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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended March 31, 2004
OR
[ ] 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 0-21940
Donnkenny, Inc.
(Exact name of registrant as specified in its charter)
Delaware 51-0228891
(State or jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
1411 Broadway, New York, NY 10018
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code (212) 790-3900
NOT APPLICABLE
(Former name, former address and former fiscal year,
if changed since last report.)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), Yes [X] No ___ and (2) has been
the subject to such filing requirements for the past 90 days. Yes [X] No ___.
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Act) Yes ___ No [X].
Indicate the number of shares outstanding of each of the issuer's classes
of Common Stock, as of the latest practicable date.
Common Stock $0.01 par value 4,367,417
(Class) (Outstanding at May 14, 2004)
DONNKENNY, INC AND SUBSIDIARIES
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
(FORM 10-Q)
PART I - FINANCIAL INFORMATION Page
----
Item 1. Consolidated financial statements:
Balance sheets as of March 31, 2004 (unaudited)
and December 31, 2003............................................1
Statements of operations for the three months ended
March 31, 2004 and 2003 (unaudited)..............................2
Statements of cash flows for the three months ended
March 31, 2004 and 2003 (unaudited)..............................3
Notes to Consolidated Financial Statements (unaudited)........4-11
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations.......................................12-18
Item 3. Quantitative and Qualitative Disclosures about Market Risk.........19
Item 4. Controls and Procedures............................................19
PART II - OTHER INFORMATION
Item 1. Legal Proceedings..................................................20
Item 6. Exhibits and Reports on Form 8-K...................................20
Signatures......................................................21
Certifications...............................................22-25
DONNKENNY, INC. AND SUBSIDIARIES
Consolidated Balance Sheets
(in thousands, except per share data)
March 31, December 31,
2004 2003
------------- --------------
(Unaudited)
CURRENT ASSETS
Cash.................................................... $ 88 $ 64
Accounts receivable, net of allowances for doubtful
accounts of $864 and $933, in 2004 and 2003
respectively............................................ 386 1,287
Due from factor, net.................................... 18,300 20,730
Inventories, net........................................ 20,608 20,128
Prepaid expenses and other current assets............... 1,198 1,256
Assets held for sale.................................... 260 270
------- --------
Total current assets.................................... 40,840 43,735
PROPERTY, PLANT AND EQUIPMENT, NET........................... 3,721 3,631
OTHER ASSETS................................................. 348 366
GOODWILL..................................................... 1,641 1,641
OTHER INTANGIBLE ASSETS...................................... 1,244 1,332
------- --------
TOTAL........................................................ $47,794 $ 50,705
======= ========
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Current portion of long-term debt....................... $ 358 $ 353
Accounts payable........................................ 8,532 7,713
Accrued expenses and other current liabilities.......... 1,811 1,908
------- --------
Total current liabilities............................... 10,701 9,974
LONG-TERM DEBT............................................... 32,695 35,707
COMMITMENTS AND CONTINGENCIES
STOCKHOLDERS' EQUITY:
Preferred stock $.01 par value; authorized 500
shares, issued none..................................... -- --
Common stock, $.01 par value; authorized 20,000
shares, issued and outstanding 4,367 shares
in 2004 and 2003........................................ 44 44
Additional paid-in capital.............................. 50,449 50,449
Accumulated deficit..................................... (46,095) (45,469)
------- --------
Total Stockholders' Equity.............................. 4,398 5,024
------- --------
TOTAL........................................................ $47,794 $ 50,705
======= ========
See accompanying notes to consolidated financial statements.
1
DONNKENNY, INC. AND SUBSIDIARIES
Consolidated Statements of Operations
(in thousands, except share and per share data)
(unaudited)
Three Months Ended
---------------------------------
March 31, 2004 March 31, 2003
-------------- --------------
NET SALES.................................................... $ 23,680 $ 18,954
COST OF SALES................................................ 18,112 13,249
------------ -----------
Gross profit............................................ 5,568 5,705
OPERATING EXPENSES:
Selling, general and administrative expenses............ 5,722 5,346
Amortization of intangibles............................ 88 --
------------ -----------
Operating (loss) income.............................. (242) 359
INTEREST EXPENSE............................................. 524 318
------------ -----------
(Loss) income before income tax benefit................. (766) 41
INCOME TAX BENEFIT........................................... (140) (14)
------------ -----------
NET (LOSS) INCOME...................................... $ (626) $ 55
============ ===========
Basic (loss) income per common share: $ (0.14) $ 0.01
============ ===========
Diluted (loss) income per common share: $ (0.14) $ 0.01
============ ===========
Shares used in the calculation of (loss) income per share:
Basic................................................... 4,367,417 4,367,417
============ ===========
Diluted................................................. 4,367,417 4,419,543
============ ===========
See accompanying notes to consolidated financial statements.
