10-K 1 e400287_10k-donn.txt FORM 10-K SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 ---------------------- FORM 10-K (Mark One) |X| ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the fiscal year ended December 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 other jurisdiction of (I.R.S. Employer Identification No.) incorporation or organization) 1411 Broadway New York, New York 10018 ---------------------------------------- ---------- (Address of principal executive offices) (Zip Code) Registrant's telephone number, including area code (212) 790-3900 Securities registered pursuant to Section 12(b) of the Act: Title of each class Name of each exchange on which registered ------------------- ----------------------------------------- None None Securities registered pursuant to Section 12(g) of the Act: Common Stock, $.01 par value ---------------------------- (Title of Class) 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), and (2) has been subject to such filing requirements for the past 90 days. Yes |X| No |_| Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. |_| Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Act) Yes |_| No |X| Based upon the closing sale price on the Over-the-Counter Market on June 30, 2003, the last business day of the registrant's most recently completed second fiscal quarter, the aggregate market value of the registrant's Common Stock, par Value $.01 per share, held by non-affiliates of the registrant on such date was approximately $2,552,043. The aggregate market value of the shares of Common Stock held by non-affiliates of the Registrant, based on a closing sale price of the Common Stock on the Over-the-Counter Market on March 12, 2004 of $2.58 per share, was approximately $8,894,302*. As of March 12, 2004, 4,367,417, shares of Common Stock of Registrant were outstanding. ---------- * For purposes of this report, the number of shares held by non-affiliates was determined by aggregating the number of shares held by Officers and Directors of Registrant, and by others who, to Registrant's knowledge, own more than 10% of Registrant's Common Stock, and subtracting those shares from the total number of shares outstanding. 1 PART 1 ITEM 1. BUSINESS Donnkenny, Inc. (together with its subsidiaries, the "Registrant" or the "Company") was incorporated in Delaware in 1978 and is a holding company with four subsidiaries. Donnkenny Apparel, Inc. ("Donnkenny Apparel") and Beldoch Industries Corporation ("Beldoch") are the operating subsidiaries of the Company. Products The Company designs, imports, and markets broad lines of moderately and better priced women's sportswear and coats. The Company's major labels include Pierre Cardin (R), Donnkenny (R), Bill Blass (R), Bill Blass Signature (R), Blassport (R), Casey & Max (R), Victoria Jones (R), and Harve Benard (R). In 2003 the Company's products were marketed through the following divisions: Pierre Cardin (R), Donnkenny(R), Casey & Max (R), Victoria Jones (R), Robyn Meredith (R) and Donnkenny Coats. Pierre Cardin The division sells better women's knitwear and sweaters pursuant to a license with Pierre Cardin. It also produces knitwear and sweaters under a license agreement with Harve Benard. The products are sold to knitwear and sweater departments of department and specialty stores. Its major customers include Macy's East, Macy's West, Chadwick's Catalog, Stein Mart, Sam's Club, BJ's Wholesale Club, Marshalls and Newton Buying. In addition, it sells exclusive private label products to customers such as Lerner Direct and the Bon Ton. Approximately 97% of these products are imported, predominately from Hong Kong, China, Korea and Vietnam. Donnkenny Donnkenny sells moderately priced women's career and casual pants and tops for missy, petites and large sizes. Its major customers include J.C. Penney, Kmart, and Stage Stores. Donnkenny has been an established brand name for over 60 years. In addition, it sells exclusive private label products. Approximately 74% of its products are sourced in Central America. The balance is sourced in the Far East. Casey & Max Casey & Max sells novelty woven tops and sportswear under the Casey & Max and Victoria Jones labels. The line consists of moderately priced products sold to department stores, specialty stores and chains including Catherine's, Kohl's, Goody's, Gottschalks, Peebles, Bealls, Stage Stores, Stein Mart and May Company. The products are marketed for missy, large sizes and petites. In addition, it sells exclusive private label products. The majority of these products are imported, predominately from India, Nepal, Hong Kong and Vietnam. Victoria Jones Victoria Jones sells moderately-priced women's knit and sweater products which are sold to department stores, specialty stores and chains including May Company, Catherine's, Macy's West, Bon Marche, Goody's, Peebles, Dillard's, Stage Stores and Sam's Club. Its products are marketed for missy, large sizes and petites. In addition, it sells exclusive private label products. All of these products are imported, predominately from China, Vietnam, Hong Kong, Bangladesh and Nepal. Robyn Meredith On October 1, 2003, the Company acquired certain assets of Robyn Meredith Inc. The Company's Robyn Meredith division sells moderately priced women's career and casual sportswear for missy, petites and large sizes. The majority of its products are exclusive private label products for department stores, specialty stores and catalogs. Its major customers include Coldwater Creek, Mervyn's, Chadwick's of Boston, Nordstrom, Ross Stores and B. Moss. These products are imported predominantly from China, Mexico and India. 2 Donnkenny Coats On May 1, 2003, the Company entered into a licensing agreement to manufacture and sell coats under the Bill Blass label. The coats are sold to department and specialty stores. Its major customers include Saks Fifth Avenue, Burlington Coat Factory, and Loehmann's. Substantially all of the coats are manufactured in Poland and Belarus. Manufacturing and Importing Almost all of the Company's products sold in Fiscal 2003 were produced abroad and imported into the United States, principally from Guatemala, Hong Kong, India, China, Belarus, Vietnam, Mexico, Korea, Bangladesh, Poland and Nepal. The Company's purchases from its foreign suppliers are affected through individual purchase orders specifying the price and quantity of the items to be produced. Generally, the Company does not have long-term, formal arrangements with the suppliers which manufacture its products. The Company continually seeks additional suppliers throughout the world for its sourcing needs. Three foreign contractors, one in India and two in Guatemala, accounted for 24% of the Company's purchases, but no other domestic or foreign contractor manufactured more than 6% of the Company's purchases in Fiscal 2003. Attendant with the Company's increased reliance on foreign manufacturing is a risk of excess inventory. On some products the Company must commit to its foreign manufacturers and suppliers four to six months in advance of its selling season, often before the Company has received the majority of its orders from its customers. Thus, there exists the risk that the purchase orders by the Company's customers will be less than the amount manufactured. The Company believes that this risk is outweighed by the cost savings to the Company by manufacturing such products abroad. Conversely, in the event there exists excess demand for the Company's products, the lengthy production time for imported goods makes it difficult for the Company to purchase additional goods for the same selling season. The Company's relationships with foreign suppliers also are subject to the risks of doing business abroad, including currency fluctuations, restrictions on the transfer of funds and, in certain parts of the world, political instability. In order to mitigate this risk, all of the Company's foreign purchasing is done in U.S. dollars. Additionally, virtually all of the Company's imported merchandise is subject to United States Customs duties. In addition, bilateral agreements between the major exporting countries and the United States impose quotas, which limit the amount of certain categories of merchandise that may be imported into the United States. Because the United States may, from time to time, impose new quotas, duties, tariffs or other import controls or restrictions, the Company monitors import and quota-related developments. Any material increase in duty levels, material decrease in quota levels or material decrease in available quota allocation could adversely affect the Company's operations. The Company's operations have not been materially affected by any of these factors to date. However, due to the large portion of the Company's products which is produced abroad, any substantial disruption of its relationships with its foreign suppliers could have a material adverse effect on the Company's operations and financial condition. Customers In Fiscal 2003, the Company shipped orders to approximately 10,100 stores in the United States. This customer base represents approximately 650 accounts. Of the Company's net sales for Fiscal 2003, department stores accounted for approximately 56%, wholesale clubs approximately 15%, catalog customers approximately 11%, mass merchants approximately 2%, chain stores approximately 2%, specialty retailers approximately 5% and other customers approximately 9%. 3 The Company markets its products to department stores, including J. C. Penney, May Company, Federated, Mervyn's, Stein Mart, Kohl's, Goody's, Stage Stores, Saks, Inc. and Sears, as well as wholesale clubs including Sam's, catalog customers including Chadwick's of Boston and Coldwater Creek and mass merchants including K-Mart. The Company also sells exclusive private label products to catalog specialty retailers and suppliers. In Fiscal 2003, sales to J.C. Penney accounted for 28% and sales to Sam's Club accounted for 14% of the Company's net sales. The loss of or significantly decreased sales to these customers could have a material adverse effect on the Company's consolidated financial condition and results of operations. The Company's Electronic Data Interchange computer system ("EDI") connects the Company to approximately 48 of its large customers and, in Fiscal 2003, was used to place 59% of the Company's order dollars. The Company is also linked by EDI to several of its major fabric suppliers, which allows the Company to review purchase orders for fabric on a weekly basis. Sales and Marketing At March 12, 2004, the Company had an 11 person sales force; 10 of them were Company employees and one was an independent commissioned sales representative. The Company's principal showrooms are in New York City. Raw Materials Suppliers The Company's sources of fabric and trim supply are well established. In 2003, 89% of all goods produced were manufactured using raw materials sourced from overseas. The balance of raw materials is sourced domestically. The Company typically experiences little difficulty in obtaining raw materials and believes that the current and potential sources of fabric and trim supply are sufficient to meet its needs for the foreseeable future. Trademarks and Proprietary Rights The Company owns and has registered in the United States, and in certain foreign jurisdictions, the following trademarks under which a variety of the Company's products are sold: Donnkenny (R), Casey & Max (R), Victoria Jones (R), Beldoch Popper (R) and Robyn Meredith (R) . Upon compliance with the trademark statutes of the United States and the relevant foreign jurisdictions, these trademark registrations may be renewed. The Company holds licensing rights to manufacture, import and sell women's sportswear in the United States and the U.S. Virgin Islands under the Pierre Cardin(R) trademark, including sweaters, pants, skirts, knitwear, jeans, swimwear and activewear. On February 12, 2004, the Company entered into a new License Agreement with the Pierre Cardin organization to provide for a license term of three years to conclude on December 31, 2006. On January 1, 2001 the Company signed a license agreement with Harve Benard to produce and sell a knitwear line. The Company began shipments in the fourth quarter of 2001. The Harve Benard trademark will not be used by the Company after the conclusion of this agreement on September 30, 2004. The Company does not believe that the discontinuance of this trademark will have a material effect on its operations. On May 1, 2003, the Company entered into a licensing agreement to manufacture and sell women's coats under the Bill Blass (R), Bill Blass Signature (R), and Blassport (R) labels. The three year licensing agreement has an automatic three year renewable term with additional renewable terms, thereafter. 4 On June 16, 2003, the Company entered into a three year licensing agreement to manufacture knits, sweaters, and woven tops under the Z. Cavaricci label. The Company intends to begin shipments with the Spring 2004 season. On September 10, 2003, the Company entered into a three year licensing agreement to manufacture and sell women's coats under various Nicole Miller labels. The Company intends to begin shipments of coats under this agreement with the Fall 2004 season. The guaranteed minimum royalties for these licenses are $7.6 million over the terms of the agreements through 2009. Backlog At March 12, 2004, the Company had unfilled, confirmed customer orders of approximately $30.4 million, compared to approximately $24.8 million of such orders at March 14, 2003, with such orders generally scheduled for delivery within three to six months of confirmation, although some extend until the end of the fiscal year. The amount of unfilled orders at a particular time is affected by a number of factors, including the scheduling of the production and shipment of garments, which in some instances may be delayed or accelerated at the customer's request. Generally, a comparison of unfilled orders from period to period may not necessarily be meaningful nor be indicative of eventual actual shipments. There can be no assurance that cancellations, rejections and returns will not reduce the amount of sales realized from the backlog of orders. Competition The women's apparel business is highly competitive and consists of many manufacturers and distributors, none of which accounts for a significant percentage of total sales in the overall market, but many of which are larger and have substantially greater resources than the Company. The Company competes with both domestic manufacturers and importers, primarily on an item-by-item basis, with respect to brand name recognition, price, quality and availability. Employees As of March 12, 2004 the Company had 203 full-time employees, 134 of whom were salaried and 69 were paid on an hourly basis. The Company had 8 part-time employees, of whom all worked on an hourly basis. The Company's hourly labor force is non-union. The Company believes relations with its employees are good. Environmental Matters The Company believes that it is in material compliance with all applicable federal, state and local environmental laws. The Company does not currently anticipate the need to make material capital expenditures to remain in compliance with applicable federal, state and local environmental laws. 5 ITEM 2. PROPERTIES The following table indicates the facilities owned or leased at December 31, 2003. The Company owns two facilities in Virginia, and leases five additional facilities: one in Summerville, South Carolina, one in New York State, one in Burlington, New Jersey, one in Poland and one in Hong Kong.
