10-Q 1 d10q.txt DERBY CYCLE CORPORATION FORM 10-Q SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-Q (X) QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the Fiscal Quarter ended July 1, 2001 OR (_) TRANSITION REPORT PURSUANT TO SECTION 13 or 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For Transition Period from __________ to __________ Commission File Number 0001067447 THE DERBY CYCLE CORPORATION (Exact name of registrant as specified in its charter) DELAWARE 31-1038896 (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No.) The Derby Cycle Corporation 300 First Stamford Place (5/th/ Floor) Stamford, Connecticut 06902-6765 (Address of principal executive offices, including zip code) Telephone: (203) 961-1666 (Registrant's telephone number, including area code) Securities registered pursuant to Section 12(b) of the Act: None Name of each exchange on which registered: N/A Securities registered pursuant to Section 12(g) of the Act: None Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days, Yes (X) No ( ). There were 45,440 shares of Class A common stock and 23,060 shares of Class C common stock of The Derby Cycle Corporation, par value $0.01 per share, outstanding as of October 17, 2001. THE DERBY CYCLE CORPORATION JULY 1, 2001 FORM 10-Q QUARTERLY REPORT TABLE OF CONTENTS

ITEM 1. FINANCIAL STATEMENTS Index to Condensed Consolidated Financial Statements: -------------------------------------------------------------------------------- Condensed Consolidated Balance Sheets as of December 31, 2000 and July 1, 2001 ............... 2 Unaudited Condensed Consolidated Statements of Operations for the quarters and six months ended July 2, 2000 and July 1, 2001 .............................................. 3 Unaudited Condensed Consolidated Statement of Shareholders' Deficit for the six months ended July 1, 2001 ...................................................................... 4 Unaudited Condensed Consolidated Statements of Cash Flows for the six months ended July 2, 2000 and July 1, 2001 ............................................................... 5 Notes to Condensed Consolidated Financial Statements ......................................... 7

1 The Derby Cycle Corporation Condensed Consolidated Balance Sheets (Dollars in thousands)

The accompanying notes are an integral part ofthese financial statements. 2 The Derby Cycle Corporation Unaudited Condensed Consolidated Statements of Operations (Dollars in thousands)

The accompanying notes are an integral part of these financial statements. 3 The Derby Cycle Corporation Unaudited Condensed Consolidated Statement of Shareholders' Deficit (Dollars in thousands)

4 The Derby Cycle Corporation Unaudited Condensed Consolidated Statements of Cash Flows (Dollars in thousands)

5 The Derby Cycle Corporation Unaudited Condensed Consolidated Statements of Cash Flows (continued) (Dollars in thousands)

