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Worldwide sales down at Derby - BikeBiz

Worldwide sales down at Derby

Here's the raw SEC filing for Derby Cycle Corporation. Once tidied up, I'll be posting the newsworthy stuff on the main site, but the full report will only be available here.
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Overview

The Company is a world-leading designer, manufacturer and marketer of bicycles.

The Company holds the leading market share in the United Kingdom, The

Netherlands, Canada and Ireland, holds the leading market share in the adult

bicycle market in Germany and is also a leading bicycle supplier in the United

States. Competing primarily in the medium-to premium-priced market, the Company

owns or licenses many of the most recognized brand names in the bicycle

industry, including leading global brands such as Raleigh, Diamond Back, Nishiki

and Univega, and leading regional brands such as Gazelle in The Netherlands and

Kalkhoff, Musing, Winora and Staiger in Germany. The Company designs,

manufactures and markets a wide range of bicycles in all major product

categories: (i) all-terrain or mountain bicycles ("M.T.B.s"), (ii) city

bicycles, also called touring or upright bicycles, (iii) hybrid bicycles, also

called comfort or cross bicycles, (iv) juvenile bicycles, including bicycle

motocross ("B.M.X.") bicycles, and (v) race/road bicycles. The Company

distributes branded bicycles through extensive local market networks of

independent bicycle dealers ("I.B.D.s") as well as through national retailers,

and distributes private label bicycles through mass merchandisers and specialty

stores.

Through a series of acquisitions and plant expansions, the Group has created a

global bicycle business distinguished by its leading market positions, low cost

production, extensive distribution network and reputation for high quality.

Organized in 1986 for the purpose of acquiring the Raleigh, Gazelle and Sturmey

Archer bicycle and bicycle component businesses from TI Group plc, the Group

expanded into the United States and Germany in 1988. From 1992 to 1993, taking

advantage of substantial incentives from the German government the Group built a

factory in Rostock, in the former German Democratic Republic. Since then, the

Group has acquired additional well-known brands and leveraged its existing

manufacturing plants and component sourcing operations to lower unit costs for

its acquired businesses.

On February 4, 1999, the Company acquired the assets (and assumed certain

liabilities) of the Diamond Back Group for approximately $44.3 million in cash.

The Diamond Back Group consisted of Diamond Back International Company Limited,

a private British Virgin Islands company ("Diamond Back"), Western States Import

Company Inc., a Delaware corporation ("Western States") and Bejka Trading A.B.,

a private Swedish company ("Bejka"), each of which was engaged in the bicycle,

bicycle parts and accessories and fitness equipment distribution business.

Western States and Bejka had worldwide revenues of approximately $62.9 million

and $3.1 million, respectively, in 1998. Diamond Back was essentially a holding

company for the company's intellectual property and did not generate material

revenues. The Company financed the acquisition of the Diamond Back Group by

issuing $20 million principal amount in a Subordinated Note to Vencap Holding

(1992) PTE Ltd. and $22.75 million in Class C common stock to DC Cycle, L.L.C.

and Perseus Cycle L.L.C. The Subordinated Note matures in 2010 and bears

interest at an annual rate of 19% compounded daily.

The Company's operations are concentrated in the United Kingdom, The

Netherlands, Germany, the United States and Canada, with manufacturing

operations in these countries, each led by experienced local management.

On June 30, 2000 the Company sold the business and assets of Sturmey Archer

which was engaged in the manufacture of bicycle components and other engineering

components. The purchaser assumed $4.0 million of liabilities in consideration

of the sale. Sturmey Archer had revenues of $20.6 million and EBITDA of $0.6

million in 1999.

The Company maintains marketing or purchasing operations in six additional

countries. Each local operation manages national distribution channels, dealer

service and working capital and benefits from shared product design and

manufacturing technologies as well as from economies of scale generated by the

Company's aggregate purchasing power. Consequently, each local operation has the

flexibility to respond to shifts in local market demand and product preference.

In 1999, 54% of the Company's net revenues, excluding Sturmey Archer, were

denominated in currencies, linked to the Euro, 22% were denominated in U.S.

dollars, 14% were denominated in pounds sterling and


17

10% were denominated in other currencies. The Company reduces its currency

exposure by maintaining operations in the major markets in which it sells its

products.

Results of Operations

The Company manages its business in six major operating units as shown in the

following table. Consolidation adjustments, certain small operating companies,

non-operating companies and the headquarters are included in "Other companies".

All comparisons in the following discussion and analysis are against the

corresponding quarter and nine months ended September 26, 1999, unless otherwise

stated. Operating unit figures for 1999 have been re-translated using 2000

foreign exchange rates to facilitate comparison. The results of Sturmey Archer

for 1999 and 2000 have been excluded from the calculation of operating income,

but included in the balance sheets and statements of cash flows.

