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 June 30, 2002
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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
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Donnkenny, Inc.
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(Exact name of registrant as specified in its charter)
Delaware 51-0228891
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(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
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NOT APPLICABLE
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(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 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 August 7, 2002)
DONNKENNY, INC AND SUBSIDIARIES
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
(FORM 10-Q)
PART I - FINANCIAL INFORMATION Page
----
Consolidated financial statements:
Independent Accountants' Report.............................................1
Balance sheets as of June 30, 2002 (unaudited) and December 31, 2001........2
Statements of operations for the three and six months ended
June 30, 2002 and 2001 (unaudited)..........................................3
Statements of cash flows for the six months ended
June 30, 2002 and 2001 (unaudited)..........................................4
Notes to Consolidated Financial Statements (unaudited)..................5 - 9
Management's Discussion and Analysis of Financial Condition and
Results of Operations...................................................10 - 15
Quantitative and Qualitative Disclosures about Market Risk...................15
PART II - OTHER INFORMATION
Legal Proceedings and Other Information....................................16
Exhibits and Reports on Form 8-K...........................................16
Signatures.................................................................17
INDEPENDENT ACCOUNTANTS' REPORT
To the Board of Directors and Stockholders of Donnkenny, Inc.
We have reviewed the accompanying consolidated balance sheet of Donnkenny, Inc.
and subsidiaries as of June 30, 2002, and the related consolidated statements of
operations for the three-month and six-month periods ended June 30, 2002 and
2001 and cash flows for the six-month periods ended June 30, 2002 and 2001.
These financial statements are the responsibility of the Company's management.
We conducted our review in accordance with standards established by the American
Institute of Certified Public Accountants. A review of interim financial
information consists principally of applying analytical procedures to financial
data and of making inquiries of persons responsible for financial and accounting
matters. It is substantially less in scope than an audit conducted in accordance
with auditing standards generally accepted in the United States of America, the
objective of which is the expression of an opinion regarding the financial
statements taken as a whole. Accordingly, we do not express such an opinion.
Based on our review, we are not aware of any material modifications that should
be made to such consolidated financial statements for them to be in conformity
with accounting principles generally accepted in the United States of America.
We have previously audited, in accordance with auditing standards generally
accepted in the United States of America, the consolidated balance sheet of
Donnkenny, Inc. and subsidiaries as of December 31, 2001, and the related
consolidated statements of operations, stockholders' equity, and cash flows for
the year then ended (not presented herein); and in our report dated March 25,
2002, we expressed an unqualified opinion on those consolidated financial
statements. In our opinion, the information set forth in the accompanying
consolidated balance sheet as of December 31, 2001 is fairly stated, in all
material respects, in relation to the consolidated balance sheet from which it
has been derived.
DELOITTE & TOUCHE LLP
New York, New York
August 7, 2002
1
DONNKENNY, INC. AND SUBSIDIARIES
Consolidated Balance Sheets
(in thousands, except per share data)
June 30, December 31,
2002 2001
--------------- --------------
(Unaudited)
CURRENT ASSETS
Cash......................................................... $ 32 $ 39
Accounts receivable - net of allowances of
$114 and $116, in 2002 and 2001, respectively......... 15,974 25,225
Recoverable income taxes..................................... 379 381
Inventories.................................................. 18,518 17,773
Deferred tax assets.......................................... 1,662 1,662
Prepaid expenses and other current assets.................... 435 1,220
Assets held for sale......................................... 601 788
---------- ----------
Total current assets......................................... 37,601 47,088
PROPERTY, PLANT AND EQUIPMENT, NET................................ 5,010 5,379
OTHER ASSETS...................................................... 333 368
INTANGIBLE ASSETS................................................. 821 4,198
GOODWILL.......................................................... - 25,367
---------- ----------
TOTAL............................................................. $ 43,765 $ 82,400
========== ==========
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Current portion of long-term debt.......................... $ 433 $ 933
Accounts payable........................................... 10,608 7,760
Accrued expenses and other current liabilities............. 1,782 3,504
---------- ----------
Total current liabilities............................... 12,823 12,197
---------- ----------
LONG-TERM DEBT.................................................... 24,315 34,844
DEFERRED TAX LIABILITIES.......................................... 1,662 1,662
COMMITMENTS AND CONTINGENCIES
STOCKHOLDERS' EQUITY:
Preferred stock $.01 par value; authorized 500
shares, issued none.........................................