Owned Approximate or Location Square Footage Function Leased ========================================================================================================================= Summerville, South Carolina(1)... 200,000 Distribution center Leased New York, New York(2)............ 43,034 Offices and principal showrooms Leased Wytheville, Virginia............. 161,800 Distribution, administration Owned Burlington, New Jersey (3)....... 18,216 Administration Leased Hong Kong (4).................... 2,200 Administration, sourcing, quality control Leased Poland........................... 1,000 Administration, sourcing, quality control Leased Floyd, Virginia.................. 79,600 Currently for sale Owned -------- TOTAL 505,850
1) This facility is leased, with annual rental payments totaling $491,727, and is subject to a 3% annual rental escalation, until March 19, 2006, at which time the lease expires. 2) Annual rental payments for the New York office/showroom space are approximately $1,800,000 in the aggregate. The leases for the New York office/showrooms expire in 2006 and 2008. 3) This facility is leased, with annual rental payments totaling $113,850, until September 30, 2006, at which time the lease expires. 4) Lease expires in 2004. The Company will lease a new facility beginning in March 2004. Management believes that its current facilities are sufficient to meet its needs for the foreseeable future. ITEM 3. LEGAL PROCEEDINGS a. On April 27, 1998, Wanda King, a former employee of the Company, commenced an action against the Company in the United States District Court for the Western District of Virginia. In her complaint, the Plaintiff sought damages in excess of $8.0 million claiming that she was constructively discharged by the Company. The Company interposed an Answer to the amended Complaint denying the material allegations asserted in the Complaint. This action is scheduled to go to trial in May 2004. 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. 6 PART II ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS The Company's Common Stock is currently traded on the Over-the-Counter Market under the symbol "DNKY." There is no established public trading market for the Company's Stock. The following table sets forth the quarterly high and low closing prices of a share of Common Stock for the Company's two most recent fiscal years, plus the interim period through March 12, 2004. Period High Low ------ ---- --- Fiscal 2002 First Quarter ....................... $ 1.35 0.84 Second Quarter ...................... 1.54 0.75 Third Quarter ....................... 1.25 0.60 Fourth Quarter ...................... 1.25 0.56 Fiscal 2003 First Quarter ....................... $ 1.30 0.67 Second Quarter ...................... 1.10 0.77 Third Quarter ....................... 1.48 0.77 Fourth Quarter ...................... 3.00 1.30 Fiscal 2004 Eleven Weeks Ended March 12, 2004 ... $ 2.70 $ 1.84 On March 12, 2004, the closing price for a share of Common Stock was $2.58 per share. The number of holders of record for the Company's Common Stock as of March 9, 2004 was 51. The Company currently anticipates that it will retain all its earnings for use in the operation and expansion of its business and, therefore, does not anticipate that it will pay any cash dividends in the foreseeable future. In addition, the Company's credit agreement prohibits it from declaring or paying dividends without the consent of the Company's lenders. Securities Authorized for Issuance Under Equity Compensation Plans The following table provides information as of December 31, 2003 regarding compensation plans (including individual compensation arrangements) under which equity securities of Donnkenny, Inc. are authorized for issuance. 7 EQUITY COMPENSATION PLAN INFORMATION
Number of securities to Weighted average Number of securities be issued upon exercise exercise price of remaining available for of outstanding options outstanding options, future issuance under Plan Category warrants and rights warrants and rights equity compensation plans Total ---------------------------- ----------------------- -------------------- ------------------------- ----------- Equity Compensation Plans Approved by Security Holders - Stock Options (1) 160,026 $5.16 315,149 475,175 - Warrants (2) 18,750 $20.00 N/A 18,750 Equity Compensation Plans not Approved by Security Holders N/A N/A N/A N/A ----------------------- -------------------- ------------------------- ----------- Total 178,776 N/A 315,149 493,925 ======================= ==================== ========================= ===========
(1) Stock Options The Company has a stock award and incentive program that permits the issuance of up to 500,000 options to employees on terms as determined by the Board of Directors. In addition, the Company has an award program that permits option grants to Directors up to a maximum of 75,000 shares. Under the terms of the plans, options granted may be either non-qualified or incentive stock options and the exercise price, determined by the Stock Option committee, may not be less than the fair market value of the Company's Common Stock on the dates of the grant. (2) Warrants On January 14, 1997, the Company issued warrants to purchase 18,750 shares of Common Stock at $20.00 per share to the principal of a company to rescind an acquisition transaction. The warrants are immediately exercisable and will expire on July 23, 2004. ITEM 6. SELECTED FINANCIAL DATA The following selected consolidated financial data as of and for the year ended December 31, 2003 has been derived from the Company's Consolidated Financial Statements included elsewhere in this Form 10-K which have been audited by Mahoney Cohen and Company, CPA, P.C., independent auditors, whose report thereon is also included herein. The selected consolidated financial data as of December 31, 2002 and for each of the years in the two year period ended December 31, 2002 have been derived from the Company's Consolidated Financial Statements which have been audited by Deloitte & Touche LLP, the Company's former independent auditors whose report is also included herein. The selected consolidated financial data as of December 31, 2001, 2000 and 1999 and for the fiscal years ended December 31, 2000 and 1999 have been derived from the Company's Consolidated Financial Statements, which are not included herein. The information set forth below should be read in conjunction with "Management's Discussion and Analysis of Financial Condition and Results of Operations" and the Consolidated Financial Statements of the Company and its Subsidiaries and related notes thereto incorporated by reference herein. 8
Year Ended ============================================================================ December 31, December 31, December 31, December 31, December 31, 1999 2000 2001 2002 2003 ============================================================================ (In thousands, except per share data) Consolidated Statement of Operations Data: Net sales ................................ $ 173,749 $ 151,055 $ 152,180 $ 107,102 $ 92,351 Cost of sales ............................ 138,816 124,073 117,497 80,345 70,895 --------- --------- --------- --------- --------- Gross profit ............................. 34,933 26,982 34,683 26,757 21,456 Selling, general and Administrative expenses .................. 33,002 28,194 28,367 22,339 22,011 Amortization of goodwill and other related acquisition costs (2) ........... 1,390 1,437 1,489 -- 51 Provision for settlement of litigation ... 5,875 599 -- -- -- Write-down of assets held for sale ....... -- -- 300 150 36 Restructuring Charge ..................... -- 500 -- -- -- --------- --------- --------- --------- --------- Operating income (loss) .................. (5,334) (3,748) 4,527 4,268 (642) Interest expense, net .................... 4,007 5,097 4,703 2,039 1,535 --------- --------- --------- --------- --------- Income (loss) before income taxes ........ (9,341) (8,845) (176) 2,229 (2,177) Income tax expense (benefit) ............. 87 88 (220) 36 (55) --------- --------- --------- --------- --------- Income (loss) before cumulative effect in change in accounting principle ....... (9,428) (8,933) 44 2,193 (2,122) Cumulative effect of change in accounting principle (2) ................ -- -- -- 28,744 -- --------- --------- --------- --------- --------- Net income (loss) ........................ $ (9,428) $ (8,933) $ 44 $ (26,551) $ (2,122) ========= ========= ========= ========= ========= Basic income (loss) per Common Share (1): Income (loss) before accounting change ... $ (2.65) $ (2.26) $ 0.01 $ 0.50 $ (0.49) Cumulative effect of accounting change(2) -- -- -- (6.58) -- --------- --------- --------- --------- --------- Net income (loss) ..................... $ (2.65) $ (2.26) $ 0.01 $ (6.08) $ (0.49) ========= ========= ========= ========= ========= Shares used in the calculation of basic income (loss) per share ........... 3,552 3,957 4,367 4,367 4,367 ========= ========= ========= ========= ========= Diluted income (loss) per Common Share (1): Income (loss) before accounting change ... $ (2.65) $ (2.26) $ 0.01 $ 0.50 $ (0.49) Cumulative effect of accounting change(2) -- -- -- (6.58) -- --------- --------- --------- --------- --------- Net income (loss) ..................... $ (2.65) $ (2.26) $ 0.01 $ (6.08) $ (0.49) ========= ========= ========= ========= ========= Shares used in the calculation of diluted income (loss) per share ......... 3,552 3,957 4,388 4,418 4,367 ========= ========= ========= ========= ========= Consolidated Balance Sheet Data: Working capital .......................... $ 48,302 $ 39,199 34,891 $ 25,306 $ 33,761 Total assets ............................. 101,837 91,343 82,400 43,439 50,765 Long-term debt, including current portion 42,775 42,147 35,777 23,983 36,060 Stockholders' equity ..................... 41,881 33,653 33,697 7,146 5,024
---------- (1) All per share amounts and the shares used in the calculation of basic and diluted (loss) per share have been retroactively restated to reflect the one for four reverse stock split effective April 20, 2000. (2) As discussed in Notes 1 and 4 to the Consolidated Financial Statements, in 2002, the Company changed its method of accounting for goodwill and other intangible assets to conform to Statement on Financial Accounting Standards ("SFAS") No. 142 and recorded a charge of $28.7 million. 9 ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Introductory Overview The Company is engaged in the women's apparel business. The Company's business consists of importing and marketing women's apparel, consisting primarily of women's sportswear and coats, to its retail customers who in turn sell the Company's products to the ultimate retail consumer. The business of the Company is highly competitive. The Company's products consist of its own brand names ("Branded Products") as well as those produced under a licensing arrangement for the use of Pierre Cardin(R), Harve Benard(R), Bill Blass(R), Z. Cavaricci(R) and Nicole Miller(R) trademarks ("Trademark Products"). In addition to selling its Branded and Trademark Products to its customers, the Company develops specific product ("Private Label Products") for some of its larger accounts, such as mass merchandisers and national chains. The women's apparel business is characterized by a large number of small companies selling unbranded merchandise, and by several large companies that have developed widespread consumer recognition of the trademarks and brand names associated with merchandise sold by these companies. In addition, retailers to whom the Company sells its products have sought to expand the development and marketing of their own brands and to obtain women's apparel products directly from the same sources from which the Company obtains its products. The Company's women's apparel business provides product for department stores, specialty stores, regional chains, discounters and warehouse clubs. Sportswear is marketed for four selling seasons a year. The Company's women's coat products, consisting of outerwear and rainwear, are marketed for two specific selling seasons. To be competitive, the Company is required to create a substantially new line of products for each selling season. In this competitive environment, the Company's Branded Products, which do not have widespread consumer recognition, although they are well known by the Company's retail customers, must compete with widely recognized brand names of product produced by the Company's competitors. The Company's Trademark Products have widespread brand recognition but they must compete against other widely know brands. In addition, the Company makes presentations throughout the year to Private Label accounts. The Company does not have long-term contracts with any of its customers and, therefore, its business is subject to unpredictable increases and decreases in sales depending upon the size and number of orders that the Company receives each time it presents its products to its customers. In this climate, the Company must constantly change its product mix to sell to its customers. This requires the Company not only to design products which it anticipates will have commercial appeal, but also to develop, acquire and sometimes discontinue the use of Brands and Trademarks. Thus, for the year ended December 31, 2002, the Company's Net Sales were $107.1 million, of which approximately 44% consisted of sales of Trademark Product, 48% consisted of Branded Product and the balance of Private Label Product. For the year ended December 31, 2003, the Company's Net Sales were $92.3 million, of which approximately 35% consisted of sales of Trademark Product, 40% consisted of Branded Product and the balance of Private Label Product. In 2003 the Company discontinued the marketing of products under the Rebecca Jones Brand and acquired the Z. Cavaricci(R), Nicole Miller(R) and Bill Blass(R) Trademarks for certain products. The Company's 2003 Net Sales for discontinued Brands were $1.5 million. Net Sales under the Bill Blass(R) trademarks in 2003, were approximately $7.0 million. Sales under the Company's Z. Cavaricci(R) and Nicole Miller(R) Trademarks are planned to begin in 2004. On October 1, 2003, the Company acquired its Robyn Meredith Division, which primarily sells Private Label Brands. In the fourth quarter this division accounted for 25.6% of the fourth quarter sales and 8.9% of sales for the entire year. Of the Company's net sales for Fiscal 2003, department stores accounted for approximately 56%, wholesale clubs approximately 15%, catalog customers approximately 11%, mass merchants approximately 2%, chain stores approximately 2%, specialty retailers approximately 5% and other customers approximately 9%. 10 At March 12, 2004, the Company had unfilled, confirmed customer orders of approximately $30.4 million, compared to approximately $24.8 million of such orders at March 14, 2003, with such orders generally scheduled for delivery within three to six months of confirmation, although some extend until the end of the year. The amount of unfilled orders at a particular time is affected by a number of factors, including the scheduling of the production and shipment of garments, which in some instances may be delayed or accelerated at the customer's request. Generally, a comparison of unfilled orders from period to period may not necessarily be meaningful nor be indicative of eventual actual shipments. There can be no assurance that cancellations, rejections and returns will not reduce the amount of sales realized from the backlog of orders. In addition, much of the Company's products are unbranded and based upon the current retail conditions, customers are placing orders for product closer to need. Therefore, it is difficult for the Company to estimate its future performance based upon the back log of current orders. Because of the challenges faced by the foregoing changing factors, the Company's management is constantly assessing the acceptance of its product mix and making adjustments accordingly. Results of Operations The following table sets forth selected operating data of the Company as percentages of net sales, for the periods indicated below:
December 31, ------------ Year Ended 2001 2002 2003 -------------------------------------------------------------------------------------------- Net sales ......................................... 100.0% 100.0% 100.0% Cost of sales ..................................... 77.2 75.0 76.8 ------ ------ ------ Gross profit ...................................... 22.8 25.0 23.2 Selling, general and administrative expenses ...... 18.6 20.9 23.8 Amortization of intangibles ....................... 1.0 -- 0.1 Write-down of assets held for sale ................ 0.2 0.1 -- ------ ------ ------ Operating income (loss)............................ 3.0 4.0 (0.7) Interest expense, net ............................. 3.1 1.9 1.7 ------ ------ ------ Income (loss) before income taxes ................. (0.1) 2.1 (2.4) Income tax (benefit) .............................. (0.1) 0.1 (0.1) ------ ------ ------ Income (loss) before cumulative effect of change in accounting principle .............................. -- 2.0 (2.3) Cumulative effect of change in accounting principle -- 26.8 -- ------ ------ ------ Net income (loss) ................................. 0.0% (24.8%) (2.3%) ====== ====== ======