The accompanying notes are an integral part of these financial statements. 6 The Derby Cycle Corporation Notes to Condensed Consolidated Financial Statements 1. Nature of the Business and Basis of Presentation: The condensed consolidated financial statements for the quarters and six months ended July 2, 2000 and July 1, 2001 together with the balance sheet as of July 1, 2001 included herein have not been audited by independent public accountants: the Company's independent auditor was not engaged to and did not review the condensed consolidated financial statements included herein, as required by Rule 10-01 of Regulation S-X promulgated under the Securities Exchange Act of 1934. In the opinion of The Derby Cycle Corporation (the "Company"), all adjustments (which include only normal recurring adjustments) necessary to present fairly the financial position at July 1, 2001 and the results of operations and the cash flows for the periods presented herein have been made. The results of operations for the quarter and six months ended July 1, 2001 are not indicative of the operating results for the full fiscal year due to the seasonal nature of the business and the disposal of Koninklijke Gazelle B.V. ("Gazelle"). The condensed consolidated financial statements included herein have been prepared pursuant to the rules and regulations of the Securities and Exchange Commission. Although the Company believes that the disclosures made are adequate to make the information not misleading, certain information and footnote disclosures normally included in financial statements prepared in accordance with generally accepted accounting principles have been condensed or omitted pursuant to such regulations. These condensed consolidated financial statements should be read in conjunction with the consolidated financial statements and notes thereto included in the Company's Annual Report on Form 10-K for the year ended December 31, 2000. On August 20, 2001, the Company filed a voluntary petition for relief under Chapter 11 (the "Chapter 11 Filing") of the United States Bankruptcy Code (the "Code") in the United States Bankruptcy Court for the District of Delaware (the "Bankruptcy Court"). The Company is operating as debtor-in-possession under the Code, which protects it from its creditors pending reorganization under the jurisdiction of the Bankruptcy Court. As debtor-in-possession, the Company is authorized to operate its business but may not engage in transactions outside the ordinary course of business without approval of the Bankruptcy Court. A statutory creditors committee has been appointed in the Chapter 11 case. As part of the Chapter 11 reorganization process, the Company has attempted to notify all known or potential creditors of the Chapter 11 Filing for the purpose of identifying all prepetition claims against the Company. Only the Company has filed for relief under Chapter 11 of the Code. None of the Company's subsidiaries have filed, and they continue to operate in the ordinary course of business. Substantially all of the Company's liabilities as of August 20, 2001 ("prepetition liabilities") are subject to settlement under a plan of reorganization. Generally, legal actions to enforce or otherwise effect repayment of all prepetition liabilities as well as all pending litigation against the Company are stayed while the Company continues to operate its business as debtor-in-possession. The Company can only pay prepetition obligations with the approval of the Bankruptcy Court. The Bankruptcy Court has approved payment of most prepetition liabilities to trade suppliers. The Bankruptcy Court also has approved payment of prepetition employee wages and benefits. Schedules will be filed by the Company with the Bankruptcy Court setting forth its assets and liabilities as of the filing date as reflected in the Company's accounting records. Differences between amounts reflected in such schedules and claims filed by creditors will be investigated and either mutually resolved or subsequently adjudicated before the Bankruptcy Court. The ultimate amount and settlement terms for such liabilities are subject to a plan of reorganization. There can be no assurance that any reorganization plan that is effected will be successful. Under the Code, the Company may elect to assume or reject real property leases, employment contracts, personal property leases, service contracts and other executory prepetition contracts, subject to the review of the Bankruptcy Court. Parties affected by any such rejections may file prepetition claims with the Bankruptcy Court in accordance with bankruptcy procedures. At this time, because of material uncertainties, any prepetition liabilities which arose on or before July 1, 2001 are generally carried at par value in the accompanying balance sheet as at July 1, 2001. The Company cannot presently determine or reasonably estimate the ultimate liability that may result from rejecting leases or from filing of claims for any rejected contracts, and no provisions have been made for the majority of these items. The net expense resulting from the Chapter 11 Filing by the Company will be segregated and reported as reorganization costs in the condensed consolidated statements of operations for the quarter ending September 30, 2001, and accordingly have not been included in these financial statements. 7 The Derby Cycle Corporation Notes to Condensed Consolidated Financial Statements These condensed consolidated financial statements have been prepared using accounting principles applicable to a going concern, which contemplate the realization of assets and the payment of liabilities in the ordinary course of business. The conditions leading to the Chapter 11 Filing raise substantial doubt about the Company's ability to continue as a going concern. The condensed consolidated financial statements do not include any adjustments relating to the recoverability and classification of asset carrying amounts or the amount and classification of liabilities that might result should the Company be unable to continue as a going concern. Nevertheless, the Company considers it appropriate to prepare the accompanying condensed consolidated financial statements on the going concern basis of accounting. On May 14, 1998, the Company issued $100,000,000 of 10% Senior Notes due 2008, and DM110,000,000 of 9.38% Senior Notes due 2008 (collectively, the "Senior Notes"). As co-issuers, Lyon Investments B.V. ("Lyon") and the Company (collectively, the "Issuers") are jointly and severally liable with respect to the Senior Notes, which mature in 2008. The Senior Notes are governed by indentures (as amended, the "Senior Note Indentures"). On July 19, 2001, Derby Nederland B.V., an indirect subsidiary of the Company, sold all of the issued and outstanding shares of its subsidiary, Gazelle, to Gazelle Holding B.V., a company controlled by Gilde Investment Management B.V. and located in The Netherlands (the "Gazelle Sale"). The purchase price was (euro)142,500,000 ($125,400,000 at the July 19, 2001 exchange rate) in cash, less (euro)11,970,000 ($10,534,000 at the July 19, 2001 exchange rate) of debt and taxes outstanding of Gazelle as of, June 1, 2001, and subject to certain adjustments based on Gazelle's balance sheet as of June 1, 2001. (euro)10,000,000 ($8,800,000 at the July 19, 2001 exchange rate) of the purchase price was placed in escrow, to be released to the Company upon the determination of certain contingencies. The Company estimates that the book gain on disposal of Gazelle will be approximately $66,000,000, net of tax, although only $2,500,000 of the proceeds has been retained by the Issuers (see below for utilization of proceeds). Gazelle constituted a substantial portion of the consolidated assets and operating profits of the Company. All results include Gazelle, as it is not classified as a separate segment which would be shown as a discontinued operation within the meaning given in Opinion No. 30 of the Accounting Principles Board. On July 19, 2001, the Company and Lyon, pursuant to the terms of the Senior Note Indentures, used portions of the proceeds of the Gazelle Sale to repay or collateralize all the outstanding amounts under the Company's Revolving Credit Facility, which was terminated as a result of such repayment. Additionally, pursuant to the Senior Note Indentures, the Issuers have retained the equivalent of $2,500,000 for working capital and other corporate purposes. Expenses of the Gazelle Sale, amounting to the equivalent of $4,041,000, were paid. The remaining net Gazelle Sale proceeds of $21,903,000 were delivered to the trustees under the Senior Note Indentures on July 19, 2001. The trustees applied $7,445,000 of the net Gazelle Sale proceeds to make the interest payments on the Senior Notes that the Issuers had failed to make when due on May 15, 2001. Since completion of the Gazelle Sale, $3,638,000 of the proceeds used to collateralize outstanding amounts under the Company's Revolving Credit Facility have been released and $4,071,000 due from Gazelle to Derby Nederland B.V. has been paid to the trustees under the Senior Note Indentures. The Company operates via a number of operating companies worldwide that predominantly operate as stand-alone entities. Each of the companies manufactures, assembles and/or distributes bicycles and parts and accessories. These operating companies have significant operations in The Netherlands ("Gazelle"), see Gazelle Sale above, the U.K. ("Raleigh U.K."), Canada ("Raleigh Canada"), Germany ("Derby Germany"), South Africa ("Probike") and the U.S.A. (the "Derby U.S.A." division of the Company). The Company owns many of the most recognized brands in the bicycle industry, including leading global brands such as Raleigh, Diamond Back and Univega, and leading national brands such as Gazelle in The Netherlands and Kalkhoff, Musing, Winora and Staiger in Germany. The bicycle component and other engineering component manufacturing business, trading as Sturmey Archer, was disposed of on June 30, 2000 (See note 9). The operating results of Sturmey Archer for 2000 have been excluded from operating income and included as income from discontinued operations. In July 2001, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards ("SFAS") No. 142, Goodwill and Other Intangible Assets. Under SFAS No. 142, goodwill will no longer be amortized on a straight line basis over its estimated useful life, but will be tested for impairment 8 The Derby Cycle Corporation Notes to Condensed Consolidated Financial Statements on an annual basis and whenever indicators of impairment arise. Under SFAS No. 142, intangible assets with indefinite lives will not be amortized. Instead they will be carried at the lower of cost or market value and tested for impairment at least annually. All other recognized intangible assets will continue to be amortized over their estimated useful lives. SFAS No. 142 is effective for fiscal years beginning after December 15, 2001 although goodwill on business combinations consummated after July 1, 2001 will not be amortized. On adoption the Company will record a cumulative effect adjustment to eliminate the previously recognized liability relating to the excess of assets acquired over cost of acquisitions (carrying value of $11,618,000 as of July 1, 2001) as well as any required impairment of previously recognized intangible assets. In addition, goodwill on prior business combinations will cease to be amortized. Had the Company adopted SFAS No. 142 at January 1, 2000 the Company would not have recorded amortization on the excess of assets acquired over cost of acquisitions of $238,000 or $255,000 on the amortization of intangibles for the year ended December 31, 2000. The Company has not determined the impact that SFAS No. 142 will have on intangible assets or whether a cumulative effect adjustment will be required upon adoption. 2. Restructuring charge: On February 13, 2001 the Company decided to cease manufacturing bicycles at its U.S.A. plant in Kent, Washington in April 2001. In future all bicycles for sale in the U.S.A. will be imported. Closure costs of $1,417,000 include $728,000 in respect of the compulsory terminations of 108 employees, all of whom had left by July 1, 2001. $236,000 of termination benefits remained to be paid at July 1, 2001. On February 13, 2001 the Company decided to close its U.S. internet operation, Bikeshop.com, with effect from March 2001. Closure costs of $499,000 include $65,000 for the compulsory termination of 8 employees, all of whom had left by July 1, 2001. 3. Non-recurring items: In December 2000 the Company resolved to close the corporate headquarters in Stamford, Connecticut and transfer all control and administrative activities to Nottingham, U.K 4 employees were terminated involuntarily in 2000 and $1,107,000 of accrued termination benefits was paid during the first six months. The remaining 4 corporate headquarters employees based in Stamford, Connecticut have been terminated since the year-end. Costs of $3,012,000 were incurred during the first six months for financial advisory services and related professional fees as the Company reviewed its business and explored alternatives available in order to repay the outstanding amount under the Revolving Credit Facility. 4. Impairment of long-lived assets: The manufacturing equipment at the Company's U.S.A. plant in Kent, Washington was written down by $621,000 in the first quarter, to its estimated recoverable amount, in recognition of the cessation of manufacturing in April 2001 (see note 2). 5. Derivative Financial Instruments: Adoption of SFAS 133 The Company elected to adopt SFAS 133 as of October 1, 1998. 9 The Derby Cycle Corporation Notes to Condensed Consolidated Financial Statements For the six months ended July 2, 2000 and July 1, 2001 the Company had no derivatives designated as hedges. Income and expense related to the fair value accounting of the Company's derivative instruments are included in the statement of operations as follows (in thousands):

