-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, F1Pj8eIud3gpqkph/lliEYaGnwSBOgTSO7YB8omdMHZcZxFamQ8FTaDJFNXzpYyD cXS2KyAfDSBEnbl+sgtoJQ== /in/edgar/work/0000950147-00-001612/0000950147-00-001612.txt : 20001023 0000950147-00-001612.hdr.sgml : 20001023 ACCESSION NUMBER: 0000950147-00-001612 CONFORMED SUBMISSION TYPE: 10-K/A PUBLIC DOCUMENT COUNT: 8 CONFORMED PERIOD OF REPORT: 19981231 FILED AS OF DATE: 20001020 FILER: COMPANY DATA: COMPANY CONFORMED NAME: STYLING TECHNOLOGY CORP CENTRAL INDEX KEY: 0001022832 STANDARD INDUSTRIAL CLASSIFICATION: [2844 ] IRS NUMBER: 752665378 STATE OF INCORPORATION: DE FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-K/A SEC ACT: SEC FILE NUMBER: 000-21703 FILM NUMBER: 743676 BUSINESS ADDRESS: STREET 1: 7400 TIERRA BUENA LANE STREET 2: STE 435 CITY: SCOTTSDALE STATE: AZ ZIP: 85260 BUSINESS PHONE: 602-609-60 MAIL ADDRESS: STREET 1: 7400 TIERRA BUENA LANE STREET 2: SUITE 435 CITY: SCOTTSDALE STATE: AZ ZIP: 85260 FORMER COMPANY: FORMER CONFORMED NAME: STYLING TECHNOLOGIES INC DATE OF NAME CHANGE: 19960913 10-K/A 1 0001.txt AMENDMENT NO. 1 TO FORM 10-K ================================================================================ SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 ---------- FORM 10-K/A [X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the fiscal year ended December 31, 1998 Commission file number 0-21703 STYLING TECHNOLOGY CORPORATION (Exact Name of Registrant as Specified in the Charter) DELAWARE 75-2665378 (State of Incorporation) (I.R.S. Employer Identification No.) 7400 E. Tierra Buena Lane Scottsdale, Arizona 85260 (480) 609-6000 (Address, including zip code, and telephone number, including area code, of principal executive offices) Securities registered pursuant to section 12(b) of the Exchange Act: None Securities registered pursuant to section 12(g) of the Exchange Act: Common Stock, par value $.0001 per share Preferred Stock Purchase Rights Indicated 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 1934 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 [ ] No [X] Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K/A or any amendment to this Form 10-K. [ ] As of March 29, 1999, the aggregate market value of the voting stock held by non-affiliates of the registrant, computed by reference to the average sales price of such stock as of such date on the Nasdaq National Market, was $41,640,001. Shares of Common Stock held by each officer and director have been excluded in that such persons may be deemed to be affiliates. The determination of affiliate status is not necessarily conclusive. As of March 29, 1999, there were 4,067,503 shares of registrant's Common Stock outstanding. DOCUMENTS INCORPORATED BY REFERENCE Portions of the registrant's definitive Proxy Statement for the registrant's 1999 Annual Meeting of Stockholders are incorporated by reference into Part III hereof. ================================================================================ STYLING TECHNOLOGY CORPORATION ANNUAL REPORT ON FORM 10-K/A FISCAL YEAR ENDED DECEMBER 31, 1998 TABLE OF CONTENTS PAGE PART I ITEM 1. BUSINESS........................................................... 1 ITEM 2. PROPERTIES......................................................... 21 ITEM 3. LEGAL PROCEEDINGS.................................................. 21 ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS................ 21 PART II ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS........................................ 22 ITEM 6. SELECTED FINANCIAL DATA............................................ 22 ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (AS RESTATED).................. 24 ITEM 7A.QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK........................................................ 39 ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA........................ ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE................................ 40 PART III ITEM 10.DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT................. 40 ITEM 11.EXECUTIVE COMPENSATION............................................. 40 ITEM 12.SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT..................................................... 40 ITEM 13.CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS..................... 40 PART IV ITEM 14.EXHIBITS FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K........................................................ 40 SIGNATURES ............................................................. 42 INDEX TO CONSOLIDATED FINANCIAL STATEMENTS................................. ---------- STATEMENT REGARDING FORWARD-LOOKING STATEMENTS THE STATEMENTS CONTAINED IN THIS REPORT ON FORM 10-K/A THAT ARE NOT PURELY HISTORICAL ARE FORWARD-LOOKING STATEMENTS WITHIN THE MEANING OF APPLICABLE SECURITIES LAWS. FORWARD-LOOKING STATEMENTS INCLUDE STATEMENTS REGARDING THE COMPANY'S "EXPECTATIONS," "ESTIMATES," "ANTICIPATION," "INTENTIONS," "BELIEFS," "PLANS," OR "STRATEGIES" REGARDING THE FUTURE. FORWARD-LOOKING STATEMENTS ALSO INCLUDE STATEMENTS REGARDING OPERATING RESULTS, CAPITAL RESOURCES, AND LIQUIDITY OR STATEMENTS WITH RESPECT TO THE MARKETS IN WHICH THE COMPANY COMPETES OR THE BEAUTY CARE INDUSTRY IN GENERAL. ALL FORWARD-LOOKING STATEMENTS INCLUDED IN THIS REPORT ARE BASED ON INFORMATION AVAILABLE TO THE COMPANY AS OF THE FILING DATE OF THIS REPORT, AND THE COMPANY ASSUMES NO OBLIGATION TO UPDATE ANY SUCH FORWARD-LOOKING STATEMENTS. THE COMPANY'S ACTUAL RESULTS COULD DIFFER MATERIALLY FROM THE FORWARD-LOOKING STATEMENTS. AMONG THE FACTORS THAT COULD CAUSE ACTUAL RESULTS TO DIFFER MATERIALLY ARE THE FACTORS DISCUSSED IN ITEM 1, "BUSINESS - SPECIAL CONSIDERATIONS." ---------- "ABBA," "Alpha 9," "Biogenol," "Body Drench," "Clean + Easy," "Cosmic," "European Touch," "Framesi," "Gena," "Kizmit," "Maiko," "One Touch," "Pro Finish," "Revivanail," "Roffler," "SRC," and "Suntopia" are the Company's principal registered trademarks. This Report also includes other trademarks of the Company. EXPLANATORY NOTE AMENDED FILING OF FORM 10-K FOR 1998 RESTATEMENT OF FINANCIAL STATEMENTS AND CHANGES TO CERTAIN INFORMATION In November 1999, we announced that as a result of errors and irregularities primarily discovered in the Body Drench division in the recording of net sales and income the Company anticipated restating its financial statements. The procedures we have undertaken to determine the extent of the restatement have resulted in the restatement of our financial statements for 1997 and 1998 (see Note 1 and 13 to the Consolidated Financial Statements filed with this Report). General information in the originally filed Form 10-K was presented as of the March 31, 1999 filing date or earlier, as indicated. Unless otherwise stated, such information has not been updated in this amended filing. Concurrent with the filing of this report, we have filed with the Securities and Exchange Commission (SEC) the 1999 Form 10-K, which discusses recent developments and contains updated general information. Financial statements and related disclosures, including Management's Discussion and Analysis of Financial Condition and Results of Operations, contained in this amended filing reflect, where appropriate, changes to conform to the restatement. PART I ITEM 1. BUSINESS INTRODUCTION The Company is a leading developer, producer, and marketer of a wide array of professional salon products, including hair care, nail care, and skin and body care products, as well as salon appliances and sundries. The Company has well-recognized brand names, a strong distribution network, established marketing and salon industry education programs, and significant production and sourcing capabilities. The Company believes it is the only company that develops, produces, and markets products in each category of the professional salon products industry and that its ability to offer customers a "one-stop shop" for brand-name professional salon products creates a competitive advantage. The Company currently sells more than 550 products under 17 principal brand names, including ABBA Pure and Natural Hair Care products, AquaTonic hair care products, Biogenol hair products, Body Drench skin and body care products, Clean + Easy hair removal products, European Touch II pedicure spa equipment, Framesi hair care products, Gena nail and pedicure products, Kizmit acrylic nail enhancements, Revivanail nail treatments, and Roffler hair care products. In the United States, the Company markets its product lines through professional salon industry distribution channels to more than 2,300 customers, consisting primarily of salon product and tanning supply distributors (which resell to beauty and tanning salons), beauty supply outlets, and salon chains. The Company also markets its products directly to more than 3,000 spas, resorts, and health and country clubs through its in-house sales force. Internationally, the Company sells its products primarily through international salon product distributors. The Company was founded in June 1995 and commenced operations on November 26, 1996. On that date, the Company simultaneously completed its initial public offering and acquired four professional salon products businesses (the "Initial Businesses"). Since that time, the Company has completed seven additional acquisitions. The following table sets forth information regarding each of the Company's acquisitions: 1
ACQUISITION ACQUISITION DATE BRAND NAME (PRODUCT DESCRIPTION) - ----------- ---------------- -------------------------------- Gena Laboratories, Inc. ("Gena") November 1996 Gena (professional natural nail care, pedicure, skin care, and hair care products) Body Drench Division ("Body Drench") November 1996 Body Drench (high-end professional tanning and of Designs by Norvell, Inc. ("DBN") moisturizing products and resort, spa, and health and country club personal care products) J.D.S. Manufacturing Co., Inc. ("JDS") November 1996 Alpha 9 (acrylic and fiberglass nail enhancement products) Kotchammer Investments, Inc. (dba Styling November 1996 SRC (high-end salon appliances and salonwear) Research Company) ("KII") Suntopia Division of Creative Laboratories, March 1997 Suntopia (high-end tanning products) Inc. ("Suntopia") U.K. ABBA Products, Inc. ("ABBA") June 1997 ABBA Pure and Natural Hair Care (aromatherapy-based professional hair care products) One Touch and Clean + Easy Division of December 1997 Clean + Easy and One Touch (salon and retail hair Inverness Corporation and Inverness (UK) removal products) Limited (together, "Inverness") Pro Finish USA, Ltd. ("Pro Finish") May 1998 Pro Finish, Kizmit, and Cosmic (nail care products) European Touch Co., Incorporated, and June 1998 European Touch (professional nail enhancement and two related nail companies ("European treatment products) Touch") European Touch, Ltd. II ("European Touch II") June 1998 European Touch II (pedicure spa equipment) Ft. Pitt Acquisition, Inc. and its 90% August 1998 Framesi, Roffler, and Biogenol (professional hair owned subsidiary Ft. Pitt - Framesi, care products) Ltd. (together, "Framesi USA")
The Company's principal executive offices are located at 7400 East Tierra Buena, Scottsdale, Arizona, 85260. The Company's telephone number is (480) 609-6000. As used herein, the terms the "Company" and "Styling" mean Styling Technology Corporation and its subsidiaries. INDUSTRY OVERVIEW Professional salon products consist of hair care, nail care, and skin and body care products as well as salon appliances and sundries that are used by salon professionals in rendering salon services to their clients. Many professional salon products also are retailed to clients and other customers of salons, resorts, spas, health and country clubs, and beauty supply outlets, typically upon the advice of a salon professional who recommends products to address the client's individual needs. Professional hair care products include shampoo, conditioner, styling gel, glaze, mousse, hair spray, permanent, hair relaxer, and hair color products. Professional nail care products include fiberglass and acrylic nail enhancement solutions applied by the salon professional when performing the nail service and the accessories used by the professional to apply the solutions; natural nail care and pedicure solutions and accessories; and polishes. Skin and body care products include body lotions, tanning products, cosmetics, skin moisturizers, hair removal and depilatory products, and other personal care products (such as shaving creams and antiperspirants) used by salon professional in rendering salon services (such as facials, manicures, pedicures, leg and body waxing, paraffin therapy, aromatherapy, and thermo-therapy) or available for use by patrons of tanning salons, spas, resorts, and health and country clubs. 2 Professional salon appliances and sundries include hair dryers, curling irons, brushes, pedicure spas, furniture, and salon wear (such as capes). The professional salon products industry has grown significantly during the last several years. According to industry sources, professional salon industry revenue (which includes revenue from salon services and the sale of salon products) for 1998 was approximately $40 billion in the United States and $80 billion worldwide. Industry sources estimate that there are approximately 127 million client visits to salons each month and that there are more than 200,000 beauty salons and 1.8 million licensed cosmetologists in the United States. Professional salon products companies sell their products primarily to regional, full-service salon product distributors that resell products from multiple manufacturers to salons and salon professional. The professional salon products industry is highly fragmented. Of the approximately 700 companies selling professional salon products in the United States, most generate less than $10 million in sales and focus on a single product category. For example, most companies offering professional salon hair care products do not also offer nail or skin care products. Professional salon products have two end consumers: the salon professional who uses them in the performance of salon services and the salon client who purchases them for personal use. The Company believes salons typically generate between 10% and 30% of their revenue from retail sales of professional salon products. As the users and "prescribers" of professional salon products, salon professionals typically select products on the basis of performance rather than price. As a result, suppliers of professional salon products focus on educating distributors and salon professionals on the uses and benefits of their products and on industry trends. Because salon professionals "prescribe" these products and sell them primarily in connection with the rendering of a service, professional salon products typically foster strong brand loyalty and exhibit relative price insensitivity. Consequently, professional salon products generally command substantially higher profit margins that mass-marketed beauty products. STRATEGY The Company's objective is to be the leading professional salon products company in the United States and internationally. In order to achieve this objective, the Company is pursuing a strategy of continued growth through internal business expansion and acquisitions. Key elements of this strategy include the following: INTERNAL GROWTH STRATEGY The Company intends to increase revenue and improve margins within its existing product lines and to develop new product lines. Elements of its internal growth strategy include the following: * LEVERAGE WELL-ESTABLISHED DISTRIBUTION CHANNELS. The Company intends to leverage its distribution channels by providing distributors with an increasingly comprehensive array of products through acquisitions and internal development of new brands. Through management's existing relationships and those of acquired companies, the Company has developed and integrated an increasingly extensive distribution network. The Company believes that offering a growing array of well-known brands in all salon product categories will further enhance its position as a key supplier to many of its customers. * CAPITALIZE ON BRAND NAME RECOGNITION; LINE EXTENSIONS. The Company believes the strong brand name recognition of its product lines lends itself to line extension. For example, ABBA, one of the top brands in the aromatherapy segment of the hair care category, recently introduced its Botanical High line of volume therapy hair care products. The Company believes that the loyalty of salons and salon professionals to strong brands generally makes them receptive to line extensions that capitalize on the credibility of those brands. Strong brand names also provide the Company the opportunity to cross-market established and developing brands and products. * EXPAND DISTRIBUTION TO SALON CHAINS. The Company is aggressively targeting sales directly to salon chains, which the Company believes are underserved by distributors and other salon product companies. The Company believes that its increasingly diverse product offerings will enable it to offer salon chains the benefits of one-stop shopping, centralized single-source ordering, tailored promotional programs, and dedicated customer service. The Company has formed a sales and marketing team focused exclusively on further penetrating this underserved segment of the salon product market. 3 * EXPAND DISTRIBUTION OF EXISTING PRODUCTS INTERNATIONALLY. The Company believes significant opportunities exist to increase sales and profits through the expansion of the international distribution of its products. Currently, the non-U.S. market for professional salon products represents approximately 50% of the worldwide market. The Company, however, generated only approximately 6% of its pro forma 1998 net sales outside of the United States. The Company is expanding its international distribution, which currently includes 37 countries. The Company will continue to focus on introducing its products into its recently expanded international distribution channels, which provide access to most international beauty markets. * ENHANCE OPERATIONAL EFFICIENCIES OF ACQUIRED BUSINESSES. The Company focuses on integrating acquired businesses. Following each acquisition, the Company enhances operational efficiency by (1) eliminating duplicative administrative functions, thereby lowering overhead expenses, (2) expanding distribution channels, and (3) adding and disseminating further market and product knowledge throughout the Company's operations. The Company plans to further enhance operational efficiency through its new corporate headquarters and centralized operations center in Scottsdale, Arizona. The Company believes that the continued realization of operational efficiencies through its centralization and business process reengineering efforts will enhance internal growth and profitability. * CAPITALIZE ON LIFESTYLE TRENDS. The Company intends to continue to capitalize on current lifestyle trends that are favorable to the professional salon industry. Growing consumer focus on healthy living and personal indulgences will continue to fuel expansion in the salon/spa industry, as the demand for services such as body treatments and massages increases. Additionally, the aging of the "baby boomers," those born between 1945 and 1964, is expected to benefit the salon industry. During 1999, the Company will be implementing new centralized management and information systems, which the Company believes will enhance the productivity of its existing operations and future acquisitions. The system will permit the Company to improve economies of scale through centralized systems for accounting, purchasing, inventory management, financial reporting, and customer service. The Company believes that its investment in its management and information systems will create a platform for long-term growth. The new systems will assist the Company to access real-time information regarding customers, distributors, purchase orders, inventory availability, sales order history, and other information. The systems will facilitate the Company's integration of future acquired businesses and improve operations by allowing the Company to: * provide greater customer service by providing sales representatives with product information, promotions, and individual customer purchasing patterns; * improve sales and marketing functions by tracking fast and slow moving products and creating customized sales reports; * facilitate improved inventory management and purchase forecasting; and * transition acquired businesses onto the Company's centralized management and information systems more efficiently by providing a more flexible platform for data conversion. ACQUISITION STRATEGY The Company seeks to acquire professional salon product businesses possessing complementary salon products with well-recognized brand names and strong distribution networks and to capitalize on the substantial fragmentation and growth potential existing in the professional salon products industry. The Company believes that there are many attractive acquisition candidates in the professional salon products industry, primarily as a result of the highly fragmented nature of the industry and the desire of owners for exit strategies. The Company maintains a disciplined approach to acquisitions and evaluates each potential acquisition based on the following acquisition goals: * CONTINUE TO ACQUIRE LEADING BRANDS. The Company plans to continue its strategy of acquiring leading brand names that complement its portfolio of brands and command strong customer loyalty. By following this strategy, the Company plans to solidify its position as a leading supplier of professional salon products and further enhance its 4 relationships with distributors. Additionally, well-known and well-respected professional brands are able to command consistently higher prices than mass-marketed retail brands and lesser known or respected professional brands. * DIVERSIFY AND STRENGTHEN PRODUCT OFFERINGS. The Company intends to acquire companies and product lines that diversify and strengthen its portfolio of salon products. In this regard, the Company seeks to acquire complementary products that will enable it to offer multiple brands in each salon product category and a broader range of products addressing the various niches within these categories. The Company believes that this approach will enable it to offer distributors and beauty supply outlets, which typically carry multiple brands in each category, a more complete "one-stop shop" for the majority of their salon products. * STRENGTHEN DISTRIBUTION NETWORK. The Company intends to acquire companies and product lines that strengthen its relationships with domestic and international distributors. By acquiring companies with strong distribution networks, the Company will be in a position to increase sales by introducing its existing products into new distribution channels and newly acquired or developed products into existing distribution channels. * CONTINUE TO PURSUE ACQUISITIONS AT ATTRACTIVE CASH FLOW MULTIPLES. The Company plans to continue to pursue acquisition candidates at attractive cash flow multiples. To achieve this goal, the Company evaluates each acquisition candidate's historical operating results and future earnings potential, the size and anticipated growth of the market it serves, and its relative position in that market. The Company typically seeks to acquire companies and product lines at acquisition multiples of three to six times earnings before interest, taxes, depreciation, and amortization "EBITDA." PRODUCTS The Company offers products in all salon product categories. The Company sells more than 550 professional salon hair care, natural nail care and nail enhancement products, skin and body care products, and salon accessories and sundries, representing approximately 1,500 stock keeping units ("SKUs"). The Company believes that the strength of its brand names is based on the reputation of its products for quality among salon professionals, the performance of its products, and its focused commitment to the needs of salon professionals and their clientele. The Company believes these brand names are widely recognized by salon product distributors and salon professionals and their clients as high-quality, effective products. In addition, the Company believes that the strength of the brand names of its existing products and its reputation within the industry will assist it to successfully develop and market product line extension and new brands. The table below sets forth a description of the Company's principal products, the brand names under which the products are sold, and the Company's estimate of approximate percentages of such products sold for professional salon use and retailed to salon and customers.
% % RETAIL SALON SALES BY PRODUCT CATEGORY PRODUCT DESCRIPTION BRAND NAMES USE(1) SALONS(1) - ---------------- ------------------- ----------- ------ --------- Hair Care Shampoo, conditioner, hair ABBA, AquaTonic, 40% 60% color, and styling and Biogenol, Body Drench, finishing aids Framesi, Gena, Roffler Nail Care Natural nail care products, Alpha 9, Cosmic, 70 30 acrylic and fiberglass nail European Touch, Gena, enhancement products, nail Kizmit, Pro Finish, treatments, nail polish, Revivanail light-bonded nail systems, and manicure and pedicure solutions and accessories
5
Skin and Body Care Moisturizing lotion, indoor and Body Drench, Clean + 35 65 outdoor tanning products, Easy, Gena, One Touch, personal care products, Suntopia paraffin waxes, thermo-therapy treatments, and hair removal systems and depilatory products Salon Equipment Hairdryers, curling irons, European Touch II, 100 0 Appliances and Sundries salon pedicure spas, salon Maiko, SRC furniture, and salonwear (capes/aprons)
- ---------- (1) Company estimates HAIR CARE PRODUCTS The Company offers a variety of hair care products at various price points under the ABBA, AquaTonic, Biogenol, Body Drench, Framesi, Gena, and Roffler brands. The ABBA line, which is marketed under the ABBA Pure and Natural trademark, consists of highly concentrated, high-quality products. The ABBA line consists of 100% vegan, aromatherapy inspired, herbal hair care products using botanical ingredients. The ABBA line includes shampoo, conditioner, gel, and hair spray made using a blend of herbal therapy botanicals, tri-molecular proteins, panthenol, and neutral henna designed to produce fuller, thicker, and shinier hair. The Company recently introduced AquaTonic, its internally developed, pure and natural hair care line, which is designed to protect hair against the negative effects of hard and soft water and variances in humidity. The Company's Framesi product line features premium quality hair color products marketed exclusively for use in salons. The Company also markets under the Biogenol brand name a complementary line of shampoos, conditioners, and styling aids specifically formulated for color-treated hair. The Roffler line includes high-quality, salon-distributed shampoos, conditioners, and styling aids designed primarily for men between the ages of 18 and 40. ABBA, Biogenol, Framesi, and Roffler products are used widely throughout the hair care industry and generate significant salon retail sales. Under the Gena brand name, the Company offers a line of tea-tree oil hair care products with anesthetic qualities designed to relieve dry, itching scalp. In addition, the Company markets hair care products as a part of its Body Drench line of personal care products, primarily to spas, resorts, and health and country clubs. NAIL CARE PRODUCTS The Company believes that it has the most complete and diverse line of branded products for salon professionals in the nail care category. The Company's nail care product offerings consist of products designed to support the various salon services performed by nail technicians, including manicure, pedicure, acrylic and fiberglass nail enhancement, natural nail treatments, and nail polishes. Most nail care companies encourage distributors to purchase their entire product line in order to buy any of their nail care products. The Company, however, offers a number of top-selling products across all segments of the nail category, permitting its customers to select and purchase individual SKUs from among multiple brands, including Alpha 9, European Touch, Gena, Kizmit, Pro Finish, and Revivanail. The Company, for example, offers distributors and salon chains the ability to purchase the Company's Revivanail nail treatments and Alpha 9 acrylic nail enhancement products without having to purchase the full line of Revivanail or Alpha 9 products. The Company's Alpha 9, European Touch, and Kizmit acrylic professional nail enhancement products consist of complete lines of liquids, powders, tips, files, and other implements and treatments necessary for the professional nail technician to complete the acrylic nail enhancement process. The Gena line of natural nail care products features Warm-O-Lotion, a collagen-enriched manicure lotion that is prominently featured in salons throughout the United States. The Gena line also includes professional pedicure products, such as Pedi Soft, a collagen-enriched conditioning lotion; Pedi Care dry skin lotion; and Pedi Soak foot bath. The Gena product line also includes paraffin therapy products, such as Paraffin Springs Therapy Spa, a paraffin bath 6 for conditioning heat therapy treatments; the Healthy Hoof nail and skin treatment line to strengthen, moisturize, and condition nail and cuticles; and MRX antiseptics and lotions for use by salon professionals. The Company offers base coats, top coats, nail glues, and cuticle lotions under its European Touch and Pro Finish brands. The Pro Finish line of nail care products also features a light bonded nail system that seals the nail enhancement under ultraviolet lighting. The Company's European Touch brand features nail treatment products, such as Revivanail and Theracreme. The Company also offers Momentum, a three-step nail overlay system that offers simplicity, speed, and strength. SKIN AND BODY CARE The Company sells a broad range of professional skin and body care and tanning products, including moisturizers, lotions, depilatories, and hair removal products, under its Body Drench, Clean + Easy, Gera, One Touch, and Suntopia brands. Body Drench professional skin care products include moisturizing lotions and body baths supplemented and Vitamins A and E and botanical extracts for moisture retention and skin rejuvenation and alpha hydroxy acids for natural skin exfoliation. Body Drench indoor tanning products replace moisture lost during tanning and promote faster, darker tanning results. The Company also offers outdoor tan care and sun protection products under the Body Drench name. The Suntopia line of exclusively distributed professional tanning products includes various tanning creams and lotions, enriched shower gels, a moisture replenishing lotion, and a tan enhancing product. Suntopia products, which are made using an exotic blend of botanicals and forested extracts, are designed to promote and maintain a long-lasting tan. The Suntopia line complements the Body Drench line by targeting a younger market. Clean + Easy and One Touch brands include patented professional hair removal products. The Clean + Easy brand serves the professionals salon market with an extensive line of hair removal products and related sundries used by salon professional. The Clean + Easy Roll-On Wax System is one of the Company's top selling hair removal products. The One Touch line serves the retail consumer in the personal care market. One Touch products include roll-on waxers, depilatories, and electrolysis products. SALON EQUIPMENT, APPLIANCES, AND SUNDRIES The Company sells salon equipment, appliances, and sundries, including pedicure spa equipment, hairstyling appliances, and salonwear. The Company markets under the European Touch II name various salon equipment products, such as whirlpool footspas, salon chairs designed for clients and technicians, manicure and pedicure tables and footrests, and portable salon accessory carts. These products are intended to capitalize on the growing trend among salons to offer services beyond the basic salon services. The SRC line of professional curling irons and blow dryers are recognized within the salon industry as among the finest quality in salon appliances. The appliances are designed for high usage and durability and feature quick startup and recovery capabilities. All SRC professional curling irons are backed by the industry's only three-year warranty. The Company's Maiko salonwear line features capes and aprons for the stylist and the stylist's clientele. PRODUCT DEVELOPMENT The Company seeks to leverage the significant brand-name recognition of its existing product lines by introducing new products and formulations under its core brand names as well as under newly developed brands. The Company believes that its diverse product offerings provide it with greater capacity and know-how to develop, test, and market new products in each of its product lines, including the expanded application of proprietary technologies. The Company contracts with third-party manufacturers to develop new formulations that meet the Company's specifications and quality standards. The Company has not incurred and does not expect to incur significant capital expenditures in connection with its product development efforts. The Company's management, working together with its sales and marketing and product development personnel, continuously monitors shifts in the salon industry to identify new product opportunities. Feedback 7 from salon professionals and the Company's educators also play a significant role in product development. The Company believes the experience of its key managers, their relationships within the industry, and the Company's product line orientation enable it to quickly recognize and respond to salon innovations and industry trends. MARKETING The Company sells its professional salon products and appliances primarily through professional salon industry distribution channels to salon product and tanning supply distributors, salon chains, and beauty supply outlets, and, to a lesser extent, directly to spas, resorts, and health and country clubs throughout the United States and in Canada, Europe, Latin America, Australia, and Asia. The Company believes that its strategy of marketing its salon products exclusively for use in or resale by the salon industry complements the professional image of the Company's products and fosters a high degree of loyalty by distributors of professional salon products. The Company's sales and marketing efforts focus on educating salon professionals and salon product distributors regarding the high quality and performance benefits of the Company's products as well as the latest trends and developments in the salon industry. The Company's marketing program includes participation in salon industry trade shows, at which salon product manufacturers exhibit and sell their products to wholesale salon product distributors; several annual domestic and international salon professionals trade shows; and numerous professional salon distributor-sponsored shows, at which products, styles, and techniques are demonstrated to salon professionals. The Company's marketing program emphasizes customer education through regular in-the-field product demonstrations for salon professionals, usually in conjunction with the distributors' sales and marketing efforts. In addition, the Company's products are advertised in trade and distributor publications and promoted in national magazines, including GLAMOUR, GOOD HOUSEKEEPING, INSTYLE, MARIE CLAIRE, MCCALL'S, MIRABELLA, and Self. The Company also produces educational videos and literature for distribution to distributors and salon professionals. SALON AND DISTRIBUTION The Company believes that it has strong relationships in each of the professional salon distribution channels, including exclusive and open channels. Products sold through exclusive channels are available to a limited number of distributors in each region, while those sold through open channels are available to all distributors. See Item 1, "Business -Special Considerations - Dependence on Major Customers." (As Restated) Seven regional sales managers and a strong educational support team sell the ABBA line of hair care products on an exclusive basis to approximately 50 salon product distributors and salon chains throughout the United States, Canada, and Australia. Eight regional sales managers and an in-house educational support team sell the Company's hair color and hair care products under the Framesi, Biogenol, and Roffler brand names on an exclusive basis to 61 salon product distributors throughout the United States and Latin America. A professional outside sales force of 24 representatives sells the Company's nail care product lines nationally and internationally to approximately 500 salon product distributors. This distribution base includes Sally Beauty Company, Inc. ("Sally"), the largest wholesale supplier of professional supply products with more than 1,900 supply stores worldwide. A sales force of seven marketing representatives, telemarketers, and field sales personnel as well as approximately 25 independent manufacturer representatives sell Body Drench products to approximately 155 salon product distributors, 75 tanning supply distributors, and directly to more than 3,000 spas, resorts, and health and country clubs throughout the United States and in Canada, Europe, Latin America, and Australia. A sales force of two employees and approximately 30 manufacturer representatives sell SRC salon appliances and salonwear nationally on an exclusive basis to more than 50 salon product distributors, 14 beauty schools, and six salon chains. One sales manager and approximately 25 manufacturer representatives sell Clean + Easy products to approximately 1,000 customers. Two sales managers and approximately 25 manufacturer representatives sell One Touch products to approximately 400 customers. Together, Clean + Easy and One Touch products are sold internationally to approximately 100 customers by a director of international sales. An internal sales force of six marketing representatives sells the Company's European Touch II pedicure spa products to approximately 700 salon product distributors and three salon chains. 8 PRODUCTION The Company has developed relationships with third parties to manufacture most of its products. Two manufacturers in China produce certain of the Company's hair removal appliances. Although the Company generally does not have long-term contracts with its manufacturers, the Company owns most of the formulations, tools, and molds utilized in the manufacturing processes of its products and believes it could substitute other manufacturers if necessary. See Item 1, "Business - Special Considerations - Dependence on Third Parties for Manufacturing" and "Special Considerations - Risk of International Operations." The Company produces certain of its Clean + Easy and One Touch depilatory products at its 32,000 square foot facility in Fair Lawn, New Jersey. The 8,600 square foot manufacturing area in the Company's Fair Lawn facility is devoted to the production of wax and the packaging of a variety of hair removal appliances for domestic and export markets. The wax production area consists of automatic and manual batching and filling operations. The Company maintains raw materials and work-in-process inventories in a 10,000 square foot warehouse and maintains finished goods in the 5,000 square foot shipping and receiving area. The Company produces certain of its Biogenol and Roffler hair care products, including shampoos, conditioners, and styling aids in its approximately 47,000 square foot facility in Corapolis, Pennsylvania. In addition, the Company assembles and upholsters its European Touch II salon furniture and appliances in its 15,000 square foot manufacturing and warehousing facility in Butler, Wisconsin. Raw materials used to produce the Company's professional salon products (other than salon appliances and sundries) include water, alcohol, mineral and natural oils, fragrances, other chemicals, and a wide variety of packaging materials and compounds including containers, such as cardboard boxes and plastic containers, container caps, tops, valves and labels. The Company purchases all of these raw materials from outside sources. The principal raw materials and packaging components for the Company's products are available from numerous domestic and international suppliers. Although the Company itself does not purchase the raw materials used to manufacture the majority of its products, it is potentially subject to variations in the prices it pays its third-party manufacturers for products depending on their costs for raw materials. While the industry from time to time has experienced raw material cost increases, the Company believes it will be able to purchase its requirements at competitive prices. To date, increases in raw material costs have not had a material effect on the Company's operating results. The Company continually monitors the quality of its products. The Company also carries product liability insurance at levels it believes to be adequate. COMPETITION The Company's products compete directly against professional salon and other similar products sold through distributors and professional salons. The Company competes on the basis of brand recognition, quality, performance, distribution, and price. The Company's principal competitors in the professional salon hair care products market include Nexxus Products Co., Paul Mitchell Systems, Matrix, Redken, and Sebastian International. The Company's competitors in the professional salon nail care market include Creative Nail Design, Inc., OPI Products, Inc., Star Nail Products, Inc., and Backscratchers, Inc. The Company's largest competitors in the professional salon skin and body care products market include California Suncare, Inc., Supre Inc., Swedish Beauty Manufacturing, Inc., Australian Gold, Inc., American International, Inc. and Divi International. The Company's largest competitors in the professional salon appliances and sundries market are Helen of Troy Limited, Belson Products (a division of Windmere Corporation), Conair Corporation, Cricket Brush Company (a division of West Coast Beauty Supply Co.), Andre (a division of Fromm International, Inc.), and Betty Dain Creations, Inc. In addition, the Company's professional salon products compete indirectly against hair care, nail care, and skin and body care products as well as salon appliances and sundries sold through a variety of non-salon retail channels, including department stores, mall-based specialty stores and, to a lesser extent, mass merchants, drugstores, supermarkets, telemarketing programs, television "infomercials," and catalogs. See Item 1, "Business - Special Considerations - Competition." 9 INTELLECTUAL PROPERTY The Company has registered, or has pending applications for registration for, its principal trademarks and brand names in the United States and in foreign countries. Principal trademarks and brand names of the Company include ABBA Pure and Natural Hair Care, Alpha 9, AquaTonic, Biogenol, Body Drench, Clean + Easy, Cosmic, European Touch, Gena, Kizmit, One Touch, Pro Finish, Revivanial, Roffler, SRC, and Suntopia. The Company believes its position in the marketplace depends to a significant extent upon the goodwill engendered by its trademarks and brand names and, therefore, considers trademark protection to be important to its business. The Company will seek to register or otherwise protect all significant trademarks and brand names in all active geographic markets. While the Company currently holds certain patents, the Company does not consider any single patent to be material to the conduct of its business. The Company relies on all facets of intellectual property law to protect its proprietary information. See Item 1, "Business - Special Considerations - Intellectual Property." GOVERNMENT REGULATION Certain of the Company's advertising and product labeling practices are subject to regulation by the Federal Trade Commission (the "FTC"), and certain of its professional salon product production practices are subject to regulation by the Food and Drug Administration (the "FDA") as well as by various other federal, state, and local regulatory authorities. Compliance with federal, state, and local laws and regulations has not had a material adverse effect on the Company to date. Nonetheless, federal, state, and local regulations in the United States that are designed to protect consumers have had, and can be expected to have, an increasing influence on product liability claims, production methods, product content, labeling, and packaging. In addition, any expansion by the Company of its operations to produce professional salon products that include over-the-counter drug ingredients (such as certain sun screen ingredients) would result in the Company becoming subject to additional FDA regulations as well as a higher degree of inspection and greater burden of regulatory compliance than currently exist. EMPLOYEES As of March 1, 1999, the Company employed 346 persons, consisting of 135 administrative employees, 139 warehouse and production employees, and 72 sales and marketing employees. Framesi USA, a subsidiary of the Company, is a party to a collective bargaining agreement relating to certain production employees. The Company believes that its relations with its employees are good. NAME AGE POSITION ---- --- -------- Sam L. Leopold......... 