Common stock, $.01 par value. Authorized 10,000
shares, issued and outstanding 4,367 shares
in 2002 and 2001............................................. 44 44
Additional paid-in capital.................................... 50,449 50,449
Deficit....................................................... (45,528) (16,796)
---------- ----------
Total Stockholders' Equity..................................... 4,965 33,697
---------- ----------
TOTAL............................................................. $ 43,765 $ 82,400
========== ==========
See accompanying notes to consolidated financial statements.
2
DONNKENNY, INC. AND SUBSIDIARIES
Consolidated Statements of Operations
(in thousands, except share and per share data)
(unaudited)
Three Months Ended Six Months Ended
----------------------------- -----------------------------
June 30, 2002 June 30, 2001 June 30, 2002 June 30, 2001
-------------- ------------- ------------- -------------
NET SALES..................................................$ 22,358 $ 30,539 $ 46,796 $ 67,847
COST OF SALES.............................................. 17,170 23,968 35,191 52,422
------ ------ ------ ------
Gross profit........................................... 5,188 6,571 11,605 15,425
OPERATING EXPENSES:
Selling, general and administrative expenses........... 5,067 6,466 10,412 13,239
Amortization of goodwill and other related
acquisition costs..................................... - 372 - 745
----- ----- ----- -----
Operating income (loss)............................ 121 (267) 1,193 1,441
INTEREST EXPENSE........................................... 423 1,120 1,091 2,426
----- ----- ----- -----
Income (loss) before income taxes and
cumulative effect of change in accounting princple....... (302) (1,387) 102 (985)
INCOME TAXES............................................... 45 45 90 90
----- ----- ----- -----
Income (loss) before cumulative effect
of change in accounting principle........................ (347) (1,432) 12 (1,075)
CUMULATIVE EFFECT OF CHANGE IN ACCOUNTING
PRINCIPLE (NO TAX BENEFIT REC-GNIZED)..................... - - 28,744 -
------- ------- ------ -----
NET LOSS.............................................$ (347) $ (1,432) $ (28,732) $ (1,075)
=========== =========== =========== ===========
Basic earnings per common share:
Income (loss) before accounting change..................$ (0.08) $ (0.33) $ - $ (0.25)
Cumulative effect of accounting change.................. - - (6.58) -
----------- ----------- ----------- -----------
Net loss...............................................$ (0.08) $ (0.33) $ (6.58) $ (0.25)
=========== =========== =========== ===========
Diluted earnings per common share:
Income (loss) before accounting change..................$ (0.08) $ (0.33) $ - $ (0.25)
Cumulative effect of accounting change.................. - - (6.58) -
----------- ----------- ----------- -----------
Net loss...............................................$ (0.08) $ (0.33) $ (6.58) $ (0.25)
=========== =========== =========== ===========
Shares used in the calculation of earnings per share:
Basic................................................... 4,367,417 4,367,417 4,367,417 4,367,417
=========== =========== =========== ===========
Diluted................................................. 4,367,417 4,367,417 4,367,417 4,367,417
=========== =========== =========== ===========
See accompanying notes to consolidated financial statements.