11 Comparison of Fiscal 2003 with Fiscal 2002 Net Sales Net Sales decreased by $14.8 million or 13.8% from $107.1 million in Fiscal 2002 to $92.3 million in Fiscal 2003. The net decrease in sales was caused by a deterioration of some of the Company's non-branded products appeal in the marketplace, increased competition from customers' own labels and the continuing slow retail environment. In addition, the Company experienced a decrease in orders for certain products made under licensed trademarks in favor of competitors whose brand names provided more appeal. To a certain degree, these decreases were offset by increases in the Company's private label businesses and by the sales generated by the two divisions acquired late in the year; Robyn Meredith and Donnkenny Coats. Gross Profit Gross profit in 2003 was $21.4 million, or 23.2% of net sales, compared to $26.8 million, or 25.0% of net sales, in 2002. The decrease in gross profit as a percentage of net sales was primarily attributable to the sale of excess inventory and strong price competition in the marketplace. Selling, General and Administrative Expenses Selling, general and administrative expenses ("SG&A") decreased to $22.0 million in 2003 from $22.3 million in 2002. The decrease in selling, general and administrative expenses was primarily due to reductions in headcount and reductions in distribution, sales, design and product-related expenses. These reductions were offset by additional expenses incurred attributable to the two divisions acquired late in the year, Robyn Meredith and Donnkenny Coats. In addition, in 2003, the Company recorded a provision for bad debts not sold to its commercial factor of $0.9 million due to the fact that the ultimate collection of the balance of a certain receivable is in dispute. The Company intends to vigorously pursue the collection of this receivable. Operating Income In 2003, the Company had operating income of $0.6 million versus $4.3 million for 2002. Interest Expense In 2003, interest expense was $1.5 million versus $2.0 million in 2002. The decrease was attributable to lower borrowings under the Company's credit agreement due to decreased inventory purchases and lower operating expenses and a decrease in the Company's interest rate. Net Income (Loss) In 2003, the Company reported a net loss of $2.1 million or $(0.49) per share versus a net loss of $26.6 million, or $(6.08) per share in 2002. Fiscal 2002 Compared to Fiscal 2001 Net Sales Net Sales decreased by $45.1 million or 29.6% from $152.2 million in Fiscal 2001 to $107.1 million in Fiscal 2002. The decline in the net sales was primarily due to the elimination of certain product lines including the Decade dress line, a significant cashmere program, career private label, the de-emphasis and consolidation of Pierre Cardin Options into Pierre Cardin and the continuing slow retail environment, which caused a drop in the Company's core business. 12 Gross Profit Gross profit for Fiscal 2002 was $26.8 million, or 25.0% of net sales, compared to $34.7 million, or 22.8% of net sales, for Fiscal 2001. The increase in gross profit as a percentage of net sales was primarily attributable to decreases in the levels and sales of non-current inventory and the continued effort to improve sourcing. Selling, General and Administrative Expenses Selling, general and administrative expenses ("SG&A") decreased to $22.3 million in Fiscal 2002 from $28.4 million in Fiscal 2001. The decrease in selling, general and administrative expenses was primarily due to reductions in headcount and reductions in distribution sales, design and product-related expenses. Amortization of Goodwill and Other Related Acquisition Costs As a result of the Company's adoption of SFAS No. 142 the Company ceased the amortization of goodwill and other intangible assets with the indefinite lives in 2002 as compared to amortization of $1.5 million in 2001 (see Recent Accounting Pronouncements and Note 4 to the Consolidated Financial Statements). Write-down of Assets Held For Sale In Fiscal 2002, the Company recorded a charge of $0.2 million related to the write-down of assets held for sale as compared to $0.3 million in Fiscal 2001. Operating Income In Fiscal 2002, the Company had operating income of $4.3 million versus $4.5 million for Fiscal 2001. Interest Expense In Fiscal 2002, interest expense was $2.0 million versus $4.7 million in 2001. The decrease was attributable to lower borrowings under the credit agreement due to decreased inventory purchases and lower operating expenses and a decrease in the Company's interest rate. Provision for Income Taxes The Company recorded a provision for state and local income taxes of $0.04 million in 2002 compared to an income tax benefit of $0.2 million in 2001. In fiscal 2001, the IRS and the Joint Committee on Taxation completed the audit of the Company's amended prior year tax returns. As a result, the Company received net refunds of approximately $0.2 million. No federal income tax provision was recorded due to the Company's net operating loss carryforwards. Net Income Before Cumulative Effect of Change in Accounting Principle In Fiscal 2002 the Company reported net income before cumulative effect of change in accounting principle of $2.2 million of $0.50 per share versus a net income of $44,000, or $0.01 per share in Fiscal 2001. 13 Cumulative Effect of Change in Accounting Principle 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 (See Notes 1 and 4 to the Consolidated Financial Statements). As a result of adopting SFAS No. 142 on January 1, 2002, the Company ceased the amortization of goodwill and determined that the value of its intangible assets had been impaired. The impairment charge of $28.7 million was calculated based upon a valuation of the Company's market capitalization on January 1, 2002, adjusted for an estimated premium that a willing buyer would assign the market capitalization in the event of a sale of the Company. The premium was based on an average of such premiums paid in similar transactions in the industry. The impairment charge consists of $25.4 million related to goodwill and $3.3 million related to intangible assets. Net Income (Loss) In Fiscal 2002 the Company reported a net loss of $26.6 million or $(6.08) per share versus a net income of $44,000, or $0.01 per share in Fiscal 2001. Liquidity and Capital Resources The Company's liquidity requirements arise from the funding of working capital needs, primarily inventory and accounts receivable, and interest and principal payments related to certain indebtedness and capital expenditures. The Company's borrowing requirements for working capital fluctuate throughout the year. On June 29, 1999, the Company and its operating subsidiaries signed a Credit Agreement (the "Credit Agreement") with CIT Group/Commercial Services (the "Lender"). The Credit Agreement initially provided the Company with a $75 million facility comprised of a $72 million revolver with sublimits up to $52 million for direct borrowings, $35 million for letters of credit, certain overadvances and a $3 million term loan which was paid in full as of June 30, 2002. The Credit Agreement provides for advances of (i) up to 90% of eligible accounts receivable plus (ii) up to 60% of eligible inventory plus (iii) up to 60% of the undrawn amount of all outstanding letters of credit plus (iv) allowable overadvances. Collateral for the Credit Agreement includes a first priority lien on all accounts receivable, machinery, equipment, trademarks, intangibles and inventory, a first mortgage on all real property and a pledge of the Company's stock interest in its operating subsidiaries, Donnkenny Apparel, Inc. and Beldoch Industries Corporation. The Credit Agreement contains numerous financial and operational covenants, including limitations on additional indebtedness, liens, dividends, stock repurchases and capital expenditures. In addition, the Company is required to maintain specified levels of tangible net worth and comply with a requirement for minimum earnings before depreciation, amortization, interest and taxes (EBITDA) and a minimum interest coverage ratio, all based upon the Company's annual business plan approved by the lender. 14 In July 2000, the Credit Agreement was amended to provide for an additional $1.3 million term loan to finance an acquisition. This term loan bore interest at the prime rate plus 2% and was paid from January 1, 2001 to March 2003, at which time this term loan was paid. On March 28, 2001, the Company entered into an Amendment and Waiver Agreement to extend the Final Maturity Date of the original agreement to June 30, 2004, to waive existing events of default under the Credit Agreement as of December 31, 2000 with respect to the Company's non-compliance with covenants related to minimum interest coverage, EBITDA and Tangible Net Worth, and to amend certain other provisions of the Credit Agreement including covenants and the level of allowable overadvances to support the Company's 2001 business plan. Pursuant to this amendment, the interest rate on borrowings was increased to 2.0% above the prime rate effective January 1, 2001. A fee of $200,000 was paid in connection with the Amendment and Waiver. Effective January 1, 2002, the Company established covenants and the level of allowable overadvances with the lender to support its 2002 business plan. This Amendment and Waiver Agreement also amended the interest rate on the revolving credit borrowings to the prime rate plus one and three quarters percent and provide for an additional interest rate reduction effective July 1, 2002 if certain objectives were achieved (6.50% at January 1, 2002). No fee was paid in connection with the Amendment and Waiver. The Company had achieved the objectives and received an additional rate reduction effective July 1, 2002. The interest rate on the revolving credit borrowings was now prime plus one and one-half percent (5.75% at December 31, 2002). Effective January 1, 2003, the Company established convenants 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 and one-quarter percent. No fee was paid in connection with this amendment. Effective June 30, 2003, the Company through an Amendment and Waiver Agreement dated August 11, 2003, extended the Credit Agreement to June 30, 2007. This Amendment provides the Company with a $65 million facility with the original sublimits remaining the same. The interest rate on the revolving credit borrowings is the current prime rate plus one and one-quarter percent (5.25% at December 31, 2003). Fees paid in connection with this Amendment were $243,750. All other terms and conditions of the Credit Agreement remained unchanged. As of December 31, 2003, the Company was not in compliance with the quarterly financial covenants. The Lender has waived this non-compliance. The Company paid a fee of $100,000 in connection with this waiver. At the end of Fiscal 2003, direct borrowings under its Credit Agreement were $35 million. Additionally, the Company had letters of credit outstanding of $6.6 million, with an unused facility of $23.4 million. At the end of Fiscal 2002, direct borrowings, term loan balance and letters of credit outstanding under the credit facility were $23.7 million, $0.3 million and $11.8 million, respectively. Effective January 1, 2004, the Company established covenants and the level of allowable overadvances with the lender, through an Amendment to the Credit Agreement dated March 26, 2004, to support its 2004 business plan. No fee was paid in connection with the Amendment. The Company also has a factoring agreement with CIT Group/Commercial Services. The Company sells a substantial portion of its trade receivables to CIT Group without recourse, up to maximum credit limits established by CIT Group for each individual account. 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 gives appropriate notice of nonrenewal. In connection with the acquisition of Robyn Meredith (see note 14 to the Consolidated Financial Statements), a note payable of $1.1 million was incurred. This note is payable in monthly installments of $33,333 including imputed interest at an interest rate of 5.25%. The final payment will be due October 2006. During Fiscal 2003, cash used by operating activities was $6.7 million, principally as the result of decreases in accounts payable and increases in inventory, accounts receivable and due from factor. During Fiscal 2002, cash provided by operating activities was $12.2 million, principally as the result of decreases in inventory and due from factor and increases in accounts payable offset by decreases in accrued expenses and other current liabilities. 15 Cash used in investing activities in Fiscal 2003 included $0.4 million for the purchase of fixed assets, principally computer equipment and related software, the acquisition of Robyn Meredith of $3.4 million (including inventory acquired ) and the acquisition of the Bill Blass licenses of $0.5 million. Cash used in investing activities in Fiscal 2002 included $0.5 million for the purchase of fixed assets, principally computer equipment and related software, offset by $0.1 million received from the sale of property, plant and equipment. In Fiscal 2003, the Company was permitted to spend up to $2.0 million on the combination of capital investments or the repurchase of its own stock in accordance with the Credit Agreement described below. Cash provided by financing activities in Fiscal 2003 was $11.0 million which represents net borrowings under the Credit Agreement of $11.3 million partially offset by repayments of $0.3 million of a term loan and a note payable. Cash used in financing activities in Fiscal 2002 was $11.8 million which represents net repayments under the Credit Agreement of $10.7 million, and repayments of $1.1 million of a term loan. 16 The Company believes that cash flows from operations and amounts available under the Credit Agreement will be sufficient for its needs for the next twelve months. Contractual Commitments and Contingent Liabilities The following table summarizes the Company's contractual commitments and contingent liabilities at December 31, 2003:
Contractual Obligations Payments due by Less than 1-3 years 3-5 years More than (In Thousands) period 1 year 5 years Total Long Term debt (1) $36,142 $ 400 $ 733 $35,009 -- Operating Leases (2) $ 9,530 $ 2,767 $ 4,372 $ 2,391 -- Guaranteed Minimum Royalties (3) $ 7,643 $ 1,798 $ 5,020 $ 550 $ 275 Letters of Credit (4) $ 6,570 $ 6,570 -- -- -- Inventory Purchase Agreement (5) $ 1,100 $ 1,100 -- -- -- ------- ------- ------- ------- ------- Total $60,985 $12,635 $10,125 $37,950 $ 275
(1) See Note 6 to the Consolidated Financial Statements (2) See Note 11e to the Consolidated Financial Statements (3) The Company has guaranteed minimum royalties which represent those minimum amounts due in connection with the Pierre Cardin, Harve Benard, Bill Blass, Z. Cavaricci and Nicole Miller licenses. (4) As of December 31, 2003, the Company was contingently liable for outstanding letters of credit (See Note 6 to the Consolidated Financial Statements). (5) See Note 11d to the Consolidated Financial Statements. Off-Balance Sheet Arrangements The Company has not created, and is not party to, any special-purpose or off-balance sheet entities for the purpose of raising capital, incurring debt or operating its business. The Company does not have any arrangements or relationships with related entities that are not consolidated into the Company's financial statements that are reasonably likely to materially affect the Company's liquidity or the availability of capital resources. On May 1, 2003, the Company purchased certain assets from Rose Cloak & Suit Co., Inc. ("Rose Cloak"), an unrelated company. The purchased assets were used by the Company to establish its Donnkenny Coats Division. Two of the principals of Rose Cloak became full time employees of the Company and were allowed to continue their ownership interest in Rose Cloak. In connection with the asset purchase transaction, the Company agreed to purchase from Rose Cloak raw materials inventory for $2.7 million of which $1.6 million was purchased in 2003 and the balance is to be purchased in 2004. The Company believes that this was an arms length, commercially reasonable transaction. (See Contractual Commitments and Contingent Liabilities above). 17 Other Items Affecting the Company Competition The apparel industry in the United States is highly competitive and characterized by a number of multi-line wholesalers (such as the Company) and a larger number of specialty manufacturers. The Company faces substantial competition in its markets in both categories. Apparel Industry Cycles and other Economic Factors The apparel industry historically has been subject to substantial cyclical variation, with consumer spending on apparel tending to decline during recessionary periods. A continuing decline in the general economy or uncertainties regarding future economic prospects may affect consumer spending habits, which in turn, could have a material adverse effect on the Company's results of operations and its financial condition. Retail Environment Various retailers, including some of the Company's customers, have experienced declines in revenue and profits in recent periods and some have been forced to file for bankruptcy protection. Retailers are now placing smaller orders and ordering closer to need. To the extent that these current market conditions continue, there can be no assurance that the Company's financial condition and results of operations will not be adversely affected. 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. Foreign Operations Attendant with the Company's increased reliance on foreign manufacturing is a risk of excess inventory. On some products the Company must commit to its foreign manufacturers and suppliers four to six months in advance of its selling season, often before the Company has received the majority of its orders from its customers. Thus, there exists the risk that the purchase orders by the Company's customers will be less than the amount manufactured. The Company believes that this risk is outweighed by the cost savings to the Company by manufacturing such products abroad. Conversely, in the event there exists excess demand for the Company's products, the lengthy production time for imported goods makes it difficult for the Company to purchase additional goods for the 18 same selling season. The Company's relationships with foreign suppliers also are subject to the risks of doing business abroad, including currency fluctuations, restrictions on the transfer of funds and, in certain parts of the world, political instability. In order to mitigate this risk, all of the Company's foreign purchasing is done in U.S. dollars. Additionally, virtually all of the Company's imported merchandise is subject to United States Customs duties. In addition, bilateral agreements between the major exporting countries and the United States impose quotas, which limit the amount of certain categories of merchandise that may be imported into the United States. Because the United States may, from time to time, impose new quotas, duties, tariffs or other import controls or restrictions, the Company monitors import and quota-related developments. Any material increase in duty levels, material decrease in quota levels or material decrease in available quota allocation could adversely affect the Company's operations. The Company's operations have not been materially affected by any of these factors to date. However, due to the large portion of the Company's products which is produced abroad, any substantial disruption of its relationships with its foreign suppliers could have a material adverse effect on the Company's operations and financial condition. Factors that May Affect Future Results and Financial Condition The Company's future operating results and financial condition are dependent upon its ability to successfully design, import and market apparel. Also impacting the Company and its operations are a variety of economic, social and political factors, including the following: o Risks associated with war and terrorist activities, including reduced shopping activity as a result of public safety concerns and disruption in the receipt and delivery of merchandise; o Changes in national and global microeconomic conditions in the markets where the Company sells or sources its products, including the levels of consumer confidence and discretionary spending, consumer income growth, personal debt levels, rising energy costs and energy shortages; o Risks of increased sourcing costs; o Any significant disruption in the Company's relationships with its suppliers, manufacturers and employees. o Risk of foreign currency fluctuations. Recent Accounting Pronouncements In January 2003, the Financial Accounting Standards Board ("FASB") issued FASB Interpretation No. 46, "Consolidation of Variable Interest Entities" ("FIN 46"). FIN 46 requires that a variable interest entity be consolidated by a company if that company is subject to a majority of the risk of loss from the variable interest entity's activities or entitled to receive a majority of the entity's residual returns or both. The consolidation requirements apply to the first fiscal year or interim period ending after March 31, 2004. The Company believes the adoption FIN 46 will not have a material impact on its reported consolidated financial position or results of operations. In April 2003, the FASB issued SFAS No. 149, "Amendment of Statement No.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. 19 In May 2003, the FASB issued SFAS No. 150, "Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity," effective for financial instruments entered into or modified after May 31, 2003, and otherwise is effective at the beginning of the first interim period beginning after June 15, 2003. This statement establishes standards for how an issuer classifies and measures certain financial instruments with characteristics of both liabilities and equity. It requires that an issuer classify a freestanding financial instrument that is within its scope as a liability (or an asset in some circumstances). The adoption of SFAS No.150 will not have an impact on the Company's reported consolidated financial position, results of operations or cash flows. Critical Accounting Policies and Estimates The Company's significant accounting policies are more fully described in Note 1 to the Consolidated Financial Statements. Certain of the Company's accounting policies require the application of significant judgment by management in selecting the appropriate assumptions for calculating financial estimates. By their nature, these judgments are subject to an inherent degree of uncertainty. These judgments are based on historical experience, observation of trends in the industry, information provided by customers and information available from other outside sources, as appropriate. 