<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 25, 1999
COMMISSION FILE NUMBER 0-27002
--------------------------------------
MORROW SNOWBOARDS, INC.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
OREGON 93-1011046
(STATE OR OTHER JURISDICTION OF (I.R.S. EMPLOYER IDENTIFICATION NO.)
INCORPORATION OR ORGANIZATION)
---------------------------------------------------------------
2600 PRINGLE ROAD, S.E.
SALEM, OREGON 97302
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES)
REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE:
(503) 375-9300
Indicate by check mark whether the Registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
Registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. /X/ yes / / no
The number of shares outstanding of the registrant's common stock, no par value,
as of November 1, 1999 was 9,176,556.
1
<PAGE>
MORROW SNOWBOARDS, INC.
INDEX
<TABLE>
<S> <C>
Part I. Financial Information
Item 1. Financial Statements 3
Consolidated Balance Sheets 4
Consolidated Statements of Operations 5
Consolidated Statement of Shareholders' Equity 6
Consolidated Statements of Cash Flow 7
Notes to Consolidated Financial Statements 8
Item 2. Management's Discussion & Analysis of Financial Condition and Results of 15
Operations
Part II. Other Information
Item 1. Legal Proceedings 22
Item 2. Changes in Securities 23
Item 3. Defaults upon Senior Securities 23
Item 4. Submission of Matters to a Vote of Security Holders 23
Item 5. Other Information 23
Item 6. Exhibits and Reports on Form 8-K 24
Signatures 25
</TABLE>
2
<PAGE>
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
MORROW SNOWBOARDS, INC.
For the Quarter Ended
September 25, 1999
3
<PAGE>
MORROW SNOWBOARDS, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS, EXCEPT SHARE DATA)
(UNAUDITED)
<TABLE>
<CAPTION>
------------------- -----------------
ASSETS September 25, December 26,
1999 1998
------------------- -----------------
<S> <C> <C>
Current Assets:
Cash and cash equivalents $ 97 $ 1,348
Accounts receivable, less allowance for uncollectible accounts 863 4,843
Inventories 1,678 1,452
Prepaid expense 82 497
Refundable deposits 778 99
Refundable income taxes 53 -
Other current assets 280 119
Net current assets of discontinued operations - 2,439
------------------- -----------------
Total Current Assets 3,831 10,797
Equipment and fixtures, net 399 571
Property held for sale, net 3,061 3,108
Other assets:
Goodwill, net 2,577 3,926
Net non-current assets of discontinued operations - 1,468
Other assets, net - 208
------------------- -----------------
Total Other Assets 2,577 5,602
------------------- -----------------
Total Assets $ 9,868 $ 20,078
=================== =================
</TABLE>
LIABILITIES AND SHAREHOLDERS' EQUITY
<TABLE>
<CAPTION>
<S> <C> <C>
Current Liabilities:
Line of credit $ - $ 3,698
Accounts payable 4,239 3,053
Accrued liabilities 712 2,321
Income tax payable 20 -
Accrued loss on disposal - 1,498
Current portion of long-term debt 675 2,013
------------------- -----------------
Total Current Liabilities 5,646 12,583
Long Term Liabilities 750 -
Commitments and Contingencies
Shareholders' Equity
Preferred stock, no par, 10,000,000 shares authorized
no shares issued or outstanding - -
Common stock, no par, 20,000,000 shares authorized,
6,176,556 and 6,176,556 shares issued and outstanding 27,116 27,116
Accumulated deficit (23,609) (19,602)
Other Comprehensive Loss (35) (19)
------------------- -----------------
Total Shareholders' Equity 3,472 7,495
------------------- -----------------
Total Liabilities and Shareholders' Equity $ 9,868 $ 20,078
=================== =================
</TABLE>
The accompanying notes are an integral part of these
consolidated financial statements
4
<PAGE>
MORROW SNOWBOARDS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(IN THOUSANDS, EXCEPT SHARE DATA)
(UNAUDITED)
<TABLE>
<CAPTION>
FOR THE NINE MONTHS ENDED FOR THE THREE MONTHS ENDED