Quarter ended Nine months ended

------------- -----------------

Sept 26, Oct 1, Sept 26, Oct 1,

1999 2000 1999 2000

---- ---- ---- ----

Units sold:

Thousands of bicycles

Raleigh U.K................................................ 128 103 323 264

Gazelle.................................................... 57 58 257 290

Derby Germany.............................................. 102 89 480 551

Derby U.S.A................................................ 121 113 367 339

Raleigh Canada............................................. 15 22 220 259

Probike.................................................... 34 51 93 136

Other companies and group transactions..................... 5 8 10 14

--- --- ----- -----

Total units sold......................................... 462 444 1,750 1,853

=== === ===== =====

Units sold. Units sold decreased by 18 thousand units and increased by 103

thousand units for the quarter and nine months ended October 1, 2000. Organic

growth achieved was 55 thousand units in the nine month period compared with

year ago, representing an annual volume growth rate of approximately 3%. 16

thousand units of the increase represented Diamond Back sales in January 1999

not included in the 1999 results as that business was acquired on February 4,

1999 and 32 thousand units of the increase related to the 5 days through October

1, 1999 included in the fourth quarter's results in 1999. Particularly strong

growth was seen at Gazelle and Derby Germany following successful product range

launches, advertising and lower retail inventories. In Canada, sales grew in the

private label channel as orders were won from offshore competitors, while

Probike in South Africa increased inventory levels to avoid sales lost in

previous years when this was cut-back too far. The change in sales volume at

Raleigh U.K. arose because a major customer ended 1999 with excess inventory and

cut back its purchase from 12 thousand units in the first quarter of 1999 to

less than 1 thousand units in the first quarter of 2000 while sales have since

suffered from the introduction of competing brands, leading to a reduction of 29

thousand units in sales for the nine months ended October 1, 2000. Sales also

suffered from less availability from stock due to the longer lead-time on out-

sourced frames compared with in-house manufacture which ceased in December 1999:

this is estimated to have caused the loss of sales of 15 thousand units as

demand was concentrated more towards the lower price-points than had been

anticipated.

For the quarter ended October 1, 2000, UK sales were adversely affected by wet

weather and low availability of those models in demand, while both manufacturing

plants in Germany were shut down for an extended period to reduce finished

inventories. The sales force in U.S.A. was reorganized in August 2000 to

eliminate overlapping territories and reduce expenses through increased tele-

marketing, although this has had an adverse impact on sales in the transition

period. Probike increased its marketing activity and its distribution through

national retailers in 2000, which, together with better inventory availability,

is growing sales at close to 50%.


18

Quarter ended Nine months ended

------------- -----------------

Sept 26, Oct 1, Sept 26, Oct 1,

1999 2000 1999 2000

---- ---- ---- ----

Net revenues:

$ millions

Raleigh U.K................................................ $ 19.6 $17.4 $ 52.9 $ 46.2

Gazelle.................................................... 17.3 19.6 82.8 99.4

Derby Germany.............................................. 21.9 23.8 105.6 132.9

Derby U.S.A................................................ 25.9 25.7 84.9 81.4

Raleigh Canada............................................. 1.5 2.1 20.1 22.7

Probike.................................................... 3.0 4.1 9.5 11.7

Other companies and group transactions..................... 4.1 6.5 10.2 13.9

----- ----- ----- ------

Total at comparable foreign exchange rates............... 93.3 99.2 366.0 408.2

Re-translation to actual foreign exchange rates.......... 8.0 - 30.5 -

----- ---- ----- -----

Total net revenues as reported........................... $101.3 $99.2 $396.5 $408.2

===== ==== ===== =====

Net revenues. Net revenues at comparable foreign exchange rates for the quarter

and nine months ended October 1, 2000 grew by $5.9 million (6.4%) and $42.2

million (11.5%). This was driven by the change in bicycle units sold of 3.9%

decrease and 5.9% increase for those periods and an increase in average unit

selling price of 10.6% and 5.5% for the same periods. The increase in price was

driven by an increase in models sold with suspension, offset by a weaker mix

from increasing sales through mass merchants. The weakness of the Euro in 2000

reduced the reported growth in consolidated net revenues by more than 8

percentage points upon translation of net revenues into U.S. Dollars at the

actual rates applicable to each year. Sales of parts and accessories saw double

digit percentage growth in all markets apart from the U.K. and the U.S.A.. Parts

and accessories revenues fell in the third quarter in the U.K. as the disruption

of relocating the distribution center continued in July, but were still ahead of

year ago for the first nine months. Parts and accessories revenues fell at Derby

U.S.A. as the sales force was reorganized and due to the disruption while the

Diamond Back and Raleigh parts and accessories warehousing was consolidated. The

recovery seen in the Diamond Back fitness business in the last quarter of 1999

with the launch of the new range of products continued, with revenues in the

quarter 60% up on year ago.

Gross profit. Gross profit of $4.3 million for the quarter ended October 1, 2000

compares with $22.7 million for the same period in 1999. The drop was the result

of inventory adjustments in Germany as failures in the implementation of the new

ERP system were corrected, totalling $6.8 million, plus a $3.7 million increase

in the provision for slow moving inventory in Germany. Although it is clear that

such failures existed in both the first and second quarters, it is not possible,

retrospectively, to quantify their effects on the results for those quarters.

Therefore, there has been no restatement of the first and second quarters'

results. Additionally, because this quarter's results include the total

correction resulting from the failures in the implementation of the ERP system,

it is difficult to draw meaningful comparisons with the results for the quarter

ended September 26, 1999. However, meaningful comparisons with the results for

the nine months ended September 26, 1999 are possible as the cumulative effect

of the failures referred to above has been appropriately reflected in the

results for the nine months ended October 1, 2000 and no such failures occurred

in the nine months ended September 26, 1999. The slow moving inventory arose

from the ordering of excess components, also due to failures in the

implementation of the ERP system. Inventory reserves in U.K. and U.S.A. were

also increased by $2.3 million in aggregate to cover inventory issues following

changes in manufacturing methods at those companies. Surplus inventory arose in

U.K. as the manufacture of frames stopped at the beginning of the year and an

inflexible manufacturing procedure was introduced. The U.S.A. geared up to

double shift working in the first half of 2000, but this was found to be

uneconomic and has reverted to single-shift working. Excess component inventory

built-up in that period as production did not achieve anticipated levels. In

addition, margins fell by 5.4% across all companies. This was mainly due to the

weakening of the Euro and sterling against the U.S. dollar, which increased the

imported component costs, in local currency, at the European operations.