45 Chairman of the Board, President, and Chief Executive Officer Richard R. Ross........ 32 Executive Vice President, Chief Financial Officer, Treasurer, and Director N. Bruce Cowgill....... 52 Executive Vice President - Operations Michael L. Kaplan...... 30 Executive Vice President, General Counsel, and Secretary J. Timothy Montrose.... 32 Chief Accounting Officer SAM L. LEOPOLD, a founder of the Company, has served as Chairman of the Board and Chief Executive Officer of the Company since June 1995 and as President of the Company since February 1998. Mr. Leopold previously owned and served as President and Chairman of Beauty Boutique International, which was founded in 1990 and operated three retail salons in Arizona. From 1986 to 1991, Mr. Leopold served as Executive Vice President of Consumer Beauty Supply, Inc. (dba Beauty Express), a mall-based retail chain of beauty salons. During that time, Mr. Leopold was responsible for day-to-day operations and oversaw the growth and development of Beauty Express from fewer than 20 retail salons to 10 more than 50 retail salons. From 1989 to 1991, Mr. Leopold served as President of Avanti International, Inc. and developed a line of hair care products. RICHARD R. ROSS has served as Chief Financial Officer and Treasurer of the Company since April 1997 and as Executive Vice President and a director of the Company since May 1998. Mr. Ross served in the audit and business advisory group of Arthur Andersen LLP from June 1989 to April 1997, most recently in the position of Manager. In his capacity at Arthur Andersen LLP, Mr. Ross worked with the Company from its inception in June 1995, as well as with other acquisition-oriented public companies, until joining the Company in April 1997. Mr. Ross is a certified public accountant. N. BRUCE COWGILL has served as Executive Vice President - Operations of the Company since July 1998. Mr. Cowgill served as Vice President, North American Sales of Sebastian International, a professional hair care company, from August 1995 to July 1998. In 1989, Mr. Cowgill founded Environmental Solutions Labs, a consulting firm serving health and beauty aid manufacturers. Mr. Cowgill served as President of Environmental Solutions Labs until 1995. Mr. Cowgill served as President and Chief Executive Officer of State Supply Warehouse Co., the largest professional beauty supply distributor in North America, from December 1986 to April 1989. In addition, he served as Vice President of Global Marketing, Advertising and Education, and International Sales for Redken Laboratories from July 1978 to August 1983. Mr. Cowgill held marketing management positions with Proctor and Gamble, Warner Lambert, and R.J. Reynolds from 1972 to 1978. MICHAEL L. KAPLAN has served as Executive Vice President, General Counsel, and Secretary of the Company since July 1998. Mr. Kaplan was an attorney with the Phoenix-based law firm of O'Connor, Cavanagh, Anderson, Killingsworth & Beshears, P.A. from September 1995 to June 1998, when he specialized in mergers, acquisitions, and corporate finance and represented acquisition-oriented public companies, including the Company. Mr. Kaplan also was an attorney with Fennemore Craig, P.C. from September 1993 to August 1995. J. TIMOTHY MONTROSE has served as Chief Accounting Officer of the Company since November 1998 and has been employed by the Company since December 1996. From November 1995 to December 1996, Mr. Montrose served as the Accounting Manager for Cellular World Corporation, a retail chain of wireless communication products stores. From April 1993 to November 1995, Mr. Montrose served as Senior Accountant with the Dallas Stars Hockey Club of the National Hockey League and was actively involved in the club's transition from Minneapolis to Dallas. 11 SPECIAL CONSIDERATIONS THE FOLLOWING FACTORS, IN ADDITION TO THOSE DISCUSSED ELSEWHERE IN THIS REPORT, SHOULD BE CAREFULLY CONSIDERED IN EVALUATING THE COMPANY AND ITS BUSINESS. CERTAIN FACTORS THAT COULD ADVERSELY AFFECT OPERATING RESULTS A wide variety of factors could adversely impact the Company's net sales and operating results. Many of these factors are beyond the Company's control. These factors include: * the Company's ability to identify trends in the professional salon products industry; * the Company's ability to create and introduce products on a timely basis that take advantage of industry trends; * the continued market acceptance of the Company's products among salon professionals and their clientele; * the Company's ability to arrange for timely production and delivery of its products; * the level and timing of orders placed by customers; and * competition and competitive pressures on prices. The success of the Company's operations depends to an extent upon a number of factors relating to discretionary consumer spending. These factors include economic conditions, such as employment, business conditions, interest rates, and tax rates, as well as the continued growth of the professional salon products industry. General social trends and economic conditions could adversely affect consumer spending, which would impact the Company's growth, net sales, and profitability. In addition, a decline in the demand for professional salon products and related merchandise could adversely affect the Company's business, financial condition, and operating results. ACQUISITION STRATEGY The Company completed four acquisitions in fiscal 1996, three acquisitions in fiscal 1997, and four acquisitions in fiscal 1998. The success of the Company's acquisition strategy depends in large part on its ability to acquire additional professional salon product businesses. The Company may not be able to continue to identify and complete suitable acquisition opportunities. In addition, increased competition for acquisition candidates may increase purchase prices for acquisitions to levels beyond the Company's financial capability or assessment of value. Unforeseen expenses, difficulties, and delays frequently encountered in connection with acquisitions could inhibit the Company's growth and negatively impact profitability. The Company's ability to complete acquisitions successfully will depend upon the availability of adequate cash reserves, the Company's ability to issue its securities, including Common Stock, in acquisitions, and its ability to raise additional cash through debt and equity financing. The amount of securities that the Company may be required to issue and the terms on which the Company can secure debt or equity financing will depend on the operating performance and financial condition of the Company, the trading price of its Common Stock, and conditions in the debt and equity markets. The size, timing, and integration of any future acquisitions may cause substantial fluctuations in operating results from quarter to quarter. Consequently, operating results for any quarter may not be indicative of the results that may be achieved for any subsequent fiscal quarter or full fiscal year. In addition, the Company may issue shares of Common Stock in connection with future acquisitions. The issuance of such shares would result in the dilution of the voting power of the currently outstanding shares and could have a dilutive effect on earnings per share. 12 INTEGRATION OF BUSINESS OPERATIONS The integration of the management, operations, and facilities of acquired businesses could involve unforeseen difficulties. The difficulties could have a material adverse effect on the Company's business, financial condition, and operating results. The Company could encounter difficulties in: * integrating and managing effectively the operations of acquired businesses with the Company's operations; * achieving the Company's operating growth strategies with respect to acquired businesses; * obtaining increased revenue opportunities as a result of the anticipated synergies created by expanded product offerings and additional distribution channels; and * reducing the overall selling, general, and administrative expenses associated with acquired businesses. The Company conducts due diligence reviews of each acquired business and receives representations and warranties regarding each acquired business. The Company's acquisition agreement with respect to each acquisition generally contains purchase price adjustments, rights of set-off, and other remedies in the event that certain unforeseen liabilities or issues arise in connection with the acquisition. However, these remedies may not be sufficient to compensate the Company in the event that any unforeseen liabilities or other issues arise. The Company has begun to use the opportunities created by the combination of acquired businesses to effect substantial cost savings, including a reduction in operating expenses as a result of the elimination of duplicative administrative, warehouse, and distribution facilities, functions, and personnel. During fiscal 1998, the Company began to implement a new computer system to assist with the integration of acquired businesses. The new computer system will assist Company personnel in accessing information regarding customers, distributors, purchase orders, inventory levels, sales order history, and other information. See Item 1, "Business - Strategy - Internal Growth Strategy." Significant uncertainties, however, accompany any business combination, and the Company may not always be able to integrate the facilities, functions, and personnel of an acquired business in order to achieve operating efficiencies or otherwise realize cost savings. The inability to achieve the anticipated cost savings could have a material adverse effect on the Company's business, financial condition, and operating results. CONSUMER PREFERENCES AND NEW PRODUCT INTRODUCTIONS Consumer preferences in the professional salon products industry depend to a significant extent on the prescriptive role of salon professionals. Relatively few products achieve wide acceptance in the professional salon market. The Company believes that its success depends, in part, on its continued ability to introduce new and attractive products on a regular basis that anticipate and respond to changing consumer demands and preferences in a timely manner. New products introduced by the Company may not achieve any significant degree of market acceptance. Any acceptance that is achieved may not be sustained for any significant amount of time. The failure of new product lines or product innovations to achieve or sustain market acceptance could have a material adverse effect on the Company's business, financial condition, and operating results. DEPENDENCE ON DISTRIBUTION CHANNELS The Company sells a significant portion of its products to professional salon product distributors and salon chains. Distributors and salon chains in the United States and in foreign markets have periodically experienced consolidation and other ownership changes and in the future may consolidate, restructure, or realign their ownership or affiliations. Some distributors and salons may be thinly capitalized and unable to withstand changes in business conditions. These circumstances could decrease the number of distributors and salons that sell the Company's products or increase the ownership concentration within the professional salon products industry. If a significant distributor or salon chain discontinues selling or using the Company's products, performs poorly, cannot pay for purchased products, or reorganizes or liquidates and is unable to continue selling the Company's products, the Company's business, financial condition, and operating results could be materially and adversely affected. In addition, the laws and regulations of various states may limit the ability of the Company to change 13 distributors under certain circumstances, making it difficult to terminate a distributor without good or just cause, as defined by applicable statutes or regulations. The resulting difficulty or inability to replace distributors, poor performance of distributors, or the inability to collect accounts receivable from major distributors could have a material adverse effect on the Company's business, financial condition, and operating results. DEPENDENCE ON THIRD PARTIES FOR MANUFACTURING The Company depends upon third parties to manufacture most of its products. Although the Company owns many of the formulations, tools, and molds used in the manufacturing processes of its products, the Company has limited control over the manufacturing processes themselves. As a result, any difficulties encountered by the third-party manufacturers that result in product defects, production delays, cost overruns, or the inability to fulfill orders on a timely basis could have a material adverse effect on the Company's business, financial condition, and operating results. The Company generally does not have long-term contracts with its third-party manufacturers. Although the Company believes it would be able to secure other third-party manufacturers to produce its products, particularly as a result of its ownership of many of the formulations, tools, and molds used in the manufacturing process, the Company's operations would be adversely affected if it lost its relationship with any of its current suppliers (including particularly two manufacturers of hair removal appliances in China) or if the operations of its current suppliers or sea or air transportation with its China-based manufacturers were disrupted or terminated even for a relatively short period of time. See Item 1, "Business --Special Considerations - Risk of International Operations." The Company's tools and molds are located at the facilities of its domestic and offshore third-party manufacturers. Accordingly, significant damage to these facilities could result in the loss of or damage to a material portion of the Company's key tools and molds, and production delays could result while new facilities are being arranged and replacement tools and molds are being produced. The Company does not maintain an inventory of sufficient size to provide protection for any significant period against an interruption of supply, particularly if it were required to obtain alternative sources of supply. Although the Company does not purchase directly the raw materials used to manufacture the majority of its products, it is potentially subject to variations in the prices it pays its third-party manufacturers for products depending on their cost for raw materials. DEPENDENCE ON FRAMESI S.P.A. The Company holds exclusive license rights to sell Framesi brand hair color and hair care products in the majority of the Western Hemisphere, including the United States and most of Latin America. The Company sells these products pursuant to an exclusive 40-year license with Framesi S.p.A. that expires in 2036. In addition, the Company manufacturers and sells hair care products under the Framesi and Biogenol brand names pursuant to the license. Under the agreement, the Company imports hair color products manufactured by Framesi S.P.A. Any difficulties encountered by Framesi S.p.A. with respect to product defects, production delays, cost overruns, or the inability to fulfill orders on a timely basis or the termination or breach of the license agreement could have a material adverse effect on the Company's business, financial condition, and operating results. DEPENDENCE ON MAJOR CUSTOMERS The Company depends upon salon product and tanning supply distributors, beauty supply outlets, and salon chains to distribute its products. The Company's largest customer, Sally, a division of Alberto-Culver Company, accounted for approximately 14% of the net sales of the Company during 1997 and 9% of the net sales of the Company during 1998. Sally would have accounted for approximately 9% of the pro forma consolidated net sales of the Company during 1997 and 7% of the pro forma consolidated net sales of the Company during 1998. The Company currently maintains more than 5,300 active customer accounts. The Company, however, does not have long-term contracts with any of its customers. An adverse change in, or termination of, the Company's relationship with, or an adverse change in the financial viability of, one or more of its major customers, including Sally, could have a material adverse effect on the Company's business, financial condition, and operating results. 14 MANAGEMENT OF GROWTH Since its initial public offering in November 1996, the Company's operations have undergone significant changes and growth. These changes include: * the acquisition and integration of 11 professional salon businesses; * the expansion of its product lines and distribution channels; and * the restructuring of its third-party manufacturing arrangements. The Company's growth and expanding operations may place a significant strain on the Company's management, administrative, operational, and financial resources as well as increased demands on its systems and controls. The Company's ability to manage its growth will require it to: * integrate successfully the operations of acquired businesses with the Company's operations; * enhance further its operational, financial, and management systems and its marketing programs; * motivate, manage, and retain its current employees; and * identify, hire, and train additional employees. The failure of the Company to effectively manage its growth could have a material adverse effect on the Company's business, financial condition, and operating results. LEVERAGE The Company is highly leveraged. On December 31, 1998, the Company had total indebtedness of approximately $143.1 million and stockholders' equity of approximately $29.2 million. This indebtedness included $100 million of 10 7/8% senior subordinated notes due 2008 (the "Notes"), approximately $37 million of debt under its five-year senior credit facility with a group of banks ("1998 Credit Facility"), and approximately $6.1 million of indebtedness in connection with one acquisition. Subject to certain conditions, the Company and its subsidiaries will be permitted to incur additional indebtedness in the future. The Company intends to raise additional capital through debt or equity financings beginning in the second quarter of 1999 to fund its continued growth. At this time, it is not possible to assess the type of financings the Company will pursue or the terms or availability of such financings. The inability to secure such financing on acceptable terms could have an adverse effect on the Company's business, operations, and financial position. In addition, it is possible that such financing will further increase the Company's leverage. The Company's ability to service, repay, or refinance its indebtedness and to fund planned capital expenditures and product development expenses will depend on its future performance. To a certain extent, the Company's performance will be subject to general economic, financial, competitive, legislative, regulatory, and other factors that are beyond its control. The Company may not be able to generate sufficient cash flow from operations, or future borrowings may not be available under the 1998 Credit Facility in an amount sufficient to enable the Company to service or repay its indebtedness or to fund its other liquidity needs. In addition, the Company may not be able to refinance its indebtedness on commercially reasonable terms or at all if it desires to do so. The degree to which the Company is leveraged could have important consequences, including the following: * making it more difficult for the Company to raise additional funds to finance desired acquisitions; * increasing the Company's vulnerability to general adverse economic and industry conditions; 15 * limiting the Company's ability to obtain other funds to finance future working capital, capital expenditures, product development, and other general corporate requirements; * limiting the Company's flexibility in planning for, or reacting to, changes in its business and the industry; and * placing the Company at a competitive disadvantage as compared to less leveraged competitors. RESTRICTIVE DEBT COVENANTS The Company's 1998 Credit Facility and the agreement covering the Notes contain certain restrictive financial and operating covenants that limit the Company's discretion with respect to certain business matters. These covenants place significant restrictions on, among other things, the ability of the Company to: * incur additional indebtedness; * create liens or other encumbrances; * make certain payments and investments; and * purchase, sell, or otherwise dispose of assets and merge or consolidate with other entities. The 1998 Credit Facility requires the Company to meet certain financial ratios and tests. A failure to comply with the obligations contained in the 1998 Credit Facility or the agreement covering the Notes, if not cured or waived, could result in the acceleration of the related debt and the acceleration of debt under other instruments that contain cross-acceleration or cross-default provisions. If the Company were obligated to repay all or a significant portion of its indebtedness, the Company may not have sufficient cash to do so and may not be able to refinance such indebtedness. Other indebtedness that the Company may incur in the future may contain financial or other covenants more restrictive than those of the 1998 Credit Facility or the Notes. POSSIBLE INABILITY TO FUND A CHANGE OF CONTROL OFFER Upon a change of control, the Company will be required to offer to repurchase all outstanding Notes at 101% of their principal amount plus accrued and unpaid interest to the date of repurchase. The Company may not have sufficient funds available at the time of any change of control to make any required repurchases of Notes tendered. In addition, restrictions in the 1998 Credit Facility may not allow the Company to make such required repurchases. RISK OF INTERNATIONAL OPERATIONS International sales constituted approximately 14% of the Company's pro forma consolidated net sales during 1997 and approximately 6% of the Company's pro forma consolidated net sales during 1998. In addition, certain of the Company' s products are manufactured in China. See Item 1, "Business - Special Considerations - Dependence on Third Parties for Manufacturing." The Company intends to expand its international sales through acquisitions and internal growth. The Company's international operations require it to maintain equipment and inventories abroad, manufacture and sell products internationally, and purchase raw materials and components from foreign suppliers. The Company also relies on its third-party manufacturers to provide personnel and facilities in China. The Company's international operations expose it to certain economic and political risks, including the following: * compliance with local laws and regulatory requirements, as well as changes in such laws and requirements; * foreign currency exchange rate fluctuations; * restrictions on the repatriation of funds; 16 * overlap of tax issues; * the business and financial condition of the third-party manufacturers; * political and economic conditions abroad; and * the possibility of: - expropriation or nationalization of assets - supply disruptions - currency controls - changes in tax laws, tariffs, and freight rates. These factors could disrupt or adversely affect the Company's relationships with its third-party manufacturers in China. Based on existing market conditions, the Company believes that it could establish alternative supply relationships if its supply sources in China were disrupted. However, because establishing these relationships involves numerous uncertainties relating to delivery requirements, price, payment terms, quality control, and other matters, the Company is unable to predict whether such relationships would be on terms satisfactory to the Company. The Company's relationships with its third-party manufacturers in China are also subject to risks associated with changes in U.S. legislation and regulations relating to imports, including quotas, duties, taxes, and other charges or restrictions on imports. Products that the Company imports from China currently receive preferential tariff treatment accorded to goods from countries granted "most favored nation" status. Under the Trade Act of 1974, the President of the United States has the authority, upon making specified findings, to waive certain restrictions that would otherwise render China ineligible for most favored nation treatment. The President has waived these provisions each year since 1979. Most favored nation status was accordingly renewed in 1998 despite opposition by certain members of Congress. In the future, Congress may encourage the President to reconsider the renewal of most favored nation status for China. China may not continue to enjoy most favored nation status. Raw materials and finished products entering the United States from China without the benefit of most favored nation treatment would be subject to significantly higher duty rates. DEPENDENCE ON KEY PERSONNEL The Company's success depends to a significant degree upon the skills of its current key employees and its ability to identify, hire, and retain additional sales, marketing, and financial personnel. The Company cannot provide assurance that it will be able to retain its existing key personnel or attract and retain additional key personnel. The loss of services of key personnel, particularly Sam Leopold (the Company's chairman of the Board, President, and Chief Executive Officer), or the inability to attract and retain additional qualified personnel could have a material adverse effect upon the Company's business, financial condition, and operating results. The Company has an employment agreement with Mr. Leopold that extends through September 2001. INTELLECTUAL PROPERTY The market for the Company's products depends to a significant extent upon the goodwill associated with its trademarks and trade names. Therefore, trademark protection is important to the Company's business. Although most of the Company's trademarks and trade names are registered in the United States and in foreign countries, the Company may not be successful in asserting trademark or trade name protection for its trademarks and trade names in the United States or other markets, and the costs to the Company of such efforts may be substantial. In addition, the laws of certain foreign countries may not protect the Company's intellectual property rights to the same extent as the laws of the United States. 17 While the Company currently holds certain patents, the Company does not consider any single patent to be material to the conduct of its business. The Company relies primarily on trade secret protection for its proprietary information. The Company faces risks associated with its intellectual property, including the following: * the Company's intellectual property rights may be challenged, invalidated, or circumvented; * the Company's intellectual property rights may not provide adequate protection; * the Company may not have sufficient resources to prosecute infringements of its intellectual property rights; * the Company may not be able to protect its intellectual property; and * third parties may assert intellectual property infringement claims against the Company See Item 1, "Business - Intellectual Property." COMPETITION The professional salon products industry is very competitive. The Company's products compete directly against professional salon and other similar products sold through distributors of professional salon products and professional salons. In addition, the Company's professional salon products compete indirectly against hair care, nail care, and skin and body care products as well as salon appliances and sundries sold through a variety of non-salon retail channels, including department stores, mall-based specialty stores and, to a lesser extent, mass merchants, drugstores, supermarkets, telemarketing programs, television "infomercials," and catalogs. Current and potential competitors include a number of companies that have substantially greater resources than the Company, including better brand-name recognition, broader product lines, and wider distribution channels. The professional salon products industry is characterized by a lack of significant barriers to entry with respect to the development and production of professional salon products, which may result in new competition, including possible imitators of one or more of the Company's recognized product lines. In addition, companies in the professional salon products industry commonly market products that are similar to products being successfully marketed by competitors. Increased competition and any reductions in competitors' prices that require the Company to implement price reductions in order to remain competitive could have a material adverse effect on the Company's business, financial condition, and operating results. GOVERNMENT REGULATION AND POTENTIAL CLAIMS Certain of the Company's advertising and product labeling practices are subject to regulation by the FTC, and certain of its professional salon product production practices are subject to regulation by the FDA as well as by various other federal, state, and local regulatory authorities. Compliance with federal, state, and local laws and regulations has not had a material adverse effect on the Company to date. Nonetheless, federal, state, and local regulations in the United States that are designed to protect consumers have had, and can be expected to have, an increasing influence on product claims, production methods, product content, labeling, and packaging. In addition, any expansion by the Company of its operations to produce professional salon products that include over-the-counter drug ingredients (such as certain sun screen ingredients) would result in the Company becoming subject to additional FDA regulations as well as a higher degree of inspection and greater burden of regulatory compliance than currently exist. The operations of the Company subject it to federal, state, and local government regulations related to the use, storage, discharge, and disposal of hazardous chemicals. The Company's failure to comply with current or future environmental regulations could result in the imposition of fines, suspension of production, or a cessation of operations. Compliance with such regulations could require the Company to acquire costly equipment or to incur other significant expenses. Any failure by the Company to control the use, or adequately restrict the discharge, of hazardous substances could subject it to future liabilities. The Company believes that it is in substantial compliance with applicable 18 federal, state, and local rules and regulations governing the discharge of hazardous materials into the environment. The Company does not anticipate that it will make significant capital expenditures for environmental control matters in the near future. The nature and use of professional salon products could give rise to product liability claims if one or more users of the Company's products were to suffer adverse reactions following their use of the products. Such reactions could be caused by various factors, many of which are beyond the Company's control, including hypoallergenic sensitivity and the possibility of malicious tampering with the Company's products. In the event of such an occurrence, the Company could incur substantial litigation expense, receive adverse publicity, and suffer a loss of sales. CONTROL BY MANAGEMENT Sam Leopold (the Chairman of the Board, President, and Chief Executive Officer of the Company) beneficially owns approximately 25% of the outstanding shares of the Company's Common Stock. Consequently, Mr. Leopold has the ability to influence the election of all of the directors of the Company and thereby control the business, affairs, and management of the Company. In addition, Mr. Leopold has the ability to influence most matters requiring stockholder approval including significant corporate matters, such as amendments to the Company's Certificate of Incorporation and any merger, consolidation, or sale of all or substantially all of the assets of the Company. Such a high level of ownership may have the effect of delaying, deterring, or preventing a change in the control of the Company, even when such a change would be in the best interests of the other stockholders, and may adversely affect the voting and other rights of the other holders of the Company's Common Stock. POSSIBLE VOLATILITY OF MARKET PRICE OF COMMON STOCK The market price of the Company's Common Stock has fluctuated significantly since the Company's initial public offering in November 1996. The period was marked by generally rising stock prices, extremely favorable industry conditions, and substantially improved operating results by the Company. These favorable conditions may not continue. The trading price of the Company's Common Stock in the future could be subject to a variety of factors, including: * wide fluctuations in response to quarterly variations in operating results of the Company; * actual or anticipated announcements of new products by the Company or its competitors; * changes in analysts' estimates of the Company's financial performance; * general conditions in the markets in which the Company competes; and * worldwide economic and financial conditions. The stock market also has experienced extreme price and volume fluctuations that have particularly affected the market prices for many rapidly expanding companies and that often have been unrelated to the operating performance of such companies. These broad market fluctuations and other factors may adversely affect the market price of the Company's Common Stock. Any reduction in the trading price of the Company's Common Stock could adversely affect the Company's ability to raise capital in the public market and adversely affect the Company's ability to complete acquisitions. The market price of the Company's Common Stock may affect the willingness of the Company to use its Common Stock to acquire other companies and the willingness of potential acquired companies or their owners to accept the Company's Common Stock. Declines in the market price of the Company's Common Stock may cause acquired companies to seek adjustments to purchase prices or other remedies to offset any decline in value. SHARES ELIGIBLE FOR FUTURE SALE Sales of substantial amounts of Common Stock by stockholders of the Company, or even the potential for such sales, are likely to adversely affect the market price of the Common Stock and could impair the Company's ability to raise capital by selling equity securities. Of the 4,067,503 shares of Common Stock outstanding as of March 29, 1999, approximately 3,203,077 were freely 19 tradeable without restriction or further registration under the securities laws. An aggregate of 864,426 shares held by certain officers and directors currently are available for sale. Shares held by these affiliates of the Company are subject to the resale limitations of Rule 144 described below. Generally, under Rule 144, an affiliate of the Company or any person who beneficially owns restricted securities with respect to which at least one year has elapsed since the later of the date the shares were acquired from the Company may, every three months, sell in ordinary brokerage transactions or to market makers and amount of shares equal to the greater of 1% of the Company's then-outstanding Common Stock or the average weekly trading volume for the four weeks prior to the proposed sale of such shares. The Company also has authority to issue additional shares of Common Stock and shares of one or more series of preferred stock. The Company may issue shares of Common Stock or preferred stock for use as a portion of the consideration in future acquisitions. These shares may be registered under the Securities Act, in which case they generally will be freely tradeable upon their issuance. RIGHT TO ACQUIRE SHARES A total of 891,200 shares of Common Stock have been reserved for issuance upon exercise of options granted or which may be granted under the Company's stock option plans. Options to acquire 794,381 shares of Common Stock currently are outstanding, including options to purchase 785,381 shares granted under the Company's stock option plans. In addition, there are outstanding warrants to acquire 203,000 shares of Common Stock at an exercise price of $12.00 per share, warrants to acquire 150,000 shares of Common Stock at an exercise price of $10.18 per share, and warrants to acquire 10,000 shares of Common Stock at an exercise price of $11.38 per share, in each case subject to adjustment in accordance with the anti-dilution and other provisions set forth in the warrants. During the terms of such options and warrants, the holders will have the opportunity to profit from an increase in the market price of the Common Stock. The existence of such stock options and warrants may adversely affect the terms on which the Company can obtain additional financing, and the holders of such options and warrants can be expected to exercise or convert such options and warrants at a time when the Company, in all likelihood, would be able to obtain additional capital by offering shares of its Common Stock on terms more favorable to the Company than those provided by the exercise of such options and warrants. LACK OF DIVIDENDS The Company has never paid any cash dividends on its Common Stock and does not currently anticipate that it will pay dividends in the foreseeable future. Instead, the Company intends to apply its earnings to the expansion and development of its businesses. CHANGE IN CONTROL PROVISIONS The Company's First Amended and Restated Certificate of Incorporation, Bylaws, and the Shareholder Rights Plan contain provisions that may have the effect of making more difficult or delaying attempts by others to obtain control of the Company, even when these attempts may be in the best interests of stockholders. During February 1999, the Company adopted a Shareholder Rights Plan pursuant to which holders of shares of Common Stock are entitled to purchase one one-thousandth of a share of Series A Junior Participating Preferred Stock at a purchase price of $70, subject to certain antidilution adjustments. The rights will expire 10 years after issuance and will be exercisable if (i) a person or group becomes the beneficial owner of 15% or more of the Company's Common Stock; (ii) persons currently holding 15% or more of the Common Stock acquire an additional 1% or more of the Common Stock; or (iii) a person or group commences a tender or exchange offer that would result in the offeror beneficially owning 15% or more of the Common Stock (a "Stock Acquisition Date"). If a Stock Acquisition Date occurs, each right, unless redeemed by the Company, entitles the holder to purchase an amount of Common Stock of the Company, or in certain circumstances a combination of securities and/or assets or the common stock of the acquiror, having a market value of twice the exercise price of the right. Rights held by the acquiring person will become void and will not be exercisable to purchase shares at the bargain purchase price. 20 The rights have certain anti-takeover effects. The rights will cause substantial dilution to a person or group that attempts to acquire the Company on terms not approved by the Company's Board of Directors, except pursuant to an offer conditioned on a substantial number of rights being acquired. The rights should not interfere with any merger or other business combination approved by the Board of Directors since the rights may be redeemed by the Company at $.01 per right at any time before a Stock Acquisition Date. YEAR 2000 COMPLIANCE Many currently installed computer systems and software products are coded to accept only two-digit entries in the date code field. Beginning in the year 2000, these date code fields will need to accept four-digit entries to distinguish 21st century dates from 20th century dates. As a result, computer systems and software used by many companies may need to be upgraded to comply with such "Year 2000" requirements. Significant uncertainty exists concerning the potential effects associated with the impact the Year 2000 issue will have on the reporting and operating systems maintained by the Company, its customers and suppliers, and other service providers. Although the Company does not anticipate that the Year 2000 issue will have a significant impact on its business, any significant Year 2000 compliance problem of any of the Company, its customers, or its third-party contract manufacturers or suppliers could have a material adverse effect on the Company's business, financial condition, and operating results. See Item 7, "Management's Discussion and Analysis of Financial Condition and Results of Operations (as restated) - Year 2000 Compliance." CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING STATEMENTS Certain statements and information contained in this Report under the headings "Business - Special Considerations," and "Management's Discussion and Analysis of Financial Condition and Results of Operations" (as restated) concerning future, proposed, and anticipated activities of the Company; certain trends with respect to the Company's revenue, operating results, capital resources, and liquidity or with respect to the markets in which the Company competes or the beauty care industry in general; and other statements contained in this Report regarding matters that are not historical facts are forward-looking statements, as such term is defined in the applicable securities laws. Forward-looking statements, by their very nature, include risks and uncertainties, many of which are beyond the Company's control. Accordingly, actual results may differ, perhaps materially, from those expressed in or implied by such forward-looking statements. Factors that could cause actual results to differ materially include those discussed elsewhere under "Business - Special Considerations." ITEM 2. PROPERTIES The Company leases its corporate headquarters and operations center located in a 66,000 square-foot facility in Scottsdale, Arizona. The facility includes approximately 43,000 square feet of executive and administrative offices; approximately 20,000 square fee utilized for warehousing; and approximately 3,000 square feet utilized for a test salon and a retail store. The Company believes the facility will be adequate for its needs for the foreseeable future. The Company also leases production, administrative, and warehouse space in Fair Lawn, New Jersey; Butler, Wisconsin; Corapolis, Pennsylvania; and the United Kingdom; as well as administrative space in Lebanon, Tennessee, and Costa Mesa, California. ITEM 3. LEGAL PROCEEDINGS The Company is, and may in the future be, party to litigation arising in the ordinary course of its business. The Company does not consider any current claims to be material to its business, financial condition, or operating results. The Company's insurance coverage may not be adequate to cover all liabilities occurring out of any claims that may be instituted in the future, and insurance may not cover some future claims. A lack of insurance coverage may have an adverse effect on the Company's business, financial condition, or operating results. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS Not applicable. 21 PART II ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS The Company's Common Stock has been traded on the Nasdaq National Market under the symbol "STYL" since its initial public offering on November 21, 1996 at $10.00 per share. The following table sets forth the high and low sale prices of the Common Stock for the calendar quarters indicated as reported on the Nasdaq National Market. HIGH LOW ---- --- 1996 Fourth quarter (since November 21, 1996)........... $10 5/8 $ 9 1/4 1997 First quarter...................................... $12 1/4 $10 Second quarter..................................... $11 1/2 $ 9 Third quarter...................................... $16 $11 3/8 Fourth quarter..................................... $17 1/2 $14 3/4 1998 First quarter...................................... $24 1/8 $15 3/4 Second quarter..................................... $26 5/8 $22 Third quarter...................................... $23 3/8 $10 7/8 Fourth quarter..................................... $18 7/8 $ 8 3/8 1999 First quarter (through March 29, 1999)............. $14 3/4 $ 9 5/8 On March 29, 1999, the closing sale price of the Company's Common Stock was $13 per share. On March 29, 1999, there were approximately 14 holders of record and approximately 1,142 beneficial owners of the Company's Common Stock. The Company has never paid any cash dividends on its Common Stock. The Company currently plans to retain earnings to finance the growth of the Company's business rather than to pay cash dividends. Payments of any cash dividends in the future will depend on the financial condition, results of operations, and capital requirements of the Company as well as other factors deemed relevant by the Board of Directors. The Company's credit facility and its agreement covering the Notes contain restrictions on the Company's ability to pay cash dividends, and future borrowing may contain similar restrictions. See "Management's Discussion and Analysis of Financial Condition and Results of Operations - Liquidity and Capital Resources" contained in Item 7 of this Report. ITEM 6. SELECTED FINANCIAL DATA The following selected consolidated financial data as of and for the fiscal years ended December 31, 1998 and 1997 and as of December 31, 1996 and the period from November 27, 1996 to December 31, 1996 is derived from the consolidated financial statements (1997 and 1998 have been restated) of the Company, which have been audited by Arthur Andersen LLP, independent public accountants. The selected historical financial data for Gena and Body Drench for each of the three years in the periods ended February 29, 1996 and December 31, 1995, respectively, was derived from their financial statements, which have been audited by Arthur Andersen LLP, independent public accountants. The selected historical financial data for JDS for the three years in the period ended September 30, 1996 was derived from its financial statements, which have been audited by Arthur Andersen LLP, independent public accountants. The selected historical financial data for KII for the year ended December 31, 1995 was derived from its financial statements, which have been audited by Arthur Andersen LLP, independent public accountants. The selected historical financial data for KII for the year ended December 31, 1995 was derived from its financial statements, which have been audited by Arthur Andersen LLP, independent public accountants. In addition, the selected historical financial data for Gena, Body Drench, JDS, and KII for the periods March 1, 1996 to November 26, 1996; January 1, 1996 to November 26, 1996; October 1, 1996 to November 26, 1996; and January 1, 1996 to November 26, 1996, respectively, was derived from the financial statements of each of the Initial Businesses, which have been audited by Arthur Andersen LLP, independent public accountants. The historical financial information for earlier periods for Gena, Body Drench, JDS, and KII not specifically referenced above was derived from each of the Initial Businesses unaudited financial statements. The selected financial data provided below 22 should be read in conjunction with Item 7, "Management's Discussion and Analysis of Financial Condition and Results of Operations" and the Consolidated Financial Statements of the Company and related notes thereto appearing elsewhere in this Report. SELECTED HISTORICAL FINANCIAL DATA (DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
