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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTER ENDED SEPTEMBER 30, 2002
Commission file number: 0-19298
VARSITY BRANDS, INC.
(Exact name of registrant as specified in its charter)
DELAWARE 22-2890400
(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
6745 LENOX CENTER COURT, SUITE 300, MEMPHIS, TN
38115 (Address of principal executive offices)
(Zip code)
(901) 387-4300
(Registrant's telephone number, including area code)
(Former name, former address and former fiscal year,
if changed since last report)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1935 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes [X] No [ ]
Indicate the number of shares outstanding of each of the registrant's classes of
common stock, as of the latest practicable date.
9,522,250 Common Shares as of November 12, 2002
1
VARSITY BRANDS, INC.
INDEX
PAGE
Form 10-Q Cover Page 1
Form 10-Q Index 2
Part I. Financial Information:
Item 1. Financial Statements:
Condensed Consolidated Balance Sheets 3
Condensed Consolidated Statements of Operations 4
Condensed Consolidated Statements of Stockholders' Equity 5
Condensed Consolidated Statements of Cash Flows 6
Notes to Condensed Consolidated Financial Statements 7
Item 2. Management's Discussion and Analysis of
Financial Condition and Results of Operations 14
Item 4. Controls and Procedures 20
Part II. Other Information:
Item 1. Legal Proceedings 21
Item 2. Changes in Securities 21
Item 3. Defaults upon Senior Securities 21
Item 4. Submission of Matters to a Vote of Security Holders 21
Item 5. Other Information 21
Item 6. Exhibits and Reports on Form 8-K 21
Signatures 22
SPECIAL CAUTIONARY NOTICE REGARDING FORWARD-LOOKING STATEMENTS
This report contains certain statements which are "forward-looking"
statements under the federal securities laws that are based on the beliefs of
management as well as assumptions made by and information currently available to
management. Forward-looking statements appear throughout Item 2 of Part I,
"Management's Discussion and Analysis of Financial Condition and Results of
Operations" concerning the Company's seasonal patterns of working capital and
revenue and operating results in its business. Certain factors could cause
actual results to differ materially from those in the forward-looking statements
including without limitation, (i) continuation of historical seasonal patterns
of demand for the Company's products and the Company's ability to meet the
demand; (ii) actions by competitors, including without limitation new product
introductions; (iii) the loss of domestic or foreign suppliers; (iv) changes in
business strategy or new product lines and the Company's ability to successfully
implement these; (v) moderation of uniform and accessories revenue growth; and
(vi) changes in interest rates and general economic conditions. These
"forward-looking statements" are based on currently available information and
plans. They are inherently uncertain, and investors must recognize that events
could turn out to be significantly different from the Company's expectations.
2
Part I. FINANCIAL INFORMATION; Item 1. FINANCIAL STATEMENTS
VARSITY BRANDS, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(UNAUDITED)
(IN THOUSANDS)
September 30, December 31, September 30,
2002 2001 2001
-------- -------- --------
ASSETS
Current assets:
Cash and cash equivalents $ 10,631 $ 14,397 $ 26,299
Accounts receivable, trade less
allowance for doubtful accounts
($578, $429 and $394, respectively) 26,941 12,161 27,710
Inventories 9,543 7,863 9,148
Prepaid expenses 1,948 3,937 1,636
Other receivables 23 3,555 3,205
Deferred taxes 1,483 2,383 2,040
Assets held for disposal -- -- 5,830
-------- -------- --------
Total current assets 50,569 44,296 75,868
Property, plant and equipment, less
accumulated depreciation ($5,290,
$4,929 and $8,616, respectively) 3,588 4,387 4,129
Goodwill, less accumulated amortization
($9,595, $9,595 and $9,123, respectively) 66,596 66,596 67,067
Intangibles and deferred charges, less
accumulated amortization ($3,371,
$3,048 and $2,950, respectively) 2,085 2,793 3,775
Other assets 623 559 614
-------- -------- --------
$123,461 $118,631 $151,453
======== ======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 8,894 $ 5,891 $ 11,289
Accrued liabililties 6,588 8,258 8,907
Customer deposits 3,817 5,132 3,275
Current portion of long-term debt 1,375 1,375 --
-------- -------- --------
Total current liabilities 20,674 20,656 23,471
Long-term debt 72,160 80,410 112,500
Deferred taxes 188 188 --
Contingent liabilities -- -- --
Stockholders' equity:
Preferred stock -- -- --
Common stock 95 95 95
Additional paid-in capital 37,499 37,306 37,306
Accumulated deficit (7,155) (20,024) (21,919)
-------- -------- --------
30,439 17,377 15,482
-------- -------- --------
$123,461 $118,631 $151,453
======== ======== ========
See notes to condensed consolidated financial statements.
