ITEM 1. BUSINESS
The First Years Inc. (the "Company") is a leading developer and worldwide marketer of a broad line of products for infants and toddlers. Major channels through which the Company sells its products include mass merchants, supermarkets, drug stores, department stores, wholesale clubs, convenience stores, specialty stores, mail-order catalogs and catalog showrooms.
The Company was incorporated in 1952 in Massachusetts under the name Kiddie Products, Inc. The Company changed its name to The First Years Inc. in May, 1995, and is headquartered in Avon, Massachusetts.
Products
The Company's product line, which contains approximately 320 items that range in retail price from approximately $0.99 to $69.99, is categorized and color-coded into five distinct product categories as follows:
Feeding & Soothing. The Feeding & Soothing category is comprised of bottles and accessories, nipples, pacifiers, teethers, bowls, drinking cups, dishes, flatware, and breast-feeding accessories. This category includes the TumbleMates line of training cups, bowls, plates and utensils, designed for serving, storing and transporting drinks and snacks, and which features a system of interchangeable cups and lids. This category also includes the Neats line of stain-resistant bibs specially made with a 3M Scotchgard stain-release system.
Play & Discover. The Play & Discover category consists of an extensive line of entertaining, skill-developing toys for infants and toddlers including crib toys, floor toys, hand-held toys, and large play items. The Play & Discover category includes the Company's Washables line of 100% washable, dishwasher-safe toys and its Firstronics line of hand-held electronic toys for children under three years of age. In 1996, the Firstronics line was expanded to include a new line of sports-oriented toys called Sportstronics. In 1996, the Company also introduced its first large play, stationary toy into this category with its 2-in-1 Playcenter, an infant activity center that converts to a toddler play table.
Care & Safety. The Care & Safety category consists of a broad line of fashion and grooming items, home safety products such as door and cabinet latches, and products appropriate for the health and hygiene needs of infants, such as digital thermometers. This category includes the Nurserytronics line of electronic products designed especially for use in the nursery; a line of machinewashable travel tote bags, child carriers and harnesses, marketed under the PackMates name, and the Step-by-Step line of furnishings comprised of a bath seat, booster seat, baby bather, step stool and toilet trainer that are adjustable as a child grows.
First Gifts. The Company markets a variety of specially-designed gift bags and gift sets, which combine the Company's most popular items as attractively-packaged, ready-to-give gifts, or theme-related starter sets. Gift sets include the Washables gift pack, the TumbleMates gift pack, newborn gift bags and furnishings gift sets.
Winnie the Pooh. The Winnie the Pooh category consists of over 45 basic products including teethers, rattles, bibs, bottles, bathing accessories and gift sets featuring Winnie the Pooh characters. In 1996, the Company introduced numerous additional items in this category including Pooh characters on cups, hooded towels, bath puppets, teethers, and electronic musical toys. ------------------------
THE FIRST YEARS(R) Ideas Inspired by Parents(R), TumbleMates(R), Firstronics(R), and Washables(R) are registered trademarks of The First Years Inc. Neats(TM), PackMates(TM), Nurserytronics(TM), Step-by-Step(TM), and First Gifts(TM) are trademarks of The First Years Inc. 3m(R) and SCOTCHGARD(R) are registered trademarks of Minnesota Mining and Manufacturing Company, WINNIE THE POOH(R) and POOH(R) are registered trademarks of Disney Enterprises, Inc.
I-1
PRODUCT DESIGN, DEVELOPMENT AND MARKETING
The Company devotes substantial resources to product development. The Company employs a staff of professionals engaged in the creation of new products and also uses, from time to time, a diverse group of outside designers and developers. For the past 16 years the Company's product line also has been designed in consultation with Dr. T. Berry Brazelton, the well-known pediatrician and authority on child development, and staff members of the Child Development Unit at Children's Hospital in Boston, Massachusetts (the "CDU"), of which Dr. Brazelton is founder and Director Emeritus.
The Company spent approximately $2.2, $1.8 and $1.5 million on new product development in 1996, 1995 and 1994, respectively. Most of the Company's new products are shown at the Juvenile Products Manufacturers Association Trade Show, in Dallas, Texas in the fall of each year, and a variety of other national and international toy and baby fairs.
SALES
The Company's products are sold nationally and internationally to a broad spectrum of customers including mass merchants, national variety and drug stores, supermarkets, wholesale clubs, convenience stores, toy specialty stores, wholesale distributors, department stores, mail order catalogs and catalog stores. The Company currently has customers in over 40 countries. Major customers include Wal*Mart, Toys "R" Us, Target, Kmart, Kroger, Sears, and J.C. Penney.
The Company's products are sold in the United States and Canada primarily through the Company's thirteen-person internal sales staff and a network of 48 independent sales representatives. The Company's sales staff is responsible for supervising and training the sales representatives. Such training is conducted at the Company's headquarters and throughout the United States. In Central and South America and the Pacific Rim, the Company's products are sold by its internal sales staff which manages a network of foreign distributors and independent sales representatives in such areas.
