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, 2003
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 9, 2003)
DONNKENNY, INC AND SUBSIDIARIES
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
(FORM 10-Q)
PART I - FINANCIAL INFORMATION Page
----
Item 1. Consolidated financial statements:
Independent Accountants' Report............................................................1
Balance sheets as of March 31, 2003 (unaudited) and December 31, 2002......................2
Statements of operations for the three months ended
March 31, 2003 and 2002 (unaudited)........................................................3
Statements of cash flows for the three months ended
March 31, 2003 and 2002 (unaudited)........................................................4
Notes to Consolidated Financial Statements (unaudited)...................................5-9
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations.............................................................................10-14
Item 3. Quantitative and Qualitative Disclosures about Market Risk...................................14
Item 4. Controls and Procedures......................................................................14
PART II - OTHER INFORMATION
Item 1. Legal Proceedings............................................................................15
Item 6 Exhibits and Reports on Form 8-K.............................................................15
Signatures................................................................................16
Certifications.........................................................................17-20
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 March 31, 2003, and the related consolidated statements
of operations and cash flows for the three-month periods ended March 31, 2003
and 2002. These financial statements are the responsibility of the Company's
management.
We conducted our reviews 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 reviews, 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, 2002, 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 17,
2003 except, for Note 6 dated March 27, 2003, we expressed an unqualified
opinion on those consolidated financial statements and included an explanatory
paragraph concerning the change in the Company's method of accounting for
goodwill and other intangible assets, to conform to Statement of Financial
Accounting Standards No. 142. In our opinion, the information set forth in the
accompanying consolidated balance sheet as of December 31, 2002 is fairly
stated, in all material respects, in relation to the consolidated balance sheet
from which it has been derived.
/s/ DELOITTE & TOUCHE LLP
New York, New York
May 9, 2003
1
DONNKENNY, INC. AND SUBSIDIARIES
Consolidated Balance Sheets
(in thousands, except per share data)
March 31, December 31,
2003 2002
-------------- ---------------
(Unaudited)
CURRENT ASSETS
Cash $ 126 $ 66
Accounts receivable - net of allowances of
$119 and $116 in 2003 and 2002, respectively 14,798 20,634
Recoverable income taxes 62 203
Inventories, net 13,561 15,949
Prepaid expenses and other current assets 607 615
Assets held for sale 380 402
---------------- -----------------
Total current assets 29,534 37,869
PROPERTY AND EQUIPMENT, NET 4,181 4,515
OTHER ASSETS 211 234
INTANGIBLE ASSETS 821 821
---------------- -----------------
TOTAL $ 34,747 $ 43,439
================ =================
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Current portion of long-term debt $ - $ 253
Accounts payable 4,920 10,101
Accrued expenses and other current liabilities 1,859 2,209
---------------- -----------------
Total current liabilities 6,779 12,563
---------------- -----------------
LONG-TERM DEBT 20,767 23,730
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 2003 and 2002 44 44
Additional paid-in capital 50,449 50,449
Deficit (43,292) (43,347)
---------------- -----------------
Total Stockholders' Equity 7,201 7,146
---------------- -----------------
TOTAL $ 34,747 $ 43,439
================ =================
See accompanying notes to consolidated financial statements.