---------------------------------------------------------------
SEPTEMBER 25, SEPTEMBER 26, SEPTEMBER 25, SEPTEMBER 26,
1999 1998 1999 1998
--------------- --------------- --------------- ---------------
<S> <C> <C> <C> <C>
Net Sales $ 5,319 $ 6,271 $ 1,960 $ 3,861
Cost of Goods Sold 3,303 3,758 1,201 2,143
--------------- --------------- --------------- ---------------
Gross Profit 2,016 2,513 759 1,718
Operating Expenses:
Selling, marketing and customer service 1,593 2,261 382 743
Engineering, advance design and product
management 368 522 84 88
General and administrative 2,753 2,980 767 1,071
Loss on impairment of assets 1,135 - 1,135 -
--------------- --------------- --------------- ---------------
Total Operating Expenses 5,849 5,763 2,368 1,902
--------------- --------------- --------------- ---------------
Operating Loss (3,833) (3,250) (1,609) (184)
Other Expense:
Interest expense, net (73) (379) (7) (147)
Other Expense (13) (14) (99) (18)
--------------- --------------- --------------- ---------------
Total Other Expense (86) (393) (106) (165)
--------------- --------------- --------------- ---------------
Loss from Continuing Operations (3,919) (3,643) (1,715) (349)
Income Tax (Provision) Benefit 33 (55) - (55)
--------------- --------------- --------------- ---------------
Loss from Continuing Operations, Net of Taxes (3,886) (3,698) (1,716) (404)
Income(Loss) from Discontinued Operations, net of taxes 166 (430) 23 1,264
--------------- --------------- --------------- ---------------
Income (Loss) Before Extraordinary Item (3,720) (4,128) (1,692) 860
Extraordinary Loss on Extinguishment of Debt (287) - - -
--------------- --------------- --------------- ---------------
Net Income (Loss) $ (4,007) $ (4,128) $ (1,692) $ 860
=============== =============== =============== ===============
Net Loss Per Share - Continuing Operations
Basic $ (0.63) $ (0.60) $ (0.28) $ (0.06)
=============== =============== =============== ===============
Diluted $ (0.63) $ (0.60) $ (0.28) $ (0.06)
=============== =============== =============== ===============
Net Income(Loss) Per Share - Discontinued Operations
Basic $ 0.03 $ (0.07) $ 0.00 $ 0.20
=============== =============== =============== ===============
Diluted $ 0.03 $ (0.07) $ 0.00 $ 0.20
=============== =============== =============== ===============
Extraordinary Loss Per Share
Basic $ (0.05) $ - $ - $ -
=============== =============== =============== ===============
Diluted $ (0.05) $ - $ - $ -
=============== =============== =============== ===============
Net Income (Loss) Per Share - Total
Basic $ (0.65) $ (0.67) $ (0.27) $ 0.14
=============== =============== =============== ===============
Diluted $ (0.65) $ (0.67) $ (0.27) $ 0.14
=============== =============== =============== ===============
Weighted Average Number of Shares Used in
Computing Per Share Amounts:
Basic 6,176,556 6,176,556 6,176,556 6,176,556
=============== =============== =============== ===============
Diluted 6,176,556 6,176,556 6,176,556 6,176,556
=============== =============== =============== ===============
</TABLE>
The accompanying notes are an integral part of these
consolidated financial statements
5
<PAGE>
MORROW SNOWBOARDS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF SHAREHOLDERS' EQUITY
(IN THOUSANDS, EXCEPT SHARE DATA)
(UNAUDITED)
<TABLE>
<CAPTION>
Common Stock Other
---------------------- Accumulated Comprehensive
Shares Amount Deficit Loss Total
---------- ---------- ----------- ------------- ---------
<S> <C> <C> <C> <C>
Balance, December 26, 1998 6,176,556 $ 27,116 $ (19,602) $ (19) $ 7,495
Comprehensive Loss:
Net Loss - - (4,007) - (4,007)
Change in translation adjustment - - - (16) (16)
---------
Total Comprehensive Loss (4,023)
========== ========== =========== ============= =========
Balance, September 25, 1999 6,176,556 $ 27,116 $ (23,609) $ (35) $ 3,472
========== ========== =========== ============= =========
