial position or results of operations.
ITEM 4.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY-HOLDERS
No matters were submitted to a vote of security holders during the fourth quarter of the fiscal year ended January 31, 1998.
PART II
ITEM 5.
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
Market information. The Company's Common Stock, $.01 par value ("Common Stock") has been traded on the Nasdaq National Market (the "National Market") under the symbol "FRAG" since December 21, 1995. The following table sets forth the high and low sales prices for the Common Stock, as reported on the National Market for each of the Company's fiscal quarters from February 1, 1996 through January 31, 1998. OTC quotations reflect interdealer prices, without retail mark-up, mark-down or commission and may not necessarily represent actual transactions.
Holders. As of March 31, 1998 there were approximately 530 record holders of the Common Stock.
Dividends. The Company has not declared any cash dividends in its two most recent fiscal years and currently has no plans to declare dividends in the foreseeable future. Any future determination by the Company's Board of Directors to pay dividends will be made only after consideration of the Company's financial condition, results of operations, capital requirements and other relevant factors. The Company's credit facility with Fleet prohibits the payment of cash dividends by the Company and the Indenture relating to the Company's 10-3/8% Series B Senior Notes due 2007 (the "Series B Senior Notes") makes the payment of cash dividends subject to the satisfaction of certain financial and other covenants.
ITEM 6.
ITEM 6. SELECTED FINANCIAL DATA (In thousands, except earnings per share data)
The shoe manufacturing and importing operations of the Company were permanently discontinued in the first quarter of 1995, and the operations of the Company following the November 30, 1995 Merger have consisted solely of the fragrance operations of FFI, which was the accounting acquiror in the Merger. Therefore, the following selected financial data represent the selected financial data of FFI until the Merger and the selected financial data of the Company following the Merger. The information has been derived from the audited and unaudited consolidated financial statements of the Company and FFI for the relevant periods. Effective January 31, 1995, FFI changed its fiscal year end to January 31 from June 30. For this reason, the seven months ended January 31, 1995 and 1994 are presented. The following data should be read in conjunction with the Financial Statements and related notes, "Management's Discussion and Analysis of Financial Condition and Results of Operations" and the other financial information included elsewhere herein.
ITEM 7.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
THIS MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS CONTAINS INFORMATION WHICH CONSTITUTES FORWARD-LOOKING STATEMENTS. FORWARD-LOOKING STATEMENTS INHERENTLY INVOLVE RISKS AND UNCERTAINTIES. THE FACTORS, AMONG OTHERS, THAT COULD CAUSE ACTUAL RESULTS TO DIFFER MATERIALLY FROM THOSE SET FORTH IN OR IMPLIED BY FORWARD-LOOKING STATEMENTS IN THIS MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS INCLUDE THOSE SET FORTH UNDER PART I OF THIS ANNUAL REPORT ON FORM 10-K.
OVERVIEW
The shoe manufacturing and importing operations of the Company were permanently discontinued in the first quarter of 1995, and the operations of the Company following the Merger, which was consummated on November 30, 1995, consist solely of the fragrance operations of FFI, which was the accounting acquiror in the Merger. Therefore, the following discussion and analysis relates to the results of operation of FFI until the Merger and the financial condition and results of operation of the Company following the Merger.
The Company's business is the manufacturing, distribution and marketing of prestige fragrances and related cosmetic products. The Company distributes and markets on an exclusive basis in the United States to both department stores and mass-market retailers the Controlled Brands, including, the Geoffrey Beene brands of Grey Flannel, Eau de Grey Flannel and Bowling Green, the Halston brands of Halston, Catalyst, Z-14 and 1-12, and several other brands including Colors of Benetton, Hot and Cold, Tribu, Ombre Rose, Ombre D'or, Faconnable, Salvador Dali, Salvador, Laguna, Dalissime, Dalimix, Cafe, Taxi, Watt, Balenciaga, Rumba, Lapidus, Creation, Fantasme and Chevignon, as well as the Galenic Elancyl skin care products. In the case of the Halston and Geoffrey Beene fragrance brands, the Company also controls the manufacturing and exclusive worldwide distribution of such brands. In addition to the Controlled Brand operations, the Company also distributes, primarily to mass-market retailers, Distributed Brands it obtains from manufacturers and other sources.
The Controlled Brand operations have somewhat different financial characteristics than the Distributed Brand operations. As a percentage of net sales, the Controlled Brand operations tend to have higher gross margins, as well as higher marketing and selling, general and administrative expenses, than the Distributed Brand operations. The higher gross margins have been greater than the higher marketing and selling, general and administrative expenses associated with the Controlled Brand operations. The acquisition of the licenses and trademarks associated with the Controlled Brand operations also increases amortization expense. Overall, brand contribution margin (operating income after amortization of acquisition costs and amortization of exclusive brand licenses, as a percentage of net sales) of Controlled Brands is greater than that of Distributed Brands. The JPF Acquisition, which closed on March 31, 1998, is anticipated to increase the proportion of the Company's business in Distributed Brands. See Item 1 "Business - Recent Developments."
The following discussion of the Company's (and FFI's prior to the Merger) results of operations is presented for the fiscal years ended January 31, 1996, 1997 and 1998.
RESULTS OF OPERATIONS
General - ------- The following table sets forth, for the periods indicated, certain information relating to the Company's (and FFI prior to the Merger) operations expressed as percentages of net sales for the period (percentages may not add due to rounding):
Fiscal Year Ended January 31, 1998 Compared to the Fiscal Year Ended January 31, 1997 - --------------------------------------------------------------------
NET SALES. Net sales increased $75.0 million, or 53.4%, to $215.5 million for the fiscal year ended January 31, 1998 from $140.5 million for the fiscal year ended January 31, 1997. Of the increase in net sales (i) approximately $18.3 million was attributable to an increase in sales of Controlled Brands, resulting primarily from the increased sales of the Halston, Geoffrey Beene and Benetton brands (including through the launch of the Hot and Cold product line) and the addition of the net sales of COFCI fragrance products following the Fine Fragrances Acquisition (which were previously accounted for under the equity in earnings of unconsolidated affiliate, 50% owned), and (ii) the balance was attributable to an increase in sales of Distributed Brands, including specially designed products, for the mass market. The increase in net sales represents both an increase in the volume of products sold to existing customers (including through increased sell through of existing products and sales of new products), as well as sales to new customers. Management believes that the increased sales resulted primarily from the Company's ability to provide its customers with a larger selection of products and a continuous, direct supply of product, and the growth in sales of customized gift sets.
GROSS PROFIT. Gross profit increased $22.9 million, or 49.7%, to $69.0 million for the fiscal year ended January 31, 1998 from $46.1 million for the fiscal year ended January 31, 1997. The increase in gross profit was primarily attributable to the increase in product sales of both the Controlled Brands and the Distributed Brands, including an increase in the sale of holiday fragrance sets. Gross margins decreased slightly from 32.8% to 32.0% primarily as a result of a proportionally larger increase in sales of Distributed Brands, which typically sell at lower margins than the Controlled Brands.