Furthermore, discounting necessary to both close out 2000 model year products

before the September introduction of 2001 models in U.S.A. and to use up surplus

components in Germany reduced gross margins. Additional factors included a

weaker distribution mix, with a higher proportion of mass merchant sales in

U.K., Germany and Canada, plus lower recovery of production expenses on the

lower production volumes.

The gross profit of $79.8 million for the nine months ended October 1, 2000 was

$15.7 million below the gross profit for the same period in 1999. For the first

half year the gross margin was only 0.2 percentage points below year ago, with

additional volume increasing the gross profit to $2.7 million higher than year

ago: the third quarter adverse variance of $18.4 reduced the gross profit for

the nine months ended to $15.7 million lower than year ago.


19

Quarter ended Nine months ended

------------- -----------------

Sept 26, Oct 1, Sept 26, Oct 1,

1999 2000 1999 2000

---- ---- ---- ----

Selling, general and administrative expenses:

$ millions

Translated at comparable foreign exchange rates............ $22.3 $29.1 $73.2 $88.4

Re-translation to actual foreign exchange rates............ 1.8 - 5.3 -

----- ---- ---- -----

Total selling general and administrative expenses as

reported................................................ $24.1 $29.1 $78.5 $88.4

==== ==== ==== ====

Selling, general and administrative expenses. Selling, general and

administrative expenses at comparable foreign exchange rates increased by $6.8

million and $15.2 million for the quarter and nine months ended October 1, 2000.

This included $1.6 million of expenses at Diamond Back in January 1999 not

included in the 1999 results as that business was acquired on February 4, 1999

and the costs of corporate marketing initiatives, sourcing project fees, the

corporate headquarters and Bikeshop.com of $1.8 million and $5.3 million for the

quarter and nine months ended October 1, 2000: neither of these had been

established in the first half of 1999. Distribution expenses increased by $1.0

million and $3.9 million for the quarter and nine months ended October 1, 2000

due to lower recharges to customers as an incentive to place increased orders

plus higher freight rates. In addition, the allowance for doubtful trade

accounts at Raleigh USA was increased by $1.5 million to cover the increase in

accounts receivable over 60-days overdue. The remaining increases in expenses

arose in Holland, Germany and USA, where administration expenses increased from

lower discounts received, legal and recruiting costs, plus higher bonuses at

Gazelle. The above increases were reduced upon translation into U.S. Dollars at

the actual rates applicable for each year, due to the weakness of the Euro in

2000.


Quarter ended Nine months ended

------------- -----------------

Sept 26, Oct 1, Sept 26, Oct 1,

1999 2000 1999 2000

---- ---- ---- ----

Operating income:

$ millions

Raleigh U.K................................................ $ 1.9 $ (1.0) $ 0.2 $(1.2)

Gazelle.................................................... 1.6 0.9 11.8 13.7

Derby Germany.............................................. (2.7) (16.0) 3.4 (8.0)

Derby U.S.A................................................ - (5.4) 0.9 (7.9)

Raleigh Canada............................................. (0.1) (0.3) 2.0 1.9

Probike.................................................... 0.2 0.2 0.4 0.7

Other companies and group transactions..................... (1.6) (3.2) (3.2) (7.8)

---- ---- --- -----

Underlying operating income at comparable foreign (0.7) (24.8) 15.5 (8.6)

exchange rates..........................................

Re-translation to actual foreign exchange rates....... (0.6) - 1.5 -

Restructuring charge.................................. (0.1) (0.7) (6.5) (0.8)

Non-recurring items................................... (0.1) (0.1) (1.5) (0.2)

Gain on dispositions of property, plant and equipment. - 2.2 - 1.6

---- ---- --- -----

Total operating income as reported....................... $(1.5) $(23.4) $ 9.0 $(8.0)

==== ==== === =====

Operating income. The underlying operating loss at comparable foreign exchange

rates, of $24.8 million and $8.6 million for the quarter and nine months ended

October 1, 2000, compares with a loss of $0.7 million for the same quarter in

the previous year and operating income of $15.5 million for the nine months

ended September 26, 1999. The reversal in operating results of $24.1 million for

the quarter and nine months ended October 1, 2000 compared with year ago, was

the result of the reduction in gross margin at comparable foreign exchange rates

of $17.4 million and $9.0 million respectively for the same periods and

20


increases of $6.8 million and $15.2 million in selling, general and

administrative expenses. The 2000 figures were reduced, relative to 1999, upon

translation into U.S. Dollars at the actual foreign exchange rates applicable

for each year, due to the weakness of the Euro.

Restructuring charge and non-recurring items. The Company reorganized parts of

its business in 1999, as described in Notes 2 and 3 of the attached financial

statements, at a total cost of $8.7 million, of which $8.0 million arose in the

first nine months of 1999. In 2000 the U.S. sales forces for Raleigh and Diamond

Back have been combined, resulting in employee termination expenses of $0.6

million, while $0.2 million of expenses were incurred in the relocation of the

U.K. parts and accessories business. $0.2 million of expenses incurred in the

investigation of the German ERP system issues have been expensed as a non-

recurring item.

