10-Q 1 cand_10q073102.txt 10Q FOR CANDIE'S INC U.S. Securities and Exchange Commission Washington, D.C. 20549 ------------------------------------ FORM 10-Q [X] Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 For the Quarterly Period Ended July 31, 2002 ------------- 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 0-10593 -------- CANDIE'S, INC. -------------------------------------------------------------------------------- (Exact name of registrant as specified in its charter) Delaware 11-2481903 ---------------------------------------- ------------------------------------- (State or other jurisdiction of (I.R.S. Employer Identification No.) incorporation or organization) 400 Columbus Avenue Valhalla, NY 10595 ---------------------------------------- ------------------------------------- (Address of principal executive offices) (Zip Code) (914) 769-8600 -------------------------------------------------------------------------------- (Registrant's telephone number, including area code) Not Applicable -------------------------------------------------------------------------------- (Former name, former address and former fiscal year, if changed since last report) Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter periods 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 the number of shares outstanding of each of the issuer's classes of Common Stock, as of the latest practicable date. Common Stock, $.001 Par Value -- 24,945,544 shares as of August 29, 2002 INDEX FORM 10-Q CANDIE'S, INC. and SUBSIDIARIES
Page No. ----------- Part I. Financial Information Item 1. Financial Statements - (Unaudited) Condensed Consolidated Balance Sheets - July 31, 2002 and January 31, 2002......................... 2 Condensed Consolidated Statements of Income - Three and Six Months Ended July 31, 2002 and 2001....................................................................... 3 Condensed Consolidated Statement of Stockholders' Equity - Six Months Ended July 31, 2002...................................................................................... 4 Condensed Consolidated Statements of Cash Flows - Six Months Ended July 31, 2002 and 2001...................................................................................... 5 Notes to Condensed Consolidated Financial Statements............................................... 6 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations ................................................................................... 11 Item 3. Quantitative and Qualitative Disclosures about Market Risk (not applicable).................... 14 Item 4. Internal Controls and Procedures (not applicable).............................................. 14 Part II. Other Information Item 1. Legal Proceedings.............................................................................. 15 Item 2. Changes in Securities and Use of Proceeds ..................................................... 15 Item 3. Defaults upon Senior Securities (Not Applicable)............................................... Item 4. Submission of Matters to a Vote of Security Holders ........................................... 15 Item 5. Other Information (Not Applicable)............................................................. Item 6. Exhibits and Reports on Form 8-K............................................................... 16 Signatures ........................................................................................... 17 Certifications of Principal Executive Officer and Principal Financial Officer........................... 18 Exhibit index........................................................................................... 20
Page 1 Part I. Financial Information Item 1. FINANCIAL STATEMENTS-(Unaudited) Candie's, Inc. and Subsidiaries Condensed Consolidated Balance Sheets
July 31, January 31, 2002 2002 ---------- ---------- (Unaudited) Assets (000's omitted, except par value) Current Assets Cash............................................................... $ 258 $ 636 Accounts receivable, net........................................... 9,149 4,674 Due from factors, net.............................................. 26,356 5,791 Due from affiliate................................................. 444 565 Inventories........................................................ 18,821 8,368 Refundable income taxes............................................ 168 - Deferred income taxes.............................................. 1,881 1,881 Prepaid advertising and other...................................... 1,835 718 Other current assets............................................... 125 97 ------- ------- Total Current Assets................................................... 59,037 22,730 Property and equipment, at cost: Furniture, fixtures and equipment.................................. 10,777 9,618 Less: Accumulated depreciation and amortization.................... 5,326 4,470 ------- ------- 5,451 5,148 Other assets: Goodwill, net...................................................... 23,641 1,868 Intangibles, net.................................................... 19,767 18,158 Deferred financing costs........................................... 777 741 Deferred income taxes.............................................. 1,741 1,741 Other.............................................................. 259 284 ------- ------- 46,185 22,792 ------- ------- Total Assets........................................................... $110,673 $ 50,670 ======= ======= Liabilities and Stockholders' Equity Current Liabilities: Revolving notes payable - banks.................................... $ 17,268 $ 12,366 Accounts payable and accrued expenses.............................. 27,487 12,672 Current portion of long-term debt............................... 4,265 1,225 Losses in excess of joint venture investment....................... - 250 ------- ------- Total Current Liabilities.............................................. 49,020 26,513 ------- ------- Long-term liabilities.................................................. 465 638 Long-term debt......................................................... 12,763 - Dividend payable....................................................... 200 - Redeemable preferred stock............................................. 11,000 - Stockholders' Equity Preferred and common stock to be issued........................... 2,000 2,000 Preferred stock, $.01 par value - shares authorized 5,000; none issued and outstanding................................... - - Common stock, $.001 par value - shares authorized 30,000; shares issued 24,295 at July 31, 2002 and 20,400 issued at January 31, 2002........................................... 24 20 Additional paid-in capital......................................... 67,706 58,188 Retained earnings (deficit)........................................ (31,838) (36,214) Treasury stock - at cost - 198 shares at July 31, 2002 and 113 shares at January 31, 2002................................ (667) (475) ------- ------- Total Stockholders' Equity............................................. 37,225 23,519 ------- ------- Total Liabilities and Stockholders' Equity............................. $110,673 $ 50,670 ======= ======= See notes to condensed consolidated financial statements.
