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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
|X| QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 2004
------------------
OR
|_| TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the transition period from _________ to __________
Commission file number 0-21940
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Donnkenny, Inc.
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(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
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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 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 November 11, 2004)
DONNKENNY, INC AND SUBSIDIARIES
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
(FORM 10-Q)
PART I - FINANCIAL INFORMATION Page
----
Item 1. Consolidated financial statements:
Balance sheets as of September 30, 2004 (unaudited)
and December 31, 2003..............................................................1
Statements of operations for the three and nine months ended
September 30, 2004 and 2003 (unaudited)............................................2
Statements of cash flows for the nine months ended
September 30, 2004 and 2003 (unaudited)............................................3
Notes to Consolidated Financial Statements (unaudited)...........................4-9
Item 2. Management's Discussion and Analysis of Financial Condition and Results
Of Operations..................................................................10-16
Item 3. Quantitative and Qualitative Disclosures about Market Risk........................17
Item 4. Controls and Procedures...........................................................18
PART II - OTHER INFORMATION
Item 1. Legal Proceedings.................................................................19
Item 6. Exhibits and Reports on Form 8-K..................................................19
Signatures.....................................................................20
Certifications..............................................................21-24
DONNKENNY, INC. AND SUBSIDIARIES
Consolidated Balance Sheets
(in thousands, except per share data)
September 30, December 31,
2004 2003
------------- ------------
ASSETS (Unaudited)
CURRENT ASSETS
Cash ............................................. $ 375 $ 64
Accounts receivable, net of allowance for doubtful
accounts of $5 and $933, in 2004 and 2003
respectively ..................................... 293 1,287
Due from factor, net ............................. 17,239 20,730
Inventories, net ................................. 19,490 20,128
Prepaid expenses and other current assets ........ 1,735 1,256
Assets held for sale ............................. 240 270
-------- --------
Total current assets ............................. 39,372 43,735
PROPERTY, PLANT AND EQUIPMENT, NET ................. 3,667 3,631
OTHER ASSETS ....................................... 336 366
GOODWILL ........................................... 1,641 1,641
OTHER INTANGIBLE ASSETS ............................ 654 1,332
-------- --------
TOTAL .............................................. $ 45,670 $ 50,705
======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIENCY)
CURRENT LIABILITIES:
Current portion of long-term debt ................ $ 40,121 $ 353
Accounts payable ................................. 8,369 7,713
Accrued expenses and other current liabilities ... 1,356 1,908
-------- --------
Total current liabilities ...................... 49,846 9,974
LONG-TERM DEBT ..................................... 408 35,707
COMMITMENTS AND CONTINGENCIES
STOCKHOLDERS' EQUITY (DEFICIENCY):
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 2004 and 2003 ................................. 44 44
Additional paid-in capital ....................... 50,449 50,449
Accumulated deficit .............................. (55,077) (45,469)
-------- --------
Total Stockholders' (Deficiency) Equity .......... (4,584) 5,024
-------- --------
TOTAL .............................................. $ 45,670 $ 50,705
======== ========
See accompanying notes to consolidated financial statements.
-1-
DONNKENNY, INC. AND SUBSIDIARIES
Consolidated Statements of Operations
(in thousands, except share and per share data)
(unaudited)
Three Months Ended Nine Months Ended
-------------------------------------- --------------------------------------
September 30, 2004 September 30, 2003 September 30, 2004 September 30, 2003
------------------ ------------------ ------------------ ------------------
NET SALES .......................................... $ 22,561 $ 23,436 $ 61,410 $ 60,235
COST OF SALES ...................................... 20,867 18,276 52,806 45,472
----------- ----------- ----------- -----------
Gross profit .................................. 1,694 5,160 8,604 14,763
OPERATING EXPENSES:
Selling, general and administrative expenses ... 5,648 5,081 16,112 15,542
Amortization and impairment of intangibles .... 494 32 678 32
----------- ----------- ----------- -----------
Operating (loss) income .................... (4,448) 47 (8,186) (811)
INTEREST EXPENSE ................................... 559 406 1,553 1,018
----------- ----------- ----------- -----------
Loss before provision for income taxes (benefit) (5,007) (359) (9,739) (1,829)
INCOME TAXES PROVISION (BENEFIT) ................... 18 27 (131) 58
----------- ----------- ----------- -----------
NET LOSS ..................................... $ (5,025) $ (386) $ (9,608) $ (1,887)
=========== =========== =========== ===========
Basic loss per common share: ....................... $ (1.15) $ (0.09) $ (2.20) $ (0.43)
=========== =========== =========== ===========
Diluted loss per common share: ..................... $ (1.15) $ (0.09) $ (2.20) $ (0.43)
=========== =========== =========== ===========
Shares used in the calculation of loss 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.