NOVEMBER 27, 1996 YEAR ENDED YEAR ENDED TO DECEMBER 31, 1997 DECEMBER 31, 1998 DECEMBER 31, 1996 (AS RESTATED) (AS RESTATED) ----------------- ------------- ------------- STATEMENT OF OPERATIONS DATA - STYLING TECHNOLOGY CORPORATION: Net sales ......................................... $ 1,083 $ 36,505 $ 83,366 Gross profit ...................................... 512 19,749 44,368 Selling, general, and administrative expenses...... 737 12,201 31,619 Income (loss) from operations ..................... (225) 7,548 12,327 Income (loss) before extraordinary item ........... (151) 3,164 1,651 Extraordinary item, net of tax benefit ............ -- (1,377) (1,091) Income (loss) after extraordinary item ............ (151) 1,787 560 Basic earnings (loss) per share: Income (loss) before extraordinary item ......... $ (0.04) $ 0.80 $ 0.41 Extraordinary item, net ......................... -- (0.35) (0.27) Net income (loss) ............................... (0.04) 0.45 0.14 Diluted earnings (loss) per share: Income (loss) before extraordinary item ......... (0.04) 0.77 0.38 Extraordinary item, net ......................... -- (0.34) (0.25) Net income (loss) ............................... (0.04) 0.43 0.13 BALANCE SHEET DATA: Working capital .................................. 4,459 13,005 30,566 Total assets ..................................... 32,234 90,886 214,073 Long-term debt and other, less current portion.... 2,316 47,377 140,366 Total stockholders' equity ....................... 25,319 27,525 29,248 STATEMENT OF OPERATIONS DATA - INITIAL BUSINESSES FOR THE PERIOD YEARS ENDED FEBRUARY 28, MARCH 1, 1996 ---------------------------------- TO 1993 1994 1995 1996 NOVEMBER 26, 1996 ---- ---- ---- ---- ----------------- STATEMENT OF OPERATIONS DATA - GENA Net sales ........................... $6,537 $6,426 $7,524 $8,384 $6,708 Gross profit ........................ 2,868 3,146 3,360 3,565 2,807 Selling, general, and administrative expenses............ 2,570 2,744 2,964 3,033 1,984 Income from operations .............. 298 402 396 532 823 Net income .......................... 204 278 232 317 529
23
FOR THE PERIOD YEARS ENDED DECEMBER 31, JANUARY 1, 1996 ---------------------------------- TO 1992 1993 1994 1995 NOVEMBER 26, 1996 ---- ---- ---- ---- ----------------- STATEMENT OF OPERATIONS DATA - BODY DRENCH Net sales ........................... $6,234 $6,653 $11,138 $11,871 $ 9,642 Gross profit ........................ 2,667 2,614 4,796 5,444 3,776 Selling, general, and administrative expenses............ 2,285 2,055 4,076 4,883 4,005 Income (loss) from operations........ 382 559 720 561 (229) Net income (loss) ................... 382 328 446 294 (137) FOR THE PERIOD YEARS ENDED SEPTEMBER 30, OCTOBER 1, 1996 ---------------------------------- TO 1993 1994 1995 1996 NOVEMBER 26, 1996 ---- ---- ---- ---- ----------------- STATEMENT OF OPERATIONS DATA - JDS Net sales ........................... $3,799 $3,578 $3,368 $3,114 $613 Gross profit ........................ 2,054 1,926 1,817 1,707 338 Selling, general, and administrative expenses............ 2,092 1,982 1,844 1,615 258 Income (loss) from operations........ (38) (56) (27) 92 80 Net income (loss) ................... (29) (16) 9 69 45 FOR THE PERIOD YEARS ENDED DECEMBER 31, JANUARY 1, 1996 --------------------------------- TO 1992 1993 1994 1995 NOVEMBER 26, 1996 ---- ---- ---- ---- ----------------- STATEMENT OF OPERATIONS DATA - KII Net sales ......................... -- $ 102 $1,999 $1,558 $1,248 Gross profit ...................... -- 60 1,014 846 663 Selling, general, and administrative expenses ......... -- 87 1,040 891 591 Income (loss) from operations...... -- (27) (26) (45) 72 Net income (loss) ................. -- (32) (104) (135) (2)
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (AS RESTATED) - INTRODUCTION The following discussion reflects the restatement of our financial statements for the fiscal years 1997 and 1998. The restatement is a result of an internal investigation that revealed financial reporting errors and irregularities in the Body Drench division. It was determined that revenue was recognized improperly on certain transactions where inventory was not shipped to customers. The restatement resulted in a decrease in revenues from $38.1 million and $90.4 million, previously reported, to $36.5 million and $83.4 million for the years ended December 31, 1997 and 1998, respectively. Net income decreased from $2.8 million and $4.1 million, previously reported, to $1.8 million and $560,000 for the years ended December 31, 1997 and 1998, respectively. 24 The Company develops, produces, and markets a wide array of professional salon products. The Company offers a diversified line of well-established, brand-name professional salon products across all salon product categories, including hair care, nail care, and skin and body care products, as well as salon appliances and sundries. The Company sells it products primarily to professional salon industry distribution channels, beauty salon outlets, and salon chains, and, to a lesser extent, to spas, resorts, and health and country clubs throughout the United States as well as in other parts of North America, Latin America, Europe, and Asia. The Company was founded in June 1995 and has grown its business, expanded its product offerings, and strengthened its distribution channels principally through acquisitions. The Company acquired four professional salon product businesses in November 1996, simultaneously with the Company's initial public offering. Prior to that date, the Company had conducted no operations. The four professional salon product businesses acquired by the Company were (i) Gena, a producer and marketer of professional natural nail care products, pedicure products, skin care products, including paraffin therapy products and, to a lesser extent, hair care products; (ii) Body Drench, a producer and marketer of high-end professional tanning, moisturizing, and personal care products; (iii) JDS, a producer and marketer of acrylic and fiberglass nail enhancement products; and (iv) KII, a marketer of high-end salon appliances (such as curling irons and blow dryers) and salon wear (such as capes and aprons). Gena, Body Drench, JDS, and KII collectively are referred to as the "Initial Businesses." During 1997, the Company further expanded its product offerings by acquiring three professional salon product businesses to complement the Company's existing operations. In March 1997, the Company acquired the "Utopia" line of indoor tanning products now sold under the "Suntopia" brand name from Creative Laboratories, Inc. In June 1997, the Company purchased ABBA, which produces a proprietary line of aromatherapy-based professional hair care products. In December 1997, the Company acquired the Clean + Easy and One Touch product lines of Inverness, consisting of salon and retail hair removal apparatus and products marketed under the "Clean + Easy" and "One Touch" brand names. In May 1998, the Company acquired substantially all of the assets and assumed certain operating liabilities of Pro Finish, a producer of name-brand professional nail enhancement and nail care products. In June 1998, the Company acquired European Touch and European Touch II (together the "European Touch Companies"). European Touch is a developer, producer, and marketer of professional nail enhancement and treatment products and European Touch II is a developer, producer, and marketer of salon pedicure equipment. In August 1998, the Company acquired Framesi USA. Framesi holds exclusive license rights for the sale in the United States and most of Latin America of Framesi hair color products along with its complementary Biogenol line of shampoos, conditioners, and styling products. Through these strategic transactions, the Company has acquired an extensive network of strong distribution relationships, experienced sales forces, established marketing and salon industry education programs, significant production and sourcing capabilities, and experienced management personnel with extensive relationships in the professional salon products industry. The combined purchase price of the acquisitions in 1997 and 1998 were approximately $45.0 million and $63.0 million, respectively. On a pro forma basis, total revenue of the Company would have been approximately $109.4 million and $108.6 million in 1997 and 1998, respectively, assuming the acquisitions described above had taken place on January 1, 1997. The following discussion has been divided into ten sections. The first section presents the restated results of operations of the Company for the year ended December 31, 1998; the second section presents the restated results of operations of the Company for the year ended December 31, 1997; the next four sections contain a discussion of the historical results of operations for each of the four Initial Businesses, and the last three sections contain discussions of the Company's seasonality and quarterly results, liquidity and capital resources, and its Year 2000 compliance. The information presented for the four Initial Businesses is based on each Company's historical fiscal year end and the period from the most recently completed fiscal year to November 26, 1996 (the closing date of the acquisitions of the Initial Businesses). Except for the historical information contained herein, the discussion in this Report contains or may contain forward-looking statements that involve risks and uncertainties. The Company's actual results could differ materially from those discussed here. Factors that could cause or contribute to such differences include those discussed herein, as well as those factors discussed under "Special Considerations" contained in Item 1 of this Report. Historical results are not necessarily indicative of trends in operating results for any future period. 25 RESULTS OF OPERATIONS - YEAR ENDED DECEMBER 31, 1998 (AS RESTATED) NET SALES Net sales for the year ended December 31, 1998 amounted to $83.4 million compared with net sales of $36.5 million for the year ended December 31, 1997. The $46.9 million or 128%, increase in net sales was due primarily to the addition of the operating results of the brands acquired during 1998, which included the results of Pro Finish from May 1, 1998 to December 31, 1998; the European Touch Companies from June 1, 1998 to December 31, 1998; and Framesi USA from August 1, 1998 to December 31, 1998. The increase in sales also was due to growth in the Company's existing brands, particularly the ABBA hair care brand, which introduced new packaging during the third quarter of 1998. COST OF SALES Cost of sales amounted to $39.0 million, or 46.8% of net sales, for the year ended December 31, 1998, up slightly on a percentage basis from cost of sales of $16.8 million, or 46.0% of net sales, during the year ended December 31, 1997. GROSS PROFIT As a result of the foregoing, the Company realized gross profit of $44.4 million, or 53.2% of net sales, for the year ended December 31, 1998, remaining relatively constant with gross profit of $19.7 million, or 54.0% of net sales, for the year ended December 31, 1997. SELLING, GENERAL, AND ADMINISTRATIVE EXPENSES Selling, general, and administrative expenses were $31.6 million, or 37.9% of net sales, for the year ended December 31, 1998, before recording centralization and reengineering costs of approximately $422,000. Selling, general, and administrative expenses including the centralization and reengineering costs amounted to $32.0 million, or 38.4% of net sales, for the year ended December 31, 1998 compared with $12.2 million, or 33.4% of net sales for the year ended December 31, 1997. The increase in selling, general, and administrative expenses resulted in part from the acquisitions completed during 1998 having, on average, a higher percentage of selling, general, and administrative expenses than the Company's existing business. The increase also is attributable to the resulting increases in the amortization of goodwill of the businesses acquired during 1998. In addition, expenses during 1998 included planned increases in sales and marketing costs in the fourth quarter in preparation for new products and distribution for 1999. On November 5, 1998, the Company announced it would centralize its operations in Scottsdale, Arizona and outsource segments of its production and warehousing functions. These initiatives are part of the further integration and consolidation of the Company's acquired businesses with the goal of obtaining additional operating efficiencies and positioning the Company for continued internal growth and future acquisitions. The Company also announced it would take advantage of new capabilities in computer technologies by combining the reengineering of its business processes with an Enterprise Resource Planning information technology transformation, which it expects will drive operating efficiencies and improved customer service. These initiatives took place during the fourth quarter of 1998 and will continue during the first and second quarters of 1999. In connection with the centralization and business process reengineering activities, the Company anticipates approximately $1.5 million (before income taxes) in non-recurring reengineering costs, which will be reflected in the Company's income statement as incurred. Over the same period, the Company will invest approximately $3.0 million in capital expenditures related to its information technology transformation. The costs of reengineering and information technology will be accounted for under recently issued accounting pronouncements, Emerging Issues Task Force Issue No. 97-13, "Accounting for Costs Incurred In Connection With a Consulting Contract or an Internal Project that Combines Business Process Reengineering and Information Technology Transformation," Statement of Position 98-1, "Accounting for the Costs of Computer Software Developed or Obtained for Internal Use," and Statement of Position 95-3, "Recognition of Liabilities In Connection with a Purchase Business Combination." 26 EXTRAORDINARY ITEM In June 1998, the Company issued $100 million of 10 7/8% Senior Subordinated Notes due 2008 in an offering exempt from registration under the Securities Act. A portion of the proceeds from the offering was used to repay the Company's $75.0 million credit facility ("December 1997 Credit Facility"). The Company reported an extraordinary, non-cash charge during the quarter ended June 30, 1998 of approximately $1.1 million, net of taxes, or $(0.25) per diluted share, related to unamortized financing costs associated with the December 1997 Credit Facility. NET INCOME The Company earned net income of $1.7 million, or $0.38 per diluted share, for the year ended December 31, 1998 before the extraordinary item discussed above. After the extraordinary item, net income for the year ended December 31, 1998 was $0.6 million, or $0.13 per diluted share. Net income for the year ended December 31, 1997 was $3.2 million, or $0.77 per diluted share, before the extraordinary item discussed below. After the extraordinary item, net income for the year ended December 31, 1997 was $1.8 million, or $0.43 per diluted share. INCOME FROM OPERATIONS AND EARNINGS BEFORE INTEREST, TAXES, DEPRECIATION & AMORTIZATION (EBITDA) Income from operations was $12.3 million for the year ended December 31, 1998, an increase of $4.8 million, or 64.0%, over income from operations of $7.5 million for the year ended December 31, 1997. Earnings before interest, taxes, depreciation, and amortization ("EBITDA") was $17.5 million for the year ended December 31, 1998, an increase of $8.1 million, or 86.2%, over EBITDA of $9.4 million for the year ended December 31, 1997. EBITDA is not intended to represent net cash provided by operating activities as defined by generally accepted accounting principles and should not be considered as an alternative to net income as an indicator of operating performance or to net cash provided by operating activities as a measure of liquidity. The Company believes EBITDA is a measure commonly reported and widely used by analysts, investors, and other interested parties who monitor business performance. Accordingly, the Company has disclosed this information to permit a more complete comparative analysis of its operating performance. RESULTS OF OPERATIONS - YEAR ENDED DECEMBER 31, 1997 (AS RESTATED) NET SALES Net sales amounted to $36.5 million for the year ended December 31, 1997 compared to combined net sales for the Initial Businesses of $23.0 million for the year ended December 31, 1996. The $13.5 million, or 58.7%, increase in net sales was partly the result of increased sales of the Company's Body Drench and Gena product lines as compared to the sales achieved by the individual Initial Businesses in the same period during 1996. In addition, net sales for the year ended December 31, 1997 include the operating results of ABBA from June 26, 1997 to December 31, 1997 and the operating results of Clean + Easy and One Touch from December 1, 1997 to December 31, 1997. GROSS PROFIT As a result of the foregoing, the Company realized gross profit for the year ended December 31, 1997, of $19.7 million, or 54.0% of net sales. The improvement in gross margin percentage over that reported by the individual Initial Businesses prior to their acquisition is attributable primarily to the negotiation of reduced product costs in December 1996 with the primary supplier of the Company's Body Drench product line and the consolidation of warehousing and production functions of the Gena and Alpha 9/Omni product lines at the Company's old facility in Duncanville, Texas. The Company also achieved substantial reduction in cost of goods through negotiation with third party suppliers at ABBA and Clean + Easy and One Touch. SELLING, GENERAL, AND ADMINISTRATIVE EXPENSES Selling, general, and administrative expenses were $12.2 million, or 33.4% of net sales, for the year ended December 31, 1997, which represents a significant improvement over such expenses incurred by the individual Initial 27 Businesses, and other acquired companies prior to their acquisition by the Company. This improvement in selling, general, and administrative expenses as a percentage of net sales is primarily attributable to the elimination of duplicative management and other personnel, duplicative selling and distribution costs, the consolidation of certain accounting, human resources, and other administrative functions of the Initial Businesses and the acquired companies. This improvement, however, is partially offset by non-cash goodwill amortization resulting from acquisitions and increased costs of operating as a public company. EXTRAORDINARY ITEM In connection with the December 1997 acquisition of the Clean + Easy and One Touch product lines discussed above, the Company entered into the December 1997 Credit Facility, as discussed under "Liquidity and Capital Resources" below. The December 1997 Credit Facility replaced the previous credit facility negotiated in connection with the June 1997 acquisition of ABBA ("June 1997 Credit Facility"). The Company reported an extraordinary, non-cash charge of approximately $1.4 million, net of income taxes, or $(0.34) per diluted share, related to the write-off of unamortized financing costs associated with its June 1997 Credit Facility. NET INCOME The Company earned net income of $3.2 million, or $0.80 per diluted share, for the year ended December 31, 1997 before the extraordinary item discussed above. After the extraordinary item, net income for the year ended December 31, 1997 was $1.8 million, or $0.43 per diluted share. These results mark significant improvement over the operating results of the Initial Businesses prior to their acquisition. The Company attributes the improvement in net income during the year ended December 31, 1997 primarily to the successful implementation of a key component of its business strategy, the enhancement of operating efficiencies of the Initial Businesses, and subsequent acquisitions. Prior year financial information for the Initial Businesses presented and discussed herein excludes the operating results of ABBA and the Clean + Easy, One Touch, and Suntopia product lines, which were acquired during 1997. INCOME FROM OPERATIONS AND EARNINGS BEFORE INTEREST, TAXES, DEPRECIATION & AMORTIZATION (EBITDA) Income from operations was $7.5 million for the year ended December 31, 1997. Earnings before interest, taxes, depreciation, and amortization ("EBITDA") was $9.4 million for the year ended December 31, 1997. PERIOD FROM NOVEMBER 27, 1996 TO DECEMBER 31, 1996 NET SALES Net sales amounted to $1.1 million for the period from November 27, 1996 to December 31, 1996. The level of sales during this period is not indicative of anticipated future sales levels or historical sales of the Initial Businesses, as the Company's primary focus during this period was the consolidation of the four Initial Businesses, which impacted selling efforts at each of the Company's division that existed at that time. COST OF SALES Cost of sales was $600,000 for the period from November 27, 1996 to December 31, 1996. Cost of sales was 52.7% of net sales for this period, which is consistent with the combined cost of sales as a percentage of net sales incurred by the Initial Businesses, prior to their acquisition. GROSS PROFIT As a result of the foregoing, gross profit amounted to $500,000 for the period from November 27, 1996 to December 31, 1996. SELLING, GENERAL, AND ADMINISTRATIVE EXPENSES Selling, general and administrative expenses were $700,000 for the period from November 27, 1996 to December 31, 1996, which is generally consistent with the level of selling, general, and administrative expenses incurred by the 28 Initial Businesses on a combined basis, prior to their acquisition. During this period, the Company was focused primarily on the process of integrating the operations of the Initial Businesses. NET LOSS Net loss for the Company was $200,000 for the period from November 27, 1996 to December 31, 1996. RESULTS OF OPERATIONS - GENA PERIOD FROM MARCH 1, 1996 TO NOVEMBER 26, 1996 NET SALES Net sales amounted to $6.7 million for the period from March 1, 1996 to November 26, 1996. Annualized net sales for this period were approximately $8.9 million, which represents an increase of 6.6% as compared with $8.4 million recorded in the fiscal year ended February 29, 1996. The increase in net sales was primarily attributable to an increase in sales related to Gena's paraffin spa product line. COST OF SALES Cost of sales amounted to $3.9 million for the period from March 1, 1996 to November 26, 1996. Cost of sales as a percentage of net sales, increased slightly to 58.1% for the period from March 1, 1996 to November 26, 1996 as compared to 57.5% for the 12 months ended February 29, 1996. The increase in cost of sales as a percentage of net sales was primarily attributable to an increase in certain material costs, partially offset by increased sales of Gena's paraffin spa line, which generates higher margin than Gena's other products. GROSS PROFIT As a result of the foregoing, gross profit amounted to $2.8 million for the period from March 1, 1996 to November 26, 1996, which represents a decrease to 41.9% of net sales as compared to 42.5% of net sales for the fiscal year ended February 29, 1996. SELLING, GENERAL, AND ADMINISTRATIVE EXPENSES Selling, general and administrative expenses were $2.0 million for the period from March 1, 1996 to November 26, 1996. Selling, general, and administrative expenses, as a percentage of net sales, decreased to 29.6% as compared with 36.2% for the 12 months ended February 29, 1996. The decrease in selling, general, and administrative expenses was primarily attributable to reduced shareholder compensation for the period March 1, 1996 to November 26, 1996 in connection with the sale of Gena to the Company. NET INCOME Net income for the Company was $500,000 for the period from March 1, 1996 to November 26, 1996. TWELVE MONTHS ENDED FEBRUARY 29, 1996 NET SALES Net sales increased 11.4% to $8.4 million in the 12 months ended February 29, 1996 from $7.5 million in the 12 months ended February 28, 1995. The increase in net sales was attributable to growth in sales of existing products, which consisted primarily of increased acceptance of the paraffin spa product line that was introduced in February 1993 and the continued sales growth of the MRX product line that was acquired in September 1994. COST OF SALES Cost of sales, as a percentage of net sales, increased to 57.5% in the 12 months ended February 29, 1996 as compared with 55.3% in the 12 months ended February 28, 1995. The increase was attributable to additional costs incurred to produce the new paraffin spa equipment, which has a higher cost of sales, as a percentage of net sales, at approximately 64.0%. Additionally, cost of sales, as 29 a percentage of net sales, on the new MRX product line, introduced in September 1994, was approximately 60.0%, which was also higher than Gena's other product lines. GROSS PROFIT As a result of the foregoing, gross profits increased 6.1% to $3.6 million in the 12 months ended February 29, 1996 from $3.4 million in the 12 months ended February 28, 1995. SELLING, GENERAL, AND ADMINISTRATIVE EXPENSES Selling, general, and administrative expenses were $3.0 million in the 12 months ended February 29, 1996 and 1995. The slight increase in selling, general, and administrative expenses was attributable to an increase in selling and promotional costs primarily related to increased sales of the paraffin spa product. Additionally, Gena was offering greater promotional incentive to generate additional sales resulting in increased selling costs. The above increases were partially offset by reduced travel expenses and smaller management bonuses than had been paid in the previous period. NET INCOME Net income increased 36.6% to $300,000 in the 12 months ended February 29, 1996 from $200,000 in the 12 months ended February 28, 1995. TWELVE MONTHS ENDED FEBRUARY 28, 1995 NET SALES Net sales increased 17.1% to $7.5 million in the 12 months ended February 28, 1995 from $6.4 million in the 12 months ended February 28, 1994. The increase was primarily a result of increased sales of Gena's paraffin spa product line, which had been introduced in February 1993, and the February 1994 acquisition of Design Classic, a manufacturer of fiberglass nail products. Gena also acquired the MRX product line, an all-purpose antiseptic and hydrating lotion, in September 1994 and began to ship substantial quantities in fiscal 1995. Total sales related to the Design Classic and MRX product lines were approximately $1.0 million in 1995. COST OF SALES Cost of sales, as a percentage of net sales, increased to 55.3% in the 12 months ended February 28, 1995 as compared with 51.0% in the 12 months ended February 28, 1994, as a result of additional labor, machine retooling, and material costs incurred to produce the new paraffin spa product, which has lower gross margins that Gena's other products. In addition, Gena incurred certain one-time packaging and other costs to integrate their newly acquired Design Classic product line. Gena also experienced an increase in certain raw materials costs. GROSS PROFIT As a result of the foregoing, gross profit increased 6.8% to $3.4 million in the 12 months ended February 28, 1995 from $3.1 million in the 12 months ended February 28, 1994. SELLING, GENERAL, AND ADMINISTRATIVE EXPENSES Selling, general, and administrative expenses increased 8.0% to $3.0 million in the 12 months ended February 28, 1995 from $2.7 million in the 12 months ended February 28, 1994, as a result of the increase in selling and promotional costs related to the introduction and promotion of the paraffin spa product line. In addition, Gena incurred an increase in costs related to the acquisition of Design Classic, which includes amortization of intangible assets, and increased personnel costs required to support the new product. NET INCOME Net income decreased 16.5% to $200,000 in the 12 months ended February 28, 1995 from $300,000 in the 12 months ended February 28, 1994. 30 RESULTS OF OPERATIONS - BODY DRENCH PERIOD FROM JANUARY 1, 1996 TO NOVEMBER 26, 1996 NET SALES Net sales amounted to $9.6 million for the period from January 1, 1996 to November 26, 1996. Annualized net sales for the period were $10.5 million, which decreased 11.3% as compared with the net sales of $11.9 million recorded in fiscal year ended December 31, 1995. The decrease in net sales was attributable to difficulty in obtaining inventory from third party manufacturers, due to cash flow difficulties experienced by Body Drench's parent company. Such difficulties caused Body Drench to be unable to fulfill certain sales orders due to its inability to deliver products to customers in time for the Spring 1996 tanning season. In addition, sales of the Contemporary product line, which was introduced in October 1994, declined during 1996, but was partially offset by the increased sales of its new tanning product releases: Tan FX, Tan EX, and increased sales of the Company's line of moisturizing lotion products. COST OF SALES Cost of Sales amounted to $5.9 million for the period January 1, 1996 to November 26, 1996. Cost of sales as a percentage of net sales increased to 60.8% for the period January 1, 1996 to November 26, 1996 as compared with 54.1% for the 12 months ended December 31, 1995. The increase in cost of sales was primarily attributable to a reduction in selling prices for certain products, as well as increased cash discount for certain customers in an effort to maximum cash collections, related to the cash flow difficulties experienced by Body Drench's parent company. GROSS PROFIT As a result of the foregoing, gross profit amounted to $3.8 million for the period from January 1, 1996 to November 26, 1996. SELLING, GENERAL, AND ADMINISTRATIVE EXPENSES Selling, general, and administrative expenses were $4.0 million for the period from January 1, 1996 to November 26, 1996. Selling, general, and administrative expenses, as a percentage of net sales, remained relatively unchanged at 41.5% for the period January 1, 1996 to November 26, 1996 as compared with 41.1% for the 12 months ended December 31, 1995. NET LOSS As a result of the foregoing, Body Drench incurred a net loss amounting to $137,000 for the period from January 1, 1996 to November 26, 1996. TWELVE MONTHS ENDED DECEMBER 31, 1995 NET SALES Net sales in 1995 increased 6.6% to $11.9 million compared with $11.1 million in 1994. The increase in net sales was due to the release of the new Contemporary product line introduced in October 1994. During 1995, Body Drench realized a full year of Contemporary sales as compared to only a partial year in 1994. The increase in net sales was also impacted by the release of the Tan FX and Tan EX products, and the Contemporary products introduced in the fourth quarter of 1994. COST OF SALES Cost of sales, as a percentage of net sales, decreased to 54.1% for the 12 months ended December 31, 1995 as compared with 56.9% for the 12 months ended December 31, 1994. This decrease was due primarily to the introduction of the Contemporary product line in October 1994, which carried a lower raw material cost in relation to net sales as compared to products sold during 1995. 31 GROSS PROFIT As a result of the foregoing, gross profit increased 13.5% to $5.4 million in the 12 months ended December 31, 1995 from $4.8 million in the 12 months ended December 31, 1994. SELLING, GENERAL, AND ADMINISTRATIVE EXPENSES Selling, general, and administrative expenses increased 19.8% to $4.9 million in 1995 compared with $4.1 million in 1994. The increase was attributable to the continued increased of shipping costs in proportion to sales levels due to the growing number of backorders from the Contemporary product line. Backorders resulted primarily from Body Drench's inability to produce sufficient product to meet customer orders due to cash flow shortages at DBN and Body Drench. Additionally, advertising expenses increased by approximately 1.0% of net sales as a result of the heavy promotional efforts in various magazines, catalogs and brochures with the release of the new Contemporary product line. Body Drench also incurred higher personnel costs through the addition of several marketing and sales professionals. NET INCOME Net income decreased 34.1% to $300,000 in the 12 months ended December 31, 1995 compared with $400,000 in the 12 months ended December 31, 1994. TWELVE MONTHS ENDED DECEMBER 31, 1994 NET SALES Net sales increased 67.4% to $11.1 million in the 12 months ended December 31, 1994 compared with $6.7 million in the 12 months ended December 31, 1993. The increased in net sales was attributable to management's decision to expand the distribution network to include several beauty supply distributors. This expansion of distribution channels included establishing a dedicated sales force to promote Body Drench's products to the tanning and beauty industry. In addition, Body Drench introduced the Contemporary product line in October 1994. COST OF SALES Cost of sales, as a percentage of net sales, decreased to 56.9% for the 12 months ended December 31, 1994 as compared with 60.7% for the 12 months ended December 31, 1993. This decrease was due primarily to lower purchasing costs as a result of the higher volume of purchases during 1994. In addition, Body Drench incurred lower overhead and labor costs as a percentage of revenues, as a result of increased production efficiencies due to higher utilization of prepackaged, ready to ship products. GROSS PROFIT As a result of the foregoing, gross profit increased 83.5% to $4.8 million in the 12 months ended December 31, 1994 from $2.6 million in the 12 months ended December 31, 1993. SELLING, GENERAL, AND ADMINISTRATIVE EXPENSES Selling, general, and administrative expenses increased 98.3% to $4.1 million in 1994 compared with $2.1 million in 1993. The increase in selling, general, and administrative expenses related to additional sales and administrative positions to support the corresponding increase in sales. In addition, Body Drench incurred significant upfront costs of promotional literature, including new catalogs, brochures and price sheets, related to the introduction of the Contemporary product line introduced in October 1994. Body Drench also incurred a higher level of freight charges in proportion to sales levels due to significant number of backorders, resulting from inventory shortages, which caused additional shipment costs to customers. NET INCOME Net income increased 36.0% to $400,000 in 1994 compared with $300,000 in 1993. 32 RESULTS OF OPERATIONS - JDS PERIOD FROM OCTOBER 1, 1996 TO NOVEMBER 26, 1996 NET SALES Net sales amounted to $600,000 for the period from October 1, 1996 to November 26, 1996. COST OF SALES Cost of sales amounted to $300,000 for the period from October 1, 1996 to November 26, 1996. Cost of sales, as a percentage of net sales, remained relatively constant at 44.9% for the period October 1, 1996 to November 26, 1996 as compared with 45.2% for the 12 months ended September 30, 1996. GROSS PROFIT As a result of the foregoing, gross profit amounted to $300,000 for the period from October 1, 1996 to November 26, 1996. SELLING, GENERAL, AND ADMINISTRATIVE EXPENSES Selling, general, and administrative expenses were $300,000 for the period from October 1, 1996 to November 26, 1996. Selling, general, and administrative expenses, as a percentage of net sales, decreased to 42.0% as compared with 51.8% for the 12 months ended September 30, 1996. The decrease in selling, general, and administrative expenses as a percentage of net sales was primarily attributable to reduced shareholders' compensation for the period October 1, 1996 to November 26, 1996, in connection with the sale of JDS to the Company. NET INCOME As a result of the foregoing, net income for the Company was approximately $45,000 for the period October 1, 1996 to November 26, 1996. TWELVE MONTHS ENDED SEPTEMBER 30, 1996 NET SALES Net sales decreased 7.5% to $3.1 million in the 12 months ended September 30, 1996 compared with $3.4 million in the 12 months ended September 30, 1995. The decrease was caused primarily by a decline in its customer base as a result of the acquisition of several of JDS' customers by a large beauty supply company that is not a customer of JDS. COST OF SALES Cost of sales, as a percentage of net sales, for the 12 months ended September 30, 1996 decreased to 45.2%, as compared with 46.0% in the 12 months ended September 30, 1995. The decrease as a percentage of net sales is related primarily to the negotiation of more favorable pricing on its materials costs with certain of its vendors. GROSS PROFIT As a result of the foregoing, gross profit decreased 6.1% to $1.7 million in the 12 months ended September 30, 1996 compared with $1.8 million in the 12 months ended September 30, 1995. 33 SELLING, GENERAL, AND ADMINISTRATIVE EXPENSES Selling, general, and administrative expenses decreased 12.4% to $1.6 million in the 12 months ended September 30, 1996 compared with $1.8 million in the 12 months ended September 30,1995. The decrease resulted primarily from the elimination of warehouse personnel, as a result of JDS' efforts to reduce overhead costs. NET INCOME As a result of the foregoing, net income was approximately $69,000 in the 12 months ended September 30, 1996 as compared with approximately $9,000 in the 12 months ended September 30, 1995. TWELVE MONTHS ENDED SEPTEMBER 30, 1995 NET SALES Net sales decreased 5.9% to $3.4 million for the 12 months ended September 30, 1995, compared with $3.6 million for the 12 months ended September 30, 1994. The decrease was primarily a result of increased competition from several new products in the market that impacted JDS' market share. COST OF SALES Cost of sales, as a percentage of net sales, remained relatively constant at 46.9% in the 12 months ended September 30, 1995 as compared with 46.2% in the 12 months ended September 30, 1994. The decrease was a result of obtaining more favorable freight terms with its shipping contractors. GROSS PROFIT As a result of the foregoing, gross profit decreased 5.6% to $1.8 million in the 12 months ended September 30, 1995 from $1.9 million in the 12 months ended September 30, 1994. SELLING, GENERAL, AND ADMINISTRATIVE EXPENSES Selling, general, and administrative expenses decreased 7.0% to $1.8 million for the 12 months ended September 30, 1995, compared with $2.0 million for the 12 months ended September 30, 1994. The decrease was primarily a result of a decrease in promotional costs, as no new products were introduced during 1995, and a decrease in management salaries resulting from an effort to reduce overhead costs. NET INCOME Net income was $8,574 in the 12 months ended September 30, 1995 compared with a net loss of $16,494 in the 12 months ended September 30, 1994. RESULTS OF OPERATIONS - KII PERIOD FROM JANUARY 1, 1996 TO NOVEMBER 26, 1996 NET SALES Net sales amounted to $1.2 million for the period from January 1, 1996 to November 26, 1996. Annualized net sales for this period were $1.4 million, which represents a decrease of 12.6% as compared with $1.6 million of net sales recorded in the fiscal year ended December 31, 1995. The decrease in net sales was primarily attributable to a reduction in the customer base and decreased promotional efforts. COST OF SALES Cost of sales amounted to $600,000 for the period from January 1, 1996 to November 26, 1996. Cost of sales, as a percentage of net sales, remained relatively unchanged at 46.9% for the period from January 1, 1996 to November 26, 1996 as compared with 45.7% for the 12 months ended December 31, 1995. 34 GROSS PROFIT As a result of the foregoing, gross profit amounted to $600,000 for the period from January 1, 1996 to November 26, 1996. SELLING, GENERAL, AND ADMINISTRATIVE EXPENSES Selling, general, and administrative expenses were $600,000 for the period from January 1, 1996 to November 26, 1996. Selling, general, and administrative expenses, as a percentage of net sales, decreased to 47.3% for the period from January 1, 1996 to November 26, 1996, as compared with 57.2% for the 12 months ended December 31, 1995. The decrease in selling, general, and administrative expenses as a percentage of net sales was primarily attributable to a reduction in commission expenses related to the decrease in sales as well as lower promotional costs. NET LOSS As a result of the foregoing, net loss for the KII was approximately $2,000 for the period from January 1, 1996 to November 26, 1996. TWELVE MONTHS ENDED DECEMBER 31, 1995 COMPARED WITH TWELVE MONTHS ENDED DECEMBER 31, 1994 NET SALES Net sales in the 12 months ended December 31, 1995 decreased 22.1% to $1.6 million as compared with $2.0 million in the 12 months ended December 31, 1994. As part of its overall strategy, KII acquired a division of Redken in December 1993. During 1994, Redken reduced its customer base by 17 distributors, which had a direct impact on sales for KII. COST OF SALES Cost of sales, as a percentage of net sales, increased to 45.7% in the 12 months ended December 31, 1995 as compared with 49.3% in the 12 months ended December 31, 1994. The increase was primarily attributable to increased freight and duty costs associated with international purchases. GROSS PROFIT As a result of the foregoing, gross profit decreased 16.6% to $800,000 in the 12 months ended December 31, 1995 from $1.0 million in the 12 months ended December 31, 1994. SELLING, GENERAL, AND ADMINISTRATIVE EXPENSES Selling, general, and administrative expenses decreased 14.3% to $900,000 in the 12 months ended December 31, 1995 compared with $1.0 million in the 12 months ended December 31, 1994. The decrease in selling, general, and administrative expenses was attributable to a decrease in salaries and commissions through the elimination of several sales positions. NET LOSS Net loss increased to approximately $135,000 in the 12 months ended December 31, 1995 from approximately $72,000 in the 12 months ended December 31, 1994. SEASONALITY AND QUARTERLY FINANCIAL RESULTS (AS RESTATED) The following table sets forth certain unaudited quarterly results of operations for each of the eight quarters in the fiscal years ended December 31, 1997 and 1998 as restated. All quarterly information was obtained from unaudited 35 financial statements not otherwise contained herein. The Company believes that all necessary adjustments have been made to present fairly the quarterly information when read in conjunction with the restated Consolidated Financial Statements and Notes thereto included elsewhere in this Report. The operating results for any quarter are not necessarily indicative of the results for any future period (in thousands, except per share data).