Page 2 Candie's, Inc. and Subsidiaries Condensed Consolidated Statements of Income (Unaudited)
Three Months Ended Six Months Ended July 31, July 31, ------------------ ------------------- ------------------ ------------------- 2002 2001 2002 2001 (000's omitted, except per share data) Net sales...................................... $ 48,218 $ 30,570 $ 72,408 $ 53,222 Licensing income............................... 1,345 1,316 2,772 2,518 ------------------ ------------------- ------------------ ------------------- Net revenues................................... 49,563 31,886 75,180 55,740 Cost of goods sold............................. 35,568 22,755 52,492 38,300 ------------------ ------------------- ------------------ ------------------- Gross profit................................... 13,995 9,131 22,688 17,440 Operating expenses: Selling, general and administrative expenses... 9,898 7,683 17,623 15,209 Special charges................................ 78 178 93 243 ------------------ ------------------- ------------------ ------------------- 9,976 7,861 17,716 15,452 ------------------ ------------------- ------------------ ------------------- Operating income............................... 4,019 1,270 4,972 1,988 Other expenses: Interest expense............................... 508 296 785 621 Equity income in joint venture................. - - (250) - ------------------ ------------------- ------------------ ------------------- 508 296 535 621 ------------------ ------------------- ------------------ ------------------- Income before income taxes..................... 3,511 974 4,437 1,367 Income tax benefit............................. - - (139) - ------------------ ------------------- ------------------ ------------------- Net income..................................... 3,511 974 4,576 1,367 Dividends on preferred stock................... 200 - 200 - ------------------ ------------------- ------------------ ------------------- Income available to common stockholders........ $ 3,311 $ 974 $ 4,376 $ 1,367 ================== =================== ================== =================== Earnings per common share: Basic..................................... $ 0.14 $ 0.05 $ 0.20 $ 0.07 ================== =================== ================== =================== Diluted................................... $ 0.12 $ 0.04 $ 0.17 $ 0.06 ================== =================== ================== =================== Weighted average number of common shares outstanding: Basic..................................... 24,176 19,169 22,438 19,153 ================== =================== ================== =================== Diluted................................... 27,835 22,327 25,499 22,405 ================== =================== ================== ===================
See notes to condensed consolidated financial statements. Page 3 Candie's, Inc. and Subsidiaries Condensed Consolidated Statement of Stockholders' Equity (Unaudited) Six Months Ended July 31, 2002 (000's omitted)
Preferred & Common Additional Retained Common Stock Stock to be Paid-In Earnings Treasury Shares Amount Issued Capital (Deficit) Stock Total ---------------------------------------------------------------------------------- Balance at February 1, 2002 20,400 $ 20 $ 2,000 $ 58,188 $(36,214) $ (475) $ 23,519 Issuance of common stock to retirement plan 35 -- -- 54 -- -- 54 Exercise of stock options................. 842 1 -- 1,119 -- -- 1,120 Shares granted to board members........... 18 -- -- 40 -- -- 40 Options granted to non-employees.......... -- -- -- 58 -- -- 58 Purchase of treasury shares............... -- -- -- -- -- (192) (192) Acquisition of Unzipped Apparel, LLC...... 3,000 3 -- 8,247 -- -- 8,250 Dividends on preferred stock ............. -- -- -- -- (200) -- (200) Net income................................ -- -- -- -- 4,576 -- 4,576 ---------------------------------------------------------------------------------- Balance at July 31, 2002 24,295 $ 24 $ 2,000 $ 67,706 $(31,838) $ (667) $ 37,225 ==================================================================================
See notes to condensed consolidated financial statements. Page 4 Candie's, Inc. and Subsidiaries Condensed Consolidated Statements of Cash Flows (Unaudited)
Six Months Ended --------------------------- July 31, July 31, 2002 2001 --------------------------- (000's omitted) OPERATING ACTIVITIES: Net cash provided (used) in operating activities........................... $ (10,472) $ (3,992) --------------------------- INVESTING ACTIVITIES: Purchases of property and equipment................................... (948) (663) --------------------------- Net cash used in investing activities...................................... (948) (663) --------------------------- FINANCING ACTIVITIES: Proceeds from exercise of stock options and warrants.................. 1,120 355 Purchase of treasury stock............................................ (192) (201) Capital lease reduction............................................... (474) (438) Debt payable.......................................................... 10,588 5,409 --------------------------- Net cash provided by financing activities.................................. 11,042 5,125 --------------------------- INCREASE IN CASH........................................................... (378) 470 Cash at beginning of period................................................ 636 366 --------------------------- Cash at end of period...................................................... $ 258 $ 836 =========================== Supplemental disclosure of cash flow information: Cash paid for interest..................................................... $ 1,097 $ 622 =========================== Supplemental disclosure of cash flow information: Cash paid for interest................................................ $ 508 $ 296 =========================== Value of common and preferred shares issued to acquire Unzipped Apparel, LLC.................................. $ 19,250 $ - ===========================
See notes to condensed consolidated financial statements. Page 5 Candie's, Inc. and Subsidiaries Notes to Condensed Consolidated Financial Statements (Unaudited) July 31, 2002 NOTE A BASIS OF PRESENTATION The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with generally accepted accounting principles for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all the information and footnotes required by generally accepted accounting principles for complete financial statements. In the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation have been included. Operating results for the three-month and six-month periods ended July 31, 2002 are not necessarily indicative of the results that may be expected for a full fiscal year. Certain reclassifications have been made to conform prior year data with the current presentation. Warehousing and distribution costs of $664,000 for the three months ended July 31, 2001, and $1.3 million for the six months ended July 31, 2001, have been included in SG&A expenses in the consolidated statements of income. The Company had previously included such expenses in cost of goods sold. For further information, refer to the consolidated financial statements and footnotes thereto included in the Company's annual report on Form 10-K for the year ended January 31, 2002. NOTE B REVENUE RECOGNITION Wholesale revenues are recognized upon the shipment of products to the customers FOB shipping point. Allowances for chargebacks, returns and other charges are recorded at the sales date based on customer specific projections as well as historical rates of such allowances. Retail revenues are recognized at the "point of sales," which occur when merchandise is sold "over the counter" in retail stores. NOTE C FINANCING AGREEMENTS On January 23, 2002, the Company entered into a three-year $20 million credit facility ("the Credit Facility") with CIT Commercial Services ("CIT") replacing its arrangement