2
DONNKENNY, INC. AND SUBSIDIARIES
Consolidated Statements of Cash Flows
(in thousands)
(unaudited)
Three Months Ended
---------------------------------
March 31, 2004 March 31, 2003
-------------- --------------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net (loss) income............................................ $ (626) $ 55
Adjustments to reconcile net (loss) income to net cash
provided by operating activities:
Depreciation and amortization of plant, property and
equipment............................................... 295 382
Amortization of intangibles............................. 88 --
Allowance for doubtful accounts......................... (69) 3
Changes in assets and liabilities:
Decrease (increase) in accounts receivable.............. 970 (731)
Decrease in amount due from factor...................... 2,430 6,564
Decrease in recoverable income taxes.................... -- 141
(Increase) decrease in inventories...................... (480) 2,388
Decrease in prepaid expenses and other current
assets.................................................. 58 8
Decrease in other non-current assets.................... 18 23
Increase (decrease) in accounts payable................. 819 (5,181)
Decrease in accrued expenses and other current
liabilities............................................. (97) (350)
---------- --------
Net cash provided by operating activities............ 3,406 3,302
---------- --------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchase of property, plant and equipment............... (375) (26)
---------- --------
Net cash used in investing activities................ (375) (26)
---------- --------
CASH FLOWS FROM FINANCING ACTIVITIES:
Repayment of long-term debt............................. (87) (253)
Borrowings under revolving credit line.................. 24,760 22,080
Repayments under revolving credit line.................. (27,680) (25,043)
---------- --------
Net cash used in financing activities................ (3,007) (3,216)
---------- --------
NET INCREASE IN CASH......................................... 24 60
CASH, AT BEGINNING OF PERIOD................................. 64 66
---------- --------
CASH, AT END OF PERIOD....................................... $ 88 $ 126
========== ========
SUPPLEMENTAL DISCLOSURES
Income taxes paid............................................ $ 4 $ 2
========== ========
Interest paid................................................ $ 525 $ 319
========== ========
See accompanying notes to consolidated financial statements.
3
DONNKENNY, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(Unaudited)
NOTE 1 - BASIS OF PRESENTATION
The accompanying unaudited consolidated financial statements have been
prepared by the Company pursuant to the Rules of the Securities and Exchange
Commission ("SEC") and, in the opinion of management, include all adjustments
(consisting of normal recurring accruals) necessary for the fair presentation of
financial position, results of operations and cash flows. Certain information
and footnote disclosures normally included in financial statements prepared in
accordance with accounting principles generally accepted in the United States of
America have been condensed or omitted pursuant to such SEC rules. The Company
believes the disclosures made are adequate to make such financial statements not
misleading. The results for the interim periods presented are not necessarily
indicative of the results to be expected for the full year. These financial
statements should be read in conjunction with the Company's Report on Form 10-K
for the year ended December 31, 2003. Balance sheet data as of December 31, 2003
have been derived from audited financial statements of the Company.
NOTE 2 - STOCK BASED COMPENSATION
The Company accounts for its stock-based employee compensation plans under
the recognition and measurement principles of Accounting Principles Board
("APB") Opinion No. 25, Accounting for Stock Issued to Employees, and related
interpretations. No stock-based employee compensation cost is reflected in net
income as all options granted under those plans had exercise prices equal to the
market value of the Common Stock on the dates of grant. The following table
details the effect on net income and earnings per share if the Company had
applied the fair value recognition provisions of Statement of Financial
Accounting Statement ("SFAS") No. 123, Accounting for Stock-Based Compensation,
as amended by SFAS No. 148, to stock-based employee compensation.
March 31, 2004 March 31, 2003
-------------- --------------
(in thousands except per share data)
Net (loss) income, as reported $(626) $55
Deduct: Total stock-based employee
Compensation expense determined
under fair value based method 6 31
- --
Pro-forma net (loss) income $(632) $24
===== ===
(Loss) income per share:
Basic- as reported $(0.14) $0.01
====== =====
Basic - pro-forma $(0.14) $0.01
====== =====
Diluted - as reported $(0.14) $0.01
====== =====
Diluted - pro-forma $(0.14) $0.01
====== =====
4
Information regarding the Company's stock option plan is summarized below:
March 31, 2004 March 31, 2003
------------------------------ ----------------------------
Weighted- Weighted-
Average Average
Options Exercise Price Options Exercise Price
------- -------------- ------- --------------
Outstanding at beginning of the
period......................... 160,026 $5.16 367,427 $5.64
Granted........................ -- -- -- --
Exercised...................... -- -- -- --
Cancelled...................... -- -- (21,875) $0.69
------- ----- ------- -----
Outstanding at end of period.. 160,026 $5.16 345,552 $5.95
======= ===== ======= =====
Exercisable at end of period. 137,276 $5.88 229,552 $8.45
======= ===== ======= =====
Available for grant at period
end............................ 315,149 129,623
======= =======
The options outstanding at March 31, 2004 range in exercise price as
follows:
OPTIONS OUTSTANDING OPTIONS EXERCISABLE
----------------------------------------------------------------------------------------------------------
Weighted-Average
----------------
Range of Exercise Outstanding as of Remaining Contractual Weighted-Average Exercisable as of Weighted-Average
- ----------------- ----------------- --------------------- ---------------- ----------------- ----------------
Prices 03/31/2004 Life Exercise Price 03/31/2004 Exercise Price
------ ---------- ---- -------------- ---------- --------------
$0.00 - $7.23 135,000 6.9 $ 1.39 112,250 $ 1.51
$7.23 - $14.45 4,375 4.3 $11.29 4,375 $11.29
$14.45 - $28.90 13,125 3.3 $16.61 13,125 $16.61
$28.90 - $43.35 1,750 1.1 $33.25 1,750 $33.25
$43.35 - $65.03 3,751 0.1 $44.25 3,751 $44.25
$65.03 - $72.25 2,025 2.1 $72.25 2,025 $72.25
------- --- ------ ------- ------
160,026 6.3 5.16 137,276 $5.88
======= === ====== ======= ======
NOTE 3 - EARNINGS PER SHARE
Basic net (loss) income per share is computed by dividing net (loss) income
attributable to common stockholders by the weighted number of common shares
outstanding during the period. Diluted net income per share is computed by
dividing the net income attributable to common stockholders by the weighted
average number of common and common equivalent shares outstanding during the
period.
For the three months ended March 31, 2004, the effect of options to purchase
90,000 shares of the Company's common stock at less than market value was not
considered for the diluted earnings per share calculation as their effect would
be antidilutive. For the three months ended March 31, 2003, shares under stock
plans of 183,750 were considered for the diluted earnings per share calculation.