3
VARSITY BRANDS, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
(IN THOUSANDS, EXCEPT FOR PER SHARE AMOUNTS)
THREE MONTHS ENDED NINE MONTHS ENDED
------------------ ------------------
SEPTEMBER 30, SEPTEMBER 30,
------------------ ------------------
2002 2001 2002 2001
------- ------- ------- --------
Net revenues:
Uniforms and accessories $32,913 $32,049 $80,614 $ 76,030
Camps and events 28,283 28,077 56,645 54,766
------- ------- ------- --------
Net revenues 61,196 60,126 137,259 130,796
Cost of revenues:
Uniforms and accessories 16,422 16,390 41,888 40,383
Camps and events 19,509 19,248 38,241 36,698
------- ------- ------- --------
Cost of revenues 35,931 35,638 80,129 77,081
------- ------- ------- --------
Gross profit 25,265 24,488 57,130 53,715
Selling, general and
administrative expenses 12,612 12,697 37,362 36,551
------- ------- ------- --------
Income from operations 12,653 11,791 19,768 17,164
Other expense
Interest expense, net 1,975 2,990 6,149 7,536
------- ------- ------- --------
Total other expense 1,975 2,990 6,149 7,536
------- ------- ------- --------
Income from continuing operations
before income taxes, discontinued
operations and extraordinary items 10,678 8,801 13,619 9,628
Income taxes 690 2,948 890 3,225
------- ------- ------- --------
Income from continuing operations 9,988 5,853 12,729 6,403
Discontinued operations:
Income (loss) from operations of
discontinued businesses -- -- -- (1,358)
Gain (loss) on disposal of businesses -- 1,379 -- (16,921)
------- ------- ------- --------
Income (loss) from operations before
extraordinary items 9,988 7,232 12,729 (11,876)
Extraordinary item - gain on retirement
of bonds, net of tax -- 1,486 140 1,486
------- ------- ------- --------
Net income (loss) $ 9,988 $ 8,718 $12,869 $(10,390)
======= ======= ======= ========
Income from continuing operations
per share
Basic $ 1.05 $ 0.62 $ 1.34 $ 0.68
Diluted $ 0.89 $ 0.53 $ 1.16 $ 0.61
Income (loss) per share:
Basic $ 1.05 $ 0.92 $ 1.36 $ (1.10)
Diluted $ 0.89 $ 0.79 $ 1.17 $ (1.10)
Weighted average number common and
common equivalent shares outstanding:
Basic 9,488 9,452 9,464 9,452
Diluted 11,382 11,149 11,203 11,048
See notes to condensed consolidated financial statements.
4
VARSITY BRANDS, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
(UNAUDITED)
(IN THOUSANDS)
Retained Total
Common Stock Additional Earnings Stock-
--------------- paid-in (Accumulated holders'
Shares Amount Capital deficit) Equity
------ ------ -------- ----------- --------
FOR THE NINE MONTHS
ENDED SEPTEMBER 30, 2001
Balance, January 1, 2001 9,452 $ 95 $ 37,306 $(11,529) $25,872
Net loss for the period -- -- (10,390) (10,390)
------ ------ -------- -------- -------
9,452 $ 95 $ 37,306 $(21,919) $15,482
====== ====== ======== ======== =======
FOR THE NINE MONTHS
ENDED SEPTEMBER 30, 2002
Balance, January 1, 2002 9,452 $ 95 $ 37,306 $(20,024) $17,377
Issuance of common stock
for stock option exercise 60 -- 193 -- 193
Net income for the period -- -- 12,869 12,869
------ ------ -------- -------- -------
9,512 $ 95 $ 37,499 $ (7,155) $30,439
====== ====== ======== ======== =======
See notes to condensed consolidated financial statements.
5
VARSITY BRANDS, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
2002 2001 2002 2001
------- ------- ------- -------
Cash flows from operating activities:
Net income (loss) $ 9,988 $ 8,718 $12,869 $(10,390)
Adjustments to reconcile net income (loss) to net
cash provided by (used in) continuing operations:
Loss from operations of discontinued businesses -- -- -- 1,358
(Gain) loss on sale of businesses -- (1,379) -- 16,921
Extraordinary gain -- (1,486) (140) (1,486)
Depreciation and amortization:
Amortization of debt issue costs 122 173 375 605
Other depreciation and amortization 467 1,041 1,456 2,946
Provision for losses on accounts receivable 280 150 386 275
Deferred taxes 690 -- 900 (2,040)
Changes in assets and liabilities, net of
assets held for disposal:
(Increase) decrease in:
Accounts receivable, trade 7,028 6,603 (15,166) (13,512)
Inventories 4,578 4,236 (1,680) (1,946)
Prepaid expenses 2,627 2,586 1,989 1,614
Other receivables 103 (750) 3,532 (1,751)
Other assets 9 (54) (64) (151)
Increase (decrease) in:
Accounts payable (7,314) (5,431) 3,003 7,217
Accrued liabilities (2,012) 313 (1,670) 1,776
Customer deposits (9,283) (10,751) (1,315) (2,215)
------- ------- ------- -------
Net cash provided by (used in) continuing operations 7,283 3,969 4,475 (779)
Cash flows from discontinued operations
and extraordinary item
Net change in assets held for disposal -- 1,159 -- (9,335)
Costs associated with bond redemption -- (270) (51) (270)
------- ------- ------- -------
Net cash provided by (used by) discontinued
operations and extraordinary item -- 889 (51) (9,605)
Cash flows from investing activities:
Capital expenditures (204) (344) (522) (1,245)
Other assets -- (360) -- (360)
Net proceeds received from the sale of businesses -- -- -- 61,871
------- ------- ------- -------
Net cash provided by (used in) investing activities (204) (704) (522) 60,266
Cash flows from financing activities:
Net repayments under line-of-credit agreement -- -- -- (16,419)
Redemption of senior bonds -- (7,050) (7,858) (7,050)
Debt issue costs -- (223) (3) (223)
Proceeds from issuance of common stock 193 -- 193 --
------- ------- ------- -------
Net cash provided by (used) by financing activities 193 (7,273) (7,668) (23,692)
------- ------- ------- -------
Net increase (decrease) in cash 7,272 (3,119) (3,766) 26,190
Cash, beginning 3,359 29,418 14,397 109
------- ------- ------- -------
Cash, ending $10,631 $26,299 $10,631 $26,299
======= ======= ======= =======
See notes to consolidated financial statements.