with Rosenthal & Rosenthal, Inc ("Rosenthal"). Borrowings under the Credit Facility are formula based and include a $5 million over advance provision with interest at 1.00% above the prime rate. In June 2002, the Company agreed to amend the Credit Facility to increase the over advance provision to $7 million and include certain retail inventory in the availability formula. Borrowings under the amended Credit Facility bear interest at 1.5% above the prime rate. In August 2002, $16.2 million from the net proceeds from a private placement of asset backed notes were used to reduce amounts due under this Credit Facility. Concurrently with this payment the Credit Facility was further amended to eliminate the over advance provision along with certain changes in the availability formula. See Note I of the Notes to the Condensed Consolidated Financial Statements. See Note F of the Notes to the Condensed Consolidated Financial Statements regarding the financing agreement of Unzipped Apparel, LLC. At July 31, 2002, borrowings totaled $34.3 million at an average interest rate of 5.38% NOTE D EARNINGS PER SHARE Basic earnings per share includes no dilution and is computed by dividing earnings attributable to common stockholders by the weighted average number of common shares outstanding for the period. Diluted earnings per share reflects, in periods in which they have a dilutive effect, the effect of common shares issuable upon the conversion of preferred stock to be issued and the exercise of stock options and warrants. Page 6 The following is a reconciliation of the shares used in calculating basic and diluted earnings per share:
Three Months Ended July 31, Six Months Ended July 31, ---------------------------- -------------------------- 2002 2001 2002 2001 ---------------------------- -------------------------- (000's omitted) Basic .......................................................... 24,176 19,169 22,438 19,153 Effect of assumed conversions of employee stock options......... 2,985 1,595 2,308 1,239 Effect of assumed conversions of preferred stock to be issued... 674 1,563 753 2,013 ---------------------------- -------------------------- Diluted ........................................................ 27,835 22,327 25,499 22,405 ============================ ==========================
NOTE E COMMITMENTS AND CONTINGENCIES On August 4, 1999, the staff of the SEC advised the Company that it had commenced a formal investigation into the actions of the Company and others in connection with, among other things, certain accounting issues concerning the restatement of certain of the Company's financial statements in prior years. In January 2002, Redwood, one of the Company's former buying agents and a supplier of footwear to the Company, filed a Complaint in the United States District Court for the Southern District of New York, alleging that the Company breached various contractual obligations to Redwood and seeking to recover damages in excess of $20 million and its litigation costs. The Company has filed a motion to dismiss the Complaint based upon Redwood's failure to state a claim, in response to which Redwood has filed an amended complaint, which the Company has moved to dismiss. In the event that some or all of the amended Complaint survives the motion to dismiss, the Company intends to vigorously defend this lawsuit and to file counterclaims. The Company is a defendant in an action brought by Bank One Leasing Corp. in the Franklin County Court of Common Pleas (Ohio) to recover on an accelerated basis certain capitalized lease payments which otherwise would have been due in various installments through April 2003 and is classified as current liabilities on the Company's July 2002 balance sheet. The Company does not believe that this action will have a material adverse effect on its business, operations or financial condition. From time to time, the Company is also made a party to certain litigation incurred in the normal course of business. While any litigation has an element of uncertainty, the Company believes that the final outcome of any of these routine matters will not have a material effect on the Company's financial position or future liquidity. Except as set forth above, the Company knows of no material legal proceedings, pending or threatened, or judgments entered, against any director or officer of the Company in his capacity as such. NOTE F INVESTMENT IN JOINT VENTURE Equity Investment: On October 7, 1998, the Company formed Unzipped Apparel, LLC ("Unzipped") with joint venture partner Sweet Sportswear LLC ("Sweet"), the purpose of which was to market and distribute apparel under the BONGO label. The Company and Sweet each had a 50% interest in Unzipped. Pursuant to the terms of the joint venture, the Company licensed the BONGO trademark to Unzipped for use in the design, manufacture and sale of certain designated apparel products. At January 31, 2002 and 2001, the Company believed that Unzipped was in breach of certain provisions of the agreements among the parties, and notified Unzipped that the Company did not intend to contribute any additional capital or otherwise support the joint venture. Accordingly, as of January 31, 2001, the Company recorded $750,000 as its maximum liability to Unzipped, consisting primarily of a guarantee of bank debt, and suspended booking its share of Unzipped losses beyond its liability. During the fourth quarter of fiscal 2002, the Company reduced its liability by $500,000 with the termination of the guarantee of the bank debt. During the quarter ended April 30, 2002, the Company reduced the remaining $250,000 in connection with the acquisition of Unzipped (see below). The Company was entitled to receive an advertising royalty from Unzipped equal to 3% of Unzipped's net sales prior to the acquisition. Included in royalty income is $414,000 and $626,000 of such royalties for the six months ended July 31, 2002 and 2001, respectively. Acquisition: On April 23, 2002, the Company, through a subsidiary, acquired Sweet's 50% interest in Unzipped for $19.3 million payable in the form of 3 million shares of the Company's common stock at a price of $2.75 per share, totaling $8.3 Page 7 million, and an additional $11 million obligation to be evidenced by an 8% senior preferred stock which the Company will be required to redeem in 2012. The Company may issue subordinated debt in lieu of the redeemable preferred stock, subject to the approval of Sweet. The acquisition was recorded as of April 30, 2002. Accordingly the operations of Unzipped have been included beginning May 1, 2002. The following table shows the value of assets and liabilities recorded for the purchase of Unzipped, adjusted to reflect changes in fair value of assets and liabilities and purchase accounting liabilities: (000's omitted) Accounts receivable, net $ 593 Due from factors and accounts receivable, net 7,509 Inventories 5,485 Prepaid advertising and other 61 Property and equipment 156 Other assets 11 --------- Total assets acquired 13,815 Revolving notes payable - banks 10,512 Accounts payable and accrued expenses 8,167 --------- Total liabilities assumed 18,679 --------- Net assets acquired $ (4,864) ========= The excess purchase price over net assets acquired of $21.8 million has been recorded as goodwill and $2.4 million as other intangible assets. The Company is in the process of obtaining a third party valuation of certain intangible assets; thus the allocation of the purchases price is subject to change. The following unaudited pro-forma information presents a summary of the Company's consolidated results of operations as if the Unzipped acquisition and its related financing had occurred on February 1, 2001. These pro forma results have been prepared for comparative purposes only and do not purport to be indicative of the results of operations which actually would have resulted had the acquisition occurred on February 1, 2001, or which may result in the future.