The change in fair value of unexpired forward foreign exchange contracts includes $75,000 relating to Sturmey Archer for the six months ended July 2, 2000, which is included in Loss from discontinued operations in the Statement of Operations. 6. Short Term Borrowings: Short term borrowings consist of the following (in thousands): Dec 31, Jul 1, 2000 2001 unaudited ---------- ---------- Short term bank borrowings .................. $ 70,807 $ 61,069 Bank overdraft .............................. 5,844 2,220 ---------- ---------- Total short term borrowings ............. $ 76,651 $ 63,289 ========== ========== As at December 31, 2000 and July 1, 2001, the Company was in breach of the financial covenants under the agreement which provided for the Revolving Credit Facility to be made available to the Company's operating and finance subsidiaries (as amended, the "Revolving Credit Agreement"). All amounts outstanding under the Revolving Credit Facility were repaid in full on July 19, 2001 and the facility was terminated. 7. Long Term Debt: On May 14, 1998, the Company issued $100,000,000 of 10% Senior Notes due 2008, and DM110,000,000 of 9.38% Senior Notes due 2008. The Issuers are jointly and severally liable with respect to the Senior Notes, which mature in 2008. The Senior Notes are governed by the Senior Note Indentures. Interest on the Senior Notes is payable semi-annually on May 15 and November 15. The interest payment of $7,445,000 due for payment on May 15, 2001 was not paid within the 30-day grace period under the terms of the Senior Note Indentures, but was paid together with defaulted interest on July 20, 2001. As the Company is no longer in default under the Senior Note Indentures, the Senior Notes continue to be classified as long term debt. On February 4, 1999, the Company issued a $20,000,000 19% subordinated note to Vencap Holdings (1992) Pte Limited, a Singapore corporation affiliated with GIC Special Investments Pte Limited (the "Subordinated Note"). The Subordinated Note is subordinated and junior in right of payment and enforcement to the prior payment of the amounts due under the Company's Revolving Credit Facility and the Senior Notes. Interest on the Subordinated Note is compounded daily, with an annual effective yield of 20.9%. The Subordinated Note together with accrued interest thereon matures on February 3, 2009. The Subordinated Note is issued under an agreement which cross-defaults upon certain events of default under the Revolving Credit Agreement or the Senior Note Indentures. As of December 31, 2000 and July 1, 2001, long term debt consists of the following (in thousands): 10 The Derby Cycle Corporation Notes to Condensed Consolidated Financial Statements Dec 31, Jul 1, 2000 2001 unaudited --------- ---------- 10% $100,000,000 Senior Notes .................... $ 100,000 $ 100,000 9.38% DM110,000,000 Senior Notes ................. 52,884 48,035 19% $20,000,000 Subordinated Note ................ 20,000 20,000 --------- ---------- Total long-term debt ............................. $ 172,884 $ 168,035 ========= ========== The Senior Note Indentures required the Issuers, after making the payments and retaining the funds as described in Note 1 above, to use any remaining proceeds of the Gazelle Sale (including certain amounts that were to be received post-closing) to make offers to repurchase a portion of the Senior Notes. On July 30, 2001 the Issuers made offers to purchase (the "Offers") for cash up to $14,058,000 principal amount of the outstanding Senior Notes at par value plus accrued interest thereon. On September 7, 2001 the Issuers amended the Offers to increase the maximum principal amount of outstanding Senior Notes they are offering to purchase to $21,404,000, as a result of the proceeds received from the Gazelle Sale since completion. To the extent that the Issuers receive further additional proceeds from the Gazelle Sale, they may amend the Offers to further increase the principal amount of Senior Notes they will offer to purchase, or make additional offers to purchase Senior Notes using such further proceeds. 8. Commitments and Contingencies: International operations; dependence on foreign suppliers and sales A significant portion of the Company's operations are conducted in foreign countries and are subject to the risks that are inherent in operating abroad, including, without limitation, the risks associated with foreign governmental regulation, foreign taxes, import duties and trade restrictions. The Company's business is highly dependent upon products manufactured by foreign suppliers located primarily in Taiwan, Japan and the People's Republic of China. A substantial majority of the Company's multi-speed bicycles contain components supplied on a purchase order basis by one Japanese manufacturer. The Company's business is also subject to the risks generally associated with doing business abroad, such as delays in shipment and foreign governmental regulations which could have a material adverse effect on the results of operations and financial condition of the Company. In addition, several of the Company's manufacturing operations are unionized. Product liability Because of the nature of the Company's business, the Company at any particular time is a defendant in a number of product liability lawsuits and expects that this will continue to be the case in the future. The plaintiffs in these lawsuits generally seek damages, sometimes in amounts that may be material, for personal injuries allegedly sustained as a result of alleged defects in the Company's products. Although the Company maintains product liability insurance, due to the uncertainty as to the nature and extent of manufacturers' and distributors' liability for personal injuries, there can be no assurance that the product liability insurance maintained by the Company is or will be adequate to cover product liability claims or that the applicable insurer will be solvent at the time of any covered loss. In addition, due to deductibles, self-retention levels and aggregate coverage amounts applicable under the Company's insurance policies, the Company may bear responsibility for a significant portion, if not all, of the defense costs (which include attorneys' fees and expenses incurred in the defense of any claim), and the related payments to satisfy any judgments associated with any claim asserted against the Company in excess of any applicable coverage. The successful assertion or settlement of an uninsured claim, the settlement of a significant number of insured claims, or a claim exceeding the Company's insurance coverage could have a material adverse effect on the Company's business, results of operations and financial condition. In addition, there can be no assurance that insurance will remain available or, if available, will not be prohibitively expensive. The self-insured retention under the Company's insurance policies is currently $125,000 per claim for domestic claims and $1,000 for foreign claims; however, prior to 1993, the self-insured retention for domestic claims was $1,000,000 per claim. Not all claims arising during the period in which the Company's self-insured retention for domestic claims was $1,000,000 have been resolved and it is possible that additional claims may be filed. The aggregate amount of liability under existing and potential claims, so far as they are not covered by insurance, could exceed the reserves of $184,000 established by the Company as at July 1, 2001 for product liability claims. 11 The Derby Cycle Corporation Notes to Condensed Consolidated Financial Statements Common stock and preferred stock During the six months ended July 1, 2001 the Company repurchased and cancelled 1,860 Class A and 465 Class C common shares issued under the management stock plan. Of the total number of 2,325 shares repurchased, 200 shares were repurchased for cash at a price of $248,000 and loans receivable from shareholders of $2,125,000 were cancelled in consideration for the repurchase of 2,125 shares. The terms of the Class C common stock include mandatory redemption and therefore this stock is classified in the balance sheet with preferred stock, rather than with shareholders' equity. Following the repurchase of management held shares as listed above, the stock in the Company (at issue price plus accrued preferred stock dividends) was held by the following shareholders and their affiliates as of July 1, 2001 (in thousands):

12 The Derby Cycle Corporation Notes to Condensed Consolidated Financial Statements 9. Discontinued Operations: On June 6, 2000 the Company determined to dispose of the bicycle component and other engineering component manufacturing segment of its business, Sturmey Archer. The sale of the U.K. net trading assets and certain overseas subsidiaries to Lenark Limited, on a going concern basis, was completed on June 30, 2000. The Statement of Operations for the discontinued segment for the quarter and six months ended July 2, 2000 was as follows (in thousands):

There was no tax impact from the disposal of Sturmey Archer. 10. Segmental Information: Reportable business segments The Company manages its business in six major operating units as shown in the following tables. In addition "HQ, treasury, sourcing and elimination of group transactions" comprises the Chinese and Taiwanese sourcing operations (Derby Trading Co.), the recently closed internet operation (Bikeshop.com), the headquarters, treasury operations and consolidation adjustments. Certain small European distribution and non-operating companies are now included in the operating units where management responsibility lies, and the comparative figures for 2000 have been re-allocated accordingly. The reportable segments are managed separately because each business has differing customer requirements, either as a result of the regional environment of the country or differences in products and services offered. 13 The Derby Cycle Corporation Notes to Condensed Consolidated Financial Statements A summary of net revenues and operating income categorized by business segment is as follows (in thousands):