5
NOTE 4 - INVENTORIES
Inventories consist of the following:
March 31, December 31,
2004 2003
---- ----
(In thousands)
Raw materials ................... $ 3,670 $ 3,317
Work-in-process ................. 1,658 2,189
Finished goods .................. 15,958 15,873
Reserves......................... (678) (1,251)
------- -------
$20,608 $20,128
======= =======
Inventories at March 31, 2003 were $13.6 million consisting primarily of
finished goods.
NOTE 5 - DEBT
On June 29, 1999, the Company and its operating subsidiaries signed a
Credit Agreement (the "Credit Agreement") with CIT Group/Commercial Services
(the "Lender"). The Credit Agreement initially provided the Company with a $75
million facility comprised of a $72 million revolver with sub limits up to $52
million for direct borrowings, $35 million for letters of credit, certain
overadvances and a $3 million term loan which was paid in full as of June 30,
2002.
The Credit Agreement provides for advances of (i) up to 90% of eligible
accounts receivable plus (ii) up to 60% of eligible inventory plus (iii) up to
60% of the undrawn amount of all outstanding letters of credit plus (iv)
allowable overadvances.
Collateral for the Credit Agreement includes a first priority lien on all
accounts receivable, machinery, equipment, trademarks, intangibles and
inventory, a first mortgage on all real property and a pledge of the Company's
stock interest in its operating subsidiaries, Donnkenny Apparel, Inc. and
Beldoch Industries Corporation. The Credit Agreement contains numerous financial
and operational covenants, including limitations on additional indebtedness,
liens, dividends, stock repurchases and capital expenditures. In addition, the
Company is required to maintain specified levels of tangible net worth and
comply with a requirement for minimum earnings before depreciation,
amortization, interest and taxes (EBITDA) and a minimum interest coverage ratio,
all based upon the Company's annual business plans approved by the Lender.
In July 2000, the Credit Agreement was amended to provide for an additional
$1.3 million term loan to finance an acquisition. This term loan bore interest
at the prime rate plus 2% through March 2003, at which time this term loan was
paid.
On March 28, 2001, the Company entered into an Amendment and Waiver
Agreement to extend the Final Maturity Date of the original agreement to June
30, 2004, to waive existing events of default under the Credit Agreement as of
December 31, 2000 with respect to the Company's non-compliance with covenants
related to minimum interest coverage, EBITDA and Tangible Net Worth, and to
amend certain other provisions of the Credit Agreement including covenants and
the level of allowable overadvances to support the Company's 2001 business plan.
Pursuant to this amendment, the interest rate on borrowings was increased to
2.0% above the prime rate effective January 1, 2001. A fee of $200,000 was paid
in connection with the Amendment and Waiver.
6
Effective January 1, 2002, the Company established covenants and the level
of allowable overadvances with the Lender to support its 2002 business plan.
This Amendment and Waiver Agreement also amended the interest rate on the
revolving credit borrowings to the prime rate plus one and three quarters
percent and provide for an additional interest rate reduction effective July 1,
2002 if certain objectives were achieved (6.50% at January 1, 2002). No fee was
paid in connection with the Amendment and Waiver. The Company achieved the
objectives and received an additional rate reduction effective July 1, 2002. The
interest rate on the revolving credit borrowings was prime plus one and one-half
percent (5.75% at December 31, 2002).
Effective January 1, 2003, the Company established covenants and the level
of allowable overadvances with the Lender, through an Amendment to the Credit
Agreement dated March 27, 2003, to support its 2003 business plan. The Amendment
also amended the interest rate on the revolving credit borrowings to the prime
rate plus one and one-quarter percent. No fee was paid in connection with the
Amendment.
Effective June 30, 2003, the Company through an Amendment and Waiver
Agreement dated August 11, 2003, extended the Credit Agreement to June 30, 2007.
This Amendment provides the Company with a $65 million facility; the sublimits
have remained the same. The interest rate on the revolving credit borrowings is
the current prime rate plus one and one-quarter percent (5.25% at March 31,
2004). Fees paid in connection with this Amendment were $243,750. All other
terms and conditions of the Revolving Credit Agreement remained unchanged.
As of December 31, 2003, the Company was not in compliance with the
quarterly financial covenants. The Lender has waived this non-compliance. The
Company paid a fee of $100,000 in connection with this waiver.
Effective January 1, 2004, the Company established covenants and the level
of allowable overadvances with the Lender, through an Amendment to the Credit
Agreement dated March 26, 2004, to support its 2004 business plan. No fee was
paid in connection with the Amendment.
As of March 31, 2004, the Company was in compliance with the quarterly
financial covenants.
The Company also has a factoring agreement with CIT Group/Commercial
Services. The factoring agreement provides for a factoring commission equal to
..35% of gross sales, plus certain customary charges. The factoring agreement
renews annually in June each year unless either party to the agreement gives
appropriate notice of non-renewal.
In connection with the acquisition of Robyn Meredith (see Note 9 to the
Consolidated Financial Statements), a note payable of $1.1 million was incurred.
This note is payable in monthly installments of $33,333 including imputed
interest at an interest rate of 5.25%. The final payment will be due October
2006.
At March 31, 2004 and December 31, 2003, the Company was contingently
liable for outstanding letters of credit issued amounting to $4.3 million and
$6.6 million, respectively.
7
NOTE 6 - GOODWILL AND INTANGIBLE ASSETS
Goodwill and Other Intangible Assets consisted of the following at March 31,
2004 and December 31, 2003:
(In Thousands)
March 31, Dec. 31,
--------- --------
2004 2003
---- ----
Goodwill $1,641 $1,641
Covenant not to Compete 50 50
License agreements 1,333 1,333
Accumulated amortization (139) (51)
------- -------
1,194 1,282
------- -------
$2,885 $2,973
======= =======
The goodwill which represented the excess purchase price over the fair
value of the net assets acquired and the covenant not to compete are
attributable to the acquisition of Robyn Meredith (see Note 9 to the
Consolidated Financial Statements). The covenant not to compete is amortized
over the contract life of four years.