Quarter ended Nine months ended

------------- -----------------

Sept 26, Oct 1, Sept 26, Oct 1,

1999 2000 1999 2000

---- ---- ---- ----

Interest expense:

$ millions

Senior Notes............................................... $3.8 $ 3.7 $11.6 $11.3

Subordinated Note.......................................... 1.1 1.3 2.8 3.8

Revolving credit facility.................................. 0.9 0.7 3.3 3.8

Bridge loan................................................ - - - 2.9

Other interest............................................. 0.1 0.5 0.6 1.1

Amortization of deferred financing costs................... 0.5 0.5 1.4 1.4

--- ---- ---- ----

Total interest expense................................... $6.4 $ 6.7 $19.7 $24.3

=== ==== ==== ====

Interest expense. Interest expense increased by $0.3 million and $4.6 million

for the quarter and nine months ended October 1, 2000, of which $2.9 million

represents the fair value of Class C common stock warrants issued in the first

quarter in consideration for the use of the bridge loan. The remaining increase

was caused by four factors: a longer accounting period, higher revolver

borrowings, interest paid to vendors on overdue accounts payable plus interest

on the Subordinated Note for January 2000 and the effect of compounding the PIK

interest thereon: the Subordinated Note was issued on February 4, 1999 and

therefore the 1999 nine month figures only include 8 months interest on the

Subordinated Note. Interest on the Subordinated Note is paid-in-kind by way of

the issue of further subordinated notes.

Interest income. Interest income was earned on the cash proceeds of a property

disposition in December 1999, which were placed temporarily on deposit during

the first quarter of 2000.

Gain on dispositions of property, plant and equipment. The final part of the

UK manufacturing site was sold in the third quarter for $3.2 million cash,

realizing a gain of $2.2 million over book value. Additional costs of $0.6

million associated with the property disposition in December 1999 were

identified in the first quarter of 2000 and therefore expensed.

Quarter ended Nine months ended

------------- -----------------

Sept 26, Oct 1, Sept 26, Oct 1,

1999 2000 1999 2000

---- ---- ---- ----

Provision for income taxes:

$ millions

Current taxes.............................................. $(0.6) $ 0.2 $ 2.2 $ 3.7

Deferred taxes............................................. 0.1 0.5 (2.8) 1.5

---- --- ---- ----

Total provision for income taxes......................... $(0.5) $ 0.7 $(0.6) $ 5.2

==== === ==== ====

Provision for income taxes. Deferred tax has been calculated in 2000 using the

same more prudent assumptions first adopted in the 1999 year end financials,

resulting in a reduction in the deferred tax recovery. Taxable losses continue

to be made in certain jurisdictions, including Germany, which cannot be offset

against the taxable income in other jurisdictions, including The Netherlands

where income has increased, leading to an increase in the provision for current

income taxes in 2000.

Net income. The net loss increased by $23.7 million and $34.5 million in the

quarter and nine months ended October 1, 2000. The increase in loss was the

21


result of the lower gross profit, higher selling, general and administrative,

higher interest expense, a book loss of $9.6 million on the sale of Sturmey

Archer in the second quarter and a higher provision for income taxes, offset by

a restructuring charge in 1999.

Dividends accrued on preferred stock. Dividends were not accrued on the

preferred stock in the first quarter of 1999 to correct an over-accrual in 1998.


Quarter ended Nine months ended

------------- -----------------

Sept 26, Oct 1, Sept 26, Oct 1,

1999 2000 1999 2000

---- ---- ---- ----

EBITDA:

$ millions

Raleigh U.K................................................ $ 1.8 $ (1.0) $ 0.7 $(1.2)

Gazelle.................................................... 1.5 1.4 12.0 14.6

Derby Germany.............................................. (2.2) (15.2) 5.5 (5.3)

Derby U.S.A................................................ 0.2 (5.3) 1.4 (7.4)

Raleigh Canada............................................. (0.1) (0.2) 2.3 2.3

Probike.................................................... 0.2 0.3 0.5 0.8

Other companies and group transactions..................... (1.2) (2.8) (2.4) (6.9)

---- ---- --- ---

Total EBITDA at comparable exchange rates................ 0.2 (22.8) 20.0 (3.1)

Retranslation to actual foreign exchange rates........... - - 2.2 -

---- ---- --- ---

Total EBITDA as reported................................. $ 0.2 $(22.8) $22.2 $(3.1)

==== ==== ==== =====

EBITDA. EBITDA at comparable exchange rates decreased by $23.0 million in the

quarter compared with year ago, in line with the decrease in underlying

operating income explained above. This produced an EBITDA loss for the first

nine months of $3.1 million, $23.1 million below year ago at comparable exchange

rates.

EBITDA is calculated as follows (excluding Sturmey Archer):

Quarter ended Nine months ended

------------- -----------------

Sept 26, Oct 1, Sept 26, Oct 1,

1999 2000 1999 2000

---- ---- ---- ----

EBITDA:

$ millions

Underlying operating income at actual foreign exchange $(1.3) $(24.8) $17.0 $(8.6)

rates.....................................................

