<PAGE>   1

                                  UNITED STATES
                       SECURITIES AND EXCHANGE COMMISSION
                             Washington, D.C. 20549

                                    FORM 10-Q

(Mark One)

[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
    ACT OF 1934.

    For the quarterly period ended June 30, 2001.

[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
    ACT OF 1934.

    For the transition period from _______ to _______

                        Commission File Number 333-61119

                              AAI.FOSTERGRANT, INC.
             (Exact name of registrant as specified in its charter)

          RHODE ISLAND                                        05-0419304
(State or other jurisdiction of                            (I.R.S. Employer
incorporation or organization)                          Identification Number)

                          500 GEORGE WASHINGTON HIGHWAY
                              SMITHFIELD, RI 02917
               (Address of principal executive offices) (Zip code)

                                 (401) 231-3800
              (Registrant's telephone number, including area code)

Indicate by checkmark 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:

    As of August 14, 2001, the aggregate market value of the voting equity held
by non-affiliates of the Registrant was none.

    As of August 14, 2001, 608,000 shares of Common Stock, 43,700 shares of
Series A Preferred Stock and 70,870 shares of Series B Preferred Stock of the
Registrant were issued and outstanding.



<PAGE>   2


                     AAI.FOSTERGRANT, INC. AND SUBSIDIARIES

                                QUARTERLY REPORT
                                TABLE OF CONTENTS


                                                                          PAGE
PART I. - FINANCIAL INFORMATION

     ITEM 1. CONSOLIDATED CONDENSED FINANCIAL STATEMENTS

             Consolidated Condensed Balance Sheets as of December 30,
             2000 and June 30, 2001                                           3

             Consolidated Condensed Statements of
             Operations for the three and six months ended July 1, 2000
             and June 30, 2001                                                4

             Consolidated Condensed Statements of Cash Flows
             for the six months ended July 1, 2000 and June 30, 2001          5

             Notes to Consolidated Condensed Financial Statements          6-16

     ITEM 2. Management's Discussion and Analysis of Financial
              Condition and Results of Operations                         17-22

     ITEM 3. Quantitative and Qualitative Disclosures About
              Market Risk                                                 22-23

PART II - OTHER INFORMATION

     ITEM 1. Legal Proceedings                                               24

     ITEM 2. Changes in Securities and Use of Proceeds                       24

     ITEM 3. Defaults Upon Senior Securities                                 24

     ITEM 4. Submission of Matters to a Vote of Security Holders             24

     ITEM 5. Other Information                                               24

     ITEM 6. Exhibits and reports on Form 8-K                                24

SIGNATURES                                                                   25


                                       2

<PAGE>   3


                     AAI.FOSTERGRANT, INC. AND SUBSIDIARIES

                      CONSOLIDATED CONDENSED BALANCE SHEETS
                                 (In thousands)
<TABLE>
<CAPTION>




                                                    ASSETS                              DECEMBER 30,    JUNE 30,
                                                                                            2000          2001
                                                                                        -----------    ---------
<S>                                                                                      <C>            <C>
CURRENT ASSETS:
   Cash and cash equivalents                                                             $     578     $   1,497
   Accounts receivable less reserves of approximately $9,370 and $10,737                    32,839        23,615
   Inventories                                                                              33,083        24,146
   Prepaid expenses and other current assets                                                 1,280         1,154
   Deferred tax assets                                                                         980           980
                                                                                         ---------     ---------
       Total current assets                                                                 68,760        51,392
                                                                                         ---------     ---------
Property, plant and equipment, net                                                          18,658        18,047
Intangible assets                                                                           12,830        12,501
Other assets                                                                                 5,914         5,467
Deferred tax assets                                                                          2,009         2,009
                                                                                         ---------     ---------
       Total assets                                                                      $ 108,171     $  89,416
                                                                                         =========     =========

                                    LIABILITIES AND SHAREHOLDERS' DEFICIT

CURRENT LIABILITIES:
   Borrowings under revolving note payable                                               $  25,263     $  19,623
   Current maturities of long-term obligations                                               1,427         1,780
   Deferred compensation - current portion                                                      10            12
   Accounts payable                                                                         21,380        14,538
   Accrued expenses                                                                         17,678        15,116
   Accrued income taxes                                                                      2,403         2,733
                                                                                         ---------     ---------
       Total current liabilities                                                            68,161        53,802
                                                                                         ---------     ---------

10 3/4% series B senior notes due 2006                                                      51,850        51,850
Long-term obligations - less current maturities                                              6,561         5,669
Deferred compensation - less current portion                                                 1,287         1,521
Series A  redeemable convertible Preferred stock, $.01 par value --
   Designated, issued and outstanding -- 43,700 shares stated at redemption value           35,147        36,895
Series B redeemable Preferred stock, $.01 par value --
   Designated -- 75,000 shares
   Issued and outstanding - 70,870 shares stated at redemption value                           945         1,129

SHAREHOLDERS' DEFICIT:
      Common stock, $.01 par value -- Authorized -- 4,800,000 shares
        Issued and outstanding -- 608,000 shares                                                 6             6
      Additional paid-in capital                                                               270           270
      Accumulated other comprehensive loss                                                    (575)       (1,058)
      Accumulated deficit                                                                  (55,481)      (60,668)
                                                                                         ---------     ---------
          Total shareholders' deficit                                                      (55,780)      (61,450)
                                                                                         ---------     ---------
Total liabilities and shareholders' deficit                                              $ 108,171     $  89,416
                                                                                         =========     =========
</TABLE>


                 The accompanying notes are an integral part of
               these consolidated condensed financial statements.


                                       3
<PAGE>   4


                     AAI.FOSTERGRANT, INC. AND SUBSIDIARIES

                 CONSOLIDATED CONDENSED STATEMENTS OF OPERATIONS
                                 (In thousands)

<TABLE>
<CAPTION>


                                                            THREE MONTHS ENDED                SIX MONTHS ENDED
                                                         -----------------------          -----------------------
                                                         JULY 1,         JUNE 30,         JULY 1,        JUNE 30,
                                                          2000             2001            2000            2001
                                                         -------         -------          -------         -------
<S>                                                      <C>             <C>              <C>             <C>
NET SALES                                                $45,707         $38,273          $88,235         $68,372
COST OF GOODS SOLD                                        25,529          21,338           49,111          39,304
                                                         -------         -------          -------         -------
   Gross profit                                           20,178          16,935           39,124          29,068

OPERATING EXPENSES:
   Selling                                                12,062           9,609           23,505          18,287
   General and administrative                              4,539           3,728            9,129           8,251
   Restructuring charge                                       --             338            2,500             338
                                                         -------         -------          -------         -------
      Income from operations                               3,577           3,260            3,990           2,192
Interest expense                                          (2,851)         (2,489)          (5,448)         (5,056)
Other income (expense), net                                   94             (59)             145             (14)
Equity in losses of investment in affiliates                  --             (84)              --             (98)
                                                         -------         -------          -------         -------
Income (loss) before income tax expense                      820             628           (1,313)         (2,976)
Income tax expense                                            43             380               43             462
                                                         -------         -------          -------         -------
Net income (loss) before extraordinary items                 777             248           (1,356)         (3,438)
Extraordinary gain, net of $3.2 million in taxes           4,429              --            4,429              --
                                                         -------         -------          -------         -------
Net income (loss) before dividends and accretion
  on preferred stock                                       5,206             248            3,073          (3,438)

Dividends and accretion on preferred stock                   801             885            1,588           1,749
                                                         -------         -------          -------         -------
Net income (loss) applicable to common shareholders      $ 4,405         $  (637)         $ 1,485         $(5,187)
                                                         =======         =======          =======         =======
</TABLE>

                 The accompanying notes are an integral part of
               these consolidated condensed financial statements.