6
VARSITY BRANDS, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
1. BASIS OF PRESENTATION
The condensed consolidated financial statements represent Varsity Brands,
Inc. ("Varsity" or the "Company") and its wholly-owned subsidiaries. All
significant intercompany accounts and transactions have been eliminated. These
statements are unaudited and, in the opinion of management, include all
adjustments (consisting only of normal recurring adjustments) necessary for fair
presentation of the Company's condensed consolidated financial position and the
condensed consolidated results of its operations and cash flows at September 30,
2002 and 2001 and for the periods then ended. Certain information and footnote
disclosures made in the Company's last Annual Report on Form 10-K have been
condensed or omitted for these interim statements. Accordingly, these condensed
consolidated financial statements should be read in conjunction with the
Company's Annual Report on Form 10-K for the year ended December 31, 2001.
Operating results for the nine months ended September 30, 2002 are not
necessarily indicative of the results to be expected during the remainder of
2002.
2. DISPOSITION OF ASSETS
In June 2001, the Company sold its Riddell Group Division to an affiliate
of Lincolnshire Management, Inc. ("Lincolnshire"), a private-equity fund. The
purchase price, which was determined by an arms-length negotiation, was
approximately $67.5 million.
The sale was made pursuant to a stock purchase agreement dated April 27,
2001 between the Company and Lincolnshire. The Riddell Group Division included:
(i) all of the Company's team sports business, excluding Umbro branded team
soccer products, (ii) the Company's licensing segment, which allows
third-parties to market certain products using the Riddell and MacGregor
trademarks, and (iii) the Company's retail segment, including the New York
Executive Office, which managed the retail and licensing segments, and marketed
a line of sports collectibles and athletic equipment, principally to retailers
in the United States, and to a limited extent internationally. In conjunction
with the sale of the Riddell Group Division, the Company recognized a decline in
value in its net minority investment in a company that made game uniforms on
behalf of the Riddell Group Division. The Company had previously accounted for
its investment in the game uniform company using the equity method of
accounting. As a result of the sale of the Riddell Group Division and the
write-down in the value of its minority investment in the game uniform company,
the Company recorded a loss on the sale of the Riddell Group Division of $20.5
million ($16.9 million after tax) in the second quarter of 2001.
The net operating results of the Riddell Group Division for the periods
ending September 30, 2001 are presented as income from operations of
discontinued
7
businesses in the Condensed Consolidated Statements of Operations. Revenues
generated by the Riddell Group Division for the nine-month and three-month
periods ended September 30, 2001 were $42.4 million and $0.0 million,
respectively.
In September 2001, the Company settled the litigation that it had brought
earlier that year against Umbro Worldwide, Ltd. ("Umbro Worldwide") involving
the licensing agreement between the Company and Umbro Worldwide. The license
agreement allowed Varsity to sell Umbro branded soccer apparel, equipment and
footwear to soccer specialty stores and others in the team channel of
distribution, principally in the United States.
In connection with the settlement the Company voluntarily terminated its
license effective November 30, 2001 in exchange for a lump sum payment to the
Company of $5.5 million and Umbro Worldwide's agreement to make certain payments
to the Company in the future, including the purchase, for $2.6 million, of
certain inventory from the Company. As a result of the early termination of the
Umbro license, the Company recognized a gain of approximately $4.9 million ($2.9
million after tax) during the fourth quarter of 2001.
The net operating results of the Umbro Division for the periods ended
September 30, 2001 are presented in income from discontinued operations of
discontinued businesses in the Condensed Consolidated Statements of Operations.
Revenues generated by the Umbro division for the nine-month and three-month
periods ended September 30, 2001 were $8.6 million and $3.9 million,
respectively.
3. EARNINGS PER SHARE
Basic earnings (loss) per share amounts have been computed by dividing
earnings (loss) by the weighted average number of outstanding common shares.