Intangible assets of $0.8 million are attributable to those intangible
assets acquired related to the Pierre Cardin license which was classified as an
intangible asset with an indefinite life on the Company's December 31, 2003
Consolidated Balance Sheet because the Company held the license in perpetuity.
On February 12, 2004, the Company signed a new Pierre Cardin license to provide
for a term of three years in exchange for reduced future minimum payments.
Beginning in 2004, this intangible asset is being amortized over three years.
Intangible assets of $0.5 million are attributable to costs in connection
with the acquisition of the Company's licensing agreement to manufacture and
sell coats under the Bill Blass(R), Bill Blass Signature(R), and Blassport(R)
Labels. This intangible asset is being amortized over the expected lives of the
licenses through 2009.
8
NOTE 7 - RECENT ACCOUNTING PRONOUNCEMENTS
In January 2003, the FASB issued FASB Interpretation No. 46, "Consolidation
of Variable Interest Entities" ("FIN 46"). FIN 46 requires that a variable
interest entity be consolidated by a company if that company is subject to a
majority of the risk of loss from the variable interest entity's activities or
entitled to receive a majority of the entity's residual returns or both. The
consolidation requirements apply to the first fiscal year or interim period
ending after March 31, 2004. The adoption of FIN 46 did not have an impact on
the Company's consolidated financial position or results of operations.
In April 2003, the FASB issued SFAS No. 149, "Amendment of Statement 133 on
Derivative Instruments and Hedging Activities." SFAS No. 149 amends and
clarifies financial accounting and reporting for derivative instruments,
including certain derivative instruments embedded in other contracts and for
hedging activities under FASB Statement No. 133, "Accounting for Derivative
Instruments and Hedging Activities." SFAS No. 149 is effective for contracts
entered into or modified after June 30, 2003, and for hedging relationships
designated after June 30, 2003. The adoption of SFAS No. 149 did not have an
impact on the consolidated financial statements as the Company does not engage
in derivative or hedging activity.
In May 2003, the FASB issued SFAS 150, "Accounting for Certain Financial
Instruments with Characteristics of both Liabilities and Equity," effective for
financial instruments entered into or modified after May 31, 2003, and otherwise
is effective at the beginning of the first interim period beginning after June
15, 2003. This statement establishes standards for how an issuer classifies and
measures certain financial instruments with characteristics of both liabilities
and equity. It requires that an issuer classify a freestanding financial
instrument that is within its scope as a liability (or an asset in some
circumstances). The adoption of SFAS 150 did not have an impact on the Company's
reported consolidated financial position, results of operations or cash flows.
NOTE 8 - COMMITMENTS AND CONTINGENCIES
a. On April 27, 1998, Wanda King, a former employee of the Company,
commenced an action against the Company in the United States District
Court for the Western District of Virginia. By Order dated May 4,
2004, based upon the case being settled, the action was dismissed. The
Company has accrued the settlement amount on the March 31, 2004
financial statements.
b. The Company is a party to legal proceedings arising in the ordinary
course of its business. Management believes that the ultimate
resolution of these proceedings will not, in the aggregate, have a
material adverse effect on the financial condition, results of
operations, liquidity or business of the Company.
c. The Company's License Agreements for the manufacture of garments under
licensed trademarks provide for payments of annual minimum royalty
amounts. The Company estimates that the minimum total guaranteed
royalties for these Licenses are approximately $12.3 million as of
March 31, 2004. These minimum payments are payable over the terms of
the Agreements, including renewal periods, through 2009. There are no
maximums to the royalty amounts.
9
d. On June 16, 2003, the Company entered into a licensing agreement to
manufacture knits, sweaters, and woven tops under the Z. Cavaricci(R)
label. The Company began shipments with the Spring 2004 season. The
guaranteed minimum royalties for this license are reflected in the
amount disclosed in Note 8c above.
e. On September 10, 2003, the Company entered into a licensing agreement
to manufacture women's coats under various Nicole Miller(R) labels.
The Company intends to begin shipments with the Fall 2004 season. The
guaranteed minimum royalties for this license are reflected in the
amount disclosed in Note 8c above.
f. On March 8, 2004, the Company entered into a licensing agreement to
manufacture women's suits under various Nicole Miller(R) labels. The
Company intends to begin shipments with the Spring 2005 season. The
guaranteed minimum royalties for this license are reflected in the
amount disclosed in Note 8c above.
g. On April 14, 2004, the Company entered into a licensing agreement to
manufacture women's sportswear under various Nicole Miller(R) labels.
The Company intends to begin shipments with the Spring 2005 season.
The guaranteed minimum royalties for this license are reflected in the
amount disclosed in Note 8c above.
h. The Company has agreed to purchase $2.7 million of raw materials in
connection with the manufacturing of coats. As of March 31, 2004
approximately $1.7 million has been purchased against this commitment.
The balance will be purchased and paid in full by June 30, 2004.
NOTE 9 - ROBYN MEREDITH ACQUISITION
On October 1, 2003, the Company acquired certain assets of Robyn
Meredith Inc.("RMI"). The assets that were acquired were the assets of
RMI devoted to its women's sportswear business and consisted
principally of inventory of finished goods, raw materials and trim and
certain tradenames including the name "Robyn Meredith". The Company
intends to continue to use these assets for the manufacture and
distribution of women's sportswear. The purchase price paid to RMI by
the Company was $4.6 million which was determined by valuing the
inventory and through negotiations between the parties as to the
balance of the purchase price.
