<PAGE>
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
/X/ QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 27, 1998
OR
/_/ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (D) OF THE
SECURITIES EXCHANGE ACT OF 1934
Commission File Number 1-11805
-------------------------
DONNA KARAN INTERNATIONAL INC.
(Exact name of registrant as specified in its charter)
Delaware 13-3882426
(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
550 Seventh Avenue, New York, New York 10018
(Address of principal executive offices)
(Zip Code)
(212) 789-1500
(Registrant's telephone number, including area code)
-------------------------
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 |_|
At November 10, 1998, the Registrant had 21,599,334 shares of Common Stock
outstanding.*
*Does not include 18 shares of Class A Common Stock, par value $.01 per share,
and two shares of Class B Common Stock, par value $.01 per share, outstanding as
of such date.
<PAGE>
DONNA KARAN INTERNATIONAL INC.
INDEX
PART I. FINANCIAL INFORMATION
<TABLE>
<CAPTION>
Page
----
Item 1. Financial Statements
<S> <C> <C>
Statements of Operations -
Three Months and Nine Months Ended September 27, 1998 and September 28, 1997........... 3
Balance Sheets -
September 27, 1998 and December 28, 1997............................................... 4
Statements of Cash Flows -
Nine Months Ended September 27, 1998 and September 28, 1997............................ 5
Notes to Financial Statements................................................................ 6
Item 2. Management's Discussion and Analysis of
Financial Condition and Results of Operations.......................................... 9
PART II. OTHER INFORMATION
Item 1. Legal Proceedings........................................................................... 14
Item 5. Other Information........................................................................... 14
Item 6. Exhibits and Reports on Form 8-K............................................................ 14
</TABLE>
2
<PAGE>
DONNA KARAN INTERNATIONAL INC.
STATEMENTS OF OPERATIONS
(Unaudited)
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
----------------------------- ------------------------------
September 27, September 28, September 27, September 28,
1998 1997 1998 1997
------------- ------------- ------------- -------------
(In thousands, except per share data)
<S> <C> <C> <C> <C>
Net revenues........................................... $ 170,569 $214,870 $476,576 $ 484,691
Cost of sales.......................................... 120,343 158,069 359,118 360,241
--------- -------- -------- ---------
Gross profit........................................... 50,226 56,801 117,458 124,450
Selling, general and administrative expenses........... 35,701 54,409 109,571 146,753
Restructuring charges.................................. - - - 1,571
--------- -------- -------- ---------
Operating income (loss)................................ 14,525 2,392 7,887 (23,874)
Other income (expense):
Equity in earnings (loss) of affiliates.......... - 649 (65) 1,358
Gain on sale of affiliate........................ - - 88 -
Interest expense, net............................ (516) (1,331) (1,768) (1,470)
--------- -------- -------- ---------
Income (loss) before income taxes...................... 14,009 1,710 6,142 (23,986)
Income tax expense (benefit)........................... 6,444 787 2,825 (11,034)
--------- -------- -------- ---------
Net income (loss)...................................... $ 7,565 $ 923 $ 3,317 $ (12,952)
--------- -------- -------- ---------
--------- -------- -------- ---------
Net income (loss) per common share (Note 1):
Basic............................................ $ .35 $ .04 $ .15 $ (.60)
--------- -------- -------- ---------
--------- -------- -------- ---------
Diluted.......................................... $ .35 $ .04 $ .15 $ (.60)
--------- -------- -------- ---------
--------- -------- -------- ---------
</TABLE>
See Notes to Financial Statements
3
<PAGE>
DONNA KARAN INTERNATIONAL INC.
BALANCE SHEETS
<TABLE>
<CAPTION>
September 27, December 28,
1998 1997
------------- ------------
(Unaudited)
(In thousands)
ASSETS
<S> <C> <C>
Current assets
Cash and cash equivalents............................................... $ 4,072 $ 4,537
Accounts receivable, net of allowances of $38,452 at
September 27, 1998 and $52,035 at December 28, 1997.................. 82,881 68,138
Inventories............................................................. 77,150 112,366
Deferred income taxes................................................... 23,693 33,474
Prepaid expenses and other current assets............................... 14,431 12,248
-------- --------
Total current assets................................................. 202,227 230,763
Property and equipment, net................................................. 31,171 31,005
Deferred income taxes....................................................... 19,145 7,278
Deposits and other noncurrent assets........................................ 16,030 18,442
-------- --------
$268,573 $287,488
-------- --------
-------- --------
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable........................................................ $ 36,361 $ 61,013
Accrued expenses and other current liabilities.......................... 52,898 60,711
Current portion of capital lease obligations............................ - 36
Note payable to principal stockholder................................... - 6,700
Borrowing under revolving line of credit................................ 2,198 22,314
-------- --------
Total current liabilities............................................ 91,457 150,774
-------- --------
Deferred income............................................................. 51,537 14,250
Stockholders' equity
Common stock, $0.01 par value, 35,000,000 shares
authorized, 21,618,034 shares issued and 21,599,334 shares
outstanding at September 27, 1998 and 21,597,834 shares
outstanding at December 28, 1997..................................... 216 216
Common stock class A, $0.01 par value, 18 shares
authorized, issued and outstanding................................... - -
Common stock, class B, $0.01 par value, 2 shares
authorized, issued and outstanding................................... - -
Preferred stock, $0.01 par value, 1,000,000 shares
authorized, no shares issued and outstanding......................... - -
Additional paid-in capital.............................................. 188,478 188,491
Retained deficit........................................................ (60,558) (63,875)
Cumulative translation adjustment....................................... (919) (455)
-------- --------
127,217 124,377
Less: Treasury stock, at cost (18,700 shares at September 27, 1998
and 20,200 shares at December 28, 1997).............................. (443) (479)
Unearned compensation................................................... (1,195) (1,434)
-------- --------
Total stockholders' equity.............................................. 125,579 122,464
-------- --------
$268,573 $287,488
-------- --------
-------- --------
</TABLE>
See Notes to Financial Statements
4
<PAGE>
DONNA KARAN INTERNATIONAL INC.