11. Lyon Investments B.V.: Lyon, a Dutch company, is a wholly owned subsidiary of the Company which is a co-issuer of the Senior Notes. As co-issuers, Lyon and the Company are jointly and severally liable with respect to the Senior Notes. Lyon received $20,250,000 plus DM110,000,000 of the issue proceeds of the Senior Notes, which are included as liabilities in Lyon's balance sheet. The Company received $79,750,000 of the issue proceeds, which are shown as liabilities in the Company's unconsolidated balance sheet. As co-issuer, Lyon has a contingent liability for the $79,750,000 of proceeds due by the Company should the Company default in servicing those Senior Notes. 12. Subsequent events: On July 19, 2001, Derby Nederland B.V., an indirect subsidiary of the Company, sold all of the issued and outstanding shares of its subsidiary Gazelle, to Gazelle Holding B.V., a company controlled by Gilde Investment Management B.V. and located in The Netherlands. The purchase price was (euro)142,500,000 ($125,400,000 at the July 19, 2001 exchange rate) in cash, less (euro)11,970,000 ($10,534,000 at the July 19, 2001 exchange rate) of debt and taxes outstanding of Gazelle as of, June 1, 2001, and subject to certain adjustments based on Gazelle's balance sheet as of June 1, 2001. (euro)10,000,000 ($8,800,000 at the July 19, 2001 exchange rate) of the purchase price was placed in escrow, to be released to the Company upon 14 The Derby Cycle Corporation Notes to Condensed Consolidated Financial Statements the determination of certain contingencies. The Company estimates that the book gain on disposal of Gazelle will be approximately $66,000,000, net of tax, although only $2,500,000 of the proceeds has been retained by the Issuers (see below for utilization of proceeds). Gazelle constituted a substantial portion of the consolidated assets and operating profits of the Company. On July 19, 2001, the Company and Lyon , pursuant to the terms of the Senior Note Indentures, used portions of the proceeds of the Gazelle Sale to repay or collateralize all the outstanding amounts under the Company's Revolving Credit Facility, which was terminated as a result of such repayment. Additionally, pursuant to the Senior Note Indentures, the Issuers have retained the equivalent of $2,500,000 for working capital and other corporate purposes. Expenses of the Gazelle Sale, amounting to the equivalent of $4,041,000, were paid. The remaining net Gazelle Sale proceeds of $21,903,000 were delivered to the trustees under the Senior Note Indentures on July 19, 2001. The trustees applied $7,445,000 of the net Gazelle Sale proceeds to make the interest payments on the Senior Notes that the Issuers had failed to make when due on May 15, 2001. Since completion of the Gazelle Sale, $3,638,000 of the proceeds used to collateralize outstanding amounts under the Company's Revolving Credit Facility have been released and $4,071,000 due from Gazelle to Derby Nederland B.V. has been paid to the trustees under the Senior Note Indentures. Indentures required the Issuers, after making the payments and retaining the funds as described above, to use any remaining proceeds of the Gazelle Sale (including certain amounts that were to be received post-closing) to make offers to repurchase a portion of the Senior Notes. On July 30, 2001 the Issuers made offers to purchase for cash up to $14,058,000 principal amount of the outstanding Senior Notes at par value plus accrued interest thereon. On September 7, 2001, the Issuers amended the Offers to increase the maximum principal amount of outstanding Senior Notes they are offering to purchase to $21,404,000, as a result of the proceeds received from the Gazelle Sale since completion. The deadline for tendering Senior Notes in the Offers has also been extended to September 24, 2001, and the scheduled payment date is now September 27, 2001. To the extent that the Issuers receive more of the proceeds from the Gazelle Sale, they may amend the Offers to further increase the principal amount of Senior Notes they will offer to purchase, or make additional offers to purchase Senior Notes using such further proceeds. On August 20, 2001 the Company filed a motion in the Bankruptcy Court seeking authorization to consummate an asset purchase agreement between the Company and Cycle Bid Co., a corporation controlled by Alan Finden-Crofts and other executives of the Company. The asset purchase agreement provides for the sale of substantially all of the operations and assets of the Company (the "MBO") for approximately $43,000,000. Under the terms of the MBO, certain liabilities of the Company including trade accounts payable aggregating approximately $23,000,000 will be assumed by Cycle Bid Co., and approximately $20,000,000 will be paid in cash. The obligations assumed exclude the Senior Notes, the Subordinated Note and certain other excluded liabilities. 15 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Overview On August 20, 2001, The Derby Cycle Corporation (the "Company") filed a voluntary petition for relief under Chapter 11 (the "Chapter 11 Filing") of the United States Bankruptcy Code (the "Code") in the United States Bankruptcy Court for the District of Delaware (the "Bankruptcy Court"). The Company is operating as debtor-in-possession under the Code, which protects it from its creditors pending reorganization under the jurisdiction of the Bankruptcy Court. As debtor-in-possession, the Company is authorized to operate its business but may not engage in transactions outside the ordinary course of business without approval of the Bankruptcy Court. A statutory creditors committee may be appointed in the Chapter 11 case, but at this point such a committee has not been formed. As part of the Chapter 11 reorganization process, the Company has attempted to notify all known or potential creditors of the Chapter 11 Filing for the purpose of identifying all prepetition claims against the Company. Only the Company has filed for relief under Chapter 11 of the Code. None of the Company's subsidiaries have filed, and they continue to operate in the ordinary course of business. Substantially all of the Company's liabilities as of August 20, 2001 ("prepetition liabilities") are subject to settlement under a plan of reorganization. Generally, legal actions to enforce or otherwise effect repayment of all prepetition liabilities as well as all pending litigation against the Company are stayed while the Company continues to operate its business as debtor-in-possession. The Company can only pay prepetition obligations with the approval of the Bankruptcy Court. The Bankruptcy Court has approved payment of most prepetition liabilities to trade suppliers. The Bankruptcy Court also has approved payment of prepetition employee wages and benefits. Schedules will be filed by the Company with the Bankruptcy Court setting forth its assets and liabilities as of the filing date as reflected in the Company's accounting records. Differences between amounts reflected in such schedules and claims filed by creditors will be investigated and either mutually resolved or subsequently adjudicated before the Bankruptcy Court. The ultimate amount and settlement terms for such liabilities are subject to a plan of reorganization. There can be no assurance that any reorganization plan that is effected will be successful. Under the Code, the Company may elect to assume or reject real property leases, employment contracts, personal property leases, service contracts and other executory prepetition contracts, subject to the review of the Bankruptcy Court. Parties affected by any such rejections may file prepetition claims with the Bankruptcy Court in accordance with bankruptcy procedures. At this time, because of material uncertainties, any prepetition liabilities which arose on or before July 1, 2001 are generally carried at par value in the accompanying balance sheet as at July 1, 2001. The Company cannot presently determine or reasonably estimate the ultimate liability that may result from rejecting leases or from filing of claims for any rejected contracts, and no provisions have been made for the majority of these items. The net expense resulting from the Chapter 11 Filing by the Company will be segregated and reported as reorganization costs in the condensed consolidated statements of operations for the quarter ending September 30, 2001, and accordingly have not been included in the accompanying financial statements. The accompanying condensed consolidated financial statements have been prepared using accounting principles applicable to a going concern, which contemplate the realization of assets and the payment of liabilities in the ordinary course of business. As a result of the Chapter 11 Filing, such realization of assets and liquidation of liabilities is subject to uncertainty. The Company's independent auditor was not engaged to and did not review the condensed consolidated financial statements included herein, as required by Rule 10-01 of Regulation S-X promulgated under the Securities Exchange Act of 1934. The Company is a designer, manufacturer and marketer of bicycles. 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 global brands such as Raleigh, Diamond Back and Univega, and regional brands such as 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 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. 16 The Company's operations are concentrated in the U.K. ("Raleigh U.K."), The Netherlands ("Gazelle"), Germany ("Derby Germany"), the U.S.A. (the "Derby U.S.A." division of the Company), Canada ("Raleigh Canada"), and South Africa ("Probike"), with manufacturing operations in all countries other than the U.S.A. and South Africa, each led by local management. The Company maintains marketing or purchasing operations in five 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. The poor financial results of the Company in 2000 caused a breach of the financial covenants under the Revolving Credit Facility and the Company applied part of the proceeds of the Gazelle Sale (see Note 1) on July 19, 2001 to repay this facility in full and thereby terminate it (see "Liquidity and Capital Resources - Revolving Credit Facility"). The Company was unable to pay the May 15, 2001 interest payment due on the Company's $100,000,000 of 10% Senior Notes due 2008, and DM110,000,000 of 9.38% Senior Notes due 2008 (collectively, the "Senior Notes") until July 19, 2001, which was after the end of the 30-day grace period for payment. As a result, the Company was in default of the indentures which govern the Senior Notes (as amended, the "Senior Note Indentures"), which default was cured by a subsequent interest payment on July 19, 2001 (see Disposition of Assets, below). During the first six months of 2001 the Company took certain steps to improve future prospects. Manufacturing of bicycles at Derby U.S.A. ceased in the first week of April, and products will now be imported. The Stamford, Connecticut office and Bikeshop.com have been closed down, and both the employees and certain consultancy arrangements were terminated. Experienced senior management were appointed at corporate level and in the U.S.A. to (i) stabilize the business, (ii) cut back on unnecessary corporate overhead, and (iii) manage cash flow through the Company's February/March/April 2001 peak season. 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. On July 19, 2001 the Company sold its investment in Koninklijke Gazelle B.V. ("Gazelle") which operates the Gazelle bicycle business in The Netherlands. In 2000, 56% of the Company's net revenues were earned in currencies which are denominations of the Euro, 21% were denominated in U.S. Dollars, 11% were denominated in Pounds Sterling and 12% were denominated in other currencies. The Company reduces its currency exposure by maintaining operations in the major markets in which it sells its products. However, as a result of the Company's curtailment of its hedging program both in 2000 and 2001, the Company faced, and will continue to face, significant exposure to foreign exchange risk (please see "Quantitative and Qualitative Disclosures about Market Risk" for further details). Results of Operations The Company manages its business in six major operating units as shown in the following tables. In addition "HQ, treasury, sourcing and elimination of group transactions" comprises the Chinese and Taiwanese sourcing operations (Derby Trading Co.), the recently closed internet operation (Bikeshop.com), the headquarters, treasury operations and consolidation adjustments. Certain small European distribution and non-operating companies are now included in the operating units where management responsibility lies, and the comparative figures for 2000 have been re-allocated accordingly. All comparisons in the following discussion and analysis are against the quarter and six months ended July 2, 2000, unless otherwise stated. The results for 2000 of Sturmey Archer, which was sold on June 30, 2000, have been excluded from the calculation of operating income, but included in the balance sheets, statements of cash flows and as income from discontinued operations in the statement of operations. All results include Gazelle, although it was sold on July 19, 2001, as it is not classified as a separate segment which would be shown as a discontinued operation within the meaning given in Opinion No. 30 of the Accounting Principles Board. 17 Units sold: Quarter ended Six months ended --------------- ---------------- Thousands of bicycles Jul 2, Jul 1, Jul 2, Jul 1, 2000 2001 2000 2001 ------- ------- ------- ------- Raleigh U.K. ................................ 99 80 166 151 Gazelle ..................................... 126 115 238 239 Derby Germany ............................... 259 129 477 316 Derby U.S.A. ................................ 128 95 225 167 Raleigh Canada .............................. 93 70 237 182 Probike ..................................... 41 29 85 60 HQ, treasury, sourcing and elimination of group transactions ..................... (4) 5 (20) (13) ----- ----- ----- ----- Total units sold ....................... 742 523 1,408 1,102 ===== ===== ===== ===== Units sold. Management believes that particularly bad weather in the first quarter of 2001, weakening economies in several of its markets and the effect of this on consumer confidence led to lower unit sales. Units sold decreased by 219 thousand units (30%) and 306 thousand units (22%) for the quarter and six months ended July 1, 2001, as compared with the quarter and six months ended July 2, 2000. Sales in the U.K. in the first quarter of 2001 included 25 thousand units of obsolete models with low promotional prices to generate cash, compared with 12 thousand such units sold in the first quarter of 2000. Derby Germany reduced its participation in the lowest margin segments of the private label and contract manufacturing areas of the market, in order to increase overall margin to a more acceptable level. In addition, the market fell by 22% in the second quarter compared with year ago and a dominant German retail buying group has switched more of its products from domestic German sources to foreign sources, which adversely affected sales to I.B.D.s by Derby Germany, as well as other German manufacturers. In the U.S.A., sales fell by 25% for both the quarter and the six month period, as the market fell, with the key segments for Raleigh (M.T.B.) and Diamond Back (B.M.X.) down 19% and 9% respectively, for the quarter, and down 22% and 11% respectively, for the six months ended July 1, 2001. In addition, competitors carrying over high inventory levels from December 2000 launched aggressive close out programs during the season, resulting in further volume loss at Derby U.S.A.. Business from mass merchandisers for private label products in Canada gained in 2000 was lost in 2001 to lower priced offers from competitors, both local manufacturers and importers, taking 18 thousand units out of the sales program for the first quarter. In addition, the market is exceptionally soft in both I.B.D. and mass merchandiser channels, with promotional pricing needed to stimulate sales. The weakening of the South African consumer durable market seen in the last quarter of 2000, continued in 2001 as limited discretionary spending has been diverted into other areas. Management believes that this has in part caused a reduction in sales from 85 thousand units in the first half of 2000, to 60 thousand units in the six months ended July 1, 2001, which is very close to 1999 levels. Net revenues: Quarter ended Six months ended --------------- ---------------- Jul 2, Jul 1, Jul 2, Jul 1, $ millions 2000 2001 2000 2001 ------- ------- -------- ------- Raleigh U.K. ................................ $ 17.7 $ 15.1 $ 31.1 $ 27.2 Gazelle ..................................... 42.6 41.5 80.9 86.1 Derby Germany ............................... 61.1 36.9 109.9 81.9 Derby U.S.A. ................................ 32.2 23.3 58.1 42.8 Raleigh Canada .............................. 8.1 5.6 20.6 14.8 Probike 3.6 2.7 7.6 5.9 HQ, treasury, sourcing and elimination of group transactions ..................... 1.5 0.9 3.2 2.1 ------- ------- ------- ------- Total net revenues ..................... $ 166.8 $ 126.0 $ 311.4 $ 260.8 ======= ======= ======= ======= 18 Net revenues for the quarter and six months ended July 1, 2001 compared with year ago at comparable foreign exchange rates decreased by $33.4 million (20%) and $35.0 million (11%). The relative weakness of the Euro in 2001, together with, to a lesser extent, Pound Sterling, the Canadian Dollar and the South African Rand, reduced the consolidated net revenues by $7.4 million and $15.6 million for the quarter and six months ended July 1, 2001 upon translation of net revenues into U.S. Dollars at the actual rates applicable to each year. While the lost bicycle sales volume reduced sales revenues by $49.0 million and $60.4 million for the quarter and six months ended July 1, 2001, this was partly recovered through higher sales prices, which contributed $17.5 million and $28.5 million to net revenues for the quarter and six month periods. The higher price was driven by the success of upscale models at Gazelle, price increases and a withdrawal from the lower priced segments of the market in Germany, the partial recovery of adverse exchange rates in South Africa and by an increase in models sold with suspension. Sales of parts and accessories remained stable in all markets apart from the U.S.A Parts and accessories revenues fell by $1.2 million and $2.4 million for the quarter and six month periods at Derby U.S.A. due to weak market conditions. Sales in the Diamond Back fitness business of Derby U.S.A. fell back in the second quarter and ended $0.1 million below year ago for the six month period. Net revenues for the quarter and six months ended July 2, 2000 have been adjusted to include $1.4 million and $2.4 million of revenue from charging for shipping costs previously treated as an expense recovery. Gross profit. Gross profit for the quarter and six months ended July 1, 2001 decreased by $10.0 million and $12.4 million in-line with the decrease in revenues. Gross margins for the Company saw a small improvement on year ago, although this was a combination of stronger figures in The Netherlands and Germany as the impact of the weak Euro on component costs was recovered through price rises, and weaker figures in U.K., Canada and South Africa due to weak markets, intense price competition and, in the U.K., the disposal of excess inventories at substantially below cost. Selling, general and administrative expenses: Quarter ended Six months ended -------------- ---------------- Jul 2, Jul 1, Jul 2, Jul 1, $ millions 2000 2001 2000 2001 ------ ------ ------ ------ Operating companies ............................ $27.8 $26.7 $54.9 $52.8 Bikeshop.com ................................... 0.6 - 1.1 0.3 Headquarters ................................... 1.9 0.4 3.9 1.4 Corporate expenses ............................. 0.4 1.3 0.8 2.5 Consulting fees ................................ 0.7 (0.4) 1.0 (0.4) ----- ----- ----- ----- Total selling, general and administrative expenses as reported ................. $31.4 $28.0 $61.7 $56.6 ===== ===== ===== ===== Selling, general and administrative expenses. Selling, general and administrative expenses of the operating companies were reduced by $1.1 million and $2.1 million for the quarter and six months ended July 1, 2001 upon translation into U.S. Dollars at the actual rates applicable for each year, due to the relative weakness of European currencies in 2001. In the first quarter, expenses at Raleigh U.K. increased by $0.4 million as they included (i) the higher expenses of the new leased stand alone warehouse for the parts and accessories business, which the Company moved to in May 2000 from its former freehold premises adjoining the U.K. manufacturing site and (ii) higher sales promotional expenses. Bikeshop.com's expenses fell by $0.2 million in the first quarter following its closure then, with no expenses in the second quarter compared with $0.6 million in the second quarter of 2000. Headquarters' expenses for the quarter and six month periods fell by $0.9 million and $1.5 million following the closure of the Stamford office during the first quarter, and were further reduced by $0.5 million and $0.9 million of pension income arising on the Sturmey Archer pension plans for those periods. The Company remains the principal employer under these plans, which were not transferred upon the disposal of the Sturmey Archer business in June 2000. The pension income was included in the results of Sturmey Archer in the 2000 financial statements, which is included in the results from discontinued operations in the comparative figures in the attached statement of operations. Corporate expenses for the quarter and six month periods rose by $1.0 million and $1.8 million, in the main due to legal and accounting monitoring costs reimbursed to the lenders under the Revolving Credit Facility and related expenses. The consulting arrangements have been terminated, and no fees were incurred in 2001. Discounts were obtained on the payment of fees incurred in 2000, resulting in credits in the second quarter of $0.1 million for headquarters' expenses, $0.1 million for corporate expenses and $0.4 million for consulting expenses. 19