Three months ended Six months ended July 31, July 31, 2002 2001 2002 2001 ---------------------------------------------------------------------- (000's omitted, except per share) Total net revenues $49,563 $43,263 $87,873 $76,068 Operating income $4,019 $2,775 $5,038 $3,690 Net income $3,511 $2,455 $3,921 $2,507 Basic earnings per common share $0.15 $0.11 $0.17 $0.11 Diluted earnings per common share $0.13 $0.10 $0.15 $0.10
Revolving Credit Agreement: Unzipped has a credit facility with Congress Financial Corporation ("Congress"). Under the facility as amended, Unzipped may borrow up to $15 million under revolving loans until September 30, 2002. Borrowings are limited by advance rates against eligible accounts receivable and inventory balances, as defined. Under the facility, Unzipped may also arrange for letters of credit. The borrowings bear interest at the lender's prime rate or at a rate of 2.25% per annum in excess of the Eurodollar rate. Borrowings under the facility are secured by substantially all of the assets of Unzipped and are guaranteed by the former Chairman/Manager of Unzipped who is also a director of the Company and his family trust, with such guarantee being limited to $500,000. The Company has agreed to cause the guarantee of the Chairman/Manager and his family trust to be released on or before February 1, 2003. At July 31, 2002, borrowings totaled $15.0 million and approximately $29,000 of additional funds were available to be borrowed under the revolving credit agreement. Page 8 The facility requires Unzipped to be in compliance with certain financial and nonfinancial covenants. At January 31, 2002, Unzipped was required to have a minimum members' equity balance of $750,000. Unzipped obtained an amendment to the facility dated March 15, 2002, under which the minimum members' equity balance was waived for the period from November 1, 2001 through February 28, 2002. In consideration for the amendment, Azteca Production International, Inc.("Azteca"), a company that shares common ownership with Sweet, agreed to increase the amount of a subordinated loan that Azteca previously made to Unzipped from $3.5 million to $5 million. In connection with its acquisition of the remaining interest in Unzipped, the Company agreed that on or before February 1, 2003, it will pay any amount remaining due under the subordinated loan made to Unzipped by Azteca. Related Party Transactions: Unzipped has a supply agreement with Azteca for the development, manufacturing, and supply of certain products bearing the Bongo trademark for the exclusive use by Unzipped. As consideration for the development of the products, Unzipped pays Azteca pursuant to a separate pricing schedule. For the three months ended July 31, 2002, Unzipped purchased $16.3 million of products from Azteca. The supply agreement was consummated upon Unzipped's formation and originally extended through January 31, 2003. In connection with the acquisition, the Company agreed to renew its supply agreement with Azteca for a three year period, the details of which are not yet finalized. Azteca also allocates expenses to Unzipped for Unzipped's use of a portion of Azteca's office space, design and production team and support personnel. For the three months ended July 31, 2002, Unzipped incurred $118,242 of such allocated expenses. In connection with the acquisition, the Company agreed to enter into a three-year management agreement with Sweet or its designee that provides for Sweet or its designee to manage the operations of Unzipped in return for a management fee which is based upon certain specified percentages of net income that Unzipped achieves during the three-year term, the details of which are not yet finalized. Unzipped has a distribution agreement with Apparel Distribution Services (ADS), an entity that shares common ownership with Sweet. The agreement provides for a $0.35 per unit fee for warehousing and distribution functions and $0.15 per unit fee for processing and invoicing orders. For the three months ended July 31, 2002, Unzipped incurred $993,707 for such services. The agreement also provides for reimbursement for certain operating costs incurred by ADS and charges for special handling fees at hourly rates approved by management. These rates can be adjusted annually by the parties to reflect changes in economic factors. The distribution agreement was consummated upon Unzipped's formation and extends through December 31, 2002. In connection with the acquisition, the Company agreed to cause Unzipped to renew its distribution agreement with ADS for a three-year period, the details of which are not yet finalized. Unzipped occupies office space in a building rented by ADS and Commerce Clothing Company, LLC (Commerce), a related party to Azteca. Amounts due to related parties at July 31, 2002 and included in accounts payable and accrued expenses, consist of the following: Azteca $ 4,362,000 ADS 3,305,000 Commerce 8,000 ------------------- $ 7,675,000 =================== NOTE G SEGMENT INFORMATION The Company identifies operating segments based on, among other things, the way the Company's management organizes the components of its business for purposes of allocating resources and assessing performance. With the recent acquisition of Unzipped, the Company has redefined the reportable operating segments. The Company's operations are now comprised of two reportable segments: footwear and apparel. Segment revenues are generated from the sale of footwear, apparel and accessories through wholesale channels and the Company's retail locations. The Company defines segment income as operating income before interest expense and income taxes. Summarized below are the Company's segment revenues, income (loss) and total assets by reportable segments for the fiscal quarter and six-month period ended July 31, 2002. Page 9
(000's omitted) Footwear Apparel Elimination Consolidated For the fiscal quarter ended July 31, 2002 Total revenues $ 29,756 $ 19,828 $ (21) $ 49,563 Segment income 2,118 1,901 - 4,019 Net interest expense 235 273 - 508 Income before provision for income taxes $ 1,883 $ 1,628 $ - $ 3,511 For the fiscal quarter ended July 31, 20021 Total revenues $ 55,373 $ 19,828 $ (21) $ 75,180 Segment income 3,071 1,901 - 4,972 Net interest expense 512 273 - 785 Income before provision for income taxes $ 2,809 $ 1,628 $ - $ 4,437 Total assets as of July 31, 2002 $ 64,520 $ 44,925 $ (1,122) $ 110,673