3
DONNKENNY, INC. AND SUBSIDIARIES
Consolidated Statements of Cash Flows
(in thousands)
(unaudited)
Six Months Ended
----------------------------
June 30 June 30
2002 2001
----------- -----------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net (loss)................................................. $ (28,732) $ (1,075)
Adjustments to reconcile net (loss) to net cash
provided by (used in) operating activities:
Depreciation and amortization of fixed assets.............. 750 509
Disposal of fixed assets................................... 2 2
Amortization of intangibles and other assets............... - 745
Cumulative effect of change in accounting principle ....... 28,744 -
Provision for losses on accounts receivable................ 10 10
Changes in assets and liabilities:
Decrease in accounts receivable............................ 9,241 5,885
Decrease in recoverable income taxes....................... 2 12
Increase in inventories.................................... (745) (10,748)
Decrease (increase) in prepaid expenses and
other current assets....................................... 785 (99)
Decrease in other non-current assets....................... 35 10
Increase in accounts payable............................... 2,848 4,344
Decrease in accrued expenses and
other current liabilities................................. (1,722) (648)
----------- -----------
Net cash provided by (used in) operating activities........ 11,218 (1,053)
----------- -----------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchase of property, plant and equipment.................. (339) (1,079)
Proceeds from sale of property, plant and equipment........ 143 -
----------- -----------
Net cash used in investing activities...................... (196) (1,079)
----------- -----------
CASH FLOWS FROM FINANCING ACTIVITIES:
Repayment of long-term debt................................ (717) (806)
Borrowings under revolving credit line..................... 46,638 77,298
Repayments under revolving credit line..................... (56,950) (74,301)
----------- -----------
Net cash (used in) provided by financing activities........ (11,029) 2,191
----------- -----------
NET (DECREASE) INCREASE IN CASH............................ (7) 59
CASH, AT BEGINNING OF PERIOD............................... 39 65
----------- -----------
CASH, AT END OF PERIOD..................................... $ 32 $ 124
=========== ===========
SUPPLEMENTAL DISCLOSURES
Income taxes paid.......................................... $ 36 $ 77
=========== ===========
Interest paid.............................................. $ 1,096 $ 2,437
=========== ===========
See accompanying notes to consolidated financial statements.
4
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, 2001. Balance sheet data as of December 31, 2001
have been derived from audited financial statements of the Company.
NOTE 2 - INVENTORIES
Inventories consist of the following:
June 30, December 31,
2002 2001
---- ----
(In thousands)
Raw materials . . . . . . . . . . . . . . $ 1,184 $ 840
Work-in-process . . . . . . . . . . . . . . 786 331
Finished goods . . . . . . . . . . . . . . 16,548 16,602
-------- --------
$ 18,518 $ 17,773
======== ========
NOTE 3 - DEBT
On June 29, 1999, the Company and its operating subsidiaries signed a
three-year credit agreement (the "Credit Agreement") with CIT Group/Commercial
Services. The Credit Agreement provides the Company with a $75 million facility
comprised of a $72 million revolver with sublimits up to $52 million for direct
borrowings, $35 million for letters of credit, certain overadvances and a $3
million term loan.
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. The term loan requires quarterly payments of $0.25
million plus all accrued and unpaid interest beginning September 30, 1999
through June 30, 2002. The Credit Agreement as amended expires on June 30, 2004.
5
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 minimum
earnings before depreciation, amortization, interest and taxes (EBITDA) and a
minimum interest coverage ratio, based upon the annual business plan approved by
the lender.
During Fiscal 1999 and Fiscal 2000, the Company entered into various
amendments and agreements to waive the Company's noncompliance with financial
covenants on certain dates and to reset overadvanced amounts and covenants.
These amendments and agreements also increased the interest rate on borrowings.
On July 6, 2000, the Company entered into an Amendment to finance the
acquisition of the Ann Travis business by the issuance of an additional $1.3
million term loan. The new term loan bears interest at the prime rate plus 2.0%
(6.75% at June 30, 2002) and is repayable over thirty-six months commencing
January 1, 2001. A fee of $100,000 was paid for the Amendment.
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 this 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 (6.50% at June 30, 2002) and provided for an additional interest rate
reduction effective July 1, 2002 if certain objectives were achieved. No fee was
paid in connection with this Amendment and Waiver. The Company has achieved the
objectives and will receive an additional rate reduction effective July 1, 2002.
The interest rate on the revolving credit borrowings will now be prime plus one
and one half percent.
On June 30, 2002, the Company made the final payment on the $3 million
term loan in accordance with the terms of the Credit Agreement. Direct
borrowings under the revolving credit facility were $24.1 million and the
remaining acquisition term loan amounted to $0.6 million as of June 30, 2002.
Additionally, the Company had letters of credit outstanding of $17.4 million,
with an unused facility of $33.5 million. As of June 30, 2001, direct
borrowings, term loans and letters of credit outstanding under the credit
facility were $42.3 million, $2.0 million and $17.5 million, respectively.
The Company also has a factoring agreement with CIT. The factoring
agreement provides for a factoring commission equal to .35% of gross sales, plus
certain customary charges. The agreement is in effect through December 31, 2002.