2
DONNKENNY, INC. AND SUBSIDIARIES
Consolidated Statements of Operations
(in thousands, except shares and per share data)
(unaudited)
Three Months Ended
-------------------------------
March 31, 2003 March 31, 2002
---------------- --------------
NET SALES $ 18,954 $ 24,438
COST OF SALES 13,249 18,021
--------------- ---------------
Gross profit 5,705 6,417
OPERATING EXPENSES:
Selling, general and administrative expenses 5,346 5,345
--------------- ---------------
Operating income 359 1,072
INTEREST EXPENSE 318 668
--------------- ---------------
Income before income taxes and cumulative effect of change in
accounting principle 41 404
INCOME TAXES (BENEFIT) (14) 45
--------------- ---------------
Income before cumulative effect of change in accounting
principle 55 359
CUMULATIVE EFFECT OF CHANGE IN ACCOUNTING PRINCIPLE (no tax
benefit recognized) - 28,744
--------------- ---------------
NET INCOME (LOSS) $ 55 $ (28,385)
=============== ===============
Basic earnings per common share:
Income before accounting change $ 0.01 $ 0.08
Cumulative effect of accounting change - (6.58)
--------------- ---------------
Net income (loss) $ 0.01 $ (6.50)
=============== ===============
Diluted earnings per common share:
Income before accounting change $ 0.01 $ 0.08
Cumulative effect of accounting change - (6.58)
--------------- ---------------
Net income (loss) $ 0.01 $ (6.50)
=============== ===============
Shares used in the calculation of earnings per share:
Basic 4,367,417 4,367,417
=============== ===============
Diluted 4,419,543 4,434,407
=============== ===============
3
DONNKENNY, INC. AND SUBSIDIARIES
Consolidated Statements of Cash Flows
(in thousands)
(unaudited)
Three Months Ended
-------------------------------------
March 31, March 31,
2003 2002
--------------- ----------------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income (loss) $ 55 $ (28,385)
Adjustments to reconcile net income (loss) to net cash
provided by operating activities:
Depreciation and amortization of fixed assets 382 372
Cumulative effect of change in accounting principle - 28,744
Provision for losses on accounts receivable 3 5
Changes in assets and liabilities:
Decrease in accounts receivable 5,833 7,175
Decrease in recoverable income taxes 141 -
Decrease in inventories 2,388 4,333
Decrease in prepaid expenses and
other current assets 8 655
Decrease (increase) in other non-current assets 23 (9)
Decrease in accounts payable (5,181) (2,321)
Decrease in accrued expenses and
other current liabilities (350) (1,449)
--------------- ----------------
Net cash provided by operating activities 3,302 9,120
--------------- ----------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchase of property and equipment (26) (217)
Proceeds from sale of property and equipment - 143
--------------- ----------------
Net cash used in investing activities (26) (74)
--------------- ----------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Repayment of long-term debt (253) (358)
Borrowings under revolving credit line 22,080 23,625
Repayments under revolving credit line (25,043) (32,250)
--------------- ----------------
Net cash used in financing activities (3,216) (8,983)
--------------- ----------------
NET INCREASE IN CASH 60 63
CASH, AT BEGINNING OF PERIOD 66 39
--------------- ----------------
CASH, AT END OF PERIOD $ 126 $ 102
=============== ================
SUPPLEMENTAL DISCLOSURES
Income taxes paid $ 2 $ 32
=============== ================
Interest paid $ 319 $ 671
=============== ================
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, 2002. Balance sheet data as of December 31, 2002
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 an exercise price equal to
the market value of the Common Stock on the date 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, 2003 March 31, 2002
-------------- --------------
(in thousands)
Net income (loss), as reported $55 $(28,385)
Deduct: Total stock-based employee
compensation expense determined
under fair value based method 31 49
-- --
Pro-forma net income (loss) $ 24 $(28,434)
===== =========
Earnings (loss) per share:
Basic- as reported $ 0.01 $(6.50)
====== =======
Basic - pro-forma $ 0.01 $(6.51)
====== =======
Diluted - as reported $ 0.01 $(6.50)
====== =======
Diluted - pro-forma $ 0.01 $(6.51)
====== =======
5
The weighted-average Black-Scholes value of the options granted during
first quarter 2002 which was used to calculate the pro-forma compensation
expense was $0.84. The following weighted-average assumptions were used in the
Black-Scholes option-pricing model for grants in 2002: dividend yield of 0%,
volatility of 253%; risk-free interest rate of 2.40%; and an expected life of 5
years.