WAREHOUSE AND SHIPPING EXPENSE. Warehouse and shipping expenses increased $2.7 million, or 59.6%, to $7.2 million for the fiscal year ended January 31, 1998, from $4.5 million for the fiscal year ended January 31, 1997. The increase resulted from both an increase in labor, warehouse, shipping materials and freight costs, all of which were associated with the increase in net sales, and an increase in inventory reserve for shrinkage and obsolescence.
SG&A. Selling, general and administrative ("SG&A") expenses increased $5.9 million, or 30.0%, to $25.6 million for the fiscal year ended January 31, 1998 from $19.7 million for the fiscal year ended January 31, 1997. As a percentage of net sales, SG&A expenses decreased from 14.0% in fiscal 1997 to 11.9% in fiscal 1998. Of the increase in SG&A expenses, approximately $2.8 million represented an increase in selling expenses, primarily as a result of increased advertising and promotional expenses, the addition of sales and marketing personnel and salary support programs with retailers, partially offset by the decrease in sales commissions and national media advertising costs. General and administrative expenses increased $3.1 million primarily as a result of the addition of administrative personnel, the termination of the management fees derived from Fine Fragrances following the Fine Fragrances Acquisition (which had reduced general and administrative expenses in the prior year's period), the increased reserve for management incentive compensation (which is based on the pre-tax income of the Company) and an increase in the provision for bad debt.
DEPRECIATION AND AMORTIZATION. Depreciation and amortization increased $1.1 million, or 29.3%, to $4.7 million for the fiscal year ended January 31, 1998 from $3.7 million for the fiscal year ended January 31, 1997. The increase was primarily attributable to the depreciation of costs related to (i) improvements to the Miami Lakes facility, (ii) new machinery and equipment (including equipment for the new pick/sortation system and computer equipment associated with the Company's new management information system), and (iii) tools and molds used in connection with the manufacture of products, including gift sets; and to the amortization of the trademarks and licenses from the Halston Acquisition, the FMG Acquisition and the Fine Fragrances Acquisition. See "Management's Discussion and Analysis of Financial Condition and Results of Operations - Liquidity and Capital Resources."
INTEREST EXPENSE, NET. Interest expense, net of interest income, increased $5.6 million, or 81.5%, to $12.4 million for the fiscal year ended January 31, 1998 from $6.8 million for the fiscal year ended January 31, 1997. This increase was due to the increase in average debt outstanding resulting from the May 1997 offering (the "Note Offering") of $115 million principal amount of 10-3/8% Series A Senior Notes (the "Series A Senior Notes"). During the fiscal year ended January 31, 1998, interest income increased by approximately $398,000 resulting from the investment of the excess proceeds from the Note Offering.
OTHER INCOME. Other income decreased during the fiscal year ended January 31, 1998 by approximately $0.5 million from the fiscal year ended January 31, 1997, primarily as a result of the receipt of $0.5 million from the September 1996 sale of the common stock of a company engaged in an unrelated business which Suave had held since 1984.
NET INCOME. Net income increased $4.1 million, or 49.6%, to $12.3 million for the fiscal year ended January 31, 1998, from $8.2 million for the fiscal year ended January 31, 1997, primarily as a result of the increase in net sales, which were partially offset by higher interest and SG&A expenses.
EBITDA. EBITDA increased $14.3 million, or 65.4%, to $36.2 million for the fiscal year ended January 31, 1998 from $21.9 million for the fiscal year ended January 31, 1997. The EBITDA margin increased to 16.8% for the fiscal year ended January 31, 1998 from 15.6% for the fiscal year ended January 31, 1997. The increases in EBITDA and EBITDA margin were primarily attributable to the decrease in SG&A expenses as a percentage of net sales.
Fiscal Year Ended January 31, 1997 Compared to the Fiscal Year Ended January 31, 1996 - --------------------------------------------------------------------
NET SALES. Net sales increased $52.5 million, or 60%, to $140.5 million for the fiscal year ended January 31, 1997 from $88.0 million for the fiscal year ended January 31, 1996. Of the increase in net sales (i) approximately $28.0 million was attributable to an increase in sales of Controlled Brands resulting primarily from the Halston Acquisition, the FMG Acquisition, the Company's engagement to serve as the exclusive United States distributor of the Benetton fragrance brands and increased sales of the Geoffrey Beene fragrance brands, and (ii) the balance was attributable to an increase in sales of Distributed Brands, including specially designed products, for the mass market. International sales increased to
approximately $5.1 million for the fiscal year ended January 31, 1997, compared to approximately $1.2 million for the fiscal year ended January 31, 1996, as a result of both increased sales of Geoffrey Beene products and sales of Halston products since the Halston Acquisition. The increase in net sales represents both an increase in the volume of products sold to existing customers, as well as sales to new customers. Management believes that the increased sales resulted primarily from the Company's ability to provide its customers with a larger selection of products and a continuous, direct supply of product, and the growth in sales of customized gift sets.
GROSS PROFIT. Gross profit increased $24.5 million, or 113%, to $46.1 million for the fiscal year ended January 31, 1997 from $21.6 million for the fiscal year ended January 31, 1996. The increase in gross profit and gross margin (from 24.6% to 32.8%) was primarily attributable to the increase in product sales of the Controlled Brands, including the Halston, Geoffrey Beene and Benetton brands, as well as the brands formerly distributed by FMG (all of which were at higher gross margins) and an increase in the sale of certain product categories with higher gross margins such as holiday fragrance sets. The increase in gross margin was partially offset by an increase in sales of certain Distributed Brands which typically sell at lower margins.
WAREHOUSE AND SHIPPING EXPENSE. Warehouse and shipping expenses increased $1.8 million, or 67%, to $4.5 million for the fiscal year ended January 31, 1997, from $2.7 million for the fiscal year ended January 31, 1996. The increase resulted from both the increase in net sales and higher customer service expenses.
SG&A. Selling, general and administrative expenses increased $10.5 million, or 114%, to $19.7 million for the fiscal year ended January 31, 1997 from $9.2 million for the fiscal year ended January 31, 1996. The increase in SG&A expenses (which increased as a percentage of net sales from 10.5% to 14.0%), was primarily a result of an increase in advertising and promotional expenses for the Halston and Geoffrey Beene brands, an increase in sales commissions associated with the increase in net sales and the addition of sales, marketing and administrative personnel since the FMG Acquisition in May 1996.
DEPRECIATION AND AMORTIZATION. Depreciation and amortization increased $2.4 million, or 185%, to $3.7 million for the fiscal year ended January 31, 1997 from $1.3 million for the fiscal year ended January 31, 1996. The increase was primarily attributable to increased amortization of intangibles arising from the acquisition of the Halston trademarks in March 1996 and the acquisition of the exclusive license agreements in the FMG Acquisition in May 1996.