                                       4

<PAGE>   5


                     AAI.FOSTERGRANT, INC. AND SUBSIDIARIES

                 CONSOLIDATED CONDENSED STATEMENTS OF CASH FLOWS
                                 (In thousands)
<TABLE>
<CAPTION>

                                                                                            SIX MONTHS ENDED
                                                                                        ------------------------
                                                                                         JULY 1,        JUNE 30,
                                                                                          2000            2001
                                                                                        --------       ---------
<S>                                                                                     <C>            <C>
   CASH FLOWS FROM OPERATING ACTIVITIES:
       Net income (loss) before dividends and accretion on preferred stock              $  3,073       $ (3,438)
       Adjustments to reconcile net loss to net cash used in operating activities-
       Depreciation and amortization                                                       6,039          5,590
       Extraordinary gain on early extinguishment of debt                                 (4,429)            --
       Amortization of interest costs related to debt                                        272            683
       Equity in losses of investments in affiliates                                          --             98
       Changes in assets and liabilities, net of acquisitions -
         Accounts receivable                                                              (6,704)         8,759
         Inventories                                                                      (5,164)         8,484
         Prepaid expenses and other current assets                                           212            120
         Deferred costs                                                                     (230)           (83)
         Accounts payable                                                                  6,116         (6,497)
         Accrued expenses                                                                   (792)        (2,429)
         Accrued income taxes                                                                 26            330
                                                                                        --------       --------
                Net cash (used in) provided by operating activities                       (1,581)        11,617
                                                                                        --------       --------
   CASH FLOWS FROM INVESTING ACTIVITIES
       Purchases of property, plant and equipment                                         (5,534)        (4,476)
       (Increase) decrease in other assets                                                  (179)             2
                                                                                        --------       --------
               Net cash used in investing activities                                      (5,713)        (4,474)
                                                                                        --------       --------
   CASH FLOWS FROM FINANCING ACTIVITIES:
       Net borrowings (repayments) under revolving note payable                            8,564         (5,640)
       Proceeds from issuance of long-term debt                                            2,750             --
       Repurchase of 10 3/4% Series B Senior Notes due 2006                               (2,750)            --
       Payments on long term obligations and deferred compensation                          (677)          (544)
       Redemption of Preferred Stock of a subsidiary                                      (1,000)            --
                                                                                        --------       --------

               Net cash provided by (used in) financing activities                         6,887         (6,184)
                                                                                        --------       ---------
       Effect of exchange rate changes on cash and cash equivalents                          (97)           (40)

   NET (DECREASE) INCREASE IN CASH AND CASH EQUIVALENTS                                     (504)           919
   CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD                                          2,289            578
                                                                                        --------       --------
   CASH AND CASH EQUIVALENTS, END OF PERIOD                                             $  1,785       $  1,497
                                                                                        ========       ========
   SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
      Cash paid during the period for-
         Interest                                                                       $  5,355       $  5,080
                                                                                        ========       ========
         Income taxes                                                                   $     40       $    108
                                                                                        ========       ========
   SUPPLEMENTAL DISCLOSURE OF NON-CASH ACTIVITIES:
         Acquisition of equipment under capital lease obligations                       $    557       $     --
                                                                                        ========       ========
         Issuance of Series B Preferred Stock in connection with debt repurchase        $    367       $    184
                                                                                        ========       ========
</TABLE>

                 The accompanying notes are an integral part of
               these consolidated condensed financial statements.


                                       5
<PAGE>   6


                     AAI.FOSTERGRANT, INC. AND SUBSIDIARIES

              NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS

Note 1 - Significant Accounting Policies

    (a) Interim Consolidated Condensed Financial Statements

    The accompanying unaudited interim consolidated condensed financial
statements have been prepared in accordance with generally accepted accounting
principles for interim financial information and pursuant to the rules and
regulations of the Securities and Exchange Commission (SEC) for reporting on
Form 10-Q. Accordingly, certain information and footnote disclosure required for
complete financial statements are not included herein. It is recommended that
these financial statements be read in conjunction with the consolidated
financial statements and related notes of AAi.FosterGrant, Inc. (the "Company"
or "AAi") for the year ended December 30, 2000 as reported in the Company's 10-K
filed with the SEC on March 29, 2001. In the opinion of management, all
adjustments (consisting of normal, recurring adjustments) considered necessary
for a fair presentation of financial position, results of operations and cash
flows at the dates and for the periods presented have been included. The
consolidated condensed balance sheet presented as of December 30, 2000 has been
derived from the consolidated financial statements that have been audited by the
Company's independent public accountants. The results of operations for the
period ended June 30, 2001 may not be indicative of the results that may be
expected for the year ending December 29, 2001, or for any other future period.

    (b) Revenue Recognition

    The Company recognizes revenue from product sales, net of estimated agreed
upon future allowances and anticipated returns and discounts, taking into
account historical experience, upon shipment to the customer.

    (c) Inventories

    Inventories are stated at the lower of cost (first-in, first-out) or market
and consist of the following at December 30, 2000 and June 30, 2001 (in
thousands):

                                                 DECEMBER 30,        JUNE 30,
                                                    2000              2001
                                                 ------------       ---------


      Finished goods............................  $ 26,881          $  21,156
      Work-in-process and raw materials.........     6,202              2,990
                                                  --------          ---------
                                                  $ 33,083          $  24,146
                                                  ========          =========

    (d) Customer Acquisition Costs

    The Company incurs direct and incremental costs in connection with the
acquisition of certain new customers and new store locations from existing
customers under multi-year agreements. The Company may also receive the previous
vendor's merchandise from the customer in connection with these agreements. In
these situations, the Company values this inventory at its fair market value,
representing the lower of cost or net realizable value, and records that value
as inventory. The Company sells this inventory through various liquidation
channels. Except as provided below, the excess costs over the fair market value
of the inventory received is charged to selling expense when incurred. The
Company expensed customer acquisition costs of approximately $225,000 and
$372,000 for the three and six months ended July 1, 2000 and $31,000 and $44,000
for the three and six months ended June 30, 2001, respectively.

    The excess costs over the fair market value of the inventory received is
capitalized as deferred costs and amortized over the agreement period if the
Company enters into a minimum purchase agreement with the customer from which
the estimated gross profits from future minimum sales during the term of the
agreement are sufficient to recover the amount of the deferred costs. The
Company capitalized costs of approximately $230,000 during the three and six
months ended July 1, 2000. During the three and six months ended June 30, 2001
the Company capitalized approximately $47,000 and $87,000, respectively, of
these costs. Amortization expense related to these costs as well as previously
capitalized costs was approximately $339,000 and $659,000 for the three and six
months ended July 1, 2000 and $93,000 and $177,000 for the three and six months
ended June 30, 2001, respectively.


                                       6
<PAGE>   7

Note 2 - Long-Term Obligations

    On July 21, 1998, the Company sold $75.0 million of 10 3/4% Senior Series A
Notes due 2006 (the Notes) through a Rule 144A offering. The net proceeds of
approximately $71.3 million received by the Company from the issuance and sale
of the Notes were used to repay outstanding indebtedness under the credit
facility with a bank and certain subordinated promissory notes to shareholders,
net of amounts due the Company from certain of these shareholders. The Company
incurred issuance costs of approximately $3.7 million in relation to the Notes.
These costs are being amortized over the life of the Notes and are included in
other assets in the accompanying consolidated balance sheets. In December 1998,
the Notes were exchanged for 10 3/4% Series B Notes due 2006 registered with the
SEC. Interest on the Series B Notes is payable semiannually on January 15 and
July 15.

    The Notes are general unsecured obligations of the Company, rank senior in
right of payment to all future subordinated indebtedness of the Company and rank
pari passu in right of payment to all existing and future unsubordinated
indebtedness of the Company including the bank credit facility. Accounts
receivable and inventory of the Company and its domestic subsidiaries secure the
bank credit facility. Accordingly, the Company's obligations under the bank
credit facility will effectively rank senior in right of payment to the Notes to
the extent of the assets subject to such security interest. The Notes are fully
and unconditionally guaranteed, on a joint and several basis, by each of the
Company's current and future Domestic Subsidiaries (as defined) (the
Guarantors). The Indenture under which the Notes were issued (the Indenture)
imposes certain limitations on the ability of the Company, and its subsidiaries
to, among other things, incur indebtedness, pay dividends, prepay subordinated
indebtedness, repurchase capital stock, make investments, create liens, engage
in transactions with shareholders and affiliates, sell assets and engage in
mergers and consolidations. At June 30, 2001 management believes the Company was
in compliance with these covenants.

    The Notes are redeemable at the option of the Company, in whole or in part,
on or after July 15, 2002 at various redemption prices, declining from 105.375%
of the principal amount to par on and after July 15, 2004. In addition, on or
prior to July 15, 2001, the Company may use the net cash proceeds of one or more
equity offerings to redeem up to 35% of the aggregate principal amount of the
Notes originally issued at a redemption price of 110.750% of the principal
amount thereof plus accrued interest to the date of redemption. Upon a change of
control, each Note holder has the right to require the Company to repurchase
such holder's Notes at a purchase price of 101% of the principal amount plus
accrued interest.

    During the second quarter of fiscal 2000, the Company repurchased $10.75
million face amount of the Notes for a purchase price of $2.75 million. In
addition, during the third quarter of fiscal 2000, the Company repurchased an
additional $12.4 million face amount of the Notes for a purchase price of $4.34
million. The purchase price was financed utilizing a term loan under its
existing senior credit facility (the "Senior Credit Facility"). The term loan is
secured by a mortgage on its Smithfield, RI property and subject to the
obligation of certain preferred shareholders to purchase participations in the
term loan upon the happening of certain events. The term loan is being amortized
over 60 months commencing April 1, 2001, with the principal balance due at the
expiration of the Senior Credit Facility on July 31, 2003. As a result of the
second quarter Note repurchase, the Company recognized $4.4 million
extraordinary gain, net of $3.2 million in taxes, and wrote off $42,000 of
unamortized issuance costs related to the $10.75 million of Notes that were
repurchased. These purchases resulted from inquiries from holders of the Notes.
The Company does not solicit offers to tender Notes for repurchase, but may,
from time to time, consider requests to repurchase Notes, subject to the
availability of appropriate financing.