-2-
DONNKENNY, INC. AND SUBSIDIARIES
Consolidated Statements of Cash Flows
(in thousands)
(unaudited)
Nine Months Ended
----------------------------
September 30, September 30,
2004 2003
------------- -------------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss ....................................................... $ (9,608) $ (1,887)
Adjustments to reconcile net loss to net cash
used in operating activities:
Depreciation and amortization of property, plant and equipment 797 1,051
Loss on disposal of fixed assets ............................. -- 16
Amortization and impairment of intangibles ................... 678 32
Bad debt (recovery) expense .................................. (928) 5
Changes in assets and liabilities:
Decrease (increase) in accounts receivable ................... 1,922 (164)
Decrease in amount due from factor ........................... 3,491 2,885
Decrease in recoverable income taxes ......................... -- 203
Decrease (increase) in inventories ........................... 638 (1,773)
Increase in prepaid expenses and other current assets ........ (479) (640)
Decrease (increase) in other non-current assets .............. 30 (135)
Increase (decrease) in accounts payable ...................... 656 (3,594)
Decrease in accrued expenses and other current liabilities ... (552) (238)
-------- --------
Net cash used in operating activities ...................... (3,355) (4,239)
-------- --------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchase of property, plant and equipment .................... (803) (189)
Proceeds from sale of property, plant and equipment .......... -- 80
License acquisition cost ..................................... -- (512)
-------- --------
Net cash used in investing activities ...................... (803) (621)
-------- --------
CASH FLOWS FROM FINANCING ACTIVITIES:
Repayment of long-term debt .................................. (395) (253)
Borrowings under revolving credit line ....................... 71,352 68,323
Repayments under revolving credit line ....................... (66,488) (63,214)
-------- --------
Net cash provided by financing activities .................. 4,469 4,856
-------- --------
NET INCREASE (DECREASE) IN CASH ................................ 311 (4)
CASH, AT BEGINNING OF PERIOD ................................... 64 66
-------- --------
CASH, AT END OF PERIOD ......................................... $ 375 $ 62
======== ========
SUPPLEMENTAL DISCLOSURES
Income taxes paid .............................................. $ 6 $ 16
======== ========
Interest paid .................................................. $ 1,551 $ 999
======== ========
See accompanying notes to consolidated financial statements.
-3-
DONNKENNY, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(Unaudited)
NOTE 1 - BASIS OF PRESENTATION
The accompanying unaudited consolidated financial statements have been
prepared by the Company pursuant to the Rules of the Securities and Exchange
Commission ("SEC") and, in the opinion of management, include all adjustments
(consisting of normal recurring accruals) necessary for the fair presentation of
financial position, results of operations and cash flows. Certain information
and footnote disclosures normally included in financial statements prepared in
accordance with accounting principles generally accepted in the United States of
America have been condensed or omitted pursuant to such SEC rules. The Company
believes the disclosures made are adequate to make such financial statements not
misleading. The results for the interim periods presented are not necessarily
indicative of the results to be expected for the full year. These financial
statements should be read in conjunction with the Company's Report on Form 10-K
for the year ended December 31, 2003. Balance sheet data as of December 31, 2003
have been derived from audited financial statements of the Company.
The accompanying consolidated financial statements have been prepared
assuming that the Company will continue as a going concern. At September 30,
2004 the Company has working capital and stockholders' deficiencies of $10.5
million and $4.6 million, respectively. For the nine months ended September 30,
2004 the Company had a net loss of $9.6 million. The Company's ability to
continue as a going concern is dependent upon ongoing financial support from its
Lender. Without the continued support of its Lender to fund its operations for
the balance of the year and the future, the Company would be without adequate
working capital and funding, which would have a material adverse effect on the
Company's ability to operate. The Company is preparing its 2005 fiscal plan to
present to its Lender and management will continue to reorganize the business
and streamline operations, as well as monitor overhead and administrative
expenses (See Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operation). The consolidated financial statements do
not include any adjustments related to the recoverability and classification of
recorded asset amounts or the amounts or classification of liabilities that
might be necessary should the Company be unable to continue in existence.
NOTE 2 - STOCK BASED COMPENSATION
The Company accounts for its stock-based employee compensation plans under
the recognition and measurement principles of Accounting Principles Board
("APB") Opinion No. 25, Accounting for Stock Issued to Employees, and related
interpretations. No stock-based employee compensation cost is reflected in net
income as all options granted under those plans had exercise prices equal to or
greater than the market value of the Common Stock on the dates of grant. The
following table details the effect on net income and earnings per share if the
Company had applied the fair value recognition provisions of Statement of
Financial Accounting Statement ("SFAS") No. 123, Accounting for Stock-Based
Compensation, as amended by SFAS No. 148, to stock-based employee compensation.