STATEMENTS OF CASH FLOWS
(Unaudited)
<TABLE>
<CAPTION>
Nine Months Ended
------------------------------
September 27, September 28,
1998 1997
------------- -------------
(In thousands)
<S> <C> <C>
Operating Activities
Net income (loss) ........................................................$ 3,317 $(12,952)
Adjustments to reconcile net income to net cash provided by (used for)
operating activities:
Depreciation and amortization ..................................... 10,292 9,265
Provision for bad debts ........................................... 1,134 492
Gain on sale of affiliate ......................................... (88) --
Treasury stock used for restricted stock grants ................... 24 --
Provision for restricted stock compensation ....................... 239 79
Amortization of deferred income ................................... (5,553) --
Equity in earnings (loss) of affiliate ............................ 65 (1,358)
Deferred income taxes ............................................. (2,086) (632)
Changes in operating assets and liabilities:
Increase in accounts receivable ................................... (15,877) (31,670)
Decrease (increase) in inventories ................................ 35,216 (16,084)
(Increase) decrease in prepaid expenses and other current assets .. (2,360) 1,072
Increase in deposits and other noncurrent assets .................. (2,656) (3,001)
Decrease in accounts payable, accrued expenses, and
other current liabilities ..................................... (29,281) (34,662)
Increase in deferred income ....................................... 38,811 --
-------- --------
Net cash provided by (used for) operating activities .......... 31,197 (89,451)
-------- --------
Investing Activities
Proceeds from sale of affiliate .......................................... 646 --
Purchase of property and equipment ....................................... (5,456) (7,927)
-------- --------
Net cash (used for) investing activities ...................... (4,810) (7,927)
-------- --------
Financing Activities
Net (repayment) proceeds of revolving credit facility .................... (20,116) 60,094
Payments under capital lease ............................................. (36) (209)
Repayment of note payable to principal stockholder ....................... (6,700) --
-------- --------
Net cash (used for) provided by financing activities .......... (26,852) 59,885
-------- --------
Net decrease in cash and cash equivalents ................................ (465) (37,493)
Cash and cash equivalents at beginning of period ......................... 4,537 40,550
-------- --------
Cash and cash equivalents at end of period ...............................$ 4,072 $ 3,057
-------- --------
-------- --------
Supplemental cash flow information
Interest paid ............................................................$ 1,282 $ 1,641
-------- --------
-------- --------
Taxes paid ...............................................................$ 6,009 $ 9,278
-------- --------
-------- --------
</TABLE>
See Notes to Financial Statements
5
<PAGE>
DONNA KARAN INTERNATIONAL INC.
NOTES TO FINANCIAL STATEMENTS
NOTE 1 -- SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Basis of Presentation
The accompanying unaudited consolidated financial statements include the
results of operations of Donna Karan International Inc. and its subsidiaries
(collectively, the "Company"). All significant intercompany balances and
transactions have been eliminated in consolidation. The equity method of
accounting is used for Donna Karan Japan, K.K., a Japanese stock company
("DKJ"), which was 70% owned by a nonaffiliated entity.
The unaudited 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 Rule 10-01 of Regulation
S-X. Accordingly, they do not include all of 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. On a quarterly basis, the Company's operations may vary as a result
of, among other things, production and shipping schedules, the introduction of
new products, and variations in the timing of certain holidays from year to
year. The results of operations for any interim period are not necessarily
indicative of the results of operations to be expected for a full year. For
further information, refer to the consolidated financial statements and
accompanying footnotes included in the Company's Annual Report on Form 10-K for
the year ended December 28, 1997.
Comprehensive Income (Loss)
Comprehensive income (loss) consists of net income (loss) and foreign
currency translation adjustments and totaled $7.5 million and $0.9 million and
$2.9 million and ($13.0) million for the quarter and nine months ended September
27, 1998 and September 28, 1997, respectively.
Net Income (Loss) Per Common Share
For the period ended September 27, 1998, in accordance with the
requirements of Statement of Financial Accounting Standards ("SFAS") No. 128,
"Earnings per Share," net income (loss) per common share amounts ("basic
EPS") were computed by dividing net income (loss) by the weighted average
number of common shares outstanding and excluded any potential dilution. Net
income (loss) per common share amounts -- assuming dilution ("diluted EPS")
were computed by reflecting potential dilution from the exercise of stock
options. SFAS No. 128 requires the presentation of both basic EPS and diluted
EPS on the face of the income statement. Earnings per share amounts for the
same prior-year periods have been restated to conform with the provisions of
SFAS No. 128.