INTEREST EXPENSE, NET. Interest expense, net of interest income, increased $2.7 million, or 66%, to $6.8 million for the fiscal year ended January 31, 1997 from $4.1 million for the fiscal year ended January 31, 1996. This increase was primarily due to the increase in average debt outstanding resulting from the Halston Acquisition and the FMG Acquisition and increased borrowings under the revolving portion of the existing credit facility to accommodate increased working capital requirements, including the increased inventory levels needed to support higher net sales.
OTHER INCOME. Other income primarily reflects the receipt by the Company of $0.5 million from the September 1996 sale of the common stock of
a company engaged in an unrelated business which Suave had held since 1984, as well as approximately $0.1 million from the sale of shoe products and equipment held by Suave from before the Merger.
EQUITY IN EARNINGS OF AFFILIATE. Equity in earnings of unconsolidated affiliate increased $0.1 million, or 33%, to $0.4 million for the fiscal year ended January 31, 1997 from $0.3 million for the fiscal year ended January 31, 1996, as a result of increases in net sales by Fine Fragrances of fragrance products manufactured by COFCI, partially offset by an increase in the management fee paid to the Company.
NET INCOME. Net income increased $5.2 million, or 173%, to $8.2 million for the fiscal year ended January 31, 1997, from $3.0 million for the fiscal year ended January 31, 1996, primarily as a result of the increase in net sales and gross profit which were partially offset by increased amortization expenses resulting from the Halston Acquisition and the FMG Acquisition, increased interest expense and increased selling expenses.
EBITDA. EBITDA increased $12.2 million, or 126%, to $21.9 million for the fiscal year ended January 31, 1997 from $9.7 million for the fiscal year ended January 31, 1996. The EBITDA margin increased to 15.6% for the fiscal year ended January 31, 1997 from 11.1% for the fiscal year ended January 31, 1996. The increase was primarily attributable to the increase in gross profit discussed above, partially offset by the increase in SG&A expenses.
SEASONALITY
The fragrance operations of the Company have historically been seasonal, with higher sales generally occurring in the second half of the fiscal year as a result of increased demand by retailers in anticipation of and during the holiday season. For example, in fiscal 1998, 67% of the Company's net sales were made during the second half of the fiscal year. Due to the size and timing of certain orders from its customers, sales and results of operations can vary significantly between quarters of the same and different years. As a result, the Company expects to experience variability in net sales and net income on a quarterly basis.
The Company's working capital borrowings are also seasonal, and are normally highest in the months of September and October. During the fourth fiscal quarter ending January 31, significant cash is normally generated as customer payments on holiday orders are received.
LIQUIDITY AND CAPITAL RESOURCES
The Company used approximately $40.7 million of net cash in operations during the fiscal year ended January 31, 1998, compared to $23.2 million of net cash used in operations during the fiscal year ended January 31, 1997, primarily as a result of a significant decrease in accounts payable partially offset by a decrease in the level of inventory purchases. The Company utilized a portion of the proceeds from the Note Offering to significantly reduce its accounts payable. The Company used net cash in investing activities of approximately $7.4 million during the fiscal year ended January 31, 1998, compared to approximately $21.1 million during the fiscal year ended January 31, 1997, primarily as a result of the cash used for purchases of brand licenses and trademarks for the Halston
Acquisition and the FMG Acquisition during fiscal 1997, partially offset by significant additions to property and equipment for the Miami Lakes Facility, including for a new racking system, a computerized pick/sortation system and computer software and equipment associated with a new management information system. During the fiscal year ended January 31, 1998, the Company received approximately $54.9 million of net cash from financing activities, which related to the proceeds from the May 1997 Note Offering and the uses of a portion of such proceeds to pay off the outstanding balances under the Company's credit facility and certain subordinated debentures and for working capital purposes. During the fiscal year ended January 31, 1997, the Company received approximately $45.1 million of net cash from financing activities, primarily to fund the Halston Acquisition, the FMG Acquisition and for working capital purposes. The Company financed these activities through the public offering of Common Stock in July 1996, the issuance of subordinated debentures, the mortgage on the Miami Lakes Facility and the revolving portion of its credit facility. See Notes 2, 3 and 7 to the Notes to Consolidated Financial Statements.
The Company (and FFI prior to the Merger) has historically financed, and expects to continue to finance, its internal growth and acquisitions primarily through its credit facility, external financing and internally generated funds. The Company's principal future uses of funds are for working capital requirements, debt service and additional brand acquisitions or product distribution arrangements. As a result of several acquisitions during the past three years, including the Geoffrey Beene Acquisition, the Halston Acquisition and the FMG Acquisition, the growth in direct distribution relationships for additional fragrance brands and certain favorable product buying opportunities, the Company's working capital needs have increased significantly and are expected to continue to increase, especially following the closing of the JPF Acquisition.
The Company financed approximately $39 million of the purchase price (not including the accounts payable assumed) for the JPF Acquisition with available cash from operations, the Company's revolving credit facility with Fleet (the "Credit Facility") and the $3 million Debenture. The Debenture is non-interest bearing, with the principal amount being payable in three equal annual installments if certain conditions relating to the JPF Business are achieved by the Company, including achieving certain gross profit thresholds from the JPF Business. See Item 1 "Business - Recent Developments." Since a significant portion of the purchase price for the JPF Acquisition was paid from the Credit Facility, management of the Company is evaluating alternatives for additional external financing of $30 million, which may be debt or equity financing, to pay down the amounts borrowed under the Credit Facility. Management of the Company believes that such financing (or other financing such as an increase in the size of the Credit Facility) is, and will be, available. Subject to receipt of financing to pay down and thereby create availability under the Credit Facility, management of the Company believes that internally generated funds and available financing under the Credit Facility will be sufficient to cover the Company's working capital and debt service requirements (other than any additional working capital requirements which may result from further expansion, through acquisitions of brands or new product distribution arrangements, of the Company's operations) for at least the next 12 months.
The Company's future liquidity will continue to be dependent upon its relative amounts of current assets (principally cash, accounts receivable and inventories) and current liabilities (principally short-term debt, accrued expenses and accounts payable). Additional inventory requirements and accounts receivable can have a significant impact on the Company's liquidity, particularly during expansion. To date, the Company generally has not experienced any material adverse problems with the collection of accounts receivable relating to its fragrance operations. There can be no assurance that refusals to pay or delays in payment would not have a material adverse effect on the Company's liquidity, results of operations and general financial condition in the future. The Company establishes reserves and provides allowances for returns at the time of sale, but there can be no assurance that such reserves and allowances will be adequate.
Further expansion of the Company's operations, including through additional brand acquisitions or the acquisition of exclusive distribution rights to additional fragrance brands, will require increased investment in accounts receivable and inventories, which may negatively impact the Company's cash flow from operations. The Company has discussions from time to time with manufacturers of prestige fragrance brands and with distributors that hold exclusive distribution rights regarding possible acquisitions by the Company of additional exclusive manufacturing and/or distribution rights. The Company currently has no agreements or commitments with respect to any such acquisition, although it periodically executes routine agreements to maintain the confidentiality of information obtained during the course of discussions with manufacturers and distributors. There is no assurance that the Company will be able to negotiate successfully for any such future acquisitions or that it will be able to obtain acquisition financing or additional working capital financing on satisfactory terms for further expansion of its operations.