In Europe and the Middle East, the Company's products are sold by the Company's internal staff at its sales office in Cirencester, England, which is headed by the Director of European Sales. This staff manages a network of foreign distributors and independent sales representatives. The Company's international sales in 1996 and 1995 were approximately $11.6 and $7.7 million, respectively, and accounted for approximately 12% and 10% of the Company's total net sales in 1996 and 1995, respectively. (See "Notes to Financial Statements, Number 8.")
During 1996, Wal*Mart, Toys "R" Us, and Target accounted for approximately 26%, 19%, and 10% of the Company's net sales, respectively. A significant reduction in purchases by any of these customers could have a material adverse effect on the Company's business.
Backlog is not a significant and material aspect of the Company's business. Customers place orders on an as needed basis. As the Company's sales have increased, the amount of unfilled orders at any time has not been indicative of future results.
MERCHANDISING
To help retailers use their shelf space efficiently in marketing the Company's products, the Company utilizes computerized planogram programs which divide the space a retailer has allocated for the Company's products to create a mix of the five product categories that is designed to maximize the retailer's profitability.
In recent years, the Company expanded its promotional programs and created a cross-merchandising program for its customers, by which ready-to-use display panels and floor stand display units containing THE FIRST YEARS products are placed next to related items in a customer's store (i.e., the Company's feeding products are placed in a customer's baby food aisle) to encourage synergistic and impulse buying by consumers. These display units are pre-pegged, pre-stocked, easily re-stockable, and can be customized to the customer's needs.
I-2
LICENSED CHARACTER PRODUCTS
In 1996, the Company renewed and entered into various agreements which provide for the payment of royalties on certain of the Company's products featuring licensed cartoon characters. The agreements have terms ranging from one to three years and require minimum royalty payments of $4,682,000 during the terms of these agreements. Sales of products under these license agreements accounted for approximately 32% of the Company's total net sales in 1996.
MANUFACTURING AND SOURCES OF SUPPLY
The Company does not own or operate its own manufacturing facilities. In 1996, all of the Company's products were manufactured either using the Company's custom tools (molds and dies) or to the Company's specifications by approximately 25 manufacturers located in the United States, Canada, China, Taiwan, Thailand, and Mexico. Approximately 55% of all of its products sold in 1996 were manufactured in Asia, primarily in China. A large percentage of the Company's furnishings and other large products were manufactured in 1996 by suppliers in the United States and Canada because of the significantly higher shipping costs from the Far East.
Generally the Company uses one manufacturer to make each product from its supplier base in Asia, Canada, and the United States. Due to the high cost of developing duplicate tooling (predominantly molds and dies), most of the Company's products are made using one set of tools; however, the Company has developed duplicate tools for several of its key and high-volume products. The Company believes it has alternative manufacturing sources available for all of its products. Because it owns its tools, it could shift its sources of manufacturing for any product to an alternative supplier.
In 1996, the Company was not dependent on any one supplier, although its largest supplier, which is based in the United States, accounted for products that represented approximately 20% of its net sales in 1996. In 1996 approximately 11% of the Company's products sold were manufactured by one supplier located in China. The Company has not entered into long-term contractual arrangements with any of its suppliers.
The principal raw materials used in the production and sale of the Company's products are plastic, paperboard and cloth. Raw materials are purchased by the manufacturers who deliver completed products to the Company. Because the primary source used in manufactured plastic is petroleum, the cost and availability of plastic for use in the Company's products varies to a great extent with the price of petroleum. The inability of the Company's suppliers to acquire sufficient plastic and paperboard at a reasonable price could have a material adverse effect on the Company's profitability. The Company did not experience any difficulties in obtaining materials in 1996.
The Company purchases its products from its suppliers primarily in the U.S. dollar and the Hong Kong dollar which is currently pegged to the U.S. dollar. Generally, the Company's suppliers ship the products on the basis of open credit terms or upon the acceptance of products by the Company. In addition, some suppliers require shipment against letters of credit.
Foreign manufacturing is subject to a number of risks including transportation delays and interruptions, the imposition of tariffs, quotas, and other import or export controls, currency fluctuations, misappropriation of intellectual property, political and economic disruptions, and changes in governmental policies. From time to time, the United States Congress has attempted to impose additional restrictions on trade with China. Enactment of legislation or the imposition of restrictive regulations conditioning or revoking China's "most favored nation" ("MFN") trading status could have a material adverse effect upon the Company's business because products originating from China could be subjected to substantially higher rates of duty. China's MFN trading status has been extended through July 3, 1997. Unless Congress takes action to override this decision, China will continue to enjoy MFN treatment during this period. The European Community (the "EC") has enacted a quota and tariff system with respect to the importation into the EC of certain toy products originating in China. The Company, therefore, continues to evaluate alternative sources of supply outside of China.
I-3
The Company, because of its substantial reliance on suppliers in foreign countries, is required to order products further in advance of customer orders than would generally be the case if such products were produced in the United States. As a result, the Company is required to carry significant amounts of inventory to meet rapid delivery requirements of customers and to assure itself of continuous allotment of goods from suppliers.
WORKING CAPITAL ITEMS
See Item 7, "Management Discussion and Analysis of Financial Condition and Results of Operation."