Operating income. The underlying operating income of $4.4 million and $8.9 million for the quarter and six months ended July 1, 2001, compares with operating income of $11.0 million and $16.2 million for the quarter and six months ended July 2, 2000. The decrease in operating income of $6.6 million and $7.3 million for the quarter and six month periods was the result of lower gross profit due to lower revenues, without a corresponding reduction in selling, general and administrative expense at the operating companies and high bank monitoring expenses. Restructuring charge, non-recurring items and impairment of property, plant and equipment. The Company has now closed down its domestic bicycle manufacturing plant in Kent, Washington at a cost of $2.6 million expensed in the first quarter, of which $0.5 million was in respect of remaining component inventory that has been expensed in cost of goods sold, $1.5 million was included in the restructuring charge and $0.6 million was expensed as impairment of recoverable value of property, plant and equipment. The Company closed its internet operation, Bikeshop.com, in February 2001, at a cost of $1.5 million, of which $1.0 million was shown as the impairment of the recoverable value of plant and equipment (including software) in the statement of operations for the year ended December 31, 2000 and $0.2 million and $0.5 million were included in the restructuring charge for the quarter and six month periods. Following the closure of the Stamford headquarters, all the remaining employees were terminated, resulting in $0.1 million in termination benefits included in non-recurring items for the first quarter. $2.1 million and $3.0 million of fees for financial advisory services and related professional advice paid by the Company for the review of its business and exploration of alternatives available in order to repay the Revolving Credit Facility have also been included in non-recurring items for the quarter and six months ended July 1, 2001. The expenses increased from the first to the second quarter, as the more recent figures include the expenses of legal counsel and financial advisors to the ad hoc committee of holders of the Senior Notes. 20