A reconciliation between net income (loss) and shares used to compute
basic and diluted EPS computations for net income (loss) is as follows:
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
------------------------------- ---------------------------------
September 27, September 28, September 27, September 28,
1998 1997 1998 1997
--------------- -------------- ---------------- ----------------
(In thousands)
<S> <C> <C> <C> <C>
Net income (loss), as reported....................... $ 7,565 $ 923 $ 3,317 $ (12,952)
Effect of dilutive securities:
Stock options...................................
- - - -
---------- --------- ---------- -----------
Net income (loss), assuming full dilution............ $ 7,565 $ 923 $ 3,317 $ (12,952)
---------- --------- ---------- -----------
---------- --------- ---------- -----------
Weighted average common shares, basic................ 21,598 21,448 21,598 21,448
Effect of dilutive securities:
Stock options................................... 18 27 45 9
---------- --------- ---------- -----------
Weighted average common shares, assuming
full dilution................................... 21,616 21,475 21,643 21,457
---------- --------- ---------- -----------
---------- --------- ---------- -----------
</TABLE>
6
<PAGE>
DONNA KARAN INTERNATIONAL INC.
NOTES TO FINANCIAL STATEMENTS
Inventories
Inventories consist of the following:
<TABLE>
<CAPTION>
September 27, December 28,
1998 1997
---------------- ----------------
(In thousands)
<S> <C> <C>
Raw material................................................... $ 7,243 $ 10,306
Work in process................................................ 7,500 11,316
Finished goods................................................. 62,407 90,744
--------- -----------
$ 77,150 $ 112,366
--------- -----------
--------- -----------
</TABLE>
Property and Equipment
Property and equipment are carried at cost. Depreciation is computed
primarily on the straight-line basis over the estimated useful lives of the
assets ranging from 5 to 7 years. Leasehold improvements are amortized on a
straight-line basis over the shorter of the expected useful lives or the lease
term, which in certain instances include the anticipated renewal period.
Property and equipment consist of the following:
<TABLE>
<CAPTION>
September 27, December 28,
1998 1997
---------------- -----------------
(In thousands)
<S> <C> <C>
Machinery, equipment, and fixtures............................ $ 25,283 $ 20,314
Property and equipment under capital leases................... - 1,207
Leasehold improvements........................................ 42,381 40,688
---------- ----------
67,664 62,209
Less accumulated depreciation................................. (36,493) (31,204)
---------- ----------
$ 31,171 $ 31,005
---------- ----------
---------- ----------
</TABLE>
Accrued Expenses and Other Current Liabilities
Accrued expenses and other current liabilities are comprised of the
following:
<TABLE>
<CAPTION>
September 27, December 28,
1998 1997
---------------- ----------------
(In thousands)
<S> <C> <C>
Accrued operating expenses................................... $ 22,415 $ 22,417
Accrued compensation......................................... 11,133 10,947
Accrued restructuring and other charges...................... 8,609 23,927
Accrued royalties............................................ 6,838 823
Unearned revenues............................................ 2,274 -
Accrued income taxes......................................... - 109
Accrued taxes other than income taxes........................ 941 1,895
Other........................................................ 688 593
---------- ----------
$ 52,898 $ 60,711
---------- ----------
---------- ----------
</TABLE>
7
<PAGE>
DONNA KARAN INTERNATIONAL INC.
NOTES TO FINANCIAL STATEMENTS
Provision for Income Taxes
The provision for income taxes represents federal, foreign, state and local
income taxes. The effective income tax rate was approximately 46% for the three
and nine months ended September 27, 1998 and September 28, 1997. This rate
reflects the effect of state and local taxes, tax rates in certain foreign
jurisdictions, and certain nondeductible expenses.
Management Estimates
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets, liabilities, revenues
and expenses reported in those financial statements. Actual results could differ
from those based upon such estimates and assumptions.
NOTE 2 -- RESTRUCTURING AND OTHER CHARGES
For the three months ended June 29, 1997, the Company implemented a
multi-step plan aimed at containing costs and restructuring certain of its
operations. In connection with this plan, the Company recorded a pre-tax
restructuring charge of $1.6 million, relating primarily to severance costs and
other related benefits. In addition, the Company recorded several other pre-tax
charges during this period aggregating $3.6 million. These charges, which are
included in selling, general and administrative expenses, relate to additional
severance costs, a provision for the estimated economic impairment of Donna
Karan New York accessories inventory and receivables not qualifying as a
restructuring charge as a result of the Company's decision to reduce operations
to a level to meet existing commitments, as well as certain other charges
recorded during the cost containment process.
NOTE 3 -- PRO FORMA FINANCIAL INFORMATION
In connection with the Company's licensing of its beauty business in fiscal
1997, the following table presents pro forma condensed financial information of
the Company for the three and nine months ended September 28, 1997, to reflect
results of operations as if the Company had exited the beauty business as of
January 1, 1997.