Foreign currency contracts allocated to other income....... - 0.7 - 1.2

Depreciation............................................... 2.0 1.7 6.7 5.6

Amortization

Intangibles.............................................. 0.1 0.2 0.4 0.4

Investment grants........................................ (0.1) (0.1) (0.4) (0.3)

Positive goodwill........................................ 0.1 0.1 0.3 0.4

Negative goodwill........................................ (0.1) (0.1) (0.3) (0.3)

Pension transition asset................................. (0.5) (0.5) (1.5) (1.5)

---- ----- ---- -----

$ 0.2 $(22.8) $22.2 $(3.1)

==== ===== ==== =====

From September 27, 1999 the Company did not designate its forward foreign

currency exchange contracts as hedges, recording any realized gain or loss

through other income in the income statement in accordance with SFAS 133. As all

of these contracts were initiated to mitigate the Company's foreign currency

trading transaction exposure: the realized gain of $0.7 million and $1.2 million

in the quarter and nine months ended October 1, 2000 arising from them has been

included in EBITDA to match these contracts with the transactions they relate

to, albeit that they do not meet all the hedge designation requirements of SFAS

133. The resulting EBITDA is consistent with the calculation used for the

quarter ended September 26, 1999, when the realized gain or loss resulting from

all such hedge contracts was included in operating income.

22


Depreciation reduced in 2000 following the disposal of the U.K. frame

manufacturing equipment in December 1999.

Liquidity and Capital Resources

Demand for bicycles in the Company's principal markets is seasonal,

characterized in most cases by a majority of consumer sales in the spring and

summer months. The exceptions to this are in the United Kingdom, South Africa

and Ireland, where consumer sales of bicycles increase in the months preceding

Christmas: accordingly, dealers' peak purchasing months in those countries are

October and November when they build inventory in anticipation of Christmas

sales of juvenile bicycles. Excluding this holiday seasonality, the Company's

working capital requirements are greatest during February, March and April (the

Company's "Peak Season") as receivable levels increase. The Company offers

extended credit terms on sales during the months prior to the Peak Season,

although the Company encourages early payments through trade discounts.

Finished goods inventory remains relatively constant throughout the fiscal year

and the level of raw materials increases and decreases normally only to

accommodate production needs. Work in process represents, on average, nine days'

production. Inventory levels should reach a minimum at the end of the season.

Net cash flows provided by operating activities decreased by $13.5 million to a

$5.7 million inflow for the first nine months from an inflow of $19.2 million in

1999. Five of the constituent elements of cash flow changed significantly year-

on-year. Firstly, operating income fell by $17.0 million as discussed in the

previous section. Secondly, although receivables were above year ago due to

higher revenues, the increase was actually $5.1 million lower due to an $11.0

million higher starting position in 2000 (including the Diamond Back acquisition

balance sheet in the 1999 starting position) caused by strong sales in the final

quarter of 1999. Third, higher planned production, together with unforeseen

production arrears in Germany and a fall in UK demand combined with an inventory

mix mis-aligned with market requirements, lead to an accumulation of inventories

in those countries and a $9.2 million lower overall decrease in inventories.

Fourth, the credit period taken from vendors has increased by 18 days,

generating $8.6 million of cash, while other liabilities dropped by $1.6

million, compared with a $5.0 million increase in 1999, as restructuring

expenses were accrued in the second quarter of 1999 and largely disbursed in the

last quarter of 1999 and the first quarter of 2000. Finally, income taxes paid

were $2.7 million net this period, compared with $7.3 million in the first nine

months of the previous year when tax postponed from 1997 and 1998 was paid.

Cash on hand at the beginning of the year was applied to the repayment of short-

term bank borrowings. Drawings of $30.8 million under the revolving credit

facility were repaid during the period, mainly from the proceeds of the $7.0

million bridge loan, which was converted into Junior Subordinated notes on July

31, 2000, the application of the $12.7 million cash proceeds of the property

disposal made in December 1999 and $9.1 million of cash on hand at the end of

1999. At the end of the period $26.7 million of the revolving credit facility

was unutilized and cash of $7.2 million was held.

The Company adopted SFAS 87, "Employers' Accounting for Pensions and other Post

Retirement Benefits" on January 1, 1993. The impact of adopting SFAS 87 was the

recognition of a transition asset of $37.8 million. The transition asset is

being amortized into income over 15 years from January 1, 1989, the effective

date of SFAS 87. Net periodic pension income was $3.9 million in the first nine

months of 1999 and 2000. Net periodic pension income includes amortization of

the transition asset into income of $1.8 million and $1.7 million in the first

nine months of 1999 and 2000.

The Company's capital expenditures were $4.5 million and $6.5 million in the

first nine months of 1999 and 2000. Apart from $0.8 million invested in the UK

relocating the parts and accessories distribution center and reorganizing the

manufacturing following the cessation of frame manufacture and $0.7 million

invested in Bikeshop.com systems, this comprised (i) on-going cost reduction

projects, (ii) replacements and (iii) items required to satisfy statutory

environmental and health and safety legislation.