FISCAL 1998 (AS RESTATED) ---------------------------------------------------- MARCH 31, JUNE 30, SEPTEMBER 30, DECEMBER 31, 1998 1998 1998 1998 ---- ---- ---- ---- Net sales................................. $14,073 $16,795 $25,400 $27,098 Gross profit.............................. 7,488 8,895 14,195 13,790 Selling, general and administrative....... 5,395 6,514 9,689 10,021 Centralization and reengineering costs.... -- -- -- 422 Income from operations.................... 2,093 2,381 4,506 3,347 Income (loss) before extraordinary item... (256) (164) 437 1,634 Extraordinary item, net................... -- (1,091) -- -- Net income (loss)......................... (256) (1,255) 437 1,634 Diluted EPS before extraordinary item..... $ (0.06) $ (0.04) $ 0.10 $ 0.40 Diluted EPS after extraordinary item...... (0.06) (0.28) 0.10 0.40 FISCAL 1997 (AS RESTATED) ------------------------------------------------------ MARCH 31, JUNE 30, SEPTEMBER 30, DECEMBER 31, 1997 1997 1997 1997 ---- ---- ---- ---- Net sales................................. $ 7,479 $7,093 $10,210 $11,723 Gross profit.............................. 4,245 3,994 5,480 6,030 Selling, general and administrative....... 2,398 2,333 3,574 3,896 Income from operations.................... 1,847 1,661 1,906 2,134 Income before extraordinary item.......... 1,054 834 506 770 Extraordinary item, net................... -- -- -- (1,377) Net income (loss)......................... 1,054 834 506 (607) Diluted EPS before extraordinary item..... $ 0.26 $ 0.20 $ 0.12 $ 0.19 Diluted EPS after extraordinary item...... 0.26 0.20 0.12 (0.15)
The Company has experienced moderate seasonality in quarterly operating results due mainly to the effect of the seasonality of the indoor tanning season on the operating results of the Body Drench and Suntopia product lines. The Company expects the seasonal effect of Body Drench and Suntopia sales to diminish in the future due to the substantial acquisition and internal growth of non-tanning brands, which are less affected by seasonality. LIQUIDITY AND CAPITAL RESOURCES (AS RESTATED) The Company's working capital position increased to $30.6 million at December 31, 1998 from $13.0 million at December 31, 1997. The increase of $17.6 million is primarily due to increases in accounts receivable and inventory as a result of the completion of the acquisitions during 1998. The Company's working capital position at December 31, 1997 was primarily the result of the completion of the acquisitions completed during 1997 and the Company's results of operations for the year ended December 31, 1997. During the year ended December 31, 1998, the Company used $6.8 million of cash in operating activities, which was primarily the result of the increased investment in accounts receivable and inventory of $4.6 million and $8.6 million, respectively, offset by the increase in accounts payable and accrued liabilities of $1.8 million. The increased investment in accounts receivable and inventories at December 31, 1998 is primarily related to increased revenue and inventories as a result of the acquisitions, and sales growth in the existing businesses during the fiscal year ended December 31, 1998. The increases in accounts payable and accrued liabilities during the period relates primarily to the liabilities assumed in the acquisitions, as well as internal growth of the Company's business. 36 Capital expenditures for the year ended December 31, 1998 totaled approximately $2.0 million, primarily related to computer hardware and software costs in connection with Company's new centralized management and information systems. Effective June 26, 1997, the Company acquired all of the issued and outstanding capital stock of ABBA, a producer of a proprietary line of aromatherapy-based professional hair care products. The Company paid a purchase price of $20.0 million for the stock of ABBA. The transaction was accounted for using the purchase method of accounting. In connection with the acquisition of ABBA, the Company entered into the June 1997 Credit Facility. The Company repaid the June 1997 Credit Facility with the proceeds from the December 1997 Credit Facility, discussed below. In connection with the refinancing of the June 1997 Credit Facility, costs previously deferred resulted in an extraordinary charge to earnings of approximately $1.4 million, net of income taxes, or $0.34 per diluted share, in the fourth quarter of 1997. On December 10, 1997, the Company acquired certain assets and assumed certain liabilities of Inverness. Inverness produces salon and retail hair removal apparatus and products under lines known as "One Touch" and "Clean + Easy". The Company paid a purchase price of $20.0 million, consisting of $16.5 million in cash and an additional $3.5 million in cash held in escrow pending release contingent upon the successful transition of the manufacturing of certain hair removal appliances to offshore manufacturing. The Inverness acquisition was accounted for using the purchase method of accounting. In connection with the acquisition of the Clean + Easy and One Touch product lines, the Company entered into the December 1997 Credit Facility with a group of banks for whom Credit Agricole Indosuez acted as agent. The Company used $50.0 million of the December 1997 Credit Facility to pay for the acquisition, acquisition fees, and the payoff of the June 1997 Credit Facility. The Company repaid the December 1997 Credit Facility with the proceeds from the 1998 Credit Facility, discussed below. In May 1998, the Company acquired substantially all of the assets and assumed certain operating liabilities of Pro Finish, a producer of name-brand professional nail enhancement and nail care products. The Company paid a purchase price of approximately $5.0 million in cash. The Company financed the acquisition with proceeds from the December 1997 Credit Facility. The acquisition was accounted for using the purchase method of accounting. In June 1998, the Company issued the Notes. The Company used the $100.0 million proceeds to finance the purchase price and related costs of acquiring all of the issued and outstanding capital stock of the European Touch Companies, as well as to repay all amounts outstanding under the December 1997 Credit Facility. European Touch is a developer, producer, and marketer of professional nail enhancement and treatment products and European Touch II is a developer, producer, and marketer of salon pedicure equipment. These companies were purchased for a purchase price of approximately $25.0 million in cash, using the purchase method of accounting. In connection with the offering of the Notes, the Company entered into the 1998 Credit Facility, which is a five-year, $50.0 million senior credit facility with a group of banks for which NationsBank, N.A. and Bank of Boston, N.A. acted as co-agents. The 1998 Credit Facility consists of two separate loans: a $25.0 million acquisition term loan and a $25.0 million revolving line of credit. The interest on the 1998 Credit Facility is paid quarterly and the interest rate is determined by the base rate (the "Base Rate"), as defined in the credit agreement. The Base Rate is equal to the higher of (a) the sum of (i) 0.50% plus (ii) the Federal Funds Rate plus (iii) the Applicable Base Rate Margin or (b) the sum of (i) the Prime Rate plus (ii) the Applicable Base Rate Margin. Principal payments on the acquisition term loan are paid quarterly beginning in March 2000. Principal payments on the revolving line of credit are due on the maturity date. The acquisition term loan and the revolving line of credit mature in June 2003. The revolving line of credit will be used for working capital purposes. The Company has the option to convert the interest rates relating to any of the loans to LIBOR plus 150 to 250 basis points. If the Company converts to the LIBOR-based interest rate, interest is paid on the LIBOR-based maturity date, which is generally three months from the conversion date. The Company utilized net proceeds of $37.0 million from the 1998 Credit Facility to finance acquisitions and working capital requirements during the year ended December 31, 1998. In August 1998, the Company acquired Framesi USA. Framesi USA holds exclusive license rights for the sale in the United States and most of Latin America of Framesi brand hair color products along with its complementary Biogenol line of shampoos, conditioners, and styling products. The Company paid approximately $33.0 million for Framesi USA in the form of cash and seller 37 carryback financing of approximately $5.0 million. Approximately $25.0 million from the 1998 Credit Facility was used to finance the purchase price. The acquisition was accounted for using the purchase method of accounting. As of December 31, 1998, the Company owned approximately 85% of Ft. Pitt Acquisition, Inc. As of December 31, 1998, the Company had borrowed approximately $12.0 million under the revolving line of credit for working capital purposes, including financing the inventory and receivable buildup related to the launch of the new ABBA packaging and funding capital expenditures associated with the centralization and business process reengineering project undertaken during the fourth quarter of 1998. In addition, the borrowing was used to repay debt created in conjunction with the acquisition of Gena and JDS as well as to repay existing debt assumed in the acquisition of Framesi USA. The Company intends to raise additional capital through debt and equity financings beginning in the second quarter of 1999 to fund its continued growth. At this time, it is not possible to assess the type of financings the Company will pursue or the terms or availability of such financings. The inability to secure such financing on acceptable terms could have an adverse effect on the Company's business, operations, and financial position. In addition, it is possible that such financing will further increase the Company's leverage. The Company plans to drive internal growth through the expansion of distribution, new products, product line extensions, and brand introductions. The Company also plans to pursue strategic acquisitions to capitalize on the substantial fragmentation and growth potential existing in the professional salon and personal care products industry. The Company intends to fund its future capital needs through a combination of current cash resources, expected cash flows from operations, bank financing, seller notes payable, issuance of its Common Stock, and additional public or private debt or equity financing. These capital resources may not be available, and the availability of such capital depends upon prevailing market conditions, interest rates, and the financial condition of the Company. YEAR 2000 COMPLIANCE Many currently installed computer systems and software products are coded to accept only two-digit entries in the date code field. Beginning in 2000, these date code fields will need to accept four-digit entries to distinguish 21st century dates from 20th century dates. As a result, within the next year, computer systems and software used by many companies may need to be upgraded to comply with such "Year 2000" requirements. Significant uncertainty exists concerning the potential effects associated with such compliance. COMPANY'S STATE OF READINESS The Company has completed an assessment of its internal systems and processes with respect to the "Year 2000" issue. The Company's sales, accounts receivable, inventory management, accounts payable, general ledger and payroll systems comprise its critical information technology ("IT") systems. The Company has assessed its "Year 2000" readiness with regard to these critical IT systems. Based on internal assessments and upon vendor representations, the Company believes that its critical IT systems currently in place or being implemented as part of the centralization and business process reengineering plan are or will be "Year 2000" complaint. The Company believes that it will complete the implementation of its new processes and systems associated with the critical IT systems by June 30, 1999. The Company intends to assess the potential impact of "Year 2000" failures from vendors, customers, and outside parties upon its business and is currently taking steps to assess and minimize the risk of such "Year 2000" failures. Based upon the Company's current state of readiness and the steps currently being taken, the Company does not believe that the "Year 2000" problem will have a material adverse effect on the Company's business, financial condition, or results of operations. Software and hardware, such as security and telephone systems, that facilitate the operations of its warehouses and operating locations that are not affected by the centralization and reengineering plan comprise the Company's primary non-IT systems. The Company is in the process of assessing the "Year 2000" compliance of these non-IT systems and expects to conclude this assessment by June 30, 1999. The Company has not incurred, nor does it expect to incur, material costs in readying its non-IT systems for the Year 2000. 38 COMPANY'S RISKS OF "YEAR 2000" ISSUES The Company procures a significant amount of raw materials and components from external suppliers and relies upon third-party contract manufacturers to manufacture most of its products. As a result, the Company may be at risk from suppliers and manufacturers, foreign and domestic, that are not taking adequate measures to ensure "Year 2000" compliance. The failure of such suppliers and manufacturers to be "Year 2000" compliant may cause raw material and product shortage that would adversely impact the Company's operations. As a result, the Company may be at risk with respect to suppliers and manufacturers that may not be "Year 2000" compliant. The Company believes that the most likely negative effects, if any, could include disruption in both shipments and receipts of raw materials, components, and products by the Company and its customers. In addition, the Company's customers may experience "Year 2000" failures, which could result in delays in the Company's receipt of payments from customers. CONTINGENCY PLANS The Company is developing contingency plans with respect to significant "Year 2000" issues. For example, the Company is in the process of assessing and verifying the "Year 2000" compliance of its international and domestic suppliers and contract manufacturers. Verification will be accomplished through the use of "Year 2000" readiness inquiries sent to key suppliers and manufacturers. The Company is investigating transferring supplier and manufacturing relationships to alternate providers if current suppliers and manufacturers are not "Year 2000" compliant. ITEM 7A..QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK DERIVATIVE FINANCIAL INSTRUMENTS, OTHER FINANCIAL INSTRUMENTS, AND DERIVATIVE COMMODITY INSTRUMENTS. At December 31, 1998, the Company did not participate in any derivative financial instruments, or other financial and commodity instruments for which fair value disclosure would be required under Statement of Financial Accounting Standards No. 107. The Company holds no investment securities that would require disclosure on market risk. PRIMARY MARKET RISK EXPOSURES. The Company's primary market risk exposures are in the areas of interest rate risk and foreign currency exchange rate risk. The Company incurs interest expense on loans made under the Notes at an interest rate, which is fixed, for a maximum of ten years. At December 31, 1998, the Company's outstanding borrowings on the Notes were $100 million, at an interest rate of 10.875%. The Company also incurs interest on loans made under a revolving line of credit and other debt instruments at variable interest rates ranging from 6.0% to 8.5%. At December 31, 1998, the Company's total outstanding borrowings on the instruments was approximately $43.1 million. The Company entered into an interest rate swap agreement and an interest rate cap agreement to limit the effect of increases in the interest rates on floating rate debt. The notional amounts of interest rate agreements are used to measure interest to be paid or received and do not represent the amount of exposure to credit loss. The net cash amounts paid or received on the agreements are accrued and recognized as an adjustment to interest expense. The interest rate swap agreement is a contract to exchange floating rate for fixed rate interest payments periodically over the life of the agreement. During March 1998, the Company entered into an interest rate swap agreement, which effectively fixed the interest rate on $12.5 million notional principal amount under the 1998 Credit Facility at 5.75% plus a credit margin ranging from 150 to 250 basis points, for a period ending March 2000. During April 1998, the Company entered into an interest rate cap agreement, which effectively limits the Company's interest rate exposure on a $12.5 million notional principal amount under the 1998 Credit Facility at 7.50% plus a credit margin ranging from 250 to 300 basis points, for a period ending April 2000. The borrowings not subject to interest rate swap or interest rate cap agreements at December 31, 1998 totaled $12.0 million. Substantially all of the Company's business outside the United States is conducted in U.S. dollar denominated transactions. The Company has a sales division located in the United Kingdom. Some of the expenses of this foreign subsidiary are denominated in the British pound sterling. These expenses include local salaries and wages, utilities, and some operating supplies. However, the Company believes that the operating expenses currently incurred in foreign currency are immaterial, and therefore any associated market risk is unlikely to have a material adverse effect on the Company's business, results of operations, or financial condition. 39 ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE Not applicable. PART III ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT The information required by this Item relating to directors of the Company is incorporated herein by reference to the definitive Proxy Statement to be filed pursuant to Regulation 14A of the Securities Exchange Act of 1934, as amended (the "Exchange Act") for the Company's 1999 Annual Meeting of Stockholders. The information required by this Item relating to executive officers of the Company is included in Item 1, "Business - Executive Officers." ITEM 11. EXECUTIVE COMPENSATION The information required by this Item is incorporated herein by reference to the definitive Proxy Statement to be filed pursuant to Regulation 14A of the Exchange Act for the Company's 1999 Annual Meeting of Stockholders. ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT The information required by this Item is incorporated herein by reference to the definitive Proxy Statement to be filed pursuant to Regulation 14A of the Exchange Act for the Company's 1999 Annual Meeting of Stockholders. ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS The information required by this Item is incorporated herein by reference to the definitive Proxy Statement to be filed pursuant to Regulation 14A of the Exchange Act for the Company's 1999 Annual Meeting of Stockholders PART IV ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K (a) FINANCIAL STATEMENTS AND FINANCIAL STATEMENT SCHEDULES: (1) Financial Statements are listed in the Index to Consolidated Financial Statements on page F-1 of this Report. (2) Financial Statement Schedule All other schedules have been omitted because they are not applicable or are not required or the information required to be set forth therein is included in the consolidated financial statements or notes thereto. (b) REPORTS ON FORM 8-K Not applicable. (c) EXHIBITS EXHIBIT NO. DESCRIPTION OF EXHIBIT - ----------- ---------------------- 3.1 First Amended and Restated Certificate of Incorporation of the Registrant 3.3 Bylaws of the Registrant(1) 4.1 Specimen of Stock Certificate(1) 4.2 Specimen of Redeemable Common Stock Warrant(1) 40 4.3 Form of Warrant issued to Credit Agricole Indosuez(2) 4.4 Form of Warrant issued to Bank Boston N.A.(3) 4.5 Indenture dated as of June 23, 1998, by and among the Company, the Guarantors Signatories thereto, and State Street Bank and Trust Company of California, N.A.(4) 4.6 Form of Global Notes(4) 4.8 Rights Agreement, dated February 23, 1999, between Styling Technology Corporation and American Securities Transfer & Trust, Inc., as Rights Agent, together with the following exhibits thereto; Exhibit A-Form of Certificate of Designation of Series A Junior Participating Preferred Stock of Styling Technology Corporation; Exhibit B-Form of Right Certificate; Exhibit C-Summary of Rights to Purchase Shares of Preferred Stock of Styling Technology Corporation.(5) 10.5 Employment Agreement between Registrant and Sam L. Leopold(1) 10.11 1996 Stock Option Plan(1) 10.19 Asset Purchase Agreement dated as of October 31, 1997 among the Registrant, Inverness Corporation, and Inverness (UK) Limited.(6) 10.20 Transition and Manufacturing Agreement dated as of December 10, 1997 the Registrant and Inverness Corporation.(6) 10.23 Stock Purchase Agreement dated as of June 23, 1998 among the Company and the former shareholders of European Touch, Ltd. II(7) 10.24 Credit Agreement dated June 30, 1998 among the Company, BankBoston, N.A., and NationsBank, N.A.(8) 10.25 Stock Purchase Agreement dated as of August 3, 1998, among the Company, Kevin T. Weir, Carol M. Weir, and Dennis M. Katawczik(6) 10.26 1998 Employee Stock Option Plan 12 Computation of Ratio of Earnings to Fixed Charges 21 Subsidiaries of Registrant 23.1 Consent of Arthur Andersen LLP 27 Financial Data Schedules - ---------- (1) Incorporated by reference to the Registration Statement on Form S-1 (Registration No. 333-12469) filed September 20, 1996 and declared effective November 12, 1996. (2) Incorporated by reference to the Registrant's Quarterly Report on Form 10-Q as filed with the Securities and Exchange Commission (the "Commission") on August 14, 1997. (3) Quarterly Report on Form 10-Q as filed with the Commission on November 14, 1997. (4) Incorporated by reference to the Registration Statement on From S-4 (Registration No. 333-61035) filed August 7, 1998 and declared effective September 18, 1998. (5) Incorporated by reference to the Registration Statement on Form 8-A as filed with the Commission on March 8, 1999. (6) Incorporated by reference to the Registrant's Current Report on Form 8-K as filed with the Commission on December 24, 1997. (7) Incorporated by reference to the Registrant's Current Report on Form 8-K as filed with the Commission on July 8, 1998. (8) Incorporated by reference to Amendment No. 1 to Form S-4 (Registration No. 333-61035) filed September 17, 1998 and declared effective September 18, 1998. 41 SIGNATURES In accordance with Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has fully caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. STYLING TECHNOLOGY CORPORATION /s/ Sam L. Leopold ---------------------------------------- Sam L. Leopold Chairman of the Board, President, and Chief Executive Officer Date: October 20, 2000 ----------------------------------- In accordance with the Securities Exchange Act of 1934, this Report has been signed below by the following persons on behalf of the registrant and in the capacities and on the date indicated.
SIGNATURE CAPACITY DATE --------- -------- ---- /s/ Sam L. Leopold Chairman of the Board, President, and October 20, 2000 - ---------------------------- Chief Executive Officer (Principal Sam L. Leopold Executive Officer) /s/ James Yeager Executive Vice President and Chief October 20, 2000 - ---------------------------- Financial Officer, Treasurer, and James Yeager Secretary (Principal Financial and Accounting Officer) /s/ James A. Brooks Director October 20, 2000 - ---------------------------- James A. Brooks /s/ Michael H. Feinstein Director October 20, 2000 - ---------------------------- Michael H. Feinstein
42 STYLING TECHNOLOGY CORPORATION AND SUBSIDIARIES Index to Consolidated Financial Statements and Schedules Consolidated Financial Statements PAGE Styling Technology Corporation Report of Independent Public Accountants F-2 Consolidated Balance Sheets F-3 Consolidated Statements of Operations F-4 Consolidated Statements of Stockholders' Equity F-5 Consolidated Statements of Cash Flows F-6 Notes to Consolidated Financial Statements F-7 Gena Laboratories, Inc. Report of Independent Public Accountants F-38 Balance Sheets F-39 Statements of Operations F-40 Statements of Stockholders' Equity F-41 Statements of Cash Flows F-42 Notes to Financial Statements F-43 Body Drench (a Division of Designs by Norvell, Inc.) Report of Independent Public Accountants F-49 Balance Sheets F-50 Statements of Operations F-51 Statements of Changes in Owners' Investment F-52 Statements of Cash Flows F-53 Notes to Financial Statements F-54 JDS Manufacturing Co., Inc. Report of Independent Public Accountants F-57 Balance Sheets F-58 Statements of Operations F-56 Statements of Stockholders' Equity F-60 Statements of Cash Flows F-61 Notes to Financial Statements F-62 Kotchammer Investments, Inc. Report of Independent Public Accountants F-65 Balance Sheet F-66 Statements of Operations F-67 Statements of Stockholders' Deficit F-68 Statements of Cash Flows F-69 Notes to Financial Statements F-70 Financial Statement Schedule Valuation and Qualifying Accounts S-1 F-1 REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS To Styling Technology Corporation: We have audited the accompanying consolidated balance sheets of STYLING TECHNOLOGY CORPORATION, a Delaware corporation, and subsidiaries (the "Company"), as of December 31, 1997 and 1998, and the related consolidated statements of operations and cash flows for the period from November 27, 1996 (commencement of operations) to December 31, 1996 and for the years ended December 31, 1997 and 1998, and the related consolidated statements of stockholders' equity for the three years in the period ended December 31, 1998 (1997 and 1998 restated - See Notes 1 and 13). These financial statements and the schedule referred to below are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements and schedule based on our audits. We conducted our audits in accordance with auditing standards generally accepted in the United States. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. As discussed in Note 15, the Company has incurred substantial losses and defaulted under certain provisions of its Senior Secured Credit facility and Senior Subordinated Notes. Management's current projections indicate that there will not be sufficient cash flow from operations to fund the Company's debt payments in the normal course of operations. On August 31, 2000, the Company entered into Chapter 11 bankruptcy. In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of the Company as of December 31, 1997 and 1998, and the results of its operations and its cash flows for the period from November 27, 1996 to December 31, 1996 and for the years ended December 31, 1997 and 1998, in conformity with accounting principles generally accepted in the United States. Our audits were made for the purpose of forming an opinion on the basic financial statements taken as a whole. Schedule II listed in Item 14 of Part IV (1997 and 1998 restated) herein is presented for purposes of complying with the Securities and Exchange Commission's rules and is not a required part of the basic financial statements. This information has been subjected to the auditing procedures applied in our audits of the basic financial statements and, in our opinion, fairly state in all material respects the financial data required to be set forth therein in relation to the basic financial statements taken as a whole. /s/ Arthur Andersen LLP Phoenix, Arizona October 18, 2000 F-2 STYLING TECHNOLOGY CORPORATION AND SUBSIDIARIES Consolidated Balance Sheets (in thousands except share data)
DECEMBER 31, ----------------------- 1997 1998 --------- --------- (RESTATED) (RESTATED) Assets Current Assets: Cash and cash equivalents $ 3,063 $ 4,023 Accounts receivable, net of allowance for doubtful accounts of $1,032 and $1,786 12,693 24,812 Inventories, net 10,951 25,599 Prepaid expenses and other current assets 2,120 1,375 --------- --------- Total current assets 28,827 55,809 Property and Equipment, net 2,640 5,362 Goodwill and Other Intangibles, net of accumulated amortization of $1,375 and $5,188 56,506 139,566 Other Assets 2,913 13,336 --------- --------- $ 90,886 $ 214,073 ========= ========= Liabilities and Stockholders' Equity Current Liabilities: Accounts payable $ 6,505 $ 12,108 Accrued liabilities 3,670 10,367 Current portion of long-term debt and other 5,647 2,768 --------- --------- Total current liabilities 15,822 25,243 --------- --------- Deferred Income Taxes 162 19,216 Long-Term Debt and Other, less current portion 47,377 140,366 Commitments and Contingencies Stockholders' Equity: Preferred stock, $.0001 par value, 1,000,000 shares authorized, no shares issued and outstanding -- -- Common stock, $.0001 par value, 10,000,000 shares authorized, 4,757,000 shares issued and 3,949,000 shares outstanding at December 31, 1997; and 4,876,000 shares issued and 4,068,000 shares outstanding at December 31, 1998 1 1 Additional paid-in capital 27,875 29,038 Retained earnings 1,449 2,009 Treasury stock (1,800) (1,800) --------- --------- Total stockholders' equity 27,525 29,248 --------- --------- $ 90,886 $ 214,073 ========= =========
The accompanying notes are an integral part of these consolidated balance sheets. F-3 STYLING TECHNOLOGY CORPORATION AND SUBSIDIARIES Consolidated Statements of Operations (in thousands except share data)
FOR THE PERIOD FROM NOVEMBER 27, 1996 (COMMENCEMENT OF OPERATIONS) TO YEAR ENDED YEAR ENDED DECEMBER 31, 1996 DECEMBER 31, 1997 DECEMBER 31, 1998 ----------------- ----------------- ----------------- (RESTATED) (RESTATED) Net Sales $ 1,083 $ 36,505 $ 83,366 Cost of Sales 571 16,756 38,998 ----------- ----------- ----------- Gross profit 512 19,749 44,368 ----------- ----------- ----------- Selling, General and Administrative Expenses 737 12,201 31,619 Centralization and Reengineering Costs -- -- 422 ----------- ----------- ----------- 737 12,201 32,041 ----------- ----------- ----------- Income (Loss) from Operations (225) 7,548 12,327 Interest Expense and Other, net 2 (1,847) (9,206) ----------- ----------- ----------- Income (Loss) Before Extraordinary Item and Income Taxes (223) 5,701 3,121 Provision for (Benefit from) Income Taxes (72) 2,537 1,470 ----------- ----------- ----------- Income (Loss) Before Extraordinary Item (151) 3,164 1,651 Extraordinary Item, net of tax benefit of $882,000 and $822,000 -- (1,377) (1,091) ----------- ----------- ----------- Net income (loss) $ (151) $ 1,787 $ 560 =========== =========== =========== Basic Earnings (Loss) per Share: Income (loss) before extraordinary item $ (0.04) $ 0.80 $ 0.41 Extraordinary item -- (0.35) (0.27) ----------- ----------- ----------- Net income (loss) $ (0.04) $ 0.45 $ 0.14 =========== =========== =========== Weighted average shares 3,770,000 3,949,000 4,033,000 =========== =========== =========== Diluted Earnings (Loss) per Share: Income (loss) before extraordinary item $ (0.04) $ 0.77 $ 0.38 Extraordinary item -- (0.34) (0.25) ----------- ----------- ----------- Net income (loss) $ (0.04) $ 0.43 $ 0.13 =========== =========== =========== Weighted average shares 3,770,000 4,113,000 4,313,000 =========== =========== ===========
The accompanying notes are an integral part of these consolidated financial statements. F-4 STYLING TECHNOLOGY CORPORATION AND SUBSIDIARIES Consolidated Statements of Stockholders' Equity (in thousands)
COMMON STOCK RETAINED --------------------- ADDITIONAL EARNINGS TOTAL SHARES COMMON PAID-IN (ACCUMULATED TREASURY STOCKHOLDERS' OUTSTANDING STOCK CAPITAL DEFICIT) STOCK EQUITY ----------- ----- ------- -------- ----- ------ (RESTATED) (RESTATED) Balance, December 31, 1995 1,616 $ 1 $ -- $ -- $ -- $ 1 Issuance of common stock and warrants 20 -- 179 (187) -- (8) Issuance of common stock and warrants in initial public offering, net of offering costs of approximately $1,351,000 3,116 -- 27,227 -- -- 27,227 Issuance of common stock in KII acquisition 5 -- 50 -- -- 50 Purchase of 808,000 shares of treasury stock (808) -- -- -- (1,800) (1,800) Net loss for the period from November 27, 1996 (commencement of operations) to December 31, 1996 -- -- -- (151) -- (151) ------ ----- ------- ------ ------- ------- Balance, December 31, 1996 3,949 1 27,456 (338) (1,800) 25,319 Issuance of warrants -- -- 419 -- -- 419 Net income -- -- -- 1,787 -- 1,787 ------ ----- ------- ------ ------- ------- Balance, December 31, 1997 3,949 1 27,875 1,449 (1,800) 27,525 Issuance of common stock on exercise of stock options and warrants 119 -- 426 -- -- 426 Tax benefit from stock options exercised -- -- 737 -- -- 737 Net income -- -- -- 560 -- 560 ------ ----- ------- ------ ------- ------- Balance, December 31, 1998 4,068 $ 1 $29,038 $2,009 $(1,800) $29,248 ====== ===== ======= ====== ======= =======
The accompanying notes are an integral part of these consolidated financial statements. F-5 STYLING TECHNOLOGY CORPORATION AND SUBSIDIARIES Consolidated Statements of Cash Flows (in thousands)
FOR THE PERIOD FROM NOVEMBER 27, 1996 TO DECEMBER 31, DECEMBER 31, DECEMBER 31, 1997 1998 1996 (RESTATED) (RESTATED) ------------ ------------ ------------ Cash Flows from Operating Activities: Net income (loss) $ (151) $ 1,787 $ 560 Adjustments to reconcile net income (loss) to net cash used in operating activities: Depreciation and amortization 97 1,846 5,187 Interest accretion to note payable -- 174 159 Extraordinary loss on early extinguishment of debt -- 1,377 1,091 Changes in assets and liabilities: Accounts receivable, net 532 (5,802) (4,638) Inventories, net (21) (2,992) (8,588) Prepaid expenses and other assets (36) (1,730) (2,363) Accounts payable and accrued liabilities (788) 2,960 1,807 -------- -------- -------- Net cash used in operating activities (367) (2,380) (6,785) -------- -------- -------- Cash Flows from Investing Activities: Purchase of acquired businesses, net of cash acquired (20,523) (45,150) (62,677) Purchases of property and equipment (46) (582) (1,962) Changes in other assets, net -- -- (4,251) -------- -------- -------- Net cash used in investing activities (20,569) (45,732) (68,890) -------- -------- -------- Cash Flows from Financing Activities: Proceeds from issuance of common stock, net of offering and acquisition costs 27,227 -- -- Proceeds from credit facility, net of financing costs -- 71,633 47,298 Proceeds from bond offering, net of financing costs -- -- 96,400 Exercise of stock options -- -- 1,163 Payments on long-term debt -- (24,949) (68,226) Purchase of treasury stock (1,800) -- -- -------- -------- -------- Net cash provided by financing activities 25,427 46,684 76,635 -------- -------- -------- Increase (Decrease) in Cash and Cash Equivalents 4,491 (1,428) 960 Cash and Cash Equivalents, beginning of period -- 4,491 3,063 -------- -------- -------- Cash and Cash Equivalents, end of period $ 4,491 $ 3,063 $ 4,023 ======== ======== ======== Supplemental Disclosure of Cash Flow Information: Cash paid for income taxes $ -- $ 1,727 $ 2,634 ======== ======== ======== Cash paid for interest $ -- $ 1,155 $ 3,699 ======== ======== ========
The accompanying notes are an integral part of these consolidated financial statements. F-6 STYLING TECHNOLOGY CORPORATION AND SUBSIDIARIES Notes to Consolidated Financial Statements 1. Formation and Significant Accounting Policies a. Initial Public Offering and the Initial Businesses Styling Technology Corporation (the "Company") was formed in June 1995. From June 1995 through November 26, 1996, the Company conducted no operations and its only activities related to negotiating acquisitions and related financing. In November 1996, the Company completed an initial public offering (the "Offering") of 3,116,000 shares of its common stock. Simultaneously with the consummation of the Offering, the Company acquired in separate transactions four businesses that develop, produce, and market professional salon products. Prior to the Offering, the Company effected a 0.808-for-1 reverse stock split on all its outstanding common stock. As a result, all share amounts were adjusted to give effect to the reverse split. Upon consummation of the Offering, the Company acquired all of the outstanding stock of Gena Laboratories, Inc. ("Gena") and JDS Manufacturing Co., Inc. ("JDS") and certain assets and liabilities of the Body Drench Division of Designs by Norvell, Inc. ("Body Drench") and Kotchammer Investments, Inc. ("KII") (collectively, the "Initial Businesses"). The cost of the Initial Businesses, including direct acquisition costs, was approximately $22.9 million. The combined purchase price was funded with approximately $20.8 million in cash from the net proceeds of the Offering, and approximately $2.1 million of seller carryback financing and issuance of common stock. The acquisitions were accounted for using the purchase method of accounting. The purchase price was allocated based on the fair market value of the assets and liabilities acquired. Approximately $5.2 million was allocated to current assets, approximately $1.1 million to property and equipment, approximately $5.0 million to current liabilities, and approximately $0.3 million to long-term debt. Approximately $21.9 million of the purchase price represents costs in excess of fair values acquired, and was recorded as goodwill. b. Restatement On November 29, 1999, the Company announced that the Audit Committee of the Board of Directors was initiating (with the assistance of outside counsel and other experts) an internal investigation of the Body Drench division and certain financial reporting related errors and irregularities reported in the previously issued financial statements for first and second quarter 1999 and the 1998 fiscal year end. The Audit Committee's investigation has since been completed and as a result of its findings, the Company has restated its previously issued consolidated financial statements for 1997 and 1998 (See Notes 13, 14 and 15). c. Principles of Consolidation The consolidated financial statements include all the accounts of the Company and its subsidiaries. All significant intercompany accounts and transactions are eliminated in consolidation. All references to the Company herein refer to Styling Technology Corporation and its subsidiaries. F-7 d. Cash and Cash Equivalents and Concentrations of Credit Risk All highly liquid investments purchased with original maturities of three months or less are considered to be cash equivalents. Financial instruments which potentially subject the Company to concentrations of credit risk consist of cash and cash equivalents and trade receivables. The Company believes that it places its cash and cash equivalents in high quality credit institutions. Concentration of credit risk is limited due to the large number of customers comprising the Company's customer base. The Company performs ongoing credit evaluations of its customers, but does not require collateral to support customer receivables. The Company establishes an allowance for doubtful accounts based upon factors surrounding the credit risk of specific customers, historical trends and other information. e. Inventories Inventories are valued at the lower of cost (first-in, first-out) or net realizable value. Reserves are established against inventories for excess, slow-moving and obsolete items and for items where the net realizable value is less than cost. Inventories consist of the following: (in thousands) DECEMBER 31, ------------------------------ 1997 1998 ------------- ------------- Raw materials and work-in-process $ 2,594 $ 8,612 Finished goods 8,357 16,987 ------------- ------------- $ 10,951 $ 25,599 ============= ============= f. Property and Equipment Property and equipment are recorded at cost and depreciation on property and equipment is provided using the straight-line method over their estimated useful lives. Expenditures for major renewals and betterments are capitalized, while expenditures for maintenance and repairs, which do not improve assets or extend their useful lives are charged to expense as incurred. g. Goodwill and Other Intangibles Goodwill is the cost in excess of fair value of net assets of acquired businesses and is amortized using the straight-line method over 25 years. Other intangible assets include the cost assigned to an exclusive license, which is being amortized using the straight-line method over its contractual life of 40 years. The Company continually evaluates whether events and circumstances have occurred subsequent to acquisitions that indicate the remaining estimated useful life of goodwill or other intangible assets may warrant revision or that the remaining balance may not be recoverable. When factors indicate that goodwill or other intangible assets should be evaluated for possible impairment, the Company uses an estimate of the undiscounted future cash flows over the remaining life in measuring whether the goodwill or other intangible assets are recoverable. h. Use of Estimates The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, 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 F-8 estimates. Significant accounting estimates include establishment of allowance for doubtful accounts, reserves for sales returns and allowances, excess and obsolete inventory and litigation exposures. i. Fair Value of Financial Instruments The Company's financial instruments include cash and cash equivalents, accounts receivable, accounts payable, accrued liabilities, debt and letters of credit. The carrying values of cash and cash equivalents, accounts receivable, accounts payable and accrued liabilities approximate fair values due to the short-term maturities of these instruments. The carrying amount on the debt is estimated to approximate fair value as the actual interest rates are consistent with rates estimated to be currently available for debt with similar terms and remaining maturities. The carrying amount of the letters of credit reflects fair value as the related fees are competitively determined in the marketplace. Fair value estimates are made at a specific point in time, based on relevant market information about the financial instrument. These estimates are subjective in nature and involve uncertainties and matters of significant judgment and therefore cannot be determined with precision. Changes in assumptions could significantly affect these estimates. j. Revenue Recognition The Company recognizes revenue when title passes, which is usually upon shipment. Net sales is comprised of gross sales less provisions for estimated returns, discounts and promotional allowances. k. Business Process Reengineering Charges and Exit Costs of Acquired Businesses During the third quarter of 1998, the Company implemented a strategic consolidation initiative, which included the centralization of its operations into a new facility located in Scottsdale, Arizona. This initiative included the closing of several of its facilities. In addition, the Company is combining the reengineering of its business processes with an Enterprise Resource Planning (ERP) information technology transformation. During the year ended December 31, 1998, the Company recorded a pre-tax charge of $422,000 related to the reengineering of its business processes, as prescribed under EITF 97-13, Accounting for Business Process Reengineering-Consulting Costs. EITF 97-13 requires companies to expense all costs related to business process reengineering activities, whether done internally or by third parties as they are incurred. In addition, the Company accrued approximately $3.5 million in connection with management's plan to close the facilities of certain businesses acquired during 1998, as prescribed in EITF 95-3, Recognition of Liabilities in Connection with a Purchase Business Combination. Under this guidance, the Company has accrued certain costs as part of the acquisitions during 1998, based on a specific plan identified by management to close these specific facilities. During the year, the Company charged approximately $1.5 million against this accrual related to direct costs paid to exit these activities, which included employee severance costs, costs associated with the physical closing of the facilities, and external consulting costs. The balance of this accrual of approximately $2.0 million is included in accrued liabilities in the accompanying 1998 consolidated balance sheet. l. Income Taxes The Company provides for income taxes using the asset and liability method. Under this method, deferred income tax assets and liabilities are recognized for the expected future income tax consequences, based on enacted tax laws, of temporary differences between the financial statement carrying amounts and the tax bases of assets and liabilities and carryforwards. This method requires recognition of deferred tax assets for the expected future tax effects of all deductible temporary differences, loss carryforwards and tax credit carryforwards. Deferred tax assets are then reduced, if deemed necessary, by a valuation allowance for the amount of any tax benefits which, more likely than not based on current circumstances, are not expected to be realized. F-9 m. Other Assets Other assets consist primarily of the following: (i) deferred financing costs associated with the Company completing various financings transactions (see Note 5) and (ii) deferred tax assets (see Note 7). Deferred financing costs are amortized over the life of the related obligation. The Company recorded approximately $170,000 and $333,000 in deferred financing cost amortization for the years ended December 31, 1997 and 1998, respectively. n. Recently Issued Accounting Pronouncements In June 1998, the Financial Accounting Standards Boards issued Statement of Financial Accounting Standards ("SFAS") No. 133 (as amended by SFAS No. 137 and SFAS No. 138), Accounting for Derivative Instruments and Hedging Activities. This statement establishes accounting and reporting standards for derivative instruments, including derivative instruments embedded in other contracts, and for hedging activities. The statement, as amended, is effective for the Company's quarter ending September 30, 2000. The Company is currently evaluating the impact from the adoption of SFAS No. 133, as amended, on its future results of operations and financial position. Effective January 1, 1998, the Company adopted SFAS No. 130 Reporting Comprehensive Income. This statement requires the Company to classify items of other comprehensive income, defined to be the change in equity of the Company during the period from transactions and other events and circumstances from non-owner sources, in a separate financial statement and display the accumulated balance of other comprehensive income separately from retained earnings and additional paid-in capital. Adoption of this standard did not have an effect on the Company's financial statements as the Company has no items of other comprehensive income for any period presented. During 1998, the American Institute of Certified Public Accountants issued Statement of Position 98-5 Reporting on the Costs of Start-Up Activities ("SOP 98-5"). SOP 98-5 requires costs of start-up activities and organization costs to be expensed as incurred. This new statement is effective for fiscal years beginning after December 15, 1998. The Company intends to adopt this statement effective January 1, 1999. Initial application of SOP 98-5 is required to be reported as the cumulative effect of a change in accounting. The Company believes that its adoption will not have a material effect on its financial position or results of operations. o. Earnings (Loss) Per Share In February 1997, the FASB issued SFAS No. 128, Earnings Per Share, which supersedes Accounting Principles Board Opinion No. 15. SFAS No. 128 modifies the calculation of primary and fully diluted earnings per share (EPS) and replaces them with basic and diluted EPS. SFAS No. 128 is effective for financial statements for both interim and annual periods presented after December 15, 1997, and as a result, all prior-period EPS data presented herein has been restated. F-10 A reconciliation of the numerators and denominators of the basic and diluted EPS computations for the period from November 27, 1996 to December 31, 1996 and the years ended December 31, 1997 and 1998 is as follows:
1996 1997 ---------------------------------- ------------------------------------- EFFECT OF EFFECT OF STOCK STOCK OPTIONS OPTIONS BASIC AND DILUTED BASIC AND DILUTED EPS WARRANTS EPS EPS WARRANTS EPS --- -------- --- --- -------- --- Income (loss) before extraordinary item $ (151,000) -- $ (151,000) $ 3,164,000 -- $3,164,000 Extraordinary item, net -- -- -- 1,377,000 -- 1,377,000 ---------- ---- ---------- ----------- ------- ---------- Net income (loss) $ (151,000) -- $ (151,000) $ 1,787,000 -- $1,787,000 ========== ==== ========== =========== ======= ========== Shares 3,770,000 -- 3,770,000 3,949,000 164,000 4,113,000 ========== ==== ========== =========== ======= ========== Per share amount -- income (loss) before extraordinary item $ (0.04) $ (0.04) $ 0.80 $ 0.77 Per share amount -- extraordinary item, net -- -- (0.35) (0.34) ---------- ---------- ----------- ---------- Per share amount -- net income (loss) $ (0.04) $ (0.04) $ 0.45 $ 0.43 ========== ========== =========== ========== 1998 ----------------------------------------- EFFECT OF STOCK OPTIONS BASIC AND DILUTED EPS WARRANTS EPS --- -------- --- Income before extraordinary item $1,651,000 -- $1,651,000 Extraordinary item, net 1,091,000 -- 1,091,000 ---------- ------- ---------- Net income $ 560,000 -- $ 560,000 ========== ======= ========== Shares 4,033,000 280,000 4,313,000 ========== ======= ========== Per share amount - income before extraordinary item $ 0.41 $ 0.38 Per share amount - extraordinary item, net $ (0.27) $ (0.25) ----------- ---------- Per share amount - net income $ 0.14 $ 0.13 ========== ==========
For the period from November 27, 1996 to December 31, 1996, no common stock equivalents were considered in the EPS calculations as their effect was antidilutive. For purposes of applying the treasury stock method, the Company has assumed that it will fully utilize tax deductions arising from the assumed exercise of non-qualified stock options. F-11 2. Business Combinations During March 1997, the Company acquired inventory and other assets of the Utopia product line of high-end tanning products from Creative Laboratories, Inc. for approximately $350,000 in cash. On June 25, 1997, the Company acquired all of the issued and outstanding common stock of ABBA, which produces a proprietary line of aromatherapy-based professional hair care products. The Company paid a purchase price of approximately $20 million in cash for the ABBA common stock. In connection with the ABBA acquisition, the Company also negotiated approximately $1.1 million in facilitation fees, payable over three years, to certain former shareholders of ABBA for pre-closing efforts to facilitate completion of the acquisition (see Note 5). The Company satisfied its obligation with respect to this facilitation agreement during 1998. The ABBA acquisition was accounted for under the purchase method of accounting. On December 10, 1997, the Company acquired certain assets and assumed certain liabilities of Inverness Corporation and Inverness (UK) Limited (collectively Inverness). Inverness produces salon and retail hair removal apparatus and products under the brand names "One Touch" and "Clean + Easy". The Company paid a purchase price consisting of (i) $16.5 million in cash; and (ii) an additional $3.5 million in cash held in escrow pending release contingent upon the successful transition of the manufacture of certain hair removal appliances to offshore manufacturing. The Inverness acquisition is accounted for under the purchase method of accounting. In May 1998, the Company acquired substantially all of the assets and assumed certain operating liabilities of Pro Finish USA, Ltd. (Pro Finish), a producer of name-brand professional nail enhancement and nail care products. The Company paid a purchase price of approximately $5.0 million in cash. The acquisition was accounted for using the purchase method of accounting. In June 1998, the Company acquired European Touch Co. and two related companies (collectively European Touch) and European Touch, Ltd. II. European Touch is a developer, producer, and marketer of professional nail enhancement and treatment products and European Touch II is a developer, producer, and marketer of salon pedicure equipment. These companies were purchased for a combined purchase price of approximately $25.0 million in cash, using the purchase method of accounting. In August 1998, the Company acquired a controlling interest in Ft. Pitt Acquisition, Inc. and its 90% owned subsidiary, Ft. Pitt-Framesi, Ltd. (together Framesi USA). Framesi USA holds exclusive license rights for the sale in the United States and most of Latin America of Framesi hair color products along with its complementary Biogenol line of shampoos, conditioners, and styling products. The Company paid approximately $33.0 million for the Ft. Pitt Acquisition, Inc. stock, in the form of cash and seller carryback financing of approximately $5.0 million. The acquisition was accounted for using the purchase method of accounting. As of December 31, 1998, the Company owned approximately 85% of Ft. Pitt Acquisition, Inc. The excess of the purchase price paid over the net assets was allocated to the exclusive license rights, which is being amortized over its contractual life of 40 years. F-12 The following table summarizes acquisitions for the two years ended December 31, 1997 and 1998 (in thousands). 1997 1998 ------------- ------------- Accounts receivable $ 5,251 $ 7,481 Inventories 5,324 6,060 Other assets 1,475 803 Property and equipment 1,316 968 Assumed accounts payable and accrued liabilities (2,861) (9,563) Assumed debt - (1,716) ------------- ------------- Net assets acquired 10,505 4,033 Cash paid at closing for purchase price and acquisition costs 45,150 62,677 ------------- ------------- Goodwill and other intangibles $ 34,645 $ 58,644 ============= ============= a. Unaudited Pro Forma Consolidated Results of Operations The following table depicts, for the years ended December 31, 1997 and 1998, unaudited pro forma consolidated information as if all of the companies acquired in 1997 and 1998 were acquired on January 1, 1997 (in thousands). 1997 1998 ----------- ---------- Net sales $ 109,430 $ 108,601 Net income 2,636 246 Income per basic share 0.67 0.06 Income per diluted share 0.64 0.06 The unaudited pro forma financial data is for informational purposes only, is not necessarily indicative of the results of operations had the acquisitions occurred at the beginning of 1997 and 1998, and is not necessarily indicative of future operating results. 3. Property and Equipment Property and equipment consist of the following at December 31 (in thousands): USEFUL LIVES (YEARS) 1997 1998 ------- ---- ---- Land -- $ 150 $ 150 Building and leasehold improvements 7-40 594 1,065 Machinery and equipment 3-7 1,559 1,706 Furniture and fixtures 7 375 1,326 Computers, vehicles and other 3-5 356 4,216 -------- -------- 3,034 8,463 Less -- accumulated depreciation (394) (3,101) -------- -------- $ 2,640 $ 5,362 ======== ======== The Company recorded approximately $11,000, $383,000 and $1,342,000 in depreciation expense during the period from November 27, 1996 to December 31, 1996, and for the years ended December 31, 1997 and 1998, respectively, which is included in selling, general and administrative expenses in the accompanying consolidated statements of operations. 4. Accrued Liabilities Accrued liabilities consist of amounts accrued but unpaid as of December 31, 1997 and 1998. Accrued interest at December 31, 1997 and December 31, 1998 was $291,000 and $5,798,000, respectively. Accrued liabilities also include commissions, professional fees, taxes, payroll, and other liabilities. F-13 5. Long-Term Debt and Other Long-term debt and other consists of the following at December 31 (in thousands):
1997 1998 --------- --------- Senior subordinated notes (the "Notes"), bearing interest at 10 7/8%, maturing 2008 $ -- $ 100,000 Senior credit facility (the "1998 Credit Facility"), collateralized by substantially all the assets of the Company, maturing through June 2003 -- 37,033 Seller carryback financing, related to the acquisition of Ft. Pitt Acquisition, Inc., bearing interest at 6%, maturing through August 2001 -- 5,000 Unsecured note payable of Ft. Pitt Acquisition, Inc. -- 1,101 Senior credit facility (the "December 1997 Credit Facility"), collateralized by substantially all the assets of the Company, paid in full in June 1998 50,000 -- Gena Note, paid in full in November 1998 1,841 -- Other 1,183 -- --------- --------- 53,024 143,134 Less: current portion (5,647) (2,768) --------- --------- $ 47,377 $ 140,366 ========= =========
Aggregate future maturities of long-term debt and other are as follows at December 31, 1998 (in thousands): 1999 $ 2,768 2000 6,304 2001 5,444 2002 3,076 2003 25,542 Thereafter 100,000 ---------- $ 143,134 ========== a. Senior Credit Facilities In December 1997, in connection with the acquisition of Clean + Easy and One Touch product lines, the Company extinguished a previous credit facility and entered into the December 1997 Credit Facility. The December 1997 Credit Facility was a seven-year, $75.0 million credit facility with a group of banks with Credit Agricole Indosuez acting as agent. In connection with the extinguishment of the previous credit facility, the Company took an extraordinary non-cash charge of approximately $1.4 million, net of income taxes, related to the write-off of unamortized financing costs. In connection with the Notes Offering as defined below, the Company entered into a five-year, $50.0 million senior credit facility (the "1998 Credit Facility") with a group of banks for whom NationsBank, N.A. and Bank of Boston, N.A. acted as co-agents. The 1998 Credit Facility consists of two separate loans: a $25.0 million acquisition term loan and a $25.0 million revolving line of credit. The interest on the 1998 Credit Facility is paid quarterly and the interest rate is determined by the base rate (the "Base Rate"), as defined in the credit agreement. The Base Rate is equal to the higher of (a) the sum of (i) 0.50% plus (ii) the Federal Funds Rate plus (iii) the Applicable Base Rate Margin or (b) the sum of (i) the Prime Rate plus (ii) the Applicable Base Rate Margin. Principal payments on the acquisition term loan are paid quarterly beginning in March 2000. Principal F-14 payments on the revolving line of credit are due on the maturity date. The acquisition term loan and the revolving line of credit mature in June 2003. The revolving line of credit will be used for working capital purposes. The Company has the option to convert the interest rates relating to any of the loans to LIBOR plus 150 to 250 basis points. If the Company converts to the LIBOR-based interest rate, interest is paid on the LIBOR-based maturity date, which is generally three months from the conversion date. As of December 31, 1998, the Company had borrowed approximately $12.0 million under the revolving line of credit for working capital purposes including financing the inventory and receivable buildup related to the launch of the ABBA packaging and funding capital expenditures associated with the centralization and reengineering project undertaken during the fourth quarter of 1998. In addition, the borrowing was used to repay debt created in conjunction with the initial public offering in November 1996 as well as to repay existing debt assumed in the acquisition of Framesi USA. b. Notes On June 23, 1998, the Company issued the Notes in an offering (the "Notes Offering") exempt from registration under the Securities Act of 1933. Interest under the Notes is payable semi-annually in arrears commencing January 1, 1999, and the Notes are not callable until July 2003 subject to the terms of the Indenture under which the Notes were issued. The Company filed a registration statement under the Securities Act, relating to an exchange offer for these Notes, which was declared effective in August 1998. The proceeds of the Notes Offering were used to finance the purchase price and related costs of acquiring all of the issued and outstanding capital stock of the European Touch Companies, to repay existing indebtedness (including the Company's previous credit facility) and for working capital purposes. A portion of the proceeds from the Notes Offering was used to repay the December 1997 Credit Facility. The Company reported an extraordinary, non-cash charge of approximately $1.1 million, net of taxes, or $0.25 per diluted share, related to unamortized financing costs associated with the repayment of the December 1997 Credit Facility. c. Debt Covenants The Company's 1998 Credit Facility agreement contains provisions that, among other things, require the Company to comply with certain financial ratios and net worth requirements and will limit the ability of the Company and its subsidiaries to incur additional indebtedness, pay dividends, sell assets, or engage in certain mergers or consolidations. At December 31, 1998, the Company was in compliance with all applicable covenants. Subsequent to year end, the Company defaulted on certain credit agreements due to non-compliance with certain financial and non-financial convents (see Note 15). The Notes described above are general unsecured obligations of the Company and are unconditionally guaranteed on a joint and several basis by all of the Company's wholly owned current and future subsidiaries (see Note 12). d. Interest Rate Protection In connection with the 1998 Credit Facility, the Company maintains certain interest rate protection instruments. As of December 31, 1998, the Company has entered into interest rate swap and interest rate cap agreements (the Agreements) to reduce the impact of changes in interests rates. The Company is exposed to a risk of credit loss in the event of nonperformance by financial institutions that are also party to the Agreements. However, the F-15 Company believes that, based on the high creditworthiness of these counterparties, nonperformance is unlikely. The following is a summary of the Company's Agreements (in thousands) as of December 31, 1998: Company's Notional Instrument Effective Rate Amount ---------- -------------- ------ Swap 8.50% $ 12,500 Cap 10.25% 12,500 -------- $ 25,000 ======== 6. Stockholders' Equity a. Treasury Stock In October 1996, the Company entered into a stock repurchase agreement with a founder, pursuant to which the founder agreed to sell approximately 808,000 shares of Company's common stock to the Company for $1.8 million, payable upon consummation of the Offering. Accordingly, upon consummation of the Offering, the founder was no longer a stockholder of the Company. b. Initial Public Offering In November 1996, the Company completed the Offering of approximately 2.9 million shares of its common stock with an issue price of $10.00 per share. During December 1996, the Company's underwriters exercised an over allotment option, resulting in the issuance of approximately 216,000 additional shares. Net proceeds from the Offering and over allotment option amounted to approximately $27,227,000. c. Warrants In connection with a previous credit facility, the Company issued 160,000 five year warrants to lenders with exercise prices between $10.18 and $11.38 per share. In connection with the Offering, the Company issued 203,000 five-year warrants to its underwriters with an exercise price of $12.00 per share. These warrants have been recorded at fair value as additional paid-in capital in the accompanying consolidated balance sheets. Prior to the Offering, the Company issued 20,000 warrants with an exercise price $12.50 per share. During 1998, this warrant holder exercised all 20,000 warrants. d. Stock Options At the initial capitalization of the Company, 162,000 stock options to purchase shares of the common stock of the Company were issued to an officer with an exercise price of $0.10 per share. During the year ended December 31, 1998, approximately 72,000 stock options were cancelled in connection with the officer's retirement. During 1996, the Company adopted the 1996 Stock Option Plan, which was amended during 1998 to provide up to 750,000 incentive and nonqualified stock options to acquire common stock of the Company to key personnel and directors of the Company. e. Shareholder Rights Plan During February 1999, the Company's Board of Directors adopted a shareholder rights plan, which authorized the distribution of one right to purchase one one-thousandth of a share of Series A Junior Participating Preferred Stock, at a purchase price of $70, subject to certain antidilution adjustments. The rights will expire 10 years after issuance and will be exercisable if (i) a person or group becomes the beneficial F-16 owner of 15% or more of the Company's Common Stock; (ii) persons currently holding 15% or more of the Common Stock acquire an additional 1% or more of the Common Stock; or (iii) a person or group commences a tender or exchange offer that would result in the offeror beneficially owning 15% or more of the Common Stock (a "Stock Acquisition Date"). If a Stock Acquisition Date occurs, each right, unless redeemed by the Company, entitles the holder to purchase an amount of Common Stock of the Company, or in certain circumstances a combination of securities and/or assets or the common stock of the acquiror, having a market value of twice the exercise price of the right. Rights held by the acquiring person will become void and will not be exercisable to purchase shares at the bargain purchase price. During 1998, the Company adopted the 1998 Employee Stock Option Plan, which provides for the grant of up to 150,000 nonqualified stock options to acquire common stock of the Company to employees of the Company. On December 14, 1998, the Company repriced 246,000 options. A summary of the status of all the Company's stock options at December 31, 1996, 1997 and 1998 and changes during the periods ended is presented in the following table:
1996 1997 1998 ------------------ -------------------- --------------------- WEIGHTED WEIGHTED WEIGHTED AVERAGE AVERAGE AVERAGE EXERCISE EXERCISE EXERCISE OPTIONS PRICE OPTIONS PRICE OPTIONS PRICE ------- ----- ------- ----- ------- ----- Outstanding at beginning of year 162,000 $ 0.10 250,000 $ 3.58 549,000 $ 7.38 Granted 88,000 10.00 430,000 10.57 694,000 12.83 Exercised -- -- -- -- (99,000) 1.87 Canceled -- -- (131,000) 10.60 (350,000) 12.09 ------- ------ --------- ------ --------- ------ Outstanding at end of year 250,000 $ 3.58 549,000 $ 7.38 794,000 $10.76 ======= ====== ========= ====== ========= ====== Exercisable at end of year 18,000 $10.00 136,000 $ 9.71 279,000 $10.10 ======= ====== ========= ====== ========= ====== Weighted average fair value per share of options granted $ 5.65 $ 4.13 $ 5.44 ======= ========= =========
Options outstanding at December 31, 1998 have exercise prices between $0.10 and $24.00. 9,000 options have an exercise price of $0.10 with a remaining average contractual life of 6.1 years, and are fully vested. 597,000 options have exercise prices between $9.25 and $11.38 with a remaining average contractual life of 9.03 years, with vesting between one and five years. 188,000 options have exercise prices between $11.80 and $24.00 with a remaining average contractual life of 9.57 years, with vesting between one and five years. F-17 The following pro forma disclosures of net income (loss) are made assuming the Company had accounted for the stock options pursuant to the provision of SFAS No. 123, Accounting for Stock-Based Compensation.
FOR THE PERIOD FROM NOVEMBER 27, 1996 (COMMENCEMENT OF OPERATIONS) TO DECEMBER 31, DECEMBER 31, DECEMBER 31, 1996 1997 1998 ---- ---- ---- Income (loss) before extraordinary item As reported $ (151,000) $ 3,164,000 $ 1,651,000 Pro forma (226,000) 2,833,000 849,000 Diluted EPS - as reported (0.04) 0.77 0.38 Diluted EPS - pro forma (0.06) 0.69 0.20 Extraordinary item, net As reported -- (1,337,000) (1,091,000) Diluted EPS - as reported -- (0.33) (0.25) Net income (loss) As reported (151,000) 1,787,000 560,000 Pro forma (226,000) 1,456,000 (242,000) Diluted EPS - as reported (0.04) 0.43 0.13 Diluted EPS - pro forma (0.06) 0.36 (0.06)
The fair value of each option is estimated on the date of grant using the Black-Scholes options pricing model with the following weighted average assumptions used for grants in 1996: risk-free interest rates of 5.85%, expected lives of 3.8 years; and a volatility factor of 60%. The weighted average assumptions used for grants in 1997 were as follows: risk-free interest rates of 5.99% to 6.62%, expected lives of two to six years; and a volatility factor of 38.59%. The weighted average assumptions used for grants in 1998 were as follows: risk-free interest rates of 4.98%, expected lives of 4.97 years; and a volatility factor of 43.07%. The assumed dividend yield is zero for 1996, 1997 and 1998. 7. Income Taxes The provision for (benefit from) income taxes (in thousands) for the period from November 27, 1996 to December 31, 1996 and for the years ended December 31, 1997, and 1998 consists of the following: 1996 1997 1998 ---- ------- ------ Current expense $ -- $ 2,586 $ 940 Deferred expense (benefit) (72) (49) 530 ---- ------- ------ Net income tax expense (benefit) $(72) $ 2,537 $1,470 ==== ======= ====== F-18 The components of the deferred tax accounts (in thousands) as of December 31, 1997 and 1998, consist of the following: 1997 1998 ------ -------- Current deferred tax assets: Reserves and other accruals $ 232 $ 516 Inventory capitalization 222 1,298 Other 8 -- ------ -------- Total current deferred tax assets 462 1,814 ------ -------- Long-term deferred tax assets: Net operating loss carryforward -0- 2,581 Reserves and accruals -- 2,562 ------ -------- Total long-term deferred tax assets -- 5,143 ------ -------- Non-current deferred tax liabilities: Accelerated tax deductions, depreciation, and amortization 162 6,118 Effect of book basis in excess of tax basis of licenses -- 13,098 ------ -------- Total non-current deferred tax liabilities 162 19,216 ------ -------- Net deferred tax asset (liability) $ 300 $(12,259) ====== ======== A reconciliation of the U.S. federal statutory income tax rate to the Company's income before extraordinary item effective tax rate is as follows: DECEMBER 31, ------------------------- 1996 1997 1998 ---- ---- ---- Statutory federal rate (34)% 34% 34% Effect of state taxes (5)% 4% 4% Nondeductible amortization of goodwill 7% 7% 9% --- --- --- (32)% 45% 47% === === === 8. Related Party Information During 1996, certain founders advanced approximately $112,500 to the Company to fund various Offering and acquisition costs, all of which was repaid during the year. A member of the Company's Board of Directors serves as president of a consulting firm which was paid a $150,000 fee during 1997 in connection with the ABBA acquisition. A member of the Company's Board of Directors is a partner in a merchant banking firm which provided services to the Company related to obtaining financing and completing certain acquisitions. During 1997, this firm earned $1,120,000 for these services. 9. Segment Information The Company monitors its salon distribution operations by the hair-care, nail-care, skin and body care, and appliances and sundries product categories. Distribution of the product takes place primarily throughout the United States. Management monitors and evaluates the financial performance of the Company's operations by its current four operating segments. F-19 The following operating segment information includes financial information (in thousands) for all four of the Company's operating segments.
DECEMBER 31, 1998 APPLIANCES SKIN AND AND HAIR CARE NAIL CARE BODY CARE SUNDRIES PARENT ELIMINATIONS TOTAL --------- --------- --------- -------- ------ ------------ ----- Net sales $29,224 $18,902 $25,930 $ 9,310 $ -- $ -- $ 83,366 Operating income (loss) 4,385 3,467 3,165 3,489 (2,179) -- 12,327 Depreciation and amortization 107 2,561 1,189 215 1,115 -- 5,187 Total assets 97,571 46,796 80,375 30,326 94,258 (135,253) 214,073 Capital expenditures 25 134 661 146 996 -- 1,962 DECEMBER 31, 1997 APPLIANCES SKIN AND AND HAIR CARE NAIL CARE BODY CARE SUNDRIES PARENT ELIMINATIONS TOTAL --------- --------- --------- -------- ------ ------------ ----- Net sales $ 8,768 $12,545 $14,078 $ 1,114 $ -- $ -- $ 36,505 Operating income (loss) 2,352 2,226 4,311 268 (1,609) -- 7,548 Depreciation and amortization 13 1,058 292 62 421 -- 1,846 Total assets 27,180 20,757 48,686 1,842 25,238 (32,817) 90,886 Capital expenditures -- 90 275 2 215 -- 582 DECEMBER 31, 1996 APPLIANCES SKIN AND AND HAIR CARE NAIL CARE BODY CARE SUNDRIES PARENT ELIMINATIONS TOTAL --------- --------- --------- -------- ------ ------------ ----- Net sales $ -- $ 697 $ 337 $ 49 $ -- $ -- $ 1,083 Operating income (loss) -- 11 5 (19) (222) -- (225) Depreciation and amortization -- 58 11 3 25 -- 97 Total assets -- 15,066 12,542 663 6,156 (2,193) 32,234 Capital expenditures -- -- -- -- 46 -- 46
Sales to a major U.S. beauty supply chain as a percentage of total net sales approximated 25% for the period from November 27, 1996 to December 31, 1996. During 1997, this customer accounted for approximately 13% of the total net sales of the Company. During 1998, sales to any single customer as a percentage of total net sales did not exceed 10%. 10. Commitments and Contingencies a. Legal Matters The Company is party to certain legal matters arising in the ordinary course of its business. In management's opinion, as of December 31, 1998, the expected outcome of such matters will not have a material adverse effect on the Company's financial position or results of operations (see Note 15). F-20 b. Operating Leases The Company leases certain equipment and office and warehouse space under noncancelable operating leases. Rent expense related to these lease agreements totaled approximately $12,000, $313,000 and $1,132,000 for the period from November 27, 1996 to December 31, 1996 and for the years ended December 31, 1997 and 1998. Future lease payments under noncancelable operating leases (in thousands) are as follows: YEARS ENDING DECEMBER 31, ------------ 1999 $ 2,330 2000 2,117 2001 1,526 2002 1,261 2003 950 Thereafter 4,815 -------- $ 12,999 ======== c. Retirement Plans On April 1, 1998, the Company adopted the Styling Technology Corporation 401(k) Plan (the "401(k) Plan"). The 401(k) Plan allows eligible employees to contribute up to 20% of their annual pre-tax compensation. The Company will make a matching contribution of 50% of the first 5% of the employee's contribution. Generally, employees are eligible to participate at the first calendar quarter following 90 days of continuous service. Collective bargaining units are excluded from participation. Vesting in the Company's matching contribution is 25% per year of service; the employee would be 100% vested after four years of service. The Company made payments to this 401(k) Plan in the sum of $98,000 during 1998. An employee's unvested portion of the Company match goes back to the 401(k) Plan upon a termination distribution. Forfeited amounts are first applied toward 401(k) Plan expenses and are then applied toward future matching contributions. Four of the Company's divisions or subsidiaries had other 401(k) plans in place at the time of the acquisition. With the April 1, 1998 adoption of the 401(k) Plan, these four plans are no longer active. All participants of these plans are eligible to participate in the Company's 401(k) Plan. Ultimately, these plans will be terminated. Active employees who had participated in these plans may have the opportunity to roll existing balances into the 401(k) Plan or to their personal IRA. Terminated employees will have the opportunity to rollover to their IRA or receive a direct distribution. Another of the Company's Subsidiaries, Ft. Pitt Acquisition, Inc., ("Ft. Pitt") sponsors a 401(k) plan ("Ft. Pitt 401(k) Plan") for its separate employees. All full time Ft. Pitt employees, except employees covered by a union plan, are eligible to participate. The Ft. Pitt 401(k) Plan allows employees to contribute up to 20% of their annual pre-tax compensation. Ft. Pitt will match 20% of the employees' deferral, subject to a six year vesting schedule. The Ft. Pitt 401(k) Plan also provides for discretionary profit-sharing contributions. During 1998, Ft. Pitt made matching contributions of approximately $11,000. Ft. Pitt made a discretionary profit sharing contribution of $20,000 in 1998. F-21 11. Vendor Concentration As part of the Company's strategy, the Company uses third parties to manufacture the majority of the Company's products. One of these third party suppliers accounted for approximately 15% of the total cost of sales for the year ended December 31, 1997. During 1998, purchases from a single supplier as a percentage of total purchases did not exceed 10%. 12. Guarantor and Non-Guarantor Subsidiaries The Notes described in Note 5 are general unsecured obligations of the Company and are unconditionally guaranteed on a joint and several basis by all of the Company's wholly owned current and future subsidiaries. The financial statements presented below include the combined financial position as of December 31, 1997 and 1998; the results of operations for the period from November 27, 1996 to December 31, 1996 and for the restated years ended December 31, 1997 and 1998; and the statements of cash flows for the period from November 27, 1996 to December 31, 1996 and for the restated years ended December 31, 1997 and 1998 of Styling Technology Corporation (Parent); guarantor subsidiaries (Guarantors) and the non-guarantor subsidiaries (Non-guarantors). F-22 STYLING TECHNOLOGY CORPORATION AND SUBSIDIARIES Balance Sheet as of December 31, 1997 (in thousands)
NON- PARENT GUARANTORS GUARANTORS ELIMINATING CONSOLIDATED ------ ---------- ---------- ----------- ------------ Assets Current Assets: Cash and cash equivalents $ 2,907 $ 156 $ -- $ -- $ 3,063 Accounts receivable, net 8,251 4,442 -- -- 12,693 Inventories, net 5,882 5,069 -- -- 10,951 Prepaid expenses and other current assets 1,581 539 -- -- 2,120 Due to/from affiliates (2,379) 2,379 -- -- -- -------- ------- -------- -------- -------- Total current assets 16,242 12,585 -- -- 28,827 Property and Equipment, net 1,558 1,082 -- -- 2,640 Goodwill and Other Intangibles, net 26,106 30,400 -- -- 56,506 Other Assets 2,902 11 -- -- 2,913 Investment in Subsidiaries, net 39,468 -- -- (39,468) -- -------- ------- -------- -------- -------- $ 86,276 $44,078 $ -- $(39,468) $ 90,886 ======== ======= ======== ======== ======== Liabilities and Stockholders' Equity Current Liabilities: Accounts payable $ 4,101 $ 2,404 $ -- $ -- $ 6,505 Accrued liabilities 1,481 2,189 -- -- 3,670 Current portion of long-term debt and other 5,630 17 -- -- 5,647 -------- ------- -------- -------- -------- Total current liabilities 11,212 4,610 -- -- 15,822 -------- ------- -------- -------- -------- Deferred Income Taxes 162 -- -- -- 162 -------- ------- -------- -------- -------- Long-Term Debt and Other, less current portion 47,377 -- -- -- 47,377 -------- ------- -------- -------- -------- Commitments and Contingencies Stockholders' Equity: Preferred stock -- -- -- -- -- Common stock 1 -- -- -- 1 Additional paid-in capital 27,875 36,768 -- (36,768) 27,875 Retained earnings 1,449 2,700 -- (2,700) 1,449 Treasury stock (1,800) -- -- -- (1,800) -------- ------- -------- -------- -------- Total stockholders' equity 27,525 39,468 -- (39,468) 27,525 -------- ------- -------- -------- -------- $ 86,276 $44,078 $ -- $(39,468) $ 90,886 ======== ======= ======== ======== ========
F-23 STYLING TECHNOLOGY CORPORATION AND SUBSIDIARIES Balance Sheet as of December 31, 1998 (in thousands)
NON- PARENT GUARANTORS GUARANTORS ELIMINATING CONSOLIDATED ------ ---------- ---------- ----------- ------------ Assets Current Assets: Cash and cash equivalents $ 2,867 $ 343 $ 813 $ -- $ 4,023 Accounts receivable, net 10,100 8,830 5,882 -- 24,812 Inventories, net 13,456 10,060 2,083 -- 25,599 Prepaid expenses and other current assets 597 695 83 -- 1,375 Due to/from affiliates 2,383 5,462 (7,845) -- -- --------- ------- --------- --------- --------- Total current assets 29,403 25,390 1,016 -- 55,809 Property and Equipment, net 3,625 1,626 111 -- 5,362 Goodwill and Other Intangibles, net 37,128 52,509 49,929 -- 139,566 Other Assets 13,033 118 185 -- 13,336 Investment in Subsidiaries, net 104,317 -- -- (104,317) -- --------- ------- --------- --------- --------- $ 187,506 $79,643 $ 51,241 $(104,317) $ 214,073 ========= ======= ========= ========= ========= Liabilities and Stockholders' Equity Current Liabilities: Accounts payable $ 8,224 $ 2,960 $ 924 $ -- $ 12,108 Accrued liabilities 1,884 5,841 2,642 -- 10,367 Current portion of long-term debt and other 1,309 357 1,102 -- 2,768 --------- ------- --------- --------- --------- Total current liabilities 11,417 9,158 4,668 -- 25,243 --------- ------- --------- --------- --------- Deferred Income Taxes 6,475 -- 12,741 -- 19,216 --------- ------- --------- --------- --------- Long-Term Debt and Other, less current portion 140,366 -- -- -- 140,366 --------- ------- --------- --------- --------- Commitments and Contingencies Stockholders' Equity: Preferred stock -- -- -- -- -- Common stock 1 -- -- -- 1 Additional paid-in capital 29,038 61,770 32,527 (94,297) 29,038 Retained earnings 2,009 8,715 1,305 (10,020) 2,009 Treasury stock (1,800) -- -- -- (1,800) --------- ------- --------- --------- --------- Total stockholders' equity 29,248 70,485 33,832 (104,317) 29,248 --------- ------- --------- --------- --------- $ 187,506 $79,643 $ 51,241 $(104,317) $ 214,073 ========= ======= ========= ========= =========
F-24 STYLING TECHNOLOGY CORPORATION AND SUBSIDIARIES Statement of Operations November 27, 1996 to December 31, 1996 (in thousands)
NON- PARENT GUARANTORS GUARANTORS ELIMINATING CONSOLIDATED ------ ---------- ---------- ----------- ------------ Net sales $ 386 $ 697 $ -- $ -- $ 1,083 Cost of sales 162 409 -- -- 571 ----- ----- -------- ------ ------- Gross profit 224 288 -- -- 512 Selling, general and administrative expenses 460 277 -- -- 737 ----- ----- -------- ------ ------- Income (loss) from operations (236) 11 -- -- (225) Interest (expense) and other income, net 2 -- -- -- 2 ----- ----- -------- ------ ------- Income (loss) before income taxes (234) 11 -- -- (223) Provision for (benefit from) income taxes (84) 12 -- -- (72) Income (loss) from wholly owned subsidiaries (1) -- -- 1 -- ----- ----- -------- ------ ------- Net loss $(151) $ (1) $ -- $ 1 $ (151) ===== ===== ======== ====== =======
F-25 STYLING TECHNOLOGY CORPORATION AND SUBSIDIARIES Statement of Operations for the Year Ended December 31, 1997 (in thousands)
NON- PARENT GUARANTORS GUARANTORS ELIMINATING CONSOLIDATED -------- -------- -------- ------- -------- Net sales $ 15,193 $ 21,312 $ -- $ -- $ 36,505 Cost of sales 6,348 10,408 -- -- 16,756 -------- -------- -------- ------- -------- Gross profit 8,845 10,904 -- -- 19,749 Selling, general and administrative expenses 5,874 6,327 -- -- 12,201 -------- -------- -------- ------- -------- Income from operations 2,971 4,577 -- -- 7,548 Interest expense and other, net (1,789) (58) -- -- (1,847) -------- -------- -------- ------- -------- Income before extraordinary item and income taxes 1,182 4,519 -- -- 5,701 Provision for income taxes 719 1,818 -- -- 2,537 -------- -------- -------- ------- -------- Income before extraordinary item 463 2,701 -- -- 3,164 Extraordinary item, net (1,377) -- -- -- (1,377) Income from wholly owned subsidiaries 2,701 -- -- (2,701) -- -------- -------- -------- ------- -------- Net income $ 1,787 $ 2,701 $ -- $(2,701) $ 1,787 ======== ======== ======== ======= ========
F-26 STYLING TECHNOLOGY CORPORATION AND SUBSIDIARIES Statement of Operations for the Year Ended December 31, 1998 (in thousands)
NON- PARENT GUARANTORS GUARANTORS ELIMINATING CONSOLIDATED ------ ---------- ---------- ----------- ------------ Net sales $ 30,958 $40,326 $12,082 $ -- $ 83,366 Cost of sales 15,684 18,470 4,844 -- 38,998 -------- ------- ------- ------- -------- Gross profit 15,274 21,856 7,238 -- 44,368 Selling, general and administrative expenses 14,200 11,439 5,980 -- 31,619 Centralization and reengineering costs 422 -- -- -- 422 -------- ------- ------- ------- -------- Income from operations 652 10,417 1,258 -- 12,327 Interest income (expense) and other, net (9,302) -- 96 -- (9,206) -------- ------- ------- ------- -------- Income (loss) before extraordinary item (8,650) 10,417 1,354 -- 3,121 Provision (benefit) for income taxes (2,981) 4,402 49 -- 1,470 -------- ------- ------- ------- -------- Income (loss) before extraordinary item (5,669) 6,015 1,305 -- 1,651 Extraordinary item, net (1,091) -- -- -- (1,091) Income from wholly owned subsidiaries 7,320 -- -- (7,320) -- -------- ------- ------- ------- -------- Net income $ 560 $ 6,015 $ 1,305 $(7,320) $ 560 ======== ======= ======= ======= ========
F-27 STYLING TECHNOLOGY CORPORATION AND SUBSIDIARIES Statement Of Cash Flow as of November 27, 1996 to December 31, 1996 (in thousands)
NON- PARENT GUARANTORS GUARANTORS ELIMINATING CONSOLIDATED ------ ---------- ---------- ----------- ------------ Cash Flows from Operating Activities: Net Loss $ (151) $ (1) $ -- $ 1 $ (151) Adjustments to reconcile net loss to net cash provided by (used in) in operating activities: Depreciation and amortization 93 4 -- -- 97 Change in certain assets and liabilities: Accounts receivable, net 390 142 -- -- 532 Inventory, net (28) 7 -- -- (21) Prepaid expenses and other assets (67) 31 -- -- (36) Accounts payable and accrued liabilities (756) (32) -- -- (788) Due to/from affiliates, net 2 (1) -- (1) -- -------- ----- --------- ----- -------- Net cash provided by (used in) operating activities (517) 150 -- -- (367) -------- ----- --------- ----- -------- Cash Flows from Investing Activities: Purchase of acquired business, net of cash acquired (20,523) -- -- -- (20,523) Purchase of property, and equipment (46) -- -- -- (46) -------- ----- --------- ----- -------- Net cash used in investing activities (20,569) -- -- -- (20,569) -------- ----- --------- ----- -------- Cash Flows from Financing Activities: Proceeds from issuance of common stock, net of offering and acquisition costs 27,227 -- -- -- 27,227 Purchase of treasury stock (1,800) -- -- -- (1,800) -------- ----- --------- ----- -------- Net cash provided by financing activities 25,427 -- -- -- 25,427 -------- ----- --------- ----- -------- Increase in Cash and Cash Equivalents 4,341 150 -- -- 4,491 -------- ----- --------- ----- -------- Cash and Cash Equivalents, beginning of Period -- -- -- -- -- -------- ----- --------- ----- -------- Cash and Cash Equivalents, end of period $ 4,341 $ 150 $ -- $ -- $ 4,491 ======== ===== ========= ===== ========
F-28 STYLING TECHNOLOGY CORPORATION AND SUBSIDIARIES Statement of Cash Flows for the Year Ended December 31, 1997 (in thousands)
NON- PARENT GUARANTORS GUARANTORS ELIMINATING CONSOLIDATED ------ ---------- ---------- ----------- ------------ Cash Flows from Operating Activities: Net Income $ 1,787 $ 2,701 $ -- $(2,701) $ 1,787 Adjustments to reconcile net income to net cash provided by (used in) in operating activities: Depreciation and amortization 1,058 788 -- -- 1,846 Interest accretion on note payable 6 168 -- -- 174 Extraordinary loss on early extinguishment of debt 1,377 -- -- -- 1,377 Change in certain assets and liabilities: Accounts receivable, net (3,624) (2,178) -- -- (5,802) Inventories, net (2,063) (929) -- -- (2,992) Prepaid expenses and other assets (1,825) 95 -- -- (1,730) Accounts payable and accrued liabilities 845 2,115 -- -- 2,960 Due to/from affiliates, net (507) (2,194) -- 2,701 -- -------- ------- ------ ------- -------- Net cash provided by (used in) operating activities (2,946) 566 -- -- (2,380) -------- ------- ------ ------- -------- Cash Flows from Investing Activities: Purchase of property and equipment (518) (64) -- -- (582) Purchase of acquired business, net of cash acquired (45,131) (19) -- -- (45,150) -------- ------- ------ ------- -------- Net cash investing activities (45,649) (83) -- -- (45,732) -------- ------- ------ ------- -------- Cash Flows from Financing Activities: Proceeds from credit facility, net of financing costs 71,633 -- -- -- 71,633 Payments on long-term debt (24,472) (477) -- -- (24,949) -------- ------- ------ ------- -------- Net cash provided by (used in) financing activities 47,161 (477) -- -- 46,684 -------- ------- ------ ------- -------- Increase (Decrease) in Cash and Cash Equivalents (1,434) 6 -- -- (1,428) -------- ------- ------ ------- -------- Cash and Cash Equivalents, beginning of year 4,341 150 -- -- 4,491 -------- ------- ------ ------- -------- Cash and Cash Equivalents, end of year $ 2,907 $ 156 $ -- $ -- $ 3,063 ======== ======= ====== ======= ========
F-29 STYLING TECHNOLOGY CORPORATION AND SUBSIDIARIES Statement of Cash Flow for the Year Ended December 31, 1998 (in thousands)
NON- PARENT GUARANTORS GUARANTORS ELIMINATING CONSOLIDATED ------ ---------- ---------- ----------- ------------ Cash Flows from Operating Activities: Net Income $ 560 $ 6,015 $ 1,305 $(7,320) $ 560 Adjustments to reconcile net income to net cash provided by (used in) operating activities: Depreciation and amortization 2,993 1,839 355 -- 5,187 Interest accretion on note payable 159 -- -- -- 159 Extraordinary loss on early extinguishment of debt 1,091 -- -- -- 1,091 Change in certain assets and liabilities: Accounts receivable, net (195) (3,217) (1,226) -- (4,638) Inventories, net (3,997) (5,329) 738 -- (8,588) Prepaid expenses and other assets (2,636) (51) 324 -- (2,363) Accounts payable and accrued liabilities (2,124) 2,641 1,290 -- 1,807 Due to/from affiliates, net (16,157) 992 7,845 7,320 -- -------- ------- -------- ------- -------- Net cash provided by (used in) operating activities (20,306) 2,890 10,631 -- (6,785) -------- ------- -------- ------- -------- Cash Flows from Investing Activities: Purchase of property, plant and equipment (1,766) (174) (22) -- (1,962) Purchase of acquired business, net of cash acquired (62,677) -- -- -- (62,677) Change in other assets 2,978 (2,510) (4,719) -- (4,251) -------- ------- -------- ------- -------- Net cash provided by used in investing activities (61,465) (2,684) (4,741) -- (68,890) -------- ------- -------- ------- -------- Cash Flows from Financing Activities: Proceeds from credit facility, net of financing costs 47,298 -- -- -- 47,298 Proceeds from bond offering, net of offering costs 96,400 -- -- -- 96,400 Exercise of stock options 1,163 -- -- -- 1,163 Payments on long-term debt (63,130) (19) (5,077) -- (68,226) -------- ------- -------- ------- -------- Net cash provided by (used in) financing activities 81,731 (19) (5,077) -- 76,635 -------- ------- -------- ------- -------- Increase (Decrease) in Cash and Cash Equivalents (40) 187 813 -- 960 Cash and Cash Equivalents, beginning of year 2,907 156 -- -- 3,063 -------- ------- -------- ------- -------- Cash and Cash Equivalents, end of year $ 2,867 $ 343 $ 813 $ -- $ 4,023 ======== ======= ======== ======= ========
F-30 13. Restatement Subsequent to the issuance of the Company's consolidated financial statements for the fiscal years ended December 31, 1997 and 1998, it was determined through an internal investigation that the previously reported results included errors and irregularities in the Body Drench division. Upon examination it was determined revenue for certain Body Drench transactions was improperly recognized when inventory was not shipped to customers. During subsequent periods, certain of the amounts, which were improperly recognized as sales by the Body Drench division, were written-off through the bad debt provision. As a result, the Company has restated previously reported annual results including the 1998 and 1997 financial information set forth herein. In addition to the Company's investigation, in October 1999, the Securities and Exchange Commission (SEC) issued a Formal Order of Private Investigation (see Note 15). While management has made all adjustments considered necessary as a result of the investigation into accounting irregularities in the preparation of the restated financial statements for 1998 and 1997, there can be no assurances that additional adjustments will not be required as a result of the SEC investigation. The following statements of operations and balance sheets reconcile previously reported and restated financial information (in thousands, except for per share amounts). F-31 CONSOLIDATED STATEMENTS OF OPERATIONS FOR THE YEAR ENDED (in thousands)
DECEMBER 31, 1997 DECEMBER 31, 1998 ------------------------ ------------------------ AS REPORTED AS RESTATED AS REPORTED AS RESTATED ----------- ----------- ----------- ----------- Net Sales $ 38,108 $ 36,505 $ 90,373 $ 83,366 Cost of Sales 16,756 16,756 39,222 38,998 -------- -------- -------- -------- Gross profit 21,352 19,749 51,151 44,368 -------- -------- -------- -------- Selling, General and Administrative Expenses 12,201 12,201 32,715 31,619 Centralization and Reengineering Costs -- -- 422 422 -------- -------- -------- -------- 12,201 12,201 33,137 32,041 -------- -------- -------- -------- Income (Loss) from Operations 9,151 7,548 18,014 12,327 Interest Expense and Other, net (1,847) (1,847) (9,206) (9,206) -------- -------- -------- -------- Income (Loss) Before Extraordinary Item and Income Taxes 7,304 5,701 8,808 3,121 Provision for (Benefit from) Income Taxes 3,097 2,537 3,635 1,470 -------- -------- -------- -------- Income (Loss) Before Extraordinary Item 4,207 3,164 5,173 1,651 Extraordinary Item, net of tax benefit of $882 and $822 (1,377) (1,377) (1,091) (1,091) -------- -------- -------- -------- Net Income (Loss) $ 2,830 $ 1,787 $ 4,082 $ 560 ======== ======== ======== ======== Basic Earnings (Loss) per Share: Income (loss) before extraordinary item $ 1.07 $ 0.80 $ 1.28 $ 0.41 Extraordinary item (.35) (.35) (.27) (.27) -------- -------- -------- -------- Net income (loss) $ 0.72 $ 0.45 $ 1.01 $ 0.14 ======== ======== ======== ======== Weighted average shares 3,949 3,949 4,033 4,033 ======== ======== ======== ======== Diluted Earnings (Loss) per Share: Income (loss) before extraordinary item $ 1.02 $ 0.77 $ 1.20 $ 0.38 Extraordinary item (.33) (.34) (.25) (.25) -------- -------- -------- -------- Net income (loss) $ 0.69 $ 0.43 $ 0.95 $ 0.13 ======== ======== ======== ======== Weighted average shares diluted 4,113 4,113 4,313 4,313 ======== ======== ======== ========
F-32 CONSOLIDATED BALANCE SHEETS
DECEMBER 31, 1997 DECEMBER 31, 1998 ------------------------ ------------------------ AS REPORTED AS RESTATED AS REPORTED AS RESTATED ----------- ----------- ----------- ----------- Assets Current Assets: Cash and cash equivalents $ 3,063 $ 3,063 $ 4,023 $ 4,023 Accounts receivable, net of allowance for doubtful accounts of $1,032 and $1,786 14,296 12,693 32,326 24,812 Inventories, net 10,951 10,951 25,375 25,599 Prepaid expenses and other current assets 2,120 2,120 1,791 1,375 -------- --------- --------- --------- Total current assets 30,430 28,827 63,515 55,809 Property and Equipment, net 2,640 2,640 5,362 5,362 Goodwill and Other Intangibles, net of accumulated amortization of $1,375 and $4,749 56,506 56,506 139,566 139,566 Other Assets 2,913 2,913 10,755 13,336 -------- --------- --------- --------- $ 92,489 $ 90,886 $ 219,198 $ 214,073 ======== ========= ========= ========= Liabilities and Stockholders' Equity Current Liabilities: Accounts payable $ 7,065 $ 6,505 $ 12,668 $ 12,108 Accrued liabilities 3,670 3,670 10,367 10,367 Current portion of long-term debt and other 5,647 5,647 2,768 2,768 -------- --------- --------- --------- Total current liabilities 16,382 15,822 25,803 25,243 -------- --------- --------- --------- Deferred Income Taxes 162 162 19,216 19,216 Long-Term Debt and Other, less current portion 47,377 47,377 140,366 140,366 -------- --------- --------- --------- Commitments and Contingencies Stockholders' Equity: Preferred stock -- -- -- -- Common stock 1 1 1 1 Additional paid-in capital 27,875 27,875 29,038 29,038 Retained earnings 2,492 1,449 6,574 2,009 Treasury stock (1,800) (1,800) (1,800) (1,800) -------- --------- --------- --------- Total stockholders' equity 28,568 27,525 33,813 29,248 -------- --------- --------- --------- $ 92,489 $ 90,886 $ 219,198 $ 214,073 ======== ========= ========= =========
F-33 14. Unaudited Quarterly Financial Data During 1997 and 1998, the Company recorded transactions in the Body Drench division that require restatement (see Note 13).