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 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, an evaluation of the impact of economic conditions and other factors. The Company sells a substantial portion of its trade receivables to a commercial factor, without recourse, up to maximum credit limits established by the factor for each individual account. Receivables sold in excess of these limitations are subject to recourse in the event of non-payment by the customer. An allowance for discounts is based on those discounts relating to open invoices where trade discounts have been extended to customers. Costs associated with potential returns of products as well as allowable customer markdowns and operational charge backs, net of expected recoveries, are included as a reduction to net sales and are part of the provision for allowances. These provisions result from seasonal negotiations as well as historic deduction trends, net expected recoveries and the evaluation of current market conditions. The Company's historical estimates of these costs have not differed materially from actual results. Inventories - Inventory is stated at the lower of cost or market, cost being determined on the first-in, first-out method. Reserves for slow moving and aged merchandise are provided based on historical experience and current product demand. Inventory reserves for slow moving and aged merchandise were $1.3 million at December 31, 2003 and 2002. 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. These reviews are 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. 20 Income Taxes - The Company provides for income taxes only to the extent that it expects to pay taxes (primarily state 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 asset 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-K (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 7a. 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. Those debt obligations with interest rates tied to the prime rate are described in "Liquidity and Capital Resources", as well as Note 6 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 December 31, 2003 and 2002, the carrying amounts of the Company's revolving credit borrowings and term loans approximated fair value. The Company's revolving credit borrowings under its Credit Agreement bear interest at the prime rate plus one and one-quarter percent (5.25% at December 31, 2003). As of December 31, 2003, a hypothetical immediate 10% adverse change in prime interest rates (from 4.0% to 4.4%) relating to the Company's revolving credit borrowings and term loan would have a $0.1 million unfavorable impact on the Company's earnings and cash flows over a one-year period. ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA See Financial Statements following Item 15 of this Annual Report of Form 10-K. 21 ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE Effective August 26, 2003 the Company discharged Deloitte & Touche LLP as its independent accountants. The reports of Deloitte & Touche LLP on the Company's consolidated financial statements for the past two fiscal years did not contain an adverse or disclaimer of opinion and were not qualified or modified as to uncertainty, audit scope or accounting principles. The Company's Audit Committee participated in and approved the decision to change independent accountants. In connection with its audits for the two most recent fiscal years and through August 26, 2003, the Company had no disagreements with Deloitte & Touche LLP on any matter of accounting principles or practices, financial statement disclosure, or auditing scope or procedure, which would have caused them to make reference to the subject matter of the disagreement in connection with their reports. The Company requested that Deloitte & Touche LLP furnish it with a letter addressed to the SEC stating whether or not it agrees with the above statement. A letter from Deloitte & Touche LLP dated September 10, 2003 was provided, and an amended Form 8K/A dated September 11, 2003 containing that letter was filed with the Securities and Exchange Commission. The Company has engaged Mahoney Cohen & Company, CPA, P.C. as its new independent accountants. During the two most recent fiscal years and through August 26, 2003 the Company has not consulted with Mahoney Cohen & Company, CPA, P.C. regarding (i) the application of accounting principles to a specified transaction either completed or proposed, or the type of audit opinion that might be rendered on the Company's consolidated financial statements, and no written report or oral advice was provided to the Company concluding there was an important factor to be considered by the Company in reaching a decision as to an accounting, auditing, or financial reporting issue; (ii) any matter that was either the subject of a disagreement, as that term is defined in Item 304(a) (1) (iv) of Regulation S-K and the related instruction to Item 304 of Regulation S-K, or a reportable event, as that term is defined in Item 304(a) (1) (iv) of Regulation S-K. ITEM 9A. 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 has evaluated the effectiveness of the Company's disclosure controls and procedures as of the year 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 controls over financial reporting that occurred during the year ended December 31, 2003, that has materially affected, or is reasonably likely to materially affect, the Company's internal control over financial reporting. 22 PART III ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF REGISTRANT Daniel H. Levy, a director of the Company since 1997, became Chairman of the Board and Chief Executive Officer of the Company on January 1, 2000. Prior thereto, he had been a principal of and consultant to LBK Consulting Inc., a retail consulting business, since January 1997 and during the period of 1994 to April 1996. From April 1996 through January 1997, he served as Chairman of the Board and Chief Executive Officer of Best Products, Inc., a retail sales company which filed for bankruptcy in September 1996. From 1993 through 1994, Mr. Levy served as Chairman of the Board and Chief Executive Officer of Conran's, a retail home furnishings company. From 1991 to 1993, he was Vice Chairman and Chief Operating Officer of Montgomery Ward, a retail sales company. Mr. Levy is a director of Whitehall Jewellers, Inc. Mr. Levy is 60 years old. Maureen d. Schimmenti, has been Vice President and Chief Financial Officer of the Company since June 2001. She joined the Company in May 2000 as its Corporate Controller. Prior thereto, she was the Executive Vice President and Corporate Controller of the Anne Klein Company from 1986 to 2000. Ms. Schimmenti also serves as Secretary of the Company. Ms. Schimmenti is 52 years old. Sheridan C. Biggs, a director of the Company since 1997, is Executive-in-Residence at the Graduate College of Union University. Prior to that, he was a senior partner of Price Waterhouse, the accounting and consulting firm; he was with that firm for thirty-one years until his retirement in 1994. During his career at Price Waterhouse, Mr. Biggs served as a Vice Chairman and member of the firm's management committee. Mr. Biggs is 69 years old. Harvey Horowitz, a director of the Company since 1994, served as Vice President, and General Counsel of the Company from October 1, 1996 to February 28, 1998. Mr. Horowitz is of counsel to the law firm of Mintz & Gold LLP, which provides legal services to the Company. For more than five years, prior to October 1, 1996, he was a partner of the law firm Squadron, Ellenoff, Plesent & Sheinfeld, LLP. Mr. Horowitz is 61 years old. Robert A. Kasenter, a director of the Company since 2001, is the Vice President of Human Resources for EZ Corp., a company in the specialty consumer finance industry. He is also Chief Executive Officer of Strategic Executive Actions, a consulting firm specializing in human resources crisis management issues. Prior to that, he was the Executive Vice President, Human Resources & Corporate Communication for Montgomery Ward. He was employed by Montgomery Ward from June, 1968 until May, 1999 in various field and corporate positions. Mr. Kasenter is 57 years old. Richard C. Rusthoven, a director of the Company since 2000, is a retired retail Executive with a 35-year career in the retail and apparel business. He was President and Chief Operating Officer of Stix, Baer and Fuller, a retail department store in St. Louis, Missouri. He was also Chairman and Chief Executive Officer of the Outlet Department Store and Denby Apparel chain store of Providence, Rhode Island. He was President and Chief Executive Officer of TG&Y stores, a discount chain store in Oklahoma City, Oklahoma. He was President of Gentlemen's Warehouse, a men's specialty chain in New Bedford, Massachusetts and most recently was Executive Vice President of Apparel for Montgomery Ward & Company, Inc., a former retail chain based in Chicago, Illinois. Mr. Rusthoven is 63 years old. 23 Robert W. Schwartz, a director of the company since July 1, 2003, is a Managing Director and founder of Schwartz Heslin Group, Inc. which specializes in corporate planning, finance and development. Mr. Schwartz was elected to the Board to fill the vacancy created by the resignation of Lynn Siemers. Mr. Schwartz also is a director of Docucon, Inc. a NASDAQ company. Mr. Schwartz is 58 years old. Section 16(a) Beneficial Ownership Reporting Compliance Section 16(a) of the Securities Exchange Act of 1934 requires the Company's directors and executive officers, and persons who own more than ten percent of a registered class of the Company's equity securities, to file with the Securities Exchange Commission initial reports of ownership and reports of changes in ownership of common stock and other equity securities of the Company. Officers, directors and greater than ten percent shareholders are required to furnish the Company with copies of all Section 16(a) forms they file. To the Company's knowledge, based solely on review of the copies of such reports furnished to the Company during the fiscal year ended December 31, 2003, all Section 16(a) reporting requirements applicable to the Company's officers, directors and greater than ten percent shareholders were in compliance. Audit Committee and Financial Reports The Board of Directors of the Company has established an Audit Committee from among its members consisting of Sheridan C. Biggs, Chair, Richard C. Rusthoven and Robert W. Schwartz. Each member of the Audit Committee meets the independence requirements of the Securities Exchange Act of 1934. Each member of the Audit Committee is financially literate, knowledgeable and qualified to review financial statements. The "audit committee financial expert" designated by the Company's Board of Directors is Sheridan C. Biggs, Chair of the Audit Committee and a former senior partner of Price Waterhouse, the accounting and consulting firm. Code of Ethics The Company has adopted a code of business conduct and ethics applicable to the Company's Directors, Officers (including the Company's principal executive officer and principal financial officer) and all other Company employees known as the Standards of Business Conduct. A copy of the Company's Standards of Business Conduct is being filed with the Securities and Exchange Commission as exhibit 32.3 to this Annual Report on Form 10-K. The Company undertakes to provide to any person without charge, upon request, a copy of the Company's Standards of Business Conduct. Requests for such copy should be made in writing to the Company at its principal office, which is set forth on the first page of this Form 10-K, attention Chief Financial Officer. ITEM 11. EXECUTIVE COMPENSATION The following table sets forth compensation paid in the fiscal years ended December 31, 2003, December 31, 2002, and December 31, 2001 to those persons who were, at December 31, 2003 (i) the chief executive officer and (ii) the chief financial officer. SUMMARY COMPENSATION TABLE
------------------------------- Long Term Annual Compensation Compensation Awards ---------------------------------------------------------------------------- Securities All Other Fiscal Restricted Underlying Compensation Name and Principal Position Year Salary Bonus Stock Awards Options/SARs (1) -------------------------------------------------------------------------------------------------------------------------- Daniel H. Levy 2003 $924,383 $191,250 $40,595 Chairman of the Board and 2002 $895,054 $350,000 $ 7,449 Chief Executive Officer 2001 $715,928 $200,000 $ 2,580 Maureen d. Schimmenti (2) 2003 $256,230 $ 22,591 $ 1,220 Vice President and Chief 2002 $243,210 $ 43,702 $ 1,192 Financial Officer 2001 $204,039 $ 10,000 $ 1,104
---------- (1) Represents insurance premiums paid by, or on behalf of, the Company during the covered fiscal year with respect to term life insurance for the benefit of the Named Executive Officer. (2) This individual became an Executive Officer in June 2001. 24 Employment Agreements Daniel H. Levy As of January 1, 2000, Mr. Levy entered into an employment agreement with the Company to serve as its Chairman of the Board and Chief Executive Officer. Mr. Levy's employment agreement provided for a base annual salary of $500,000, as well as a discretionary performance bonus based on the achievement of goals to be set by the Compensation Committee of the Company's Board of Directors, and certain insurance benefits which are grossed up for tax impact. The Company paid Mr. Levy a relocation bonus of $25,000 in 2000, with a gross-up for the tax effect of this bonus. In connection with the execution of the employment agreement, the Compensation Committee granted Mr. Levy 37,500 restricted shares of the Company's stock, which would vest on December 31, 2002. The employment agreement further provided for the issuance of another 37,500 restricted shares of the Company's stock if Mr. Levy was employed by the Company on June 30, 2002, which shares would also vest on December 31, 2002. Mr. Levy also was granted options to purchase 37,500 shares of the Company's Common Stock, at a purchase price of $2.75 a share. 25,000 of these stock options vested on June 30, 2000 and the balance of 12,500 vested on December 31, 2000. The employment agreement provided that the restricted shares and the options granted would have accelerated vesting in the event of a change in control of the Company. The agreement provided that in the event Mr. Levy's employment was terminated (except in certain limited circumstances) following a change in control of the Company, Mr. Levy would have the right to receive severance benefits equal to three times the sum of his then annual salary inclusive of any performance bonus. On February 26, 2001 Mr. Levy's employment agreement was amended to eliminate the restricted stock award referred to in his original agreement, and increased his annual base salary to $700,000 effective January 1, 2001. As of January 1, 2002, Mr. Levy entered into a new employment agreement with the Company to serve as its Chairman of the Board and Chief Executive Officer. The term of the employment agreement is for an ongoing and continuous term of three years, with an automatic extension and renewal each day subsequent to January 1, 2002, so that at all times after January 1, 2002, the remaining term shall be three years. Mr. Levy's employment agreement provides for a base annual salary of $850,000, a performance bonus based on participation in the bonus plan in effect for all other senior executives of the Company and certain insurance and other benefits which are grossed up for tax impact. In addition, commencing January 1, 2003 and on each January 1 thereafter Mr. Levy shall be eligible for an increase in his base annual salary equal to the greater of either the percentage increase in the Cost of Living Index (as defined) or at such higher rate as the Compensation Committee of the Board of Directors at its discretion designates. The agreement further states that if Mr. Levy's employment is terminated (except in certain limited circumstances) following a Change of Control, as defined, then Mr. Levy shall be entitled to receive severance benefits equal to three times the sum of his then base annual salary inclusive of performance bonus payable. Mr. Levy and his eligible dependents will be provided with medical insurance coverage at the Company's expense for a maximum of five years following termination. 25 2003 Stock Options Grants The Company's long-term performance ultimately determines compensation from stock options because stock option value is entirely dependent on the long-term growth of the Company's Common Stock price. The following table sets forth certain information concerning options granted to the Chief Executive Officer and the Named Executive Officers and Directors during Fiscal 2003, including information concerning the potential realizable value of such options. OPTION GRANTS IN LAST FISCAL YEAR
Potential Realizable Value at Assumed Annual Rates of Stock Price Appreciation for Individual Grants Option Term (1) ---------------------------------------------------------- ------------------------ Number of Securities % of Total Exercise Underlying # of Options Price (3) Expiration Name Option (#) Granted in 2003 ($/Sh) Date 5% ($) 10% ($) ---- ---------- --------------- ------ ---- ------ ------- Sheridan C. Biggs (2) 1,250 11.1% 0.7800 09/22/13 613 1,554 Harvey Horowitz (2) 1,250 11.1% 0.7800 09/22/13 613 1,554 Richard Rusthoven (2) 1,250 11.1% 0.7800 09/22/13 613 1,554 Robert A. Kasenter (2) 1,250 11.1% 0.7800 09/22/13 613 1,554 Harry A. Katz (2) (4) 1,250 11.1% 0.7800 10/01/04 48 98 Robert W. Schwartz (2) 3,750 33.3% 0.9700 07/01/13 2,288 5,797 Robert W. Schwartz (2) 1,250 11.1% 0.7800 09/22/13 613 1,554
---------- (1) The dollar amounts under these columns are the result of calculations at the 5% and 10% rates set by the SEC and, therefore, are not intended to forecast possible future appreciation, if any, of the Company's stock price. (2) Represents options granted as directors pursuant to the Company's 1994 Non-Employee Director Option Plan. (3) All options were granted at an exercise price equal to the market value of the Company's Common Stock on the date of grant. (4) Mr. Katz resigned as a member of the Company's Board of Directors effective October 1, 2003. AGGREGATE OPTION EXERCISES IN LAST FISCAL YEAR AND FISCAL YEAR ENDED OPTION VALUES(1)
Number of Securities Underlying Unexercised Value of Unexercised Shares Options at In-The-Money Options at Acquired December 31, 2003 December 31, 2003 (2) On Exercise Value ----------------- --------------------- (#) Realized Exercisable Unexercisable Exercisable Unexercisable --- -------- ----------- ------------- ----------- ------------- Daniel H. Levy (3) 43,750 -- -- -- Maureen d. Schimmenti (4) 16,000 19,000 34,400 40,850 Sheridan C. Biggs 30,000 -- 51,063 -- Harvey Horowitz 11,876 -- 8,063 -- Robert A. Kasenter 6,250 -- 13,438 -- Harry A. Katz 6,250 -- 5,375 -- Richard C. Rusthoven 7,500 -- 16,125 -- Robert W. Schwartz 5,000 -- 10,750 --
---------- (1) All options were granted at an exercise price equal to market value of the common stock on the date of grant. (2) Amount reflects the market value of the underlying shares of common stock at the closing sales price reported on the Over-the-Counter Market on December 31, 2003 ($2.15 per share). 26 (3) Represents 6,250 options granted to him under the Company's 1994 Non-Employee Director Option Plan and 37,500 options granted to him in connection with the execution of his employment agreement. (4) Represents 10,000 options granted pursuant to her employment under the Company's 1992 Stock Option Plan, and 25,000 options, which were granted in 2002. ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS The following table sets forth certain information, as of March 12, 2004, with respect to beneficial ownership of the Company's Common Stock by: (i) each of the Company's directors, (ii) each of the Company's Named Executive Officers, (iii) each person who is known by the Company beneficially to own more than 5% of the Company's Common Stock, and (iv) by all directors and executive officers who served as directors or executive officers as of March 12, 2004 as a group. For purposes of this table, beneficial ownership is defined in accordance with 13d-3 under the Securities Exchange Act of 1934, as amended and means generally the power to vote or dispose of the securities, regardless of any economic interest therein.