COMPETITION
The juvenile products industry is highly competitive and includes numerous domestic and foreign competitors, some of which are substantially larger and have greater financial and other resources than the Company. The Company competes with a number of different competitors, depending on the product category, and it competes against no single company across all product categories. Its competition includes large, diversified health care product companies, specialty infant products makers, toy makers and specialty health care products companies. The Company competes principally on the basis of brand name recognition and price/value relationship. In addition, the Company believes that it competes favorably with respect to product quality, customer service and breadth of product line.
DISTRIBUTION
The Company distributes its products in the United States from its 103,500 square foot warehouse facility in Avon, Massachusetts and from a public warehouse in Fontana, California. The Company distributes its products in Canada from a public warehouse in Toronto, Ontario. In Europe, the Company distributes its products from a public warehouse in Ghent, Belgium. Warehouse services at the various public warehouses are performed by warehouse operators unaffiliated with the Company.
TRADEMARKS, PATENTS AND COPYRIGHTS
The Company's principal trademark, THE FIRST YEARS and design, is registered in the United States and in a number of foreign countries. The Company also uses other trademarks for certain of its products and product categories, some of which are registered in the United States and in various foreign countries. Applications are pending in the U.S. and various foreign countries for registration of some of the Company's trademarks.
The Company also owns patents, design patents and design registrations, as well as pending applications in the United States and certain foreign countries. Although the Company believes such are important to its business, it does not believe that any single patent, design patent, or design registration, including any which may be issued on a pending application, is material to its business. There can be no assurance that the Company's patents, design patents, or design registrations, including those that may be issued on pending applications, will offer any significant competitive advantage for the Company's products.
The Company also owns copyrights, some of which are registered in the United States. The Company does not believe that any single copyright is material to its business. There can be no assurance that the Company's copyrights will offer any significant competitive advantage for the Company's products.
EMPLOYEES
As of December 31, 1996, the Company employed 120 full-time and 2 part-time employees, of whom 11 are executive officers, 52 are in sales, marketing and product development, 39 are in materials, purchasing, quality control, data processing, finance, administration and clerical, and 20 are in warehousing positions. None of the Company's employees is represented by a union, and the Company has not experienced any work stoppages. The Company believes that relations with employees are good.
I-4
GOVERNMENT REGULATIONS
The Company's products are subject to the provisions of the Federal Consumer Product Safety Act, the Federal Hazardous Substances Act, as amended, the Federal Flammable Fabrics Act, and the Child Safety Protection Act, and the regulations promulgated thereunder (the "Acts"). The Company's nursery monitors are subject to regulations of the Federal Communications Commission. The Company's medical devices and drug products are subject to the regulations of the Food and Drug Administration. The Acts enable the Consumer Product Safety Commission (the "CPSC") to protect children from hazardous toys and other articles. The CPSC has the authority to exclude from the market certain consumer products which are found to be hazardous. The CPSC's determination is subject to court review. The CPSC can require the repurchase by the manufacturer of articles which are banned. The Federal Flammable Fabrics Act enables the CPSC to regulate and enforce flammability standards for fabrics used in consumer products. Similar laws exist in some states and cities and in various international markets. The Company designs and tests its products to ensure compliance with the various federal, state and international requirements. Any recall of a product could have a material adverse effect on the Company, depending on the particular product.
EXECUTIVE OFFICERS AND DIRECTORS OF THE COMPANY
The names of the Company's Executive Officers and Directors and certain information about them are set forth below. Officers have served in the capacity indicated in the table below for at least five years, unless otherwise indicated in the notes.
- ---------------
* Effective as of July 1, 1997, Mr. Peltz's position will be split in two. He will continue to be the Treasurer of the Company. Mr. Beals will be promoted to Vice President -- Finance, and Chief Financial Officer, and will remain as Assistant Treasurer of the Company; and Mr. Stephen Lyons, currently the Company's Assistant Controller since January, 1995, will be promoted to Controller of the Company. - ---------------
Mr. Sidman has served as President of the Company for over five years and was elected to the offices of Chairman of the Board of Directors and Chief Executive Officer on March 28, 1995.
Mr. Page was appointed President -- Network Services of Southern New England Telecommunications Corporation ("SNET") in January of 1994, and has been with SNET for over five years.
I-5
Mr. Alperin, a Certified Public Accountant, has been a financial consultant for over five years. He was the Chairman of the Board of Public Accountancy of Massachusetts for the years 1979, 1982 and 1984.
Mr. Roche has been Vice President of Worldwide Marketing since January, 1995. From January, 1992 to December, 1994, Mr. Roche was Vice President of European Sales of the Company. Prior to that time, from 1989 to 1991, Mr. Roche held several managerial positions for Fisher-Price Kiddie Craft in the United Kingdom, the last of which was Managing Director.
Mr. Shea has been Vice President of Worldwide Sales & Merchandising since January, 1995. From July, 1991 to December, 1994, Mr. Shea was Vice President of Service and Merchandising of the Company, and from January, 1985 to June, 1991, Mr. Shea was Director of Merchandising of the Company.