The Company is primarily financed by equity purchased by Thayer, Perseus, DICSA

and management as part of a recapitalization in May 1998 and subsequently, plus

retained equity that was not recapitalized of, in aggregate, $135.2 million and

23


debt in the form of Senior Notes, the revolving credit facility and subordinated

notes. The Company incurred significant indebtedness in connection with the

Recapitalization. As of October 1, 2000, the Company had $233.4 million of

combined indebtedness, comprising $149.3 million of Senior Notes, a $20.0

million Subordinated Note, $7.0 million of Junior Subordinated Notes from Thayer

and Perseus, as well as $37.1 million of draw downs, $0.3 million of overdraft

and $4.9 million of guarantees under the revolving credit facility and $1.0

million of borrowings under the South African Credit Facility. The Senior Notes

are issued under Indentures which contain certain covenants that, among other

things, restrict the ability of the Company and its Restricted Subsidiaries to

incur additional indebtedness, pay dividends, redeem capital stock, redeem

subordinated obligations, make investments, undertake sales of assets and

subsidiary stock, engage in transactions with affiliates, issue capital stock,

permit liens to exist, operate in other lines of business, engage in certain

sale and leaseback transactions and engage in mergers, consolidations or sales

of all or substantially all the assets of the Company. Accordingly, certain

activities or transactions that the Company may want to pursue or enter into may

be restricted or prohibited, and such restrictions and prohibitions could, from

time to time, impact available cash on hand and the liquidity of the Company.

The Company uses derivative financial instruments including interest rate caps,

forward foreign exchange contracts, and currency options. The Company enters

into forward foreign exchange contracts and options to reduce the impact of

currency movements, principally on purchases of inventory and sales of goods

denominated in currencies other than the subsidiaries' functional currencies.

Interest rate caps were purchased to limit the blended interest rate paid on the

revolving credit facility to under 8.4% until July 2001. Currency options were

purchased to substantially maintain the value of part of the foreign operating

income upon conversion into U.S. Dollars, in order to protect the ability to

service the U.S. Dollar Senior Notes from the effect of changes in foreign

exchange rates until May 2001.

The Revolving Credit Agreement provided for a seven-year DM214 million secured

senior revolving credit facility to be made available to the Company's operating

companies. Borrowings under this revolving credit facility are available subject

to a borrowing base determined as a percentage of eligible assets. The Company's

borrowings peak in February, March and April each year. The facility was reduced

to DM183 million on June 30, 2000, the DM31 million reduction being equivalent

to the proceeds of a property sale completed in December 1999 and the working

capital of the Sturmey Archer business that was sold.

On July 31, 2000 Thayer and Perseus converted their interest free bridge loans

of $7.0 million into Junior Subordinated Notes due May 15, 2008. The Company

issued 2,500 Class C Warrants to Thayer and Perseus in consideration for the use

of the bridge loan. Interest accrues on the Junior Subordinated Notes at 18% pa

and is paid-in-kind by way of issue of further Junior Subordinated Notes.

The Company expects that the existing revolving credit facility will not be

sufficient to cover its liquidity requirements. The Company is currently

negotiating with the lenders under its Credit Agreement to increase its line of

credit and to amend certain financial covenants in the Credit Agreement. In

addition, the Company is exploring other financing options including raising new

equity and/or debt capital. No assurance can be given that the Company will be

successful in meeting these objectives. The Company's non-compliance with

certain borrowing covenants is discussed under "Restrictive loan covenants".

Quantitative and Qualitative Disclosures about Market Risk

The Company is exposed to market risk from changes in foreign currency exchange

rates and interest rates. In order to manage the risk arising from these

exposures, the Company enters into a variety of foreign currency and interest

rate contracts and options. The Company's accounting policies for derivative

instruments are included in Note 2 to the consolidated financial statements

included in the Company's form 10-K for the year ended December 31, 1999.

Foreign currency exchange rate risk

The Company has foreign currency exposures related to buying and selling in

currencies other than the functional currencies in which it operates. The

Company's net trading position is long in the Euro, Pounds Sterling, Canadian

Dollar and South African Rand, arising from its revenues in those currencies,

and short of the New Taiwan Dollar, Japanese Yen and U.S. Dollar as a result of

components purchased in those currencies. The Company had a natural currency

hedge against fluctuations in Pounds Sterling arising from its position as both

an importer and exporter in U.K. until it sold Sturmey Archer.

24

The Company generally introduces its new bicycle model ranges annually in the

fall of each year, at a similar time to most of its competitors. Product

specifications, component costs and selling prices are kept as stable as

possible during the model year to satisfy the requirements of mass-merchandisers

and facilitate orderly marketing of branded products amongst I.B.D.s. The

Company initiates foreign currency forward exchange contracts or options in the

fall to hedge some of its foreign currency trading transaction exposure for the

upcoming season. The fair value of such contracts at December 31, 1999 was $0.9

million. The potential loss in fair value for such financial instruments from a

hypothetical 10% adverse change in quoted foreign currency exchange rates would

be approximately $2.0 million for 1999. Each year the Company changes the

specification of its products to endeavor to optimize its competitive position

and margins. Since most of the Company's competitors purchase comparable

components from similar sources to the Company and are believed not to hedge

beyond the current season, the Company does not generally hedge its transaction

exposure beyond the end of the season, to stay competitive. Management believes

the likelihood of obtaining a competitive advantage would not justify the cost

of hedging beyond the end of the season. Sales and purchases in currencies other

than the functional currencies in which the Company operates were $30.4 million

and $127.4 million respectively in 1999, treating the currencies within the Euro

currency area as one.

The foreign currency element of the Company's debt under the Senior Notes and

revolving credit facility is generally arranged to align with the denomination

of the book value of net assets. By doing this, the Company reduces the

translation exposure of net worth to changes in foreign currency exchange rates.