Name and Address Common Stock Percentage of Outstanding of Beneficial Owner Beneficially Owned Shares ------------------- ------------------ ------ Daniel H. Levy 849,888 (1) 19.46% Bruce Galloway 285,650 (2) 6.54% 1325 Avenue of the Americas New York, NY 10019 Roger Tullberg 8.71% 11 Knight Way 380,450 (3) Mansfield, MA 02048 Sheridan C. Biggs 65,250 (4) 1.49% Harvey Horowitz 37,500 (5) * Robert A. Kasenter 9,750 (6) * Richard C. Rusthoven 42,000 (7) * Robert W. Schwartz 5,000 (8) * Maureen d. Schimmenti 31,000 (9) * All directors and officers as a group (7 persons) 1,040,388 23.82%
---------- * Less than 1%. (1) Based on the Company's records and information filed in Schedule 13D/A filed with the Company on September 25, 2003, Daniel H. Levy is the beneficial owner of 849,888 shares of Common Stock, or 19.46% of the outstanding Common Stock, consisting of 806,138 shares of Common Stock owned directly by Mr. Levy, and 43,750 shares of Common Stock which Mr. Levy has a right to acquire pursuant to presently exercisable stock options which were issued to Mr. Levy pursuant to the Company's 1994 Non-Employee Director Option Plan. (2) Based on information contained in Schedule 13G/A filed with the Company on January 17, 2001. (3) Based on information contained in Schedule 13G/A filed with the Company on April 2, 2003. (4) Includes 35,250 shares owned by Sheridan C. Biggs and 30,000 shares underlying options, which were granted to Mr. Biggs pursuant to the Company's 1994 Non-Employee Director Option Plan. Such options are currently exercisable. 27 (5) Includes 25,625 shares owned by Harvey Horowitz and 11,875 shares underlying options, which were granted to Mr. Horowitz pursuant to the Company's 1994 Non-Employee Director Option Plan. Such options are currently exercisable. (6) Includes 3,500 shares owned by Robert A. Kasenter and 6,250 shares underlying options which were granted to Mr. Kasenter pursuant to the Company's 1994 Non-Employee Director Option Plan. Such options are currently exercisable. (7) Includes 34,500 shares owned by Richard C. Rusthoven and 7,500 shares underlying options, which were granted to Richard C. Rusthoven pursuant to the Company's 1994 Non-Employee Director Option Plan. Such options are currently exercisable. (8) Includes 5,000 shares underlying options, which were granted to Robert W. Schwartz pursuant to the Company's 1994 Non-Employee Director Option Plan Such options are currently exercisable. (9) Includes 15,000 shares owned by Maureen Schimmenti and 6,000 shares underlying options granted to Maureen d. Schimmenti pursuant to her employment under the Company's 1992 Stock Option Plan and 10,000 shares granted in March 2002. Not included are 4,000 shares underlying options issued pursuant to her employment, which are exercisable 2004 and 2005, and 15,000 underlying options which were granted in March 2002, which are exercisable in January 2005, 2006 and 2007. Item 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS Mr. Horowitz is of counsel to the law firm of Mintz & Gold LLP, which provides legal services to the Company. Mintz & Gold LLP received $287,624 in fees during 2003 for legal services rendered to the Company. On October 1, 2003, the Company purchased certain assets from Robyn Meredith, Inc. an unrelated company. The purchased assets were used by the Company to establish its Robyn Meredith Division. The principals of Robyn Meredith, Inc. became employees of the Company. Some of the principals of Robyn Meredith, Inc. were also principals in H&W partnership, a company which owned real estate facility in Burlington New Jersey. The Company rents space for approximately $9,000 per month in the H&W building in Burlington New Jersey under a lease which the Company believes was an arms length, commercially reasonable transaction. Item 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES Aggregate fees billed to the Company for the year ended December 31, 2003 by the accounting firms retained during the year, Deloitte & Touche LLP and Mahoney Cohen & Company, CPA, P.C., see Item 9, and aggregate fees billed for the year ended December 31, 2002 by the accounting firm Deloitte & Touche, LLP. Year Ended Year Ended December 31, 2003 December 31, 2002 Audit Fees (a) ........................... $208,000 $226,000 Audit Related Fees (b) (d) ............... $143,000 $ 46,000 Other Fees (c) (d) ....................... $ 6,000 $ 30,000 (a) Includes fees in connection with the audit of the Company's consolidated financial statements and reviews of the consolidated financial statements included in the Company's Quarterly Reports on Form 10-Q. (b) Includes fees for the audit of the Company's employee benefit plan, and acquisition due diligence services. (c) Other fees relate to tax advisory services. (d) The Audit Committee has considered whether the provision of these services is compatible with maintaining the principal accountant's independence and has concluded that such services are compatible. All fees paid were reviewed and approved by the Audit Committee. 28 ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K (a) The following documents are filed as part of this report: 1. Independent Auditors' Reports Consolidated Balance Sheets at December 31, 2003 and 2002 Consolidated Statements of Operations for the Years ended December 31, 2003, 2002 and 2001 Consolidated Statements of Stockholders' Equity for the Years ended December 31, 2003, 2002 and 2001 Consolidated Statements of Cash Flows for the Years ended December 31, 2003, 2002 and 2001 Notes to Consolidated Financial Statements 2. Financial Statement Schedule Valuation and Qualifying Accounts 3. The Exhibits, which are listed on the Exhibit Index attached hereto (b) Reports on Form 8-K On December 11, 2003, the Company filed a Current Report on Form 8-K-A to amend Item 7 "Financial Statements, Pro Forma Financial Information and Exhibits" to include the financial statements of the Robyn Meredith Sportswear business (the business acquired). 29 SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Company has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. Dated: March 30, 2004 DONNKENNY, INC. By: /s/ Daniel H. Levy ---------------------------------------- Daniel H. Levy, Chairman of the Board of Directors and Chief Executive Officer Pursuant to the requirements of the Securities Exchange Act of 1934. This report has been signed below by the following persons on behalf of the Company in the capacities and on the dates indicated. /s/ Daniel H. Levy ---------------------------------------- Dated: March 30, 2004 Daniel H. Levy, Chairman of the Board of Directors and Chief Executive Officer (Principal Executive Officer) /s/ Maureen d. Schimmenti ---------------------------------------- Dated: March 30, 2004 Maureen d. Schimmenti, Chief Financial Officer, Vice President-Finance and Secretary (Principal Financial and Accounting Officer) /s/ Sheridan C. Biggs ---------------------------------------- Dated: March 30, 2004 Sheridan C. Biggs, Director /s/ Harvey Horowitz ---------------------------------------- Dated: March 30, 2004 Harvey Horowitz, Director /s/ Robert A. Kasenter ---------------------------------------- Dated: March 30, 2004 Robert A. Kasenter, Director /s/ Richard C. Rusthoven ---------------------------------------- Dated: March 30, 2004 Richard C. Rusthoven, Director /s/ Robert W. Schwartz ---------------------------------------- Dated: March 30, 2004 Robert W. Schwartz, Director 30 EXHIBIT INDEX
Exhibit Description Sequentially No. of Exhibit Numbered Page --- ---------- ------------- 3.1 Amended and Restated Certificate of Incorporation of Donnkenny, Inc., dated May 15, 1992.(1) 3.3 Certificate of Ownership and Merger of DHC Holding Corporation into Donnkenny, Inc.(1) 3.4 Certificate of Amendment to the Amended and Restated Certificate of Incorporation of Donnkenny, Inc., dated May 18, 1993.(2) 3.5 By-laws of Donnkenny, Inc., dated May 18, 1993.(2) 4.1 Specimen form of Common Stock Certificate.(4) 10.12 Amended and Restated Donnkenny, Inc. 1992 Stock Option Plan.(9) 10.13 Form of Indemnification Agreement with Directors and Executive Officers.(2) 10.14 Donnkenny, Inc. Employees Savings 401(k) Plan.(1) 10.28 Asset Purchase Agreement between Oak Hill Sportswear Corporation and Donnkenny Apparel, Inc., dated as of May 23, 1995,5 together with Amendment No. 1 thereto, dated as of June 26, 1995.(7) 10.29 Stock Purchase Agreement among Donnkenny Apparel, Inc. and all of the Shareholders of Beldoch Industries Corporation, dated June 5, 1995.(6) 10.32 Donnkenny, Inc. 1994 Stock Option Plan for Non-Employee Directors.(8) 10.33 Donnkenny, Inc. 1996 Restricted Stock Plan.(9) 10.41 Employment Agreement between Harvey A. Appelle and the Company, dated April 14, 1997.(10) 10.42 Employment Agreement between Lynn Siemers and the Company, dated April 14, 1997.(10) 10.46 Employment Agreement between Beverly Eichel and the Company dated September 28, 1998.(11) 10.48 Commission's Order Instituting Public Administrative Proceedings, Make Findings and Instituting a Cease-and-Desist Order and Offer of Settlement of Donnkenny, Inc. released on February 2, 1999.(12) 10.49 Credit Agreement among Donnkenny Apparel, Inc., Beldoch Industries Corporation, the Guarantors Named therein, the Lenders Named therein and the CIT Group/Commercial Services, Inc., dated as of June 29, 1999.(13) 10.50 The Waiver and First Amendment to Credit Agreement, dated as of November 11, 1999 among the Company, the Lenders Named therein and the CIT Group/Commercial Services, Inc.(14)
31 10.51 The Second Amendment Agreement, dated as of December 23, 1999 among the Company, the Lenders Named therein and the CIT Group/Commercial Services, Inc.(15) 10.52 Employment agreement between Daniel H. Levy and the Company, dated January 1, 2000.(15) 10.53 The Third Amendment and Waiver Agreement, dated as of February 29, 2000 among the Company, the Lenders Named therein and the CIT Group/Commercial Services, Inc.(15) 10.54 The Fourth Amendment and Waiver Agreement, dated as of April 13, 2000 among the Company, the Lenders Named therein and the CIT Group/Commercial Services, Inc.(15) 10.55 Asset Purchase Agreement between Ann Travis, Inc. and Donnkenny Apparel, Inc. dated as of June 1, 2000.(16) 10.56 The Fifth Amendment and Waiver Agreement, dated as of July 6, 2000 among the Company, the Lenders Named therein and the CIT Group/Commercial Services, Inc.(16) 10.57 The First Amendment to the Employment Agreement between Daniel H. Levy and the Company dated May 17, 2000.(16) 10.58 Employment Agreement between Beverly Eichel and the Company dated June 6, 2000.(16) 10.59 The Sixth Amendment and Waiver Agreement, dated as of November 13, 2000, among the Company, the Lenders Named therein and the CIT Group/Commercial Services, Inc.(17) 10.60 Employment Agreement between Lynn Siemers and the Company dated October 11, 2000.(17) 10.61 Amendment to Rights Agreement dated January 4, 2001 between Donnkenny, Inc. and Mellon Investor Services.(18) 10.62 The Second Amendment to the Employment Agreement between Daniel H. Levy and the Company dated February 26, 2001.(19) 10.63 The Seventh Amendment and Waiver Agreement dated as of March 28, 2001, among the Company, the Lenders Named therein and the CIT Group/Commercial Services, Inc.(19) 10.64 The Eighth Amendment and Waiver agreement dated as of March 13, 2002, among the Company, the Lenders Named therein and the CIT Group/Commercial Services, Inc.(20) 10.65 Amended and restated employment agreement between Daniel H. Levy and the Company dated January 1, 2002(20) 10.66 Employment agreement between Harry A. Katz and the Company dated January 1, 2002(20) 10.67 Amended and restated employment agreement between Lynn Siemers and the Company dated January 1, 2002(20) 10.68 Certification Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.(21) 10.69 Certification Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.(21)
32 10.70 The Ninth Amendment dated as of March 27, 2003, among the Company Lenders named therein and the CIT Group/commercial Services Inc.(23) 10.71 The Tenth Amendment among the Company Lenders named therein and the CIT Group/Commercial Services Inc. dated August 11, 2003.(24) 99.1 Certification Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.(22) 99.2 Certification Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.(22) 99.3 Certification Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.(23) 99.4 Certification Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.(23) 99.5 Certification Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.(24) 99.6 Certification Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.(24) 31.1 Certification Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. (25),(26) 31.2 Certification Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.(25),(26) 32.1 Certification Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.(25),(26),(27) 32.2 Certification Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.(25),(26),(27) 32.3 Donnkenny Standards of Business Conduct.(27) 32.4 The Eleventh Amendment and Waiver among the Company Lenders named therein and the CIT Group/Commercial Services Inc. dated March 26, 2004.(27) 21 Subsidiaries of the Company.