    In conjunction with the commitment to purchase participations in the term
loan, the Company issued 70,870 shares of Series B Preferred Stock. The holders
of Series B Preferred Stock are entitled to receive, prior and in preference to
any distribution with respect to any other capital stock of the Company, an
amount per share equal to $6.67 multiplied by the number of six month periods
and fractions thereof in the period during which the participation commitment is
outstanding. The Company is amortizing the value related to each six-month
participation commitment to interest expense. As the participation commitment is
extended for additional six-month periods, the Company is recording additional
value to the Series B Preferred Stock and amortizing the related costs over the
additional period of the participation commitment as required. During the six
months ended June 30, 2001, the Company recorded additional value to the Series
B Preferred Stock of $184,000.

Note 3 - Senior Credit Facility

    In May 2001, the Company amended its Senior Credit Facility. Borrowings
under the Senior Credit Facility are limited to the lesser of $60.0 million or
the borrowing base, which is defined as a percentage of eligible accounts
receivable and the lesser of (i) inventories or (ii) $30.0 million less the
interest rate protection reserve and the foreign exchange exposure, reduced by
outstanding letters of credit. Revolving credit borrowings bear interest at the
bank's prime rate (7.75% at June 30, 2001) plus 0.5% or LIBOR (3.77% at June 30,
2001) plus 2.75%. The Company has the option of electing the rate; however, the
use of LIBOR is limited. The

                                       7

<PAGE>   8

Senior Credit Facility expires July 2003. As of June 30, 2001, the Company had
approximately $1.8 million borrowing availability under the Senior Credit
Facility.

    The Senior Credit Facility is subject to certain restrictive covenants,
including a fixed charge coverage ratio, leverage ratio and minimum EBITDA. As
of June 30, 2001, the Company was not in compliance with certain financial
covenants. As of August 13, 2001 the Company received a verbal waiver for such
noncompliance from the bank and expects a formal written waiver to be received
shortly. The company is currently negotiating its financial covenants going
forward so that they reflect performance levels that the Company believes it can
attain.

Note 4 - Comprehensive Income (Loss)

    Comprehensive income (loss) for the three and six months ended June 30, 2001
was $0.2 million and ($3.0) million, respectively, as compared to comprehensive
income for the three and six months ended July 1, 2000 of $4.7 million and $2.4
million, respectively. Differences between comprehensive income (loss) and
income (loss) before dividends and accretion on preferred stock for each period
represents the foreign currency translation adjustment for each period.

Note 5 - Restructuring Charge

    In March 2000, the Company recorded a restructuring charge of $2.5 million
related to the termination of three executives. The charge consists of an
accrual of severance payments due to three executives for a two-year period. The
severance will be paid through fiscal 2002.

    In May 2001, the Company recorded a restructure charge of $0.3 million
related to one senior executive. In addition, in July 2001, the Company took
steps to realign its organization and reduce operating costs that resulted in a
workforce reduction. As a result, the Company will recognize a third quarter
charge of approximately $0.3 million.

<TABLE>
<CAPTION>


                           March 2000            Fiscal 2000            May 2001            Fiscal 2001      Restructuring Balance
Description           Restructuring Charge        Payments        Restructuring Charge       Payments          At June 30, 2001
-----------           --------------------        --------        --------------------       --------          ----------------
<S>                           <C>                    <C>                 <C>                   <C>                  <C>
Severance benefits            $2,500                 $896                $338                  $1,062               $880
                              ======                 ====                ====                  ======               ====
</TABLE>


Note 6 - New Accounting Standards

    In June 2001, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards (SFAS) No. 141, "Business
Combinations". SFAS 141 requires all business combinations initiated after June
30, 2001 to be accounted for using the purchase method. The Company does not
expect the adoption of this statement to have a material impact on their
operations.

    In June 2001, the FASB issued Statement of Financial Accounting Standards
(SFAS) No. 142, "Goodwill and Other Intangible Assets". With the adoption of
SFAS No. 142, goodwill is no longer subject to amortization over its estimated
useful life, but instead goodwill is subject to at least an annual assessment
for impairment by applying a fair-value-based test. The Company will adopt this
statement at the beginning of fiscal year 2002. The Company is currently
assessing the impact of this pronouncement.

Note 7 - Segment Reporting

    The Company has determined it has three reportable segments: mass
merchandisers, chain drug stores/combo stores/supermarkets, and variety stores.
The Company distributes accessories such as, costume jewelry, optical products,
watches, clocks and other accessories.

    The Company's reportable segments are strategic business units that sell the
Company's products to distinct distribution channels. They are managed
separately because each business requires different marketing strategies. The
Company's approach is based on the way that management organizes the segments
within the enterprise for making operating decisions and assessing performance.

    The accounting policies of the segments are the same as those described in
the summary of significant accounting policies. The Company evaluates
performance based on profit or loss from operations before income taxes not
including nonrecurring gains and losses.

                                       8

<PAGE>   9

<TABLE>
<CAPTION>

                                                       CHAIN DRUG
      THREE MONTHS                                    STORES/COMBO
          ENDED                    MASS                  STORES/
      JULY 1, 2000             MERCHANDISERS          SUPERMARKETS              VARIETY              OTHER             TOTAL
-----------------------        -------------          ------------              -------             ------           --------
<S>                              <C>                    <C>                     <C>                 <C>              <C>
Net sales                        $ 27,492               $ 10,023                $5,447              $2,745           $ 45,707
                                 ========               ========                ======              ======           ========
Segment profit                   $    467               $    187                $   47              $   24           $    725
                                 ========               ========                ======              ======           ========
</TABLE>

<TABLE>
<CAPTION>
                                                       CHAIN DRUG
      THREE MONTHS                                    STORES/COMBO
          ENDED                    MASS                  STORES/
      JUNE 30, 2001            MERCHANDISERS          SUPERMARKETS              VARIETY              OTHER             TOTAL
-----------------------        -------------          ------------              -------             ------           --------
<S>                              <C>                    <C>                     <C>                 <C>              <C>
Net sales                        $ 24,377               $  8,181                $4,498              $1,217           $ 38,273
                                 ========               ========                ======              ======           ========
Segment profit                   $  1,119               $    387                $ (466)             $ (254)          $    786
                                 ========               ========                =======             =======          ========
</TABLE>

<TABLE>
<CAPTION>
                                                       CHAIN DRUG
       SIX MONTHS                                     STORES/COMBO
          ENDED                    MASS                  STORES/
      JULY 1, 2000             MERCHANDISERS          SUPERMARKETS              VARIETY              OTHER              TOTAL
-----------------------        -------------          ------------             --------             ------            --------
<S>                              <C>                    <C>                    <C>                  <C>               <C>
Net sales                        $ 51,147               $ 20,066               $ 12,750             $4,272            $ 88,235
                                 ========               ========               ========             ======            ========
Segment profit (loss)            $  1,402               $    910               $   (687)            $ (582)           $  1,043
                                 ========               ========               ========             ======            ========
</TABLE>

<TABLE>
<CAPTION>
                                                       CHAIN DRUG
       SIX MONTHS                                     STORES/COMBO
          ENDED                    MASS                  STORES/
      JUNE 30, 2001            MERCHANDISERS          SUPERMARKETS              VARIETY              OTHER              TOTAL
-----------------------        -------------          ------------             --------             ------            --------
<S>                              <C>                    <C>                    <C>                  <C>               <C>
Net sales                        $ 40,491               $ 16,904               $  8,595             $2,382            $ 68,372
                                 ========               ========               ========             ======            ========
Segment profit (loss)            $    688               $    883               $ (1,198)            $ (669)           $   (296)
                                 ========               ========               =========            ======            ========
</TABLE>

    Revenues from segments below the quantitative thresholds are attributable to
five operating segments of the Company. Those segments include department
stores, armed forces' PX stores, boutique stores, gift shops, bookstores and
catalogues. None of these segments have ever met any of the quantitative
thresholds for determining reportable segments and their combined results are
presented as Other.

    Segment profit (loss) differs from the profit (loss) before income tax
expense and dividends and accretion on preferred stock by the amount of other
income, restructure charge and extraordinary items which are not allocated by
segment. The chief operating decision-maker does not review segment assets.

    Total assets specifically identifiable with each reportable segment are as
follows:

                                                  DECEMBER 30,       JUNE 30,
                                                      2000            2001
                                                 -------------     ----------

Mass merchandisers                                $   22,497       $   19,058
Chain drug stores/combo stores/supermarkets            7,795            8,487
Variety                                                4,631            2,081
Other                                                  2,701            3,523
Unassigned assets                                     70,547           56,267
                                                  ----------       ----------
                                                  $  108,171       $   89,416
                                                  ==========       ==========

Note 8 - Sale of Fantasma Product Lines

    On April 6, 2001, the Company sold the majority of its remaining inventory
related to the Fantasma product lines (watches and clocks) and related licenses
to sell the product lines. The sales price of approximately $344,000 consisted
of approximately $294,000 of cash and $50,000 to be placed in escrow to fund
future customer credits taken on sales made by the Company prior to the
transaction date. The Buyer did not assume trade receivables and remaining
liabilities related to Fantasma.