Diluted earnings (loss) per share is computed by adjusting earnings for the
effect of the assumed conversion of dilutive securities and dividing the result
by the weighted average number of common share and common equivalent shares to
dilutive securities. A reconciliation between the numerators and denominators
for these calculations follows:
Three months ended Nine months ended
------------------ -------------------
September 30, September 30,
2002 2001 2002 2001
------- ------- ------- --------
NET INCOME
EARNINGS (LOSS) - NUMERATOR
Net income (loss) $ 9,988 $ 8,718 $12,869 $(10,390)
8
Effect of assumed conversion
of convertible debt, when
dilutive - interest savings 94 105 282 --
------- ------- ------- --------
Numerator for diluted
per share computation $10,082 $ 8,823 $13,151 $(10,390)
======= ======= ======= ========
SHARES - DENOMINATOR
Weighted average number of
outstanding common shares 9,488 9,452 9,464 9,452
Weighted average common
equivalent shares:
Options, assumed exercise of
dilutive options, net of
treasury shares which could
have been purchased from the
proceeds of the assumed exercise
based on average market prices 197 -- 42 --
Convertible debt, assumed
conversion when dilutive 1,697 1,697 1,697 --
------- ------- ------- --------
Denominator for diluted
per share computation 11,382 11,149 11,203 9,452
======= ======= ======= ========
INCOME FROM CONTINUING OPERATIONS
INCOME FROM CONTINUING
OPERATIONS - NUMERATOR
Income from continuing operations $ 9,988 $ 5,853 $12,729 $ 6,403
Effect of assumed conversion of
convertible debt, when
dilutive - interest savings 94 105 282 315
------- ------- ------- --------
Numerator for diluted
per share computation $10,082 $ 5,958 $13,011 $ 6,718
======= ======= ======= ========
SHARES - DENOMINATOR
Weighted average number of
outstanding common shares
9,488 9,452 9,464 9,452
9
Weighted average common
equivalent shares:
Options, assumed exercise of
dilutive options, net of treasury
shares which could have been
purchased from the proceeds of
the assumed exercise based on
average market prices
197 -- 42 --
Convertible debt, assumed
conversion when dilutive 1,697 1,697 1,697 1,596
------- ------- ------- --------
Denominator for diluted
per share computation 11,382 11,149 11,203 11,048
======= ======= ======= ========
For the nine months ended September 30, 2001, potentially dilutive
securities, which include convertible debt and common stock options, were not
dilutive and were excluded from the computation of diluted earnings per share.
4. RECEIVABLES
Accounts receivable include unbilled shipments of approximately $1,704,000,
$610,000 and $1,636,000 at September 30, 2002, December 31, 2001 and September
30, 2001, respectively. It is the Company's policy to record revenues when the
related goods have been shipped. Unbilled shipments represent receivables for
shipments that have not yet been invoiced. These amounts relate principally to
partial shipments to customers who are not invoiced until their order is shipped
in its entirety or customers with orders containing other terms that require a
deferral in the issuance of the invoice. Management believes that substantially
all of these unbilled receivables will be invoiced within the current sales
season.
5. INVENTORIES
Inventories consist of the following:
(In thousands) September 30, December 31, September 30,
2002 2001 2001
-----------------------------------------
Finished goods $6,111 $5,904 $6,893
Raw materials 3,432 1,959 2,255
-----------------------------------------
$9,543 $7,863 $9,148
=========================================
6. SUPPLEMENTAL CASH FLOW INFORMATION
Cash paid for interest was $3,530,000 and $6,780,000 for the three-month
periods ended September 30, 2002 and 2001, respectively, and $7,914,000 and
$14,349,000 for the nine-month periods ended September 30, 2002 and 2001,
respectively. During the nine months ended September 30, 2001, the Company
received an income tax refund of approximately $1,500,000 related to a carry
back of net operating losses of its Varsity Spirit Corporation subsidiary for
periods preceding the 1997 acquisition of Varsity Spirit Corporation. This tax
refund had been recorded as a receivable at the time of the acquisition. Other
income tax payments, or refunds, were not significant for the three and nine
month periods ended September 30, 2002.
10
7. INCOME TAXES
Operating results from continuing operations for the three-month and
nine-month periods ended September 30, 2002 reflect a tax expense based on the
anticipated effective annual tax rate for 2002. The anticipated effective annual
tax rate is estimated based on remaining net operating loss carryforwards and
anticipated income and non-deductible expenses for the year. The actual tax rate
for the year could vary substantially from the anticipated rate due to the use
of these estimates.
Operating results from continuing operations for the nine month period
ended September 30, 2001 reflect a tax expense based on the anticipated
effective annual tax rate for 2001.
8. SEGMENT INFORMATION
Net revenues and income or loss from operations for the Company's two
reportable segments are as follows:
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
------------------ --------------------
2002 2001 2002 2001
------- ------- -------- --------
(In thousands) (In thousands)
Net revenues:
Uniforms and accessories $32,913 $32,049 $ 80,614 $ 76,030
Camps and events 28,283 28,077 56,645 54,766
------- ------- -------- --------
Consolidated total $61,196 $60,126 $137,259 $130,796
======= ======= ======== ========
Income from operations
Uniforms and accessories $ 8,434 $ 7,314 $ 15,325 $ 12,798
Camps and events 4,582 4,920 5,794 5,872
Corporate and unallocated expenses (363) (443) (1,351) (1,506)
------- ------- -------- --------
Consolidated total $12,653 $11,791 $ 19,768 $ 17,164
======= ======= ======== ========
9. ACCOUNTING PRONOUNCEMENTS
In June 2001, the Financial Accounting Standards Board (FASB) issued SFAS
No. 142, "Goodwill and Other Intangible Assets." SFAS No. 142 was effective
January 1, 2002. Under the new rules, goodwill and indefinite lived intangible
assets will no longer be amortized, but will be reviewed annually for
impairment. Intangible assets that are not deemed to have an indefinite life
will continue to be amortized over their useful lives.