10
Pro Forma Financial Information:
The pro forma financial information presented below gives effect to
the Robyn Meredith acquisition as if it had occurred as of the
beginning of the Company's fiscal year 2003. Actual results for 2004
have been included for comparative purposes. The information presented
below is for illustrative purposes only and is not indicative of
results that would have been achieved or results which may be achieved
in the future.
Three Month Financial Information
(in thousands, except share and per share data)
(unaudited)
Three Months Ended
Actual Pro- Forma
March 31, 2004 March 31, 2003
-------------- --------------
Net sales $ 23,680 $ 26,853
Net (loss) income ($626) $194
========== ==========
Basic net (loss) income per common share $ (0.14) $ 0.04
========== ==========
Diluted net (loss) income per common share $ (0.14) $ 0.04
========== ==========
Shares used in the calculation of (loss) income per share:
Basic 4,367,417 4,367,417
========== ==========
Diluted 4,367,417 4,419,543
========== ==========
11
DONNKENNY, INC. AND SUBSIDIARIES
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
Introductory Overview
- ---------------------
The Company is engaged in the women's apparel business. The Company's
business consists of importing and marketing women's apparel, consisting
primarily of women's sportswear and coats, to its customers who in turn sell the
Company's products to the ultimate retail consumers. The business of the Company
is highly competitive. The Company's products consist of its in-house brand
names ("In-house Branded Products") as well as those produced under a licensing
arrangement for the use of Pierre Cardin(R), Harve Benard(R), Bill Blass(R), Z.
Cavaricci(R) and Nicole Miller(R) trademarks ("Licensed Products"). In addition
to selling its In-House Branded and Licensed Products to its customers, the
Company develops specific product ("Private Label Products") for some of its
larger accounts, such as mass merchandisers and national chains.
The women's apparel business is characterized by a large number of small
companies selling branded and unbranded merchandise, and by several large
companies that have developed widespread consumer recognition of the trademarks
and brand names associated with merchandise sold by these companies. In
addition, retailers to whom the Company sells its products have sought to expand
the development and marketing of their own brands and to obtain women's apparel
products directly from the same sources from which the Company obtains its
products.
The Company's women's apparel business provides product for department
stores, specialty stores, regional chains, discounters and warehouse clubs.
Sportswear is marketed for four selling seasons a year. The Company's women's
coat products, consisting of outerwear and rainwear, are marketed for two
specific selling seasons. To be competitive, the Company is required to create a
substantially new line of products for each selling season. In this competitive
environment, the Company's In-house Branded Products, which do not have
widespread consumer recognition, although they are well known by the Company's
retail customers, must compete with widely recognized brand names of product
produced by the Company's competitors. The Company's Licensed Products have
widespread brand recognition but they must compete against other widely known
In-house and National brands. In addition, the Company makes presentations
throughout the year to Private Label accounts. The Company does not have
long-term contracts with any of its customers and, therefore, its business is
subject to unpredictable increases and decreases in sales depending upon the
size and number of orders that the Company receives each time it presents its
products to its customers.
In this climate, the Company must constantly change its product mix to sell
to its customers. This requires the Company not only to design products which it
anticipates will have commercial appeal, but also to develop, acquire and
sometimes discontinue the use of In-house Branded Products and Licensed
Products.
In 2003 the Company discontinued the marketing of products under the
Rebecca Jones Label and commenced a long-term strategy of being a private label
and licensed product business to expand its avenues of distribution. The Company
acquired the use of Z. Cavaricci(R), Nicole Miller(R) and Bill Blass(R) Licenses
for certain products. On October 1, 2003, the Company acquired its Robyn
Meredith Division, which primarily sells Private Label Product. Sales under the
Bill Blass(R) trademark and Robyn Meredith Division began in the second half of
2003. Sales under the Z. Cavaricci(R) trademark began in the first quarter of
2004. Sales for products under the Nicole Miller(R) trademarks for coats will
begin in the Fall of 2004 and suits for the Spring 2005 season. In the three
months ended March 31, 2004, the Company's net sales were
12
$23.7 million of which 26% was Licensed Product, 29% was In-house Branded
Product and the balance was Private Label Product. Net Sales for the first
quarter of 2003 were $19 million, of which 45% was Licensed Product, 40% was
In-house Branded Product and the balance was Private Label Product. The $4.7
million net sales increase was attributable to a $7.8 million increase in the
Company's Private Label Products, offset by a $4.1 million decrease in the sales
of the Company's In-house Branded Products and Licensed Products.
Because of the challenges faced by the foregoing changing factors, the
Company's management is constantly assessing the acceptance of its product mix
and making adjustments accordingly.
On April 14, 2004, the Company entered into a licensing agreement to
manufacture sportswear under the Nicole Miller(R) label. The Company intends to
begin shipments with the Spring 2005 season.
Comparison of Quarters Ended March 31, 2004 and 2003
- ----------------------------------------------------
Net sales increased by $4.7 million, or 24.7% from $19.0 million in the
first three months of 2003 to $23.7 million in the first three months of 2004.
The increase was primarily due to the Company's Private Label business,
partially offset by decreases in the Company's other businesses.
Gross profit for the first three months of 2004 was $5.6 million, or 23.6%
of net sales, compared to $5.7 million, or 30.0% of net sales, during the first
three months of 2003. The decrease in gross profit was due to sell off of slow
moving inventory which resulted in lower margins in the Company's other
businesses.
Selling, general and administrative expenses for the first three months of
2004 were $5.7 million compared to $5.3 million in the first three months of
2003. The increase in selling, general and administrative expenses was due to
incremental costs of the Donnkenny Coats and Robyn Meredith divisions of $1.0
million offset by efficiencies gained of $0.6 million in other divisional
expenses.