</TABLE>
The accompanying notes are an integral part of these
consolidated financial statements
6
<PAGE>
MORROW SNOWBOARDS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
(UNAUDITED)
<TABLE>
<CAPTION>
FOR THE NINE MONTHS ENDED
-------------------------------------------------
SEPTEMBER 25, SEPTEMBER 26,
1999 1998
----------------------- -----------------------
<S> <C> <C>
Cash Flows from Operating Activities:
Net loss $ (4,007) $ (4,128)
Adjustments to reconcile net loss to net cash provided by
(used in) operating activities:
Depreciation and amortization 700 1,644
Loss on impairment of assets 1,135 -
Loss on retirement of fixed assets 48 160
Other (16) (27)
Changes in operating assets and liabilities
(Increase) Decrease in accounts receivable 3,980 (1,714)
(Increase) Decrease in inventories 2,491 (1,247)
Decrease in prepaid expenses 415 347
(Increase) Decrease in refundable deposits (679) 77
(Increase) in refundable income taxes (53) -
(Increase) Decrease in other assets 1,008 (257)
Increase in accounts payable 1,186 1,492
Increase (Decrease) in accrued liabilities (1,788) 540
Increase in income tax payable 20 -
Decrease in accrued loss on disposal (1,498) -
----------------------- -----------------------
Net Cash Provided By (Used In)
Operating Activities 2,942 (3,113)
Cash Flows From Investing Activities:
Acquisition of property and equipment (139) (1,230)
Proceeds from sale of equipment 470 47
----------------------- -----------------------
Net Cash Provided By (Used In)
Investing Activities 331 (1,183)
Cash Flows From Financing Activities:
Proceeds from issuance of long-term liabilities 1,425 2,000
Principal payments on long-term liabilities (2,251) (98)
Line of credit borrowings (payments), net (3,698) 1,899
----------------------- -----------------------
Net Cash Provided By (Used In)
Financing Activities (4,524) 3,801
----------------------- -----------------------
Decrease In Cash and Cash Equivalents (1,251) (495)
Cash and Cash Equivalents at Beginning of Period 1,348 855
----------------------- -----------------------
Cash and Cash Equivalents at End of Period $ 97 $ 360
======================= =======================
Supplemental disclosure:
Cash paid for interest $ 73 $ 261
</TABLE>
The accompanying notes are an integral part of these
consolidated financial statements.
7
<PAGE>
MORROW SNOWBOARDS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
1. ORGANIZATION AND CURRENT EVENTS
DESCRIPTION OF BUSINESS
Morrow Snowboards, Inc., dba Westbeach, and subsidiaries (the
"Company"), headquartered in Salem, Oregon, was organized in October 1989 to
design, manufacture and market snowboards, boots, bindings, apparel and
accessories to retail outlets in the United States as well as international
distributors in several foreign countries. On November 13, 1997, the Company
acquired all of the outstanding securities of Westbeach Snowboard Canada Ltd., a
manufacturer, wholesaler and retailer of snowboarding apparel and casual
clothing. Westbeach Snowboard Canada, Ltd. was later reorganized as Morrow
Westbeach Canada ULC, a Nova Scotia unlimited liability company ("Westbeach").
Westbeach has three subsidiaries, an Austrian organization whose principal
activity consists of a European sales and warehousing operation, a United
Kingdom organization consisting of European sales and a Washington State
corporation whose principal activity is U.S. retail sales. On March 26, 1999,
the Company sold all of its "Morrow" intellectual property, along with all
1999/2000 snowboard inventories and its snowboard and binding production
equipment to K2 Acquisitions Inc. (K2) ("Note 6").
The consolidated financial statements include the wholly owned
subsidiaries, Morrow Westbeach Canada ULC, a Nova Scotia unlimited liability
company and Morrow International, Inc., a Guam foreign sales corporation. All
significant intercompany accounts and transactions have been eliminated.