6
NOTE 4 - GOODWILL AND INTANGIBLE ASSETS
In June 2001, the Financial Accounting Standards Board ("FASB") issued
Statement on Financial Accounting Standards ("SFAS") No. 142, "Goodwill and
Other Intangible Assets". SFAS No. 142 addresses financial accounting and
reporting for acquired goodwill and other intangible assets and supersedes APB
No. 17, "Intangible Assets". It changes the accounting for goodwill from an
amortization method to an impairment only approach. SFAS No. 142 is effective
for fiscal years beginning after December 15, 2001 for all goodwill and other
intangible assets recognized in an entity's statement of financial position at
that date, regardless of when those assets were initially recognized.
Prior to January 1, 2002, the Company had net intangible assets of
$29.6 million on its Consolidated Balance Sheet. The intangible assets included
goodwill of $25.4 million, which represented the excess purchase price over fair
value of net assets acquired. The assets acquired related to the acquisitions of
(1) the Company in 1989 following a change in control, (2) the sportswear
division of Oak Hill Sportswear Corporation ("Oak Hill"), (3) Beldoch Industries
Corporation ("Beldoch") in 1995, and (4) Ann Travis in 2000. Goodwill was
amortized on a straight-line basis over expected periods to be benefited,
ranging from 10 to 40 years. Also included in the net intangible assets were
$4.2 million of costs related to the Pierre Cardin license acquired by the
Company in connection with the Beldoch acquisition, which were amortized on a
straight-line basis over 20 years.
As a result of adopting SFAS No. 142 on January 1, 2002, the Company
ceased the amortization of goodwill and determined that the value of its
intangible assets had been impaired. The impairment charge of $28.7 million was
calculated based upon a valuation of the Company's market capitalization on
January 1, 2002, adjusted for an estimated premium that a willing buyer would
assign to the market capitalization in the event of a sale of the Company. The
premium was based on an average of such premiums paid in similar transactions in
the industry. The impairment charge consists of $25.4 million related to
goodwill and $3.3 million related to intangible assets.
The impairment charge is reflected in the Company's Consolidated
Statement of Operations as a line item disclosing the cumulative effect of a
change in accounting principle before the net income for the period. The Company
did not record an income tax benefit related to this charge.
The remaining value of intangible assets of $0.8 million is
attributable to those intangible assets acquired related to the Pierre Cardin
license from the Beldoch acquisition, and is classified as an intangible asset
with an indefinite life on the Company's June 30, 2002 Consolidated Balance
Sheet.
Actual results of operations for the six-month period ended June 30,
2002 and pro forma results of operations for the six-month period ended June 30,
2001 had the Company applied the non-amortization provisions of SFAS No. 142 in
that period follows (in thousands, except per share amounts):
7
Six Month Periods Ended
June 30,
--------
2002 2001
---- ----
Income before cumulative
effect of change in accounting principle.................. $ 12 $ (1,075)
Cumulative effect of change in accounting
principle (no tax benefit recognized)..................... 28,744 -
--------- ---------
Reported net income (loss)................................. (28,732) (1,075)
Add: Amortization of goodwill and intangibles.............. - 745
--------- ---------
-
Adjusted net income (loss)................................. $ (28,732) $ (330)
========= =========
Basic and diluted net income (loss) per share:
Reported net income (loss).............................. $ - $ (0.25)
Amortization of goodwill and intangibles................ (6.58) .17
--------- ---------
Adjusted net income (loss) per share.................... $ (6.58) $ (0.08)
========= =========
NOTE 5 - RECENT ACCOUNTING PRONOUNCEMENTS
In June 2001, the FASB issued SFAS No. 143, "Accounting for Asset
Retirement Obligations". SFAS No. 143 addresses financial accounting and
reporting for obligations associated with the retirement of tangible long-lived
assets and the associated asset retirement costs. This Statement requires that
the fair value of a liability for an asset retirement obligation be recognized
in the period in which it is incurred if a reasonable estimate of fair value can
be made. The associated asset retirement costs are capitalized as part of the
carrying amount of the long-lived asset. This Statement is effective for
financial statements issued for fiscal years beginning after June 15, 2002.