<TABLE>
<CAPTION>
September 28, 1997
--------------------------------------------------------------------------------
Three Months Ended Nine Months Ended
--------------------------------------- ---------------------------------------
As Pro As Pro
Reported Beauty Forma Reported Beauty Forma
------------ ------------ ----------- ------------ ----------- -----------
(In thousands)
<S> <C> <C> <C> <C> <C>
Net sales............................ $ 214,870 $ 7,278 $ 207,592 $ 484,691 $ 19,730 $ 464,961
Operating income (loss).............. 2,392 (2,110) 4,502 (23,874) (10,744) (13,130)
Net income (loss).................... 923 (1,140) 2,063 (12,952) (5,802) (7,150)
</TABLE>
NOTE 4 -- SUBSEQUENT EVENTS
On October 29, 1998, the Company and a wholly-owned affiliate of Ms. Donna
Karan, Chairman of the Board and Chief Designer of the Company, entered into a
boutique license agreement (the "Boutique Agreement"), granting the affiliated
entity the right to open and operate a Donna Karan New York Flagship Collection
Store. The store, which is currently scheduled to open in the Fall of 1999, will
be located at 819 Madison Avenue in New York City. The Boutique Agreement states
that the Company will provide the affiliated entity with certain management
services related to the operation of the store in exchange for a fee. The store
also will be entitled to offer a limited amount of non-branded products.
8
<PAGE>
DONNA KARAN INTERNATIONAL INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITIONS AND RESULTS OF OPERATIONS
OVERVIEW
Donna Karan International Inc. (together with its subsidiaries, the
"Company") is one of the world's leading international fashion design houses.
The Company designs, contracts for the production of, markets, and distributes
"designer" and "bridge" collections of men's and women's clothing, sportswear,
accessories, and shoes under the Donna Karan New York and DKNY brand names,
respectively. In addition, the Company selectively has granted licenses for the
manufacture and distribution of certain other products under the Donna Karan New
York and DKNY brand names, including beauty and beauty-related products, DKNY
jeanswear and activewear products, men's tailored clothing, shirts, neckwear,
hosiery, intimate apparel, eyewear, and children's apparel.
In March 1998, the Company and a nonaffiliated party sold all of their
outstanding shares in Donna Karan Japan, K.K. ("DKJ") to a subsidiary of Onward
Kashiyama Co. Ltd., a Japanese public company. As a result of this transaction,
the Company will no longer recognize equity in earnings (loss) of affiliate. The
Company also granted DKJ a 16-year exclusive license to import, manufacture,
license, and/or distribute Donna Karan New York and DKNY products in Japan, with
certain exceptions. The Company expects that over an approximately three-year
period, DKJ will transition from importing and reselling substantially all of
its products to manufacturing and selling a majority of products under its
licensing agreement. As a result, in the future the Company expects to recognize
decreasing revenues from its wholesale business and increasing revenues from its
licensing activities in its Japanese business.
RESULTS OF OPERATIONS
The following discussion provides information and analysis of the Company's
results of operations for the three and nine months ended September 27, 1998 and
September 28, 1997. The Company utilizes a 52 or 53-week fiscal year ending on
the Sunday nearest December 31. The Company's business is comprised of
wholesale, licensing, and retail activities.
The following table sets forth certain condensed statement of
operations data.
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
-------------------------------------- --------------------------------------
September 27, September 28, September 27, September 28
1998 1997 1998 1997
------------------ ------------------ ------------------ ------------------
(Dollars in millions)
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Net revenues............................. $ 170.6 100.0% $ 214.9 100.0% $ 476.6 100.0% $ 484.7 100.0%
Gross profit............................. 50.2 29.4 56.8 26.4 117.5 24.7 124.5 25.7
Selling, general and administrative
expenses............................. 35.7 20.9 54.4 25.3 109.6 23.0 146.8 30.3
Operating income (loss).................. 14.5 8.5 2.4 1.1 7.9 1.7 (23.9) (4.9)
Net income (loss)........................ 7.6 4.5 0.9 0.4 3.3 0.7 (13.0) (2.7)
</TABLE>
NET REVENUES
Net revenues for the three and nine months ended September 27, 1998
decreased $44.3 million, or 20.6%, and $8.1 million, or 1.7%, respectively, as
compared to net revenues of $214.9 million and $484.7 million in the
corresponding prior-year periods. Excluding certain sales of merchandise to Liz
Claiborne Inc. ("LCI") relating to the DKNY Jeans license in fiscal 1998 and
revenues in fiscal 1997 related to the Company's beauty business, revenues
decreased $37.3 million, or 17.8%, and $15.8 million, or 3.3%, as compared to
the corresponding prior-year periods. For the three months ended September 27,
1998, the decrease (excluding the DKNY Jeans sales) primarily related to a $43.9
million, or 23.7%, decrease in wholesale revenues, partially offset by a $4.5
million, or 23.1%, increase in retail sales and a $2.0 million, or 71.8%,
increase in licensing revenues. For the nine months ended September 27, 1998,
the decrease was attributable to a $36.1 million, or 8.8%, decrease in wholesale
revenues, partially offset by a $14.3 million, or 29.8%, increase in retail
sales and a $5.9 million, or 80.2%, increase in licensing revenues.