-4-
Three Months Ended Nine Months Ended
------------------ -----------------
September 30, September 30, September 30, September 30,
2004 2003 2004 2003
------------- ------------- ------------- -------------
(in thousands except per share data)
Net loss, as reported $ (5,025) $ (386) $ (9,608) $ (1,887)
Deduct: Total stock-based employee
Compensation expense determined
under fair value based method 105 34 108 78
--------- --------- --------- ---------
Pro-forma net loss $ (5,130) $ (420) $ (9,716) $ (1,965)
========= ========= ========= =========
Loss per share:
Basic - as reported $ (1.15) $ (0.09) $ (2.20) $ (0.43)
========= ========= ========= =========
Basic - pro-forma $ (1.17) $ (0.10) $ (2.22) $ (0.45)
========= ========= ========= =========
Diluted - as reported $ (1.15) $ (0.09) $ (2.20) $ (0.43)
========= ========= ========= =========
Diluted - pro-forma $ (1.17) $ (0.10) $ (2.22) $ (0.45)
========= ========= ========= =========
Information regarding the Company's stock option plan is summarized below:
September 30, 2004 September 30, 2003
------------------------- ---------------------------
Weighted- Weighted-
Average Average
Options Exercise Price Options Exercise Price
------- -------------- ------- --------------
Outstanding at beginning of the
period ........................ 389,687 $2.21 234,552 $6.95
Granted ....................... -- -- 11,250 0.84
Exercised ..................... -- -- -- --
Cancelled ..................... -- -- (85,776) 9.50
-------- ----- -------- -----
Outstanding at end of period .. 389,687 $2.21 160,026 $5.16
======== ===== ======== =====
Exercisable at end of period .. 135,525 $4.74 131,026 $6.12
======== ===== ======== =====
Available for grant at period
end ........................... 85,488 315,149
======== ========
The options outstanding at September 30, 2004 range in exercise price as
follows:
OPTIONS OUTSTANDING OPTIONS EXERCISABLE
------------------------------------------------------------------------------------------------------
Weighted-Average
Range of Exercise Outstanding as of Remaining Contractual Weighted-Average Exercisable as of Weighted-Average
Prices 09/30/2004 Life Exercise Price 09/30/2004 Exercise Price
------ ---------- ---- -------------- ---------- --------------
$0.00 - $7.23 368,412 8.5 $ 1.09 114,250 $ 1.49
$7.23 - $14.45 4,375 3.8 $11.29 4,375 $11.29
$14.45 - $28.90 13,125 2.8 $16.61 13,125 $16.61
$28.90 - $43.35 1,750 0.6 $33.25 1,750 $33.25
$43.35 - $72.25 2,025 1.6 $72.25 2,025 $72.25
------- --- ------ ------- ------
389,687 8.2 $ 2.21 135,525 $ 4.74
======= === ====== ======= ======
-5-
NOTE 3 - LOSS PER SHARE
The basic net loss per share is computed by dividing net loss attributable to
common stockholders by the weighted average number of common shares outstanding
during the period. Diluted net income per share, if applicable, would be
computed by dividing the net income attributable to common stockholders by the
weighted average number of common and common equivalent shares outstanding
during the period.
For the three and nine months ended September 30, 2004, the effect of options to
purchase 31,770 and 134,610 shares, respectively, of the Company's common stock
at less than market value was not considered for the diluted earnings per share
calculation as their effect would be antidilutive. For the three and nine months
ended September 30, 2003, the effect of the options to purchase 11,065 and
26,208 shares, respectively, of the Company's common stock at less than market
value was not considered for the diluted earnings per share calculation as their
effect would be antidilutive.
NOTE 4 - INVENTORIES
Inventories consist of the following:
September 30, December 31,
2004 2003
---- ----
(In thousands)
Raw materials ...................... $ 5,240 $ 3,317
Work-in-process .................... 1,086 2,189
Finished goods ..................... 14,147 15,873
Reserves ........................... (983) (1,251)
-------- --------
$ 19,490 $ 20,128
======== ========
Inventories at September 30, 2003 were $17.7 million consisting primarily
of finished goods.
NOTE 5 - DEBT
The Company's liquidity requirements arise from the funding of working
capital needs, primarily inventory and accounts receivable, and interest and
principal payments related to certain indebtedness and capital expenditures. The
Company's borrowing requirements for working capital fluctuate throughout the
year.
On June 29, 1999, the Company and its operating subsidiaries signed a
Credit Agreement (the "Credit Agreement") with CIT Group/Commercial Services
(the "Lender"). The Credit Agreement initially provided the Company with a $75
million facility comprised of a $72 million revolver with sub limits up to $52
million for direct borrowings, $35 million for letters of credit, certain
overadvances and a $3 million term loan which was paid in full as of June 30,
2002.
The Credit Agreement provides for advances of (i) up to 90% of eligible
accounts receivable plus (ii) up to 60% of eligible inventory plus (iii) up to
60% of the undrawn amount of all outstanding letters of credit plus (iv)
allowable overadvances.
-6-
Collateral for the Credit Agreement includes a first priority lien on all
accounts receivable, machinery, equipment, trademarks, intangibles and
inventory, a first mortgage on all real property and a pledge of the Company's
stock interest in its operating subsidiaries, Donnkenny Apparel, Inc. and
Beldoch Industries Corporation. The Credit Agreement contains numerous financial
and operational covenants, including limitations on additional indebtedness,
liens, dividends, stock repurchases and capital expenditures. In addition, the
Company is required to maintain specified levels of tangible net worth and
comply with a requirement for minimum earnings before depreciation,
amortization, interest and taxes (EBITDA) and a minimum interest coverage ratio.
Effective June 30, 2003, the Company through an Amendment and Waiver
Agreement dated August 11, 2003, extended the Credit Agreement to June 30, 2007.
This Amendment provided the Company with a $65 million facility; the sub-limits
remained the same as in the original Credit Agreement. The interest rate on the
revolving credit borrowings is the current prime rate plus one and one-quarter
percent (6.00% at September 30, 2004).
As previously reported, on December 31, 2003 and June 30, 2004, the
Company was not in compliance with the financial covenants contained in the
Credit Agreement. In each instance, the Lender has waived these events of non
compliance.