Early adoption is encouraged. Adoption of SFAS No. 143 on January 1, 2002 did
not have an impact on the Company's consolidated financial statements.
In August 2001, the FASB issued SFAS No. 144, "Accounting for the
Impairment or Disposal of Long-Lived Assets". SFAS No. 144 addresses financial
accounting and reporting for the impairment or disposal of long-lived assets.
SFAS No. 144 replaces SFAS No. 121, "Accounting for the Impairment of Long-Lived
Assets and for Long-Lived Assets to Be Disposed Of" and provides updated
guidance concerning the recognition and measurement of an impairment loss for
certain types of long-lived assets. This Statement is effective for financial
statements issued for fiscal years beginning after December 15, 2001, and
interim periods within those fiscal years. Adoption of SFAS No. 144 on January
1, 2002 did not have an impact on the Company's consolidated financial
statements.
In April 2002, the FASB issued SFAS No. 145, "Rescission of FASB
Statements No. 4, 44 and 64, Amendment of FASB Statement No. 13, and Technical
Corrections ("SFAS No. 145"). SFAS No. 145 rescinds the provisions of SFAS No. 4
that requires companies to classify certain gains and losses from debt
extinguishments as extraordinary items, eliminates the provisions of SFAS No. 44
regarding the Motor Carrier Act of 1980 and amends the provisions of SFAS No. 13
to require that certain lease modifications be treated as sale leaseback
transactions. The provisions of SFAS No. 145 related to classification of debt
extinguishment is effective for fiscal years beginning after May 15, 2002.
Earlier application is encouraged. The adoption of SFAS No. 145 is not expected
to have a material impact in the financial position or results of operation of
the Company.
8
In June 2002, the FASB issued SFAS No. 146, "Accounting for Costs
Associated with Exit or Disposal Activities". SFAS No. 146 addresses financial
accounting and reporting for costs associated with exit or disposal activities
and nullifies Emerging Issues Task Force ("EITF") Issue No. 94-3, "Liability
Recognition for Certain Employee Termination Benefits and Other Costs to Exit an
Activity (including Certain Costs Incurred in a Restructuring)." SFAS No. 146
requires that a liability for a cost associated with an exit or disposal
activity be recognized when the liability is incurred. This statement also
established that fair value is the objective for initial measurement of the
liability. The provisions of SFAS No. 146 are effective for exit or disposal
activities that are initiated after December 31, 2002. The Company is currently
evaluating the impact, if any, of SFAS No. 146 on its consolidated financial
statements.
NOTE 6 - 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. In her complaint, the Plaintiff sought damages
in excess of $8.0 million claiming that she was constructively discharged by the
Company. The Company interposed an Answer to the amended Complaint denying the
material allegations asserted in the Complaint and brought a motion for summary
judgment to dismiss the case. On October 22, 2001, the Magistrate Judge, after
considering the Motion for Summary Judgment, recommended to the United States
District Court that the case against the Company be dismissed in its entirety.
The Plaintiff objected to the recommendation of the Magistrate Judge. By Order
dated February 25, 2002, the United States District Judge granted the Company's
motion for summary judgment and the case was dismissed. The Plaintiff has
appealed this dismissal to the United States Court of Appeals for the Fourth
Circuit.
b. The Company is also 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.
9
DONNKENNY, INC. AND SUBSIDIARIES
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
Comparison of Six Months Ended June 30, 2002 and 2001
- -----------------------------------------------------
Net sales decreased by $21.0 million, or 31.0% from $67.8 million in
the first half of 2001 to $46.8 million in the first half 2002. The decline was
primarily due to the Company's discontinuation of the Decade dress business, the
de-emphasis and consolidation of Pierre Cardin Options into Pierre Cardin Knits,
the Company's decision to exit the career private label business and the
continuing slow retail environment, which caused a drop in the Company's core
businesses.
Gross profit for the first half of 2002 was $11.6 million, or 24.8% of
net sales, compared to $15.4 million, or 22.7% of net sales, during the first
half of 2001. The increase in gross profit as a percentage of net sales was
primarily attributable to decreases in the levels and sales of non-current
inventory and the continued effort to improve sourcing.