11
The adoption of SFAS No. 142 requires that an initial impairment assessment
be performed on all goodwill and indefinite lived intangible assets. The Company
completed its initial evaluation of its goodwill in accordance with the
provisions of SFAS No. 142 as of January 1, 2002 and has determined that, at
present, goodwill was not impaired and there is no change in its carrying value
or corresponding charge to the Company's earnings. Fair values were derived
using cash flow analysis. The assumptions used in this cash flow analysis were
consistent with the Company's internal planning. The adoption of the new
standard will benefit earnings beginning in 2002 by approximately $1.9 million
in reduced goodwill amortization. The Company will continue to evaluate the
carrying value of its goodwill in accordance with SFAS No. 142.
The Financial Accounting Standards Board has issued SFAS No. 143,
"Accounting for Asset Retirement Obligations." SFAS No. 143 will be effective
January 1, 2003. The new rules apply to all entities that have legal obligations
associated with the retirement of a tangible long-lived asset. The entity should
recognize a liability for an asset retirement obligation if (a) the entity has a
duty or responsibility to settle an asset retirement obligation, (b) the entity
has little or no discretion to avoid the future transfer or use of the assets,
and (c) the transaction or other event obligating the entity has occurred. The
Company does not believe this pronouncement will have a material impact on its
financial statements.
Effective January 1, 2002, the Financial Accounting Standards Board issued
SFAS No. 144, "Impairment or Disposal of Long-Lived Assets." Under the
provisions of SFAS No. 144, an entity should recognize an impairment loss if the
carrying amount of a long-lived asset or asset group if it is not recoverable
and exceeds its fair value. An entity must test an asset or asset group for
impairment whenever events or changes in circumstances indicate that its
carrying amount may not be recoverable. SFAS No. 144 also includes criteria for
classifying a long-lived asset or asset group as held for sale. Assets held for
sale must be shown at the lower of its carrying amount or fair value less cost
to sell. The Company does not believe SFAS No. 144 will have a material impact
on its financial statements.
Effective January 1, 2002, the Financial Accounting Standards Board issued
SFAS No. 146, "Accounting for Costs Associated with Exit or Disposal
Activities." SFAS No. 146 addresses the accounting and reporting for costs
associated with exit or disposal activities. This Statement requires that a
liability for a cost associated with an exit or disposal activity be recognized
and measured initially at fair value only when the liability is incurred.
12
10. SUBSEQUENT EVENTS
On November 1, 2002, the Company's convertible debt holder elected to
receive their scheduled $1,375,000 debt repayment. The debt holder did not elect
to exercise their right to convert this repayment into equity.
11. RECLASSIFICATION OF PRIOR PERIODS
Certain prior period balances have been reclassified to conform to current
year presentation.
13
Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
RESULTS OF OPERATIONS
Overview and seasonality
In June 2001, the Company sold its Riddell Group Division ("RGD") to an
affiliate of Lincolnshire Management, Inc., a private-equity fund. In
conjunction with this sale, the Company wrote down its net minority investment
in an entity that provided game uniforms to RGD. As a result of these two
transactions, the Company recorded a loss of $20.5 million ($16.9 million after
tax). In September 2001, the Company settled the litigation that had been
brought earlier that year against Umbro Worldwide, Ltd. ("Umbro Worldwide")
involving its licensing agreement between the Company and Umbro Worldwide. In
connection with the settlement and in exchange for an upfront payment and Umbro
Worldwide's agreement to make certain additional payments to the Company, the
Company voluntarily agreed to terminate its license effective November 30, 2001.
The Company recorded the transaction during the fourth quarter of 2001,
establishing the reserves necessary to record the purchase of inventory by Umbro
Worldwide. In April 2002, the Company received a Settlement Agreement from Umbro
Worldwide in which the final selling price of the Umbro-related inventory was
set at $2.6 million. RGD's and Umbro's operating results are shown as income
from operations of discontinued businesses in the Condensed Consolidated
Statements of Operations.
RGD included: (i) all of the Company's Team Sports business, excluding
Umbro branded team soccer products, (ii) the Company's licensing segment, which
allowed third-parties to market certain products using the Riddell and MacGregor
trademarks, and (iii) the Company's retail segment, which marketed a line of
sports collectibles and athletic equipment to retailers.
The Umbro operations that were discontinued as a result of the termination
of the license with Umbro Worldwide included sales of Umbro branded soccer
apparel, equipment and footwear to soccer specialty stores and others within the
team channel of distribution, primarily in the United States.
As a result of the sale of RGD and the discontinuance of the Umbro license,
the Company's continuing financial results consist of operations within the
school spirit industry, including: (i) the design, market and manufacture of
cheerleader and dance team uniforms and accessories, (ii) the operation of
cheerleading and dance team camps throughout the United States, (iii) the
production of nationally televised cheerleading and dance team championships and
other special events and (iv) the operation of studio dance competitions and
conventions.
14
Operations for the three-month period ended September 30, 2002 resulted in
a net income of $10.0 million, or $0.89 per share on a diluted basis, as
compared to a net income of $8.7 million, or $0.79 per share on a diluted basis,
for the third quarter of 2001. The primary reasons for the increase in net
income is increased gross margins realized on uniform and accessories sales
combined with a decrease in net interest expense offset by an extraordinary gain
realized on the early retirement of senior bonds in the third quarter of 2001.
Operating income before interest, taxes, discontinued operations and
extraordinary items for the third quarter of 2002 increased $0.9 million, or
7.3%, to $12.7 million from $11.8 million in the third quarter of 2001. For the
nine-month period, operating income before taxes, interest, discontinued
operations and extraordinary items increased $2.6 million, or 15.2%, in 2002 to
$19.8 million from $17.2 million in 2001. The Company benefited from increases
in revenues and gross margins and decreases in selling, general and
administrative expenses as a percentage of sales, as described in more detail in
the discussion which follows this overview.