NOTE H RECENT ACCOUNTING STANDARDS In June 2001, the FASB issued Statement of Financial Accounting Standards No. 142 (SFAS No. 142), "Goodwill and Other Intangible Assets," which changes the accounting for goodwill from an amortization method to an impairment-only approach. The amortization of goodwill totaled $36 in the quarter ended April 30, 2001. Under SFAS No. 142, beginning on February 1, 2002, amortization of goodwill ceased. In August 2001, the FASB issued Statement of Financial Accounting Standards No. 144 (SFAS 144), "Accounting for the Impairment or Disposal of Long-Lived Assets," which addresses financial accounting and reporting for the impairment or disposal of long-lived assets and supercedes SFAS No. 121 and the accounting and reporting provisions of APB Opinion No. 30 for a disposal of a segment of a business. SFAS No. 144 is effective for the fiscal years beginning after December 15, 2001, with earlier application encouraged. The Company adopted SFAS No. 144 as of February 1, 2002, and the adoption of the Statement did not have a significant impact on the Company's financial position and results of operations. In November 2001, the FASB Emerging Issues Task Force released Issue 01-9, "Accounting for Consideration Given by a Vendor to a Customer (Including a Reseller of the Vendor's Products)." The scope of Issue 01-9 includes vendor consideration to any purchasers of the vendor's products at any point along the distribution chain, regardless of whether the purchaser receiving the consideration is a direct customer of the vendor. The adoption, effective February 1, 2002, required the Company to reclassify cooperative advertising expenses from a deduction against revenues to a selling, general and administrative ("SG&A") expense. As a result, restated net sales, gross profit and SG&A expenses for first fiscal six months ended July 31, 2002 increased by $243,000. This reclassification on the prior year was impractical to do so, but was expected to be immaterial. NOTE I SUBSEQUENT EVENTS In August 2002 the Company issued $20 million of asset-backed notes in a private placement. The notes were issued by IP Holdings LLC, an indirect wholly owned subsidiary of the Company, and were secured by intellectual property assets (tradenames, trademarks and license payments thereon). The notes have a 7-year term with a fixed interest rate of 7.93% with quarterly principal and interest payments of approximately $859,000. The notes are subject to a liquidity reserve account of $2.9 million, funded by a deposit of a portion of the proceeds of the notes. The net proceeds of $16.2 million were used to reduce amounts due by the Company under its existing revolving credit facilities which will provide additional availability for the Company to fund its expansion, see Note C of the Notes to the Condensed Consolidated Financial Statements. In August 2002, the Company converted $2 million of preferred stock into 674,300 shares of the Company's Common Stock at a price of $2.97 per share. Page 10 Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Safe Harbor Statement under the Private Securities Litigation Reform Act of 1995. The statements that are not historical facts contained in this Form 10-Q are forward looking statements that involve a number of known and unknown risks, uncertainties and other factors, all of which are difficult or impossible to predict and many of which are beyond the control of the Company, which may cause the actual results, performance or achievements of the Company to be materially different from any future results, performance or achievements expressed or implied by such forward looking statements. Such factors include, but are not limited to, uncertainty regarding continued market acceptance of current products and the ability to successfully develop and market new products, particularly in light of rapidly changing fashion trends, the impact of supply and manufacturing constraints or difficulties relating to the Company's dependence on foreign manufacturers, uncertainties relating to customer plans and commitments, competition, uncertainties relating to economic conditions in the markets in which the Company operates, the ability to hire and retain key personnel, the ability to obtain capital if required, the risks of litigation, the risks of uncertainty of trademark protection, the uncertainty of marketing and licensing trademarks and other risks detailed below and in the Company's other Securities and Exchange Commission filings. The words "believe", "expect", "anticipate", "seek" and similar expressions identify forward-looking statements. Readers are cautioned not to place undue reliance on these forward looking statements, which speak only as of the date the statement, was made. Seasonal And Quarterly Fluctuations. The Company's quarterly results may fluctuate quarter to quarter as a result of holidays, weather, the timing of footwear shipments, market acceptance of the Company's products, the mix, pricing and presentation of the products offered and sold, the hiring and training of additional personnel, the timing of inventory write downs, fluctuations in the cost of materials, the timing of licensing payments and reporting, and other factors beyond the Company's control, such as general economic conditions and the action of competitors. Accordingly, the results of operations in any quarter will not necessarily be indicative of the results that may be achieved for a full fiscal year or any future quarter. In addition, the timing of the receipt of future revenues could be impacted by the recent trend among retailers in the Company's industry to order goods closer to a particular selling season than they have historically done so. The Company continues to seek to expand and diversify its product lines to help reduce the dependence on any particular product line and lessen the impact of the seasonal nature of its business. However, the success of the Company will still remain largely dependent on its ability to predict accurately upcoming fashion trends among its customer base, build and maintain brand awareness and to fulfill the product requirements of its retail channel within the shortened timeframe required. Unanticipated changes in consumer fashion preferences, slowdowns in the United States economy, changes in the prices of supplies, consolidation of retail chains, among other factors noted herein, could adversely affect the Company's future operating results. Results of Operations For the three months ended July 31, 2002 Revenues. Net revenues increased by $17.7 million to $49.6 million from $31.9 million in the comparable period of the prior year. The net revenue increase resulted primarily from the sales of $19.8 million by Unzipped, partially offset by a decrease of $2.1 million to $29.8 million from $31.9 million in Candie's in the comparable period of the prior year. The net revenue decrease in Candie's resulted primarily from decreases in sales in Candie's wholesale footwear of $1.3 million and the Company's private label men's division of $1.2 million, partially offset by $310,000 sales increases in the retail stores and $30,000 increase in licensing income. Retail store sales increased to $2.5 million, as compared to $2.2 million in the second quarter of the prior year. The retail sales increase resulted from the sales of $927,000 in six new stores, partially offset by sales decreases of $151,000 in comparable retail stores and $466,000 in two discontinued stores. Comparable licensing income increased $375,000, as the prior year period included $346,000 of royalties from Unzipped, which payments ceased with