1998 FIRST QUARTER SECOND QUARTER ------------------------ ------------------------ AS REPORTED AS RESTATED AS REPORTED AS RESTATED ----------- ----------- ----------- ----------- (DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA) Net Sales $16,225 $ 14,073 $19,074 $ 16,795 Gross Profit (a) 9,183 7,488 10,624 8,895 Selling, General and Administrative Expenses 5,395 5,395 6,514 6,514 Income from Operations 3,788 2,093 4,110 2,381 Net Income (Loss) before Extraordinary Item 1,439 (256) 1,565 (164) Extraordinary Item, net -- -- 1,091 1,091 Net Income (Loss) 1,439 (256) 474 (1,255) Diluted EPS before Extraordinary Item $ 0.34 $ (0.06) $ 0.36 $ (0.04) Diluted EPS after Extraordinary Item 0.34 (0.06) 0.11 (0.28) THIRD QUARTER FOURTH QUARTER ------------------------ ------------------------ AS REPORTED AS RESTATED AS REPORTED AS RESTATED ----------- ----------- ----------- ----------- (DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA) Net Sales $26,539 $ 25,400 $28,535 $ 27,098 Gross Profit (a) 15,001 14,195 16,343 13,790 Selling, General and Administrative Expenses 9,689 9,689 11,117 10,021 Income from Operations 5,312 4,506 4,804 3,347 Net Income before Extraordinary Item 1,243 437 926 1,634 Extraordinary Item -- -- -- -- Net Income 1,243 437 926 1,634 Diluted EPS before extraordinary item $ 0.29 $ 0.10 $ 0.23 $ 0.40 Diluted EPS after extraordinary item 0.29 0.10 0.23 0.40
- ---------- (a) Management has estimated the gross margin for the Body Drench division on an interim basis for the restated quarters. F-34
1997 FIRST QUARTER SECOND QUARTER ------------------------ ------------------------ AS REPORTED AS RESTATED AS REPORTED AS RESTATED ----------- ----------- ----------- ----------- (DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA) Net Sales $ 7,479 $ 7,479 $ 7,437 $ 7,093 Gross Profit 4,245 4,245 4,191 3,994 Selling, General and Administrative Expenses 2,398 2,398 2,333 2,333 Income from Operations 1,847 1,847 1,858 1,661 Net Income before Extraordinary Item 1,054 1,054 1,031 834 Extraordinary Item -- -- -- -- Net Income 1,054 1,054 1,031 834 Diluted EPS before Extraordinary Item $ 0.26 $ 0.26 $ 0.25 $ 0.20 Diluted EPS after Extraordinary Item 0.26 0.26 0.25 0.20 THIRD QUARTER FOURTH QUARTER ------------------------ ------------------------ AS REPORTED AS RESTATED AS REPORTED AS RESTATED ----------- ----------- ----------- ----------- (DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA) Net Sales $10,669 $10,210 $ 12,523 $ 11,723 Gross Profit 5,802 5,480 7,114 6,030 Selling, General and Administrative Expenses 3,574 3,574 3,896 3,896 Income from Operations 2,228 1,906 3,218 2,134 Net Income before Extraordinary Item 828 506 1,294 770 Extraordinary Item -- -- 1,377 1,377 Net Income (Loss) Net 828 506 (83) (607) Diluted EPS before Extraordinary Item $ 0.20 $ 0.12 $ 0.31 $ 0.19 Diluted EPS after Extraordinary Item 0.20 0.12 (0.02) (0.15)
F-35 15. Subsequent Events a. Litigation During the period from December 1999 to January 2000, four class action lawsuits were filed on behalf of certain shareholders against the Company and certain of its present and former officers alleging violations of the federal securities laws. The complaints allege that the defendants reported increasing sales and earnings before interest, taxes, depreciation and amortization which caused the Company's stock to trade at artificially inflated levels and allowed the Company to complete a $100 million senior subordinated notes offering. The complaints further allege that as a result of announcements made by the Company of errors and irregularities in previously issued financial statements, trading of the Company's stock was halted and the stock was delisted by Nasdaq. If the Company is unable to settle this matter with the plaintiffs within a reasonable amount of time, then the Company intends to defend this matter vigorously. A former employee of Ft. Pitt Acquisition, Inc. is suing the Company for breach of contract for an employment agreement and non-competition in place at the time of the acquisition. The employment agreement requires accelerated payments in the event of a change in control at Ft. Pitt Acquisition, Inc. The Company's acquisition of Ft. Pitt Acquisition, Inc. is alleged to constitute a change of control. The alleged payment due to the former employee is $1.7 million. The Company believes that the agreements were not properly approved by the board of directors of Ft. Pitt Acquisition, Inc. and not executed. In addition, the Company believes the former employee did not perform under the employment agreement. The Company intends to defend this matter vigorously. Four minority interest shareholders of Ft. Pitt Acquisition, Inc. filed separate complaints against the former majority shareholders and the Company for not accepting an offer from Graham Webb Company to buy all of the shares of Ft. Pitt Acquisition, Inc., but rather accepting an offer from the Company. In addition, the minority shareholders allege that the Company did not allow the minority shareholders to sell to the Company. The minority shareholders allege these actions by the Company and the former majority shareholders cause them to incur losses. The minority shareholders are seeking damages of approximately $5.3 million. The Company is defending all of these allegations vigorously and is not participating in any settlement discussions at this time. A former manufacturer, Amole Incorporated (Amole) assigned receivables (including amounts owed from Body Drench to Amole) to Comerica Bank. Comerica Bank filed a claim against the Company for collection of outstanding receivables in the amount of approximately $1.1 million. The Company filed a counterclaim in the amount of approximately $1 million against Amole for breach of contract, negligence, false representation, negligent representation, various breaches of warranty and indemnification. Prior to Comerica Bank seizing the assets of Amole, Body Drench had several complaints regarding changes in product manufactured by Amole for Body Drench. In accordance with the Exclusive Manufacturing Agreement, Amole is prohibited from making changes in the product. The case is scheduled for discovery in fall 2000. The Company intends to defend this matter vigorously. Panint (U.S.) Ltd. and Panint Electric Limited filed a lawsuit against the Company for breach of certain purchase contracts and are seeking payment of approximately $994,000. The Company has responded to the allegations and counterclaims that the products received from the plaintiff were defective and caused the Company lost sales and damage to reputation amongst other unfavorable reactions. The Company intends to defend this matter vigorously. F-36 b. SEC Investigation On September 15, 1999 the SEC served the Company a voluntary request for production of documents. Subsequently, on October 29, 1999, the SEC issued a Formal Order of Private Investigation. The Company is cooperating with the SEC in its investigation and simultaneously negotiating a settlement. The Company cannot predict the term of such investigation or its potential outcome. c. Credit Agreements On June 22, 1999, the Company entered into a $90 million Senior Secured Revolving Credit Facility (the "GE Credit Facility") with General Electric Capital Corporation. Proceeds from the GE Credit Facility were used to repay amounts outstanding under the 1998 Credit Facility. The GE Credit Facility is collateralized by substantially all of the assets of the Company. In November, 1999, the Company defaulted on the GE Credit Facility due to non compliance with certain financial and non-financial covenants. Additionally, the Company did not make the required interest payment on July 1, 2000 to the Noteholders of the Notes. On June 28, 2000 an agreement was reached with 81% of the Noteholders to convert all $100.0 million of the Notes into 90% of the equity of the Company. The agreement, which as amended is effective through January 1, 2001, includes a provision that allows the Company to effect a debt for equity exchange through a pre-negotiated plan of reorganization if the Company is not able to secure consents from the remaining 19% of the Noteholders. There can be no assurance that the lenders will continue to grant waivers. The Company does not currently have alternative financing to meet its obligations as they come due. d. Bankruptcy During 1999, the Company recorded a net loss of $51.9 million and continued to experience negative operating results in 2000. As a result, the Company filed a voluntary petition for reorganization under Chapter 11 of the Federal Bankruptcy Code on August 31, 2000. In connection with the audit of the 1999 financial statements, the Company's independent public accountants issued their report dated October 18, 2000, which expressed significant doubt about the ability of the Company to continue as a going concern. e. Sale of One Touch and Clean + Easy In January 2000, the Company sold certain assets and liabilities of Clean + Easy and One Touch and entered into a 2 year consulting agreement with the buyer for a total of $26.5 million in cash. The Company recorded a pre-tax gain of $4.3 million and deferred $2.4 million to be earned over the two year life of the consulting agreement. F-37 REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS To the Board of Directors of Styling Technology Corporation: We have audited the accompanying balance sheets of GENA LABORATORIES, INC. as of February 28, 1995 and February 29, 1996, and the related statements of operations, stockholders' equity, and cash flows for each of the three years in the period ended February 29, 1996, and for the period March 1, 1996 to November 26, 1996. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of Gena Laboratories, Inc. as of February 28, 1995 and February 29, 1996, and the results of its operations and its cash flows for each of the three years in the period ended February 29, 1996 and for the period March 1, 1996 to November 26, 1996, in conformity with generally accepted accounting principles. /s/ ARTHUR ANDERSEN LLP Phoenix, Arizona, March 21, 1997. F-38 GENA LABORATORIES, INC. BALANCE SHEETS FEBRUARY 28, FEBRUARY 29, 1995 1996 ----------- ----------- ASSETS CURRENT ASSETS: Cash and cash equivalents $ 390,325 $ 250,644 Investments 14,999 46,500 Accounts receivable, net of allowance for doubtful accounts of $120,347 and $136,093, respectively 863,208 965,615 Inventory 965,335 1,213,688 Deferred tax asset 99,055 131,790 ----------- ----------- Total current assets 2,332,922 2,608,237 ----------- ----------- PROPERTY AND EQUIPMENT, net of accumulated depreciation of $392,026 and $471,771, respectively 884,638 830,093 DEFERRED TAX ASSET, net of current portion -- 19,870 OTHER ASSETS 346,866 256,770 ----------- ----------- $ 3,564,426 $ 3,714,970 =========== =========== LIABILITIES AND STOCKHOLDERS' EQUITY CURRENT LIABILITIES: Accounts payable $ 391,381 $ 382,926 Accrued expenses 302,808 259,903 Current portion of note payable to related parties 32,571 34,929 Current portion of long-term debt 96,056 95,248 ----------- ----------- Total current liabilities 822,816 773,006 ----------- ----------- NOTE PAYABLE TO RELATED PARTIES, less current portion 342,464 307,358 ----------- ----------- LONG-TERM DEBT, net of current portion 124,186 11,518 ----------- ----------- COMMITMENTS AND CONTINGENCIES STOCKHOLDERS' EQUITY: Common stock, $5 par value, 2,000 shares authorized, issued and outstanding 10,000 10,000 Additional paid-in capital 88,303 88,303 Unrealized holding loss on investment (35,303) (3,802) Retained earnings 2,211,960 2,528,587 ----------- ----------- Total stockholders' equity 2,274,960 2,623,088 ----------- ----------- TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 3,564,426 $ 3,714,970 =========== =========== The accompanying notes to financial statements are an integral part of these balance sheets. F-39 GENA LABORATORIES, INC. STATEMENTS OF OPERATIONS
FOR THE PERIOD FOR THE YEARS ENDED MARCH 1, 1996 ------------------------------------------ TO FEBRUARY 28, FEBRUARY 28, FEBRUARY 29, NOVEMBER 26, 1994 1995 1996 1996 ---------- ---------- ---------- ---------- NET SALES $6,426,416 $7,523,751 $8,384,092 $6,707,727 COST OF SALES 3,280,046 4,163,395 4,818,786 3,900,347 ---------- ---------- ---------- ---------- GROSS PROFIT 3,146,370 3,360,356 3,565,306 2,807,380 SELLING, GENERAL AND ADMINISTRATIVE EXPENSES 2,744,363 2,963,926 3,033,409 1,983,650 ---------- ---------- ---------- ---------- INCOME FROM OPERATIONS 402,007 396,430 531,897 823,730 OTHER INCOME AND (EXPENSE), net 35,092 (35,282) (30,480) 2,225 ---------- ---------- ---------- ---------- INCOME BEFORE PROVISION FOR INCOME TAXES 437,099 361,148 501,417 825,955 PROVISION FOR INCOME TAXES 158,613 129,606 184,790 297,344 ---------- ---------- ---------- ---------- NET INCOME $ 278,486 $ 231,542 $ 316,627 $ 528,611 ========== ========== ========== ==========
The accompanying notes are an integral part of these financial statements. F-40 GENA LABORATORIES, INC STATEMENTS OF STOCKHOLDERS' EQUITY
COMMON STOCK ADDITIONAL TOTAL ---------------- PAID-IN RETAINED STOCKHOLDERS' SHARES AMOUNT CAPITAL EARNINGS EQUITY ------ ------- ---------- ---------- ------------- BALANCE AT FEBRUARY 28, 1993 2,000 $10,000 $88,303 $1,687,828 $1,786,131 Net income - - - 278,486 278,486 Net change in unrealized holding loss - - - 1,006 1,006 ----- ------- ------- ---------- ---------- BALANCE AT FEBRUARY 28, 1994 2,000 10,000 88,303 1,967,320 2,065,623 Net income - - - 231,542 231,542 Net change in unrealized holding loss - - - (22,205) (22,205) ----- ------- ------- ---------- ---------- BALANCE AT FEBRUARY 28, 1995 2,000 10,000 88,303 2,176,657 2,274,960 Net income - - - 316,627 316,627 Net change in unrealized holding loss - - - 31,501 31,501 ----- ------- ------- ---------- ---------- BALANCE AT FEBRUARY 29, 1996 2,000 10,000 88,303 2,524,785 2,623,088 Net income for the period March 1, 1996 to November 26, 1996 - - - 528,611 528,611 Distributions to stockholders - - - (513,000) (513,000) ----- ------- ------- ---------- ---------- BALANCE AT NOVEMBER 26, 1996 2,000 $10,000 $88,303 $2,540,396 $2,638,699 ===== ======= ======= ========== ==========
The accompanying notes are an integral part of these financial statements. F-41 GENA LABORATORIES, INC. STATEMENTS OF CASH FLOWS
FOR THE PERIOD FOR THE YEARS ENDED MARCH 1, 1996 ------------------------------------------ TO FEBRUARY 28, FEBRUARY 28, FEBRUARY 29, NOVEMBER 26, 1994 1995 1996 1996 --------- --------- --------- --------- CASH FLOWS FROM OPERATING ACTIVITIES: Net income $ 278,486 $ 231,542 $ 316,627 $ 528,611 Adjustments to reconcile net income to net cash used in operating activities: Depreciation and amortization 114,021 155,185 168,685 37,939 Loss on sale of securities on fixed Assets -- 32,513 -- -- Decrease (increase) in accounts Receivable 38,647 (157,714) (102,407) 90,671 Decrease (increase) in inventory (14,638) (118,638) (248,353) (24,975) Decrease (increase) in other assets 80,863 (30,814) (51,449) (228,444) (Decrease) increase in accounts payable and accrued liabilities (122,813) 210,426 (51,360) 14,157 --------- --------- --------- --------- Net cash provided by (used in) operating activities 374,566 322,500 31,743 417,959 --------- --------- --------- --------- CASH FLOWS FROM INVESTING ACTIVITIES: Capital expenditures (331,996) (23,648) (25,200) (11,886) Cost incurred to acquire new businesses (180,213) (140,000) -- -- Proceeds from sale of investments -- -- -- 46,500 --------- --------- --------- --------- Net cash provided by (used in) investing activities (512,209) (163,648) (25,200) 34,614 --------- --------- --------- --------- CASH FLOWS FROM FINANCING ACTIVITIES: Proceeds from (payments of) long-term debt, Net 178,585 (136,668) (146,224) (137,098) Distributions to stockholders -- -- -- (513,000) --------- --------- --------- --------- Net cash provided by (used in) financing activities 178,585 (136,668) (146,224) (650,098) --------- --------- --------- --------- NET INCREASE (DECREASE) IN CASH 40,942 22,184 (139,681) (197,525) CASH AND CASH EQUIVALENTS, beginning of Period 327,199 368,141 390,325 250,644 --------- --------- --------- --------- CASH AND CASH EQUIVALENTS, end of period $ 368,141 $ 390,325 $ 250,644 $ 53,119 ========= ========= ========= ========= SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION: Interest paid $ 8,325 $ 54,401 $ 43,259 $ 23,871 ========= ========= ========= ========= Income taxes paid $ 137,580 $ 127,609 $ 232,417 $ 195,860 ========= ========= ========= ========= FIXED ASSETS AND NEW BUSINESSES ACQUIRED THROUGH FINANCING TRANSACTIONS $ 528,449 $ 24,911 $ -- $ -- ========= ========= ========= =========
The accompanying notes are an integral part of these financial statements. F-42 GENA LABORATORIES, INC. NOTES TO FINANCIAL STATEMENTS (1) ORGANIZATION AND BASIS OF PRESENTATION: Acquisition and Basis of Presentation Effective November 26, 1996, shareholders of Gena Laboratories, Inc. (the Company) sold all of its outstanding stock to Styling Technology Corporation for consideration of approximately $9,700,000. These financial statements present the historical financial position and results of operations of the acquired business for periods prescribed by applicable rules of the Securities and Exchange Commission. Organization and Nature of Operations The Company was incorporated in 1930 to manufacture nail care and personal care products. In 1979, the current owners purchased the Company and focused the operation on professional salon care with an emphasis on nail products. The Company is now a recognized quality manufacturer and distributor of professional beauty products worldwide, and offers an extensive line of nail, skin and hair care products as well as pedicure and other specialty beauty products and accessories. Principally, its products are sold through wholesale distributors of professional beauty products, hair and nail salons and professional beauty supply outlets worldwide. (2) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES: Cash and Cash Equivalents All highly liquid investments purchased with original maturities of three months or less are considered to be cash equivalents. Investments The Company considers all its investments as available for sale and accordingly, recognizes any unrealized holding gains and losses as a separate component of stockholders' equity, in accordance with SFAS No. 115, Accounting for Certain Investments in Debt and Equity Securities. Inventory Inventory is valued at the lower of cost (first-in, first-out) or net realizable value. Reserves are established against inventory for excess, slow-moving and obsolete items and for items where the net realizable value is less than cost. Inventories consist of the following: FEBRUARY 28, FEBRUARY 29, 1995 1996 -------- ---------- Raw materials and work-in-process $675,735 $ 849,582 Finished goods 289,600 364,106 -------- ---------- $965,335 $1,213,688 ======== ========== F-43 Property and Equipment Property and equipment are recorded at cost and depreciation on property and equipment is provided using the straight-line method over the estimated useful lives of the assets. Expenditures for major renewals and betterments are capitalized, while expenditures for maintenance and repairs, which do not improve assets or extend their useful lives are charged to expense as incurred. For the years ended February 28, 1994 and 1995, February 29, 1996, and for the period March 1, 1996 to November 26, 1996, maintenance and repair expenses charged to cost of operations were approximately $26,000, $47,000, $23,000 and $32,245, respectively. Concentration of Credit Risk Financial instruments which potentially subject the Company to concentrations of credit risk consist principally of temporary cash investments and trade receivables. The Company places its temporary cash investments in high credit quality institutions. Concentrations of credit risk with respect to trade receivables are described in Note 6. The Company establishes an allowance for doubtful accounts based upon factors surrounding the credit risk of specific customers, historical trends and other information. Fair Value of Financial Instruments The carrying values of cash and cash equivalents, receivables, accounts payable and accrued expenses approximate fair values due to the short-term maturities of these instruments. The carrying amount on the long-term debt is estimated to approximate fair value as the actual interest rates are consistent with rates estimated to be currently available for debt with similar terms and remaining maturities. Revenue Recognition The Company recognizes revenue from sales at the time product is shipped. Use of Estimates The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, 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. Final settlement amounts could differ from those estimates. (3) OTHER ASSETS: Other assets consist primarily of goodwill, which represents the excess of consideration paid over the fair market values of identifiable net assets acquired. The goodwill is being amortized on a straight-line basis over 25 years. The Company has also recorded other intangible assets, which include noncompete, consulting and trademark agreements, related to acquisitions of various beauty companies. Such assets are being amortized on a straight-line basis, over a period of 3 to 25 years. Accumulated amortization on such intangibles was $349,423 and $433,070 as of February 28, 1995 and February 29, 1996. F-44 (4) PROPERTY AND EQUIPMENT: Property and equipment consist of the following: FEBRUARY 28, FEBRUARY 29, 1995 1996 ---------- ---------- Land $ 150,000 $ 150,000 Factory equipment 407,427 431,832 Computers 43,030 43,825 Furniture, fixtures and autos 108,875 108,875 Building and leasehold improvements 567,332 567,332 ---------- ---------- 1,276,664 1,301,864 Less: Accumulated depreciation (392,026) (471,771) ---------- ---------- $ 884,638 $ 830,093 ========== ========== (5) LONG-TERM DEBT: Long-term debt consists of the following: FEBRUARY 28, FEBRUARY 29, 1995 1996 -------- -------- Unsecured note payable, bearing interest at prime (8.25% at February 29, 1996), unpaid balance due by November 1996 $123,529 $ 52,942 Various notes payable, bearing interest from 7.5% to 8.0%, maturing through 1998 96,713 53,824 -------- -------- 220,242 106,766 Less: Current maturities (96,056) (95,248) -------- -------- $124,186 $ 11,518 ======== ======== In 1993, the Company entered into a $250,000 unsecured revolving line of credit, which bears interest at prime and matures July 1997. As of February 28, 1995 and February 29, 1996, the Company had not drawn on this facility. Aggregate principal payments on long-term debt are as follows: YEAR ENDING FEBRUARY 28, ------------ 1997 $ 95,248 1998 11,518 -------- $106,766 ======== (6) MAJOR CUSTOMERS: The Company's strategy includes providing production and distribution services to a major U.S. beauty distribution company. Sales to this customer as F-45 a percentage of total sales approximated 31%, 28% and 28% for the years ended February 28, 1994, 1995 and February 29, 1996, respectively, and 34% for the period March 1, 1996 to November 26, 1996. (7) INCOME TAXES: The Company accounts for income taxes using Statement of Financial Accounting Standards No. 109, Accounting for Income Taxes (SFAS 109). SFAS 109 requires the use of an asset and liability approach in accounting for income taxes. Deferred tax assets and liabilities are recorded based on the differences between the financial statement and tax bases of assets and liabilities and the tax rates in effect when these differences are expected to reverse. These differences result principally from the recognition of revenues and expenses using the cash basis of accounting and the use of different depreciation and amortization methods for income tax reporting. The components of the income tax provision consist of the following:
FOR THE PERIOD FOR THE YEARS ENDED MARCH 1, 1996 -------------------------------------------- TO FEBRUARY 28, FEBRUARY 28, FEBRUARY 29, NOVEMBER 26, 1994 1995 1996 1996 -------- -------- -------- -------- Current: Federal $134,927 $139,468 $208,499 $303,501 State 18,699 19,329 28,896 42,054 -------- -------- -------- -------- 153,626 158,797 237,395 345,555 Deferred provision (benefit) 4,987 (29,191) (52,605) (48,211) -------- -------- -------- -------- Provision for income taxes $158,613 $129,606 $184,790 $297,344 ======== ======== ======== ========
The components of deferred taxes are as follows: FEBRUARY 28, FEBRUARY 29, 1995 1996 -------- -------- Deferred tax assets: Inventory reserve $ 6,707 $ 8,376 Uniform inventory cost capitalization 50,233 62,739 Capital losses in excess of capital gains 1,544 10,362 Allowance for doubtful accounts 44,492 50,314 Amortization 15,773 38,586 -------- -------- Total gross deferred tax assets 118,749 170,377 -------- -------- Deferred tax liabilities: Depreciation (19,694) (18,717) -------- -------- Total gross deferred tax liabilities (19,694) (18,717) -------- -------- Net deferred tax asset $ 99,055 $151,660 ======== ======== The following is a reconciliation of income taxes provided at the federal statutory rate with income taxes recorded by the Company: F-46
FOR THE PERIOD FOR THE YEARS ENDED MARCH 1, 1996 ------------------------------------------ TO FEBRUARY 28, FEBRUARY 28, FEBRUARY 29, NOVEMBER 26, 1994 1995 1996 1996 -------- -------- -------- -------- Tax provision at statutory rate $148,614 $122,790 $170,482 $280,824 Expense of permanent differences resulting from the recognition of interest income and travel and entertainment expenses, and the effect of state taxes 9,999 6,816 14,308 16,520 -------- -------- -------- -------- Income tax provision $158,613 $129,606 $184,790 $297,344 ======== ======== ======== ========
(8) RELATED PARTY TRANSACTIONS: In the fiscal year ended February 28, 1994, the Company purchased land and building amounting to $650,000, from a partnership (the Partnership) of which three of the four partners are shareholders of the Company. The sales price approximated the book value as recorded by the Partnership. Prior to the transaction the Company leased this real estate from the Partnership. The Company acquired the land and building using cash, and financed the remaining portion with a note due the Partnership. Interest and principal of $5,105 are payable monthly. The loan bears interest at 7%, and fully matures in 2003. The total of the related party note payable is as follows: FEBRUARY 28, FEBRUARY 29, 1995 1996 -------- -------- Total shareholder note payable $375,035 $342,287 Less: Current maturities (32,571) (34,929) -------- -------- Shareholder note payable, net of current portion $342,464 $307,358 ======== ======== Principal maturities related to this loan are as follows: YEAR ENDING FEBRUARY 28, TOTAL ------------ ------- 1997 $ 34,929 1998 37,454 1999 40,162 2000 43,065 2001 46,178 Thereafter 140,499 -------- $342,287 ======== The Company also entered into a lease with the Partnership in 1991, for approximately 10,000 square feet for storage and production purposes. Lease F-47 expense related to this space totaled approximately $83,049, $44,346, $51,346 and $58,993 for the years ended February 28, 1994 and 1995, February 29, 1996, and the period March 1, 1996 to November 26, 1996, respectively. (9) COMMITMENTS AND CONTINGENCIES: In the normal course of business, the Company is named as a defendant in various litigation matters. In management's opinion, the ultimate resolution of these matters will not have a material impact on the Company's financial statements. Lease commitments related primarily to a warehouse space lease are as follows: YEAR ENDING FEBRUARY 28, TOTAL ------------ -------- 1997 $ 41,100 1998 41,100 1999 41,100 2000 41,100 2001 41,100 Thereafter 202,500 -------- $408,000 ======== F-48 REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS To the Board of Directors of Styling Technology Corporation: We have audited the accompanying balance sheets of BODY DRENCH (a Division of Designs by Norvell, Inc., a Tennessee corporation) as of December 31, 1994 and 1995, and the related statements of operations, changes in owner's investment and cash flows for each of the three years in the period ended December 31, 1995 and for the period January 1, 1996 to November 26, 1996. These financial statements are the responsibility of the Division's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of Body Drench as of December 31, 1994 and 1995, and the results of its operations and its cash flows for each of the three years then ended and for the period January 1, 1996 to November 26, 1996, in conformity with generally accepted accounting principles. /s/ ARTHUR ANDERSEN LLP Phoenix, Arizona, March 21, 1997. F-49 BODY DRENCH (A DIVISION OF DESIGNS BY NORVELL, INC.) BALANCE SHEETS DECEMBER 31, ------------------------ 1994 1995 ---------- ---------- ASSETS CURRENT ASSETS: Accounts receivable, net of allowance for doubtful accounts of $89,841 and $58,242, respectively $1,396,048 $1,234,966 Inventories 3,052,783 3,078,656 Other current assets 5,152 150,713 ---------- ---------- Total current assets 4,453,983 4,464,335 ---------- ---------- EQUIPMENT, net of accumulated depreciation of $245,424 and $297,176, respectively 167,697 316,443 ---------- ---------- Total assets $4,621,680 $4,780,778 ========== ========== LIABILITIES AND OWNER'S INVESTMENT CURRENT LIABILITIES: Accounts payable $2,550,654 $3,221,337 Bank overdraft 651,953 274,810 Accrued expenses and other 296,546 257,813 ---------- ---------- Total current liabilities 3,499,153 3,753,960 ---------- ---------- COMMITMENTS AND CONTINGENCIES (Note 5) OWNER'S INVESTMENT 1,122,527 1,026,818 ---------- ---------- Total liabilities and owner's investment $4,621,680 $4,780,778 ========== ========== The accompanying notes to the financial statements are an integral part of these balance sheets. F-50 BODY DRENCH (A DIVISION OF DESIGNS BY NORVELL, INC.) STATEMENTS OF OPERATIONS
FOR THE PERIOD YEARS ENDED DECEMBER 31, JANUARY 1, 1996 -------------------------------------- TO 1993 1994 1995 NOVEMBER 26, 1996 ---------- ----------- ----------- ----------------- NET SALES $6,653,488 $11,138,369 $11,871,171 $9,642,980 COST OF SALES 4,039,843 6,342,770 6,426,775 5,867,104 ---------- ----------- ----------- ---------- GROSS PROFIT 2,613,645 4,795,599 5,444,396 3,775,876 SELLING, GENERAL AND ADMINISTRATIVE EXPENSES 2,054,919 4,075,756 4,883,265 4,004,728 ---------- ----------- ----------- ---------- INCOME FROM OPERATIONS 558,726 719,843 561,131 (228,852) ---------- ----------- ----------- ---------- INTEREST EXPENSE 30,159 -- 87,585 -- ---------- ----------- ----------- ---------- INCOME BEFORE PROVISION FOR INCOME TAXES 528,567 719,843 473,546 (228,852) PROVISION (BENEFIT) FOR INCOME TAXES 200,855 273,540 179,947 (91,541) ---------- ----------- ----------- ---------- NET INCOME (LOSS) $ 327,712 $ 446,303 $ 293,599 $ (137,311) ========== =========== =========== ==========
The accompanying notes are an integral part of these financial statements. F-51 BODY DRENCH (A DIVISION OF DESIGNS BY NORVELL, INC.) STATEMENTS OF CHANGES IN OWNER'S INVESTMENT BALANCE, December 31, 1992 $ (127,491) Net income 327,712 Net payments to parent (748,153) ----------- BALANCE, December 31, 1993 (547,932) Net income 446,303 Net receipts from parent 1,224,156 ----------- BALANCE, December 31, 1994 1,122,527 Net income 293,599 Net payments to parent (389,308) ----------- BALANCE, December 31, 1995 1,026,818 Net loss (137,311) Net payments to parent (1,311,710) ----------- BALANCE, November 26, 1996 $ (422,203) =========== The accompanying notes are an integral part of these financial statements. F-52 BODY DRENCH (A DIVISION OF DESIGNS BY NORVELL, INC.) STATEMENTS OF CASH FLOWS
FOR THE PERIOD FOR THE YEARS ENDED JANUARY 1, DECEMBER 31, 1996 TO ----------------------------------- NOVEMBER 26, 1993 1994 1995 1996 --------- ----------- --------- ------------ CASH FLOWS FROM OPERATING ACTIVITIES: Net income (loss) $ 327,712 $ 446,303 $ 293,599 $ (137,311) Adjustments to reconcile net income (loss) to net cash used in operating activities -- Depreciation 67,244 36,619 51,752 94,963 Changes in operating assets and liabilities: Accounts receivable, net (49,548) (1,099,273) 161,082 274,164 Inventories (224,184) (2,024,887) (25,873) - Other, net (5,127) 2,084 (145,561) 1,167,937 Accounts payable 516,725 783,427 670,683 158,304 Accrued expenses 177,767 33,284 (38,733) (258,849) --------- ----------- --------- ----------- Net cash provided by (used in) operating activities 810,589 (1,822,443) 966,949 1,299,208 --------- ----------- --------- ----------- CASH FLOWS FROM INVESTING ACTIVITIES: Purchases of equipment (62,436) (53,666) (200,498) (12,502) --------- ----------- --------- ----------- Net cash provided by (used in) investing activities (62,436) (53,666) (200,498) (12,502) --------- ----------- --------- ----------- CASH FLOWS FROM FINANCING ACTIVITIES: Bank overdraft - 651,953 (377,143) 25,004 Net payments to/receipts from parent (748,153) 1,224,156 (389,308) (1,311,710) --------- ----------- --------- ----------- Net cash provided by (used in) financing activities (748,153) 1,876,109 (766,451) (1,286,706) --------- ----------- --------- ----------- NET CHANGE IN CASH -- -- -- -- --------- ----------- --------- ----------- CASH, beginning of period -- -- -- -- --------- ----------- --------- ----------- CASH, end of period $ -- $ -- $ -- $ -- ========= =========== ========= ===========
The accompanying notes are an integral part of these financial statements. F-53 BODY DRENCH (A DIVISION OF DESIGNS BY NORVELL, INC.) NOTES TO FINANCIAL STATEMENTS (1) ORGANIZATION AND BASIS OF PRESENTATION: Acquisition and Basis of Presentation Effective November 26, 1996, Designs by Norvell, Inc. (Norvell) sold the assets of its Body Drench Division (the Division) to Styling Technology Corporation (STC) for consideration of approximately $7,900,000. These financial statements present the historical financial position and results of operations of the acquired business for periods prescribed by applicable rules of the Securities and Exchange Commission. The accompanying financial statements represent the accounts of the Division pursuant to the terms of the Asset Purchase Agreement between STC and Norvell. In addition, interest expense included in the statements of operations represents allocations of parent company interest, as calculated by Norvell. Nature and Seasonality of Operations The Division is engaged in the manufacture and distribution of skin care, sun care and body care products. Their products are sold to professional hair and tanning salons, health clubs, beauty supply outlets and retail product based salons, both domestic and international. The Division's revenues are seasonal in nature, with the first six months of the year having the majority of the volume. (2) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES: Fair Value of Financial Instruments The carrying values of receivables, accounts payable and accrued expenses approximate fair values due to the short-term maturities of these instruments. Concentration of Credit Risk Financial instruments which potentially subject the Division to concentrations of credit risk consist principally of trade receivables. Concentrations of credit risk with respect to trade receivables are limited due to the number of customers comprising the Division's customer base. The Division establishes an allowance for doubtful accounts based upon factors surrounding the credit risk of specific customers, historical trends and other information. Use of Estimates The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, 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. Final settlement amounts could differ from those estimates. Revenue Recognition The Division recognizes revenue from sales at the time product is shipped. Equipment Equipment is recorded at cost and depreciation on equipment is provided using the straight-line method over the estimated useful lives of the related assets. F-54 Expenditures for major renewals and betterments are capitalized, while expenditures for maintenance and repairs, which do not improve assets or extend their useful lives are charged to expense as incurred. For the three years ended December 31, 1995 and for the period January 1, 1996 to November 26, 1996, maintenance and repair expenses charged to cost of operations were approximately $25,978, $26,117, $30,498 and $6,021, respectively. Inventory Inventory is valued at the lower of cost or market. Cost is determined using the first-in, first-out method. The components of inventories are summarized as follows: 1994 1995 ---------- ---------- Raw materials and work-in-process $1,675,601 $1,583,372 Finished goods 1,377,182 1,495,284 ---------- ---------- $3,052,783 $3,078,656 ========== ========== (3) PROPERTY AND EQUIPMENT: Property and equipment consist of the following: 1994 1995 --------- --------- Factory equipment $ 134,880 $ 178,405 Computer equipment 243,647 394,026 Furniture and fixtures 34,594 41,188 --------- --------- 413,121 613,619 Less -- Accumulated depreciation (245,424) (297,176) --------- --------- $ 167,697 $ 316,443 ========= ========= (4) INCOME TAXES: The Division accounts for income taxes using Statement of Financial Accounting Standards No. 109, Accounting for Income Taxes (SFAS 109). SFAS 109 requires the recording of deferred tax assets and liabilities based on differences between the financial statement and tax bases of assets and liabilities and the tax rates in effect when these differences are expected to reverse. In accordance with SFAS 109, the Division has recorded a provision for income taxes separately from Norvell. (5) COMMITMENTS AND CONTINGENCIES: Leases The Division leases certain facilities and equipment under operating lease agreements. F-55 Future minimum payments under noncancelable operating leases with terms in excess of one year are as follows: December 31, ------------ 1996 $79,455 1997 50,423 1998 41,067 1999 2,333 Rental expense under such operating leases was $52,163, $101,217, $238,746 and $188,761, for the three years ended December 31, 1995, and for the period January 1, 1996 to November 26, 1996, respectively. The Division is involved in certain legal proceedings arising in the normal course of business. In the opinion of management, the Division's potential exposure under the pending proceedings is adequately provided for in the accompanying financial statements. (6) SIGNIFICANT VENDORS: Two vendors accounted for 69.3%, 67.4%, 53.0% and 53.0% of the Division's total raw materials purchases from vendors for the years ended December 31, 1993, 1994, 1995 and for the period January 1, 1996 to November 26, 1996, respectively. Management does not believe that the loss of these vendors would significantly impact the Division's operations. F-56 REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS To the Board of Directors of Styling Technology Corporation: We have audited the accompanying balance sheets of JDS MANUFACTURING CO., INC. (a California corporation) as of September 30, 1995 and 1996, and the related statements of operations, stockholders' equity, and cash flows for each of the three years in the period ended September 30, 1996 and for the period October 1, 1996 to November 26, 1996. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of JDS Manufacturing Co., Inc. as of September 30, 1995 and 1996, and the results of its operations and its cash flows for each of the three years in the period ended September 30, 1996 and for the period October 1, 1996 to November 26, 1996, in conformity with generally accepted accounting principles. /s/ ARTHUR ANDERSEN LLP Phoenix, Arizona, March 21, 1997. F-57 JDS MANUFACTURING CO., INC. BALANCE SHEETS
SEPTEMBER 30, SEPTEMBER 30, 1995 1996 -------- -------- ASSETS CURRENT ASSETS: Cash $ 57,397 $ 85,260 Accounts receivable, net of allowance for doubtful accounts of $10,000, and $15,000, respectively 329,965 313,405 Inventory 264,347 209,140 Prepaid expenses 11,861 4,716 -------- -------- Total current assets 663,570 612,521 -------- -------- PROPERTY AND EQUIPMENT, net of accumulated depreciation of $100,031, and $114,660, respectively 30,292 19,157 OTHER ASSETS 102,934 136,404 -------- -------- $796,796 $768,082 ======== ======== LIABILITIES AND STOCKHOLDERS' EQUITY CURRENT LIABILITIES: Accounts payable $196,309 $152,938 Accrued expenses 53,740 81,411 -------- -------- Total current liabilities 250,049 234,349 -------- -------- NOTES PAYABLE TO RELATED PARTIES 516,200 434,210 -------- -------- COMMITMENTS AND CONTINGENCIES STOCKHOLDERS' EQUITY: Common stock, $10 par value, 10,000 shares authorized, 1,000 shares issued and outstanding 10,000 10,000 Retained earnings 20,547 89,523 -------- -------- Total stockholders' equity 30,547 99,523 -------- -------- Total liabilities and stockholders' equity $796,796 $768,082 ======== ========
The accompanying notes to financial statements are an integral part of these balance sheets. F-58 JDS MANUFACTURING CO., INC. STATEMENTS OF OPERATIONS
FOR THE PERIOD OCTOBER 1, 1996 FOR THE YEARS ENDED SEPTEMBER 30, TO ------------------------------------ NOVEMBER 26, 1994 1995 1996 1996 ---------- ---------- ---------- --------------- SALES $3,577,779 $3,367,599 $3,113,682 $613,142 COST OF SALES 1,651,965 1,550,155 1,407,128 275,513 ---------- ---------- ---------- -------- Gross profit 1,925,814 1,817,444 1,706,554 337,629 SELLING, GENERAL AND ADMINISTRATIVE EXPENSES 1,981,928 1,843,871 1,614,505 257,784 ---------- ---------- ---------- -------- Income (loss) from operations (56,114) (26,427) 92,049 79,845 OTHER INCOME, net 44,191 41,951 35,272 1,263 ---------- ---------- ---------- -------- INCOME (LOSS) BEFORE PROVISION FOR INCOME TAXES (11,923) 15,524 127,321 81,108 PROVISION FOR INCOME TAXES 4,571 6,950 58,345 35,688 ---------- ---------- ---------- -------- NET INCOME (LOSS) $ (16,494) $ 8,574 $ 68,976 $ 45,420 ========== ========== ========== ========
The accompanying notes are an integral part of these financial statements. F-59 JDS MANUFACTURING CO., INC. STATEMENTS OF STOCKHOLDERS' EQUITY
COMMON STOCK ----------------- RETAINED SHARES AMOUNT EARNINGS TOTAL ------ ------- -------- -------- BALANCE, September 30, 1993 1,000 $10,000 $ 28,467 $ 38,467 Net loss - - (16,494) (16,494) ----- ------- -------- -------- BALANCE, September 30, 1994 1,000 10,000 11,973 21,973 Net income - - 8,574 8,574 ----- ------- -------- -------- BALANCE, September 30, 1995 1,000 10,000 20,547 30,547 Net income - - 68,976 68,976 ----- ------- -------- -------- BALANCE, September 30, 1996 1,000 10,000 89,523 99,523 Net income, for the period October 1, 1996 to November 26, 1996 - - 45,420 45,420 ----- ------- -------- -------- BALANCE, November 26, 1996 1,000 $10,000 $134,943 $144,943 ===== ======= ======== ========