Selling, general and administrative expenses decreased $2.8 million
from $13.2 million in the first half of 2001 to $10.4 million in the first half
of 2002. The decrease in selling, general and administrative expenses was
primarily due to reductions in headcount and reductions in distribution, sales,
design and product related expenses.
Net interest expense decreased from $2.4 million during the first half
of 2001 to $1.1 million during the first half of 2002. The decrease was
attributable to lower revolving credit borrowings under the loan agreement in
addition to lower interest rates.
Comparison of Quarters Ended June 30, 2002 and 2001
- ---------------------------------------------------
Net sales decreased by $8.1 million, or 26.6% from $30.5
million in the second quarter of 2001 to $22.4 million in the second quarter
2002. The decline was primarily due to the Company's discontinuation of the
Decade dress business, the de-emphasis and consolidation of Pierre Cardin
Options into Pierre Cardin Knits, the Company's decision to exit the career
private label business, competitive price reductions and the continuing slow
retail environment, which caused a drop in the Company's core businesses.
Gross profit for the second quarter of 2002 was $5.2 million, or 23.2%
of net sales, compared to $6.6 million, or 21.6% of net sales, during the second
quarter of 2001. The increase in gross profit in dollars and as a percent of
sales was primarily due to decreases in the levels and sales of non-current
inventory and the continued effort to improve sourcing.
Selling, general and administrative expenses decreased $1.4 million
from $6.5 million in the second quarter of 2001 to $5.1 million in the second
quarter of 2002. The decrease in selling, general and administrative expenses
was primarily due to reductions in headcount and reductions in distribution,
sales and product related expenses.
Net interest expense decreased from $1.1 million during the second
quarter of 2001 to $0.4 million during the second quarter of 2002. The decrease
was attributable to lower revolving credit borrowings under the loan agreement
in addition to lower interest rates.
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.
10
On June 29, 1999, the Company and its operating subsidiaries signed a
three-year credit agreement (the "Credit Agreement") with CIT Group/Commercial
Services. The Credit Agreement provides the Company with a $75 million facility
comprised of a $72 million revolver with sublimits up to $52 million for direct
borrowings, $35 million for letters of credit, certain overadvances and a $3
million term loan.
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. The term loan requires quarterly payments of $0.25
million plus all accrued and unpaid interest beginning September 30, 1999
through June 30, 2002. The Credit Agreement as amended expires on June 30, 2004.
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 minimum
earnings before depreciation, amortization, interest and taxes (EBITDA) and a
minimum interest coverage ratio, based upon the annual business plan approved by
the lender.
During Fiscal 1999 and Fiscal 2000, the Company entered into various
amendments and agreements to waive the Company's noncompliance with financial
covenants on certain dates and to reset overadvanced amounts and covenants.
These amendments and agreements also increased the interest rate on borrowings.
On July 6, 2000, the Company entered into an Amendment to finance the
acquisition of the Ann Travis business by the issuance of an additional $1.3
million term loan. The new term loan bears interest at the prime rate plus 2.0%
(6.75% at June 30, 2002) and is repayable over thirty-six months commencing
January 1, 2001. A fee of $100,000 was paid for the Amendment.
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 this 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 (6.50% at June 30, 2002) and provided for an additional interest rate
reduction effective July 1, 2002 if certain objectives were achieved. No fee was
paid in connection with this Amendment and Waiver. The Company has achieved the
objectives and will receive an additional rate reduction effective July 1, 2002.
The interest rate on the revolving credit borrowings will now be prime plus one
and one half percent.
11
On June 30, 2002, the Company made the final payment on the $3 million
term loan in accordance with the terms of the Credit Agreement. Direct
borrowings under the revolving credit facility were $24.1 million and the
remaining acquisition term loan amounted to $0.6 million as of June 30, 2002.
Additionally, the Company had letters of credit outstanding of $17.4 million,
with an unused facility of $33.5 million. As of June 30, 2001, direct
borrowings, term loans and letters of credit outstanding under the credit
facility were $42.3 million, $2.0 million and $17.5 million, respectively.
The Company also has a factoring agreement with CIT. The factoring
agreement provides for a factoring commission equal to .35% of gross sales, plus
certain customary charges. The agreement is in effect through December 31, 2002.