the acquisition on April 23, 2002. Gross Profit. Gross profit increased by $4.9 million to $14.0 million as compared to $9.1 million in the prior year quarter. The gross profit increase is attributable $4.0 million to Unzipped and $859,000 to Candie's. Gross profit in Candie's increased to $10.0 million from $9.1 million in the prior year quarter. Gross profit margin decreased, as a percentage of net revenues, by 0.4% to 28.2% as compared to 28.6% in the second quarter of the prior year. The decrease in gross profit margin percentage is primarily attributable to Unzipped apparel sales in current year quarter at 20.2%, partially offset by improved margins in Page 11 Candie's. Gross profit margin in Candie's increased, as a percentage of net revenues, by 5.0% to 33.6% as compared to 28.6% in the comparable prior year quarter. The gross profit increase in Candie's is attributable $907,000 to Candie's wholesale footwear, $67,000 to retail stores and $30,000 to licensing income, partially offset by gross profit decrease of $145,000 in the Company's private label men's division. Operating Expenses. Operating expenses increased by $2.1 million to $10.0 million from $7.9 million in the prior year quarter. $2.1 million of this increase resulted from the operations of Unzipped. Operating expenses in Candie's were $7.9 million, about the same as in the prior year quarter. The operating expense increase resulted from $575,000 of incremental costs associated with the opening of new retail stores and $82,000 of operating expense increase in the comparable stores were offset by $482,000 of cost reduction in Candie's wholesale footwear and $175,000 of operating expense savings in the two discontinued retail stores. Net Interest Expense. Net interest expense increased by $212,000 to $508,000 from $296,000 in the prior year quarter. $273,000 of this increase resulted from the operations of Unzipped. Net interest expense in Candie's decreased by $61,000 to $235,000 from $296,000 in the prior year quarter. Net interest expense decrease in Candie's resulted from lower average interest rates and lower average outstanding borrowing as compared with the comparable prior year period. Income Taxes. The income tax provision for the quarter was offset by a reduction in the valuation reserve. As a result, no tax provision was recorded for the period ended July 31, 2002 and the comparable quarter in prior year. Net Income. The Company recorded net income of $3.5 million, compared to $974,000 in the prior year quarter. Dividend Payable. The Company recorded a dividend payable of $200,000 in the current year quarter associated with the acquisition of Unzipped, see Note E of the Notes to the Condensed Consolidated Financial Statements. Net Income Available to Common Stockholders. The Company recorded net income available to common stockholders of $3.3 million, compared to $974,000 in the prior year quarter. For the six months ended July 31, 2001 Revenues. Net revenues increased by $19.4 million to $75.2 million from $55.7 million in the comparable period of the prior year. The net revenue increase resulted primarily from $19.8 million sales in Unzipped. Net revenues in Candie's decreased by $367,000 to $55.4 million from $55.7 million in the comparable period of the prior year. The net revenue decrease in Candie's resulted primarily from sales decreases of $705,000 in Candie's wholesale footwear and $725,000 in the Company's private label men's division, partially offset by sales increases of $809,000 in the retail stores and $254,000 in licensing income. Retail store sales increased to $4.6 million, as compared to $3.8 million in the second quarter of the prior year. The retail sales increase resulted from $1.6 million of sales in six new stores, partially offset by $48,000 sales decreases in comparable retail stores and $800,000 in two discontinued stores. Licensing income increased to $2.8 million as compared to $2.5 million in the comparable prior year six month period. Comparable licensing income increased $600,000, as the prior year quarter included $346,000 of royalties from Unzipped. Gross Profit. Gross profit increased by $5.3 million to $22.7 million as compared to $17.4 million in the first six months of the prior year. The gross profit increase is attributable $4.0 million to Unzipped and $1.3 million to Candie's. Gross profit margin decreased, as a percentage of net revenues, by 1.1% to 30.2% as compared to 31.3% for the six months ended July 31, 2001. The decrease in gross profit margin percentage is primarily attributable to Unzipped apparel sales in the current year quarter at 20.2%, partially offset by improved margins in Candie's. Gross profit in Candie's increased by $1.3 million to $18.7 million as compared to $17.4 million in the first six months of the prior year. Gross profit margin in Candie's increased, as a percentage of net revenues, by 2.4% to 33.7% as compared to 31.3% for the six months ended July 31, 2001. The increase in gross profit in Candie's is primarily attributable $850,000 to improved margins in Candie's wholesale footwear, $238,000 to retail stores, and $254,000 to licensing income, partially offset by gross profit decrease of $100,000 in the Company's private label men's division. Operating Expenses. Operating expenses increased by $2.2 million to $17.7 million from $15.5 million in the first six months of the prior year. $2.1 million of the increase resulted from the operations of Unzipped. Operating expenses in Candie's increased by $160,000 to $15.6 million from $15.5 million in the first six months of the prior year. Operating expense increase in Candie's resulted primarily from $1.1 million of the incremental costs associated with the opening of new retail stores and $121,000 of operating expense increase in the comparable stores, substantially offset by $704,000 of cost reduction in Candie's wholesale footwear and $357,000 of operating expense savings in the two discontinued retail stores. Page 12 Net Interest Expense. Net interest expense increased by $164,000 to $785,000 from $621,000 in the first six months of the prior year. $273,000 of this increase resulted from the operation of Unzipped. Net interest expense in Candie's decreased by $109,000 to $512,000 from $621,000 in the first six months of the prior year. Net interest expense decrease in Candie's resulted from lower average interest rates and lower average outstanding borrowing as compared with the comparable prior year period. Equity Income in Joint Venture. During the quarter ended April 30, 2002, the Company reduced the remaining $250,000 liability in connection with the acquisition of Unzipped. See Note E of Notes to Condensed Consolidated Financial Statements. Income Tax Benefit. In the quarter ended April 30, 2002, the Company recorded $139,000 of income tax benefit resulting from the utilization of net operating losses to recover previously recorded minimum statutory taxes. No tax expense was recorded for the current and prior year quarter, due to a reduction in the