Information regarding the Company's stock option plan is summarized below:
March 31, 2003 March 31, 2002
------------------------ ----------------------------
Weighted- Weighted-
Average Average
Exercise Exercise
Options Price Options Price
------- ----- ------- -----
Outstanding at beginning of
the period 367,427 $5.64 294,253 $8.75
Granted - - 131,250 0.84
Exercised - - - -
Cancelled (21,875) $0.69 (21,650) $1.18
------- ----- ------- -----
Outstanding at end of period 345,552 $5.95 403,853 $6.59
======= ===== ======= =====
Exercisable at end of period 229,552 $8.45 213,728 $10.82
======= ===== ======= ======
Available for grant at period end 129,623 71,322
======= =======
The options outstanding at March 31, 2003 range in price as follows:
OPTIONS OUTSTANDING OPTIONS EXERCISABLE
--------------------------------------------------------------------------------------------------
Range of Exercise Outstanding Weighted-Average Weighted-
as of Remaining Contractual Average Exercisable as of Weighted-Average
Prices 03/31/2003 Life Exercise Price 03/31/2003 Exercise Price
------ ---------- ---- -------------- ---------- --------------
$0.00 - $7.23 261,250 7.6 $ 1.57 145,250 $ 2.03
$7.23 -$14.45 42,776 4.1 $ 11.74 42,776 $ 11.74
$14.45 -$28.90 30,000 3.0 $ 16.13 30,000 $ 16.13
$28.90 -$43.35 1,750 2.1 $ 33.25 1,750 $ 33.25
$43.35 -$65.03 3,751 1.1 $ 44.25 3,751 $ 44.25
$65.03 -$72.25 6,025 2.4 $ 72.25 6,025 $ 72.25
NOTE 3 - INVENTORIES
Inventories consist of the following:
March 31, December 31,
2003 2002
---- ----
(In thousands)
Raw materials $ 1,370 $ 701
Work-in-process 256 143
Finished goods 12,135 16,411
Reserves (200) (1,306)
---------- -----------
$ 13,561 $ 15,949
========== ===========
Inventories at March 31, 2002 were $13.4 million consisting primarily of
finished goods.
6
NOTE 4 - 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 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. 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 the Company's 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 plan approved by the lender.
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. A fee of $100,000 was paid for the Amendment. The new term
loan bore interest at the prime rate plus 2.0% and was repayable over thirty-six
months commencing January 1, 2001. On March 31, 2003, the Company paid the loan
in full.
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 provided for an additional interest rate reduction effective July 1,
2002 if certain objectives were achieved. No fee was paid in connection with the
Amendment and Waiver. The Company has 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.
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 (5.5% at March 31, 2003). As of March 31,
2003, the Company was in compliance with all covenants. No fee was paid in
connection with the Amendment.
7
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 agreement is in effect
through December 31, 2004.
At March 31, 2003 and 2002, the Company was contingently liable for
outstanding letters of credit issued amounting to $7.5 million and $10.6
million, respectively.
NOTE 5 - GOODWILL AND INTANGIBLE ASSETS
Intangible assets consisted of licenses with indefinite lives of $821,000
at March 31, 2003 and December 31, 2002.
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
the Company in 1989 following a change in control, the sportswear division of
Oak Hill Sportswear Corporation ("Oak Hill"), Beldoch Industries Corporation
("Beldoch") in 1995, and 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 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 other intangible assets with indefinite lives
and determined that the value of its intangible assets had been impaired. The
impairment charge of $28.7 million, recorded as a change in accounting
principle, 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 consisted of $25.4
million related to goodwill and $3.3 million related to the license. 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 in the Company's March 31, 2003 and December 31, 2002 Consolidated Balance
Sheet.
NOTE 6 - RECENT ACCOUNTING PRONOUNCEMENTS
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
require 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 was
encouraged. Adoption of SFAS No. 145 on January 1, 2003 did not have a material
impact on the Company's Consolidated Financial Statements.
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 adopted SFAS
No. 146 on January 1, 2003. This Statement did not have an impact on the
Company's Consolidated Financial Statements.
In December 2002, the FASB issued SFAS No. 148, "Accounting for Stock-Based
Compensation--Transition and Disclosure--an amendment of FASB Statement No.