The Company operates in a relatively new and rapidly growing segment of
the action sports industry that is highly seasonal. Further, the Company has
undergone significant expansion since its inception in 1989, related to its
manufacturing, marketing and sales activities with significant contraction of
certain operations due to the March 1999 discontinuance of its snowboard, boot
and binding operations. These and other factors present certain risks to the
future operations of the Company.
The accompanying un-audited consolidated financial statements have been prepared
in accordance with generally accepted accounting principles for interim
financial information and pursuant to the rules and regulations of the
Securities and Exchange Commission (the "Commission"). While these statements
reflect all necessary, normal and recurring adjustments in the opinion of
management required to present fairly, in all material respects, the financial
position, results of operations and cash flows of the Company and its
subsidiaries at September 25, 1999, and for the quarters and nine months ended
September 25, 1999 and September 26, 1998, they do not include all notes
required by generally accepted accounting principles for complete financial
statements. Further information is contained in the annual financial statements
of the Company and notes thereto, for the year ended December 26, 1998 ("Fiscal
1998"), contained in the Company's Form 10-K, filed with the Commission pursuant
to the Securities Exchange Act of 1934. Operating results for the quarter ended
September 25, 1999, are not necessarily indicative of the results that may be
expected for the full year.
CURRENT EVENTS
To address its ongoing working capital needs, the Company on August 25,
1999 borrowed $675,000 on a one-year bridge loan (Note 4) and raised an
additional $250,000 through the sale of its Common Stock in September 1999 (Note
7). Also on October 9,1999, the $500,000 debt under the Company's existing
credit facility with Capitol Bay Management, Inc. was converted to the Company's
Common Stock (Note 7). See the Company's Form 8-Ks for August 25, 1999 and
8
<PAGE>
September 30, 1999, and "Liquidity and Capital Resources" under "Management's
Discussion and Analysis" in Item 2 of this Form 10-Q. After reviewing its
working capital needs, the Company has determined it needs a minimum of $350,000
in additional working capital to implement its Business Plan for the 1999-2000
winter sports season for its existing business product lines. The Company is
pursuing alternatives to raise the additional capital. Further, such amount does
not include any reserves or contingencies. Such minimum number is also based on
a number of assumptions about orders of the Company's products, follow-up orders
and retail store sales, based on historical numbers. The minimum amount required
could increase significantly if the Company is unsuccessful in negotiating
acceptable settlements to the pending lawsuits and/or successfully prevailing in
such litigation. Further, the Company will need to obtain part or all of such
financing at certain dates to maintain adequate working capital and liquidity to
fund and continue its operations, as well as place and ship orders for apparel
for distribution under its Westbeach brand and acquire inventory for its
Westbeach retail stores.
Based on responses to date from potential financing sources, management
believes there is significant risk that the Company will be unable to obtain
adequate working capital at the time or in the amount needed to fund operations
and could face liquidation, either voluntary or involuntary. Further, based on a
review of expected financing needs, availability and costs, competition and
consolidation in the snow board and winter sports industry, current sales trends
for Westbeach apparel, and other factors, the Company's wholly-owned subsidiary,
Westbeach, has determined to try and sell part or all of it's two business
lines, the Westbeach apparel line and the Westbeach retail store. If Westbeach
sells part or all of it's business lines, after providing for working capital
and other expected business needs, any excess proceeds are expected to be
invested in securities or other businesses with a prospect for generating a
return to the Company's shareholders. The Company currently has several
prospective investment opportunities under review. The Company has previously
listed its office/manufacturing facility in Salem, Oregon for sale, which has
been shown in the financial statements as property held for sale. The proceeds
from sale of such real property are expected to be applied to payment of
creditors under the Payment Agreement discussed in Item 2, "Management's
Discussion and Analysis of Financial Condition and Results of Operations" under
"Liquidity and Capital Resources". Besides Westbeach considering a sale of part
or all of it's business lines, Westbeach will continue to seek additional
working capital to continue and maintain the business lines as part of the
Company, as well as continue to seek to reduce or defer expenses wherever
possible. If Westbeach's assets are sold and so reinvested, the Company's
business lines would materially change and the Company would face a different
set of risks.