valuation reserve, which offset the income tax provision. Net Income. The Company recorded net income of $4.6 million, compared to $1.4 million in the first six months of the prior year. Dividend Payable. The Company recorded a dividend payable of $200,000 in the current year quarter associated with the acquisition of Unzipped, see Note E of the Notes to the Condensed Consolidated Financial Statements. Net Income Available to Common Stockholders. The Company recorded net income available to common stockholders of $4.4 million, compared to $1.4 million in the comparable prior year period. Liquidity and Capital Resources Working Capital. At July 31, 2002, the current ratio was 1.20 to 1, as compared to 1.04:1 for the prior fiscal year The Company continues to rely upon trade credit, revenues generated from operations, especially private label and licensing activity, as well as borrowings from under its revolving loan to finance its operations. Net cash used in operating activities totaled $10.5 million, compared to cash used of $4.0 million for the six months ended July 31, 2001. The increase in cash used in operating activities resulted primarily from an increase in factoring and trade receivables related to the acquisition of Unzipped. Capital Expenditures. Capital expenditures for the six months ended July 31, 2002 were $948,000, compared to $663,000 for the comparable period in the prior year. The Company has forecasted additional capital expenditures of approximately $1.4 million in the fiscal year ending January 31, 2003. The Company believes that it will be able to fund these anticipated expenditures primarily with cash from borrowings under its Credit Facility. Current Revolving Credit Facility. On January 23, 2002, the Company entered into a three-year $20 million Credit Facility with CIT replacing its arrangement with Rosenthal. Borrowings under the Credit Facility are formula based and include a $5 million over advance provision with interest at 1.00% above the prime rate. Subsequent to April 30, 2002, the Company agreed to amend the Credit Facility to increase the over advance provision to $7 million and include certain retail inventory in the availability formula. Borrowing under the amended Credit Facility bear interest at 1.5% above the prime rate. In August 2002, $16.2 million from the net proceeds from a private placement of asset backed notes were used to reduce amounts due under this Credit Facility. Concurrently with this payment the Credit Facility was further amended to eliminate the over advance provision along with certain changes in the availability formula. See Note I of the Notes to the Condensed Consolidated Financial Statements. Page 13 Unzipped has a credit facility with Congress Financial Corporation which expires on September 30, 2002. Under the facility as amended, Unzipped may borrow up to $15 million under revolving loans. Borrowings are limited by advance rates against eligible accounts receivable and inventory balances, as defined. Under the facility, Unzipped may also arrange for letters of credit. The borrowings bear interest at the lender's prime rate or at a rate of 2.25% per annum in excess of the Eurodollar rate. In August 2002 the Company issued $20 million of asset-backed notes in a private placement. The notes were issued by IP Holdings LLC, an indirect wholly owned subsidiary of the Company, and were secured by intellectual property assets (tradenames, trademarks and license payment thereon). The notes have a 7-year term with a fixed interest rate of 7.93% with quarterly principal and interest payments of approximately $859,000. The notes are subject to a liquidity reserve account of $2.9 million, funded by a deposit of a portion of the proceeds of the notes. The net proceeds of $16.2 million were used to reduce amounts due by the Company under its existing revolving credit facilities which will provide additional availability for the Company to fund its expansion, see Note C of the Notes to the Condensed Consolidated Financial Statements. Other Borrowing Arrangements In May 1999, the Company entered into a $3.5 million master lease and loan agreement with OneSource Financial Corp. The agreement requires the Company to collateralize property and equipment of $1.9 million with the remaining balance considered to be an unsecured loan. The term of the agreement is four years at an effective annual interest rate of 10.48%. The outstanding loan balance as of July 31, 2002 was $743,000. The quarterly payment on the loan is $260,000, including interest. Other In connection with its acquisition of Unzipped (See Note F of the Notes to Condensed Consolidated Financial Statements), the Company has agreed that on or before February 1, 2003, it will pay Azteca for all receivables due from Unzipped for purchases of product that are more than 30 days past due and any amount remaining under the subordinated loan between Unzipped and Azteca. As of July 31, 2002, these amounts aggregated $4.3 million. Item 3. Quantitative and Qualitative Disclosures about Market Risk Not applicable. Item 4. Internal Controls and Procedures Not applicable. Page 14 PART II. Other Information Item 1. Legal Proceedings On August 4, 1999, the staff of the SEC advised the Company that it had commenced a formal investigation into the actions of the Company and others in connection with, among other things, certain accounting issues concerning the restatement of certain of the Company's financial statements in prior years. In January 2002, Redwood, one of the Company's former buying agents and a supplier of footwear to the Company, filed a Complaint in the United States District Court for the Southern District of New York, alleging that the Company breached various contractual obligations to Redwood and seeking to recover damages in excess of $20 million and its litigation costs. The Company has filed a motion to dismiss the Complaint based upon Redwood's failure to state a claim, in response to which Redwood has filed an amended complaint, which the Company has moved to dismiss. In the event that some or all of the amended Complaint survives the motion to dismiss, the Company intends to vigorously defend this lawsuit and to file counterclaims. The Company is a defendant in an action brought by Bank One Leasing Corp. in the Franklin County Court of Common Pleas (Ohio) to recover on an accelerated basis certain capitalized lease payments which otherwise would have been due in various installments through April 2003 and is classified as current liabilities on the Company's July 2002 balance sheet. The Company does not believe that this action will have a material adverse effect on its business, operations or financial condition. From time to time, the Company is also made a party to certain litigation incurred in the normal course of business. While any litigation has an element of uncertainty, the Company believes that the final outcome of any of these routine matters will not have a material effect on the Company's financial position or future