Net interest expense increased from $0.3 million during the first three
months of 2003 to $0.5 million during the first three months of 2004. The
increase was attributable to higher revolving credit borrowings under the credit
agreement. In 2003, the Company had lower revolving credit borrowings and
received interest from an income tax refund which decreased interest expense for
the first quarter.
In the first quarter of 2004, the Company reversed prior years tax
liabilities of approximately $0.2 million.
New Licensing Agreements
- ------------------------
On June 16, 2003, the Company entered into a licensing arrangement to
manufacture knits, sweaters, and woven tops under the Z. Cavaricci label. The
Company began shipments with the Spring 2004 season.
On September 10, 2003, the Company entered into a licensing arrangement to
manufacture women's coats under various Nicole Miller labels. The Company
intends to begin shipments with the Fall 2004 season.
On March 8, 2004, the Company entered into a licensing agreement to
manufacture women's suits under various Nicole Miller labels. The Company
intends to begin shipments with the Spring 2005 season.
On April 14, 2004, the Company entered into a licensing agreement to
manufacture women's sportswear under various Nicole Miller labels. The Company
intends to begin shipments with the Spring 2005 season.
13
Liquidity and Capital Resources
- -------------------------------
The Company's liquidity requirements arise from the funding of working
capital needs, primarily inventory and accounts receivable, and interest and
principal payments related to certain indebtedness and capital expenditures. The
Company's borrowing requirements for working capital fluctuate throughout the
year.
On June 29, 1999, the Company and its operating subsidiaries signed a
Credit Agreement (the "Credit Agreement") with CIT Group/Commercial Services
(the "Lender"). The Credit Agreement initially provided the Company with a $75
million facility comprised of a $72 million revolver with sub limits up to $52
million for direct borrowings, $35 million for letters of credit, certain
overadvances and a $3 million term loan which was paid in full as of June 30,
2002.
The Credit Agreement provides for advances of (i) up to 90% of eligible
accounts receivable plus (ii) up to 60% of eligible inventory plus (iii) up to
60% of the undrawn amount of all outstanding letters of credit plus (iv)
allowable overadvances.
Collateral for the Credit Agreement includes a first priority lien on all
accounts receivable, machinery, equipment, trademarks, intangibles and
inventory, a first mortgage on all real property and a pledge of the Company's
stock interest in its operating subsidiaries, Donnkenny Apparel, Inc. and
Beldoch Industries Corporation. The Credit Agreement contains numerous financial
and operational covenants, including limitations on additional indebtedness,
liens, dividends, stock repurchases and capital expenditures. In addition, the
Company is required to maintain specified levels of tangible net worth and
comply with a requirement for minimum earnings before depreciation,
amortization, interest and taxes (EBITDA) and a minimum interest coverage ratio,
all based upon the Company's annual business plans approved by the Lender.
In July 2000, the Credit Agreement was amended to provide for an additional
$1.3 million term loan to finance an acquisition. This term loan bore interest
at the prime rate plus 2% through March 2003, at which time this term loan was
paid.
On March 28, 2001, the Company entered into an Amendment and Waiver
Agreement to extend the Final Maturity Date of the original agreement to June
30, 2004, to waive existing events of default under the Credit Agreement as of
December 31, 2000 with respect to the Company's non-compliance with covenants
related to minimum interest coverage, EBITDA and Tangible Net Worth, and to
amend certain other provisions of the Credit Agreement including covenants and
the level of allowable overadvances to support the Company's 2001 business plan.
Pursuant to this amendment, the interest rate on borrowings was increased to
2.0% above the prime rate effective January 1, 2001. A fee of $200,000 was paid
in connection with the Amendment and Waiver.
Effective January 1, 2002, the Company established covenants and the level
of allowable overadvances with the Lender to support its 2002 business plan.
This Amendment and Waiver Agreement also amended the interest rate on the
revolving credit borrowings to the prime rate plus one and three quarters
percent and provide for an additional interest rate reduction effective July 1,
2002 if certain objectives were achieved (6.50% at January 1, 2002). No fee was
paid in connection with the Amendment and Waiver. The Company achieved the
objectives and received an additional rate reduction effective July 1, 2002. The
interest rate on the revolving credit borrowings was prime plus one and one-half
percent (5.75% at December 31, 2002).
Effective January 1, 2003, the Company established covenants and the level
of allowable overadvances with the Lender, through an Amendment to the Credit
Agreement dated March 27, 2003, to support its 2003 business plan. The Amendment
also amended the interest rate on the revolving credit borrowings to the prime
rate plus one and one-quarter percent. No fee was paid in connection with the
Amendment.
14
Effective June 30, 2003, the Company through an Amendment and Waiver
Agreement dated August 11, 2003, extended the Credit Agreement to June 30, 2007.
This Amendment provides the Company with a $65 million facility; the sublimits
have remained the same. The interest rate on the revolving credit borrowings is
the current prime rate plus one and one-quarter percent (5.25% at March 31,
2004). Fees paid in connection with this Amendment were $243,750. All other
terms and conditions of the Revolving Credit Agreement remained unchanged.
As of December 31, 2003, the Company was not in compliance with the
quarterly financial covenants. The Lender has waived this non-compliance. The
Company paid a fee of $100,000 in connection with this waiver.
Effective January 1, 2004, the Company established covenants and the level
of allowable overadvances with the Lender, through an Amendment to the Credit
Agreement dated March 26, 2004, to support its 2004 business plan. No fee was
paid in connection with the Amendment.
As of March 31, 2004, the Company was in compliance with the quarterly
financial covenants.