Note 9 - Supplemental Consolidating Financial Information

    The following is summarized consolidating financial information for the
Company, segregating the Company, wholly owned guarantor subsidiaries and
non-guarantor subsidiaries as they relate to the Notes. The wholly owned
guarantor subsidiaries are


                                       9
<PAGE>   10


domestic subsidiaries of the Company and they guarantee the Notes on a full,
unconditional and joint and several basis. Separate financial statements of the
guarantor subsidiaries have not been included because management believes that
they are not material to investors.

    The Company and guarantor subsidiaries account for investments in
subsidiaries on the equity method for the purposes of the consolidating
financial data. Earnings of subsidiaries are therefore reflected in the
Company's and subsidiary's investment accounts and earnings. The principal
elimination entries eliminate investments in subsidiaries and intercompany
balances and transactions.

                                       10

<PAGE>   11


SUPPLEMENTAL CONSOLIDATING FINANCIAL INFORMATION

<TABLE>
<CAPTION>
                                                                             DECEMBER 30, 2000
                                                   ----------------------------------------------------------------------
                                                                  GUARANTOR    NON-GUARANTOR
                                                    COMPANY     SUBSIDIARIES   SUBSIDIARIES    ELIMINATIONS  CONSOLIDATED
                                                   ---------    ------------   -------------   ------------  -------------
                                                                              (IN THOUSANDS)

                                                           ASSETS
<S>                                                <C>            <C>            <C>           <C>            <C>
CONSOLIDATING BALANCE SHEETS
CURRENT ASSETS:
   Cash and cash equivalents                       $      --      $      --      $     578     $      --      $     578
   Accounts receivable, net                           27,084          2,143          3,612            --         32,839
   Inventories                                        28,948             --          4,135            --         33,083
   Prepaid expenses and other current assets             837             42            401            --          1,280
   Deferred tax assets                                   980             --             --            --            980
                                                   ---------      ---------      ---------     ---------      ---------
       Total current assets                           57,849          2,185          8,726            --         62,760

PROPERTY, PLANT AND EQUIPMENT, NET                    16,887              6          1,765            --         18,658
OTHER ASSETS                                          38,356             --          2,729       (20,332)        20,753
                                                   ---------      ---------      ---------     ---------      ---------
       Total assets                                $ 113,092      $   2,191      $  13,220     $ (20,332)     $ 108,171
                                                   =========      =========      =========     =========      =========


                                         LIABILITIES AND SHAREHOLDERS' EQUITY (DEFICIT)

CURRENT LIABILITIES:
   Borrowings under revolving note payable         $  25,263      $      --      $      --     $      --      $  25,263
   Current maturities of long-term obligations         1,390             --             47            --          1,437
   Accounts payable                                   19,813             67          1,500            --         21,380
   Accrued expenses                                   18,251            722          1,108            --         20,081
    Due (from) to affiliate                             (631)         8,141          8,823       (16,333)            --
                                                   ---------      ---------      ---------     ---------      ---------
      Total current liabilities                       64,086          8,930         11,478       (16,333)        68,161

10 3/4% SENIOR NOTES                                  51,850             --             --            --         51,850

LONG-TERM OBLIGATIONS, LESS CURRENT
MATURITIES                                             7,652             --            196            --          7,848

      Preferred stock                                 36,092             --             --            --         36,092
      Shareholders' (deficit) equity                 (46,588)        (6,739)         1,546        (3,999)       (55,780)
                                                   ---------      ---------      ---------     ---------      ---------
      Total liabilities and shareholders'
        equity (deficit)                           $ 113,092      $   2,191      $  13,220     $ (20,332)     $ 108,171
                                                   =========      =========      =========     =========      =========
</TABLE>


                                       11
<PAGE>   12


SUPPLEMENTAL CONSOLIDATING FINANCIAL INFORMATION

<TABLE>
<CAPTION>
                                                                           JUNE 30, 2001
                                                    -----------------------------------------------------------------
                                                                GUARANTOR    NON-GUARANTOR
                                                    COMPANY    SUBSIDIARIES  SUBSIDIARIES  ELIMINATIONS  CONSOLIDATED
                                                    -------    ------------  ------------- ------------  ------------
                                                                          (IN THOUSANDS)
                                                                              ASSETS
<S>                                                <C>           <C>           <C>          <C>           <C>
CONSOLIDATING BALANCE SHEETS
   CURRENT ASSETS:
   Cash and cash equivalents                       $     19      $     --      $  1,478     $     --      $  1,497
   Accounts receivable, net                          18,763           714         4,138           --        23,615
   Inventories                                       20,459            --         3,687           --        24,146
   Prepaid expenses and other current assets            614             4           536           --         1,154
   Deferred tax assets                                  980            --            --           --           980
                                                   --------      --------      --------     --------      --------
      Total current assets                           40,835           718         9,839           --        51,392

PROPERTY, PLANT AND EQUIPMENT, NET                   16,317            --         1,730           --        18,047
OTHER ASSETS                                         35,649            --           333      (16,005)       19,977
                                                   --------      --------      --------     --------      --------
      TOTAL ASSETS                                 $ 92,801      $    718      $ 11,902     $(16,005)     $ 89,416
                                                   ========      ========      ========     ========      ========

                                                             LIABILITIES AND SHAREHOLDERS' EQUITY (DEFICIT)

CURRENT LIABILITIES:
   Borrowings under revolving note payable         $ 19,623      $     --      $     --     $     --      $ 19,623
   Current maturities of long-term
     obligations                                      1,749            --            43           --         1,792

   Accounts payable                                  12,559            11         1,968           --        14,538

   Accrued expenses                                  15,025           211         2,613           --        17,849
   Due (from) to affiliate                             (847)        7,499         5,081      (11,733)           --
                                                   --------      --------      --------     --------      --------
      Total current liabilities                      48,109         7,721         9,705      (11,733)       53,802

10 3/4% SENIOR NOTES                                 51,850            --            --           --        51,850

LONG-TERM OBLIGATIONS, LESS CURRENT
MATURITIES                                            7,021            --           169           --         7,190

      Preferred stock                                38,024            --            --           --        38,024
      Shareholders' (deficit) equity                (52,203)       (7,003)        2,028       (4,272)      (61,450)
                                                   --------      --------      --------     --------      --------
      Total liabilities and shareholders'
       equity (deficit)                            $ 92,801      $    718      $ 11,902     $(16,005)     $ 89,416
                                                   ========      ========      ========     ========      ========

</TABLE>

                                       12
<PAGE>   13


SUPPLEMENTAL CONSOLIDATING FINANCIAL INFORMATION

<TABLE>
<CAPTION>
                                                                             SIX MONTHS ENDED
                                                                               JULY 1, 2000
                                                     -----------------------------------------------------------------
                                                                   GUARANTOR   NON-GUARANTOR
                                                     COMPANY     SUBSIDIARIES  SUBSIDIARIES  ELIMINATIONS CONSOLIDATED
                                                     -------     ------------  ------------- ------------ ------------
                                                                              (IN THOUSANDS)
<S>                                                  <C>           <C>            <C>          <C>          <C>
CONSOLIDATING STATEMENTS OF OPERATIONS
Net sales                                            $ 73,681      $  1,396      $ 13,159      $     --     $ 88,235
Cost of goods sold                                     41,750         1,705         5,656            --       49,111
                                                     --------      --------      --------      --------     --------
Gross profit (loss)                                    31,931          (309)        7,503            --       39,124

Operating expenses                                     26,319         1,176         5,139            --       32,634

Restructuring charge                                    2,500            --            --            --        2,500
                                                     --------      --------      --------      --------     --------

Income (loss) from operations                           3,111        (1,485)        2,365            --        3,990
Interest expense                                       (5,144)          (30)         (274)           --       (5,448)
Other income (expense), net                               785            38          (678)           --          145
Equity in (losses) earnings of consolidated
 subsidiaries                                             (65)           --            --            65           --
                                                     --------      --------      --------      --------     --------
(Loss) income before income tax expense and
  dividends and accretion on preferred stock           (1,313)       (1,477)        1,413            65       (1,313)

Income tax expense                                        (43)           (1)           --            --          (43)
                                                     --------      --------      --------      --------     --------

Net (loss) income before extraordinary gain            (1,356)       (1,478)        1,413            65       (1,356)
Extraordinary gain, net of tax                          4,429            --            --            --        4,429
                                                     --------      --------      --------      --------     --------
Net income (loss) before dividends and accretion
  on preferred stock                                    3,073        (1,478)        1,413            65        3,073
Dividends and accretion on preferred stock              1,588            --            --            --        1,588
                                                     --------      --------      --------      --------     --------
Net income (loss) applicable to common
 shareholders                                        $  1,485      $ (1,478)     $  1,413      $     65     $  1,485
                                                     ========      ========      ========      ========     ========
</TABLE>