The accompanying notes are an integral part of these financial statements. F-60 JDS MANUFACTURING CO., INC. STATEMENTS OF CASH FLOWS
FOR THE PERIOD OCTOBER 1, 1996 FOR THE YEARS ENDED SEPTEMBER 30, TO ----------------------------------- NOVEMBER 26, 1994 1995 1996 1996 --------- --------- --------- --------------- CASH FLOWS FROM OPERATING ACTIVITIES: Net income (loss) $(16,494) $ 8,574 $ 68,976 $ 45,420 Adjustments to reconcile net income (loss) to net cash used in operating activities: Depreciation 18,735 15,661 14,628 1,439 Decrease (increase) in accounts Receivable (4,438) 89,139 16,560 (172,645) Decrease (increase) in inventory 14,441 (34,089) 55,207 47,329 Decrease (increase) in other assets (33,786) (35,112) (26,325) (19,756) Increase (decrease) in accounts payable and accrued expenses 4,263 (47,256) (15,700) 57,480 -------- -------- -------- --------- Net cash provided by (used in) operating activities (17,279) (3,083) 113,346 (40,733) -------- -------- -------- --------- CASH FLOWS FROM INVESTING ACTIVITIES: Capital expenditures (10,582) (8,203) (3,493) (1,912) -------- -------- -------- --------- Net cash used in investing Activities (10,582) (8,203) (3,493) (1,912) -------- -------- -------- --------- CASH FLOWS FROM FINANCING ACTIVITIES: Proceeds from (payments to) shareholder notes payable, net 24,012 (5,692) (81,990) (14,748) -------- -------- -------- --------- Net cash provided by (used in) financing activities 24,012 (5,692) (81,990) (14,748) -------- -------- -------- --------- NET INCREASE (DECREASE) IN CASH (3,849) (16,978) 27,863 (57,393) CASH, beginning of period 78,224 74,375 57,397 85,260 -------- -------- -------- --------- CASH, end of period $ 74,375 $ 57,397 $ 85,260 $ 27,867 ======== ======== ======== ========= SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION: Interest paid $ 36,134 $ 35,589 $ 39,030 $ - ======== ======== ======== ========= Income taxes paid $ 4,090 $ 4,571 $ 7,000 $ 53,896 ======== ======== ======== ========= EXCHANGE OF OTHER ASSET FOR REDUCTION IN SHAREHOLDER NOTES PAYABLE $ - $ - $ - $ 136,404 ======== ======== ======== =========
The accompanying notes are an integral part of these financial statements. F-61 JDS MANUFACTURING CO., INC. NOTES TO FINANCIAL STATEMENTS (1) ORGANIZATION AND BASIS OF PRESENTATION: Acquisition and Basis of Presentation Effective November 26, 1996, shareholders of JDS Manufacturing Co., Inc. (the Company) sold all of its outstanding stock to Styling Technology Corporation for consideration of approximately $4,400,000. These financial statements present the historical financial position and results of operations of the acquired business for periods prescribed by applicable rules of the Securities and Exchange Commission. Organization and Nature of Operations The Company was incorporated in 1987. Since 1989, the Company has been a manufacturer and distributor of several extensive lines of high quality, brand-recognized nail enhancement application products and nail accessories. Its products are sold throughout the United States, principally to professional supply outlets, beauty distributors, professional nail salons and professional manicurists. (2) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES: Cash and Cash Equivalents All highly liquid investments purchased with original maturities of three months or less are considered to be cash equivalents. Fair Value of Financial Instruments The carrying values of cash, receivables, accounts payable and accrued expenses approximate fair values due to the short-term maturities of these instruments. The carrying amount on the long-term debt is estimated to approximate fair value as the actual interest rates are consistent with rates estimated to be currently available for debt with similar terms and remaining maturities. Inventory Inventory is valued at the lower of cost (first-in, first-out) or net realizable value. Reserves are established against inventory for excess, slow-moving and obsolete items and for items where the net realizable value is less than cost. Inventories consist of the following: SEPTEMBER 30, SEPTEMBER 30, 1995 1996 -------- -------- Raw material and work-in process $ 31,722 $ 25,097 Finished goods 232,625 184,043 -------- -------- $264,347 $209,140 ======== ======== F-62 Property and Equipment Property and equipment are recorded at cost and depreciation on property and equipment is provided using the straight-line method over their estimated useful lives. Expenditures for major renewals and betterments are capitalized, while expenditures for maintenance and repairs, which do not improve assets or extend their useful lives, are charged to expense as incurred. For the years ended September 30, 1994, 1995, 1996 and for the period October 1, 1996 to November 26, 1996, maintenance and repair expenses charged to cost of operations were $5,452, $4,507, $2,509 and $598, respectively. Concentration of Credit Risk Financial instruments which potentially subject the Company to concentrations of credit risk consist principally of temporary cash investments and trade receivables. The Company places its temporary cash investments in high quality credit institutions. Concentrations of credit risk with respect to trade receivables are limited due to the number of customers comprising the Company's customer base. The Company establishes an allowance for doubtful accounts based upon factors surrounding the credit risk of specific customers, historical trends and other information. Revenue Recognition The Company recognizes revenue from sales at the time product is shipped. Use of Estimates The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, 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. Final settlement amounts could differ from those estimates. Reclassifications Certain prior year amounts have been reclassified to conform to the 1996 presentation. (3) PROPERTY AND EQUIPMENT: Property and equipment consist of the following: SEPTEMBER 30, SEPTEMBER 30, 1995 1996 ------------- ------------- Furniture and equipment $ 98,490 $ 101,984 Automobiles 13,976 13,976 Leaseholds and other 17,857 17,857 --------- --------- 130,323 133,817 Less: accumulated depreciation (100,031) (114,660) --------- --------- $ 30,292 $ 19,157 ========= ========= (4) NOTES PAYABLE TO RELATED PARTIES: As of September 30, 1995 and 1996, the Company had notes payable due to its two principal shareholders of $516,200 and $434,210, respectively. These notes F-63 originated in October 1994, and bear interest at 8%. Loan advances and repayments are made at the shareholders' discretion, with the entire balance becoming due on September 30, 1997. As such, the entire balance is classified as long-term. (5) INCOME TAXES: The Company accounts for income taxes using Statement of Financial Accounting Standards No. 109 (SFAS 109), Accounting for Income Taxes. SFAS 109 requires the use of an asset and liability approach in accounting for income taxes. Deferred tax assets and liabilities are recorded based on the differences between the financial statement and tax bases of assets and liabilities and the tax rates in effect when these differences are expected to reverse. These differences, resulting principally from use of accelerated depreciation methods for income tax reporting, were not material at the balance sheet dates. (6) COMMITMENTS AND CONTINGENCIES: In the normal course of business, the Company is named as a defendant in various litigation matters. In management's opinion, the ultimate resolution of these matters will not have a material impact on the Company's financial statements. Total future commitments for operating leases are $12,459 through September 30, 1997. (7) SIGNIFICANT CUSTOMER: The Company's strategy includes providing nail care and accessories to a major U.S. beauty distribution company. Sales to this customer as a percentage of total sales were approximately 11%, 14%, 26% and 26% for September 30, 1994, 1995, 1996 and for the period October 1, 1996 to November 26, 1996, respectively. F-64 REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS To the Board of Directors of Styling Technology Corporation: We have audited the accompanying balance sheet of KOTCHAMMER INVESTMENTS, INC. (a California corporation) as of December 31, 1995, and the related statements of operations, stockholders' equity, and cash flows for the year ended December 31, 1995, and for the period January 1, 1996 to November 26, 1996. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of Kotchammer Investments, Inc. as of December 31, 1995, and the results of its operations and its cash flows for the year ended December 31, 1995, and for the period January 1, 1996 to November 26, 1996, in conformity with generally accepted accounting principles. /s/ ARTHUR ANDERSEN LLP Phoenix, Arizona, March 21, 1997. F-65 KOTCHAMMER INVESTMENTS, INC. BALANCE SHEET DECEMBER 31, 1995 --------- ASSETS CURRENT ASSETS: Cash and cash equivalents $ 96,364 Accounts receivable 136,971 Inventory, net 403,730 Prepaid expenses and other 21,799 --------- Total current assets 658,864 --------- PROPERTY AND EQUIPMENT, net 75,472 OTHER ASSETS 1,026 --------- $ 735,362 ========= LIABILITIES AND STOCKHOLDERS' DEFICIT CURRENT LIABILITIES: Accounts payable $ 14,015 Accrued expenses 121,183 Line of credit 215,000 Current portion of notes payable to shareholders 270,000 --------- Total current liabilities 620,198 --------- NOTES PAYABLE TO SHAREHOLDERS, net of current portion 340,000 --------- COMMITMENTS AND CONTINGENCIES STOCKHOLDERS' DEFICIT: Common stock, $20 par value, 2,500 shares authorized, 2,500 shares issued and outstanding 50,000 Retained deficit (274,836) --------- Total stockholders' deficit (224,836) --------- Total liabilities and stockholders' deficit $ 735,362 ========= The accompanying notes to financial statements are an integral part of this balance sheet. F-66 KOTCHAMMER INVESTMENTS, INC. STATEMENTS OF OPERATIONS FOR THE PERIOD FOR THE JANUARY 1, 1996 YEAR ENDED TO DECEMBER 31, NOVEMBER 26, 1995 1996 ---------- ---------- NET SALES $1,557,709 $1,248,460 COST OF SALES 711,925 585,704 ---------- ---------- Gross profit 845,784 662,756 SELLING, GENERAL AND ADMINISTRATIVE EXPENSES 891,146 590,800 ---------- ---------- Income (loss) from operations (45,362) 71,956 INTEREST EXPENSE AND OTHER, net (89,557) (74,250) ---------- ---------- NET LOSS $ (134,919) $ (2,294) ========== ========== The accompanying notes are an integral part of these financial statements. F-67 KOTCHAMMER INVESTMENTS, INC. STATEMENTS OF STOCKHOLDERS' DEFICIT COMMON STOCK TOTAL ----------------- RETAINED STOCKHOLDERS' SHARES AMOUNT EARNINGS DEFICIT ------ ------- --------- ------------- BALANCE, December 31, 1994 2,500 $50,000 $(139,917) $ (89,917) Net loss - - (134,919) (134,919) ----- ------- --------- --------- BALANCE, December 31,1995 2,500 50,000 (274,836) (224,836) Net loss - - (2,294) (2,294) ----- ------- --------- --------- BALANCE, November 26, 1996 2,500 $50,000 $(277,130) $(227,130) ===== ======= ========= ========= The accompanying notes are an integral part of these financial statements. F-68 KOTCHAMMER INVESTMENTS, INC. STATEMENTS OF CASH FLOWS
For the Period For the January 1, 1996 Year Ended to December 31, November 26, 1995 1996 ------------ ---------------- CASH FLOWS FROM OPERATING ACTIVITIES: Net loss $(134,919) $ (2,294) Adjustments to reconcile net loss to net cash used in operating activities: Depreciation 23,436 19,203 Decrease (increase) in accounts receivable 43,004 (19,111) Decrease (increase) in inventory (45,278) 51,566 Decrease in prepaids and other assets 63,372 6,502 Increase (decrease) in accounts payable and accrued Liabilities (43,234) 89,960 --------- --------- Net cash provided by (used in) operating Activities (93,619) 145,826 --------- --------- CASH FLOWS FROM INVESTING ACTIVITIES: Capital expenditures (17,215) - --------- --------- Net cash used in investing activities (17,215) - --------- --------- CASH FLOWS FROM FINANCING ACTIVITIES: Proceeds from (payments to) shareholder notes payable, Net 100,000 - Proceeds from (payments to) line of credit, net (5,000) (215,000) --------- --------- Net cash (used in) provided by financing Activities 95,000 (215,000) --------- --------- NET DECREASE IN CASH (15,834) (69,174) CASH, beginning of period 112,198 96,364 --------- --------- CASH, end of period $ 96,364 $ 27,190 ========= ========= SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION: Interest paid $ 72,916 $ - ========= =========
The accompanying notes are an integral part of these financial statements. F-69 KOTCHAMMER INVESTMENTS, INC. NOTES TO FINANCIAL STATEMENTS (1) ORGANIZATION AND BASIS OF PRESENTATION: Acquisition and Basis of Presentation Effective November 26, 1996, shareholders of Kotchammer Investments, Inc. (the Company) sold its assets to Styling Technology Corporation for consideration of approximately $639,000. These financial statements present the historical financial position and results of operations of the acquired business for periods prescribed by applicable rules of the Securities and Exchange Commission. Organization and Nature of Operations The Company was incorporated in December 1993 to acquire a division of Redken Laboratories, Inc. The Company distributes and markets professional salon appliances and salonwear. Its products are sold throughout the United States, principally to professional supply outlets, beauty distributors, and professional hair stylists. (2) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES: Cash and Cash Equivalents All highly liquid investments purchased with original maturities of three months or less are considered to be cash equivalents. Fair Value of Financial Instruments The carrying values of cash, receivables, accounts payable and accrued expenses approximate fair values due to the short-term maturities of these instruments. The carrying amount on the long-term debt is estimated to approximate fair value as the actual interest rates are consistent with rates estimated to be currently available for debt with similar terms and remaining maturities. Inventory Inventory consists of finished goods and are valued at the lower of cost (first-in, first-out) or net realizable value. Reserves are established against inventory for excess, slow-moving and obsolete items and for items where the net realizable value is less than cost. Property and Equipment Property and equipment are recorded at cost and depreciation on property and equipment is provided using the straight-line method over their estimated useful lives. Concentration of Credit Risk Financial instruments which potentially subject the Company to concentrations of credit risk consist principally of temporary cash investments and trade receivables. The Company places its temporary cash investments in high quality credit institutions. Concentrations of credit risk with respect to trade receivables are limited due to the number of customers comprising the Company's customer base. Revenue Recognition The Company recognizes revenue from sales at the time product is shipped. F-70 Use of Estimates The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, 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. Final settlement amounts could differ from those estimates. (3) PROPERTY AND EQUIPMENT: Property and equipment consist of the following: USEFUL LIFE 1995 ----------- -------- Machinery and equipment 5 years $ 76,803 Furniture and fixtures 7 years 22,458 Computer equipment 5 years 16,652 -------- 115,913 Less -- Accumulated depreciation (40,441) -------- $ 75,472 ======== (4) LINE OF CREDIT: At December 31, 1995, the Company had a $220,000 line of credit with a bank which expired in August of 1996 and carried an interest rate of 9.75%. During 1996, the line of credit was repaid. (5) NOTES PAYABLE TO SHAREHOLDERS: Notes payable to shareholders consisted of the following: DECEMBER 31, 1995 ------------ Note payable dated December 8, 1993, interest at a bank's reference rate plus 1.25% (11% at December 31, 1995), maturing January 15, 2004 $ 120,000 Note payable dated December 8, 1993, interest at a bank's reference rate plus 1.25% (11% at December 31, 1995), maturing January 15, 2004 120,000 Note payable dated December 8, 1993, interest at a bank's reference rate plus 1.25% (11% at December 31, 1995), maturing January 31, 2004 270,000 Note payable dated May 3, 1995, interest at a bank's reference rate plus 1.25% (11% at December 31, 1995), maturing January 31, 2004 70,000 Note payable dated June 5, 1995, interest at a bank's reference rate plus 1.25% (11% at December 31, 1995), maturing January 31, 2004 30,000 --------- 610,000 Less current maturities (270,000) --------- $ 340,000 ========= F-71 As of December 31, 1995, one of the notes payable to shareholders was classified as current as a result of the Company incurring a technical default with a certain financial covenant. (6) INCOME TAXES: The Company has elected S Corporation status under Subchapter S of the Internal Revenue Code. This election results in substantially all U.S. federal taxable income being taxed to the stockholders. Accordingly, there is no provision for income taxes reflected in these financial statements for the year ended December 31, 1995, and for the period January 1, 1996 to November 26, 1996. (7) COMMITMENTS AND CONTINGENCIES: In the normal course of business, the Company is named as a defendant in various litigation matters. In management's opinion, the ultimate resolution of these matters will not have a material impact on the Company's financial statements. Total future commitments for operating leases are $45,851 through July 1997. Rent expense incurred under operating leases was $35,363, and $26,173 for the year ended December 31, 1995 and for the period January 1, 1996 to November 26, 1996, respectively. F-72 SCHEDULE II Styling Technology Corporation and Subsidiaries Valuation and Qualifying Accounts At December 31, 1996 1997 1998 ---- ------- ------- (in thousands) Allowance for Doubtful accounts: Balance at beginning of year $ -- $ 427 $ 1,032 Provision 427 710 1,614 Write-offs -- (105) (860) ---- ------- ------- Balance at end of year $427 $ 1,032 $ 1,786 ==== ======= ======= S-1 EXHIBIT NO. EXHIBIT INDEX - ----------- ------------- 3.1 First Amended and Restated Certificate of Incorporation of the Registrant 3.2 Certificate of Amendment of Certificate of Incorporation(1) 3.3 Bylaws of the Registrant(1) 4.1 Specimen of Stock Certificate(1) 4.2 Specimen of Redeemable Common Stock Warrant(1) 4.3 Form of Warrant issued to Credit Agricole Indosuez(2) 4.4 Form of Warrant issued to Bank Boston N.A.(3) 4.5 Indenture dated as of June 23, 1998, by and among the Company, the Guarantors Signatories thereto, and State Street Bank and Trust Company of California, N.A.(4) 4.6 Form of Global Notes(4) 4.8 Rights Agreement, dated February 23, 1999, between Styling Technology Corporation and American Securities Transfer & Trust Inc., as Rights Agent, together with the following exhibits thereto: Exhibit A-Form of Certificate of Designation of Series A Junior Participating Preferred Stock of Styling Technology Corporation; Exhibit B-Form of Right Certificate; Exhibit C -- Summary of Rights to Purchase Shares of Preferred Stock of Styling Technology Corporation.(5) 10.5 Employment Agreement between Registrant and Sam L. Leopold(1) 10.11 1996 Stock Option Plan(1) 10.19 Asset Purchase Agreement dated as of October 31, 1997 among the Registrant, Inverness Corporation, and Inverness (UK) Limited.(6) 10.20 Transition and Manufacturing Agreement dated as of December 10, 1997 the Registrant and Inverness Corporation.(6) 10.23 Stock Purchase Agreement dated as of June 23, 1998 among the Company and the former shareholders of European Touch, Ltd.II(7) 10.24 Credit Agreement dated June 30, 1998 among the Company, BankBoston, N.A., and NationsBank, N.A.(8) 10.25 Stock Purchase Agreement dated as of August 3, 1998, among the Company, Kevin T. Weir, Carol M. Weir, and Dennis M. Katawczik(6) 10.26 1998 Employee Stock Option Plan 12 Computation of Ratio of Earnings to Fixed Charges 21 Subsidiaries of Registrant 23.1 Consent of Arthur Andersen LLP 27 Financial Data Schedules - ---------- (1) Incorporated by reference to the Registration Statement on Form S-1 (Registration No. 333-12469) filed September 20, 1996 and declared effective November 12, 1996. (2) Incorporated by reference to the Registrant's Quarterly Report on Form 10-Q as filed with the Securities and Exchange Commission (the "Commission") on August 14, 1997. (3) Quarterly Report on Form 10-Q as filed with the Commission on November 14, 1997. (4) Incorporated by reference to the Registration Statement on Form S-4 Registration No. 333-61035) filed August 7, 1998 and declared effective September 18, 1998. (5) Incorporated by reference to the Registration Statement on Form 8-A as filed with the Commission on March 8, 1999 (6) Incorporated by reference to the Registrant's Current Report on Form 8-K as filed with the Commission on December 24, 1997. (7) Incorporated by reference to the Registrant's Current Report on Form 8-K as filed with the Commission on July 8, 1998. (8) Incorporated by reference to Amendment No. 1 to Form S-4 (Registration No. 333-61035) filed September 17, 1998 and declared effective September 18, 1998. EX-3.1 2 0002.txt AMENDED & RESTATED ARTICLES OF INCORPORATION FIRST AMENDED AND RESTATED CERTIFICATE OF INCORPORATION OF STYLING TECHNOLOGY CORPORATION 1. The name of the corporation is STYLING TECHNOLOGY CORPORATION (which is hereinafter referred to as the "Corporation"). 2. The original Certificate of Incorporation was filed with the Secretary of State of the State of Delaware on June 29, 1995, under the name LEOPOLD STYLING PRODUCTS, INC. 3. The original Certificate of Incorporation was amended on September 23, 1996 providing for a reverse stock split and changing the name of the Corporation to Styling Technology Corporation. 4. This First Restated Certificate of Incorporation has been duly proposed by resolutions adopted and declared advisable by the Board of Directors of the Corporation, duly adopted by the stockholders of the Corporation at a meeting duly called, and duly executed and acknowledged by the officers of the Corporation in accordance with the provisions of Sections 103 and 245 of the General Corporation Law of the State of Delaware, and amends, restates, and integrates the provisions of the Certificate of Incorporation of the Corporation and, upon filing with the Secretary of State in accordance with Section 103 and 242, shall thenceforth supersede the Certificate of Incorporation and all amendments thereto, and shall, as it may thereafter be amended in accordance with its terms and applicable law, be the Certificate of Incorporation of the Corporation. 5. The text of the Certificate of Incorporation of the Corporation is hereby amended and restated to read in its entirety as follows: ARTICLE I NAME The name of the Corporation shall be Styling Technology Corporation. ARTICLE II ADDRESS The registered office of the Corporation in the State of Delaware is 1209 Orange Street, in the City of Wilmington, County of New Castle. The name and address of the Corporation's registered agent is The Corporation Trust Company. ARTICLE III PURPOSE The purpose of the Corporation is to engage in any lawful act or activity for which corporations may be organized under the General Corporation Law of the State of Delaware, as the same exists or may hereafter be amended (the "GCL"). ARTICLE IV STOCK The Corporation shall be authorized to issue two classes of shares of capital stock, to be designated, respectively, "Common Stock" and "Preferred Stock." The total number of shares of Common Stock and Preferred Stock which the Corporation shall have authority to issue is eleven million (11,000,000) of which ten million (10,000,000) shares shall be Common Stock and one million (1,000,000) shall be Preferred Stock. The par value of the shares of Common Stock is one hundredth of one cent (.0001) per share. The par value of the shares of Preferred Stock is one hundredth of one cent (.0001) per share. The shares of Preferred Stock may be issued from time to time in one or more series. The Board of Directors is hereby authorized, by filing a certificate pursuant to the applicable law of the State of Delaware, to establish from time to time the number of shares to be included in each series, and to fix the designation, powers, preferences, and rights of the shares of each such series and the qualifications, limitations, or restrictions thereof, including, but not limited to, the fixing or alteration of the dividend rights, dividend rate, conversion rights, voting rights, rights and terms of redemption (including sinking fund provisions), the redemption price or prices, and the liquidation preferences of any wholly unissued series of shares of Preferred Stock, or any of them; and to increase or decrease the number of shares of any series subsequent to the issue of the shares of that series, but not below the number of shares of that series then outstanding. In case the number of shares of any series shall be so decreased, the shares constituting such decrease shall resume the status which they had prior to the adoption of the resolution originally fixing the number of shares of that series. ARTICLE V ADDRESS OF INCORPORATOR The name and mailing address of the incorporator is M.C. Kinnamon, 1209 Orange Street, City of Wilmington, County of New Castle, Delaware 19801. ARTICLE VI BOARD OF DIRECTORS The number of directors which shall comprise the initial Board of Directors of the Corporation shall be two (2). The size of the Board of Directors may be increased or decreased in the manner provided in the Bylaws of the Corporation. All corporate powers of the Corporation shall be exercised by or under the direction of the Board of Directors except as otherwise provided herein or by law. In furtherance and not in limitation of the powers conferred by law, the Board of Directors is expressly authorized: (i) to fix, abolish, determine, and vary from time to time the amount or amounts to be set apart as reserves; (ii) to adopt, amend, and repeal Bylaws of the Corporation; (iii) to authorize and cause to be executed mortgages and liens, with or without limit as to amount, upon the real or personal property of the Corporation; (iv) from time to time to determine whether and to what extent, at what time and place, and under what conditions and regulations the accounts and books of the Corporation, or any of them, shall be open to the inspection of any stockholder; and no stockholder shall have any right to inspect any account or book or document of the Corporation except as conferred by statute or bylaw or as authorized by resolution of the stockholders or Board of Directors; (v) to authorize the payment of compensation to the directors for services to the Corporation, including fees for attendance at meetings of the Board of Directors or of any committee thereof and/or salaries for serving as such directors or committee members, and to determine the amount of such compensation; (vi) from time to time to formulate, establish, promote, and carry out, and to amend, alter, change, revise, recall, repeal, or abolish, a plan or plans for the participation by all or any of the employees, including directors and officers, of the Corporation, or of any corporation, company, association, trust, or organization in which or in the welfare of which the Corporation has any interest, and those actively engaged in the conduct of the Corporation's business, in the profits, gains, or business of the Corporation or of any branch or division thereof, as part of the Corporation's legitimate expenses, and/or for the furnishing to such employees, directors, officers, or persons, or any of them, at the Corporation's expense, of medical services, insurance against accident, sickness, or death, pensions during old age, disability or unemployment, education, housing, social services, recreation, or other similar aids for their relief or general welfare, in such manner and upon such terms and conditions as the Board of Directors shall determine; and (vii) to authorize the guaranty by the Corporation of securities, evidences of indebtedness, and obligations of other persons, firms, associations, and corporations. ARTICLE VII ELECTION OF DIRECTORS Unless and except to the extent that the Bylaws of the Corporation shall so require, the election of directors of the Corporation need not be by written ballot. ARTICLE VIII STRUCTURE OF BOARD OF DIRECTORS A. The Board (other than those directors elected by the holders of any series of Preferred Stock provided for or fixed pursuant to the provisions of Article IV hereof ("Preferred Stock Directors") shall be divided into three classes, as nearly equal in number as possible, designated Class I, Class II, and Class III. Class I directors shall initially serve until the 1999 meeting of stockholders; Class II directors shall initially serve until the 2000 meeting of stockholders; and Class III directors shall initially serve until the 2001 meeting of stockholders. Commencing with the annual meeting of stockholders in 1999, directors of each class, the term of which shall then expire, shall be elected to hold office for a three-year term and until the election and qualification of their respective successors in office. In case of any increase or decrease, from time to time, in the number of directors (other than Preferred Stock Directors), the number of directors in each class shall be apportioned as nearly equal as possible. B. Any director chosen to fill a vacancy or newly created directorship shall hold office until the next election of the class for which such director shall have been chosen and until his or her successor shall be elected and qualified or until their earlier death, resignation, disqualification, or removal. ARTICLE IX INDEMNIFICATION Every person who was or is a party or is threatened to be made a party to or is involved in any threatened, pending or completed action, suit, or proceeding, whether civil, criminal, administrative, or investigative ("Proceeding"), by reason of the fact that he or she or a person of whom he or she is the legal representative, is or was a director or officer of the Corporation or is or was serving at the request of the Corporation as a director or officer of another corporation, or as its representative in a partnership, joint venture, trust, employee benefit plan, or other enterprise, shall be indemnified and held harmless by the Corporation, and the Corporation shall advance expenses to such person, to the fullest extent legally permissible under the GCL, against all expenses, liabilities, and losses (including attorneys' fees, judgments, fines, and amounts paid in settlement) reasonably incurred or suffered by him or her in connection therewith. Nothing contained herein shall affect any rights to indemnification to which employees other than directors and officers may be entitled by law. No amendment or repeal of this Article IX shall apply to or have any effect on any right to indemnification provided hereunder with respect to any acts or omissions occurring prior to such amendment or repeal. The right of indemnification shall be a contract right that may be enforced in any manner desired by such person. The right of indemnification shall not be exclusive of any other right that such directors, officers, or representatives may have or hereafter acquire and, without limiting the generality of such statement, they shall be entitled to their respective rights of indemnification under any bylaws, agreement, vote of stockholders, provision of law or otherwise, as well as their rights under this Article. Notwithstanding any other provision of this Article IX, no person shall be entitled to indemnification or advancement of expenses under this Article with respect to any Proceeding, or any claim therein, brought or made by him or her against the Corporation, unless such Proceeding or claim is approved by the Board of Directors of the Corporation. The Board of Directors may adopt bylaws from time to time with respect to indemnification to provide at all time the fullest indemnification permitted by the GCL, and may cause the Corporation to purchase and maintain insurance, at the Corporation's expense, on behalf of any person who is or was a director, officer, employee, or agent of the Corporation, or is or was serving at the request of the Corporation as a director or officer of another corporation, or as its representative in a partnership, joint venture, trust, or other enterprise against any liability asserted against such person and incurred in any such capacity or arising out of such status, whether or not the Corporation would have the power to indemnify such person against such liability. The Corporation may also create a trust fund, grant a security interest and/or use other means (including, but not limited to, letters of credit, surety bonds and/or other similar arrangements), as well as enter into contracts providing indemnification to the full extent authorized or permitted by law and including as part thereof provisions with respect to any or all of the foregoing, to ensure the payment of such amounts as may become necessary to effect indemnification as provided therein, or elsewhere. ARTICLE X REMOVAL OF DIRECTORS Any director or the entire Board of Directors may be removed, with or without cause, at any time by the holders of a majority of the shares then entitled to vote at an election of directors, and the vacancy in the Board of Directors caused by such removal may be filled by the stockholders at the time of such removal. ARTICLE XI LIMITATION ON LIABILITY FOR BREACH OF FIDUCIARY DUTY A director of the Corporation shall not be liable to the Corporation or its stockholders for monetary damages for breach of fiduciary duty as a director, except to the extent such exemption from liability or limitation thereof is not permitted under the GCL. Any repeal or modification of this Article shall not adversely affect any right or protection of a director of the Corporation existing hereunder with respect to any act or omission occurring prior to such repeal or modification. ARTICLE XII AMENDMENT OF BYLAWS Subject to the power of the stockholders of the Corporation to alter or repeal any Bylaw made by the Board of Directors, the Board of Directors is expressly authorized and empowered to make, alter, and repeal the Bylaws of the Corporation. ARTICLE XIII AMENDMENT OF ARTICLES The Corporation reserves the right at any time, and from time to time, to amend, alter, change, or repeal any provision contained in this First Restated Certificate of Incorporation, and other provisions authorized by the laws of the State of Delaware at the time in force may be added or inserted, in the manner now or hereafter prescribed by law; and all rights, preferences, and privileges of whatsoever nature conferred upon stockholders, directors, or any other persons whomsoever by and pursuant to this First Restated Certificate of Incorporation in its present form or as hereafter amended are granted subject to the rights reserved in this Article. ARTICLE XIV BOARD CONSIDERATIONS UPON SIGNIFICANT EVENTS The Board, when evaluating any (A) tender offer or invitation for tenders, or proposal to make a tender offer or request or invitation for tenders, by another party, for any equity security of the Corporation, or (B) proposal or offer by another party to (1) merge or consolidate the Corporation or any subsidiary with another corporation or other entity, (2) purchase or otherwise acquire all or a substantial portion of the properties or assets of the Corporation or any subsidiary, or sell or otherwise dispose of to the Corporation or any subsidiary all or a substantial portion of the properties or assets of such other party, or (3) liquidate, dissolve, reclassify the securities of, declare an extraordinary dividend of, recapitalize or reorganize the Corporation, shall take into account all factors that the Board deems relevant, including, without limitation, to the extent so deemed relevant, the potential impact on employees, customers, suppliers, partners, joint venturers and other constituents of the Corporation and the communities in which the Corporation operates. In addition to any affirmative vote required by applicable law and in addition to any vote of the holders of any series of Preferred Stock provided for or fixed pursuant to the provisions of Article IV of this First Restated Certificate of Incorporation, any alteration, amendment or repeal relating to this Article XIV must be approved by the affirmative vote of the holders of at least sixty six and two-thirds percent (66 2/3%) of the combined voting power of the issued and outstanding shares of Voting Stock (as defined in Article XVI), voting together as a single class. ARTICLE XV STOCKHOLDER CONSENT No action that is required or permitted to be taken by the stockholders of the Corporation at any annual or special meeting of stockholders may be effected by written consent of stockholders in lieu of a meeting of stockholders, unless the action to be effected by written consent of stockholders and the taking of such action by such written consent have expressly been approved in advance by the Board. In addition to any affirmative vote required by applicable law and in addition to any vote of the holders of any series of Preferred Stock provided for or fixed pursuant to the provisions of Article IV of this First Restated Certificate of Incorporation, any alteration, amendment or repeal relating to this Article XV must be approved by the affirmative vote of the holders of at least sixty six and two-thirds percent (66 2/3%) of the combined voting power of the issued and outstanding shares of Voting Stock (as defined in Article XVI), voting together as a single class. ARTICLE XVI BUSINESS COMBINATIONS; FAIR PRICE A. In addition to any affirmative vote required by law or this First Restated Certificate of Incorporation, and except as otherwise expressly provided in paragraph B of this Article XVI: 1. any merger or consolidation of the Corporation or any Subsidiary (as hereinafter defined) with (a) any Interested Stockholder (as hereinafter defined), or (b) any other corporation, partnership, or other entity (whether or not itself an Interested Stockholder) which is, or after such merger or consolidation would be, an Affiliate (as hereinafter defined) of an Interested Stockholder other than a merger enacted in accordance with Section 253 of the Delaware General Corporation Law or any successor thereof; or 2. any sale, lease, exchange, mortgage, pledge, transfer, or other disposition (in one transaction or a series of transactions) to or with any Interested Stockholder, including all Affiliates of the Interested Stockholder, of any assets of the Corporation or any Subsidiary having an aggregate Fair Market Value (as hereinafter defined) of ten million dollars ($10,000,000) or more; or 3. the issuance or transfer by the Corporation or any Subsidiary (in one transaction or a series of transactions) of any securities of the Corporation or any Subsidiary to any Interested Stockholder, including all Affiliates of the Interested Stockholder, in exchange for cash, securities, or other property (or a combination thereof) having an aggregate Fair Market Value of ten million dollars ($10,000,000) or more (other than on a pro rata basis to all holders of Voting Stock of the same class held by the Interested Stockholder pursuant to a stock split, stock dividend or distribution of warrants or rights and other than in connection with the exercise or conversion of securities exercisable for or convertible into securities of the Corporation of any of its subsidiaries which securities have been distributed pro rata to all holders of Voting Stock); or 4. the adoption of any plan or proposal for the liquidation or dissolution of the Corporation proposed by or on behalf of an Interested Stockholder or any Affiliates of an Interested Stockholder; or 5. any reclassification of securities (including any reverse stock split), or recapitalization of the Corporation, or any merger or consolidation of the Corporation with any of its Subsidiaries or any other transaction (whether or not an Interested Stockholder is a party thereto) which has the effect, directly or indirectly, of increasing the proportionate share by more than one percent (1%) of the issued and outstanding shares of any class of equity or convertible securities of the Corporation or any Subsidiary which are directly or indirectly owned by any Interested Stockholder or one or more Affiliates of the Interested Stockholder; shall require the affirmative vote of the holders of at least sixty six and two-thirds percent (66 2/3%) of the voting power of the then issued and outstanding Voting Stock, as hereinafter defined, voting together as a single class, including the affirmative vote of the holders of at least sixty six and two-thirds percent (66 2/3%) of the voting power of the then issued and outstanding Voting Stock not Beneficially Owned directly or indirectly by an Interested Stockholder or any Affiliate of any Interested Stockholder. Such affirmative vote shall be required notwithstanding the fact that no vote may be required, or that a lesser percentage may be permitted, by law or in any agreement with any national securities exchange or otherwise. B. The provisions of Section A of this Article XVI shall not be applicable to any particular Business Combination (as hereinafter defined), and such Business Combination shall require only such affirmative vote as is required by law or any other provision of this First Restated Certificate of Incorporation, if the conditions specified in either of the following paragraph 1 or 2 are met: 1. the Business Combination shall have been approved by a majority of the Continuing Directors (as hereinafter defined); or 2. all of the following price and procedural conditions shall have been met: (a) the aggregate amount of the cash and the Fair Market Value (as hereinafter defined) as of the date of the consummation of the Business Combination of consideration other than cash, to be received per share by the holders of Common Stock in such Business Combination, shall be at least equal to the highest of the following: (i) (if applicable) the highest per share price (including any brokerage commissions, transfer taxes and soliciting dealers' fees) paid by the Interested Stockholder for any shares of Common Stock acquired by it (A) within the two (2) year period immediately prior to the first public announcement of the proposal of such Business Combination (the "Announcement Date"), or (B) in the transaction in which it became an Interested Stockholder, whichever is higher; (ii) the Fair Market Value per share of Common Stock on the Announcement Date or on the date on which the Interested Stockholder became an Interested Stockholder (the "Determination Date"), whichever is higher; and (iii) (if applicable) the price per share equal to the Fair Market Value per share of Common Stock determined pursuant to paragraph 2(a)(ii) above, multiplied by the ratio of (A) the highest per share price (including any brokerage commissions, transfer taxes and soliciting dealers' fees) paid by the Interested Stockholder for any shares of Common Stock acquired by it within the two (2) year period immediately prior to the Announcement Date to (B) the Fair Market Value per share of Common Stock on the first day in such two (2) year period upon which the Interested Stockholder acquired any shares of Common Stock; and (b) the aggregate amount of the cash and the Fair Market Value as of the date of the consummation of the Business Combination of consideration other than cash to be received per share by holders of shares of any other class, other than Common Stock or Excluded Preferred Stock, of issued and outstanding Voting Stock shall be at least equal to the highest of the following (it being intended that the requirements of this paragraph 2(b) shall be required to be met with respect to every such class of issued and outstanding Voting Stock, whether or not the Interested Stockholder has previously acquired any shares of a particular class of Voting Stock): (i) (if applicable) the highest per share price (including any brokerage commissions, transfer taxes and soliciting dealers' fees) paid by the Interested Stockholder for any shares of such class of Voting Stock acquired by it (A) within the two (2) year period immediately prior to the Announcement Date, or (B) in the transaction in which it became an Interested Stockholder, whichever is higher; (ii) (if applicable) the highest preferential amount per share to which the holders of shares of such class of Voting Stock are entitled in the event of any voluntary or involuntary liquidation, dissolution or winding up of the Corporation; (iii) the Fair Market Value per share of such class of Voting Stock on the Announcement Date or on the Determination Date, whichever is higher; and (iv) (if applicable) the price per share equal to the Fair Market Value per share of such class of Voting Stock determined pursuant to paragraph 2(b)(iii) above, multiplied by the ratio of (A) the highest per share price (including any brokerage commissions, transfer taxes and soliciting dealers' fees) paid by the Interested Stockholder for any shares of such class of Voting Stock acquired by it within the two (2) year period immediately prior to the Announcement Date to (B) the Fair Market Value per share of such class of Voting Stock on the first day in such two (2) year period upon which the Interested Stockholder acquired any shares of such class of Voting Stock; and (c) the consideration to be received by holders of a particular class of issued and outstanding Voting Stock (including Common Stock and other than Excluded Preferred Stock) shall be in cash or in the same form as the Interested Stockholder has previously paid for shares of such class of Voting Stock (if the Interested Stockholder has paid for shares of any class of Voting Stock with varying forms of consideration, the form of consideration for such class of Voting Stock shall be either cash or the form used to acquire the largest number of shares of such class of Voting Stock previously acquired by it); and (d) after such Interested Stockholder has become an Interested Stockholder and prior to the consummation of such Business Combination: (i) there shall have been no failure to declare and pay at the regular date therefor any full quarterly dividends (whether or not cumulative) on any issued and outstanding preferred stock, except as approved by a majority of the Continuing Directors; (ii) there shall have been no reduction in the annual rate of dividends paid on the Common Stock (except as necessary to reflect any subdivision of the Common Stock), except as approved by a majority of the Continuing Directors; (iii) there shall have been an increase in the annual rate of dividends as necessary fully to reflect any recapitalization (including any reverse stock split), reorganization or any similar reorganization which has the effect of reducing the number of issued and outstanding shares of the Common Stock, unless the failure so to increase such annual rate is approved by a majority of the Continuing Directors; and (iv) such Interested Stockholder shall not have become the Beneficial Owner of any additional Voting Stock except as part of the transaction which results in such Interested Stockholder becoming an Interested Stockholder; and (e) after such Interested Stockholder has become an Interested Stockholder, such Interested Stockholder shall not have received the benefit, directly or indirectly (except proportionately as a shareholder), of any loans, advances, guarantees, pledges or other financial assistance or any tax credits or other tax advantages provided by the Corporation, whether in anticipation of or in connection with such Business Combination or otherwise; and (f) a proxy or information statement describing the proposed Business Combination and complying with the requirements of the Securities Exchange Act of 1934 and the rules and regulations thereunder (or any subsequent provisions replacing such Act, rules or regulations) shall be mailed to stockholders of the Corporation at least thirty (30) days prior to the consummation of such Business Combination (whether or not such proxy or information statement is required to be marked pursuant to such Act or subsequent provisions). C. For purposes of this Article XVI the following terms shall have the following meanings: 1. "Affiliate" or "Associate" shall have the respective meanings ascribed to such terms in Rule 12b-2 of the General Rules and Regulations under the Securities Exchange Act of 1934, as in effect on June 21, 1996. 