During the first half of 2002, cash provided by operating activities
was $11.2 million, principally as the result of decreases in accounts receivable
and prepaid expenses and increases in accounts payable partially offset by
increases in inventories and decreases in accrued expenses. During the first
half of 2001, the Company's operating activities used cash of $1.1 million
principally as a result of increases in inventory partially offset by decreases
in accounts receivable and increases in accounts payable.
Cash used in investing activities during the first half of 2002
included $0.3 million for the purchase of fixed assets, principally computer
equipment and related software, partially offset by $0.1 million from the sale
of fixed assets. Cash used in investing activities during the first half of 2001
included $1.1 million primarily relating to the upgrades in the Company's
computer system.
Cash used in financing activities during the first half of 2002 was
$11.0 million, which represents net repayments under the revolver of $10.3
million and repayments of $0.7 million of the term loan. Cash provided by
financing activities during the first half of 2001 was $2.2 million which
represents net borrowings under the revolver of $3.0 million and repayments of
$0.8 million of the term loan and a secured term loan.
The Company believes that cash flows from operations and amounts
available under the revolving credit agreement will be sufficient for its needs
for the foreseeable future.
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, Transition, 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 retail customers and the tastes of the ultimate consumer up to a year prior
to the relevant selling season.
12
Recent Accounting Pronouncements
- --------------------------------
In June 2001, the Financial Accounting Standards Board ("FASB") issued
Statement on Financial Accounting Standards ("SFAS") No. 142, "Goodwill and
Other Intangible Assets". SFAS No. 142 addresses financial accounting and
reporting for acquired goodwill and other intangible assets and supersedes APB
No. 17, "Intangible Assets". It changes the accounting for goodwill from an
amortization method to an impairment only approach. SFAS No. 142 is effective
for fiscal years beginning after December 15, 2001 to all goodwill and other
intangible assets recognized in an entity's statement of financial position at
that date, regardless of when those assets were initially recognized. The
Company ceased the amortization of goodwill, which was recorded in past business
combinations on December 31, 2001 as required by SFAS No. 142 and recorded an
impairment charge of $28.7 million related to goodwill and intangible assets as
a change in accounting principle upon the adoption of this statement (See Note 4
to the consolidated financial statements).
In June 2001, the FASB issued SFAS No. 143, "Accounting for Asset
Retirement Obligations". SFAS No. 143 addresses financial accounting and
reporting for obligations associated with the retirement of tangible long-lived
assets and the associated asset retirement costs. This Statement requires that
the fair value of a liability for an asset retirement obligation be recognized
in the period in which it is incurred if a reasonable estimate of fair value can
be made. The associated asset retirement costs are capitalized as part of the
carrying amount of the long-lived asset. This Statement is effective for
financial statements issued for fiscal years beginning after June 15, 2002.
Early adoption is encouraged. Adoption of SFAS No. 143 on January 1, 2002 did
not have an impact on the Company's consolidated financial statements.
In August 2001, the FASB issued SFAS No. 144, "Accounting for the
Impairment or Disposal of Long-Lived Assets". SFAS No. 144 addresses financial
accounting and reporting for the impairment or disposal of long-lived assets.
SFAS No. 144 replaces SFAS No. 121, "Accounting for the Impairment of Long-Lived
Assets and for Long-Lived Assets to Be Disposed Of" and provides updated
guidance concerning the recognition and measurement of an impairment loss for
certain types of long-lived assets. This Statement is effective for financial
statements issued for fiscal years beginning after December 15, 2001, and
interim periods within those fiscal years. Adoption of SFAS No. 144 on January
1, 2002 did not have an impact on the Company's consolidated financial
statements.
In April 2002, the FASB issued SFAS No. 145, "Rescission of FASB
Statements No. 4, 44 and 64, Amendment of FASB Statement No. 13, and Technical
Corrections" ("SFAS No. 145"). SFAS No. 145 rescinds the provisions of SFAS No.
4 that requires companies to classify certain gains and losses from debt
extinguishments as extraordinary items, eliminates the provisions of SFAS No. 44
regarding the Motor Carrier Act of 1980 and amends the provisions of SFAS No. 13
to require that certain lease modifications be treated as sale leaseback
transactions. The provisions of SFAS No. 145 related to classification of debt
extinguishment is effective for fiscal years beginning after May 15, 2002.