---------- (1) Incorporated herein by reference to the Company's Registration Statement on Form S-1 (Registration No. 33-48243), as filed with the Commission on May 29, 1992 (the "Registration Statement"). (2) Incorporated herein by reference to Amendment No. 4 to the Registration Statement (Registration No. 33-48243), as filed with the Commission on May 24, 1993. (3) Incorporated herein by reference to Amendment No. 3 to the Registration Statement (Registration Statement No. 33-48243), as filed with the Commission on May 10, 1993. (4) Incorporated herein by reference to Amendment No. 5 to the Registration Statement (Registration No. 33-48243), as filed with the Commission on June 11, 1993. (5) Incorporated herein by reference to the Company's Annual Report on Form 10-K for the fiscal year ended December 3, 1994. (6) Incorporated herein by reference to the Company's Report on Form 8-K, as filed with the Commission on June 2, 1995. 33 (7) Incorporated herein by reference to the Company's Report on Form 8-K, as filed with the Commission on August 8, 1995. (8) Incorporated herein by reference to the Company's Annual Report on Form 10-K for the fiscal year ended December 2, 1995. (9) Incorporated herein by reference to the Company's 1996 Proxy Statement, filed March 22, 1996. (10) Incorporated herein by reference to the Company's Report on Form 10-Q, filed with the Commission on August 6, 1997. (11) Incorporated herein by reference to the Company's Report on Form 10-Q filed with the Commission on November 15, 1998. (12) Incorporated herein by reference to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1998. (13) Incorporated herein by reference to the Company's Report on Form 10-Q filed with the Commission on August 15, 1999. (14) Incorporated herein by reference to the Company's Report on Form 10-Q filed with the Commission on November 15, 1999. (15) Incorporated herein by reference to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1999. (16) Incorporated herein by reference to the Company's Report on Form 10-Q filed with the Commission on August 25, 2000. (17) Incorporated herein by reference to the Company's Report on Form 10-Q filed with the Commission on November 14, 2000. (18) Incorporated herein by reference to the Company's Report on Form 8-K filed with the Commission on January 10, 2001. (19) Incorporated herein by reference to the Company's Report on Form 10-K for the fiscal year ended December 31, 2000. (20) Incorporated herein by reference to the Company's Report on Form 10-Q filed with the Commission on May 15, 2002. (21) Incorporated herein by reference to the Company's Report on Form 10-Q filed with the Commission on August 13, 2002. (22) Incorporated herein by reference to the Company's Report on Form 10-Q filed with the Commission on November 12, 2002. (23) Incorporated herein by reference to the Company's Report on Form 10-K filed with the Commission on March 28, 2003. (24) Incorporated herein by reference to the Company's Report on Form 10-K filed with the Commission on May 14, 2003. (25) Incorporated herein by reference to the Company's Report on Form 10-Q filed with the Commission on August 13, 2003. (26) Incorporated herein by reference to the Company's Report on Form 10-Q filed with the Commission on November 13, 2003. (27) Filed herewith. 34 INDEPENDENT AUDITOR'S REPORT To the Board of Directors and Stockholders of Donnkenny, Inc.: We have audited the accompanying consolidated balance sheet of Donnkenny, Inc. and subsidiaries as of December 31, 2003, and the related consolidated statements of operations, stockholders' equity and cash flows for the year then ended. Our audit also included the financial statement schedule listed in the index at Item 15(a)(2). These financial statements and financial statement schedule are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements and financial statement schedule based on our audit. We conducted our audit in accordance with auditing standards generally accepted in the United States of America. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audit provides a reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of Donnkenny, Inc. and subsidiaries as of December 31, 2003, and the consolidated results of their operations and their cash flows for the year then ended, in conformity with accounting principles generally accepted in the United States of America. Also, in our opinion, the financial statement schedule, when considered in relation to the basic consolidated financial statements taken as a whole, presents fairly in all material respects the information set forth therein. /s/ Mahoney Cohen & Company, CPA, P.C. New York, New York March 15, 2004, except for Note 6, as to which the date is March 26, 2004 F - 1 INDEPENDENT AUDITORS' REPORT To the Board of Directors and Stockholders of Donnkenny, Inc. We have audited the accompanying consolidated balance sheet of Donnkenny, Inc. and subsidiaries (the "Company") as of December 31, 2002, and the related consolidated statements of operations, stockholders' equity, and cash flows for each of the fiscal years in the two-year period ended December 31, 2002. Our audits also included the financial statement schedule listed in the Index at Item 15(a)2. These financial statements and financial statement schedule are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements and financial statement schedule based on our audits. We conducted our audits in accordance with auditing standards generally accepted in the United States of America. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, such consolidated financial statements present fairly, in all material respects the consolidated financial position of the Company as of December 31, 2002, and the results of its operations and its cash flows for each of the fiscal years in the two-year period ended December 31, 2002 in conformity with accounting principles generally accepted in the United States of America. Also, in our opinion, such financial statement schedule, when considered in relation to the basic consolidated financial statements taken as a whole, presents fairly in all material respects the information set forth therein. As discussed in Notes 1 and 4 to the consolidated financial statements, effective January 1, 2002, the Company changed its method of accounting for goodwill and other intangible assets, to conform to Statement of Financial Accounting Standards No. 142. /s/ Deloitte & Touche LLP New York, New York March 17, 2003 (March 27, 2003 as to Note 6) F - 2 DONNKENNY, INC. AND SUBSIDIARIES Consolidated Balance Sheets (in thousands, except per share data)
December 31, December 31, 2003 2002 -------------------------- ASSETS CURRENT ASSETS: Cash .............................................. $ 64 $ 66 Accounts receivable, net of allowances for doubtful 1,287 908 accounts of $933 and $116, respectively Due from factor, net .............................. 20,730 19,726 Recoverable income taxes .......................... -- 203 Inventories, net .................................. 20,128 15,949 Prepaid expenses and other current assets ......... 1,256 615 Assets held for sale .............................. 270 402 -------- -------- Total current assets .............................. 43,735 37,869 PROPERTY, PLANT AND EQUIPMENT, NET ................... 3,631 4,515 OTHER ASSETS ......................................... 366 234 GOODWILL ............................................. 1,641 -- OTHER INTANGIBLE ASSETS .............................. 1,332 821 -------- -------- TOTAL ................................................ $ 50,705 $ 43,439 ======== ======== LIABILITIES AND STOCKHOLDERS' EQUITY CURRENT LIABILITIES: Current portion of long-term debt ................. $ 353 $ 253 Accounts payable .................................. 7,713 10,101 Accrued expenses and other current liabilities .... 1,908 2,209 -------- -------- Total current liabilities ..................... 9,974 12,563 -------- -------- LONG-TERM DEBT ....................................... 35,707 23,730 COMMITMENTS AND CONTINGENCIES STOCKHOLDERS' EQUITY: Preferred stock $.01 par value; authorized 500 shares, issued none ............................ -- -- Common stock, $.01 par value; authorized 20,000 shares, issued and outstanding 4,367 ........... 44 44 Additional paid-in capital ........................ 50,449 50,449 Accumulated deficit ............................... (45,469) (43,347) -------- -------- Total stockholders' equity ........................ 5,024 7,146 -------- -------- TOTAL ................................................ $ 50,705 $ 43,439 ======== ========
See accompanying notes to consolidated financial statements. F - 3 DONNKENNY, INC. AND SUBSIDIARIES Consolidated Statements of Operations (in thousands, except share and per share data)
Year Ended Year Ended Year Ended December 31, December 31, December 31, 2003 2002 2001 ------------ ------------ ------------ NET SALES ............................................... $ 92,351 $ 107,102 $ 152,180 COST OF SALES ........................................... 70,895 80,345 117,497 ----------- ----------- ----------- Gross Profit ..................................... 21,456 26,757 34,683 OPERATING EXPENSES: Selling, general and administrative expenses ........ 22,011 22,339 28,367 Amortization of intangibles ......................... 51 -- 1,489 Write-down of assets held for sale .................. 36 150 300 ----------- ----------- ----------- Operating (loss) income........................... (642) 4,268 4,527 OTHER EXPENSE: Interest expense .................................... 1,535 2,039 4,703 ----------- ----------- ----------- Income (loss) before income taxes ................ (2,177) 2,229 (176) INCOME TAX EXPENSE (BENEFIT) ............................ (55) 36 (220) ----------- ----------- ----------- Income (loss) before cumulative effect of ............... (2,122) 2,193 44 change in accounting principle Cumulative effect of change in accounting ........... -- 28,744 -- principle (no tax benefit recognized) ----------- ----------- ----------- NET INCOME (LOSS) ................................... $ (2,122) $ (26,551) $ 44 =========== =========== =========== Basic earnings per common share: Income (loss) before accounting change ........... $ (0.49) $ 0.50 $ 0.01 Cumulative effect of accounting change ........... -- (6.58) -- ----------- ----------- ----------- Net income (loss) ............................. $ (0.49) $ (6.08) $ 0.01 =========== =========== =========== Diluted earnings per common share: Income (loss) before accounting change ........... $ (0.49) $ 0.50 $ 0.01 Cumulative effect of accounting change ........... -- (6.58) -- ----------- ----------- ----------- Net income (loss) ............................. $ (0.49) $ (6.08) $ 0.01 =========== =========== =========== Shares used in the calculation of earnings per share: Basic ............................................ 4,367,417 4,367,417 4,367,417 =========== =========== =========== Diluted .......................................... 4,367,417 4,417,796 4,387,685 =========== =========== ===========
See accompanying notes to consolidated financial statements. F - 4 DONNKENNY, INC. AND SUBSIDIARIES Consolidated Statements of Stockholders' Equity (in thousands)
Additional Total Preferred Common Paid-in Accumulated Stockholders' Stock Stock Capital Deficit Equity ---------- ---------- ---------- ----------- ------------- BALANCE, DECEMBER 31, 2000 $ -- $ 44 $ 50,449 $ (16,840) $ 33,653 Net Income ........... -- -- -- 44 44 ---------- ---------- ---------- ---------- ---------- BALANCE, DECEMBER 31, 2001 -- 44 50,449 (16,796) 33,697 Net Loss ............. -- -- -- (26,551) (26,551) ---------- ---------- ---------- ---------- ---------- BALANCE, DECEMBER 31, 2002 -- 44 50,449 (43,347) 7,146 Net Loss ............. -- -- -- (2,122) (2,122) ---------- ---------- ---------- ---------- ---------- BALANCE, DECEMBER 31, 2003 $ -- $ 44 $ 50,449 $ (45,469) $ 5,024 ========== ========== ========== ========== ==========
See accompanying notes to consolidated financial statements. F - 5 DONNKENNY, INC. AND SUBSIDIARIES Consolidated Statements of Cash Flows (in thousands)
Year Ended Year Ended Year Ended December 31, December 31, December 31, 2003 2002 2001 ------------ ------------ ------------ CASH FLOWS FROM OPERATING ACTIVITIES: Net income (loss) ................................................. $ (2,122) $ (26,551) $ 44 Adjustments to reconcile net income (loss) to net cash provided by(used in)operating activities: Depreciation and amortization of plant, property and equipment ................................................... 1,313 1,499 1,140 Loss on disposal of assets held for sale ......................... 16 -- 3 Amortization of intangibles and other assets ..................... 51 -- 1,489 Write-down of assets held for sale ............................... 36 150 300 Cumulative effect of change in accounting principle .............. -- 28,744 -- Allowance for doubtful accounts .................................. 817 20 20 Changes in assets and liabilities, net of the effects of acquisitions and disposals: (Increase) decrease in accounts receivable ....................... (1,196) (15) 1,111 (Increase) decrease in due from factor ........................... (1,004) 4,586 4,612 (Increase) decrease in recoverable income taxes .................. 203 178 (226) (Increase) decrease in inventories ............................... (1,331) 1,824 1,957 (Increase) decrease in prepaid expenses and other current assets ................................................ (641) 605 (43) (Increase) decrease in other non-current assets ................. (132) 134 62 (Decrease) increase in accounts payable .......................... (2,388) 2,341 (3,991) (Decrease) increase in accrued expenses and other current liabilities ..................................... (300) (1,295) 1,194 --------- --------- --------- Net cash provided by (used in) operating activities............ (6,678) 12,220 7,672 --------- --------- --------- CASH FLOWS FROM INVESTING ACTIVITIES: Purchase of property, plant and equipment ......................... (429) (542) (1,395) Proceeds from sale of assets held for sale ........................ 80 143 67 Acquisition of business ........................................... (3,432) -- -- License acquisition cost .......................................... (512) -- -- --------- --------- --------- Net cash used in investing activities ......................... (4,293) (399) (1,328) --------- --------- --------- CASH FLOWS FROM FINANCING ACTIVITIES: Repayments of long-term debt ...................................... (310) (1,113) (1,523) Borrowings under revolving credit line ............................ 103,483 102,112 153,960 Repayments under revolving credit line ............................ (92,204) (112,793) (158,807) --------- --------- --------- Net cash provided by (used in) financing activities ........... 10,969 (11,794) (6,370) --------- --------- --------- NET INCREASE (DECREASE) IN CASH ....................................... (2) 27 (26) CASH, AT BEGINNING OF YEAR ............................................ 66 39 65 --------- --------- --------- CASH, AT END OF YEAR .................................................. $ 64 $ 66 $ 39 ========= ========= ========= Supplemental Disclosures of Cash Flow Information Income taxes paid ................................................. $ 4 $ 77 $ 78 ========= ========= ========= Interest paid ..................................................... $ 1,517 $ 2,048 $ 4,722 ========= ========= ========= Supplemental schedule of non-cash financing activites Issuance of note payable for the acquisition of the RMI business .................................................. $ 1,108 $ -- $ -- ========= ========= =========
See accompanying notes to consolidated financial statements. F - 6 DONNKENNY, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS YEARS ENDED DECEMBER 31, 2003, 2002 and 2001 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES Nature of Business - The Company designs, imports and markets a broad line of moderately priced women's sportswear and coats and operates in one business segment. The Company's products are primarily sold throughout the United States by retail chains, department stores and smaller specialty shops. Principles of Consolidation - The Consolidated Financial Statements include the accounts of Donnkenny, Inc. and its wholly-owned subsidiaries (collectively, the "Company"). All significant intercompany balances and transactions have been eliminated in consolidation. Use of Estimates - The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America, requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities (such as accounts receivable, due from factor, inventories and valuation allowances for income taxes), and disclosures of contingent assets and liabilities at the date of the financial statements, and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. 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. 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, an evaluation of the impact of economic conditions and other factors. The Company sells a substantial portion of its trade receivables to a commercial factor, without recourse, up to maximum credit limits established by the factor for each individual account. Receivables sold in excess of these limitations are subject to recourse in the event of non-payment by the customer. An allowance for discounts is based on those discounts relating to open invoices where trade discounts have been extended to customers. Costs associated with potential returns of products as well as allowable customer markdowns and operational charge backs, net of expected recoveries, are included as a reduction to net sales and are part of the provision for allowances. These provisions result from seasonal negotiations as well as historic deduction trends, net expected recoveries and the evaluation of current market conditions. The Company's historical estimates of these costs have not differed materially from actual results. Inventories - Inventories are stated at the lower of cost or market using the first-in, first-out method (FIFO) (see Note 2 to the Consolidated Financial Statements). Property, Plant and Equipment - Property, Plant and Equipment are recorded at cost. Depreciation and amortization are computed on a straight-line basis over the estimated useful lives of the assets or, where applicable, the term of the lease, if shorter (see Note 3 to the Consolidated Financial Statements). Estimated useful lives are as follows: Buildings and improvements ..................... 9 to 38 years Machinery and equipment including computer equipment and software ......................... 3 to 10 years Furniture and fixtures ......................... 7 to 10 years Leasehold improvements ......................... 7 to 10 years (or lease term if shorter) F - 7 Other Assets - Other Assets at December 31, 2003 and 2002 of $0.4 million and $0.2 million, respectively, represent net deferred financing costs, which are amortized over the term of the related debt agreement. Goodwill and Other Intangible Assets - At December 31, 2003, Goodwill and Other Intangible Assets were comprised of goodwill related to acquisitions, trademarks and licenses. At December 31, 2002, other Intangible Assets were related to licenses. In 2002, the Company adopted Statement of Financial Accounting Standards ("SFAS") No. 142 "Goodwill and Other Intangible Assets", which changed the accounting for goodwill and other intangible assets to an impairment only approach. The Company periodically reviews its intangible assets to insure compliance with SFAS No. 142. (See Note 4 to the Consolidated Financial Statements). The Company ceased the amortization of goodwill and other intangible assets with indefinite lives as of January 1, 2002. Prior to the adoption of SFAS 142, goodwill and other intangible assets were amortized on a straight-line basis over the expected periods to be benefitted. Assessment of Asset Impairment - The Company periodically assesses the recoverability of the carrying value of long-lived assets, including identifiable intangible assets, whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. The assessment of recoverability of the carrying amount of an asset is based on estimated undiscounted future cash flows from the use of the asset and eventual disposition. If the estimated undiscounted future cash flows are less than the carrying value, an impairment loss is charged to operations based on the difference between the carrying amount and the fair value of the asset. Indefinite lived intangible assets are subject to an annual impairment test, which the Company performs in the fourth quarter of each fiscal year. Shipping and Handling Costs - Shipping and handling costs are recorded as a component of selling, general and administrative expenses in the consolidated statements of operations. Shipping and handling costs approximated $3.4 million, $3.3 million, and $4.7 million in years ended December 31, 2003, 2002 and 2001, respectively. 