Keith Ciampa, age 32, has been Vice President -- Executive Accounts since June, 1996. From July, 1993 to May, 1996, Mr. Ciampa was Director of Sales-Americas, and from January, 1992 to June 1993, he was Export Sales Manager of the Company.
Mr. Clive R. Wooster, age 42, has been Vice President -- International Sales/Europe since March 13, 1997. From October, 1994 to March 12, 1997, he was Director of Sales/Europe; and from April, 1992 to September, 1994, he was the General Manager of the Company's UK Sales Office.
ITEM 2.

ITEM 2. PROPERTIES
The Company owns its executive and administrative offices and principal warehouse which are located in a building at One Kiddie Drive, Avon, Massachusetts. The building contains approximately 124,000 square feet of space, of which approximately 20,500 square feet are used for executive and administrative offices and the balance, approximately 103,500 square feet is utilized for warehousing. The Company also has sales offices in leased premises in Mission Viejo, California, and in Cirencester, England.
The Company also uses public warehouses located in Fontana, California; Toronto, Canada; and in Ghent, Belgium.
The Company believes that its properties (owned and leased) are in good condition and adequate for its current needs.
ITEM 3.

ITEM 3. LEGAL PROCEEDINGS
The Company is involved in legal proceedings which have arisen in the ordinary course of business. The Company believes that there are no claims or litigation pending, the outcome of which could have a material adverse effect on the Company's financial condition or operating results.
ITEM 4.

ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matter was submitted during the fourth quarter of the fiscal year covered by this report to a vote of security holders of the Company.
I-6
PART II
ITEM 5.

ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
(A) MARKET INFORMATION
The Company's Common Stock is traded on the Nasdaq National Market. Below is a summary of the actual high and low sales prices of the Company's Common Stock for each quarter of 1995 and 1996 as reported by Nasdaq and as adjusted to reflect the Company's 2-for-1 stock split effected on December 29, 1995.
(B) APPROXIMATE NUMBER OF EQUITY SECURITY HOLDERS
(C) DIVIDEND POLICY
From 1991 to 1995, the Company paid a cash dividend on its Common Stock of $0.085 per share in June of each year. In 1996, the Company increased its annual cash dividend to $0.10 per share which was paid on June 1, 1996. The Company currently expects that comparable cash dividends will continue to be paid in the future. However, the declaration and payment of any such cash dividends in the future will depend upon the Company's earnings, financial condition, capital needs, and other factors deemed relevant by the Board of Directors. There can be no assurance that the Company will continue to pay dividends in the future.
The Company's Board of Directors declared on December 6, 1995, a 2-for-1 stock split effected in the form of a stock dividend to holders of record on December 18, 1995. The new stock certificates were mailed to stockholders on or about December 29, 1995.
II-1
ITEM 6.

ITEM 6. SELECTED FINANCIAL DATA
- ---------------
* Adjusted to reflect the two-for-one stock split effected on December 29, 1995.
II-2
ITEM 7.

ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
STATEMENT OF FORWARD LOOKING INFORMATION:
The Company may occasionally make forward-looking statements and estimates, such as forecasts and projections of the Company's future performance or statements of management's plans and objectives as discussed below. Actual results could differ materially from those in such forward-looking statements. Therefore, no assurances can be given that the results in such forward-looking statements will be achieved.
YEAR ENDED DECEMBER 31, 1996 COMPARED TO YEAR ENDED DECEMBER 31, 1995
Net sales in 1996 were $93.1 million, an increase of $17.3 million or 22.9%, as compared to $75.8 million for the comparable period last year. The increase was due to new product introductions and expanded retail distribution in domestic and foreign markets.
As of a percentage of net sales, net sales to foreign markets increased to 12.5% in 1996 from 10.3% in 1995 resulting primarily from increases in Europe and Canada. As a percentage of net sales, Winnie the Pooh products increased to 32% in 1996 from 20% in 1995. The Company does not expect the rate of increase in net sales of Winnie the Pooh products as a percentage of net sales to continue at the same pace as has occurred in the previous two years due to the level of distribution achieved during that initial period. The Company expects to initiate distribution of products featuring licensed Sesame Street characters during the second quarter of 1997.
Cost of products sold in 1996 was $55.5 million, an increase of $10.4 million or 23.0%, as compared to $45.1 million for the comparable period last year. As a percentage of sales, cost of products sold in 1996 and 1995 remained constant at approximately 59.5%.
Selling, general, and administrative expenses in 1996 were $28.6 million, an increase of $4.6 million or 19.3% as compared to $24.0 million over such expenses in 1995. The increase resulted primarily from costs related to increased sales volume, payroll and payroll related costs. As a percentage of net sales, selling, general, and administrative expenses for the year of 1996 decreased to 30.7% from 31.6% in 1995. The decrease reflects the economies of scale provided by higher volume of business.
Income tax expense as a percentage of pretax income was 40% in 1996 and 1995.
YEAR ENDED DECEMBER 31, 1995 COMPARED TO YEAR ENDED DECEMBER 31, 1994
Net sales in 1995 were $75.8 million, an increase of $22.6 million, or 42.3%, as compared to $53.2 million in 1994. The increase was due to new product introductions and expanded retail distribution in domestic and foreign markets. Net sales particularly benefited from the introduction of newly licensed Winnie the Pooh products and the introduction of new products that have higher average selling prices than products previously offered by the Company.