In May 1997, the Company consummated the Note Offering of $115 million principal amount of the Series A Senior Notes. See Note 10 to Notes to Consolidated Financial Statements. In July 1997, the Series A Senior Notes were exchanged for an equivalent principal amount of the Series B Senior Notes which contain identical terms to the Series A Senior Notes but have been registered under the Securities Act of 1933, as amended. Approximately $48.6 million of the net proceeds from the sale of the Series A Senior Notes was used to repay all of the outstanding indebtedness under the Company's then existing credit facility (including amounts outstanding under a term loan issued in connection with the Geoffrey Beene Acquisition) and such credit facility was terminated. Approximately $10.4 million of the net proceeds was used to repay the Company's 8% Secured Subordinated Debentures Series I and II (plus accrued interest) which were issued in connection with the Geoffrey Beene Acquisition and the Halston Acquisition. Approximately $3.9 million of the net proceeds was used to pay accrued interest and purchase, at a discount, an 8.5% Subordinated Debenture due 1999 which was issued in connection with the FMG Acquisition. In addition, approximately $4.2 million of the net proceeds was used for the Fine Acquisition and to repay Fine Fragrances' bank credit line. The balance of the net proceeds from the Note Offering were used for working capital support.
The Indenture pursuant to which the Series A Senior Notes (and the Series B Senior Notes following their exchange for the Series A Senior Notes) were issued (the "Indenture") provides that such notes will be
senior unsecured obligations of the Company and will rank senior in payment to all existing and future subordinated indebtedness of the Company and pari passu in right of payment with all existing and future senior indebtedness of the Company, including indebtedness under the Credit Facility. The Indenture generally limits the ability of the Company to (i) incur additional indebtedness, (ii) pay any dividend or make any distribution on account of its capital stock or other equity interest, (iii) purchase or redeem any capital stock or equity interest of the Company, (iv) make any principal payment, purchase or redeem subordinated indebtedness except at scheduled maturities, or (v) make certain investments, in each case, subject to the satisfaction of a fixed charge coverage ratio and, in certain cases, also a net income test. In addition, the Indenture generally limits the ability of the Company to create liens, merge or transfer or sell assets. The Indenture also provides that the holders of the Series B Senior Notes have the option to require the Company to repurchase their notes in the event there is a change of control in the Company.
Concurrently with the closing of the Note Offering, the Company entered into the Credit Facility with Fleet which provides for borrowings on a revolving basis of up to $40 million (including up to $3 million in commercial letters of credit) for general corporate purposes, including working capital needs and acquisitions, subject to certain borrowing base limitations. Amounts borrowed on the revolving portion of the Credit Facility mature on May 31, 1999. Loans under the revolving credit portion of the Credit Facility will bear interest, payable monthly, at a floating rate ranging from, at the option of the Company, either (i) 1.75% over LIBOR to 2.25% over LIBOR or (ii) the prime rate as quoted by Fleet to 0.5% over such prime rate, and combinations thereof, in each case depending on the ratio of the Company's total funded debt to its shareholders equity base. The Company's borrowing availability under the Credit Facility is limited to the sum of between 80 to 85% of eligible accounts receivable and 50% of eligible inventory (up to a maximum of $20 million). The Company's obligations under the Credit Facility will rank pari passu in right of payment with the Series B Senior Notes and senior in right of payment to all existing and future subordinated indebtedness of the Company. In addition, borrowings under the Credit Facility are secured by a first priority lien on all of the Company's accounts receivable and inventory. See Note 7 to Notes to Consolidated Financial Statements.
The Credit Facility: restricts the Company's ability to incur additional non-trade debt (with certain exceptions, including indebtedness not exceeding $50 million for a fiscal year issued in connection with certain asset purchases), and to enter into certain acquisitions, mergers, investments and affiliated transactions; and prohibits the declaration or payment of dividends on, or the redemption of, the Company's capital stock, certain payments on the subordinated debt and the sale of the Company's interest in its subsidiaries. The Credit Facility also contains covenants requiring the Company to maintain a minimum shareholders' equity, a maximum leverage ratio, and minimum debt service and interest coverage ratios. At January 31, 1998, the Company had the entire balance of the Credit Facility available for additional working capital support and general corporate purposes, including acquisitions. The Company pays quarterly in arrears a fee of .375% per annum on the unused portion of the Credit Facility and a letter of credit fee of 1.0% per annum on the face amount of trade letters of credit and 2.0% per annum on the face amount of stand-by letters of credit issued and outstanding. In March 1998, The Company used approximately $36 million of availability under the Credit Facility to pay for a portion of the purchase price of the JPF Acquisition.
At January 31, 1998, the Company had outstanding approximately $5.0 million aggregate principal amount of 7.5% Convertible Debentures Due 2006. See Note 4 to the Notes to Consolidated Financial Statements. The 7.5% Convertible Debentures are convertible at any time at $7.20 per share (the "Conversion Price") into shares of Common Stock, and are redeemable at par at any time commencing July 22, 1999 at the option of the Company, but only in the event the Common Stock, at the time a redemption notice is delivered by the Company, has been trading at not less than $14.40 for 20 consecutive trading days. The 7.5% Convertible Debentures are due June 30, 2006 and require interest-only payments payable semi-annually until maturity at which time the entire unpaid principal amount and any unpaid accrued interest is due and payable. The Company also has outstanding $7.0 million aggregate principal amount of 8.5% Subordinated Debentures (the "8.5% Debentures"). See Note 2 to Notes to Consolidated Financial Statements. The 8.5% Debentures require mandatory annual principal repayments in the aggregate amount of $2.33 million commencing May 2002, with the remaining balance due May 2004.
The characteristics of the Company's business do not generally require it to make significant ongoing capital expenditures. During the fiscal year ended January 31, 1998; however, the Company incurred approximately $6.9 million in capital expenditures, primarily for the renovation of the executive offices, a comprehensive re-racking of the warehouse area, the construction and installation of a computerized pick/sortation system and the purchase and installation of software and equipment for a new management information system. See Item 1 "Business - Management Information Systems." The Company is planning to expand its racked warehouse area, to rack the shipping area and install a new inbound inventory management software system by the summer of 1998 and anticipates capital expenditures for the fiscal year ended January 31, 1999 of approximately $2 million. Exclusive of the possible impact from acquisitions, the Company does not anticipate that its annual capital expenditures will be more than $1 million for the foreseeable future following fiscal 1999.
The Company has a lease on the National Trading Facility which FFI had been using for its fragrance operations. The lessor of the property is National Trading and the property has been mortgaged by National Trading as security for its obligation for Industrial Development Revenue Bonds issued through Dade County, Florida which mature on December 1, 2011. The balance of these bonds which approximate the obligations of FFI through 2011 under this lease was approximately $2.0 million at January 31, 1998. The Company and National Trading are pursuing a potential sale or lease of the National Trading Facility to a third party that would discharge the Company from the lease obligation. There is no assurance that any such sale or lease will be consummated.