                                       13

<PAGE>   14

SUPPLEMENTAL CONSOLIDATING FINANCIAL INFORMATION

<TABLE>
<CAPTION>
                                                                             SIX MONTHS ENDED
                                                                               JUNE 30, 2001
                                                     ------------------------------------------------------------------
                                                                  GUARANTOR    NON-GUARANTOR
                                                     COMPANY     SUBSIDIARIES  SUBSIDIARIES  ELIMINATIONS  CONSOLIDATED
                                                     --------    ------------  ------------- ------------  ------------
                                                                             (IN THOUSANDS)
<S>                                                  <C>           <C>           <C>           <C>          <C>
CONSOLIDATING STATEMENTS OF OPERATIONS
Net sales                                            $ 54,679      $     21      $ 13,672      $     --     $ 68,372
Cost of goods sold                                     33,140           254         5,910            --       39,304
                                                     --------      --------      --------      --------     --------

    Gross profit                                       21,539          (233)        7,762            --       29,068

Operating expenses                                     21,167            29         5,342            --       26,538
Restructuring charge                                      338            --            --            --          338
                                                     --------      --------      --------      --------     --------
    Income (loss) from operations                          34          (262)        2,420            --        2,192

Interest expense                                       (4,816)           --          (240)           --       (5,056)
Other income (expense), net                               806            --          (820)           --          (14)
Equity in (losses) earnings of consolidated
 subsidiaries                                            (552)           --            --           454          (98)
                                                     --------      --------      --------      --------     --------



    Net (loss) income before income tax expense
     and dividends and accretion and preferred
     stock                                             (3,424)         (262)        1,360           454       (2,976)

Income tax expense                                        (14)           (2)         (446)           --         (462)
                                                     --------      --------      --------      --------     --------
Net (loss) income before dividends and accretion
 on preferred stock                                    (3,438)         (264)          914           454       (3,438)
Dividends and accretion on preferred stock              1,749            --            --            --        1,749
                                                     --------      --------      --------      --------     --------
    Net (loss) income applicable to common
     shareholders                                    $ (5,187)     $   (264)     $    914      $    454     $ (5,187)
                                                     ========      ========      ========      ========     ========
</TABLE>


                                       14
<PAGE>   15


SUPPLEMENTAL CONSOLIDATING FINANCIAL INFORMATION

<TABLE>
<CAPTION>

                                                                            SIX MONTHS ENDED
                                                                              JULY 1, 2000
                                                      ---------------------------------------------------------------
                                                                  GUARANTOR   NON-GUARANTOR
                                                      COMPANY   SUBSIDIARIES  SUBSIDIARIES  ELIMINATIONS CONSOLIDATED
                                                      -------   ------------  ------------- ------------ ------------
                                                                             (IN THOUSANDS)
<S>                                                   <C>          <C>         <C>           <C>          <C>
CONSOLIDATING STATEMENTS OF CASH FLOWS
Cash flows from operating activities                  $(1,643)     $(1,413)     $ 1,475      $    --      $(1,581)

Cash flows from Investing activities:
   Purchase of property, plant and equipment           (4,775)          --         (759)          --       (5,534)
   Advance to affiliates                                 (395)          --           --          395           --
   Other investing activities                            (179)          --           --           --         (179)
                                                      -------      -------      -------      -------      -------
   Net cash (used in) provided by investing            (5,349)          --         (759)         395       (5,713)
                                                      -------      -------      -------      -------      -------
activities
Cash flows from financing activities:
   Net borrowings under revolving note payable          8,564           --           --           --        8,564
   Proceeds from issuance of long-term debt             2,750           --           --           --        2,750
   Repurchase of 10 3/4% Series B
     Senior Notes due 2006                             (2,750)          --           --           --       (2,750)
   Payments on long-term obligations and deferred
   compensation                                          (593)          --          (84)          --         (677)
   Redemption of Series A Preferred Stock              (1,000)          --           --           --       (1,000)
   Due to (from) affiliates                                --        1,405       (1,010)        (395)          --
                                                      -------      -------      -------      -------      -------
   Net cash provided by (used in) financing
    activities                                          6,971        1,405       (1,094)        (395)       6,887
                                                      -------      -------      -------      -------      -------
   Net decrease in cash                                   (21)          (8)        (475)          --         (504)
   Exchange rate effect on cash                            --           --          (97)          --          (97)
Cash and cash equivalents, beginning of period             97            8        2,184           --        2,289
                                                      -------      -------      -------      -------      -------
Cash and cash equivalents, end of period              $    76      $    --      $ 1,709      $    --      $ 1,785
                                                      =======      =======      =======      =======      =======

</TABLE>

                                       15
<PAGE>   16

SUPPLEMENTAL CONSOLIDATING FINANCIAL INFORMATION

<TABLE>
<CAPTION>
                                                                           SIX MONTHS ENDED
                                                                             JUNE 30, 2001
                                                   ------------------------------------------------------------------
                                                                 GUARANTOR   NON-GUARANTOR
                                                    COMPANY    SUBSIDIARIES  SUBSIDIARIES  ELIMINATIONS  CONSOLIDATED
                                                   --------    ------------  ------------- ------------  ------------
                                                                            (IN THOUSANDS)
<S>                                                <C>           <C>            <C>          <C>           <C>
CONSOLIDATING STATEMENTS OF CASH FLOWS
Cash flows from operating activities               $  7,593      $    643      $  3,381      $     --      $ 11,617
Cash flows from Investing activities:
   Purchase of property, plant and equipment         (3,353)           --        (1,123)           --        (4,476)
   Advance to affiliates                              2,930            --        (2,396)         (534)           --
   Other investing activities                             2            --            --            --             2
                                                   --------      --------      --------      --------      --------

   Net cash used in investing activities               (421)           --        (3,519)         (534)       (4,474)
                                                   --------      --------      --------      --------      --------

Cash flows from financing activities:
   Net borrowings under revolving note payable       (5,640)           --            --            --        (5,640)
   Payments on long-term obligations and
    Deferred compensation                              (540)           --            (4)           --          (544)
   Due (from) to affiliates                            (973)         (643)        1,082           534            --
                                                   --------      --------      --------      --------      --------

      Net cash (used in) provided by financing
       activities                                    (7,153)         (643)        1,078           534        (6,184)
                                                   --------      --------      --------      --------      --------

       Net increase in cash                              19            --           900            --           919

       Exchange rate effect on cash                      --            --           (40)           --           (40)

Cash and cash equivalents, beginning of period           --            --           578            --           578
                                                   --------      --------      --------      --------      --------
Cash and cash equivalents, end of period           $     19      $     --      $  1,478      $     --      $  1,497
                                                   ========      ========      ========      ========      ========

</TABLE>


                                       16
<PAGE>   17

ITEM 2.  MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
         RESULTS OF OPERATIONS

    The following discussion may contain "forward-looking" statements and are
subject to risks and uncertainties that could cause actual results to differ
significantly from expectations. In particular, statements contained in this
"Management's Discussion and Analysis of Financial Condition and Results of
Operations" section which are not historical facts, including, but not limited
to, statements regarding the anticipated adequacy of cash resources to meet the
Company's working capital and capital expenditure requirements and statements
regarding the anticipated proportion of revenues to be derived from a limited
number of customers, may constitute forward-looking statements. Although the
Company believes the expectations reflected in such forward-looking statements
are reasonable, it can give no assurance that such expectations will prove to
have been correct. These risks and uncertainties include the substantial
leverage of the Company, customer concentration and consolidation, dependence on
licensed brands, a single site distribution facility, operating in international
economies, unpredictability of discretionary consumer spending, competition, and
susceptibility to changing consumer preferences. The following discussion and
analysis of financial condition and results from operations should be read in
conjunction with the Consolidated Financial Statements and related Notes thereto
included elsewhere.

OVERVIEW

    The Company is a value-added distributor of optical products, costume
jewelry, watches, clocks and other accessories primarily to mass merchandisers,
chain drug stores/combo stores/supermarkets and variety stores in North America
and the United Kingdom. As a value-added distributor, the Company provides
customized store displays, merchandising management and a store-level field
service force to replenish and restock displays, reorder product and attend to
markdowns and allowances. Upon shipment to the customer, the Company estimates
agreed-upon future allowances, returns and discounts, taking into account
historical experience, and reflects revenue net of these estimates.

    When establishing or expanding a customer relationship, the Company
generally enters into multi-year agreements for the supply of specified product
lines to specific customer stores. The agreements typically do not contain
required minimum sales volumes but may provide for termination penalties equal
to the Company's unamortized cost of product displays provided to the customer.
The Company believes its relationships with retailers are dependent upon its
ability to efficiently utilize allocated floor space to generate satisfactory
returns for its customers. To meet this end, the Company strives to consistently
deliver competitively priced products and service programs, which provide
retailers with attractive gross margins and inventory turnover rates. The
Company has historically retained customers from year to year, although
retailers may drop or add product lines supplied by the Company. Generally,
customer loss has been attributable to such customer going out of business or
being acquired by a company which does not carry the Company's product line or
has prior relationships with a competitor of the Company.

    Certain segments of the retail industry, particularly mass merchandisers,
variety stores, drugstores and supermarkets, are experiencing significant
consolidation and in recent years many major retailers have experienced
financial difficulties. These industry wide developments may have an impact on
the Company's results of operations. In addition, many major retailers have
sought to reduce inventory levels in order to reduce their operating costs which
has had a negative effect on the Company's results of operations.