As of September 30, 2004, the Company was not in compliance with the
quarterly financial covenants. Through an Amendment and Waiver Agreement dated
October 1, 2004, the Lender agreed to waive the Company's non-compliance with
its September 30, 2004 quarterly financial covenants. This Amendment and Waiver
Agreement amended the financial covenants to provide that these covenants will
be evaluated by the Lender monthly rather than quarterly beginning October 31,
2004. For the month ended October 31, 2004, the Company continued not to be in
compliance with the Credit Agreement financial covenants. The Lender has waived
this non-compliance.
The Company does not expect to be in compliance with its financial
covenants for the balance of 2004. Accordingly, the Company has recorded its
obligation to the Lender as a current liability at September 30, 2004.
The Company also has a factoring agreement with CIT Group/Commercial
Services. The factoring agreement provides for a factoring commission equal to
..35% of gross sales, plus certain customary charges. The factoring agreement
renews annually in June each year unless either party to the agreement gives
appropriate notice of non-renewal.
In connection with the acquisition of Robyn Meredith (see Note 8 to the
Consolidated Financial Statements), a note payable of $1.1 million was issued.
This note is payable in monthly installments of $33,333 including imputed
interest at an interest rate of 5.25%. The final payment will be due October
2006.
At September 30, 2004 and December 31, 2003, the Company was contingently
liable for outstanding letters of credit issued amounting to $2.8 million and
$6.6 million, respectively.
-7-
NOTE 6 - GOODWILL AND INTANGIBLE ASSETS
Goodwill and Other Intangible Assets consisted of the following at September 30,
2004 and December 31, 2003:
(In Thousands)
Sept. 30, Dec. 31,
2004 2003
---- ----
Goodwill $ 1,641 $ 1,641
Covenant not to Compete 50 50
License agreements 821 1,333
Accumulated amortization (217) (51)
------- -------
$ 2,295 $ 2,973
======= =======
The goodwill which represented the excess purchase price over the fair
value of the net assets acquired and the covenant not to compete are
attributable to the acquisition of Robyn Meredith (see Note 8 to the
Consolidated Financial Statements). The covenant not to compete is being
amortized over the contract life of four years.
License Agreements of $0.8 million are attributable to the Pierre Cardin
license acquired which was classified as an intangible asset with an indefinite
life on the Company's December 31, 2003 Consolidated Balance Sheet because the
Company held the license in perpetuity. On February 12, 2004, the Company signed
a new Pierre Cardin license to provide for a term of three years in exchange for
reduced future minimum payments. Beginning in 2004, this license is being
amortized over three years. During the third quarter of 2004, the Company wrote
off the remaining intangible asset costs of $0.4 million attributable to the
acquisition of certain Bill Blass(R) Licenses due to its decision to discontinue
the Coat division.
NOTE 7 - CONTINGENCIES
The Company is a party to legal proceedings arising in the ordinary course of
its business. Management believes that the ultimate resolution of these
proceedings will not, in the aggregate, have a material adverse effect on the
financial condition, results of operations, liquidity or business of the
Company.
NOTE 8 - ROBYN MEREDITH ACQUISITION
On October 1, 2003, the Company acquired certain assets of Robyn Meredith
Inc.("RMI"). The assets that were acquired were the assets of RMI devoted to its
women's sportswear business and consisted principally of inventory of finished
goods, raw materials and trim and certain tradenames including the name "Robyn
Meredith". The Company intends to continue to use these assets for the
manufacture and distribution of women's sportswear. The purchase price paid to
RMI by the Company was $4.6 million (excluding any future purchase price
adjustments based on subsequent performance thresholds) which was determined by
valuing the inventory and through negotiations between the parties as to the
balance of the purchase price.
-8-
Pro Forma Financial Information:
The pro forma financial information presented below gives effect to the Robyn
Meredith acquisition as if it had occurred as of the beginning of the Company's
fiscal year 2003. Actual results for 2004 have been included for comparative
purposes. The information presented below is for illustrative purposes only and
is not indicative of results that would have been achieved or results which may
be achieved in the future.
Three and Nine Month Financial Information
(in thousands except per share data)
(unaudited)
Three Months Ended Nine Months Ended
------------------ -----------------
Actual Pro-Forma Actual Pro-Forma
September 30, September 30, September 30, September 30,
2004 2003 2004 2003
---- ---- ---- ----
Net sales $ 22,561 $ 30,580 $ 61,410 $ 82,485
Net loss $ (5,025) $ (1,176) $ (9,608) $ (2,659)
========== ========== ========== ===========
Basic net loss per common share $ (1.15) $ (0.27) $ (2.20) $ (0.61)
========== ========== ========== ===========
Diluted net loss per common share $ (1.15) $ (0.27) $ (2.20) $ (0.61)
========== ========== ========== ===========
Shares used in the calculation of loss 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
========== ========== ========== ===========
-9-
DONNKENNY, INC. AND SUBSIDIARIES
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
Introductory Overview
The Company is engaged in the women's apparel business. The Company's
business consists of importing and marketing women's apparel to its customers
who in turn sell the Company's products to the ultimate retail consumers. As is
explained in more detail below, the Company's cash and liquidity requirements
for the daily operation of its business are provided through a Credit Agreement
("the Credit Agreement") with CIT Group/Commercial Services ("the Lender"),
consisting of a revolving credit facility and letters of credit.