Interest expense. Interest expense increased by $0.5 million for both the quarter and six months ended July 1, 2001, due to a $0.3 million and $0.7 million increase in amortization of the deferred financing costs on the Revolving Credit Facility for those periods as a consequence of the shorter term of the facility and the effect of compounding the interest on the $20.0 million 19% subordinated note (the "Subordinated Note"), which added $0.3 million and $0.4 million to interest expense in the quarter and six months ended July 1, 2001. This was offset by the elimination of $0.4 million of interest on a bridge loan in the first quarter of 2000, which was converted into series D-1 preferred stock in November 2000. The interest on the Bridge Loan was paid by way of issue of 2,500 Class C common stock warrants. These warrants were initially valued at $2.9 million in the financial statements for July 2, 2000, but this was re-evaluated in the 2000 annual financial statements as $0.4 million, which has been shown as the comparative figure in the attached financial statements.

The tax charge increased due to the higher income earned in The Netherlands. Taxable losses continue to be made in certain jurisdictions, including Germany, the U.S.A. and the U.K., which cannot be offset against the taxable income in other jurisdictions, including The Netherlands. Net loss. The net loss increased by $1.7 million and $6.4 million in the quarter and six months ended July 1 2001. The higher loss was, in the main, the result of the lower underlying operating income, cost of closure of the U.S. manufacturing plant, financial and professional advice and higher provision for income taxes. Dividends accrued on preferred stock. Dividends accrued on the preferred stock in the quarter and six months ended July 1 2001 increased by $3.8 million and $7.2 million as additional preferred stock was issued in November 2000. 21

EBITDA. EBITDA for the quarter and six months ended July 1 2001 decreased by $7.0 million and $7.6 million below year ago due to the lower underlying operating income. EBITDA represents earnings before interest, taxes, depreciation and amortization. EBITDA is presented because it is a widely accepted supplemental indicator of an entity's ability to incur and service debt. However, EBITDA should not be considered by an investor as an alternative to net income or operating income as an indicator of operating performance, or as an alternative to cash flows as a measure of liquidity. EBITDA is calculated as follows (excluding discontinued operations):