Cost of products sold in 1995 was $45.1 million, an increase of $15.6 million or 52.9%, as compared to $29.5 million in 1994. As a percentage of net sales, cost of products sold in 1995 increased to 59.5% from 55.4% in the comparable period of 1994. The increase was due to increased sales of higher-priced, lower margin items, increased cost of products due to raw material price increases, licensing fees, and air freight shipments from overseas production facilities incurred primarily in the first three months of the year.
Selling, general, and administrative expenses in 1995 were $24.0 million, an increase of $5.1 million, or 26.7%, as compared to $18.9 million over such expenses in 1994. The increase resulted primarily from costs related to increased sales volume. As a percentage of net sales, selling, general, and administrative expenses in 1995 decreased to 31.6% from 35.5% in 1994. The decrease reflects the economies of scale provided by higher volume of business.
During 1995, the Company sought to issue additional shares of common stock in order to increase its working capital and improve the liquidity of its stock.. Due to uncertain market conditions affecting the retail sector and the price of the Company's stock, the Company decided to postpone indefinitely the public offering.
II-3
As a result, the Company wrote-off offering expenses amounting to a pretax charge of approximately $310,000 ($186,000 net of tax). The offering was subsequently resumed and consummated in 1996 (see below).
Income tax expense as a percentage of pretax income increased to 40.0% in 1995 from 38.5% in 1994.
LIQUIDITY AND CAPITAL RESOURCES
Net working capital increased by $9.4 million from $20.2 million at December 31, 1995 to $29.6 million at December 31, 1996 primarily due to a secondary public offering of the Company's Common Stock which provided net proceeds to the Company of $5.1 million and funds generated from profitable operations. Accounts receivable increased by $1.7 million primarily as a result of increased sales. Cash increased by $3.6 million primarily as a result of the above mentioned secondary offering and profitable operations.
In 1996, the Company resumed and consummated a public offering of common stock which had been postponed in 1995. The closing of the sale, consisting of 400,000 newly issued shares and 1,200,000 shares of certain selling stockholders was held on July 1, 1996 at which time the Company issued the new shares and received the net proceeds of $5,121,750. The proceeds of the newly issued shares were used to pay certain indebtedness of the Company.
Unsecured lines of credit of $20 million which are subject to annual renewal, are available from banks. Amounts outstanding under these lines are payable upon demand by the banks. During 1996, the Company has borrowed various amounts from time to time up to $9.9 million. As of December 31, 1996 no balances were outstanding.
The Company paid a cash dividend of $0.10 and $0.085 per share of Common Stock in June of 1996 and 1995, respectively.
The Company expects cash flow from operations and availability under the Company's lines of credit to be sufficient to meet cash needs for working capital expenditures for at least the next two years.
INFLATION AND FOREIGN CURRENCY FLUCTUATIONS
Inflation has not had a material effect on the Company's operating results over the past three years.
The Company enters into forward exchange contracts to minimize the impact of fluctuations in currency exchange rates on future cash flows emanating from sales denominated in foreign currencies. The Company does not purchase such contracts for trading purposes. During 1996, the Company entered into forward exchange contracts with a bank whereby the Company is committed to deliver foreign currency at predetermined rates. The contracts expire within one year. The Company's commitment under these contracts approximated $6.0 million as of December 31, 1996. At December 31, 1996, the exchange rates for such currencies covered by the contracts approximated the predetermined rate included therein. The Company routinely assesses the financial strength of the bank which is counterparty to the forward exchange contracts. As of December 31, 1996, management believes it had no significant exposure to credit risk relative to such contracts.
II-4
ITEM 8.

ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
Financial Statements listed under Item 14.(a) 1. are included in Part IV.
ITEM 9.

ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
There is nothing to report relating to this Item.
II-5
PART III
ITEM 10.

ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The information required by this item is included in the Registrant's definitive proxy statement for the 1997 Annual Meeting of Stockholders and is incorporated herein by reference.
ITEM 11.

ITEM 11. EXECUTIVE COMPENSATION
The information required by this item is included in the Registrant's definitive proxy statement for the 1997 Annual Meeting of Stockholders, except that the sections in said definitive proxy statement entitled "Board Compensation Committee Report on Executive Compensation" and the "Stock Performance Chart" shall not be deemed incorporated herein by reference to this 10-K Report.
ITEM 12.

ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The information required by this item is included in the Registrant's definitive proxy statement for the 1997 Annual Meeting of Stockholders.
ITEM 13.

ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
There is nothing to report relating to this Item.
III-1
ITEM 14.

ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
14.(a) 1. FINANCIAL STATEMENTS
Independent Auditors' Report
Balance Sheets as of December 31, 1996 and 1995
Statements of Income for the Years Ended December 31, 1996, 1995 and
Statements of Stockholders' Equity for the Years Ended December 31, 1996, 1995 and 1994
Statements of Cash Flows for the Years Ended December 31, 1996, 1995 and 1994
(a) 2. SCHEDULE II -- VALUATION AND QUALIFYING ACCOUNTS FOR THE YEARS ENDED DECEMBER 31, 1996, 1995 AND 1994
Other schedules are omitted because of the absence of conditions under which they are required or because the required information is given in the financial statements or notes thereto.