IMPACT OF INFLATION AND FOREIGN EXCHANGE FLUCTUATIONS
The Company believes that although inflation has not had a material impact on its results of operations, inflation would likely increase the interest rates that the Company pays on its floating rate indebtedness. Although large fluctuations in foreign exchange rates could have a material effect on the prices the Company pays for certain products it purchases from outside of the United States, the prices obtainable for sales denominated in foreign currencies and wholesale sales to foreign customers, such fluctuations have not been material to the Company's results of operations to date.
ITEM 8.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
INDEX TO FINANCIAL STATEMENTS*
Independent Auditors' Report
Consolidated Balance Sheets as of January 31, 1997 and 1998
Consolidated Statements of Income for the Years Ended January 31, 1996, 1997 and 1998
Consolidated Statements of Shareholders' Equity for the Years Ended January 31, 1996, 1997 and 1998
Consolidated Statements of Cash Flows for the Years Ended January 31, 1996, 1997 and 1998
Notes to Consolidated Financial Statements
- --------------------
* The shoe manufacturing and importing operations of the Company were permanently discontinued in the first quarter of 1995, and the operations of the Company following the Merger which was consummated on November 30, 1995, consist solely of the fragrance operations of FFI, which was the accounting acquiror in the Merger. Therefore, the following financial statements and supplementary data represent the financial statements and supplementary data of FFI until the Merger and the financial statements and supplementary data of the Company following the Merger.
INDEPENDENT AUDITORS' REPORT
To the Board of Directors and Shareholders of French Fragrances, Inc. and Subsidiaries:
We have audited the accompanying consolidated balance sheets of French Fragrances, Inc. and subsidiaries (the "Company") as of January 31, 1997 and 1998, and the related consolidated statements of income, shareholders' equity, and cash flows for each of the three years in the period ended January 31, 1998. These consolidated financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the consolidated financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall consolidated financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, such consolidated financial statements present fairly, in all material respects, the financial position of the Company as of January 31, 1997 and 1998, and the results of its operations and its cash flows for each of the three years in the period ended January 31, 1998, in conformity with generally accepted accounting principles.
DELOITTE & TOUCHE LLP
Miami, Florida March 31, 1998
FRENCH FRAGRANCES, INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS
See Notes to Consolidated Financial Statements.
FRENCH FRAGRANCES, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF INCOME
See Notes to Consolidated Financial Statements.
FRENCH FRAGRANCES, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
(RESTUBBED TABLE CONTINUED FROM ABOVE)
See notes to consolidated financial statements.
FRENCH FRAGRANCES, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOW
See Notes to Consolidated Financial Statements.
FRENCH FRAGRANCES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. GENERAL INFORMATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
ORGANIZATION AND BUSINESS ACTIVITY. French Fragrances, Inc. (the "Company") is a manufacturer, distributor and marketer of prestige designer fragrances and related cosmetic products, primarily to mass-market retailers in the United States. In 1992, a company called French Fragrances, Inc. ("FFI") was formed to acquire the net assets of the fragrance and cosmetics distribution business of National Trading Manufacturing, Inc. ("National Trading"). In connection with the acquisition of the net assets of National Trading, FFI purchased 50% of Fine Fragrances, Inc. ("Fine Fragrances"), a company which distributes fragrances manufactured in France by COFCI, S.A. ("COFCI"). In November 1995, FFI merged with and into Suave Shoe Corporation ("Suave") in a reverse acquisition (the "Merger"). See Note 2. In May 1997, the Company acquired the 50% of Fine Fragrances that it did not own. See Note 6.
BASIS OF CONSOLIDATION. The consolidated financial statements include the accounts of the Company's wholly owned subsidiaries G.B. Parfums, Inc. ("G.B. Parfums"), Halston Parfums, Inc., Fine Fragrances and FRM Services, Inc., an inactive subsidiary. See Note 2. All significant intercompany accounts and transactions have been eliminated in consolidation.
BASIS OF PRESENTATION. All references to the Company in these consolidated financial statements and notes refer to FFI until the Merger and to the surviving corporation following the Merger. See Note 2.
USE OF ESTIMATES. The preparation of the consolidated financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.
REVENUE RECOGNITION. Sales are recognized upon shipment. During the years ended January 31, 1996, 1997 and 1998, no customer accounted for more than 10% of total sales.
CASH AND CASH EQUIVALENTS. Cash and cash equivalents include cash and interest-bearing deposits at banks with an original maturity date of three months or less.
INVENTORIES. Inventories are stated at the lower of cost or market. Cost is determined on the weighted-average method. Inventory balances at January 31, 1997 and 1998 were as follows:
PROPERTY AND EQUIPMENT, AND DEPRECIATION. Property and equipment are stated at cost. Expenditures for major improvements and additions are recorded to the asset accounts while replacements, maintenance, and repairs which do not improve or extend the lives of the respective assets are charged to expense. Depreciation is provided over the estimated useful lives of the assets using the straight-line method, as follows:
Category Years --------------------------------------- Building 20-40 Building improvements 40 Furniture and fixtures 8 Machinery, equipment and vehicles 3-8 Computer equipment and software 3-5 Tools and molds 1-3
FRENCH FRAGRANCES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. GENERAL INFORMATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
CAPITAL LEASE. The Company leases the building and the land which were used for its principal business offices prior to May 1997 and are presently used as a warehouse (the "National Trading Facility") that transfers substantially all benefits and risks of ownership to the Company. The lessor of this property is National Trading, which is owned by a shareholder of the Company. This property is mortgaged by National Trading to secure its obligations under Industrial Development Revenue Bonds (Series 1985) (the "Bonds") issued through Metropolitan Dade County, Florida which mature on December 1, 2011. The balance of the Bonds was approximately $2,100,000 and $1,980,000 at January 31, 1997 and 1998, respectively. The Company has an option to purchase the National Trading Facility on or before the end of the lease term at a price of $1,800,000 less the amount equal to the product of $10,000 multiplied by the number of months for which the Company has paid rent pursuant to the lease ($1,130,000 at January 31, 1998).
This lease is accounted for as the acquisition of assets and incurrence of obligations under the capital lease standards issued by the Financial Accounting Standards Board. See Note 9. Accordingly, the capitalized leased assets are recorded as property at the fair value of the property, which is the present value of the minimum lease payments. Depreciation of the building is computed using the term of the lease and is included in depreciation expense.
INCOME TAXES. The provision for income taxes is the tax payable or refundable for the period plus or minus the change during the period in deferred tax assets and liabilities. The Company provides for deferred taxes under the liability method. Under such method, deferred taxes are adjusted for tax rate changes as they occur. Deferred income tax assets and liabilities are computed annually for differences between the financial statements and tax bases of assets and liabilities that will result in taxable or deductible amounts in the future based on enacted tax laws and rates applicable to the periods in which the differences are expected to affect taxable income. Valuation allowances are recorded when necessary to reduce deferred tax assets to the amount expected to be realized.