The Company also has a factoring agreement with CIT Group/Commercial
Services. The factoring agreement provides for a factoring commission equal to
..35% of gross sales, plus certain customary charges. The factoring agreement
renews annually in June each year unless either party to the agreement gives
appropriate notice of non-renewal.
In connection with the acquisition of Robyn Meredith (see Note 9 to the
Consolidated Financial Statements), a note payable of $1.1 million was incurred.
This note is payable in monthly installments of $33,333 including imputed
interest at an interest rate of 5.25%. The final payment will be due October
2006.
At March 31, 2004 and December 31, 2003, the Company was contingently
liable for outstanding letters of credit issued amounting to $4.3 million and
$6.6 million, respectively.
During the first quarter of 2004, cash provided by operating activities was
$3.4 million, principally as the result of decreases in amounts due from factor,
accounts receivable and increases in accounts payable. On a comparable basis,
net inventories at March 31, 2004 were $0.5 million more than at December 31,
2003. During the first quarter of 2003, cash provided by operating activities
was $3.3 million, principally as the result of decreases in amounts due to from
factor and inventory partially offset by decreases in accounts payable and
accrued expenses and other current liabilities.
Cash used in investing activities during the first quarter of 2004 was $0.4
million, mainly for leasehold improvements at the Company's New York showroom.
Cash used in investing activities during the first quarter of 2003 included
$0.03 million for the purchase fixed assets principally computer equipment and
related software.
Cash used in financing activities during the first quarter of 2004 was $3.0
million, which represents net repayments under the revolver of $2.9 million and
repayments of $0.1 million on a note payable. Cash used in financing activities
during the first quarter of 2003 was $3.2 million, which represents net
repayments under the revolver of $2.9 million and repayments of $0.3 million on
the term loan.
The Company believes that cash flows from operations and amounts available
under the Credit Agreement, as amended, will be sufficient for its needs for the
foreseeable future.
15
Contractual Commitments and Contingent Liabilities
The following table summarizes the Company's contractual commitments at March
31, 2004:
Contractual Obligations Payments due by Less than 1-3 years 3-5 years More than
(In Thousands) period 1 year 5 years
Total
Long Term debt $33,053 $ 358 $ 606 $32,089 --
Operating Leases $ 9,463 $ 3,040 $ 4,416 $ 2,007 --
Guaranteed Minimum Royalties $12,286 $ 2,434 $ 7,596 $ 2,050 $ 206
Inventory purchase agreement $ 1,000 $ 1,000 -- -- --
Letters of Credit $ 4,260 $ 4,260 -- -- --
------- ------- ------- ------- -----
Total $60,062 $11,092 $12,618 $36,146 $ 206
The Company has not provided any financial guarantees as of March 31, 2004.
Seasonality of Business and Fashion Risk
- ----------------------------------------
The Company's principal products are organized into seasonal lines for
resale at the retail level during the Spring, Summer, Fall and Holiday seasons.
Typically, the Company's products are designed as much as one year in advance
and manufactured approximately one season in advance of the related retail
selling season. Accordingly, the success of the Company's products is often
dependent on the ability to successfully anticipate the needs of retailers and
the tastes of the ultimate consumer up to a year prior to the relevant selling
season.
16
Critical Accounting Policies and Estimates
- ------------------------------------------
The Company's significant accounting policies are more fully described in
Note 1 to the Annual Consolidated Financial Statements filed on Form 10-K (not
presented herein). Certain of the Company's accounting policies require the
application of significant judgment by management in selecting the appropriate
assumptions for calculating financial estimates. By their nature, these
judgments are subject to an inherent degree of uncertainty. These judgments are
based on historical experience, observation of trends in the industry,
information provided by customers and information available from other outside
sources, as appropriate. Critical accounting policies include:
Revenue Recognition - The Company recognizes sales upon shipment of
products to customers as title and risk of loss pass upon shipment. Provisions
for estimated uncollectible accounts, discounts and returns and allowances are
provided when sales are recorded based upon historical experience and current
trends. While such amounts have been within expectations and the provisions
established, the Company cannot guarantee that it will continue to experience
the same rates as in the past.
Accounts Receivable and Due from Factor - Accounts Receivable and due from
factor as shown on the Consolidated Balance Sheets, are net of allowances and
anticipated discounts. An allowance for doubtful accounts is determined through
analysis of the aging of accounts receivable at the date of the financial
statements, assessments of collectibility based on historic trends and an
evaluation of the impact of economic conditions. The allowance for doubtful
accounts is not significant since the Company sells a substantial portion of its
trade receivables to a commercial factor, without recourse, up to maximum credit
limits established by the factor for each individual account. Receivables sold
in excess of these limitations are subject to recourse in the event of
non-payment by the customer. An allowance for discounts is based on those
discounts relating to open invoices where trade discounts have been extended to
customers. Costs associated with potential returns of products as well as
allowable customer markdowns and operational charge backs, net of expected
recoveries, are included as a reduction to net sales and are part of the
provision for allowances. These provisions result from seasonal negotiations as
well as historic deduction trends, net expected recoveries and the evaluation of
current market conditions. The Company's historical estimates of these costs
have not differed materially from actual results.
Inventories - Inventory is stated at the lower of cost or market, cost
being determined on the first-in, first-out method. Reserves for slow moving and
aged merchandise are provided based on historical experience and current product
demand. Inventory reserves for slow moving and aged merchandise were $0.7
million and $1.3 million at March 31, 2004 and December 31, 2003, respectively.
Inventory reserves decreased due to the composition of inventory on hand at
March 31, 2004. The Company evaluates the adequacy of the reserves quarterly.
While markdowns have been within expectations and the provisions established,
the Company cannot guarantee that it will continue to experience the same level
of markdowns as in the past.