14.(a) 3. EXHIBITS
The following are either (i) filed herewith as exhibits to this 10-K Report or (ii) have been filed as exhibits to filings under the Securities Act of 1933 or the Securities Exchange Act of 1934 and are incorporated herein by reference as exhibits to this 10-K Report.
IV-1
14.(b) REPORT ON FORM 8-K
The Company did not file any reports on Form 8-K with the Securities and Exchange Commission during the quarter ended December 31, 1996.
IV-2
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
THE FIRST YEARS INC. .................................... (Registrant)
By: /s/ RONALD J. SIDMAN ..................................
RONALD J. SIDMAN, CHIEF EXECUTIVE OFFICER, CHAIRMAN OF THE BOARD OF DIRECTORS, AND PRESIDENT Date: March 13, 1997
By: /s/ BENJAMIN PELTZ ..................................
BENJAMIN PELTZ, SENIOR VICE PRESIDENT AND TREASURER (CHIEF FINANCIAL OFFICER AND CHIEF ACCOUNTING OFFICER) Date: March 13, 1997
Pursuant to the requirements of 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 indicated on March 13, 1997.
IV-3
THE FIRST YEARS INC.
INDEX TO FINANCIAL STATEMENTS AND FINANCIAL STATEMENT SCHEDULE
IV-4
INDEPENDENT AUDITORS' REPORT
To the Board of Directors and Stockholders of The First Years Inc. Avon, Massachusetts
We have audited the accompanying balance sheets of The First Years Inc. as of December 31, 1996 and 1995, and the related statements of income, stockholders' equity, and cash flows for each of the three years in the period ended December 31, 1996. Our audits also included the financial statement schedule listed in the accompanying index. These financial statements and financial statement schedule are the responsibility of the Company's management. Our responsibility is to express an opinion on the financial statements and financial statement schedule 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, such financial statements present fairly, in all material respects, the financial position of The First Years Inc. as of December 31, 1996 and 1995, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 1996 in conformity with generally accepted accounting principles. Also, in our opinion, such financial statement schedule, when considered in relation to the basic financial statements taken as a whole, presents fairly, in all material respects, the information set forth therein.
DELOITTE & TOUCHE LLP Boston, Massachusetts March 5, 1997
IV-5
THE FIRST YEARS INC.
BALANCE SHEETS DECEMBER 31, 1996 AND 1995
See notes to financial statements.
IV-6
THE FIRST YEARS INC.
STATEMENTS OF INCOME YEARS ENDED DECEMBER 31, 1996, 1995 AND 1994
See notes to financial statements.
IV-7
THE FIRST YEARS INC.
STATEMENTS OF STOCKHOLDERS' EQUITY YEARS ENDED DECEMBER 31, 1996, 1995 AND 1994
See notes to financial statements.
IV-8
THE FIRST YEARS INC.
STATEMENTS OF CASH FLOWS YEARS ENDED DECEMBER 31, 1996, 1995 AND 1994
See notes to financial statements.
IV-9
THE FIRST YEARS INC.
NOTES TO FINANCIAL STATEMENTS
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Business -- The First Years Inc. (the "Company") is a developer, marketer, and distributor of certain basic accessory and related products for infants and toddlers. The Company was founded and incorporated in 1952. Since its inception, the Company has engaged in this single line of business, with one class of similar products. The following is a summary of the Company's significant accounting policies.
Revenue Recognition -- Revenue is recognized when products are shipped.
Cash Equivalents -- Highly liquid investments with a maturity of three months or less when purchased have been classified as cash equivalents in the accompanying financial statements. Such investments are carried at cost which approximates market value.
Inventories -- Inventories are stated at the lower of cost (first-in, first-out) or market. Inventories consist principally of finished goods, unpackaged components, and supplies.
Property, Plant, and Equipment -- Property, plant, and equipment is stated at cost. Depreciation is provided based on the estimated useful lives of the various classes of assets (building, 15 to 40 years; machinery and molds, 5 to 10 years; furniture and equipment, 5 to 10 years) using the straight-line method.
Income Taxes -- Deferred tax assets and liabilities are determined based on the differences between the financial statement and tax bases of assets and liabilities using enacted tax rates.
Employee Stock-Based Compensation -- The Company uses the intrinsic value-based method of Accounting Principles Board Opinion ("APB") No. 25 to account for employee stock-based compensation plans.
Earnings Per Share -- Earnings per share are based on the weighted average number of shares outstanding during each year (retroactively adjusted to reflect the two-for-one stock split effected on December 29, 1995) and common equivalent shares, consisting of the effect of stock options outstanding, if dilutive (4,941,196, 4,663,491 and 4,497,244 shares in 1996, 1995, and 1994, respectively) (see Note 7). Earnings per share assuming full dilution have not been presented because the dilutive effect is immaterial.
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 and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.