The Company's operations are highly seasonal. In recent years, the
Company's operations have been profitable in the second and third quarters, with
the third quarter typically the strongest, while losses have typically been
incurred in the first and fourth quarters. The factors influencing this seasonal
pattern were discussed in the Company's last Annual Report on Form 10-K.
The operating results of RGD and the Umbro Division are reported as income
from operations of discontinued businesses in the Condensed Consolidated
Statements of Operations. The following management's discussion and analysis of
financial condition reflects changes occurring in the Company's income from
continuing operations, exclusive of the discontinued operations of RGD and the
Umbro division.
Revenues
Revenues for the three-month period ended September 30, 2002 increased by
$1.1 million, or 1.8%, to $61.2 million from $60.1 million in the third quarter
of 2001. For the nine-month period ended September 30, 2002, revenues increased
by $6.5 million, or 4.9%, to $137.3 million from $130.8 million in the first
nine months of 2001.
Revenues from the sale of uniforms and accessories increased by $0.9
million, or 2.7%, to $32.9 million in the third quarter of 2002 from $32.0
million for the third quarter of 2001. For the nine-month period, uniform and
accessories revenues increased by $4.6 million, or 6.0%, to $80.6 million from
$76.0 million in 2001. The revenue increase in the third quarter was
attributable to overall increases in all product categories. Revenue increases
for the nine-month period ended September 30, 2002 are also partially due to
increases in uniform sales and product sales at the Company's national
championships combined with increased sales of dance and recital wear to the
studio dance market.
15
Revenues from camps and events increased by $0.2 million, or 0.7%, to $28.3
million in the third quarter of 2002 from $28.1 million in the third quarter of
2001. For the nine-month period, camps and events revenues increased $1.8
million, or 3.4%, to $56.6 million in 2002 from $54.8 million in 2001. The
increase in revenues for the three-month period is attributable to an 1.2%
increase in summer camp revenue and a change in the timing of the Co. Dance
National Finals from June 2001 to July 2002. These increases are offset by
significant decreases in the Company's group tour business, caused by groups
either delaying or cancelling their 2002 tours as a result of the events of
September 11. The increase in revenues for the nine-month period is also
attributable to an increase in the number of participants at the Company's
regional and national cheerleading and dance team championships and at the
Company's studio dance competitions and conventions, as compared to the prior
year. Exclusive of the effects of September 11 on the group tour business, the
Company's camps and events segment experienced revenue increases of 2.8% and
6.9%, respectively, for the three and nine month periods ended September 30,
2002.
Gross Profit
Gross profit for the third quarter of 2002 increased by 3.2% to $25.3
million from $24.5 million in the third quarter of 2001 and for the nine-month
period increased by 6.4% to $57.1 million in 2002 from $53.7 million in 2001.
Gross margin rates increased by 0.6 percentage points to 41.3% in the third
quarter of 2002 from 40.7% in the third quarter of 2001. For the nine-month
period, gross margin rates increased to 41.6% in 2002 from 41.1% in 2001.
Gross margin rates for the uniforms and accessories segment increased to
50.1% in the third quarter of 2002 from 48.9% in the third quarter of 2001. For
the nine-month period the segment's margin rates increased to 48.0% in 2002 from
46.9% in 2001. These increases are a result of the shift in product mix from
lower margin campwear and accessories to higher margin manufactured uniforms and
special event merchandise combined with manufacturing efficiencies realized
through improvements made in the Company's uniform manufacturing process.
Gross margin rates for the camps and events segment decreased slightly to
31.0% in the third quarter of 2002 from 31.4% in the third quarter of 2001. For
the nine-month period the segment's margin rates decreased to 32.5% in 2002 from
33.0% in 2001. The decrease in the gross margin rate for the third quarter is
primarily attributable to higher housing, personnel and program support expenses
associated with higher anticipated revenue growth for the Company's summer camp
operations. The overall decrease for the nine-month period is primarily due to
increased venue and production costs at the Company's special events held during
the first quarter of 2002, combined with higher personnel and program support
expenses associated with higher anticipated revenue growth for the Company's
summer camp operations.
16
Selling, General and Administrative
Selling, general and administrative expenses decreased as a percentage of
revenues to 20.6% in the third quarter of 2002 from 21.1% in the third quarter
of 2001. For the nine-month period, selling, general and administrative expense
rates decreased to 27.2% in 2002 from 27.9% in 2001. The improvement is
principally due to economies of scale realized by spreading fixed and certain
variable administrative expenses over a greater revenue base combined with a
reduction in amortization expense as a result of adopting the standards of
Statement of Financial Accounting Standards No. 142 ("SFAS 142"), "Goodwill and
Other Intangible Assets."
Selling, general and administrative expenses as a percentage of revenues
with respect to the uniforms and accessories segment decreased to 24.1% in the
third quarter of 2002 from 26.4% in the third quarter of 2001. For the
nine-month period the segment's selling, general and administrative expense rate
decreased to 28.4% in 2002 from 30.3% in 2001. These gains were due to improved
economies of scale and reductions in amortization expense as discussed in the
preceding paragraph.