As previously reported, as of September 30, 2004 and again as at October
29, 2004, the Company was not in compliance with its financial covenants
contained in the Credit Agreement. The Lender has waived the Company's
non-compliance through Amendment and Waiver Agreements which, in addition to
waiving non-compliance with covenants, provide that these covenants will be
evaluated by the Lender monthly rather than quarterly which had been the
practice prior to October 1, 2004.
The Company is wholly dependant upon its Lender to approve the Company's
request for continued credit for the operation of its business. Absent continued
support by its Lender, the Company will be left with inadequate working capital
and funding, which would have a material adverse effect on the Company's ability
to operate.
The business of the Company is highly competitive. The Company's products
consist of its in-house brand names ("In-House Branded Products") as well as
those produced under a licensing arrangement for the use of Trademarks
("Licensed Products"). In addition to selling its In-House Branded and Licensed
Products to its customers, the Company develops specific products ("Private
Label Products") for some of its larger accounts, such as mass merchandisers and
national chains. The Company is currently in the process of discontinuing its
In-House Branded business.
The women's apparel business is characterized by a large number of small
companies selling branded and unbranded merchandise, and by several large
companies that have developed widespread consumer recognition of the Trademarks
and brand names associated with merchandise sold by these companies. In
addition, retailers to whom the Company sells its products have sought to expand
the development and marketing of their own brands and to obtain women's apparel
products directly from the same sources from which the Company obtains its
products.
The Company's women's apparel business provides product for department
stores, specialty stores, regional chains, discounters and warehouse clubs. Most
of the Company's products are marketed for four selling seasons a year. To be
competitive, the Company is required to create a substantially new line of
products for each selling season. In addition, the Company makes presentations
throughout the year to Private Label accounts, depending upon the size and
number or orders that the Company receives each time it presents its products to
its customers.
-10-
In this climate, the Company must constantly change its product mix to
sell to its customers. This requires the Company not only to design products
which it anticipates will have commercial appeal, but also to develop, acquire
and sometimes discontinue the use of Products.
In 2003, the Company discontinued the marketing of products under the
Rebecca Jones Label and commenced a long-term strategy of being a Private Label
and Licensed Product business to expand its avenues of distribution. In
furtherance of this decision, the Company is in the process of discontinuing its
Victoria Jones and Casey & Max labels. The Company acquired the use of Z.
Cavaricci(R), Nicole Miller(R) and Bill Blass(R) Trademarks for certain
products. The Company intends to discontinue the use of the Z. Cavaricci(R) and
Bill Blass(R) Trademarks. On October 1, 2003, the Company acquired its Robyn
Meredith Division, which primarily sells Private Label Product. On April 14,
2004, the Company entered into a licensing agreement to manufacture sportswear
under the Nicole Miller(R) label. The Company intends to begin shipments of
sportswear under this Label with the Spring 2005 season.
Sales under the Bill Blass(R) Trademarks and Robyn Meredith Division began
in the second half of 2003. Sales under the Z. Cavaricci(R) Trademark began in
the first quarter of 2004. Sales for products under the Nicole Miller(R)
trademarks for suits will begin in 2005. In the three months ended September 30,
2004, the Company's net sales were $22.6 million of which 26% was Licensed
Product, 27% was In-House Branded Product and the balance was Private Label
Product. Net Sales for the third quarter of 2003 were $23.4 million, of which
27% was Licensed Product, 50% was In-House Branded Product and the balance was
Private Label Product. The $0.8 million net sales decrease was attributable to a
$0.4 million decrease in Licensed Products, due to the loss of a major customer
and an inability to substitute the business with other customers, and a decrease
in the In-House Branded Products of $5.8, partially offset by a $5.4 million
increase in the sales of the Company's Private Label Products due to the
acquisition of the Robyn Meredith business in 2003 and an increased demand for
the Company's Private Label Products. Sales of coats by the Company's Coat
division for the nine months ended September 30, 2004, amounted to $2.1 million.
These sales did not contribute to the Company's gross margin. The Company has
decided to discontinue the operations of this division.
In 2004, the Company's prior decision to become a Private Label and
Licensed product maker of Ladies Sportswear, coupled with its decision to
discontinue its In-House Brands, has caused a decrease in sales and a
deterioration of its gross margin in 2004. The Company does not expect that this
transformation will be complete until 2005, with the full effect to be reflected
in the second half of 2005. The Company expects that the balance of 2004 may
continue to be negatively effected by this strategic transformation.
Comparison of Nine Months Ended September 30, 2004 and 2003
Net sales increased by $1.2 million, or 2.0% from $60.2 million in the
first nine months of 2003 to $61.4 million in the first nine months of 2004. The
increase was primarily due to the Company's Private Label business and the
result of the acquisition of the Robyn Meredith business in 2003, partially
offset by decreases in the Company's other businesses due to the loss of a major
customer and the strategy to discontinue In-House Brands.
In the nine months ended September 30, 2004, only one customer accounted
for more than 10% of the Company's net sales, accounting for 30% of such sales.
In the nine months ended September 30, 2003, two customers accounted for more
than 10% of the Company's net sales. One accounted for 33% of such sales, the
other for 17% of such sales.