Research and Development Costs -- Research and development costs are expensed as incurred. During 1996, 1995, and 1994, research and development costs approximated $2,209,000, $1,834,000, and $1,466,000, respectively.
Foreign Currency Translation -- The Company's functional currency is the U.S. dollar. Accordingly, monetary assets and liabilities of the Company's foreign operations are translated from the respective local currency to the U.S. dollar using year-end exchange rates while nonmonetary items are translated at historical rates. Income and expense accounts are translated at the average rates in effect during the year. Accordingly, translation adjustments and transaction gains and losses are recognized as income in the year of occurrence and are recorded as a component of cost of sales.
Foreign Exchange Contracts -- The Company enters into forward exchange contracts to minimize the impact of fluctuations in currency exchange rates on future cash flows emanating from sales denominated in foreign currencies. The Company does not purchase such contracts for trading purposes. Gains and losses related to foreign exchange contracts which qualify as accounting hedges of firm commitments are deferred and recognized in income when the hedged transaction occurs. Gains and losses related to foreign exchange
IV-10
THE FIRST YEARS INC. NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
contracts which do not qualify for hedge accounting are marked to market currently and recognized as a foreign currency transaction gain or loss.
Fair Value of Financial Instruments -- The fair value of the Company's assets and liabilities which constitute financial instruments as defined in Statement of Financial Accounting Standards ("SFAS") No. 107 approximate their recorded value.
Reclassifications -- Certain reclassifications were made to prior year amounts in order to conform with the current year presentation.
2. DEBT
Long-term debt consists of unsecured industrial revenue bonds ("IRB"), with interest payable quarterly at 65% of the prime rate (5.4% at December 31, 1996 and 5.5% at December 31, 1995) and principal payable in equal quarterly installments of $33,333 through September 30, 1997.
Under the terms of the IRB agreement, the Company must comply with certain covenants, none of which impose a significant limitation on the Company.
The Company has available unsecured lines of credit totaling $20,000,000 with two banks. Both lines are subject to annual renewal and require no compensating balances. One line bears interest at the prime rate or the LIBOR rate plus 1.75% and the other line at the prime rate less 0.25% or the LIBOR rate plus 1.75%. During 1996 and 1995, the Company borrowed various amounts up to $9,900,000 and $6,500,000, respectively, under the lines. As of December 31, 1996 and 1995 a balance of $0 and $6,200,000 remained outstanding. The average interest rate on debt outstanding at December 31, 1995 was 7.9%. No other short-term borrowings were incurred by the Company during 1996 or 1995.
3. INCOME TAXES
Components of the Company's net deferred tax asset at December 31 are as follows:
There was no valuation allowance for the years ended December 31, 1996 and 1995.
IV-11
THE FIRST YEARS INC. NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
The provision for income taxes consists of the following:
A reconciliation of the statutory federal income tax rate and the effective tax rate as a percentage of pretax income is as follows:
4. COMMON STOCK
In December 1995, the Company's Board of Directors (the "Board") declared a two-for-one split of the Company's common stock. The stock split, effected in the form of a stock dividend, was distributed on December 29, 1995 to stockholders of record in 1995. Earnings per share amounts shown in the accompanying financial statements have been adjusted to reflect the 1995 stock split.
5. COMMITMENTS AND CONTINGENCIES
Foreign Exchange Contracts -- During 1996 and 1995, the Company entered into forward exchange contracts with a bank whereby the Company is committed to deliver foreign currency at predetermined rates. The contracts expire within one year. The Company's future commitment under these contracts approximated $6,000,000 and $4,500,000 as of December 31, 1996 and 1995, respectively. At December 31, 1996 and 1995, the exchange rates for such currencies covered by the contracts approximated the predetermined rates included therein.
Other Commitments -- At December 31, 1996 and 1995, letters of credit outstanding aggregated approximately $644,000 and $1,925,000, respectively.
During 1994, the Company entered into an employment agreement with an executive officer which provides for an annual salary of $100,000 through August 1999. On March 23, 1995, the Company entered into employment agreements with two key senior executive officers which provide for aggregate annual base salaries through March 2000 of $391,000, subject to any increases or decreases established from time to time at the discretion of the Compensation Committee of the Board and, in the event of termination, provide for noncompetition payments for two years equal to their annual base salaries.
Contingencies -- The Company is involved in legal proceedings which have arisen in the ordinary course of business. Management believes the outcome of these proceedings will not have a material adverse impact on the Company's financial condition or operating results.
6. ROYALTIES
During 1996 and 1995, the Company entered into various agreements which provide for the payment of royalties on sales of certain character and patent licensed products. The agreements have terms ranging from one to fifteen years and require minimum royalty payments of $4,715,000 and $729,000 for agreements signed during 1996 and
IV-12
THE FIRST YEARS INC. NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
1995, respectively. Future outstanding minimum royalty commitments under these agreements amounted to $4,692,000 and $92,800 at December 31, 1996 and 1995, respectively.