There is no assurance that the Company will not encounter future
financial problems due to unexpected contingencies, unsuccessful results,
adverse results in pending litigation, or other factors.
The above matters raise a doubt about the Company's ability to continue
as a going concern. The financial statements do not include any adjustments
relating to the recoverability and classification of asset carrying amounts or
the amount and classification of liabilities that might result should the
Company be unable to continue as a going concern.
2. SIGNIFICANT ACCOUNTING POLICIES
FISCAL YEAR
Effective January 1, 1997, the Company changed its year-end from a
calendar year end to a 52 or 53 week fiscal year ending on the Saturday nearest
December 31st. Accordingly, the first fiscal quarter of 1999 began on December
27, 1998, and ended on March 27, 1999, whereas the prior fiscal quarter ended on
March 28, 1998. The second fiscal quarter of 1999 began on March 28, 1999 and
ended on June 26, 1999, and the prior year's second quarter ended on June 27,
1998. The third fiscal quarter of 1999 began on June 27, 1999 and ended on
September 25, 1999, and the prior year's third quarter ended on September 26,
1998.
CASH AND CASH EQUIVALENTS
9
<PAGE>
Cash and cash equivalents consist of cash on hand and on deposit and
highly liquid investments purchased with a maturity of three months or less.
FINANCIAL INSTRUMENTS
A financial instrument is cash or a contract that imposes or conveys a
contractual obligation, or right, to deliver or receive cash or another
financial instrument. The fair value of financial instruments approximated their
carrying value as of September 25, 1999, and September 26, 1998.
INVENTORIES
Inventories for continuing operations, including retail inventories,
are stated at the lower of average cost or market. Inventories for discontinued
operations are stated at the lower of cost or market using standard costs, which
approximate the first-in, first-out (FIFO) method. Costs for valuation of
manufacturing inventory are comprised of labor, materials (including freight and
duty) and manufacturing overhead.
DEPRECIATION AND AMORTIZATION
Property, plant and equipment are carried at cost. Depreciation of
property, plant and equipment is provided using the straight-line method over
the estimated useful lives of the assets, which are 10-35 years for buildings
and improvements and 3-12 years for equipment, fixtures and other. Amortization
of leasehold improvements and equipment under capital leases is provided using
the straight-line method over the expected useful lives of the assets or the
initial term of the lease (including periods related to renewal options which
are expected to be exercised), whichever is shorter. Amortization is included in
depreciation expense.
GOODWILL AND OTHER LONG LIVED ASSETS
Goodwill resulting from the Westbeach acquisition is being amortized
over 15 years using the straight-line method and is net of amortization and
write-downs of $1,659,000 at September 25, 1999. Goodwill and other long-lived
assets are periodically evaluated when facts and circumstances indicate that the
value of such assets may be impaired. Evaluations are based on non-discounted
projected earnings. If the valuation indicates that non-discounted earnings are
insufficient to recover the recorded assets, then the projected earnings are
discounted to determine the revised carrying value and a write-down for the
difference is recorded. Evaluations are also based on expected disposition of
operating lines. The Company performed an evaluation of the goodwill balance as
of September 25, 1999, from which it was determined that $1,135,000 of the
goodwill balance was unrealizable. The goodwill balance was reduced by the
unrealizable amount, and the corresponding loss was recorded as a loss in
impairment of assets in the accompanying consolidated statements of operations.
Management believes the reevaluated goodwill is realizable from future
continuing operations, or if such assets were sold, the expected realizable
value of such assets.
PROPERTY HELD FOR SALE
As a result of the sale of its snowboard, binding, and boot business
lines, the Company has decided to sell its manufacturing facility and
improvements. Such assets are reflected as property held for sale in the
accompanying Consolidated Balance Sheets.