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 (loss) income, as all options granted under those plans had an exercise price equal to the fair market value of the Common Stock on the date of grant. The following table details the effect on net (loss) income and earnings per share if the Company had applied the fair value recognition provisions of SFAS No. 123, Accounting for Stock-Based Compensation, as amended by SFAS No. 148, to stock-based employee compensation using the Black-Scholes method of calculation. 2003 2002 2001 --------- --------- --------- (in thousands, except per share amounts) Net (loss) income, as reported $ (2,122) $ (26,551) $ 44 Deduct: Total stock-based employee compensation expense determined under fair value based method, net of tax effects 35 195 578 --------- --------- --------- Pro-forma net loss $ (2,157) $ (26,746) $ (534) ========= ========= ========= Earnings (loss) per share: Basic- as reported $ (0.49) $ (6.08) $ 0.01 ========= ========= ========= Basic - pro-forma $ (0.49) $ (6.12) $ (0.12) ========= ========= ========= Diluted - as reported $ (0.49) $ (6.08) $ 0.01 ========= ========= ========= Diluted - Pro-forma $ (0.49) $ (6.13) $ (0.12) ========= ========= ========= F - 8 The weighted-average Black-Scholes values of the options granted during 2003, 2002 and 2001, which were used to calculate the pro-forma compensation expense were $0.84, $0.83 and $0.54, respectively. The following weighted-average assumptions were used in the Black-Scholes option-pricing model for grants in 2003, 2002 and 2001 respectively: dividend yield of 0% for all periods, volatility of 249%, 253%, and 246%; risk-free interest rate of 3.73%, 2.40% and 4.05%; and expected lives of 7, 5 and 5 years. Advertising Expense - Advertising costs are expensed when incurred and are included in selling, general and administrative expenses. Advertising expenses of $1.2 million, $1.1 million and $1.0 million were recorded in the Company's Consolidated Statements of Operations for the years ended December 31, 2003, 2002 and 2001, respectively. Income Taxes - The Company accounts for income taxes in accordance with an asset and liability method. Deferred tax assets and liabilities are recognized for future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases and operating loss and tax credit carryforwards. Deferred tax assets are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect of a change in tax rates on deferred tax assets and liabilities is recognized in income in the period that includes the enactment date. The deferred tax assets are reduced by a valuation allowance if it is more likely than not that some portion or all of the deferred tax assets will not be realized (see Note 7 to the Consolidated Financial Statements). Fair Value of Financial Instruments - The carrying amounts of significant financial instruments, which includes accounts receivable, accounts payable and accrued expenses, approximated fair value as of December 31, 2003 and December 31, 2002 due to their short-term maturities. Long-term debt approximates fair value due to its variable interest rate. Recent Accounting Pronouncements - In January 2003, the FASB issued FASB Interpretation No. 46, "Consolidation of Variable Interest Entities" ("FIN 46"). FIN 46 requires that a variable interest entity be consolidated by a company if that company is subject to a majority of the risk of loss from the variable interest entity's activities or entitled to receive a majority of the entity's residual returns or both. The consolidation requirements apply to the first fiscal year or interim period ending after March 31, 2004. The Company believes the adoption of FIN 46 will not affect its consolidated financial position or results of operations. In April 2003, the FASB issued SFAS No. 149, "Amendment of Statement No.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. In May 2003, the FASB issued SFAS No.150, "Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity," effective for financial instruments entered into or modified after May 31, 2003, and otherwise is effective at the beginning of the first interim period beginning after June 15, 2003. This statement establishes standards for how an issuer classifies and measures certain financial instruments with characteristics of both liabilities and equity. It requires that an issuer classify a freestanding financial instrument that is within its scope as a liability (or an asset in some circumstances). The Adoption of SFAS No.150 will not have an impact on the Company's reported consolidated financial position, results of operations or cash flows. Reclassifications - Certain reclassifications have been made in 2002 and 2001 Consolidated Financial Statements to conform to the 2003 presentation. F - 9 2. INVENTORIES Inventories consisted of the following at December 31, 2003 and,2002: (in thousands) -------------- 2003 2002 ---- ---- Raw materials ....................... $ 3,317 $ 701 Work in process ..................... 2,189 143 Finished goods ...................... 15,873 16,411 Reserves ............................ (1,251) (1,306) -------- -------- $ 20,128 $ 15,949 ======== ======== 3. PROPERTY, PLANT AND EQUIPMENT Property, plant and equipment consisted of the following at December 31, 2003 and 2002: (in thousands) -------------- 2003 2002 ---- ---- Land and land improvements ............................... $ 213 $ 131 Buildings and leasehold improvements ..................... 3,773 4,530 Machinery and equipment including computer equipment and software ................................................. 5,992 6,044 Furniture and fixtures ................................... 1,193 1,224 ------- ------- 11,171 11,929 Less accumulated depreciation and amortization .......... 7,540 7,414 ------- ------- $ 3,631 $ 4,515 ======= ======= Assets Held for Sale During 2000 the Company completed the closing of all of its domestic manufacturing plants and put these facilities up for sale. In the years ended December 31,2003, 2002, and 2001, the Company recorded charges of $0.04 million, $0.2 million, and $0.3 million, respectively, related to the write-down of assets held for sale. As of December 31, 2002, assets held for sale included a total of two facilities. One of these facilities was sold on August 27, 2003. At December 31, 2003, the assets held for sale are recorded at their estimated net realizable value. F - 10 4. GOODWILL AND OTHER INTANGIBLE ASSETS Goodwill and Other Intangible Assets consisted of the following at December 31, 2003 and 2002: (In Thousands) 2003 2002 ---- ---- Goodwill $ 1,641 $ -- Covenant not to Compete 50 -- License agreements 1,333 821 Accumulated amortization (51) -- ------- ------- 1,282 -- ------- ------- $ 2,973 $ 821 ======= ======= 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 14 to the Consolidated Financial Statements). The covenant not to compete will be amortized over the contract life of four years. Intangible assets of $0.8 million are attributable to those intangible assets acquired related to the Pierre Cardin license from the Beldoch acquisition, and is classified as an intangible asset with an indefinite life on the Company's December 31, 2003 and 2002 Consolidated Balance Sheets because the Company held the license in perpetuity. On February 12, 2004, the Company signed a new Pierre Cardin license to provide for a term of three years in exchange for reduced future minimum payments. Beginning in 2004, this intangible asset will be amortized over three years. Intangible assets of $0.5 million are attributable to costs in connection with the acquisition of the Company's licensing agreement to manufacture and sell coats under the Bill Blass (R), Bill Blass Signature (R), and Blassport (R) Labels. This intangible asset is being amortized over the expected lives of the licenses through 2009. Over the next five years, the amortization expense relating to intangible assets will be $0.4 million, $0.4 million, $0.4 million, $0.09 million and $0.08 million, respectively. 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. F - 11 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 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. Pro-forma results of operations for the year ended December 31, 2001 had the Company applied the non-amortization provisions of SFAS No. 142 in that period follows (in thousands, except per share amounts): For the Year Ended December 31, (in thousands) -------------- 2001 ---- Net income $ 44 Add: Amortization of goodwill and intangibles 1,489 --------- Adjusted net income $ 1,533 ========= Basic and diluted net income per common share: Net income $ 0.01 Add: Amortization of goodwill and intangibles 0.34 --------- Adjusted net income $ 0.35 ========= F - 12 5. ACCOUNTS PAYABLE, ACCRUED EXPENSES AND OTHER CURRENT LIABILITIES Accrued expenses and other current liabilities consisted of the following at December 31, 2003 and 2002: (in thousands) -------------- 2003 2002 ---- ---- Accrued salaries, benefits and bonuses ..... $ 492 $ 973 Other accrued expenses ..................... 1,416 1,236 ------ ------ Total ...................................... $1,908 $2,209 ====== ====== At December 31,2003, the Company included $0.7 million of outstanding checks in the Accounts Payable Balance. 6. LONG-TERM DEBT Long-term debt consisted of the following at December 31, 2003 and 2002: (in thousands) -------------- 2003 2002 ---- ---- Revolving Credit Borrowings .......... $35,009 $23,730 Note Payable ......................... 1,051 -- Senior Term Loans .................... -- 253 ------- ------- Total ................................ 36,060 $23,983 Less current maturities .............. 353 253 ------- ------- $35,707 $23,730 ======= ======= Annual maturities of long-term debt are as follows: 2004..................... $ 353 2005..................... 372 2006..................... 326 2007..................... 35,009 ------- $36,060 ======= 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. F - 13 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. In July 2000, the Credit Agreement was amended to provide for an additional $1.3 million term loan to finance an acquisition. This term loan bore interest at the prime rate plus 2% and was paid from January 1, 2001 to March 2003, at which time this term loan was paid. On March 28, 2001, the Company entered into an Amendment and Waiver Agreement to extend the Final Maturity Date of the original agreement to June 30, 2004, to waive existing events of default under the Credit Agreement as of December 31, 2000 with respect to the Company's non-compliance with covenants related to minimum interest coverage, EBITDA and Tangible Net Worth, and to amend certain other provisions of the Credit Agreement including covenants and the level of allowable overadvances to support the Company's 2001 business plan. Pursuant to this amendment, the interest rate on borrowings was increased to 2.0% above the prime rate effective January 1, 2001. A fee of $200,000 was paid in connection with the Amendment and Waiver. Effective January 1, 2002, the Company established covenants and the level of allowable overadvances with the lender to support its 2002 business plan. This Amendment and Waiver Agreement also amended the interest rate on the revolving credit borrowings to the prime rate plus one and three quarters percent and provide for an additional interest rate reduction effective July 1, 2002 if certain objectives were achieved (6.50% at January 1, 2002). No fee was paid in connection with the Amendment and Waiver. The Company had achieved the objectives and received an additional rate reduction effective July 1, 2002. The interest rate on the revolving credit borrowings was now prime plus one and one-half percent (5.75% at December 31, 2002). Effective January 1, 2003, the Company established covenants and the level of allowable overadvances with the Lender, through an Amendment to the Credit Agreement dated March 27, 2003, to support its 2003 business plan. The Amendment also amended the interest rate on the revolving credit borrowings to the prime rate plus one and one- quarter percent. No fee was paid in connection with the Amendment. Effective June 30, 2003, the Company through an Amendment and Waiver Agreement dated August 11, 2003, extended the Credit Agreement to June 30, 2007. This Amendment provides the Company with a $65 million facility; the sublimits have remained the same. The interest rate on the revolving credit borrowings is the current prime rate plus one and one-quarter percent (5.25% at December 31, 2003). Fees paid in connection with this Amendment were $243,750. All other terms and conditions of the Revolving Credit Agreement remain unchanged. As of December 31, 2003, the Company was not in compliance with the quarterly financial covenants. The Lender has waived this non-compliance. The Company paid a fee of $100,000 in connection with this waiver. Effective January 1, 2004, the Company established covenants and the level of allowable overadvances with the lender, through an Amendment to the Credit Agreement dated March 26, 2004, to support its 2004 business plan. No fee was paid in connection with the Amendment. 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. F - 14 In connection with the acquisition of Robyn Meredith (see Note 14 to the Consolidated Financial Statements), a note payable of $1.1 million was incurred. This note is payable in monthly installments of $33,333 including imputed interest at an interest rate of 5.25%. The final payment will be due October 2006. At December 31, 2003 and 2002, the Company was contingently liable for outstanding letters of credit issued amounting to $6.6 million and $ 11.8 million, respectively. F - 15 7. INCOME TAXES Income tax expense (benefit) for the years ended December 31, 2003, 2002 and 2001 is comprised of the following: (in thousands) -------------- 2003 2002 2001 ---- ---- ---- Current: Federal ................. $ -- $ -- $(277) State and local ......... (55) 36 57 Deferred .................... -- -- -- ----- ----- ----- $ (55) $ 36 $(220) ===== ===== ===== The Company received net refunds of $0.06 million in 2003 based upon the completion of audits of amended prior year returns for the State of Virginia. In 2001, the IRS and the Joint Committee on Taxation completed the audit of amended prior year tax returns. As a result, the Company received net refunds of $0.2 million in 2002. A reconciliation of the statutory Federal tax rate and the effective rate is as follows: 2003 2002 2001 ---- ---- ---- Federal statutory tax rate ............... (34)% (34)% (34)% State and local taxes, net of federal income tax benefit ................... 2 (1) 28 Federal tax benefit of amended returns and other ............................ -- -- (157) Nondeductible items ...................... (3) 28 207 Increase (decrease) of valuation allowance 32 7 (169) ---- ---- ---- (3)% 0% (125)% ==== ==== ==== The tax effects of temporary differences that give rise to significant portions of the deferred tax assets and liabilities are presented below: (in thousands) -------------- December 31, December 31, 2003 2002 ---- ---- Deferred tax assets: Accounts receivable allowances ..... $ 360 $ 45 Inventory valuation ................ 787 685 Intangibles ........................ 316 393 Accrued expenses ................... 54 449 State operating loss carryforwards . 1,426 1,350 Federal operating loss carryforwards 6,814 6,208 Other .............................. 97 97 ------- ------- Deferred tax assets ............ 9,854 9,227 ------- ------- Deferred tax liabilities: Property, plant and equipment ...... (264) (980) ------- ------- Deferred tax liabilities ....... (264) (980) ------- ------- Net deferred tax asset ................. 9,590 8,247 Less valuation allowance ............... (9,590) (8,247) ------- ------- Net deferred taxes ..................... $ -- $ -- ======= ======= F - 16 As of December 31, 2003 and 2002, the Company recorded a valuation allowance against the net deferred tax assets due to uncertainty of their realization. As of December 31, 2003, the following Federal and State net operating loss carryforwards were available: Net Operating Losses -------------------- (in thousands) --------------------------- Expiration Dates Federal State --------- ---------- 2011...................................... $ -- $ 6,024 2012...................................... -- 5,281 2013...................................... -- 4,390 2014...................................... -- 2,323 2015...................................... -- 12,467 2016-2017................................. -- -- 2018...................................... 2,442 511 2019...................................... 2,616 -- 2020...................................... 13,315 -- 2021-2022................................. -- -- 2023...................................... 1,650 -- 8. EMPLOYEE BENEFIT PLAN The Company sponsors an Employees' Savings 401(k) Plan (the "Plan") covering substantially all of its employees. Contributions to the Plan are made by the Company at the discretion of the Board of Directors. The Company matched the employee contributions for the years ended 2003, 2002 and 2001 in cash in the amounts of $105,000, $126,000 and $44,000, respectively. 9. EARNINGS PER SHARE Basic earnings per share ("EPS") is computed by dividing net income or loss attributable to common stockholders by the weighted average of common shares outstanding for the period. Diluted EPS reflects the potential dilution that could occur if securities or other contracts to issue common stock (warrants to purchase common stock and common stock options using the treasury stock method) were exercised or converted into common stock. Potentially issuable common shares in the diluted EPS computation are excluded in net loss periods, as their effect would be antidilutive. For the year ended December 31, 2003, the effect of options to purchase 90,000 shares of the Company's common stock was not considered for the diluted earnings per share calculation as their effect would be antidilutive. For the years ended December 31, 2002 and 2001 shares under stock plans of 50,379 and 20,268 were considered for the diluted earnings per share calculations. 10. STOCK BASED COMPENSATION a. Stock Options The Company has a stock award and incentive program that permits the issuance of up to 500,000 options to employees on terms as determined by the Board of Directors. In addition, the Company has an award program that permits option grants to Directors up to a maximum of 75,000 shares. Under the terms of the plans, options granted may be either non-qualified or incentive stock options and the exercise price, determined by the Compensation committee, may not be less than the fair market value of the Company's Common Stock on the date of the grant. F - 17 Information regarding the Company's stock option plans is summarized below.