7. BENEFIT PLANS
Defined Contribution Plans -- The Company has a defined contribution trusteed benefit plan covering eligible employees, requiring annual contributions based upon certain percentages of salaries of employees. The Company's policy is to fund pension expense as accrued. Pension expense aggregated $472,000, $217,000, and $246,000 in 1996, 1995, and 1994, respectively. The Company sponsors a 401(k) defined contribution plan covering substantially all Company employees pursuant to which the Company is obligated to match, up to specified amounts, employee contributions. Company contributions to this plan were not material for the periods presented.
Stock Option Plans -- In May 1993, the Company's stockholders approved the adoption of The First Years Inc. 1993 Equity Incentive Plan and The First Years Inc. 1993 Stock Option Plan for Non-employee Directors (the "plans") which cover employees and directors of the Company. The Board has reserved 670,000 shares for issuance under the plans and 20,000 shares for another stock option plan (all share amounts adjusted to reflect the two-for-one stock split effected on December 29, 1995). The exercise price for the options granted may not be less than the fair market value of the optioned stock at the date of grant, 110% of fair market value in the case of options granted to a 10% stockholder.
Options granted must be exercised within the period prescribed by the Committee; the options vest in accordance with the vesting provisions prescribed at the time of grant.
A summary of activity (all years adjusted to reflect the two-for-one stock split effected on December 29, 1995) of stock options granted under the plans is as follows:
The grant date fair value for options granted in 1996 and 1995 was $4.19 and $3.46, respectively.
IV-13
THE FIRST YEARS INC. NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
The following table sets forth information regarding stock options outstanding at December 31, 1996 under the Stock Option Plans as described above:
PRO FORMA DISCLOSURES
As described in Note 1, the Company applies the intrinsic value method of APB No. 25 and related Interpretations in accounting for its stock option plans. Accordingly, no compensation cost has been recognized for its stock option plans. Had compensation cost been determined based on the fair value at the grant dates for awards under those plans consistent with the method of FASB Statement 123, the Company's net income and earnings per share for the years ended December 31, 1996 and 1995 would have been as follows:
For purposes of the pro forma disclosures, the fair value of the options granted under the Company's stock option plans during 1996 and 1995 was estimated on the date of grant using the Binomial option pricing model. Key assumptions used to apply this pricing model are as follows:
The pro forma disclosures only include the effects of options granted in 1996 and 1995.
8. CURRENT VULNERABILITY DUE TO CERTAIN CONCENTRATIONS
Concentrations of Credit Risk -- Financial instruments which potentially subject the Company to concentrations of credit risk consist principally of cash equivalents, trade receivables and forward exchange contracts (see Note 5). The Company's cash equivalents consist of money market funds placed with major banks and financial institutions. The Company's trade receivables principally include amounts due from retailers who are geographically dispersed. The Company's three largest customers accounted for 55% and 68% of the trade receivables outstanding at December 31, 1996 and 1995, respectively. The Company routinely assesses the financial strength of its customers and purchases credit insurance to limit its potential exposure to trade receivable credit risks. The Company routinely assesses the financial strength of the bank which is the counterparty to the forward exchange contracts. As of December 31, 1996, management believes it had no significant exposure to credit risks.
Major Customers and Export Sales -- The Company derived 10% or more of its sales from its largest customer. Such amounts aggregated $25,722,000, $21,966,000, and $14,256,000 in 1996, 1995, and 1994, respectively. The Company's second largest customer accounted for sales of $18,257,000, $16,500,000, and
IV-14
THE FIRST YEARS INC. NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
$12,118,000 in 1996, 1995, and 1994, respectively. The Company's third largest customer accounted for sales of $9,908,000 in 1996. No other customer accounted for 10% or more of the Company's sales. Export sales, primarily to Europe, Canada, South America and the Pacific Rim, were approximately $11,564,000 and $7,745,000 in 1996 and 1995, respectively.
Reliance on Foreign Manufacturers -- The Company does not own or operate its own manufacturing facilities. In 1996 and 1995, the Company derived approximately 55% and 46%, respectively, of its net sales from products manufactured by others in the Far East, mainly in the Peoples Republic of China. A change in suppliers could cause a delay in manufacturing and a possible loss of sales, which would affect operating results adversely, depending on the particular product.
9. OFFERING OF COMMON STOCK
During 1995, the Company initiated a public offering of shares of its common stock to increase its working capital and improve liquidity of its common stock. Due to uncertain market conditions affecting the retail sector and the price of its stock, the Company decided to postpone the public offering. As a result, the Company wrote off offering expenses amounting to $310,000 in December 1995.
During 1996, the Company proceeded with the postponed offering of shares and entered into an agreement with a group of underwriters to sell 1.6 million shares of common stock ("the shares"), consisting of 400,000 newly issued shares and 1,200,000 shares of certain selling stockholders. The closing of the sale was held on July 1, 1996 at which time the Company issued 400,000 new shares and received the net proceeds of $5,121,750.
* * * * * *
IV-15
SCHEDULE II
THE FIRST YEARS INC.
VALUATION AND QUALIFYING ACCOUNTS YEARS ENDED DECEMBER 31, 1996, 1995 AND 1994
- ---------------
(1) Net accounts written off.
IV-16
THE FIRST YEARS INC.
EXHIBIT INDEX
IV-17