DEFERRED LOAN COSTS
Deferred loan costs included in other assets are amortized over the
life of the related debt on a straight-line basis, which does not differ
materially from the effective rate method.
WARRANTY COSTS
The Company offered a one-year warranty on its snowboard, binding and
boot products. The Company provided for anticipated warranty expense related to
products sold. On May 11, 1999, the
10
<PAGE>
Company entered into an agreement with K2, in which K2 assumed all future
liability related to warranty claims in exchange for certain of the Company's
outstanding accounts receivable. The Company offers a one-year warranty on
its snowboard apparel and has provided for anticipated warranty expense.
ADVERTISING AND PROMOTION COSTS
Advertising and promotion costs are expensed as incurred and included
in selling, marketing and customer service expenses.
REVENUE RECOGNITION
The Company recognizes revenue from the sale of its products when the
products are shipped to customers or for retail sales when the customer takes
the product.
INCOME TAXES
The Company accounts for income taxes under the provisions of Statement
of Financial Accounting Standards No. 109, "Accounting for Income Taxes" (SFAS
109). SFAS 109 uses the liability method so that deferred taxes are determined
based on the estimated future tax effects of differences between the financial
statement and tax bases of assets and liabilities given the provisions of
enacted tax laws and tax rates. Deferred income tax expenses or credits are
based on the changes in the financial statement bases versus the tax bases in
the Company's assets or liabilities from period to period.
PRODUCT DEVELOPMENT COSTS
Expenditures associated with the development of new products and
improvements to existing products are expensed as incurred.
STOCK-BASED COMPENSATION PLANS
The Company accounts for its stock-based plans under Accounting
Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees" (APB
25). In 1996, the Company adopted the disclosure provisions of Statement of
Financial Accounting Standards No. 123, "Accounting for Stock-Based
Compensation" (SFAS 123).
NET LOSS PER SHARE
Effective December 27, 1997, the Company adopted SFAS 128, "Earnings
Per Share." SFAS 128 prescribes new calculations for Basic and Diluted Earnings
Per Share (EPS), which replaces the former calculations for Primary and Fully
Diluted EPS. Basic EPS is computed by dividing net income (loss) by the
weighted-average shares outstanding; no dilution for any potentially dilutive
securities is included. Diluted EPS is calculated differently than the Fully
Diluted EPS calculation under the old rules. When applying the treasury stock
method for Diluted EPS to compute dilution for options, SFAS 128 requires use of
the average share price for the period, rather than the greater of the average
share price or end-of-period share price.
<TABLE>
<CAPTION> Nine Months Ended
-----------------
Shares September 25, 1999 September 26, 1998
------------------ ------------------
<S> <C> <C>
Weighted average shares outstanding 6,176,556 6,176,556
Stock option and convertible debenture dilution (1) - -
------------------ ------------------
Weighted average shares outstanding for diluted EPS 6,176,556 6,176,556
------------------ ------------------
</TABLE>
11
<PAGE>
(1) The effect of potential common securities of 2,310,548 shares and
477,223 shares are excluded from the dilutive calculation for periods
ended September 25, 1999 and September 26, 1998, respectively, as their
effect would be antidilutive.
FOREIGN CURRENCY TRANSLATION
The financial statements of the Company's foreign subsidiaries are
translated into U. S. dollars using exchange rates at the balance sheet date for
assets and liabilities, and average exchange rates for the period for revenues
and expenses. Adjustments resulting from translating foreign functional currency
balance sheet components into U.S. dollars are included in Other Comprehensive
Income (Loss) in the Consolidated Statement of Shareholders' Equity.
USE OF 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 and liabilities,
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the
reporting period. Actual results could differ from those estimates.
RECLASSIFICATIONS
Certain prior period amounts have been reclassified to conform to the
current period presentation. These reclassifications had no effect on previously
reported results of operations.