-11-
Gross profit for the first nine months of 2004 was $8.6 million, or 14.0%
of net sales, compared to $14.8 million, or 24.5% of net sales, during the first
nine months of 2003. The decrease in gross profit was due to the loss of a major
customer, the strategy to discontinue In-House Brands and the sell off of slow
moving inventory, which resulted in lower margins.
Selling, general and administrative expenses for the first nine months of
2004 and 2003 were $16.1 million and $15.5 million, respectively. Selling,
general and administrative expenses in 2004 are net of a bad debt recovery in
the second quarter of $0.8 million. In the first nine months the Company
incurred expenses in connection with its repositioning strategy, the results of
which will not be seen until 2005. During the third quarter of 2004, the Company
wrote off the remaining intangible asset costs of $0.4 million attributable to
the acquisition of certain Bill Blass(R) Licenses due to its decision to
discontinue the Coat division.
Net interest expense increased from $1.0 million during the first nine
months of 2003 to $1.6 million during the first nine months of 2004. The
increase was attributable to increases in the prime rate and higher revolving
credit borrowings under the credit agreement. In 2003, the Company had lower
revolving credit borrowings and received interest from an income tax refund
which decreased interest expense for the first quarter.
In the first quarter of 2004, the Company reversed prior years' tax
liabilities of approximately $0.2 million.
Comparison of Quarters Ended September 30, 2004 and 2003
Net sales decreased by $0.8 million, or 3.4% from $23.4 million in the
third quarter of 2003 to $22.6 million in the second quarter of 2004. The
decrease was primarily due to the loss of a major customer and an inability to
substitute the business with other customers, the strategy to discontinue
In-House Brands and the failure of the Coat Division to produce expected sales
volumes partially offset by increases in the Company's Private Label business as
a result of the acquisition of the Robyn Meredith business.
Gross profit for the third quarter of 2004 was $1.7 million, or 7.5% of
net sales, compared to $5.2 million, or 22.2% of net sales, during the third
quarter of 2003. The decrease in gross profit was due to the loss of a major
customer, the strategy to discontinue In-House Brands and the sell off of slow
moving inventory, which resulted in lower margins.
Selling, general and administrative expenses for the third quarter of 2004
were $5.6 million compared to $5.1 million in the third quarter of 2003. In the
third quarter of 2004, the Company incurred expenses in connection with its
repositioning strategy, the results of which will not be seen until 2005. During
the third quarter of 2004, the Company wrote off the remaining intangible asset
costs of $0.4 million attributable to the acquisition of certain Bill Blass(R)
Licenses due to its decision to discontinue the Coat division.
Net interest expense increased from $0.4 million during the third quarter
of 2003 to $0.6 million during the third quarter of 2004. The increase was
attributable to increases in the prime rate and higher revolving credit
borrowings under the credit agreement.
-12-
Liquidity and Capital Resources
The accompanying consolidated financial statements have been prepared
assuming that the Company will continue as a going concern. At September 30,
2004 the Company has working capital and stockholders' deficiencies of $10.5
million and $4.6 million, respectively. For the nine months ended September 30,
2004 the Company had a net loss of $9.6 million. The Company's ability to
continue as a going concern is dependent upon ongoing financial support from its
Lender. Without the continued support of its Lender to fund its operations for
the balance of the year and the future, the Company would be without adequate
working capital and funding, which would have a material adverse effect on the
Company's ability to operate. The Company is preparing its 2005 fiscal plan to
present to its Lender and management will continue to reorganize the business
and streamline operations, as well as monitor overhead and administrative
expenses. The consolidated financial statements do not include any adjustments
related to the recoverability and classification of recorded asset amounts or
the amounts or classification of liabilities that might be necessary should the
Company be unable to continue in existence.
The Company's liquidity requirements arise from the funding of working
capital needs, primarily inventory and accounts receivable, and interest and
principal payments related to certain indebtedness and capital expenditures. The
Company's borrowing requirements for working capital fluctuate throughout the
year.
On June 29, 1999, the Company and its operating subsidiaries signed a
Credit Agreement (the "Credit Agreement") with CIT Group/Commercial Services
(the "Lender"). The Credit Agreement initially provided the Company with a $75
million facility comprised of a $72 million revolver with sub limits up to $52
million for direct borrowings, $35 million for letters of credit, certain
overadvances and a $3 million term loan which was paid in full as of June 30,
2002.
The Credit Agreement provides for advances of (i) up to 90% of eligible
accounts receivable plus (ii) up to 60% of eligible inventory plus (iii) up to
60% of the undrawn amount of all outstanding letters of credit plus (iv)
allowable overadvances.
Collateral for the Credit Agreement includes a first priority lien on all
accounts receivable, machinery, equipment, trademarks, intangibles and
inventory, a first mortgage on all real property and a pledge of the Company's
stock interest in its operating subsidiaries, Donnkenny Apparel, Inc. and
Beldoch Industries Corporation. The Credit Agreement contains numerous financial
and operational covenants, including limitations on additional indebtedness,
liens, dividends, stock repurchases and capital expenditures. In addition, the
Company is required to maintain specified levels of tangible net worth and
comply with a requirement for minimum earnings before depreciation,
amortization, interest and taxes (EBITDA) and a minimum interest coverage ratio.
Effective June 30, 2003, the Company through an Amendment and Waiver
Agreement dated August 11, 2003, extended the Credit Agreement to June 30, 2007.