Valuation of Long-Lived Assets - The Company periodically reviews the
carrying value of its long-lived assets for continued appropriateness. This
review is based upon projections of anticipated future undiscounted cash flows.
While the Company believes that its estimates of future cash flows are
reasonable, different assumptions regarding such cash flows could materially
affect evaluations.
Income Taxes - The Company provides for income taxes only to the extent
that it expects to pay taxes (primarily state franchise and local taxes). The
Company's cumulative net operating loss (NOL) carryforward of $20.0 million for
federal income taxes and $31.0 million for state income taxes, have resulted in
estimated tax benefits of $8.2 million as of December 31, 2003 being recorded as
a deferred tax asset. The Company has recorded a valuation allowance against the
entire net deferred tax assets balance due to the Company's history of
unprofitable operations. However, should the Company conclude that
17
future profitability is reasonably assured, the value of the deferred tax asset
would be increased by eliminating some or all of the valuation allowance.
Subsequent revisions to the estimated value of the deferred tax asset could
cause the Company's provision for income taxes to vary from period to period;
payments would remain unaffected until the benefit of the NOL is utilized.
Forward Looking Statements - This Form 10-Q (including but not limited to
the sections hereof entitled "Business" and "Management's Discussion and
Analysis") contains or incorporates by reference forward-looking statements
within the meaning of the Private Securities Litigation Reform Act of 1995.
Where any such forward-looking statement includes a statement of the assumptions
or bases underlying such forward-looking statement, the Company cautions that
assumed facts or bases almost always vary from the actual results, and the
differences between assumed facts or bases and actual results can be material,
depending on the circumstances. Where, in any forward-looking statement, the
Company or its management expresses an expectation or belief as to future
results, there can be no assurance that the statement of the expectation or
belief will result, or be achieved or accomplished. The words "believe",
"expect", "estimate", "project", "seek", "anticipate" and similar expressions
may identify forward-looking statements.
18
Item 3. Quantitative and Qualitative Disclosures about Market Risk
- ------------------------------------------------------------------
Interest Rate Risk - The Company is subject to market risk from exposure to
changes in interest rates based primarily on its financing activities. The
market risk inherent in the financial instruments represents the potential loss
in earnings or cash flows arising from adverse changes in interest rates. These
debt obligations with interest rates tied to the prime rate are described in
"Liquidity and Capital Resources", as well as Note 4 of the Notes to the
Consolidated Financial Statements. The Company manages these exposures through
regular operating and financing activities. The Company has not entered into any
derivative financial instruments for hedging or other purposes. The following
quantitative disclosures are based on the prevailing prime rate. These
quantitative disclosures do not represent the maximum possible loss or any
expected loss that may occur, since actual results may differ from these
estimates.
At March 31, 2004 and December 31, 2003, the carrying amounts of the
Company's revolving credit borrowings and term loans approximated fair value.
Effective January 1, 2003, the Company's revolving credit borrowings under its
Credit Agreement bear interest at the prime rate plus one and one-quarter
percent (5.25% at March 31, 2004). As of March 31, 2004, a hypothetical
immediate 10% adverse change in prime interest rates (from 4.0% to 4.4%)
relating to the Company's revolving credit borrowings would have a $0.1 million
unfavorable impact on the Company's earnings and cash flows over a one-year
period.
Item 4. Controls and Procedures
- -------------------------------
The Company's management with the participation of Daniel H. Levy, the
Chief Executive Officer and Maureen d. Schimmenti, the Chief Financial Officer
of the Company has evaluated the effectiveness of the Company's disclosure
controls and procedures as of the end of the period covered by this report.
Based on this evaluation the Company's Chief Executive Officer and Chief
Financial Officer, concluded that the Company's disclosure controls and
procedures are effective in alerting them on a timely basis to material
information required to be included in the reports that it files or submits
under the Securities and Exchange Act of 1934, as amended. Such evaluation did
not identify any change in the Company's internal control over financial
reporting that occurred during the quarter ended March 31, 2004, that has
materially affected, or is reasonably likely to materially affect, the Company's
internal control over financial reporting.
19
PART II. OTHER INFORMATION
ITEM 1. Legal Proceedings
-----------------
On April 27, 1998, Wanda King, a former employee of the Company, commenced
an action against the Company in the United States District Court for the
Western District of Virginia. By Order dated May 4, 2004 based upon the case
being settled, the action was dismissed. The Company has accrued the settlement
amount on the March 31, 2004 financial statements.
The Company is a party to legal proceedings arising in the ordinary course
of its business. Management believes that the ultimate resolution of these
proceedings will not, in the aggregate, have a material adverse effect on
financial condition, results of operations, liquidity or business of the
Company.
ITEM 2. Not Applicable
--------------
ITEM 3. Not Applicable
--------------
ITEM 4. Not Applicable
--------------
ITEM 5. Not Applicable
--------------
ITEM 6. Exhibits and Reports on Form 8-K
--------------------------------
(a) Exhibits
--------
Exhibit No. Description of Exhibit
----------- ----------------------
31.1 Certification Pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002.
31.2 Certification Pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002.
32.1 Certification Pursuant to 18 U.S.C. Section 1350, as
Adopted Pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002.
32.2 Certification Pursuant to 18 U.S.C. Section 1350, as
Adopted Pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002.
(b) NONE
20
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 thereunto duly authorized.
Donnkenny, Inc.
Registrant
Date: May 14, 2004 /s/ Daniel H. Levy
-------------------------------------
Daniel H. Levy
Chairman of the Board,
Chief Executive Officer
Date: May 14, 2004 /s/ Maureen d. Schimmenti
-------------------------------------
Maureen d. Schimmenti
Vice President
and Chief Financial Officer,
(Principal Financial Officer)
21