Earlier application is encouraged. The adoption of SFAS No. 145 is not expected
to have a material impact in the financial position or results of operation of
the Company.
In June 2002, the FASB issued SFAS No. 146, "Accounting for Costs
Associated with Exit or Disposal Activities". SFAS No. 146 addresses financial
accounting and reporting for costs associated with exit or disposal activities
and nullifies Emerging Issues Task Force ("EITF") Issue No. 94-3, "Liability
Recognition for Certain Employee Termination Benefits and Other Costs to Exit an
Activity (including Certain Costs Incurred in a Restructuring)." SFAS No. 146
requires that a liability for a cost associated with an exit or disposal
activity be recognized when the liability is incurred. This statement also
established that fair value is the objective for initial measurement of the
liability. The provisions of SFAS No. 146 are effective for exit or disposal
activities that are initiated after December 31, 2002. The Company is currently
evaluating the impact, if any, of SFAS No. 146 on its consolidated financial
statements.
13
Critical Accounting Policies and Estimates
- ------------------------------------------
The Company's significant accounting policies are more fully described
in Note 1 to the annual consolidated financial statements. 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. Significant accounting
policies include:
Revenue Recognition - The Company recognizes sales upon shipment of
-------------------
products and transfer of title to customers. 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.
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. 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.
14
Income Taxes - The Company has cumulative net operating loss (NOL)
------------
carry-forwards of $19.7 million for federal income taxes and $30.8 million for
state income taxes, which have generated estimated tax benefits of $8.1 million
as of December 31, 2001. In accordance with generally accepted accounting
principles, the Company has not recognized in income any of this tax benefit due
to the size of the NOL carry-forward and the Company's history of unprofitable
operations. However, should the Company conclude that future profitability is
assured; the estimated net realizable value of the deferred tax asset would be
partially or fully credited to net income. Subsequent revisions to the estimated
net realizable value of the deferred tax asset could cause the Company's
provision for income taxes to vary from period to period. The provision for
income taxes primarily consists of state and local income taxes.
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 3 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 June 30, 2002 and 2001, the carrying amounts of the Company's
revolving credit borrowings and term loans approximated fair value. Effective
July 1, 2002, the Company's revolving credit borrowings under its Credit
Agreement bear interest at the prime rate plus one and one half percent (6.25%
at July 1, 2002). The Company's acquisition term loan bears interest at the
prime rate plus two percent (6.75% at June 30, 2002). As of June 30, 2002, a
hypothetical immediate 10% adverse change in prime interest rates (from 4.75% to
5.23%) relating to our revolving credit borrowings and term loan would have a
$0.1 million unfavorable impact on our earnings and cash flows over a one-year
period.
15
PART II. OTHER INFORMATION
ITEM 1. Legal Proceedings
-----------------
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. In
her complaint, the Plaintiff sought damages in excess of $8.0
million claiming that she was constructively discharged by the
Company. The Company interposed an Answer to the amended
Complaint denying the material allegations asserted in the
Complaint and brought a motion for summary judgment to dismiss
the case. On October 22, 2001, the Magistrate Judge, after
considering the Motion for Summary Judgment, recommended to the
United States District Court that the case against the Company
be dismissed in its entirety. The Plaintiff objected to the
recommendation of the Magistrate Judge. By Order dated February
25, 2002, the United States District Judge granted the
Company's motion for summary judgment and the case was
dismissed. The Plaintiff has appealed this dismissal to the
United States Court of Appeals for the Fourth Circuit.
b. The Company is also 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
----------- ----------------------
10.68 Certification Pursuant to 18 U.S.C. Section 1350,
as Adopted Pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002.
10.69 Certification Pursuant to 18 U.S.C. Section 1350,
as Adopted Pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002.
(b) Reports on Form 8-K
-------------------
None
16
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: August 13, 2002 /s/ Daniel H. Levy
-----------------------------
Daniel H. Levy
Chairman of the Board,
Chief Executive Officer
Date: August 13, 2002 /s/ Maureen d. Schimmenti
----------------------------
Maureen d. Schimmenti
Vice President
and Chief Financial Officer,
(Principal Financial Officer)
17