EXCLUSIVE BRAND LICENSES AND TRADEMARKS, CUSTOMER LISTS AND AMORTIZATION. These intangible assets are being amortized using the straight-line method, as follows at January 31:
FRENCH FRAGRANCES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. GENERAL INFORMATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
The Company reviews its intangible assets periodically for events or changes in circumstances that may indicate that the carrying amount is not recoverable on an undiscounted cash flow basis in accordance with Statement of Financial Accounting Standards ("SFAS") No. 121, Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed 0f. If the estimated future cash flows are projected to be less than the carrying value, an impairment write-down would be recorded. No write-downs have been recorded during the fiscal years ended January 31, 1996, 1997 and 1998.
SENIOR NOTE OFFERING COSTS. Debt issuance costs and transaction fees which are associated with the issuance of the Senior Notes are being amortized (and charged to interest expense) over the term of the related notes on a method which approximates the level yield method. See Note 10.
FAIR VALUE OF FINANCIAL INSTRUMENTS. The Company's financial instruments include accounts receivable, accounts payable, short-term debt, loans from shareholders, convertible subordinated debentures, secured subordinated debentures, subordinated debentures, a capital lease, senior notes, a term loan and convertible redeemable preferred stock. The fair value of such financial instruments has been determined using available market information and interest rates as of January 31, 1997 and 1998.
At January 31, 1997 and 1998, the estimated fair value of the Company's subordinated debentures and senior notes was as follows:
The fair value of all other financial instruments was not materially different than their carrying value.
RECLASSIFICATIONS. Certain amounts in the prior period consolidated financial statements have been reclassified to conform with the fiscal 1998 presentations.
EARNINGS PER SHARE. In February 1997, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards Number 128 "Earnings per Share" ("SFAS 128") which changes the method of calculating earnings per share. SFAS 128 requires the presentation of "basic" earnings per share and "diluted" earnings per share on the face of the income statement. Basic earnings per share is computed by dividing the net income available to common shareholders by the weighted average shares of outstanding common stock. The calculation of diluted earnings per share is similar to basic earnings per share except that the denominator includes dilutive potential common stock such as stock options, warrants and
FRENCH FRAGRANCES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. GENERAL INFORMATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
convertible securities. The statement was effective for financial statements for periods ending after December 15, 1997. The Company adopted SFAS 128 in the fourth quarter of fiscal 1998 and restated its earnings per share for the fiscal years ended January 31, 1996, 1997 and 1998 to give effect to SFAS 128. Earnings per share for the year ended January 31, 1996 is based on the number of shares received by the shareholders of FFI in the Merger through the date of the Merger and thereafter is based on the actual number of common shares and common share equivalents outstanding. Earnings per share for the year ended January 31, 1997 and 1998 is based on actual number of common shares and common share equivalents outstanding. The following table represents the computation of earnings per share:
FRENCH FRAGRANCES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
5. PROPERTY AND EQUIPMENT (Continued)
Projects in progress at January 31, 1998 included the installation of a computerized pick/sortation system and the installation of a new management information system, both of which were completed in February 1998.
6. INVESTMENT IN UNCONSOLIDATED AFFILIATE
The following represents condensed financial information at January 31, 1997 and for the years ended January 31, 1997 and 1996 of Fine Fragrances, a fragrance distribution Company which, prior to May 1997, was 49.99% owned by the Company and distributed the Salvador Dali, Laguna, Dalissime, Salvador, Dalimix, Cafe, Taxi and Watt brands manufactured by COFCI. Prior to May 1997, the Company's investment in Fine Fragrances was accounted for under the equity method.
Current liabilities primarily related to a $3,000,000 secured line of credit from a bank. Amounts outstanding were $952,000 as of January 31, 1997. There were no other material commitments or contingencies for Fine Fragrances other than the management fees owed to the Company which were terminated following the acquisition of the Fine Fragrances Interest. See Note 12.
FRENCH FRAGRANCES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
6. INVESTMENT IN UNCONSOLIDATED AFFILIATE (Continued)
The reconciliation of the investment in unconsolidated affiliate is as follows:
The Company's equity in the net income of Fine Fragrances as reflected in the accompanying statements of income was reduced for the amortization of the exclusive distribution agreements held by Fine prior to May 1997. Amortization expense on these exclusive distribution agreements was approximately $75,000 for each of the years ended January 31, 1996 and 1997.
In May 1997, the Company used approximately $4,226,000 of the net proceeds from the Note Offering to acquire the 50.01% interest of Fine Fragrances that the Company did not own (the "Fine Fragrances Interest") from an unaffiliated third party and to repay Fine Fragrances' credit line. See Note 10. The purchase price for the Fine Fragrances Interest was $2,000,000, plus an additional $1,000,000 which is to be paid over time based on 5% of the net sales of COFCI products sold by Fine Fragrances or the Company, with any unpaid balance due 30 days after the third anniversary of the consummation of the transaction. The acquisition was accounted for under the purchase method. As a result of this acquisition, Fine Fragrances became a wholly-owned subsidiary of the Company and the operations of Fine Fragrances have been consolidated with those of the Company. The brands manufactured by COFCI are distributed by the Company under new agreements expiring in 2007
7. SHORT-TERM DEBT
In May 1997, the Company used approximately $48,595,000 of the net proceeds from the Note Offering to repay all amounts outstanding under its then existing credit facility (including the Geoffrey Beene Term Loan) and terminated such facility. Concurrently with the closing of the Note Offering, the Company entered into a new stand-by credit facility (the "Credit Facility") with the same lender which provides for borrowings on a revolving basis of up to $40,000,000, with a $3,000,000 sublimit for letters of credit. Borrowings under the Credit Facility are limited to eligible accounts receivable and inventories. Borrowings under the Credit Facility will be secured by a first priority lien on all of the Company's accounts receivable and inventory. The Company's obligations under the Credit Facility will rank pari passu in right of payment with the 10 3/8% Series B Senior Notes Due 2007 (the "Series B Senior Notes"). The Credit Facility contains several covenants, the more significant of which are that the Company maintain a minimum level of equity and meet certain debt-to-equity, interest coverage and liquidity ratios. The Credit
FRENCH FRAGRANCES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
7. SHORT-TERM DEBT (Continued)
Facility also includes a prohibition on the payment of dividends and other distributions to shareholders and restrictions on the incurrence of additional non-trade indebtedness. At January 31, 1997, the outstanding balance under the then existing credit facility was approximately $37,631,000. At January 31, 1998, the Credit Facility did not have an outstanding balance. As part of the Credit Facility, the Company had approximately $599,000 and $369,000 in outstanding letters of credit at January 31, 1997 and 1998, respectively.
8. SUBORDINATED DEBENTURES
The secured subordinated debentures as of January 31, 1997, included (i) $7,438,500 principal amount of 8% Series I Debentures, and (ii) $3,000,000 principal amount of 8% Series II Debentures. See Note 2. The subordinated debentures as of January 31, 1997 and 1998 represent the 8.5% Debentures. See Note 2. The convertible subordinated debentures as of January 31, 1997 and 1998 represent the 7.5% Convertible Debentures. See Note 4.