123". SFAS No. 148 amends SFAS No. 123, "Accounting for Stock-Based
Compensation", to provide alternative methods of transition for a voluntary
change to the fair value based method of accounting for stock-based employee
compensation. In addition, this Statement amends the disclosure requirements of
Statement 123 to require prominent disclosures in both annual and interim
financial statements about the method of accounting for stock-based employee
compensation and the effect of the method used on reported results. The
disclosure amendments to Statement 123 contained in SFAS No. 148 are effective
for financial statements for fiscal years ending after December 15, 2002. The
Company has adopted the disclosure provisions of SFAS No. 148.
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 Company does not expect adoption of SFAS No.
149 to have an impact on the consolidated financial statements as the Company
does not engage in derivative or hedging activity.
NOTE 7 - 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 appealed this
dismissal to the United States Court of Appeals for the Fourth Circuit. On
appeal, the United States Court of Appeals for the Fourth Circuit reversed
the United States District Court's decision and remanded the case back to
the District Court for further consideration.
9
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.
c. The Company has guaranteed minimum royalties which represent those minimum
amounts due in connection with the Pierre Cardin and Harve Benard Licenses.
The minimum guarantee for the Harve Benard license is contractual. The
minimum guarantee for the Pierre Cardin license is calculated each year. As
of January 1, 2003, the Company has estimated minimum guaranteed royalties
to be approximately $0.8 million, reflecting the contractual amount for the
Harve Benard License and the minimum calculated amounts pursuant to the
Pierre Cardin license for fiscal 2003. There are no maximum guarantees.
NOTE 8 - SUBSEQUENT EVENTS
On May 1, 2003, the Company entered into a licensing arrangement to
manufacture and sell coats under the Bill Blass(R), Bill Blass Signature(R) and
Blassport(R) labels and commenced its entry into the Ladies Coat Business. The
Company intends to begin shipments with the fall 2003 season.
10
DONNKENNY, INC. AND SUBSIDIARIES
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
Comparison of Quarters Ended March 31, 2003 and 2002
- ----------------------------------------------------
Net sales decreased by $5.4 million, or 22.1% from $24.4 million in the
first quarter of 2002 to $19.0 million in the first quarter 2003. The decline
was primarily due to the slow retail environment, uncertainty about the war with
Iraq and low consumer confidence, which caused a drop in the Company's core
businesses.
Gross profit for the first quarter of 2003 was $5.7 million, or 30.0% of
net sales, compared to $6.4 million, or 26.2% of net sales, during the first
quarter of 2002. 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 for the first quarter 2003 was
$5.3 million compared to $5.3 million in the first quarter of 2002. Selling,
general and administrative expenses remained consistent despite certain
increases in operating expenses offset by reductions in headcount and reductions
in distribution, sales and product-related expenses.
Net interest expense decreased from $0.7 million during the first quarter
of 2002 to $0.3 million during the first quarter of 2003. The decrease was
attributable to lower revolving credit borrowings under the credit agreement, a
lower interest rate and interest received from an income tax refund.
The Company recorded a provision for state and local income taxes of $0.04
million in first quarter 2002 compared to an income tax benefit of $0.01 million
in 2003. In the first quarter 2003, an audit of prior years State income tax
returns was completed. As a result, the Company received additional refunds of
$0.06 million.
In the first quarter of 2002, the Company recorded an impairment charge
related to goodwill and intangible assets of $28.7 million as a change in
accounting principle upon the adoption of SFAS No. 142.
New Licensing Arrangement
- -------------------------
On May 1, 2003, the Company entered into a licensing arrangement to
manufacture and sell coats under the Bill Blass(R), Bill Blass Signature(R) and
Blassport(R) labels and commenced its entry into the Ladies Coat Business. The
Company intends to begin shipments with the fall 2003 season.
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
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 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. The Credit Agreement as amended expires on June 30,
2004.
11
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 the Company's 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 plan approved by the lender.
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. A fee of $100,000 was paid for the Amendment. The new term
loan bore interest at the prime rate plus 2.0% and was repayable over thirty-six
months commencing January 1, 2001. On March 31, 2003, the Company paid the loan
in full.
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. No fee was paid in connection with the
Amendment and Waiver. The Company has 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.
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 (5.5% at March 31, 2003). As of March 31,
2003, the Company was in compliance with all covenants. No fee was paid in
connection with the Amendment.
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 agreement is in effect
through December 31, 2004.