This Amendment provided the Company with a $65 million facility; the sub-limits
remained the same as in the original Credit Agreement. The interest rate on the
revolving credit borrowings is the current prime rate plus one and one-quarter
percent (6.00% at September 30, 2004).
As previously reported, on December 31, 2003 and June 30, 2004, the
Company was not in compliance with the financial covenants contained in the
Credit Agreement. In each instance, the Lender has waived these events of non
compliance.
As of September 30, 2004, the Company was not in compliance with the
quarterly financial covenants. Through an Amendment and Waiver Agreement dated
October 1, 2004, the Lender agreed to waive the Company's non-compliance with
its September 30, 2004 quarterly financial covenants. This Amendment and Waiver
Agreement amended the financial covenants to provide that these covenants will
be evaluated by the Lender monthly rather than quarterly beginning October 31,
2004. For the month ended October 31, 2004, the Company continued not to be in
compliance with the Credit Agreement financial covenants. The Lender has waived
this non-compliance.
-13-
The Company does not expect to be in compliance with its financial
covenants for the balance of 2004. Accordingly, the Company has recorded its
obligation to the Lender as a current liability at September 30, 2004.
The Company also has a factoring agreement with CIT Group/Commercial
Services. The factoring agreement provides for a factoring commission equal to
..35% of gross sales, plus certain customary charges. The factoring agreement
renews annually in June each year unless either party to the agreement gives
appropriate notice of non-renewal.
Other Matters
In connection with the acquisition of the Company's Robyn Meredith
Division (see Note 8 to the Consolidated Financial Statements), a note payable
of $1.1 million was issued. This note is payable in monthly installments of
$33,333 including imputed interest at an interest rate of 5.25%. The final
payment will be due October 2006.
At September 30, 2004 and December 31, 2003, the Company was contingently
liable for outstanding letters of credit issued amounting to $2.8 million and
$6.6 million, respectively.
During the first nine months of 2004, cash used by operating activities
was $3.4 million, principally as the result of the net loss and increases in
prepaid expenses and other current assets and decreases in accrued expenses and
other current liabilities partially offset by decreases in amount due from
factor and accounts receivable. On a comparable basis, net inventories at
September 30, 2004 were $0.6 million less than at December 31, 2003. During the
first nine months of 2003, cash used in operating activities was $4.2 million,
principally as the result of the net loss and decreases in accounts payable and
increases in inventory and prepaid expenses and other current assets partially
offset by decreases in due from factor.
Cash used in investing activities during the first nine months of 2004 was
$0.8 million, mainly for leasehold improvements at the Company's New York
showroom. Cash used in investing activities during the first nine months of 2003
was $0.6 million, mainly for the purchase of fixed assets, principally computer
equipment and related software and costs associated with the acquisition of a
license.
Cash provided by financing activities during the first nine months of 2004
was $4.5 million, which represents net borrowings under the revolver of $4.9
million and repayments of $0.4 million on a note payable. Cash provided by
financing activities during the nine months of 2003 was $4.9 million, which
represents net borrowings under the revolver of $5.1 million and repayments of
$0.3 million on the term loan.
Recently Issued Accounting Standards
There were no recently issued accounting standards that the Company believes
will have a material effect on its financial position, its results of operations
or its cash flows.
-14-
Contractual Commitments and Contingent Liabilities
The following table summarizes the Company's contractual commitments at
September 30, 2004:
Contractual Obligations Payments due Less than 1-3 years 3-5 years More than
(In Thousands) by period 1 year 5 years
Total
Long Term debt $40,529 $40,121 $ 408 -- --
Operating Leases $ 7,937 $ 2,972 $ 3,670 $ 1,295 --
Guaranteed Minimum Royalties $10,668 $ 2,890 $ 6,524 $ 1,116 $ 138
Letters of Credit $ 2,757 $ 2,757 -- -- --
------- ------- ------- ------- -------
Total $61,891 $48,740 $10,602 $ 2,411 $ 138
The Company has not provided any financial guarantees as of September 30, 2004.
Included in the above are those guaranteed minimum royalties associated with the
Coat Division. The Company is discontinuing its Coat Division and the related
licenses and does not expect that the guaranteed minimum royalties of
approximately $1.9 million will have to be paid.
Seasonality of Business and Fashion Risk
The Company's principal products are organized into seasonal lines for resale at
the retail level during the Spring, Summer, Fall and Holiday seasons. Typically,
the Company's products are designed as much as one year in advance and
manufactured approximately one season in advance of the related retail selling
season. Accordingly, the success of the Company's products is often dependent on
the ability to successfully anticipate the needs of retailers and the tastes of
the ultimate consumer up to a year prior to the relevant selling season.
Critical Accounting Policies and Estimates
The Company's significant accounting policies are more fully described in
Note 1 to the Annual Consolidated Financial Statements filed on Form 10-K (not
presented herein). Certain of the Company's accounting policies require the
application of significant judgment by management in selecting the appropriate
assumptions for calculating financial estimates. By their nature, these
judgments are subject to an inherent degree of uncertainty. These judgments are
based on historical experience, observation of trends in the industry,
information provided by customers and information available from other outside
sources, as appropriate. Critical accounting policies include:
Revenue Recognition - The Company recognizes sales upon shipment of
products to customers as title and risk of loss pass upon shipment. Provisions
for estimated uncollectible accounts, discounts and returns and allowances are
provided when sales are recorded based upon historical experience and current
trends. While such amounts have been within expectations and the provisions
established, the Company cannot guarantee that it will continue to experience
the same rates as in the past.