9. COMMITMENTS AND CONTINGENCIES
As of January 31, 1998, the future minimum lease payments for the National Trading Facility under capital lease are as follows. See Note 1.
The Company is a party to a number of pending legal actions, proceedings and claims. While any litigation contains an element of uncertainty, management of the company believes, based upon the advice of counsel, that the outcome of such actions, proceedings or claims pending or known to be threatened, will not have a material adverse effect on the Company's consolidated financial position or results of operations.
FRENCH FRAGRANCES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
10. SENIOR NOTE OFFERING
In May 1997, the Company consummated the private placement of $115,000,000 principal amount of Series A Senior Notes. Approximately $48,595,000 of the net proceeds from the sale of the Series A Senior Notes was used to repay all of the outstanding indebtedness under the Company's credit facility and approximately $14,410,000 of the net proceeds was used to repay subordinated debentures of the Company. See Notes 2 and 7. In addition, the Company applied approximately $4,226,000 to the acquisition of the Fine Fragrances Interest and the repayment of all of the outstanding indebtedness under Fine Fragrances' credit facility. See Note 6. The balance of the net proceeds from the Note Offering was used to provide the Company working capital support. In July 1997, the Series A Senior Notes were exchanged for an equivalent principal amount of Series B Senior Notes which contain identical terms to the Series A Senior Notes but have been registered under the Securities Act of 1933, as amended.
The Indenture pursuant to which the Series A Senior Notes (and the Series B Senior Notes following their exchange for the Series A Senior Notes) were issued (the "Indenture") provides that such notes will be senior unsecured obligations of the Company and will rank senior in payment to all existing and future subordinated indebtedness of the Company and pari passu in right of payment with all existing and future senior indebtedness of the Company, including indebtedness under the Credit Facility. The Indenture generally limits the ability of the Company to (i) incur additional indebtedness, (ii) pay any dividend or make any distribution on account of its capital stock or other equity interest, (iii) purchase or redeem any capital stock or equity interest of the Company, (iv) make any principal payment, purchase or redeem subordinated indebtedness except at scheduled maturities, and (v) make certain investments; in each case subject to the satisfaction of a fixed charge coverage ratio and, in certain cases, also a net income test. In addition, the Indenture generally limits the ability of the Company to create liens and merge or transfer or sell assets. The Indenture also provides that the holders of the Series B Senior Notes have the option to require the Company to repurchase their notes in the event there is a change of control in the Company (as defined in the Indenture).
11. INCOME TAXES
The components of the provision for income taxes for the years ended January 31, 1996, 1997 and 1998 are as follows:
FRENCH FRAGRANCES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
11. INCOME TAXES (Continued)
Deferred income taxes reflect the net tax effects of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for tax purposes and operating loss carry forwards. The tax effects of significant items comprising the Company's net deferred tax asset are as follows:
As of January 31, 1997 and 1998, the valuation allowance relates to the net operating loss carry forwards available in connection with the Merger discussed in Note 2 which expire through 2009.
The total income tax provision differs from the amount obtained by applying the statutory federal income tax rate to pretax income for the following reasons:
FRENCH FRAGRANCES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
12. RELATED PARTY TRANSACTIONS (Continued)
As a result of the acquisition in May 1997 of the Fine Fragrances Interest, the management agreement pursuant to which the Company was performing management services on behalf of Fine Fragrances and receiving a management fee was terminated, Fine Fragrances' credit facility was terminated and advances from Fine Fragrances to the Company were canceled. See Note 6.
In April 1997, the Company terminated various monitoring agreements it had with affiliates of the Company since 1992. Pursuant to these agreements, the affiliates provided financial advisory services to the Company for annual fees totaling $275,000. These agreements were replaced by a consulting agreement with E.S.B. Consultants, Inc. ("ESB"), a Company which prior to September 1997 was wholly-owned by the President and Chief Executive Officer of the Company, pursuant to which ESB provided financial advisory and management services for a fee of $300,000. In September 1997, the consulting agreement with ESB was terminated and the President and Chief Executive Officer ceased to have an affiliation with ESB. The President and Chief Executive Officer is now an employee of the Company.
The Company has an employment agreement through April 2000 with its Chairman, whereby he agrees to devote a majority of his business time and energies to the business and affairs of the Company. The agreement is automatically renewable for successive one year periods and contains a non-compete clause during the term of the agreement and for a period of five years after its termination.
FRENCH FRAGRANCES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
13. SUPPLEMENTAL SCHEDULE OF NONCASH FINANCING AND INVESTING ACTIVITIES
The Company applies APB No. 25 and related interpretations in accounting for its stock options to employees and non-employee members of the Board as described in Note 1. Accordingly, no compensation expense has been recognized during the years ended January 31, 1996, 1997 and 1998 related to the stock options. Net income and net income per common share would have been as follows had the fair value of stock, options granted during 1996, 1997 and 1998 been recognized as compensation expense as prescribed by SFAS No. 123:
FRENCH FRAGRANCES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
14. STOCK OPTION PLANS (Continued)
The fair value of each option granted is estimated on the grant date using the Black-Sholes option pricing model with the following assumptions:
15. SUBSEQUENT EVENT
In March 1998, the Company acquired (the "JPF Acquisition") certain assets of J.P. Fragrances, Inc. ("JPF"), including inventory, returns, contract rights, accounts receivable, books and records, fixed assets (including furniture and warehouse materials and equipment), claims, intangible rights (including non-compete agreements) and goodwill. The Company also assumed certain trade and other payables of JPF, but did not assume any of JPF's facility leases. The purchase price, which will be adjusted based on JPF's balance sheet on the closing date of the JPF Acquisition and the invoice support related to a certain account receivable, was financed from available cash from operations, the Credit Facility and a subordinated debenture in the principal amount of $3,000,000 (the "JPF Debenture"). The JPF Debenture is non-interest bearing, with the principal amount being payable in three equal annual installments only if certain conditions relating to the fragrance business of JPF (the "JPF Business") are achieved by the Company, including achieving certain gross profit thresholds from the JPF Business. The JPF Acquisition will be accounted for under the purchase method.
ITEM 9.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
Not applicable.
PART III
ITEM 10.
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The information required by this item will be contained in the Company's Proxy Statement for its 1998 Annual Meeting of Shareholders (the "Proxy Statement"), and is incorporated herein by this reference, or is included in Part I under "Executive Officers of the Company."
ITEM 11.
ITEM 11. EXECUTIVE COMPENSATION
The information required by this item will be contained in the Proxy Statement and is incorporated herein by this reference, provided that the Compensation Committee Report and Performance Graph which is contained in the Proxy Statement shall not be deemed to be incorporated herein by this reference.
ITEM 12.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The information required by this item will be contained in the Proxy Statement and is incorporated herein by this reference.
ITEM 13.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information required by this item will be contained in the Proxy Statement and is incorporated herein by this reference.