The three principal exceptions are: (1) $38 million of net assets denominated in

Pounds Sterling arising from the Company's former large presence in U.K., (2)

$40 million of foreign pension assets in U.K. and The Netherlands, and, (3) $6

million denominated in South African Rand due to limits placed by the South

African Reserve Bank on the maximum indebtedness allowed by foreign owned

corporations, based on the balance sheet as at December 31, 1999.

The Company generates most of its trading income in foreign currencies. In order

to ensure that such trading income can be converted to yield sufficient U.S.

Dollars to service 67% of the interest on the $100 million 10% Senior Notes

through May 2001, currency options were purchased in 1998. These currency

options are for $6.7 million per year, selling NLG6 million, GBP2 million and

C$1.2 million. At December 31, 1999 the fair value of these currency options was

$0.1 million. As the purchaser of options has no obligations to exercise them,

any weakening of the value of the U.S. Dollar can do no more than reduce the

fair value of these currency options to zero.

Interest rate risk

Interest expense relating to the Senior Notes was $15.6 million in 1999, which

was at fixed interest rates. Interest expense on the Subordinated Note of $3.8

million in 1999 is paid-in-kind through the issue of additional Subordinated

Notes. The other major element of the Company's interest expense was $4.3

million on the revolving credit facilities in 1999. These were at floating rates

of 2.0% above the London Interbank Offer Rate through August 31, 1999 and 2.5%

thereafter. A hypothetical one percentage point shift in floating interest rates

would have a $0.7 million approximate impact on annual interest expense. As

interest rates on the revolving credit facilities have been capped at 8.4%

effective August 1998 through July 2001, increases in floating interest rates

above that level would only have limited impact on expense.

Commodity price risk

The business of the Company does not carry a significant direct exposure to the

prices of commodities.

Unsecured status of senior notes and asset encumbrance

The Senior Note Indentures permit the Company to incur certain secured

indebtedness, including indebtedness under the Revolving Credit Agreement, which

is secured and guaranteed by the obligors thereunder through a first priority

fully protected security interest in all the assets, properties and undertakings

of the Company and each other obligor thereunder where available and cost

effective to do so, and to the extent permissible by local laws. The Company has

facilities available under the Revolving Credit Agreement of DM182.9 million

($82.0 million). As of October 1, 2000, the Company had indebtedness outstanding

under the Revolving Credit Agreement of $41.4 million. Borrowings of $1.0

million under the South African Credit Facility are secured by a security

interest in certain of the assets of the Company's South African subsidiaries.

The Senior Notes are unsecured and therefore do not have the benefit of any such

collateral. Accordingly, if an event of default were to occur under the

Revolving Credit Agreement or the South African Credit Facility, the lenders

25


thereunder would have the right to foreclose upon the collateral securing such

indebtedness to the exclusion of the holders of the Senior Notes,

notwithstanding the existence of an event of default with respect to the Senior

Notes. In such event, the assets constituting such collateral would first be

used to repay in full all amounts outstanding under the Revolving Credit

Agreement or the South African Credit Facility, as applicable, resulting in all

or a portion of the assets of the Issuers being unavailable to satisfy the

claims of holders of the Senior Notes and other unsecured indebtedness of the

Issuers. The Company may also incur other types of secured indebtedness under

the Senior Note Indentures, including up to $20 million in indebtedness of any

type, indebtedness of an acquired company where the Company would have been able

to incur $1.00 of additional indebtedness under its Consolidated Coverage Ratio,

indebtedness in respect of performance bonds, bankers' acceptances, letters of

credit, and the like, purchase money indebtedness and capitalized lease

obligations in an aggregate amount not exceeding $10 million, indebtedness

incurred by foreign subsidiaries not exceeding $5 million, and indebtedness

incurred by a securitization entity.

Restrictive loan covenants

The Revolving Credit Agreement contains a number of covenants that, among other

things, restrict the ability of the Company and its subsidiaries to dispose of

shares in any subsidiary, dispose of assets, incur additional indebtedness,

engage in mergers and acquisitions, exercise certain options, make investments,

incur guaranty obligations, make loans, make capital distributions, enter into

joint ventures, repay the Notes, make loans or pay any dividend or distribution

to the Issuers for any reason other than (among other things) to pay interest

(but not principal) owing in respect of the Notes, incur liens and encumbrances

and permit the amount of receivables and inventory to exceed specified

thresholds.

The ability of the Company to comply with the covenants and other provisions of

the Revolving Credit Agreement may be affected by changes in general economic

and competitive conditions and by financial, business and other factors that are

beyond the Company's control. The failure to comply with the provisions of the

Revolving Credit Agreement could result in an event of default thereunder, and,

depending upon the actions of the lenders thereunder, all amounts borrowed under

the Revolving Credit Agreement, together with accrued interest, could be

declared due and payable. If the Company were not able to repay all amounts

borrowed under the Revolving Credit Agreement, together with accrued interest,

the lenders thereunder would have the right to proceed against the collateral

granted to them to secure such indebtedness. If the indebtedness outstanding

under the Revolving Credit Agreement were to be accelerated, there can be no

assurance that the assets of the Company would be sufficient to repay in full

such indebtedness, and there can be no assurance that there would be sufficient

assets remaining after such repayments to pay amounts due in respect of any or

all of the Notes.