    Net Sales. The Company offers optical products, costume jewelry, small
synthetic leather goods and other accessories, generally at retail price points
of $30 or less. Until the sale of its Fantasma division in April 2001, the
Company also sold watches and clocks. Net sales of the Company's optical
products accounted for approximately 77.2% and 71.5% of the Company's net sales
for the six months ended June 30, 2001 and July 1,2000, respectively. Net sales
of the Company's costume jewelry accounted for approximately 22.6% and 25.4% of
the Company's net sales for the six months ended June 30, 2001 and July 1, 2000,
respectively, and the balance represented sales of synthetic leather goods,
watches, clocks and other accessories.

    Cost of Goods Sold. The Company outsources manufacturing for all of its
products, approximately 80.5% of which is sourced to manufacturers in Asia
through its joint venture in Hong Kong, with the remainder outsourced to
independent domestic manufacturers. Accordingly, the principal element
comprising the Company's cost of goods sold is the price of manufactured goods
purchased through the Company's joint venture or from independent manufacturers.
The Company believes outsourcing manufacturing allows it to reliably deliver
competitively priced products to the retail market while retaining considerable
flexibility in its cost structure.

    Operating Expenses. Operating expenses are comprised primarily of payroll
and occupancy costs related to the Company's selling, general and administrative
activities as well as depreciation and amortization. The Company incurs various
costs in connection with the acquisition of new customers and new stores for
existing customers, principally the cost of new product display fixtures and
costs

                                       17
<PAGE>   18

related to the purchase of the customer's existing inventory. The Company makes
substantial investments in the design, production and installation of display
fixtures in connection with establishing and maintaining customer relationships.
The Company capitalizes the production cost of these display fixtures as long as
it retains ownership of them. These costs are amortized to selling expense on a
straight-line basis over the estimated useful life of these fixtures, which is
one to three years. If the Company does not retain title to the displays, the
display costs are expensed as shipped.

    The Company incurs direct and incremental costs in connection with the
acquisition of certain new customers and new store locations from existing
customers under multi-year agreements. The Company may also receive the previous
vendor's merchandise from the customer in connection with these agreements. In
these situations, the Company values this inventory at its fair market value,
representing the lower of cost or net realizable value, and records that value
as inventory. The Company sells this inventory through various liquidation
channels. Except as provided below, the excess costs over the fair market value
of the inventory received is charged to selling expense when incurred. The
Company expensed customer acquisition costs of approximately $31,000 and
$44,000, respectively, for the three and six months ended June 30, 2001 and
$225,000 and $372,000, respectively, for the three and six months ended July 1,
2000.

    The excess costs over the fair market value of the inventory received is
capitalized as deferred costs and amortized over the agreement period if the
Company enters into a minimum purchase agreement with the customer from which
the estimated gross profits from future minimum sales during the term of the
agreement are sufficient to recover the amount of the deferred costs. The
Company capitalized costs of approximately $230,000 during the three and six
months ended July 1, 2000. During the three and six months ended June 30, 2001,
the Company capitalized approximately $47,000 and $87,000 of these costs,
respectively. Amortization expense related to the costs as well as previously
capitalized costs was approximately $93,000 and $177,000, for the three and six
months ended June 30, 2001, respectively, and $339,000 and $659,000, for the
three and six months ended July 1, 2000, respectively.

    During the six months ended July 1, 2000, the Company recognized a $2.5
million restructuring charge related to the accrual of severance payments due to
three executives, which will be paid over a two-year period. In May 2001, the
Company recorded an additional restructuring charge of $0.3 million related to
the accrual of severance payments to one senior executive, which will be paid
over a twelve month period. In addition, the Company took steps in July 2001 to
realign its organization and reduce operating costs that resulted in a work
force reduction. As a result, the Company will recognize a third quarter charge
of approximately $0.3 million.

    Dividends and Accretion on Preferred Stock. The Company has 43,700 shares of
Series A Redeemable Convertible Preferred Stock ("Series A Preferred Stock")
outstanding, of which 34,200 were issued in May 1996 for gross proceeds of $18.0
million, and an additional 9,500 shares were issued for gross proceeds of $5.0
million in connection with the December 1996 acquisition of Foster Grant Group
US and related companies. Beginning on June 30, 2002, shares of the Series A
Preferred Stock are redeemable at the option of the holder for an amount equal
to the original issue price plus accrued and unpaid dividends yielding a 10%
compounded annual rate of return, provided, however, that the right to require
redemption is suspended as long as any Restrictive Indebtedness (as defined in
the Articles of Incorporation) is outstanding. Net income (loss) applicable to
common shareholders represents net income (loss) less accretion of original
issuance costs and cumulative dividends due on the Series A Preferred Stock.

    Extraordinary Gain. In June 2000 the Company repurchased $10.75 million face
value of the Notes for a purchase price of $2.75 million. As a result of this
transaction, the Company recognized a $4.4 million extraordinary gain, net of
$3.2 million in taxes. See further discussion in "Liquidity and Capital
Resources".

    Earnings Before Interest, Taxes, Depreciation and Amortization (EBITDA).
Although EBITDA is not a measure of performance calculated in accordance with
Generally Accepted Accounting Principles (GAAP), the Company believes that
EBITDA is accepted as a generally recognized measure of performance in the
distribution industry and provides an indicator of the earnings available to
meet the Company's debt service obligations. EBITDA should not be considered in
isolation or as a substitute for operating income, net income, net cash provided
by operating activities or any other measure for determining the Company's
operating performance or liquidity which is calculated in accordance with GAAP.
EBITDA, before the restructuring charge of $0.3 million, was $6.2 million and
$8.1 million for the three and six months ended June 30, 2001, respectively, as
compared to EBITDA, before the restructuring charge of $2.5 million and the
extraordinary gain of $4.4 million, of approximately $6.7 million and $12.7
million for the three and six months ended July 1, 2000, respectively. The
year-to-date decrease before the restructuring charge and extraordinary gain of
$4.7 million or 37% is principally due to the decrease in operating income.
Year-to-date EBITDA, after the restructuring charge, was $7.8 million for the
six months ended June 30, 2001.

    Net income before dividends and accretion on preferred stock, excluding the
restructuring charge was $0.6 million for the three months ended June 30, 2001
and a loss of $3.1 million for the six months ended June 30, 2001 as compared to
net income before

                                       18
<PAGE>   19

dividends and accretion on preferred stock, excluding the restructuring charge
and extraordinary gain of $0.8 million and $1.1 million for the three and six
months ended July 1, 2000, respectively. Net income before dividends and
accretion on preferred stock, including the restructuring charge was $0.2
million for the three months ended June 30, 2001 and a loss of $3.4 million for
the six months ended June 30, 2001 as compared to net income before dividends
and accretion on preferred stock, including the restructure charge and
extraordinary gain of $5.2 million and $3.1 million for the three and six months
ended July 1, 2000.

RESULTS OF OPERATIONS

    The following table sets forth, for the periods indicated, the percentage
relationship to net sales of certain items included in the Company's
Consolidated Condensed Statements of Operations:

<TABLE>
<CAPTION>

                                                                      THREE MONTHS ENDED                SIX MONTHS ENDED
                                                                  -------------------------         ------------------------
                                                                  JULY 1,          JUNE 30,         JULY 1,         JUNE 30,
                                                                   2000              2001            2000             2001
                                                                 --------          -------          -------         --------
<S>                                                                <C>              <C>             <C>              <C>
Net sales                                                          100.0%           100.0%          100.0%           100.0%
Cost of goods sold                                                  55.9             55.8            55.7             57.5
                                                                   -----            -----           -----            -----
Gross profit                                                        44.1             44.2            44.3             42.5
Operating expenses, excluding restructuring charge                  36.3             34.8            37.0             38.8
Restructuring charge                                                 --               0.9             2.8              0.5
                                                                   ----             -----           -----            -----

Income from operations                                               7.8              8.5             4.5              3.2
Interest expense                                                    (6.2)            (6.5)           (6.2)            (7.4)
Other income (expense), net                                          0.2             (0.4)            0.2             (0.2)
                                                                   -----            ------          -----            ------
Net income (loss) before taxes and dividends and
  accretion on preferred stock                                       1.8              1.6            (1.5)            (4.4)
Income tax expense                                                  (0.1)            (1.0)           (0.1)            (0.7)
                                                                   -----            -----           -----            -----
Net income (loss) before extraordinary items, dividends
  and accretion on preferred stock                                   1.7              0.6            (1.6)            (5.1)
Extraordinary gain, Net                                              9.7              --              5.0              --
                                                                   -----            ----            -----            ----
Net income (loss) before dividends and accretion on
preferred stock                                                     11.4              0.6             3.4             (5.1)
Dividend and accretion on preferred stock                            1.8              2.3             1.7              2.5
                                                                   -----            -----           -----            -----
Net income (loss) applicable to common shareholders                  9.6%            (1.7)%           1.7%            (7.6)%
                                                                   =====            ======          =====            ======
</TABLE>

THREE MONTHS ENDED JUNE 30, 2001 COMPARED TO THREE MONTHS ENDED JULY 1, 2000

    Net Sales. Consolidated net sales were $38.3 million for the three months
ended June 30, 2001 as compared to $45.7 million for the three months ended July
1, 2000, a decrease of 16.3% or $7.4 million. Sales decreased across all
segments due to a general softness in sunglasses and jewelry retail sales, a
result of current economic conditions. The decline is also attributable to
planned reductions in jewelry principally related to a change in the terms of
service with a significant customer in the mass merchandiser channel and the
planned de-emphasis on watches, clocks and certain other accessory lines across
all segments.