PART IV
ITEM 14.
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
(a) 1. Financial Statements - The consolidated financial statements and independent auditors' report are listed in the "Index to Financial Statements and Schedules" on page 23 and included on pages 24 through 42.
2. Financial Statement Schedules - All schedules for which provision is made in the applicable accounting regulations of the Commission are either not required under the related instructions, are not applicable (and therefore have been omitted), or the required disclosures are contained in the financial statements included herein.
3. Exhibits including those incorporated by reference.
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K (Continued) EXHIBIT INDEX Exhibit Number Description - ------- ----------------------------------------------------------------- 3.1 Amended and Restated Articles of Incorporation of the Company dated March 6, 1996 (incorporated herein by reference to Exhibit 3.1 filed as a part of the Company's Form 10-K for the fiscal year ended January 31, 1996 (Commission File No. 1-6370)).
3.2 Amendment dated September 19, 1996 to the Amended and Restated Articles of Incorporation of the Company (incorporated by reference to Exhibit 4.4 filed as part of the Company's Form 10-Q for the quarter ended October 31, 1996 (Commission File No. 1-6370)).
3.3 By-Laws of the Company (incorporated herein by reference to Exhibit 3.2 filed as a part of the Company's Form 10-K for the fiscal year ended January 31, 1996 (Commission File No. 1-6370)).
4.1 Indenture, dated as of May 13, 1997, between the Company and Marine Midland Bank, as trustee (incorporated herein by reference to Exhibit 4.1 filed as a part of the Company's Form 8-K dated May 13, 1997 (Commission File No. 1-6370)).
4.2 Credit Agreement, dated as of May 13, 1997, between the Company and Fleet National Bank (incorporated herein by reference to Exhibit 4.3 filed as a part of the Company's Form 8-K dated May 13, 1997 (Commission File No. 1-6370)).
4.3 First Amendment to Credit Agreement and Other Transaction Documents dated December 31, 1997 between the Company and Fleet National Bank.
4.4 Letter Agreement dated March 23, 1998 between French Fragrances, Inc. and Fleet National Bank.
10.1 Registration Rights Agreement dated as of November 30, 1995, among the Company, Bedford Capital Corporation ("Bedford"), Fred Berens, Rafael Kravec and Eugene Ramos (incorporated herein by reference to Exhibit 10.1 filed as a part of the Company's Form 10-K for the fiscal year ended September 30, 1995 (Commission File No. 1-6370)).
10.2 Amendment dated as of March 20, 1996 to Registration Rights Agreement dated as of November 30, 1995, among the Company, Bedford, Fred Berens, Rafael Kravec and Eugene Ramos (incorporated herein by reference to Exhibit 10.2 filed as a part of the Company's Form 10-K for the year ended January 31, 1996 (Commission File No. 1-6370)).
10.3 Second Amendment dated as of July 22, 1996 to Registration Rights Agreement dated as of November 30, 1995, among the Company, Bedford, Fred Berens, Rafael Kravec and the Estate of Eugene Ramos (incorporated by reference to Exhibit 10.3 filed as part of the Company's Form 10-Q for the quarter ended July 31, 1996 (Commission File No. 1-6370)).
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K (Continued) EXHIBIT INDEX Exhibit Number Description - ------- ----------------------------------------------------------------- 10.4 Employment Agreement dated as of April 1, 1997, between the Company and Rafael Kravec (incorporated herein by reference to Exhibit 10.4 filed as a part of the Company's Form 10-K for the fiscal year ended January 31, 1997 (Commission File No. 1-6370)).
10.5 Non-Employee Director Stock Option Plan (incorporated herein by reference to Exhibit 10.4 filed as a part of the Company's Form 10-K for the fiscal year ended September 30, 1995 (Commission File No. 1-6370)).
10.6 1995 Stock Option Plan (incorporated herein by reference to Exhibit 10.5 filed as a part of the Company's Form 10-K for the fiscal year ended September 30, 1995 (Commission File No. 1-6370)).
10.7 Lease Agreement, dated as of July 2,1992, between FFI and National Trading (incorporated herein by reference to Exhibit 10.13 filed as a part of the Company's Form 10-K for the fiscal year ended September 30, 1995 (Commission File No. 1-6370)).
10.8 Option Agreement, dated July 2, 1992, between FFI and National Trading and Memorandum of Lease and Option Agreement related thereto (incorporated herein by reference to Exhibit 10.14 filed as a part of the Company's Form 10-K for the fiscal year ended September 30, 1995 (Commission File No. 1-6370)).
10.9 Amended and Restated Exclusive Trademark License Agreement, dated February 29, 1980, between Geoffrey Beene, Inc., and Epocha Distributors, Inc. (now known as Sanofi Beaute, Inc.) as amended July 29, 1992 and February 13, 1995 (incorporated herein by reference to Exhibit 10.15 filed as a part of the Company's Form 10-K for the fiscal year ended September 30, 1995 (Commission File No. 1-6370)).
10.10 Asset Purchase Agreement dated as of February 1, 1996, by and between the Company and Halston-Borghese, Inc. and its affiliates (incorporated herein by reference to Exhibit 2.1 filed as a part of the Company's Form 8-K dated March 20, 1996 (Commission File No. 1-6370)).
12.1 Ratio of Earnings to Fixed Charges.
21.1 Subsidiaries of the Company.
23.1 Independent Auditors' Consent.
27.1 Financial Data Schedule. - --------------------- The foregoing list omits instruments defining the rights of holders of long term debt of the Company where the total amount of securities authorized thereunder does not exceed 10% of the total assets of the Company. The Company hereby agrees to furnish a copy of each such instrument or agreement to the Commission upon request.
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K (Continued)
(b) Reports on Form 8-K.
None.
(c) Exhibits to Form 10-K.
See Item 14(a)3.
(d) Financial Statement Schedules.
See Item 14(a)2.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized, as of the 9th day of April, 1998.
FRENCH FRAGRANCES, INC.
By: /s/ E. Scott Beattie -------------------- E. Scott Beattie President, Chief Executive Officer and Director (Principal Executive Officer)
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed by the following persons on behalf of the registrant and in the capacities and on the dates indicated.
Signature Title Date
/s/ Rafael Kravec Chairman of the Board April 9, 1998 - ----------------- and Director Rafael Kravec
/s/ E. Scott Beattie President, Chief Executive April 9, 1998 - -------------------- Officer and Director E. Scott Beattie (Principal Executive Officer)
/s/ William J. Mueller Vice President-Operations April 9, 1998 - ---------------------- and Chief Financial Officer William J. Mueller (Principal Financial and Accounting Officer)
/s/ J.W. Nevil Thomas Director April 9, 1998 - --------------------- J.W. Nevil Thomas
/s/ Richard C.W. Mauran Director April 9, 1998 - ----------------------- Richard C.W. Mauran
/s/ Fred Berens Director April 9, 1998 - --------------- Fred Berens
/s/ George Dooley Director April 9, 1998 - ----------------- George Dooley