2. "Beneficial Owner" shall have the meaning ascribed to such term in Rule 13d-3 of the General Rules and Regulations of the Securities Exchange Act of 1934, as in effect on June 21, 1996. In addition, a Person shall be the "Beneficial Owner" of any Voting Stock which such Person or any of its Affiliates or Associates has: (a) the right to acquire (whether such right is exercisable immediately or only after the passage of time), pursuant to any agreement, arrangement or understanding or upon the exercise of conversion rights, exchange rights, warrants or options, or otherwise; or (b) the right to vote pursuant to any agreement, arrangement or understanding (but neither such Person nor any such Affiliate or Associate shall be deemed to be the Beneficial Owner of any shares of Voting Stock solely by reason of a revocable proxy granted for a particular meeting of the stockholders, pursuant to a public solicitation of proxies for such meeting, and with respect to which shares neither such Person nor any such Affiliate of Associate is otherwise deemed the Beneficial Owner). 3. "Business Combination" shall mean any transaction described in any one or more of clauses (1) through (5) of Section A of this Article XVI. 4. "Continuing Director" shall mean any member of the Board who is unaffiliated with and is not the Interested Stockholder and was a member of the Board prior to the time that the Interested Stockholder became an Interested Stockholder, and any director who is thereafter chosen to fill any vacancy on the Board or who is elected and who, in either event, is unaffiliated with the Interested Stockholder and in connection with his or her initial assumption of office is recommended for appointment or election by a majority of Continuing Directors then on the Board. 5. "Excluded Preferred Stock" means any series of Preferred Stock with respect to which a majority of the Continuing Directors have approved a Preferred Stock Designation creating such series that expressly provides that the provisions of this Article XVI shall not apply. 6. "Fair Market Value" shall mean: (a) in the case of stock, the highest closing sale price during the thirty (30) day period immediately preceding the date in question of a share of such stock on the Composite Tape for New York Stock Exchange listed stocks, or, if such stock is not quoted on the composite tape, on the New York Stock Exchange, or, if such stock is not listed on such exchange, on the principal United States securities exchange registered under the Securities Exchange Act of 1934 on which such stock is listed, or, if such stock is not listed on any such exchange, the highest closing bid quotation with respect to a share of such stock during the thirty (30) day period preceding the date in question on the National Association of Securities Dealers, Inc. Automated Quotation System or any system then in use in its stead, or if no such quotations are available, the fair market value on the date in question of a share of such stock as determined by the Board in accordance with Section D of this Article XVI; and (b) in the case of property other than cash or stock, the fair market value of such property on the date in question as determined by the Board in accordance with Section D of this Article XVI. 7. "Interested Stockholder" shall mean any Person to or which: (a) itself, or along with its Affiliates, is the Beneficial Owner, directly or indirectly, of more than fifteen percent (15%) of the then issued and outstanding Voting Stock; or (b) is an Affiliate of the Corporation and at any time within the two (2) year period immediately prior to the date in question was itself, or along with its Affiliates, the Beneficial Owner, directly or indirectly, of fifteen percent (15%) or more of the then issued and outstanding Voting Stock; or (c) is an assignee of or has otherwise succeeded to any Voting Stock which was at any time within the two (2) year period immediately prior to the date in question beneficially owned by an Interested Stockholder, if such assignment or succession shall have occurred in the course of a transaction or series of transactions not involving a public offering within the meaning of the Securities Act of 1933. For the purpose of determining whether a Person is an Interested Stockholder pursuant to paragraph 7 of this Section C, the number of shares of Voting Stock deemed to be issued and outstanding shall include shares deemed owned through application of paragraph 2 of this Section C but shall not include any other shares of Voting Stock that may be issuable pursuant to any agreement, arrangement or understanding, or upon exercise of conversion rights, warrants oroptions or otherwise. Notwithstanding anything to the contrary contained in this First Restated Certificate of Incorporation, for purposes of this First Restated Certificate of Incorporation, the term "Interested Stockholder" shall not, for any purpose, include, and the provisions of Article XVI(A) hereof shall not apply to: (a) the Corporation or any Subsidiary; or (b) any employee stock ownership plan of the Corporation or any Subsidiary. 8. In the event of any Business Combination in which the Corporation survives, the phrase "other consideration to be received" as used in paragraphs 2(a) and (b) and paragraph B of this Article XVI shall include the shares of Common Stock and/or the shares of any other class of issued and outstanding Voting Stock retained by the holders of such shares. 9. "Person" shall mean any individual, firm, corporation, partnership or other entity. 10. "Subsidiary" shall mean any corporation or other entity of which the Corporation owns, directly or indirectly, securities that enable the Corporation to elect a majority of the board of directors or other persons performing similar functions of such corporation or entity or that otherwise give to the Corporation the power to control such corporation or entity. 11. "Voting Stock" means all issued and outstanding shares of capital stock of the Corporation that pursuant to or in accordance with this First Restated Certificate of Incorporation are entitled to vote generally in the election of directors of the Corporation, and each reference herein, where appropriate, to a percentage or portion of shares of Voting Stock shall refer to such percentage or portion of the voting power of such shares entitled to vote. The issued and outstanding shares of Voting Stock shall not include any shares of Voting Stock that may be issuable pursuant to any agreement, or upon the exercise or conversion of any rights, warrants or options or otherwise. D. The Continuing Directors of the Corporation shall have the power and duty to determine for the purposes of this Article XVI, on the basis of information known to them after reasonable inquiry, all facts necessary to determine compliance with this Article XVI, including, without limitation: (i) whether a Person is an Interested Stockholder; (ii) the number of shares of Voting Stock beneficially owned by any Person; (iii) whether a Person is an Affiliate or Associate of another; (iv) whether the applicable conditions set forth in paragraph 2 of paragraph B of this Article XVI have been met with respect to any Business Combination; (v) the Fair Market Value of stock or other property in accordance with paragraph 6 of paragraph C of this Article XVI; and (vi) whether the assets which are the subject of any Business Combination have, or the consideration to be received for the issuance or transfer of securities by the Corporation or any Subsidiary in any Business Combination has, an aggregate Fair Market Value of ten million dollars ($10,000,000) or more. E. Nothing contained in this Article XVI shall be construed to relieve any Interested Stockholder from any fiduciary obligation imposed by law. F. In addition to any affirmative vote required by applicable law and in addition to any vote of the holders of any series of Preferred Stock provided for or fixed pursuant to the provisions of Article IV of this First Restated Certificate of Incorporation, any alteration, amendment or repeal relating to this Article XVI must be approved by the affirmative vote of the holders of at least sixty six and two-thirds percent (66 2/3%) of the combined voting power of the issued and outstanding shares of Voting Stock, voting together as a single class. IN WITNESS WHEREOF, the undersigned, being the Chairman of the Board, President and Chief Executive Officer of the Corporation, for and on behalf of the Corporation, has executed this First Restated Certificate of Incorporation this 18th day of June, 1998, and hereby acknowledges, under penalties of perjury, that this First Restated Certificate of Incorporation is the act and deed of the Corporation and that facts stated in this First Restated Certificate of Incorporate are true. STYLING TECHNOLOGY CORPORATION By: /s/ Richard R. Ross ------------------------------------ Richard R. Ross, Executive Vice President, Chief Financial Officer and Secretary STATE OF ARIZONA ) ) ss. County of Maricopa ) The foregoing instrument was acknowledged before this ____ day of June, 1998, by Richard R. Ross, Executive Vice President, Chief Financial Officer and Secretary of Styling Technology Corporation, a Delaware corporation, on behalf of the corporation. - ----------------------------------- Notary Public My commission expires: - ----------------------------------- EX-10.26 3 0003.txt 1998 EMPLOYEE STOCK OPTION PLAN STYLING TECHNOLOGY CORPORATION 1998 EMPLOYEE STOCK OPTION PLAN SECTION 1. PURPOSE OF PLAN; TERM (a) General Purpose. The purpose of the Plan is to further the interests of Styling Technology Corporation, a Delaware corporation (the "Company"), and its stockholders by encouraging employees associated with the Company (or parent or subsidiary corporations of the Company) to acquire shares of the Company's common stock, thereby acquiring a proprietary interest in its business and an increased personal interest in its continued success and progress. Such purpose shall be accomplished by providing for the granting of options to acquire the Company's common stock ("Options"). A "parent corporation" for purposes of this Plan is any corporation in the unbroken chain of corporations ending with the employer corporation, where, at each link of the chain, the corporation and the link above owns at least 50 percent of the combined total voting power of all classes of the stock in the corporation in the link below. A "subsidiary corporation" for purposes of this Plan is any corporation in the unbroken chain of corporations starting with the employer corporation, where, at each link of the chain, the corporation and the link above owns at least 50 percent of the combined voting power of all classes of stock in the corporation below. (b) Options. All Options granted under this Plan will be nonqualified options and shall not be "incentive stock options" as defined in section 422 of the Code. (c) Duration of Plan. The term of the Plan is 10 years commencing on the date of adoption of the Plan by the Board, which was on May 4, 1998. No Option shall be granted under the Plan unless granted within 10 years of the adoption of the Plan by the Board, but Options outstanding on that date shall not be terminated or otherwise affected by virtue of the Plan's expiration. SECTION 2. STOCK AND MAXIMUM NUMBER OF SHARES SUBJECT TO PLAN (a) Description of Stock and maximum Shares Allocated. The stock subject to the provisions of the Plan and issuable upon the grant of Options granted under the Plan is shares of the Company's common stock, $.0001 par value per share (the "Stock"), which may be either unissued or treasury shares, as the Board may from time to time determine. Subject to adjustment as provided in Section 7 hereof, the aggregate number of shares of Stock covered by the Plan and issuable thereunder shall be 150,000 shares of Stock. (b) Calculation of Available Shares. For purposes of calculating the maximum number of shares of Stock that may be issued under the Plan, the shares issued (including the shares, if any, withheld for tax withholding requirements) upon exercise of an Option shall be counted. (c) Restoration of Unpurchased Shares. If an Option expires of terminates for any reason prior to its exercise in full and before the term of the Plan expires, the shares of Stock subject to, but not issued under, such Option shall, without further action or by or on behalf of the Company, again be available under the Plan. If shares of Stock are used to pay for the exercise price, those shares shall be added to the shares available under the Plan. SECTION 3. ADMINISTRATION; APPROVAL; AMENDMENTS (a) General Administration. The power to administer the Plan with respect to Eligible Persons shall be vested exclusively with the Board. (b) Plan Administrator. The Board shall be referred to herein as the "Plan Administrator." The Board may, at any time, appoint a committee of one or more persons who are members of the Aboard and delegate to that committee the power to administer the Plan. Members of such committee shall serve for such period of time as the Board may determine and shall be subject to removal by the Board at any time. The Board may, at any time, terminate the functions of any such committee and reassume all powers and authority previously delegated to that committee. The Plan Administrator shall have the authority and discretion to select which Eligible Persons shall participate in the Plan, to grant Options under the Plan, to establish such rules and regulations as they may deem appropriate with the proper administration of the Plan and to make such determinations under, and issue such interpretations of, the Plan and any outstanding Option as they may deem necessary or advisable. Decisions of the Plan Administrator shall be final and binding on all parties who have an interest in the Plan or any outstanding Option. (c) Approval of Plan. This Plan shall not require the approval of the stockholders of the Company and shall be effective as of the date adopted by the Board. (d) Amendments to Plan. The Board may, without action on the part of the Company's stockholders, make such amendments to, changes in and additions to the Plan as it may, from time to time, deem necessary or appropriate and in the best interests of the Company; provided, the Board may not, without the consent of the Optionholder, take any action which adversely affects or impairs the rights of the Optionholder of any Option outstanding under the Plan. SECTION 4. PARTICIPANTS (a) Eligibility and Participation. Options may be granted only to persons ("Eligible Persons") who at the time of grant are employees of or consultants to the Company or parent or subsidiaries of the Company; provided, however, that any person that is an Affiliate shall not be an Eligible Person under this Plan. The Plan Administrator shall have full authority to determine which Eligible Persons in its administered group are to receive Option grants under the Plan, the number of shares to be covered by each such grant, the time or times at which each such Option is to become exercisable, and the maximum term for which the Option is to be outstanding. (b) Guidelines for Participation. In designating and selecting Eligible Persons for participation in the Plan, the Plan Administrator shall consult with and give consideration to the recommendations and criticisms submitted by appropriate managerial and executive officers of the Company. The Plan Administrator also shall take into account the duties and responsibilities of the Eligible Persons, their past, present and potential contributions to the success of the Company and such other factors as the Plan Administrator shall deem relevant in connection with accomplishing the purpose of the Plan. SECTION 5. TERMS AND CONDITIONS OF OPTION (a) Allotment of Shares. The Plan Administrator shall determine the number of shares of Stock to be optioned form time to time and the number of shares to be optioned to any Eligible Person (the "Optioned Shares"). The grant of an Option to a person shall neither entitle such person to, nor disqualify such person from, participation in any other grant of Options under this Plan or any other stock option plan of the Company. (b) Exercise Price. Upon the grant of any Option, the Plan Administrator shall specify the option price per shares. In no event may the option price per share specified by the Plan Administrator be less than 100 percent of the fair market value per share of the Stock on the date the Option is granted. (c) Calculation of Fair Market Value of Stock. The fair market value of a shares of Stock on any relevant date shall be the closing selling price per share of Stock on the date in question on the stock exchange determined by the Board to be the primary market for the Stock, as such price is officially quoted in the composite tape of transactions on such exchange. If there is no reported sale of Stock on such exchange on the date in question, then the fair market value shall be the closing selling price on the exchange on the last preceding date for which such quotation exists. (d) Individual Stock Option Agreements. Options granted under the Plan shall be evidenced by option agreements in such form and content as the Plan Administrator from time to time approves, which agreements shall substantially comply with and be subject to the terms of the Plan, including the terms and conditions of this Section 5. As determined by a Plan Administrator, each option agreement shall state (i) the total number of shares to which it pertains, (ii) the exercise price for the shares covered by the Option, (iii) the time at which the Options vest and become exercisable and (iv) the Option's scheduled expiration date. The option agreements may contain such other provisions or conditions as the Plan Administrator deems necessary or appropriate to effectuate the sense and purpose of the Plan, including covenants by the Optionholder not-to-compete and remedies to the Company in the event of the breach of any such covenant. (e) Option Period. No Option granted under the Plan shall be exercisable for a period in excess of 10 years from the date of its grant subject to earlier termination in the event of termination of employment, retirement or death of the Optionholder. An Option may be exercised in full or in part at any time or from time to time during the term of the Option or provide for its exercise in stated installments at stated times during the Option's term. (f) Vesting; Limitations. The time at which the Optioned Shares vest with respect to a participant shall be in the discretion of the Plan Administrator. (g) No Fractional Shares. Options shall be exercisable only for whole shares; no fractional shares will be issuable upon exercise of any Option granted under the Plan. (h) Method of Exercising Options; Full Payment. Options shall be exercised by written notice to the Company, addressed to the Company at its principal place of business. Such notice shall state the election to exercise the Option and the number of shares with respect to which it is being exercised, and shall be signed by the person exercising the Option. Such notice shall be accompanied by payment in full of the exercise price for the number of shares being purchased. Payment may be made in cash or by check as prescribed by the applicable Plan Administrator or by tendering duly endorsed certificates representing shares of Stock then owned by the Optionholder and held for the requisite period necessary to avoid a charge to the Company's earnings and valued at fair market value on the date of exercise (as determined in accordance with Section 5(c) hereof). Upon the exercise of any Option, the Company shall deliver, or cause to be delivered, to the Optionholder a certificate or certificates representing the shares of Stock purchased upon such exercise as soon as practicable after payment for those shares has been received by the Company. If an Option is exercised pursuant to Section 5(j) hereof by any person other than the Optionholder, such notice shall be accompanied by appropriate proof of the right of such person to exercise the Option. All shares that are purchased and paid for in full upon the exercise of an Option shall be fully paid and non-assessable. (i) Rights of a Stockholder. An Optionholder shall have no rights as a stockholder with respect to shares covered by his Option until such Option holder shall have exercised the Option and paid the full exercise price for the Optioned Shares. No adjustment will be made for dividends or other rights with respect to any Optioned Shares for which the record date is prior to the date on which the Optionholder exercises the Option for such shares. (j) Exercise of Options After Cessation of Service; Termination of Employment. If any Optionholder ceases to be in Service to the Company for a reason other than death, such Optionholder may, within one month after the date of termination of such Service, but in no event after the Option's stated expiration date, exercise some or all of the Options that the Optionholder was entitled to exercise on the date the Optionholder's Service terminated; provided, that (i) if the Optionholder's Service is terminated by the Company in its good faith judgment, for (A) commission of a crime by the Optionholder or for reasons involving moral turpitude; (B) an act by the Optionholder which tends to bring the Company into disrepute; or (C) negligent, fraudulent or willful misconduct by the Optionholder, or (ii) if after the Service of the Optionholder is terminated, the Optionholder commits acts detrimental to the Company's interests, then the Option shall thereafter be void for all purposes. Notwithstanding the foregoing, if any Optionholder who is an employee of the Company ceases to be in Service to the Company by reason of permanent disability within the meaning of section 22(e)(3) of the Internal Revenue Code (as determined by the applicable Plan Administrator), the Optionholder shall have 12 months after the date of termination of Service, but in no event after Optionholder's Option's stated expiration date, to exercise Options that the Optionholder was entitled to exercise on the date the Optionholder's Service terminated as a result of disability. (k) Death of Optionholder. If an Optionholder dies while in the Company's Service, the Optionholder's vested Options on the date of death shall be exercisable within three months of such death or until the stated expiration date of the Optionholder's Option, whichever occurs first, by the person or persons ("successors") to whom the Optionholder's rights pass under a will or by the laws of descent and distribution. An Option may be exercised and payment of the option price made in full by the successors only after written notice to the Company specifying the number of shares to be purchased. Such notice shall state that the Option price is being paid in full in the manner specified in Section 5(h) hereof. As soon as practicable after receipt by the Company of such notice and of payment in full of the Option price, a certificate or certificates representing such shares shall be registered in the name or names specified by the successors in the written notice of exercise and shall be delivered to the successors. (l) Other Plan Provisions Still Applicable. If an Option is exercised upon the termination of Service or death of an Optionholder under this Section 5, the other provisions of the Plan shall still be applicable to such exercise. (m) Definition of "Service." For purposes of this Plan, unless it is evidenced otherwise in the option agreement with the Optionholder, the Optionholder shall be deemed to be in "Service" to the Company so long as such individual renders services on a periodic basis to the Company (or to any parent or subsidiary corporation) in the capacity of an employee or a consultant or independent contractor. The Optionholder shall be considered to be an employee for so long as such individual remains in the employ of the Company or one or more of its parent or subsidiary corporations. (n) Nonassignability. Except as specifically allowed by the Plan Administrator at the time of grant and as set forth in the documents evidencing an Option, no Option granted under the Plan or any of the rights and privileges conferred thereby shall be assignable or transferable by an Optionholder other than by will or the laws of descent and distribution, and such Option shall be exercisable during the Optionholder's lifetime only by the Optionholder. SECTION 6. CERTAIN ADJUSTMENT. (a) Capital Adjustments. The aggregate number of shares of Stock subject to the Plan (and the number of shares covered by outstanding Options and the price per share stated in such Options) shall be proportionately adjusted for any increase or decrease in the number of outstanding shares of Stock of the Company resulting from a subdivision or consolidation of shares or any other capital adjustment or the payment of a stock dividend or any other increase or decrease in the number of outstanding shares of Stock of the Company resulting from a subdivision or consolidation of shares or any other capital adjustment or the payment of a stock dividend or any other increase or decrease in the number of shares effected without the Company's receipt of consideration therefor in money, services or property. (b) Mergers, Etc. If the Company is the surviving corporation in any merger or consolidation, any Option granted under the Plan shall pertain to and apply to the securities to which a holder of the number of shares of Stock subject to the Option would have been entitled prior to the merger or consolidation. A dissolution or liquidation of the Company shall cause every Option outstanding hereunder to terminate. A merger or consolidation in which the Company is not the surviving corporation shall also cause every Option outstanding hereunder to terminate. (c) Change in Control. With respect to any Change in Control, the Plan Administrator shall have the discretion and authority, exercisable at any time, whether before or after the Change in Control, to provide for the automatic acceleration of one or more outstanding Options granted by it under the Plan upon the occurrence of such Change in Control. The Plan Administrator may also impose limitations upon the automatic acceleration of such Options to the extent it deems appropriate. Any Options accelerated upon a Change in Control will remain fully exercisable until the expiration or sooner termination of the Option term. SECTION 7. MISCELLANEOUS (a) Use of Proceeds. The proceeds received by the Company from the sale of Stock pursuant to the exercise of Options hereunder, if any, shall be used for general corporate purposes. (b) Cancellation of Options. The Plan Administrator shall have the authority to effect, at any time and from time to time, with the consent of the affected Optionholders, the cancellation of any or all outstanding Options granted under the Plan by the Plan Administrator and to grant in substitution therefore new Options under the Plan covering the same or different numbers of shares of Stock as long as such new Options have an exercise price per share of Stock no less than the minimum exercise price as set forth in Section 5(b) hereof on the new grant date. (c) Regulatory Approvals. The implementation of the Plan, the granting of any Option hereunder, and the issuance of Stock upon the exercise of any such Option shall be subject to the procurement by the Company of all approvals and permits required by regulatory authorities having jurisdiction over the Plan, the Options granted under it and the Stock issued pursuant to it. (d) Indemnification. In addition to such other rights of indemnification as they may have, the members of the Plan Administrator shall be indemnified and held harmless by the Company, to the extent permitted under applicable law, for, from and against all costs and expenses reasonably incurred by them in connection with any action, legal proceeding to which any member thereof may be a party by reason of any action taken, failure to act under or in connection with the Plan or any rights granted thereunder and against all amounts paid by them in settlement thereof or paid by them in satisfaction of a judgment of any such action, suit or proceeding, except a judgment based upon a finding of bad faith. (e) Plan Not Exclusive. This Plan is not intended to be the exclusive means by which the Company may issue options or warrants to acquire its Stock, stock awards or any other type of award. To the extent permitted by applicable law, any such other option, warrants or awards may be issued by the Company other than pursuant to this Plan without stockholder approval. (f) Governing Law. The Plan shall be governed by, and all questions arising hereunder shall be determined in accordance with, the laws of the State of Arizona. (g) Withholding Taxes. Whenever the Company issues Stock under the Plan pursuant to an Option, the Company shall have the right to require the grantee to remit to the Company an amount sufficient to satisfy any federal, state and/or local withholding or employment tax requirements prior to the delivery of any certificate or certificates for such shares. Alternatively, the Company may issue or transfer such shares of Stock net of the number of shares sufficient to satisfy the withholding or employment tax requirements. For such purposes, the shares of Stock shall be valued on the date the withholding or employment tax obligation is incurred. SECTION 8. SECURITIES RESTRICTIONS (a) Legend on Certificates. All certificates representing shares of Stock issued upon exercise of Options granted under the Plan shall be endorsed with a legend reading as follows: The shares of Common Stock evidenced by this certificate have been issued to the registered owner in reliance upon written representations that these shares have been purchased solely for investment. These shares may not be sold, transferred or assigned unless in the opinion of the Company and its legal counsel such sale, transfer or assignment will not be in violation of the Securities Act of 1933, as amended, and the rules and regulations thereunder. (b) Private Offering for Investment Only. The Options are, and shall be, made available only to a limited number of present and future employees of the Company, and their permitted transferees, who have knowledge of the Company's financial condition, management and its affairs. The Plan is not intended to provide additional capital for the Company, but to encourage ownership of Stock among the Company's employees. By the act of accepting an Option, each grantee or such permitted transferee agrees (i) that, any shares of Stock acquired will be solely for investment and not with any intention to resell or redistribute those shares and (ii) such intention will be confirmed by an appropriate certificate at the time the Stock is acquired if requested by the Company. The neglect or failure to execute such a certificate, however, shall not limit or negate the foregoing agreement. (c) Registration Statement. If a Registration Statement covering the shares of Stock issuable upon exercise of options granted under the Plan is filed under the Securities Exchange Act of 1933, as amended, and is declared effective by the Securities Exchange Commission, the provisions of Sections 8(a) and (b) shall terminate during the period of time that such Registration Statement, as periodically amended, remains effective. SECTION 9. DEFINITIONS. The following capitalized terms used in this Plan shall have the meaning described below: "Affiliates" shall mean all "executive officers" (as that term is defined in Rule 16a-1(f) promulgated under the Securities Exchange Act of 1934) and directors of the Company and all persons who own 10 percent or more of the Company's issued and outstanding Stock. "Board" shall mean the Board of Directors of the Company. "Change in Control" shall mean (i) a person or related group of persons, other than the Company or a person that directly or indirectly controls, is controlled by, or under common control with the Company, acquires ownership of 40 percent or more of the Company's outstanding common stock pursuant to a tender or exchange offer which the Board of Directors recommends that the Company's stockholders not accept, or (ii) the change in the composition of the Board occurs such that those individuals who were elected to the Board at the last stockholders' meeting at which there was not a contested election for Board membership subsequently ceased to comprise a majority of the Board by reason of a contested election. "Code" shall mean the Internal Revenue Code of 1986, as amended. "Company" shall mean Styling Technology Corporation, a Delaware corporation. "Eligible Persons" shall mean those persons who, at the time that the Option is granted, are employees of the Company, who provide valuable services to the Company or parent or subsidiaries of the Company. "Optionholder" shall mean an Eligible Person to whom Options have been granted. "Optioned Shares" shall be those shares of Stock to be optioned from time to time to any Eligible Person. "Options" shall mean options to acquire Stock granted under the Plan. "Plan" shall mean this stock option plan for Styling Technology Corporation. "Plan Administrator" shall mean the Board of Directors or a committee thereof. "Service" shall have the meaning set forth in Section 5(m) hereof. "Stock" shall mean shares of the Company's common stock, $.0001 par value per share, which may be unissued or treasury shares, as the Board may from time to time determine. This Plan is hereby executed this ______ day of __________, 1998. STYLING TECHNOLOGY CORPORATION By: /s/ Sam L. Leopold ------------------------------------ Name: Sam L. Leopold Its: Chairman, President, and Chief Executive Officer ATTESTED BY: - ------------------------------------ Secretary EX-12 4 0004.txt RATIO OF EARNINGS TO FIXED CHARGES STYLING TECHNOLOGY CORPORATION RATIO OF EARNINGS TO FIXED CHARGES (in thousands) PERIOD FROM YEAR ENDED DECEMBER 31, NOVEMBER 27, 1996 ----------------------- TO DECEMBER 31, 1996 1997 1998 -------------------- ------ ------- Income (Loss) Before Income Taxes $ (151) $5,701 $ 3,121 Fixed Charges: Actual Interest Expense and amortization of debt issuance costs $ -- $1,847 $ 9,540 Net Income (Loss) As Adjusted $ (151) $7,548 $12,661 Ratio N/A 4.0x 1.3x EX-21 5 0005.txt SUBSIDIARIES SUBSIDIARIES OF REGISTRANT NAME STATE OF INCORPORATION - ---- ---------------------- Gena Laboratories, Inc. Texas JDS Manufacturing Co., Inc. California U.K. ABBA Products, Inc. California Styling (UK) Limited England European Touch Co., Incorporated Wisconsin European Touch, Ltd. II Wisconsin Beauty Products Inc. Wisconsin Cosmetics International Inc. Wisconsin Ft. Pitt Acquisition, Inc. Pennsylvania Styling Technology Nail Corporation Arizona STYL Institute, Inc. Arizona EX-23.1 6 0006.txt CONSENT OF ARTHUR ANDERSEN, LLP CONSENT OF INDEPENDENT PUBLIC ACCOUNTANTS As independent public accountants, we hereby consent to the incorporation of our report included in this Form 10-K/A, into the Company's previously filed Registration Statement File Nos. 33-43599, 333-47131 and 333-61035. /s/ ARTHUR ANDERSEN LLP Phoenix, Arizona October 18, 2000 EX-27.1 7 0007.txt FINANCIAL DATA SCHEDULE
5 YEAR DEC-31-1998 JAN-01-1998 DEC-31-1998 4,023 0 24,812 0 25,599 55,809 8,463 3,101 214,073 25,243 100,000 0 0 1 29,247 214,073 83,366 83,366 38,998 32,041 0 0 9,206 3,121 1,470 1,651 0 1,091 0 560 0.14 0.13 BASIC EPS BEFORE THE EXTRAORDINARY ITEM WAS $0.41. DILUTED EPS BEFORE THE EXTRAORDINARY ITEM WAS $0.38. EPS HAS BEEN PREPARED IN ACCORDANCE WITH SFAS NO. 128 AND BASIC AND DILUTED EPS HAVE BEEN ENTERED INTO THE PRIMARY AND FULLY DILUTED EPS LINE ITEMS ABOVE.
EX-27.2 8 0008.txt FINANCIAL DATA SCHEDULE
5 YEAR DEC-31-1997 JAN-01-1997 DEC-31-1997 3,063 0 12,693 0 10,951 28,827 3,034 394 90,886 15,822 0 0 0 1 27,524 90,866 36,505 36,505 16,756 12,201 0 0 1,847 5,701 2,537 3,164 0 1,377 0 1,787 0.45 0.43 BASIC EPS BEFORE THE EXTRAORDINARY ITEM WAS $0.80. DILUTED EPS BEFORE THE EXTRAORDINARY ITEM WAS $0.77. EPS HAS BEEN PREPARED IN ACCORDANCE WITH SFAS NO. 128 AND BASIC AND DILUTED EPS HAVE BEEN ENTERED INTO THE PRIMARY AND FULLY DILUTED EPS LINE ITEMS ABOVE.
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