9
<PAGE>
DONNA KARAN INTERNATIONAL INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITIONS AND RESULTS OF OPERATIONS
Wholesale revenues, exclusive of the Company's beauty business and certain
sales of merchandise to LCI relating to the DKNY Jeans license, decreased for
the three months ended September 27, 1998 primarily due to a decrease in sales
in each of the Company's wholesale divisions. Wholesale revenues, exclusive of
the Company's beauty business and certain sales of merchandise to LCI relating
to the DKNY Jeans license, decreased for the nine months ended September 27,
1998 primarily due to a decrease in sales for DKNY collections for women and
men, DKNY Kids, and Donna Karan New York and DKNY accessories, partially offset
by higher sales of Donna Karan New York collections for women and increased
sales from DKNY shoes. Additionally, wholesale revenues for the three and nine
months ended September 27, 1998 continued to be impacted by a depressed Asian
retail environment, and the Company anticipates that this will be a difficult
market for the foreseeable future. Licensing revenues increased for the three
and nine months ended September 27, 1998 primarily due to royalties received
from LCI associated with granting LCI an exclusive long-term right to the DKNY
Jeans and DKNY Active trademarks for apparel products marketed, distributed, and
sold in the Western Hemisphere. Retail sales for the three and nine months ended
September 27, 1998 increased primarily due to an increase in the number of
outlet stores, a slight increase in comparable store sales, and the opening of
the Company's full price store in Las Vegas, as compared to the same prior-year
periods.
GROSS PROFIT
Gross profit as a percentage of sales for the three and nine months ended
September 27, 1998 was 29.4% and 24.7%, respectively, as compared to 26.4%
and 25.7% for the corresponding prior-year periods. Excluding the impact of
DKNY Jeans sales to LCI in fiscal 1998 and the effect of beauty business
sales in fiscal 1997, gross profit margins for the three and nine months
ended September 27, 1998 were 29.4% and 26.1%, respectively, as compared to
25.4% and 24.6% for the corresponding prior-year periods. The increase
primarily reflects the impact of greater licensing revenues and reduced
operating costs, partially offset by lower margins in the wholesale and
retail divisions, primarily due to shifts in product mix and higher than
normal markdowns taken on excess inventory (including prior season's
merchandise) as a result of the Company's commitment to reduce inventory
levels.
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES
Selling, general and administrative expenses decreased to 20.9% and 23.0% of
net revenues for the three and nine months ended September 27, 1998,
respectively, as compared to 25.3% and 30.3% of net revenues in the
corresponding prior-year periods. The decrease in selling, general and
administrative expenses for the three and nine months ended September 27, 1998
was primarily attributable to lower selling, marketing, advertising, and
personnel and related expenses, primarily as a result of the Company's strategic
initiatives, including the licensing of the beauty and DKNY Jeans businesses.
These decreases were partially offset by increased costs associated with the
Company's ongoing licensing efforts. In addition, selling, general and
administrative expenses for the nine months ended September 28, 1997 included a
$3.6 million charge related primarily to severance costs, provisions for the
estimated economic impairment of Donna Karan New York accessories inventory and
accounts receivable, as well as certain other charges identified during the cost
containment process. Selling, general and administrative expenses, exclusive of
these restructuring and other non-recurring charges, for the nine months ended
September 28, 1997, would have been 29.5%. See Note 2, "Restructuring and Other
Charges" in the Notes to Financial Statements.
OPERATING INCOME (LOSS)
Operating income increased $12.1 million to $14.5 million for the three
months ended September 27, 1998, as compared to the corresponding prior-year
period. Operating income for the nine months ended September 27, 1998 was $7.9
million, as compared to an operating loss of $23.9 million in the prior year.
Operating income (loss) as a percent of net revenues improved to 8.5% and 1.7%
in the current periods, as compared to 1.1% and (4.9%) in the corresponding
prior-year periods.
INTEREST EXPENSE, NET
Interest expense, net, was $0.5 million and $1.8 million for the three and
nine months ended September 27, 1998, respectively, as compared to $1.3 million
and $1.5 million for the corresponding prior-year periods. The increase in
interest expense for the nine months ended September 27, 1998 was primarily due
to higher average borrowings during fiscal 1998 as compared to fiscal 1997, when
the Company was in an investing position due to proceeds received from its
initial public offering (the "Offering").
10
<PAGE>
DONNA KARAN INTERNATIONAL INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITIONS AND RESULTS OF OPERATIONS
INCOME TAX BENEFIT
The income tax benefit represents federal, foreign, state and local income
taxes. The effective income tax rate for the three and nine months ended
September 27, 1998 and September 28, 1997 was 46%. This rate reflects the
effects of state and local taxes, tax rates in certain foreign jurisdictions,
and certain nondeductible expenses.
NET INCOME (LOSS)
Net income for the three months ended September 27, 1998 was $7.6 million,
as compared to $0.9 million for the corresponding prior-year period. For the
nine months ended September 27, 1998, net income was $3.3 million, as compared
to a loss of $13.0 million for the corresponding prior-year period. Exclusive of
restructuring charges and other non-recurring charges in 1997, net income for
the nine months ended September 27, 1998 increased $13.5 million, as compared to
the prior year.