-15-
Accounts Receivable and Due from Factor - Accounts Receivable and due from
factor as shown on the Consolidated Balance Sheets, are net of allowances and
anticipated discounts. An allowance for doubtful accounts is determined through
analysis of the aging of accounts receivable at the date of the financial
statements, assessments of collectibility based on historic trends and an
evaluation of the impact of economic conditions. The allowance for doubtful
accounts is not significant since the Company sells a substantial portion of its
trade receivables to a commercial factor, without recourse, up to maximum credit
limits established by the factor for each individual account. Receivables sold
in excess of these limitations are subject to recourse in the event of
non-payment by the customer. An allowance for discounts is based on those
discounts relating to open invoices where trade discounts have been extended to
customers. Costs associated with potential returns of products as well as
allowable customer markdowns and operational charge backs, net of expected
recoveries, are included as a reduction to net sales and are part of the
provision for allowances. These provisions result from seasonal negotiations as
well as historic deduction trends, net expected recoveries and the evaluation of
current market conditions. Principally, the Company's historical estimates of
these costs have not differed materially from actual results.
Inventories - Inventory is stated at the lower of cost or market, cost
being determined on the first-in, first-out method. Reserves for slow moving and
aged merchandise are provided based on historical experience and current product
demand. The Company evaluates the adequacy of the reserves quarterly. While
markdowns have been within expectations and the provisions established, the
Company cannot guarantee that it will continue to experience the same level of
markdowns as in the past.
Valuation of Long-Lived Assets - The Company periodically reviews the
carrying value of its long-lived assets for continued appropriateness. This
review is based upon projections of anticipated future undiscounted cash flows.
While the Company believes that its estimates of future cash flows are
reasonable, different assumptions regarding such cash flows could materially
affect evaluations.
Income Taxes - The Company provides for income taxes only to the extent
that it expects to pay taxes (primarily state franchise and local taxes). The
Company's cumulative net operating loss (NOL) carryforward of $20.0 million for
federal income taxes and $31.0 million for state income taxes, have resulted in
estimated tax benefits of $8.2 million as of December 31, 2003 being recorded as
a deferred tax asset. The Company has recorded a valuation allowance against the
entire net deferred tax assets balance due to the Company's history of
unprofitable operations. However, should the Company conclude that 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.
-16-
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 5 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 September 30, 2004 and December 31, 2003, the carrying amounts of the
Company's revolving credit borrowings and term loans approximated fair value.
Effective January 1, 2003, the Company's revolving credit borrowings under its
Credit Agreement bear interest at the prime rate plus one and one-quarter
percent (6.0% at September 30, 2004). As of September 30, 2004, a hypothetical
immediate 10% adverse change in prime interest rates (from 4.75% to 5.23%)
relating to the Company's revolving credit borrowings would have a $0.2 million
unfavorable impact on the Company's earnings and cash flows over a one-year
period.
-17-
Item 4. Controls and Procedures
The Company's management with the participation of Daniel H. Levy, the
Chief Executive Officer and Maureen d Schimmenti, the Chief Financial Officer of
the Company has evaluated the effectiveness of the Company's disclosure controls
and procedures as of the end of the period covered by this report. Based on this
evaluation the Company's Chief Executive Officer and Chief Financial Officer,
concluded that the Company's disclosure controls and procedures are effective in
alerting them on a timely basis to material information required to be included
in the reports that it files or submits under the Securities and Exchange Act of
1934, as amended. Such evaluation did not identify any change in the Company's
internal control over financial reporting that occurred during the quarter ended
September 30, 2004, that has materially affected, or is reasonably likely to
materially affect, the Company's internal control over financial reporting.
-18-
PART II. OTHER INFORMATION
ITEM 1. Legal Proceedings
The Company is a party to legal proceedings arising in the ordinary course
of its business. Management believes that the ultimate resolution of these
proceedings will not, in the aggregate, have a material adverse effect on
financial condition, results of operations, liquidity or business of the
Company.
ITEM 2. Not Applicable
ITEM 3. Not Applicable
ITEM 4. Not Applicable
ITEM 5. Not Applicable
ITEM 6. Exhibits and Reports on Form 8-K
(a) Exhibits
Exhibit No. Description of Exhibit
31.1 Certification Pursuant to Section 302 of the Sarbanes-Oxley Act of
2002.
31.2 Certification Pursuant to Section 302 of the Sarbanes-Oxley Act of
2002.
32.1 Certification Pursuant to 18 U.S.C. Section 1350, as Adopted
Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
32.2 Certification Pursuant to 18 U.S.C. Section 1350, as Adopted
Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
(b) Reports on Form 8-K
None
-19-
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: November 15, 2004 /s/ Daniel H. Levy
--------------------------------
Daniel H. Levy
Chairman of the Board,
Chief Executive Officer
Date: November 15, 2004. /s/ Maureen d. Schimmenti
--------------------------------
Maureen d. Schimmenti
Vice President
and Chief Financial Officer,
(Principal Financial Officer)
-20-