liquidity. Except as set forth above, the Company knows of no material legal proceedings, pending or threatened, or judgments entered, against any director or officer of the Company in his capacity as such. Item 2. Changes in Securities and Use of Proceeds. During the three months ended July 31, 2002, the Company granted certain of its employees and directors, pursuant to a stock option plan, 10-year non-qualified stock options to purchase a total of 319,000 shares of its common stock at prices ranging from $4.00 to $4.47 per share (an average of $4.17 per share). The options were granted in private transactions pursuant to the exemption from registration under Sections 2(a) (3) and 4(2) of the Securities Act of 1933. Item 4. Submission of Matters to a Vote of Security Holders On June 24, 2002 the Company held an Annual Meeting of Stockholders at which the holders of the Company's common stock voted on: (i) the election of directors, (ii) an amendment to the Company's Certificate of Incorporation to increase the authorized common stock from 30,000,000 to 75,000,000 shares, (iii) a proposal to approve the adoption of the Company's 2002 Stock Option Plan under which up to 2,000,000 shares of Common Stock may be issued, and (iv) the appointment of BDO Seidman, LLP as the Company's independent auditors for the fiscal year ending January 31, 2003. Messrs. Neil Cole, Barry Emanuel, Steven Mendelow, Peter Siris, Ann Iverson and Hubert Guez were elected to serve as members of the Company's Board of Directors for the ensuing year and until the election and qualification of their successors. The votes cast by stockholders with respect to the election of Directors were as follows: Votes Cast Votes Director "For" "Withheld" -------- -------------- ---------- Neil Cole 20,838,752 998,401 Barry Emanuel 21,781,900 55,253 Steven Mendelow 21,784,167 52,986 Peter Siris 21,787,567 49,586 Ann Iverson 21,787,367 49,786 Hubert Guez 21,787,917 49,236 Page 15 The amendment to the Certificate of Incorporation to increase the Company's authorized common stock was approved by the stockholders. The votes cast by stockholders with respect to the amendment to the Certificate of Incorporation were as follows: Votes Cast "For" Votes Cast "Against" Votes "Abstaining" ---------------- -------------------- ------------------ 21,491,168 297,990 47,995 The Company's 2002 Stock Option Plan was approved by the stockholders. The votes cast by stockholders with respect to the 2002 Stock Option Plan were as follows: Votes Cast "For" Votes Cast "Against" Votes "Abstaining" Not Voted ---------------- -------------------- ------------------ ----------- 6,347,975 1,524,936 62,500 13,901,742 The ratification of the appointment of BDO Seidman, LLP as the Company's independent auditors for the fiscal year ending January 31, 2003 was approved by the stockholders. The votes cast by stockholders with respect to the ratification of the appointment of BDO Seidman, LLP as the Company's independent auditors for the fiscal year ending January 31, 2003 were as follows: Votes Cast "For" Votes Cast "Against" Votes "Abstaining" ---------------- -------------------- ------------------ 21,729,072 23,741 84,340 Item 6. Exhibits and Reports on Form 8-K a. Exhibits Exhibit 10.1 - Candie's Inc. 2002 Stock Option (incorporated herein by reference to Exhibit B to the Company's Proxy Statement dated May 28, 2002 contained in the Company's Schedule 14A filed with the SEC on May 29, 2002). Exhibit 99.1 - Certification of CEO pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 Exhibit 99.2 - Certification of CFO pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 b. Reports on Form 8-K - During the quarter ended July 31, 2002, a Form 8-K and an amendment of such Form 8-K were filed under items 2 and 7 of Form 8-K to report the Company's acquisition on April 23, 2002 of the remaining 50% interest of Unzipped and to file the required financial statements of Unzipped. Page 16 Signatures Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. CANDIE'S, INC. ---------------------------- (Registrant) Date September 16, 2002 /s/ Neil Cole --------------------------- -------------------------------- Neil Cole Chairman of the Board, President And Chief Executive Officer (on Behalf of the Registrant) Date September 16, 2002 /s/ Richard Danderline --------------------------- -------------------------------- Richard Danderline Executive Vice President of Finance And Operations Page 17 Candie's, Inc. Certification of Principal Executive Officer I, Neil Cole, Chief Executive Officer of Candie's, Inc., certify that: 1. I have reviewed this quarterly report on Form 10-Q of Candie's, Inc.; 2. Based on my knowledge, this quarterly report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this quarterly report; 3. Based on my knowledge, the financial statements, and other financial information included in this quarterly report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this quarterly report. Date: September 16, 2002 /s/ Neil Cole ---------------------------------- Neil Cole Chief Executive Officer (Principal Executive Officer) EXPLANATORY NOTE REGARDING CERTIFICATION: Representations 4, 5 and 6 of the Certification as set forth in this Quarterly Report on Form 10-Q have been omitted, consistent with the Transition Provisions of SEC Exchange Act Release No. 34-46427, because this Quarterly Report on Form 10-Q covers a period ending before the Effective Date of Exchange Rules 13a-14 and 15d-14. Page 18 Candie's, Inc. Certification of Principal Financial Officer I, Richard Danderline, Chief Financial Officer of Candie's, Inc., certify that: 1. I have reviewed this quarterly report on Form 10-Q of Candie's, Inc.; 2. Based on my knowledge, this quarterly report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this quarterly report; 3. Based on my knowledge, the financial statements, and other financial information included in this quarterly report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this quarterly report. Date: September 16, 2002 /s/ Richard Danderline ---------------------------------- Richard Danderline Chief Financial Officer (Principal Financial Officer) EXPLANATORY NOTE REGARDING CERTIFICATION: Representations 4, 5 and 6 of the Certification as set forth in this Quarterly Report on Form 10-Q have been omitted, consistent with the Transition Provisions of SEC Exchange Act Release No. 34-46427, because this Quarterly Report on Form 10-Q covers a period ending before the Effective Date of Exchange Act Rules 13a-14 and 15d-14. Page 19 Candie's Inc and Subsidiaries FORM 10-Q EXHIBIT INDEX Exhibit No. Description --------------- --------------- (10)(a) Candie's Inc. 2002 Stock Option (incorporated herein by reference to Exhibit B to the Company's Proxy Statement dated May 28, 2002 contained in the Company's Schedule 14A filed with the SEC on May 29, 2002). 99.1 Certification of CEO pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 99.2 Certification of CFO pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 Page 20