In addition, the Senior Note Indentures contain certain covenants that, among

other things, restrict the ability of the Company and its Restricted

Subsidiaries to incur additional indebtedness, pay dividends on and redeem

capital stock, redeem certain subordinated obligations, make investments,

undertake sales of assets and subsidiary stock, engage in certain transactions

with affiliates, sell or issue capital stock, permit liens to exist, operate in

other lines of business, engage in certain sale and leaseback transactions and

engage in mergers, consolidations or sales of all or substantially all the

assets of the Company. A failure to comply with the restrictions contained in

either of the Senior Note Indentures could result in an event of default under

such indenture.

All of the Company's freehold property and intellectual property located in

Canada, Germany, Ireland, The Netherlands, Sweden, U.K. and U.S.A. is pledged as

security for the Company's seven year revolving credit facility of

DM182,885,854.

The Company covenanted to reduce its Aggregate Financial Indebtedness, as

defined in the Revolving Credit Agreement, to $55 million on July 4, 2000.

Aggregate Financial Indebtedness, which includes undrawn letters of credit, at

that date was $59.3 million. The banks waived the default, which was corrected

by the conversion, on July 30, 2000, of the $7.0 million bridge loan to Junior

Subordinated Notes which are excluded from the definition of Aggregate Financial

Indebtedness under the Revolving Credit Agreement as amended.

At August 6, 2000 the Company breached the Inventory Days covenant, as defined

in the Revolving Credit Agreements. Additionally at October 1, 2000 the Company

breached the Consolidated Adjusted EBITDA to Consolidated Net Interest Payable,


26


Consolidated Adjusted EBITDA and Financial Indebtedness covenants, as defined in

the Revolving Credit Agreement. The banks granted waivers of these breaches

through October 30, 2000. The Company has currently drawn down DM118.1 million

and has ancillary facilities available to it of DM24.0 million, out of the total

facility of DM182.9 million ($82 million), but cannot make further draw downs

under the Revolving Credit Agreement until and unless the current negotiations

with the lenders are complete. No assurance can be given that the Company will

be successful in its negotiations with its lenders.


Risk of foreign exchange rate fluctuations; introduction of the Euro

The Company's business is conducted by operating subsidiaries in many countries,

and, accordingly, the Company's results of operations are subject to currency

translation risk and currency transaction risk. With respect to currency

translation risk, the results of operations of each of these operating

subsidiaries are reported in the relevant local currency and then translated

into U.S. Dollars at the applicable currency exchange rate for inclusion in the

Company's financial statements. The appreciation of the U.S. Dollar against the

local currencies of the operating subsidiaries will have a negative impact on

the Company's sales and operating margin. Conversely, the depreciation of the

U.S. Dollar against such currencies will have a positive impact. Fluctuations in

the exchange rate between the U.S. Dollar and the other currencies in which the

Company conducts its operations may also affect the book value of the Company's

assets and the amount of the Company's shareholders' equity. In addition, to the

extent indebtedness of the Company is denominated in different currencies,

changes in the values of such currencies relative to other currencies in which

the Company conducts its operations may have a negative impact on the Company's

ability to meet principal and interest obligations in respect of such

indebtedness.

In addition to currency translation risk, the Company incurs currency

transaction risk to the extent that the Company's operations involve

transactions in differing currencies. Fluctuations in currency exchange rates

will impact the Company's results of operations to the extent that the costs

incurred by the operating subsidiaries are denominated in currencies that differ

from the currencies in which the related sale proceeds are denominated. To

mitigate such risk, the Company may enter into foreign currency forward exchange

contracts primarily relating to the Pound Sterling, the U.S. Dollar, the Dutch

Guilder, the Deutsche Mark, the New Taiwan Dollar and the Yen. Given the

volatility of currency exchange rates, there can be no assurance that the

Company will be able effectively to manage its currency transaction risks or

that any volatility in currency exchange rates will not have a material adverse

effect on the Company's business, financial condition or results of operations.

Under the treaty on the European Economic and Monetary Union (the "Treaty"), to

which the Federal Republic of Germany and the Netherlands are signatories, on

January 1, 1999, a European single currency (the "Euro") replaced some of the

currencies of the member states of the European Union (the "E.U."), including

the Deutsche Mark and Dutch Guilder.

Following introduction of the Euro, the existing sovereign currencies (the

"legacy currencies") of the eleven participating member countries of the E.U.

(the "participating countries") who adopted the Euro as their common legal

currency are scheduled to remain legal tender in the participating countries as

denominations of the Euro until January 1, 2002 (the "transition period"). The

Euro conversion may impact the Company's competitive position as the Company may

incur increased costs to conduct business in an additional currency during the

transition period. Additionally, the participating countries' pursuit of a

single monetary policy through the European Central Bank may affect the exchange

rate of the Euro, and therefore of the legacy currencies, as well as the

economies of significant markets of the Company. The Company will also need to

maintain and in certain circumstances develop information systems software to

(1) convert legacy currency amounts to Euro; (2) convert one legacy currency to

another; (3) perform prescribed rounding calculations to effect currency

conversions; and (4) permit transactions to take place in both legacy currencies

and the Euro during the transition period. Since the Company conducts extensive

business operations in, and exports its products to, several of the

participating countries, there can be no assurance that the conversion to the

Euro will not have a material adverse effect on the Company's business,

financial condition or results of operations. Similarly, in the event that the

Company materially underestimates the costs, timeliness and adequacy of

modifications to its information systems software, there could be a material

adverse effect on the Company's business, financial condition and result

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