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, firstly, in the U.K., South Africa and Ireland, where consumer sales of bicycles increase in the months preceding Christmas: accordingly, I.B.D.s peak purchasing months in those countries are October and November when they build inventory in anticipation of Christmas sales of juvenile bicycles, and secondly in the U.S.A., where I.B.D.s replenish their inventories in the fall with the next season's model range. 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 reach a minimum at the end of the Peak Season. Net cash flows used by operating activities were reduced by $3.1 million to a $2.4 million outflow for the six months ended July 1 2001 from a $5.5 million outflow in the six months ended July 2, 2000. This improvement of $3.0 million, despite an $11.6 million drop in operating income, resulted from the delayed payment of interest due on the Senior Notes on May 15, 2001 of $7.4 million and $8.1 million less cash 22 used in increasing working capital (defined as receivables, inventories, other current assets, accounts payable and accrued liabilities) compared with year ago. The lower working capital was a consequence of lower revenues, purchases and production than year ago including the cessation of manufacturing in the U.S.A The interest payments on the Senior Notes together with defaulted interest were paid on July 20, 2001. The Company's capital expenditures were $2.1 million in the six months ended July 1, 2001, consisting of (i) on-going cost reduction projects, (ii) replacements and (iii) items required to satisfy statutory environmental and health and safety legislation. Whenever possible, expenditure planned for the six months ended July 1, 2001 has been deferred in order to conserve cash. As discussed below in "Revolving Credit Facility" and "Senior Notes" the Company was in default of the Revolving Credit Agreement (see Note 6) and had defaulted in the payment of interest due on the Senior Notes as at July 1, 2001, but the Revolving Credit Facility was repaid on July 19, 2001 and the outstanding interest on the Senior Notes was paid together with defaulted interest on July 20, 2001. As the Company is no longer in default under the Senior Note Indentures, the Senior Notes continue to be classified as long term debt. See also "Management's Plans". Debt overview. As of July 1, 2001, the Company had $236.3 million of combined indebtedness, comprising $148.0 million of Senior Notes, the $20.0 million Subordinated Note, $62.0 million of borrowings and $4.9 million of letters of credit and guarantees under the Revolving Credit Facility, and $1.3 million of borrowings under a credit facility available to the Company's South African subsidiaries (the "South African Credit Facility"). Disposition of Assets. On July 19, 2001, Derby Nederland B.V., an indirect subsidiary of the Company, sold all of the issued and outstanding shares of its subsidiary, Gazelle, to Gazelle Holding B.V., a company controlled by Gilde Investment Management B.V. and located in The Netherlands (the "Gazelle Sale"). The purchase price was (euro)142.5 million ($125.4 million at the July 19, 2001 exchange rate) in cash, less (euro)11.9 million ($10.5 million at the July 19, 2001 exchange rate) of debt and taxes outstanding of Gazelle as of June 1, 2001, and subject to certain adjustments based on Gazelle's balance sheet as of June 1, 2001. (euro)10.0 million ($8.8 million at the July 19, 2001 exchange rate) of the purchase price was placed in escrow, to be released to the Company upon the determination of certain contingencies. Gazelle constituted a substantial portion of the consolidated assets and operating profits of the Company. The Company estimates that the book gain on disposal of Gazelle will be approximately $66,000,000, net of tax, although only $2,500,000 of the proceeds has been retained by the Issuers (see below for utilization of proceeds). On July 19, 2001 the Company and Lyon Investments B.V. ("Lyon"), pursuant to the terms of the Senior Note Indentures, used portions of the proceeds of the Gazelle Sale to repay or collateralize all the outstanding amounts under the Company's Revolving Credit Facility, which was terminated as a result of such repayment. Additionally, pursuant to the Senior Note Indentures, Lyon and the Company (the "Issuers") have retained the equivalent of $2.5 million for working capital and other corporate purposes. Expenses of the Gazelle Sale, amounting to the equivalent of $4.0 million, were paid. The remaining net Gazelle Sale proceeds of $21.9 million were delivered to the trustees under the Senior Note Indentures on July 19, 2001. The trustees applied $7.4 million of the net Gazelle Sale proceeds to make the interest payments on the Senior Notes that the Issuers had failed to make when due on May 15, 2001. Since completion of the Gazelle Sale, $3.6 million of the proceeds used to collateralize outstanding amounts under the Company's Revolving Credit Facility have been released and $4.1 million due by Gazelle to Derby Nederland B.V. has been paid to the trustees under the Senior Note Indentures. The Senior Note Indentures required the Issuers, after making the payments and retaining the funds as described above, to use any remaining proceeds of the Gazelle Sale (including certain amounts that were to be received post-closing) to make offers to repurchase a portion of the Senior Notes. On July 30, 2000 the Issuers made offers to purchase (the "Offers") for cash up to $14.1 million principal amount of the outstanding Senior Notes. On September 7, 2001, the Issuers amended the Offers to increase the maximum principal amount of outstanding Senior Notes they are offering to purchase to $21.4 million, as a result of the proceeds received from the Gazelle Sale since completion. The deadline for tendering Senior Notes in the Offers has also been extended to September 24, 2001, and the scheduled payment date is now September 27, 2001. To the extent that the Issuers receive more of the proceeds from the Gazelle sale, they may amend the Offers to increase the principal amount of Senior Notes they will offer to purchase, or make additional offers to purchase Senior Notes using such further proceeds. 23 Revolving Credit Facilities. The Revolving Credit Agreement provided for the DM209.4 million ($97.8 million at the July 1, 2001 exchange rate) secured senior revolving credit facility to be made available to the Company's operating and finance subsidiaries until June 30, 2002. Borrowings under this Revolving Credit Agreement were available subject to a borrowing base determined as a percentage of eligible assets. The South African Credit Facility provides for maximum indebtedness of South African Rand 30 million ($3.7 million at the July 1, 2001 exchange rate). The Company's borrowings peak in February, March and April each year. The Revolving Credit Agreement contained a number of covenants that, among other things, restricted the ability of the Company and its subsidiaries to dispose of shares in any subsidiary, dispose of assets, incur additional indebtedness, incur liens and encumbrances, engage in mergers and acquisitions, exercise certain options, make investments, incur guaranty obligations, make loans, make capital distributions, enter into joint ventures, repay the Senior Notes and to 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 Senior Notes. As of July 1, 2001, the Company had indebtedness outstanding under the Revolving Credit Facility of $66.9 million, which was secured and guaranteed by the obligors thereunder through a first priority security interest in all the assets, properties and undertakings of the Company and $1.3 million of borrowings under the South African Credit Facility which are secured by a security interest in certain of the assets of the Company's South African subsidiaries. The Senior Notes are unsecured and, unlike the indebtedness under the Revolving Credit Facility and the South African Credit Facility, do not have the benefit of any collateral. The Company was in breach of the financial covenants under the Revolving Credit Agreement as at December 31, 2000 and July 1, 2001. The Revolving Credit Facility was repaid in full on July 19, 2001 and has been terminated. Senior Notes. The Senior Notes are issued under the Senior Note Indentures. Interest on the Senior Notes is payable semi-annually on May 15 and November 15. As discussed below under "Management's plans", the Company has retained Lazard Freres & Co. L.L.C. ("Lazard") as its financial advisor, and has been working with an informal committee of holders of more than 50% of the principal amount of its Senior Notes (the "Informal Committee") for the purposes of negotiating a consensual restructuring of its outstanding securities. In this regard, the Company filed a voluntary petition for reorganization under the provisions of Chapter 11 of title 11 of the United States Code, 11 U.S.C. Para 101-1330 on August 20, 2001 in the Bankruptcy Court. 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, 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. On July 30, 2001 the Company and Lyon offered to purchase for cash up to $14.1 million principal amount of the outstanding Senior Notes at their par value plus accrued interest thereon, and on September 7, 2001 they amended the Offers to increase the maximum principal amount of Senior Notes they were offering to purchase to $21.4 million. The deadline for tendering Senior Notes in the Offers has also been extended to September 24, 2001, and the scheduled payment date is now September 27, 2001. Management's plans. The Company has retained Lazard as its financial advisor. Lazard advised the Company on the Gazelle Sale and has been exploring all alternatives available to the Company, including the sale of some or all remaining assets and operations. In order both to address its long-term capital and debt service requirements, and in connection with the repayment of the Revolving Credit Facility, the Company began working with the Informal Committee on March 21, 2001, for the purposes of negotiating a consensual restructuring of its outstanding securities. On August 20, 2001 the Company filed a motion in the Bankruptcy Court seeking authorization to consummate an asset purchase agreement between the Company and Cycle Bid Co., a corporation controlled by Alan Finden-Crofts and other executives of the Company. The asset purchase agreement provides for the sale of substantially all of the operations and assets of the Company (the "MBO") for approximately $43 million. Under the terms of the MBO, certain liabilities of the Company including trade 24 accounts payable aggregating approximately $23 million will be assumed by Cycle Bid Co., and approximately $20 million will be paid in cash. The obligations assumed exclude the Senior Notes, the Subordinated Note and certain other excluded liabilities. The conditions leading to the Chapter 11 Filing raise substantial doubt about the Company's ability to continue as a going concern. The condensed consolidated financial statements do not include any adjustments relating to the recoverability and classification of asset carrying amounts or the amount and classification of liabilities that might result should the Company be unable to continue as a going concern. Nevertheless, the Company considers it appropriate to prepare the accompanying condensed consolidated financial statements on the going concern basis of accounting. Accounting for pensions. The Company adopted Statement of Financial Accounting Standards ("SFAS") 87, "Employers' Accounting for Pensions" 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 the 15 years from January 1, 1989, the effective date of SFAS 87. Net periodic pension income was $3.2 million in the six months ended July 1, 2001 compared with $2.7 million in the six months ended July 2, 2000. Net periodic pension income includes amortization of the transition asset into income of $1.1 million in the six months ended July 1, 2001, compared with $1.0 million in the six months ended July 2, 2000. The main pension plans of the Company, which are in the U.K. and The Netherlands, had actuarial surpluses and therefore no employer's contributions were made to those plans in 2000 or 2001. No assurance can be given that the Company can continue to run these pension plans without making employer's contributions to those plans. Derivative financial instruments. The Company uses derivative financial instruments including currency swaps, interest rate swaps, interest rate caps, forward foreign exchange contracts, and currency options. The Company enters into currency and interest rate swaps such that the notional principal amount is equal to the principal amount of the underlying debt. The swaps achieve the effect of synthetically converting the original U.S. Dollar denominated debt into several other foreign currencies and converting the interest rate on the debt from U.S. Dollar rates to those applicable for that currency. During the fall of 1998 the Company entered into forward foreign exchange contracts and options to minimize the impact of currency movements in the following season, principally on purchases of inventory and sales of goods denominated in currencies other than the subsidiaries' functional currencies. This program was curtailed for 2000 and 2001 to release the credit line for an increased debt requirement. Consequently the Company is almost completely exposed at present to the full impact on margins of any adverse changes in foreign exchange rates. Interest rate caps were purchased in 1998 to limit the blended interest rate paid on the Revolving Credit Facility to under 8.5% until July 2001. Separately from the Company's seasonal hedging program, currency options were purchased in 1998 to substantially maintain the value of most 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 interest rate caps and currency options purchased in 1998 covered a basket of currencies, and therefore could not be designated as hedges under SFAS 133. ITEM 3. 