    Gross Profit. Gross profit was $16.9 million for the three months ended June
30, 2001 as compared to $20.2 million for the three months ended July 1, 2000.
Gross profit as a percentage of net sales increased marginally at 44.2% for the
three months ended June 30, 2001 as compared to 44.1% for the three months ended
July 1, 2000. The $3.2 million or 16.1% decrease in gross profit is primarily
due to the sales decline.

    Operating Expenses. Operating expenses were $13.3 million before the
restructuring charge of $0.3 million for the three months ended June 30, 2001 as
compared to $16.6 million for the three months ended July 1, 2000, a decrease of
19.7% or $3.3 million. Decreases occurred throughout the Company driven
primarily by the restructuring of the field service organization and staffing
reductions as well as volume related expenses and the reversal of the current
year bonus provision. These decreases reflect management's continued attention
to expense control. Operating expenses, after the restructuring charge of $0.3
million, were $13.7 million for the three months ended June 30, 2001. The
restructuring charge reflects an accrual for severance payments due to one
senior executive, which will be paid over a twelve month period.

    Interest Expense. Interest expense was $2.5 million for the three months
ended June 30, 2001 as compared to $2.9 million for the three months ended July
1, 2000, a decrease of 12.7% or $362,000. The decrease is primarily attributable
to interest savings generated by the bond repurchase during fiscal 2000 and a
lower average outstanding balance on the revolving note payable versus the prior
year.

    Income Tax. Income tax expense was $0.4 million for the three months ended
June 30, 2001 as compared to $43,000 for the three months ended July 1, 2000,
and relates to taxes due on our foreign operations.


                                       19
<PAGE>   20

    Net Income (Loss). As a result of the factors discussed above, net income
before dividends and accretion on preferred stock, excluding the restructuring
charge of $0.3 million, was $0.6 million for the three months ended June 30,
2001 as compared to net income before dividends and accretion on preferred
stock, excluding the extraordinary gain, of $0.8 million for the three months
ended July 1, 2000, a decrease of $0.2 million in earnings. Net income before
dividends and accretion on preferred stock, after the extraordinary gain was
$5.2 million for the three months ended July 1, 2000. The extraordinary gain of
$4.4 million was recognized as a result of the early extinguishment of debt.

    Net Loss Applicable to Common Shareholders. Net loss applicable to common
shareholders excluding the restructuring charge was $0.3 million for the three
months ended June 30, 2001 as compared to a loss, excluding the extraordinary
gain, of $24,000 for the three months ended July 1, 2000, an increase of $0.3
million.

SIX MONTHS ENDED JUNE 30, 2001 COMPARED TO SIX MONTHS ENDED JULY 1, 2000

    Net Sales. Consolidated net sales were $68.4 million for the six months
ended June 30, 2001 as compared to $88.2 million for the six months ended July
1, 2000, a decrease of $19.8 million or 22.5%. The decrease in net sales is
primarily attributable to a decline in optical sales in all segments related to
weather and economic conditions. The decrease in the fiscal 2001 period as
compared to the fiscal 2000 period also reflects the timing of initial customer
shipments for the 2000 sunglass roll-out, which occurred during the first
quarter of 2000 as compared to the orders being shipped in the fourth quarter of
fiscal 2000 for the 2001 sunglass season.

    Gross Profit. Gross profit was $29.1 million for the six months ended June
30, 2001 as compared to $39.1 million for the six months ended July 1, 2000.
Gross profit as a percentage of net sales decreased to 42.5% for the six months
ended June 30, 2001 from 44.3% for the six months ended July 1, 2000. The $10.0
million or 25.7% decrease in gross profit is primarily due to the sales decline
and the shift in the sales mix from higher margin segments to lower margin
segments.

    Operating Expenses. Operating expenses were $26.5 million, before the
restructuring charge of $0.3 million for the six months ended June 30, 2001 as
compared to $32.6 million, before the restructuring charge for the six months
ended July 1, 2000, a decrease of $6.1 million or 18.7%. Decreases occurred
throughout the Company driven primarily by the restructuring of the field
service organization and staffing reductions as well as volume related expenses
and the reversal of the current year bonus provision. These decreases reflect
management's continued attention to expense control. Operating expenses, after
the restructuring charge were $26.9 million for the six months ended June 30,
2001, as compared to $35.1 million for the six months ended July 1, 2000.

    Interest Expense. Interest expense was $5.0 million for the six months ended
June 30, 2001 as compared to $5.4 million for the six months ended July 1, 2000,
a decrease of $0.4 million or 7.2%. The decrease is primarily attributable to
interest savings generated by the bond repurchase during fiscal 2000 and a lower
average outstanding balance on the revolving note payable versus the prior year.

    Income Tax. Income tax expense was $0.5 million for the six months ended
June 30, 2001 as compared to $43,000 for the six months ended July 1, 2000, and
relates to taxes due on foreign operations.

    Net Income (Loss). As a result of the factors discussed above, net loss
before dividends and accretion on preferred stock, excluding the restructuring
charge of $0.3 million, was $3.1 million for the six months ended June 30, 2001
as compared to net income before dividends and accretion on preferred stock,
excluding the extraordinary gain of $4.4 million and the restructuring charge of
$2.5 million, of $1.1 million for the six months ended July 1, 2000, a decrease
of $4.2 million in earnings. Net loss before dividends and accretion on
preferred stock, after the restructuring charge, was $3.4 million for the six
months ended June 30, 2001 as compared to net income before dividends and
accretion on preferred stock, after the extraordinary gain and the restructuring
charge, of $3.1 million for the six months ended July 1, 2000.

    Net Income (Loss) Applicable to Common Shareholders. Net loss applicable to
common shareholders excluding the restructuring charge was $4.8 million for the
six months ended June 30, 2001 as compared to a net loss applicable to common
shareholders excluding the extraordinary gain and the restructuring charge of
$0.4 million for the six months ended July 1, 2000, an increase of $4.4 million.
The increase is attributable to the $4.4 million decrease in earnings. Net loss
applicable to common shareholders after the restructuring charge was $5.2
million for the six months ended June 30, 2001 as compared to net income
applicable to common shareholders after the extraordinary gain and the
restructuring charge of $1.5 million for the six months ended July 1, 2000.

                                       20
<PAGE>   21

LIQUIDITY AND CAPITAL RESOURCES

    At June 30, 2001, the Company had cash and cash equivalents of $1.5 million
and negative working capital of $2.4 million as compared to $0.6 million of cash
and cash equalent and working capital of $0.6 million at December 30, 2000. The
increase in cash and cash equivalents is due to the timing of cash receipts at
the end of the quarter. The decline in working capital was driven by a continued
focus on reduction in receivables and inventory offset by the paydown of trade
payables and the revolving note payable.

    The Company generated $11.6 million of cash in operations during the six
months ended June 30, 2001 compared to a use of $1.6 million during the six
months ended July 1, 2000. The increase in cash generated is principally due to
continued collection efforts of accounts receivable and inventory management
during the six months ended June 30, 2001 partially offset by the paydown of
trade payables and accrued expenses.

    The Company used $4.5 million in investing activities during the six months
ended June 30, 2001 compared to a use of $5.7 million during the six months
ended July 1, 2000. These investments were primarily related to the purchase of
display fixtures used in the merchandising of both optical and jewelry products
and represent normal purchases.

    The Company used $6.2 million from financing activities during the six
months ended June 30, 2001 compared to generating $6.9 million during the six
months ended July 1, 2000. The decrease in cash from financing activities is
primarily due to an increase in cash provided by operating activities, which was
utilized to pay down the revolving note payable.

    The Company has outstanding 43,700 shares of Series A Preferred Stock that
have a redemption value at June 30, 2001 of $36.9 million. Shares of Series A
Preferred Stock are convertible into Common Stock at a rate of 10 for 1,
adjustable for certain dilutive events. Conversion is at the option of the
shareholder, but is automatic upon the consummation of a qualified public
offering. The holders of Series A Preferred Stock have the right to require
redemption for cash for any unconverted shares, beginning June 30, 2002,
provided, however, that the right to require redemption is suspended as long as
any Restrictive Indebtedness (as defined in the Company's Articles of
Incorporation) is outstanding. The $75.0 million 10 3/4% Senior Notes due 2006
(the "Notes") constitute Restrictive Indebtedness. The redemption price of the
Series A Preferred Stock is an amount equal to the original issue price, $526.32
per share, plus any accrued and unpaid dividends yielding a 10% compounded
annual rate of return.