During the first quarter of 2003, cash provided by operating activities was
$3.3 million, principally as the result of decreases in accounts receivable and
inventory partially offset by decreases in accounts payable and accrued expenses
and other current liabilities. On a comparable basis, net inventories at March
31, 2003 were $0.2 million more than March 31, 2002. During the first quarter of
2002, cash provided by operating activities was $9.1 million, principally as a
result of decreases in inventory and accounts receivable partially offset by
decreases in accounts payable and accrued expenses and other current
liabilities.
12
Cash used in investing activities during the first quarter of 2003 included
$0.03 million for the purchase of fixed assets, principally computer equipment
and related software. Cash used in investing activities during the first quarter
of 2002 included $0.2 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 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 of the term loan. Cash used in financing activities
during the first quarter of 2002 was $9.0 million, which represents net
borrowings under the revolver of $8.6 million and repayments of $0.4 million of
the 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.
Recent Accounting Pronouncements
- --------------------------------
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
require 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 was
encouraged. Adoption of SFAS No. 145 on January 1, 2003 did not have an impact,
on the Company's Consolidated Financial Statements.
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 adopted SFAS
No. 146 on January 1, 2003. This Statement did not have an impact on the
Company's Consolidated Financial Statements.
13
In December 2002, the FASB issued SFAS No. 148, "Accounting for Stock-Based
Compensation--Transition and Disclosure--an amendment of FASB Statement No.
123". SFAS No. 148 amends SFAS No. 123, "Accounting for Stock-Based
Compensation", to provide alternative methods of transition for a voluntary
change to the fair value based method of accounting for stock-based employee
compensation. In addition, this Statement amends the disclosure requirements of
Statement 123 to require prominent disclosures in both annual and interim
financial statements about the method of accounting for stock-based employee
compensation and the effect of the method used on reported results. The
disclosure amendments to Statement 123 contained in SFAS No. 148 are effective
for financial statements for fiscal years ending after December 15, 2002. The
Company has adopted the disclosure provision of SFAS No. 148.
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 Company does not expect adoption of SFAS No.
149 to have an impact on the consolidated financial statements as the Company
does not engage in derivate or hedging activity.
Critical Accounting Policies and Estimates
- ------------------------------------------
The Company's significant accounting policies are more fully described in
Note 1 to the Consolidated Financial Statements (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 passes 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 - Accounts Receivable as shown on the Consolidated
-------------------
Balance Sheets, is 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. This amount is not significant since the Company has a
factoring agreement. 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 included in Accounts Receivable. 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.
14
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 $0.2
million and $0.8 million at March 31, 2003 and 2002, respectively. Inventory
reserves decreased due to the levels and composition of inventory on hand at
March 31, 2003. Additionally, during the first quarter of 2003, the Company
directly wrote down the value of certain merchandise, which reduced the cost of
finished goods and reduced corresponding inventory reserves. 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 $18.3 million for
federal income taxes and $29.4 million for state income taxes, have resulted in
estimated tax benefits of $7.6 million as of December 31, 2002 being recorded as
a deferred tax asset. The Company has recorded a valuation allowance against the
entire net deferred tax asset balance due to the size of the NOL carryforward
and the Company's history of unprofitable operations. However, should the
Company conclude that 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.
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.
15
At March 31, 2003 and 2002, 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 (5.5% at March 31,
2003). As of March 31, 2003, a hypothetical immediate 10% adverse change in
prime interest rates (from 4.25% to 4.68%) 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
- -------------------------------
Based on the evaluation of the Company's disclosure controls and procedures
as of a date within 90 days of the filing date of this quarterly report, each of
Daniel H. Levy, the Chief Executive Officer of the Company, and Maureen d.
Schimmenti, the Chief Financial Officer of the Company, has concluded that the
Company's disclosure controls and procedures are effective in ensuring that
information required to be disclosed by the Company in the reports that it files
or submits under the Securities and Exchange Act of 1934, as amended, is
properly recorded and reported.
There were no significant changes in the Company's internal controls or in
other factors that could materially affect these controls subsequent to the date
of their evaluation, including any corrective actions with regard to
deficiencies and weaknesses.