Selling, general and administrative expense ratios for the camps and events
segment increased to 16.6% in the third quarter of 2002 from 14.6% in the third
quarter of 2001. For the nine-month period the segment's selling, general and
administrative expense rate increased to 23.2% in 2002 from 22.4% in 2001. The
increases in the three-month and nine-month expense ratios are attributable to
the segment's slight revenue gains during these periods as compared to changes
in the Company's adminstrative expenditures. Specifically, the Company has
realized a significant decrease in group tour revenues as a result of the
September 11 tragedy, while group tour administrative expenditures have remained
relatively flat on a comparative basis. These increases are partially offset by
reductions in amortization expense as discussed in the above paragraph.
Interest Expense
Interest expense for the nine-month period ended September 30, 2001 has
been reduced by $3.1 million, as a result of an allocation of interest expense
to the discontinued operations of RGD.
17
Interest expense, decreased to $2.0 million in the third quarter of 2002
from $3.0 million in the third quarter of 2001. For the nine-month period ended
September 30, 2002, interest expense decreased by $1.4 million to $6.1 million
from $7.5 million in the first nine-months of 2001. Total interest expense for
the nine-month period decreased by $4.5 million due to lower interest on the
senior notes and the revolving line of credit resulting from lower outstanding
indebtedness in 2002 as compared to 2001. The net interest expense for the
nine-month period ended September 30, 2001 included approximately $250,000 of
interest received as part of a federal income tax refund. The refund, which
included approximately $1.5 million in taxes, related to a carryback of net
operating losses of the Company's Varsity Spirit Corporation subsidiary for
periods preceding the 1997 acquisition of Varsity Spirit Corporation and had
been recorded as a receivable at the time of acquisition.
As a result of the sale of RGD, the Company used a portion of the proceeds
received, approximately $32.7 million, to paydown all of the indebtedness then
outstanding on its line of credit agreement. (See "Liquidity and Capital
Resources" below.)
During 2001, the Company used a portion of the net proceeds received from
the sale of RGD to repurchase $40.7 million of its 10.5% Senior Notes for a
total cost, including commissions, of $32.0 million.
In April 2002, the Company repurchased $8.25 million of its 10.5% Senior
Notes for a total cost, including commissions, of $7.9 million resulting in an
extraordinary gain of $0.1 million, net of taxes.
Income Taxes
Operating results from continuing operations for the three-month and
nine-month periods ended September 30, 2002 include an income tax expense based
on the anticipated effective annual tax rate for 2002. The anticipated effective
annual tax rate is estimated based on the expected utilization of remaining net
operating loss carryforwards and anticipated income and non-deductible expenses
for the year. The actual tax rate for the year could vary substantially from the
anticipated rate due to the use of these estimates.
Operating results from continuing operations for the nine-month period
ended September 30, 2001 reflected a tax expense based on the anticipated
effective annual tax rate for 2001.
18
Liquidity and Capital Resources
The seasonality of the Company's working capital needs is impacted by three
key factors. First, a significant portion of the Company's products are shipped
during the late spring, summer and early fall period, with the related
receivables being paid when the school year begins during the following July to
October period. Second, the Company incurs costs related to the Company's summer
camp business during the first and second quarters as the Company prepares for
the upcoming camp season, while camp revenues are mostly collected in the June
to August period. Lastly, the Company's debt structure impacts working capital
requirements, as the semi-annual interest payments on the Company's 10.5% Senior
Notes come due each January and July.
To finance these seasonal working capital demands, the Company maintains a
credit facility in the form of a $15 million revolving line of credit.
Historically, the outstanding balance on the credit facility usually follows the
seasonal cycles described above, increasing during the early part of the
operating cycle in the first and second quarters of each year and then
decreasing from the middle of the third quarter and into the fourth quarter as
collections are used to reduce the outstanding balance. Such seasonality should
continue in the future.
There were no outstanding balances due under the credit facility as of
September 30, 2002 and 2001.
In April 2002, in accordance with the terms of the Company's debt
instruments, including the Indenture in respect of its 10.5% Senior Notes, the
Company used $7.9 million aggregate net proceeds received in the Umbro
settlement to repurchase $8.25 million aggregate principal amount of its Senior
Notes. As a result of this transaction, the Company recognized an extraordinary
gain, before related income taxes, of $0.2 million. Had the Company not used the
proceeds from the Umbro settlement to repurchase the Senior Notes, the Company
may have had to offer to repurchase a portion of the Senior Notes at par.
The Company's current debt service obligations are significant and,
accordingly, the Company's ability to meet its debt service and other
obligations will depend on the Company's future performance and is subject to
financial, economic and other factors, some of which are beyond the Company's
control. Furthermore, due to the seasonality of the Company's working capital
demands described above, year-over-year growth in the Company's business and
working capital requirements could lead to higher debt levels in future periods.
Management believes operating cash flow together with funds available from the
Company's credit facility will be sufficient to fund the Company's current debt
service, seasonal capital expenditures and other working capital requirements.
However, many factors, including growth and expansion of the Company's business,
could necessitate the need for increased lines of credit or other changes in the
Company's credit facilities in the future.