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 may enter into a variety of foreign currency and interest rate contracts and options. 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 generally introduces its new bicycle model ranges 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. In the fall of 1998 the Company initiated foreign currency forward exchange contracts or options to hedge a portion of its foreign currency trading transaction exposure for the upcoming season. This program was substantially curtailed for the 1999/2000 and 25 2000/2001 seasons in order to release more of the Revolving Credit Facility for the incurrence of additional borrowing. The curtailment of the hedging program has resulted in the Company being almost completely exposed at present to the full impact on margins of any adverse changes in foreign exchange rates. At July 1, 2001 the Company had no foreign exchange contracts. 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 would not generally hedge its transaction exposure beyond the end of the season, to stay competitive, and management believes the likelihood of obtaining a competitive advantage would not justify the cost of hedging beyond the end of the season. As noted above, the Company subsequently curtailed this program for 2000 and 2001. Sales and purchases in currencies other than the functional currencies in which the Company operates were $6.6 million and $109.0 million respectively in 2000. The foreign currency element of the Company's debt under the Senior Notes and under the Revolving Credit Facility (now repaid in full and terminated) had generally been arranged to align with the denomination of the book value of net assets. By doing this, the Company reduced the translation exposure of net worth to changes in foreign currency exchange rates. The three principal exceptions were: (i) $21 million of net assets denominated in Pounds Sterling arising from the Company's former large presence in U.K., (ii) $43 million of foreign pension assets in U.K. and The Netherlands, and, (iii) $5 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. The Company generates most of its trading income in foreign currencies. In order to ensure that such trading income could be converted to yield sufficient U.S. Dollars to service 67% of the interest on the $100 million Dollar Senior Notes through May 2001, currency options were purchased in 1998. These currency options were for $6.7 million per year, selling NLG6 million, (Pounds) 2 million and C$1.2 million. These currency options covered a basket of currencies, and therefore could not be designated as hedges under SFAS 133. Interest Rate Risk Interest expense relating to the Senior Notes was $15.6 million and $15.4 million in 1999 and 2000 respectively, which were at fixed interest rates. Interest expense of $5.0 million on the Subordinated Note in 2000 is accrued and falls due for payment on February 3, 2009. The fair value of warrants given as consideration for the use of the Bridge Loan of $0.4 million was expensed as interest in 2000. The other major element of the Company's interest expense was $4.3 million and $4.8 million on the Revolving Credit Facility in 1999 and 2000 respectively. These were at floating rates of 2.0% above the London Interbank Offer Rate through August 31, 1999, 2.5% through November 22, 2000 and 2.75% thereafter. A hypothetical one percentage point shift in floating interest rates would have made a $0.6 million approximate impact on annual interest expense. As interest rates on the Revolving Credit Facility were capped at 8.5% effective August 1998 through July 2001, increases in floating interest rates above that level would only have had a limited impact on interest expense up to July 2001. The interest rate cap purchased covered a basket of currencies, and therefore could not be designated as a hedge under SFAS 133. Commodity Price Risk The business of the Company does not carry a significant direct exposure to the prices of commodities. Risk of Foreign Exchange Rate Fluctuations 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. 26 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 to effectively 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. Forward Looking Statements This discussion contains certain forward-looking statements that involve risks and uncertainties. In addition, the Company may from time to time make oral forward-looking statements. As discussed in the Company's prospectus on Form S-4A filed with the SEC on December 4, 1998 and its later public filings, actual results are uncertain and may be impacted by various factors. In particular, certain risks and uncertainties that may impact the accuracy of the forward-looking statements with respect to revenues, expenses and operating results include, without limitation, cycles of customer orders, general economic and competitive conditions and changing consumer trends, foreign exchange rates, technological advances and the number and timing of new product introductions, shipments of products and componentry from foreign suppliers, the timing of operating and advertising expenditures and changes in the mix of products ordered by I.B.D.s and mass merchandisers. As a result, actual results may differ materially from those projected in forward-looking statements. Because of these and other factors that may affect the Company's operating results, past financial performance should not be considered an indicator of future performance, and investors should not use historical trends to anticipate results or trends in future periods. 27 PART II ------- ITEM 1. LEGAL PROCEEDINGS Product Liability Due to the nature of the Company's business, the Company at any particular time is a defendant in a number of product liability lawsuits and expects that this will continue to be the case in the future. The plaintiffs in these lawsuits generally seek damages, in amounts that may be material, for personal injuries allegedly sustained as a result of alleged defects in the Company's products. Although the Company maintains product liability insurance, due to the uncertainty as to the nature and extent of manufacturers' and distributors' liability for personal injuries, there can be no assurance that the product liability insurance maintained by the Company is or will be adequate to cover product liability claims or that the applicable insurer will be solvent at the time of any covered loss. In addition, due to deductibles, self-retention levels and aggregate coverage amounts applicable under the Company's insurance policies, the Company may bear responsibility for a significant portion, if not all, of the defense costs (which include attorneys' fees and expenses incurred in the defense of any claim) and the related payments to satisfy any judgments associated with any claim asserted against the Company in excess of any applicable coverage. The settlement of a significant number of insured claims, the settlement of a claim exceeding the Company's insurance coverage or the successful assertion or settlement of an uninsured claim could have a material adverse effect on the Company's business, results of operations and financial condition. In addition, there can be no assurance that insurance will remain available, or, if available, will not be prohibitively expensive. The self-insured retention under the Company's insurance policies is currently $125,000 per claim for domestic claims and $1,000 for foreign claims; however, prior to 1993, the self-insured retention for domestic claims was $1.0 million per claim. Not all claims arising during the period in which the Company's self-insured retention for domestic claims was $1.0 million have been resolved and it is possible that additional claims may be filed. The aggregate amount of liability under existing and potential claims, so far as they are not covered by insurance, could exceed the reserves of $184,000 established by the Company as at July 1, 2001 for product liability claims. Product Recalls Although the Company has not recently experienced a significant product recall, the Company has, in the past, recalled certain bicycle models. If the Company were required to make a significant product recall, such a recall could have a material adverse effect on the Company's business, financial condition or results of operations. In common with the rest of the bicycle industry, components fitted to its bicycles may be subject to a recall program of the component supplier. Liability For Environmental Matters The Company is subject to a wide variety of governmental requirements related to environmental protection including, among other things, the management of hazardous substances and wastes. Although the Company has made and will continue to make significant expenditures related to its environmental compliance obligations, there can be no assurance that the Company will at all times be in compliance with all such requirements. Moreover, the Company's existing and historical operations, including the operations of its predecessors, expose the Company to the risk of clean-up liabilities or environmental or personal injury claims related to releases and emissions of hazardous substances and wastes. Such liabilities and claims could require the Company to incur material costs related to such releases or to the investigation or remediation of contaminated property. Also, changes in existing environmental requirements or the imposition of additional environmental liabilities related to existing or historical operations could result in substantial cost to the Company. 28 ITEM 3. DEFAULTS UPON SENIOR SECURITIES The Company was in default under its Revolving Credit Facility, and was in default in a payment of interest due on the Senior Notes. On July 19, 2001 the Company repaid the Revolving Credit Facility. On July 20, 2001 the Company paid all outstanding interest due on its Senior Notes, together with defaulted interest. The Company filed a voluntary petition for relief with the Bankruptcy Court under the provisions of Chapter 11 of title 11 of the United States Code, 11 U.S.C. Para 101-1330 on August 20, 2001. See "Management's Discussion and Analysis of Financial Condition and Results of Operations - Liquidity and Capital Resources". ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K (a) Exhibits. See " Index to Exhibits" set forth on page 31. (b) Reports on Form 8-K. The Company filed a Current Report on Form 8-K on May 15, 2001 relating to Item 5. Other Events, announcing it would not make its scheduled interest payment on its Senior Notes. The Company filed a Current Report on Form 8-K on June 6, 2001 relating to Item 5. Other Events, announcing that it had received a bid from certain members of its management. The Company filed a Current Report on Form 8-K on June 18, 2001 relating to Item 5. Other Events, announcing that it had entered into a Sale and Purchase Agreement relating to its indirect subsidiary, Koninklijke Gazelle B.V.. 29 SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this Quarterly Report on Form 10-Q to be signed on its behalf by the undersigned, thereunto duly authorized, on October 17, 2001. The Derby Cycle Corporation By: /s/ Alan J. Finden-Crofts ------------------------------------ ALAN J. FINDEN-CROFTS EXECUTIVE CHAIRMAN By: /s/ John C. Burdett ------------------------------------ JOHN C. BURDETT CHIEF FINANCIAL OFFICER By: /s/ Simon J. Goddard ------------------------------------ SIMON J. GODDARD VICE PRESIDENT AND CORPORATE CONTROLLER 30 INDEX TO EXHIBITS Exhibit Description No. ----------- --- 2.1 Sale and Purchase Agreement dated June 15, 2001 for the sale of Koninklijke Gazelle B.V. between Derby Nederland B.V., the Purchaser, The Derby Cycle Corporation as Warrantor and Gazelle Holding B.V., the Buyer (Incorporated by reference to exhibit 10.1 to the Company's current report on Form 8-K filed with the Commission on July 2, 2001, Commission File Number 0001067447). 31

DERBY CYCLE CORP 10-Q