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. 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 appealed
this dismissal to the United States Court of Appeals for the Fourth Circuit. On
appeal, the Fourth Circuit reversed the District Court's decision and remanded
the case back to the District Court for further consideration.
16
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
----------- ----------------------
99.5 Certification Pursuant to 18 U.S.C. Section 1350, as
Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act
of 2002.
99.6 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
17
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, 2003 /s/ Daniel H. Levy
--------------------------------------
Daniel H. Levy
Chairman of the Board,
Chief Executive Officer
Date: May 14, 2003 /s/ Maureen d. Schimmenti
-------------------------------------
Maureen d. Schimmenti
Vice President
and Chief Financial Officer,
(Principal Financial Officer)
18
CERTIFICATION
-------------
I, Daniel H. Levy, certify that:
1. I have reviewed this quarterly report on Form 10-Q of Donnkenny, Inc.;
2. Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to make
the statements made, in light of the circumstances under which such statements
were made, not misleading with respect to the period covered by this quarterly
report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all material
respects the financial condition, results of operations and cash flows of the
Company as of, and for, the periods presented in this quarterly report;
4. The Company's other certifying officers/employees and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-14 and 15d-14) for the Company and we have:
a. designed such disclosure controls and procedures to ensure that material
information relating to the Company, including its consolidated
subsidiaries, is made known to us by others within those entities,
particularly during the period in which this quarterly report is being
prepared;
b. evaluated the effectiveness of the Company's disclosure controls and
procedures as of a date within 90 days prior to the filing date of this
quarterly report (the "Evaluation Date"); and
c. presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;
5. The Company's other certifying officers/employees and I have disclosed, based
on our most recent evaluation, to the Company's auditors and the audit committee
of the Company's board of directors (or persons performing the equivalent
function):
a. all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to record,
process, summarize and report financial data and have identified for the
Company's auditors any material weaknesses in internal controls; and
b. any fraud, whether or not material, that involves management or other
employees who have a significant role in the Company's internal controls;
and
6. The Company's other certifying officers/employees and I have indicated in
this quarterly report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal controls
subsequent to the date of our most recent evaluation, including any corrective
actions with regard to significant deficiencies and material weaknesses.
Date: May 14, 2003 /s/ Daniel H. Levy
--------------------------------
Daniel H. Levy
Chairman of the Board,
Chief Executive Officer
19
CERTIFICATION
-------------
I, Maureen d. Schimmenti, certify that:
1. I have reviewed this quarterly report on Form 10-Q of Donnkenny, Inc.;
2. Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to make
the statements made, in light of the circumstances under which such statements
were made, not misleading with respect to the period covered by this quarterly
report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all material
respects the financial condition, results of operations and cash flows of the
Company as of, and for, the periods presented in this quarterly report;
4. The Company's other certifying officers/employees and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-14 and 15d-14) for the Company and we have:
a. designed such disclosure controls and procedures to ensure that material
information relating to the Company, including its consolidated
subsidiaries, is made known to us by others within those entities,
particularly during the period in which this quarterly report is being
prepared;
b. evaluated the effectiveness of the Company's disclosure controls and
procedures as of a date within 90 days prior to the filing date of this
quarterly report (the "Evaluation Date"); and
c. presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;
5. The Company's other certifying officers/employees and I have disclosed, based
on our most recent evaluation, to the Company's auditors and the audit committee
of Company's board of directors (or persons performing the equivalent function):
a. all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to record,
process, summarize and report financial data and have identified for the
registrant's auditors any material weaknesses in internal controls; and b.
any fraud, whether or not material, that involves management or other
employees who have a significant role in the Company's internal controls;
and
6. The Company's other certifying officers/employees and I have indicated in
this quarterly report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal controls
subsequent to the date of our most recent evaluation, including any corrective
actions with regard to significant deficiencies and material weaknesses.
Date: May 14, 2003 /s/ Maureen d. Schimmenti
----------------------------
Maureen d. Schimmenti
Vice President
and Chief Financial Officer,
(Principal Financial Officer)
20