LIQUIDITY AND CAPITAL RESOURCES
The Company's principal sources of funds have historically been, and are
expected to continue to be, cash flow from operations and borrowings under its
Credit Facility (as herein defined). The Company's principal need for funds is
to finance working capital (principally inventory and receivables), capital
expenditures (including the construction of new retail stores), and investments
in the start up of new collections and the extension of existing collections. At
September 27, 1998, the Company had cash and cash equivalents of $4.1 million,
as compared to $4.5 million at December 28, 1997.
The Company has supplemented its cash flow from operations and bank lines of
credit with proceeds from the Offering and its license and strategic alliances.
In January 1998, the Company received from LCI $30.0 million related to the
granting of license rights for the marketing, distribution, and sale of DKNY
Jeans and Activewear apparel products in the Western Hemisphere. In March 1998,
the Company received $15.2 million related to a 16-year exclusive license to
import, manufacture, license, and/or distribute Donna Karan New York and DKNY
products in Japan, with certain exceptions.
The Company has a $150.0 million, three-year revolving credit facility (the
"Credit Facility"). The Credit Facility is used for working capital requirements
and general corporate purposes. At September 27, 1998, $2.2 million was
outstanding under the current Credit Facility, as compared to $60.1 million for
the corresponding prior-year period.
Net cash provided by operating activities increased to $31.2 million for the
nine months ended September 27, 1998 as compared to net cash used for operating
activities of $89.5 million in the corresponding prior-year period. This
increase primarily reflects the Company's recording of deferred revenues
associated with the Company's recent licensing agreements, lower inventory
levels, a lesser increase in accounts receivable and lesser decreases in
accounts payable, accrued expenses, and other current liabilities, partially
offset by an increase in deferred income taxes. Net cash used for investing
activities decreased $3.1 million for the nine months ended September 27, 1998
as compared to the prior year, primarily due to decreased purchases of property
and equipment. Financing activities reflect borrowings under the Credit Facility
and the repayment of a note payable to a principal stockholder. Net cash used by
financing activities was $26.9 million for the nine months ended September 27,
1998, as compared to net cash provided by financing activities of $59.9 million
in the prior year. This change is primarily due to lower amounts outstanding
under the Company's Credit Facility in the current year as compared with the
prior year, and the repayment of a note payable to a principal stockholder in
the current year.
The Company uses derivative financial instruments for the purpose of
managing its exposure to adverse fluctuations in foreign currency exchange
rates. The Company addresses its risks through a program of risk management, the
principal objective of which is to minimize the risks and/or costs associated
with its operating activities. The Company does not utilize derivative financial
instruments for trading or other speculative purposes. The Company conducts
business in many foreign currencies. As a result, it is subject to foreign
currency exchange rate risk due to the effects that foreign exchange rate
movements of these currencies, principally the Italian lire, Spanish peseta,
Dutch guilder, and Hong Kong dollar, have on the Company's costs and cash flows.
The Company enters into forward exchange contracts to hedge purchases,
receivables and payables denominated in foreign currencies for periods
consistent with its identified exposures. Gains and losses related to qualifying
hedges of these exposures are deferred and recognized in operating income when
the underlying hedged transaction occurs. The Company from time to time also
enters into purchased foreign currency options to hedge anticipated transactions
where there is a high probability that anticipated exposures will materialize.
Any gains realized on such options that qualify as hedges are deferred and
recognized in operating income when the underlying hedged transaction occurs.
Premiums on
11
<PAGE>
DONNA KARAN INTERNATIONAL INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITIONS AND RESULTS OF OPERATIONS
foreign currency options are amortized over the period being hedged. Foreign
currency transactions that do not qualify as hedges are marked-to-market on a
current basis with gains and losses recognized through income and reflected in
operating expenses. In addition, any previously deferred gains and losses on
hedges that are terminated prior to the transaction date are recognized in
current income when the hedge is terminated. The contracts have varying
maturities with none exceeding 18 months.
As a matter of policy, the Company enters into contracts with parties who
are major international banks and financial institutions that have at least an
"A" (or equivalent) credit rating. The Company's exposure to credit loss in the
event of nonperformance by any of the counterparties is limited to only the
recognized, but not realized, gains attributable to the contracts. Management
believes risk of loss is remote and in any event would be immaterial. Costs
associated with entering into such contracts have not been material to the
Company's financial results. At September 27, 1998, the Company had contracts to
exchange foreign currencies in the form of forward exchange contracts in the
amount of $50.3 million.
Capital expenditures, primarily for leasehold improvements, equipment,
machinery, computers, office furniture, and outlet and retail stores, were
approximately $5.5 million and $7.9 million for the nine months ended September
27, 1998 and September 28, 1997, respectively. As of November 11, 1998, the
Company had committed to additional capital expenditures during fiscal 1998 of
approximately $5.0 million. The Company anticipates that it will incur
additional capital expenditures in fiscal 1998 relating to its retail business
initiatives and other matters.