    In connection with the purchase of Foster Grant US, the Company's wholly
owned subsidiary, Foster Grant Holdings, Inc. (FG Holdings) issued 100 shares of
FG Preferred Stock, which were redeemable for $1.0 million on February 28, 2000.
The $1.0 million was paid on April 3, 2000. The former holder of the FG
Preferred Stock is entitled to receive an additional payment of between $2.5
million and $3.0 million, depending upon transaction value, in the event of an
initial public offering, merger or similar transaction, or private placement of
securities representing more than 50% of the Company's capital stock, at a
specified valuation.

    During the second quarter of fiscal 2000, the Company repurchased $10.75
million face amount of the Notes for a purchase price of $2.75 million. In
addition, during the third quarter of fiscal 2000, the Company repurchased an
additional $12.4 million face amount of the Notes for a purchase price of $4.34
million. The purchase price was financed utilizing a term loan under its
existing senior credit facility (the "Senior Credit Facility"). The term loan is
secured by a mortgage on its Smithfield, RI property and subject to the
obligation of certain preferred shareholders to purchase participations in the
term loan upon the happening of certain events. The term loan is being amortized
over 60 months commencing April 1, 2001, with the principal balance due at the
expiration of the Senior Credit Facility on July 31, 2003. As a result of the
second quarter Note repurchase, the Company recognized $4.4 million
extraordinary gain, net of $3.2 million in taxes, and wrote off $42,000 of
unamortized issuance costs related to the $10.75 million of Notes that were
repurchased. These purchases resulted from inquiries from holders of the Notes.
The Company does not solicit offers to tender Notes for repurchase, but may,
from time to time, consider requests to repurchase Notes, subject to the
availability of appropriate financing.

    In conjunction with the commitment to purchase participations in the term
loan, the Company issued 70,870 shares of Series B Preferred Stock. The holders
of Series B Preferred Stock are entitled to receive, prior and in preference to
any distribution with respect to any other capital stock of the Company, an
amount per share equal to $6.67 multiplied by the number of six month periods
and fractions thereof in the period during which the participation commitment is
outstanding. The Company is amortizing the value related to each six-month
participation commitment to interest expense. As the participation commitment is
extended for additional six-month periods, the Company is recording additional
value to the Series B Preferred Stock and amortizing the related costs over the
additional period of the participation commitment as required. During the six
months ended June 30, 2001, the Company recorded additional value to the Series
B Preferred Stock of $184,000.

                                       21
<PAGE>   22

    The Company has substantial indebtedness and significant debt service
obligations. As of June 30, 2001, the Company had total indebtedness, including
borrowings under the Senior Credit Facility, in the aggregate principal amount
of $80.5 million. The Company had current liabilities of approximately $53.8
million. In addition, the Company has significant annual obligations that
include interest on the Notes of approximately $5.7 million, minimum royalty
obligations over the next two years of approximately $2.9 million and minimum
payments under its operating leases of approximately $0.3 million. The Indenture
permits the Company to incur additional indebtedness, including secured
indebtedness, subject to certain limitations.

    The Company has up to $1.8 million available for borrowings under the Senior
Credit Facility as of June 30, 2001. Interest rates on the revolving loans under
the Senior Credit Facility are based, at the Company's option, on the Base Rate
(as defined) or LIBOR plus an applicable margin. The Senior Credit Facility
contains certain restrictions and limitations, including financial covenants
that require the Company to maintain and achieve certain levels of financial
performance and limit the payment of cash dividends and similar restricted
payments. As of August 13, 2001 the Company received a verbal waiver for such
noncompliance from the bank and expects a formal written waiver to be received
shortly. The company is currently negotiating its financial covenants going
forward so that they reflect performance levels that the Company believes it can
attain.

    The Company's ability to make scheduled payments of principal, or to pay the
interest on, or to refinance, its indebtedness (including the Notes), or to fund
planned capital expenditures will depend on its future performance, which, to a
certain extent, is subject to general economic, financial, competitive,
legislative, regulatory and other factors that are beyond its control. Based
upon the future level of operations, anticipated cost savings and an increase in
seasonal availability under the Senior Credit Facility which the Company is
currently negotiating with the bank, the Company believes that cash flow from
operations and available cash, together with available borrowings under the
Senior Credit Facility, will be adequate to meet the Company's future liquidity
needs for at least the next several years. The Company may, however, need to
refinance all or a portion of the principal of the Notes on or prior to
maturity. There can be no assurance that the Company's business will generate
sufficient cash flow from operations, that anticipated cost savings and revenue
growth will be realized or that future borrowings will be available under the
Senior Credit Facility in an amount sufficient to enable the Company to service
its indebtedness, including the Notes, or to fund its other liquidity needs. In
addition, there can be no assurance that the Company will be able to effect any
such refinancing on commercially reasonable terms or at all.

SEASONALITY AND QUARTERLY INFORMATION

    Significant portions of the Company's business are seasonal. Sunglasses are
shipped primarily during the fourth quarter of the fiscal year as retailers
build inventory for the spring and summer selling seasons, while costume jewelry
and other accessories are shipped primarily during the second half of the fiscal
year as retailers build inventory for the holiday season. Reading glasses sales
are generally uniform throughout the year. As a result of these shipping trends,
the Company's working capital requirements grow throughout the first half of the
year to fund purchases and accounts receivable. In the second half of the year,
the Company's working capital requirements decrease as accounts receivable are
collected.

RECENT ACCOUNTING PRONOUNCEMENTS

    In June 2001, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards (SFAS) No. 141, "Business
Combinations". SFAS 141 requires all business combinations initiated after June
30, 2001 to be accounted for using the purchase method. The Company does not
expect the adoption of this statement to have a material impact on their
operations.

    In June 2001, the FASB issued Statement of Financial Accounting Standards
(SFAS) No. 142, "Goodwill and Other Intangible Assets". With the adoption of
SFAS No. 142, goodwill is no longer subject to amortization over its estimated
useful life, but instead goodwill is subject to at least an annual assessment
for impairment by applying a fair-value-based test. The Company will adopt this
statement at the beginning of fiscal year 2002. The Company is currently
assessing the impact of this pronouncement.

ITEM 3.  QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.

    The following discussion about the Company's market risk disclosures
includes forward-looking statements. Actual results could differ materially from
those projected in the forward-looking statements. The Company is exposed to
market risk related to changes in interest rates and foreign currency exchange
rates. The Company does not use derivative financial instruments for speculative
or trading purposes.

    Interest Rate Risk. The Company is exposed to market risk from changes in
interest rates primarily through its borrowing activities. In addition, the
Company's ability to finance future acquisition transactions may be impacted if
the Company is unable to obtain appropriate financing at acceptable interest
rates.

                                       22
<PAGE>   23

    Foreign Currency Risk. The Company's results of operations are affected by
fluctuations in the value of the U.S. dollar as compared to the value of
currencies in foreign markets primarily related to changes in the British Pound,
the Canadian Dollar, the Mexican Peso, the Euro Dollar and the Hong Kong Dollar.
During the six months ended June 30, 2001, the net impact of foreign currency
changes was not material to the Company's financial condition or results of
operations. The Company manages its exposure to foreign currency exchange risk
by trying to minimize the Company's net investment in its foreign subsidiaries.
The Company generally does not enter into derivative financial instruments to
manage foreign currency exposure.

    The Company's operations in Europe are not significant and, therefore, the
Company has not been materially impacted by the fluctuations in the Euro dollar.

                                       23

<PAGE>   24


                     AAI. FOSTERGRANT, INC. AND SUBSIDIARIES

PART II. OTHER INFORMATION

ITEM 1.  LEGAL PROCEEDINGS

    None

ITEM 2.  CHANGES IN SECURITIES AND USE OF PROCEEDS

    None

ITEM 3.  DEFAULTS UPON SENIOR SECURITIES

    None

ITEM 4.  SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

    None

ITEM 5.  OTHER INFORMATION

    None

ITEM 6.  EXHIBITS AND REPORTS ON FORM 8-K

    (a) Exhibits

    10.20    Employment Agreement between AAi and Brian J. Lagarto dated
             May 9, 2001

    10.21    Employment Agreement between AAi and Edward J. Seibolt dated
             July 3, 2001

    (b) Report on Form 8-K

    The registrant filed no reports on Form 8-K during the quarter ended June
30, 2001.

                                       24
<PAGE>   25


                     AAI. FOSTERGRANT, INC. AND SUBSIDIARIES

                                   SIGNATURES

    Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned hereunto duly authorized.

                                          AAi.FosterGrant, Inc. (Registrant)

Dated: August 14, 2001                    /s/ Michael F. Cronin
                                          --------------------------------------
                                          Michael F. Cronin
                                          Chairman of the Board

Dated: August 14, 2001                    /s/ John R. Ranelli
                                          --------------------------------------
                                          John R. Ranelli
                                          Director, President, and Chief
                                          Executive Officer
                                          (Principal Executive Officer)

Dated: August 14, 2001                    /s/ Brian J. Lagarto
                                          --------------------------------------
                                          Brian J. Lagarto
                                          Chief Financial Officer (Principal
                                          Financial Officer)



                                       25