19
Item 4. CONTROLS AND PROCEDURES
Within the 90-day period prior to the filing of this Quarterly Report on
Form 10-Q, the Company carried out an evaluation, under the supervision and with
the participation of management, including the Chief Executive Officer and the
Chief Financial Officer, of the effectiveness of the Company's disclosure
controls and procedures. Based upon the evaluation, the Company's Chief
Executive Officer and Chief Financial Officer have concluded that the Company's
disclosure controls and procedures are effective to timely alert them to
material information required to be included in the Company's Exchange Act
filings. In addition, there have been no changes in internal controls, or in
other factors that could significantly affect internal controls subsequent to
the date the Chief Executive Officer and Chief Financial Officer completed their
evaluation.
20
Part II OTHER INFORMATION
Item 1. Legal Proceedings
The Company from time to time becomes involved in various claims and
lawsuits incidental to its business. None of these matters are expected to have
a material adverse effect on the Company's consolidated financial statements.
Item 2. Changes in Securities
None
Item 3. Defaults upon Senior Securities
None
Item 4. Submission of Matters to a Vote of Security Holders
None
Item 5. Other Information
None
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibit index:
99.3 Second Amendment to Second Amended and Restated Loan
Guaranty and Security Agreement between Bank America N.A. and Varsity
Brands, Inc.
99.4 John M. Nichols Employment Agreement dated as of
November 1, 2002
99.5 Certification pursuant to Section 906 of the Sarbanes-Oxley
Act of 2002
99.6 Certification pursuant to Section 906 of the Sarbanes-Oxley
Act of 2002
(b) Reports on Form 8-K:
None
21
SIGNATURES
Pursuant to the requirements 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.
VARSITY BRANDS, INC.
Date: November 14, 2002 By: /s/ Jeffrey G. Webb
----------------------------
President and
Chief Executive Officer
Date: November 14, 2002 By: /s/ John M. Nichols
----------------------------
Chief Financial Officer and
Principal Accounting Officer
22
CERTIFICATIONS PURSUANT TO
SECTION 302 OF
THE SARBANES-OXLEY ACT OF 2002
CERTIFICATION
I, Jeffrey G. Webb, certify that:
1. I have reviewed this quarterly report on Form 10-Q of Varsity Brands,
Inc.;
2. Based on my knowledge, this quarterly report does not contain any
untrue statement of material fact or omit to state a material fact
necessary to make the statements made, in light of the circumstances
under which such statements were made, not misleading with respect to
the period covered by this quarterly report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all
material respects the financial condition, results of operations and
cash flows of the registrant as of, and for, the periods presented in
the quarterly report;
4. The registrants's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as
defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant
and we have:
(a) designed such disclosure controls and procedures to ensure
that material information relating to the registrant,
including its consolidated subsidiaries, is made known to us
by others within those entities, particularly during the
period in which this quarterly report is being prepared;
(b) evaluated the effectiveness of the registrant's disclosure
controls and procedures as of a date within 90 days prior to
the filing date of this quarterly report (the "Evaluation
Date"); and
(c) presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures
based on our evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based
on our most recent evaluation, to the registrant's auditors and the
audit committee of registrant's board of directors (or persons
performing the equivalent function):
(a) all significant deficiencies in the design or operation of
internal controls which could adversely affect the
registrant's ability to record, process, summarize and
report financial data and have identified for the
registrant's auditors any material weaknesses in internal
controls; and
23
(b) any fraud, whether or not material, that involves management
or other employees who have a significant role in the
registrant's internal controls; and
6. The registrant's other certifying officers and I have indicated in
this quarterly report whether or not there were significant changes in
internal controls or in other factors that could significantly affect
internal controls subsequent to the date of our most recent
evaluation, including any corrective actions with regard to
significant deficiencies and material weaknesses.
Dated: November 14, 2002 /s/ Jeffrey G. Webb
President
Chief Executive Officer
24
CERTIFICATION
I, John M. Nichols, certify that:
1. I have reviewed this quarterly report on Form 10-Q of Varsity Brands,
Inc.;
2. Based on my knowledge, this quarterly report does not contain any
untrue statement of material fact or omit to state a material fact
necessary to make the statements made, in light of the circumstances
under which such statements were made, not misleading with respect to
the period covered by this quarterly report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all
material respects the financial condition, results of operations and
cash flows of the registrant as of, and for, the periods presented in
the quarterly report;
4. The registrants's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as
defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant
and we have:
(a) designed such disclosure controls and procedures to ensure
that material information relating to the registrant,
including its consolidated subsidiaries, is made known to us
by others within those entities, particularly during the
period in which this quarterly report is being prepared;
(b) evaluated the effectiveness of the registrant's disclosure
controls and procedures as of a date within 90 days prior to
the filing date of this quarterly report (the "Evaluation
Date"); and
(c) presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures
based on our evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based
on our most recent evaluation, to the registrant's auditors and the
audit committee of registrant's board of directors (or persons
performing the equivalent function):
(a) all significant deficiencies in the design or operation of
internal controls which could adversely affect the
registrant's ability to record, process, summarize and
report financial data and have identified for the
registrant's auditors any material weaknesses in internal
controls; and
25
(b) any fraud, whether or not material, that involves management
or other employees who have a significant role in the
registrant's internal controls; and
6. The registrant's other certifying officers and I have indicated in this
quarterly report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal
controls subsequent to the date of our most recent evaluation, including
any corrective actions with regard to significant deficiencies and material
weaknesses.
Dated: November 14, 2002 /s/ John M. Nichols
Senior Vice President
Chief Financial Officer
26