2003 2002 2001 ------------------------ ----------------------- ----------------------- Weighted- Weighted- Weighted- Average Average Average Exercise Exercise Exercise Options Price Options Price Options Price ------- ----- ------- ----- ------- ----- Outstanding at beginning of the year............................ 367,427 $5.64 294,253 $8.75 404,130 $ 9.85 Granted......................... 11,250 $0.84 136,250 0.84 53,750 0.54 Cancelled....................... (218,651) $5.74 (63,076) $9.81 (163,627) 8.44 -------- ----- -------- ----- -------- ------ Outstanding at end of year...... 160,026 $5.16 367,427 $5.64 294,253 $ 8.75 ======== ======== ======== Exercisable at end of year ..... 131,026 $6.12 198,177 $9.55 212,603 $10.77 ======== ======== ======== Available for grant at year end............................. 315,149 107,748 180,922 ======== ======== ========
The options outstanding at December 31, 2003 range in price as follows:
OPTIONS OUTSTANDING OPTIONS EXERCISABLE --------------------------------------------------------------------------------------------------- Weighted-Average Range of Exercise Outstanding as Remaining Contractual Weighted-Average Exercisable as of Weighted-Average Prices of 12/31/2003 Life Exercise Price 12/31/2003 Exercise Price ------ ------------- ---- -------------- ---------- -------------- 0.00 - 7.23 135,000 6.9 $ 1.39 106,000 $ 1.54 7.23 - 14.45 4,375 4.5 $ 11.29 4,375 $ 11.29 14.45 - 28.90 13,125 3.5 $ 16.61 13,125 $ 16.61 28.90 - 43.35 1,750 1.3 $ 33.25 1,750 $ 33.25 43.35 - 65.25 3,751 0.3 $ 44.25 3,751 $ 44.25 65.25 - 72.25 2,025 2.3 $ 72.25 2,025 $ 72.25
The Company accounts for its stock-based employee compensation plans under the recognition and measurement principles of 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 fair market value of the Common Stock on the date of grant. b. Warrants On January 14, 1997, the Company issued warrants to purchase 18,750 shares of Common Stock at $20.00 per share to the principal of a company to rescind an acquisition transaction. The warrants are currently exercisable and will expire July 23, 2004. F - 18 11. COMMITMENT 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. This action is scheduled to go to trial in May 2004. 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's License Agreements for the manufacture of garments under licensed trademarks provide for payments of annual minimum royalty amounts. The Company estimates that the minimum guaranteed royalties for these Licenses are approximately $7.6 million as of December 31, 2003. These minimum payments are payable over the terms of the Agreements, including renewal periods, through 2009. There are no maximums to the royalty amounts. d. The Company has agreed to purchase $2.7 million of raw materials in connection with the manufacturing of coats. As of December 31, 2003, approximately $1.6 million has been purchased against this commitment. The balance will be purchased and paid in full by June 30, 2004. e. Rental expense for operating leases for the years ended December 31, 2003, 2002 and 2001 approximated $2.9 million, $3.0 million, and $3.2 million respectively. Minimum future rental payments as of December 31, 2003 for operating leases with initial non-cancelable lease terms in excess of one year are as follows. Year Ending December 31, Amount ------------------------ (in thousands) -------------- 2004 .................................................. 2,767 2005 .................................................. 2,626 2006 .................................................. 1,746 2007 .................................................. 1,366 2008 .................................................. 1,025 ------ 9,530 ====== f. The Company has an ongoing employment agreement with its Chairman of the Board and Chief Executive Officer for a continuous three year term with automatic extensions. The agreement provides for a minimum base annual salary of $850,000, a performance bonus based upon the bonus plan in effect for all other senior executives of the Company and certain insurance and other benefits. 12. BUSINESS CONCENTRATIONS Substantially all of the Company's sales are made to customers in the United States. Sales to one chain store retailer accounted for approximately 28%, 18% and 18% of the Company's sales in 2003, 2002 and 2001, respectively. Sales to one wholesale club were 14%, 27% and 24% in 2003, 2002 and 2001 respectively. Sales to one catalog customer accounted for 5%, 8% and 9% of the Company's sales in 2003, 2002 and 2001 respectively. The Company records an allowance for doubtful accounts for those customers where it has exposure on the receivable. In 2003 the Company recorded a provision for bad debts not sold to its commercial factor of $0.9 million due to the fact that the ultimate collection of the balance of a certain receivable is in dispute. The Company intends to vigorously pursue the collection of this receivable. A substantial portion of the trade receivables are sold to a commercial factor, without recourse, and the risk of loss is minimal. F - 19 13. SHAREHOLDERS RIGHTS PLAN On April 2, 1998, the Company's Board of Directors authorized a stockholder rights plan. Under the terms of the Plan, stockholders of record at the close of business on April 13, 1998 received a dividend distribution of one preferred stock purchase right for each outstanding share of the Company's Common Stock held. The rights will become exercisable only in the event, with certain exceptions that, an acquiring party accumulates fifteen percent or more of the Company's voting stock, or if a party announces an offer to acquire fifteen percent or more. The rights will expire on April 1, 2008. Each right will entitle stockholders to buy one one-hundredth of a share of a new series of preferred stock at an exercisable price of $14.00. In addition, upon the occurrence of certain events, holders of the rights will be entitled to purchase either the Company's stock or shares in an "acquiring entity" at half of market value. Further, at any time after a person or group acquires fifteen percent or more (but less than fifty percent) of the Company's outstanding voting stock, the Board of Directors may, at its option, exchange part or all of the rights (other than rights held by the acquiring person or group, which will become void) for shares of the Company's Common Stock on a one-for-one basis. The Company will be entitled to redeem the rights at $0.01 per right at any time until the tenth day following the acquisition of a fifteen percent position in its voting stock. As of January 4, 2001, the Company amended its Rights Agreement to change the definition of "Exempt Person." The definition of an Exempt Person now includes a group consisting of persons who were at the time an executive and director of the Company and their affiliates, but only to the extent that such group does not become a beneficial owner of an additional 1% or more of the voting stock of the Company. 14. ROBYN MEREDITH ACQUISITION On October 1, 2003, the Company acquired certain assets of Robyn Meredith Inc. ("RMI") in connection with its strategy to expand the Company's avenues of distribution. 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 was $4.6 million which was determined by valuing the inventory and through negotiations between the parties as to the balance of the purchase price. The Company's acquisition of RMI was accounted for by the purchase method of accounting, pursuant to which the acquisition consideration is allocated among the tangible and intangible assets in accordance with their estimated fair values on the date of acquisition. The results of operations of RMI since October 1, 2003, are included in the Company's Consolidated Statement of Operations. The total amount of goodwill is expected to be deductible for income tax purposes. The acquisition consideration and allocation of that consideration, which does not include any future purchase price adjustments based on subsequent performance thresholds, are as follows (in thousands): Acquisition consideration: Cash consideration paid $3,168 Issuance of Promissory Note, discounted 1,108 Transaction related fees 283 ------ Total acquisition consideration $4,559 ====== Allocation of acquisition consideration: Inventory $2,868 Goodwill related to the acquisition 1,641 Other intangible assets 50 ------ $4,559 ====== F - 20 Pro Forma Financial Information: The pro forma financial information (unaudited) presented below gives effect to the Robyn Meredith acquisition as if it had occurred as of the beginning of the Company's fiscal year 2002. The information presented below is for illustrative purposes only and is not intended to be indicative of results that would have been achieved or results which may be achieved in the future.
Pro Forma Financial Information (in thousands, except share and per share data) (unaudited) Year Ended December 31, 2003 December 31, 2002 ----------------- ----------------- Net sales $114,600 $134,223 (Loss) income before cumulative effect of (3,010) 1,407 change in accounting principle Cumulative effect of change in accounting -- (28,744) principle -------- -------- Net loss ($3,010) ($27,337) ======== ======== Net (loss) income per share Basic (loss) income per common share: (Loss) income before accounting change ($0.69) $0.32 Cumulative effect of accounting change -- ($6.58) -------- -------- Net loss ($0.69) ($6.26) ======== ======== Diluted (loss) income per common share: Income (loss) before accounting change ($0.69) $0.32 Cumulative effect of accounting change -- (6.51) -------- -------- Net loss ($0.69) ($6.19) ======== ========
F - 21 15. UNAUDITED QUARTERLY RESULTS OF OPERATIONS Unaudited quarterly financial information for the years ended December 31, 2003 and 2002 is set forth in the table below:
(in thousands, except per share amounts) ---------------------------------------- First Second Third Fourth Quarter Quarter Quarter Quarter ---------- -------- -------- -------- 2003 Net Sales $ 18,954 $ 17,846 $ 23,436 $ 32,115 Gross Profit $ 5,705 $ 3,898 $ 5,160 $ 6,693 Net Income (loss) $ 55 $ (1,556) $ (386) $ (235) Basic earnings (loss) per share $ 0.01 $ (0.36) $ (0.09) $ (0.05) ========== ======== ======== ======== Diluted earnings (loss) per share $ 0.01 $ (0.36) $ (0.09) $ (0.05) ========== ======== ======== ======== 2002 Net Sales $ 24,438 $ 22,358 $ 30,688 $ 29,618 Gross Profit $ 6,417 $ 5,188 $ 7,933 $ 7,219 Income (loss) before cumulative effect of change in accounting principle $ 359 $ (347) $ 1,574 $ 607 Cumulative effect of change in accounting principle 28,744 -- -- -- ---------- -------- -------- -------- Net (loss) income $ (28,385) $ (347) $ 1,574 $ 607 ========== ======== ======== ======== Basic Income (loss) per Share Income (loss) before accounting change $ 0.08 $ (0.08) $ 0.36 $ 0.14 Cumulative effect of accounting change (6.58) -- -- -- ---------- -------- -------- -------- Basic (loss) earnings per share $ (6.50) $ (0.08) $ 0.36 $ 0.14 ========== ======== ======== ======== Diluted Income (loss) per Share Income (loss) before accounting change $ 0.08 $ (0.08) $ 0.36 $ 0.14 Cumulative effect of accounting change (6.58) -- -- -- ---------- -------- -------- -------- Diluted (loss) earnings per share $ (6.50) $ (0.08) $ 0.36 $ 0.14 ========== ======== ======== ========
The sum of the quarterly net earnings per share amounts may not equal the full-year amount since the computations of the weighted average number of common-equivalent shares outstanding for each quarter and the full year are made independently. F - 22 DONNKENNY, INC. INDEX TO FINANCIAL STATEMENT SCHEDULE Schedule II Valuation and Qualifying Accounts .......................... SCHEDULE II DONNKENNY, INC. Valuation and Qualifying Accounts For the Years ended December 31, 2003, 2002 and 2001
Balance at Charged to Beginning of Costs and Balance at End Period Expenses Deductions of Period ------------------ ------------------ ------------------ ----------------- Year ended December 31, 2003 Reserve for bad debts $116,000 817,000 0 $933,000 Reserve for discounts 0 (719,000) 719,000 0 ------------------ ----------------- Subtotal for accounts receivable $116,000 $933,000 ================== ================= Reserve for inventory markdowns $1,306,000 2,601,000 (2,656,000) $1,251,000 ================== ================= Year ended December 31, 2002 Reserve for bad debts $104,000 20,000 (8,000) $116,000 Reserve for discounts 12,000 (1,428,000) 1,416,000 0 ------------------ ----------------- Subtotal for accounts receivable $116,000 $116,000 ================== ================= Reserve for inventory markdowns $1,107,000 3,022,000 (2,823,000) $1,306,000 ================== ================= Year ended December 31, 2001 Reserve for bad debts $93,000 20,000 (9,000) $104,000 Reserve for discounts 16,000 (1,569,000) 1,565,000 12,000 ------------------ ----------------- Subtotal for accounts receivable $109,000 $116,000 ================== ================= Reserve for inventory markdowns $1,684,000 3,590,000 (4,167,000) $1,107,000 ================== =================