The Company anticipates that it will be able to satisfy its ongoing cash
requirements for the foreseeable future, primarily with cash flow from
operations, supplemented by borrowings under the Credit Facility and, from time
to time, amounts received in connection with strategic transactions, including
licensing arrangements. Events that may impact this include, but are not limited
to, future events that may have the effect of reducing available cash balances
(such as unexpected operating losses or increased capital or other
expenditures), as well as future circumstances that might reduce or eliminate
the availability of external financing.
SEASONALITY OF BUSINESS
The Company's business varies with general seasonal trends that are
characteristic of the apparel industry, and it generally experiences lower net
revenues and net income (or higher net losses) in the first half of each fiscal
year, as compared to the second half of its fiscal year. Accordingly, the
Company's outstanding borrowings under its revolving credit facility,
historically, have been lower on or about its fiscal year end. On a quarterly
basis, the Company's operations may vary with production and shipping schedules,
the introduction of new products, and variation in the timing of certain
holidays from year to year. The Company historically has experienced lower net
revenues and operating income in the second quarter than in other quarters due
to (i) lower demand among retail customers typical of the apparel industry, and
(ii) certain expenses that are constant throughout the year being relatively
higher as a percentage of net revenues. As the Company's business continues to
evolve, the Company's operating performance may not reflect the typical
seasonality of the apparel industry.
YEAR 2000
The efficient operation of the Company's business is dependent in part on its
computer software programs and operating systems (collectively, "Programs and
Systems"). These Programs and Systems are used in several key areas of the
Company's business, including purchasing, inventory management, pricing,
sales, shipping, and financial reporting, as well as in various
administrative functions. The Company is in the process of addressing the
Year 2000 issue, and as a result of this process, the Company has identified
three phases of its Year 2000 Project: i) Inventory, ii) Assessment, and iii)
Remediation and Testing. As of September 27, 1998, the Company has completed
its inventory and assessment of substantially all internal computer systems
and application software, and plans for establishing compliance have been
developed. These plans include, among other things: which non-compliant
hardware and software will be remediated, upgraded, or replaced, the
timetable and resources (both internal and external) required to achieve
those objectives, and the estimated costs. The Company currently expects to
complete remediation and testing of its internal systems during the summer of
1999.
The Company is in the process of identifying and plans to communicate with
its significant suppliers, customers, and financial institutions to determine
their Year 2000 state of readiness and the extent to which the failure of any
of those systems may otherwise impact the Company's operations.
12
<PAGE>
DONNA KARAN INTERNATIONAL INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITIONS AND RESULTS OF OPERATIONS
Based upon current information, the Company estimates that the costs of
addressing the Year 2000 issue have not been material and are expected to
continue to be immaterial. Although the Company is not currently aware of any
material operational issues or costs associated with preparing its internal
systems for the Year 2000, there can be no assurance that there will not be a
delay in, or increased costs associated with, the implementation of the
necessary systems and changes to address the Year 2000 issues.
The Company currently believes that it is difficult to identify its most
reasonably likely worst case Year 2000 scenario. However, a reasonable worst
case scenario would be the result of failures of third parties that would
continue for more than several days in various geographic areas in which the
Company's products are produced and sold. Continuing failures in these areas
which could affect the manufacture of Company products or limit the consumers'
ability to purchase the Company's products, would most likely have a material
adverse effect on the Company's results of operations. The extent of such impact
cannot be reasonably estimated at this time; however, the Company is currently
developing contingency plans to limit, to the extent possible, the effect of
Year 2000 issues on the Company's results of operations. Any such plans would
necessarily be limited to situations over which the Company can be reasonably
expected to control.
The cost of the project and the date on which the Company believes it will
complete the Year 2000 modifications are based on management's estimates. The
Company currently believes that the Year 2000 issue will not pose significant
operational problems for its computer systems. However, if the required
modifications and conversions are not made, or are not competed on a timely
basis, or the systems from third parties (i.e. suppliers, customers, and
financial institutions) with whom the Company relies on directly, or indirectly,
to be Year 2000 compliant, are not operational, the Year 2000 could have a
material adverse effect on the Company's future results of operations.
FORWARD-LOOKING STATEMENTS
When used in this Form 10-Q and in future filings by the Company with the
Securities and Exchange Commission, in the Company's press releases and annual
reports to stockholders, and in other written or oral statements made by the
Company's representatives, the words and phrases "will likely result," "are
expected to," "will continue," "is anticipated," "estimates," "projects,"
"believes," "plans," or similar expressions, are intended to identify
"forward-looking statements" within the meaning of the Private Securities
Litigation Reform Act of 1995. Such forward-looking statements include, without
limitation, the Company's expectations regarding sales, earnings, or other
future financial performance and liquidity, and general statements about future
operations and operating results. Although the Company believes that its
expectations are based on reasonable assumptions within the bounds of its
knowledge of its business and operations, there can be no assurance that actual
results will not differ materially from its expectations. Factors that could
cause actual results to differ from expectations include, without limitation:
(i)-the failure of certain key members of the Company's design teams or
management, including Ms. Karan, to continue to be active in the business of the
Company; (ii) the possibility of a termination of the Company's license with
Gabrielle Studio, Inc., a bankruptcy of Gabrielle Studio or transfer of the
stock of Gabrielle Studio; (iii) the timing and expense associated with, and
effects of, cost-cutting measures and the strategic initiatives being
implemented by the Company; (iv) risks associated with the receipt, pricing, and
timing of customer orders; (v) general competitive factors and the overall
financial condition of the apparel industry, the retail industry, and the
general economy; (vi) timing of and costs associated with new store openings;
(vii) a change in retailer or consumer acceptance of the Company's products;
(viii) the variability of the Company's results in any period due to the
seasonal nature of the business, the timing and level of the Company's sales,
the timing of launching new products and collections and opening of new doors,
fashion trends, and the timing, terms, consummation, or success of any joint
ventures, licenses, or other dispositions of product lines; (ix) consolidations
and restructurings in the retail industry causing a decrease in the number of
stores that sell the Company's products, or an increase in the ownership
concentration within the retail industry; (x) social, political, and economic
risks to the Company's foreign retail operations and customers, including
changes in foreign investment and trade policies and regulations of the host
countries and of the United States; (xi) the inability of the Company's
licensees to obtain capital, manage their labor relations, or maintain
operational or financial control over their businesses; (xii) changes in the
laws, regulations, and policies, including changes in accounting standards, that
affect, or will affect, the Company in the United States and abroad; (xiii)
foreign currency fluctuations affecting the Company's results of operations and
value of its foreign assets, the relative prices at which the Company and
foreign competitors sell their products in the same market, and the Company's
operating and manufacturing costs outside of the United States; (xiv) shipment
delays, depletion of inventory, and increased production costs resulting from
disruption at any of the Company's facilities or other causes; (xv) changes in
product mix to ones which are less profitable; and (xvi) the ability of the
Company and third parties, including customers or suppliers, to adequately
address Year 2000 issues. The Company assumes no responsibility to update
forward-looking statements made herein or elsewhere.
13
<PAGE>
DONNA KARAN INTERNATIONAL INC.
PART II. OTHER INFORMATION
Item 1. Legal Proceedings.
In 1997, the Company and certain directors and officers of the Company (the
"DK Defendants") were named as defendants in four separate class actions
filed in the United States District Court for the Eastern District of New
York. Each of the actions seeks unspecified damages and purports to be a
class action on behalf of all purchasers of common stock of the Company
during certain specified periods between June 1996 and May 1997. In
September 1997, these actions were consolidated by court order. The
complaints allege that the DK Defendants violated certain provisions of the
Securities Exchange Act of 1934, as amended, and the Securities Act of 1933,
as amended, and the rules thereunder as well as New York common law by (i)
making public statements and filing with the Securities and Exchange
Commission documents allegedly containing materially false and misleading
statements relating to the Company's license agreement with Designer
Holdings, Inc., which agreement was terminated on or about March 5, 1997 and
(ii) including in the Company's prospectus for its initial public offering
allegedly untrue statements and omissions of material facts with respect to
the business, management, and financial condition of the Company. In
addition to the DK Defendants, certain underwriters (the "Underwriters") of
the Company's initial public offering were named as defendants in the
actions relating to such public offering. In January 1998, the DK Defendants
filed a motion to dismiss the complaint in its entirety, with prejudice. The
Underwriters also filed a motion to dismiss.
On August 14, 1998, the Court granted the motions filed by the Company and
the Underwriters and dismissed the action in all respects. The Court offered
plaintiffs the opportunity to file a motion seeking leave to file an amended
complaint. Plaintiffs did not file such a motion and the Court entered
judgment dismissing the action. On October 9, 1998, plaintiffs filed a
notice of appeal which is expected to be heard by the United States Court of
Appeals for the 2nd Circuit during the first quarter of 1999. The United
States Court of Appeals has not yet set a schedule for the briefing and
argument of plaintiffs' appeal.
Item 5. Other Information
A stockholder who intends to submit a proposal for the Company's 1999
annual meeting of stockholders that the stockholder does not intend to
request be included in the Company's proxy materials in accordance with
the proxy solicitation regulations of the Securities and Exchange
Commission must give notice to the Company prior to December 29, 1998 and
also must comply with the provisions of the Company's Restated Certificate
of Incorporation and By-laws relating to stockholder proposals. The ability
of the persons designated as management proxies on the Company's proxy card
to exercise their discretionary authority to vote on such proposal depends,
in part, on the timely notification of such proposal by such stockholder.
Item 6. Exhibits and Reports on Form 8-K.
(a) Exhibits
27.1 - Financial Data Schedule
(b) Reports on Form 8-K
There were no reports on Form 8-K filed by the Company during the
three months ended September 27, 1998.
14
<PAGE>
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.
DONNA KARAN INTERNATIONAL INC.
(Registrant)
Date: November 11, 1998 By: /s/John D. Idol
----------------------------
John D. Idol
Chief Executive Officer
Date: November 11, 1998 By: /s/Joseph B. Parsons
----------------------------
Joseph B. Parsons
Executive Vice President and
Chief Financial Officer
15
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<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE DONNA
KARAN INTERNATIONAL INC. FORM 10-Q AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE
TO SUCH FINANCIAL STATEMENTS.
</LEGEND>
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