3. INVENTORIES
<TABLE>
<CAPTION>
Inventories consisted of the following:
Sept 25, Dec 26,
1999 1998
--------------- ---------------
(in thousands)
<S> <C> <C>
Finished goods $ 747 $ 846
Retail goods 928 787
Work-in-process - 13
Raw materials 49 247
--------------- ---------------
1,724 1,893
Less reserve for obsolete inventory ( 46) (441)
--------------- ---------------
Total continuing operations inventories, net $ 1,678 $ 1,452
=================================
Total discontinued operations inventories, net $ - $ 2,717
=================================
</TABLE>
4. LONG-TERM DEBT
On May 7, 1998, the Company entered into a new credit facility with
Foothill Capital Corporation ("Foothill"), which credit facility replaced the
Company's prior credit facility with LaSalle Business Credit, Inc., which has
been fully repaid. The Foothill credit facility was acquired from Foothill by
Capitol Bay Management, Inc. ("Capitol Bay") on May 7, 1999. References to
"Lender" herein are to Foothill through May 6, 1999 and to Capitol Bay
thereafter. Through conversion of $500,000 of principal and interest of the
credit line to the Company's Common Stock on October 9, 1999, and payment of the
balance owing, the amount outstanding under the credit facility has subsequently
been reduced to zero. The Company does not expect to be able to borrow any
additional funds under this credit facility due to existing defaults and the
Company's failure to meet certain financial covenants. Due to the subsequent
conversion to Common Stock, the $500,000 outstanding balance as of September 30,
1999 has been classified as Long Term in the accompanying consolidated balance
sheet. The remaining $250,000 in the Long Term Liabilities balance relates to
the refundable payments that were received in advance of consummation of the
12
<PAGE>
September 30, 1999 sale of Common Stock (Note 7).
The credit facility bears interest at the Lender's Reference Rate plus
.5% to 1.5% depending on the principal amount outstanding. The Company is
required to pay a monthly fee equal to .25% per annum on the average unused
amount of the revolving credit facility. The credit facility allows the Lender,
in the event of a loan default, to charge interest at the default rate of 5.5%
above the Lender's prime rate as specified in the Credit Agreement. Based on
certain ongoing defaults under the Credit Agreement, such default rate of
interest has been in effect under the credit facility since March 12, l999. The
credit facility was issued based on a loan fee of $200,000, payable in
installments and monthly servicing fees of $4,000 per month. A fee of 1.5% per
annum is payable on the undrawn amount of outstanding letters of credit.
The credit facility was originally secured by substantially all of the
Company's assets. On August 25, 1999, the Lender under the credit facility
released its security interest in the Company's office/manufacturing facility in
Salem, Oregon, which building now secures repayment of the August 1999 bridge
loan and payment of amounts owing under the Payment Agreement with certain of
the Company's creditors (see the "Liquidity and Capital Resources" Section of
Item 2.).
On August 25, 1999, Morrow Snowboards, Inc. (the "Company") borrowed
$675,000 (the "Bridge Loan") secured by a first lien against the Company's
approximately 103,000 square foot offices and warehouse in Salem, Oregon and
related real estate ("Real Property"). The amounts owing under the Payment
Agreement are also secured by a trust deed against the Real Property. The
security interest in the Real Property under the Payment Agreement is
subordinate up to $750,000 to the Trust Deed signed in connection with the
Bridge Loan. The $675,000 outstanding balance as of September 25, 1999 is
classified as Current Portion of Long Term Debt in the accompanying consolidated
balance sheet.
5. SEGMENT AND GEOGRAPHIC REPORTING
Under Statement of Financial Accounting Standards No. 131, "Disclosures
about Segments of an Enterprise and Related Information" (SFAS 131), public
companies are required to disclose certain information about the enterprise's
reportable segments. The Company has two continuing reportable product segments
within four major geographic territories. The product segments are categorized
as softgoods and retail. Softgoods consist of apparel and accessories. The
geographic territories are the United States, Canada, Europe and Japan. The
accounting policies of the segments are the same as those described in the
summary of significant accounting policies. The Company's territorial segments
market, sell and distribute essentially the same products with the exception of
its retail stores, which additionally market and sell competitor products. The
following represents continuing operations segment and geographical data.
<TABLE>
<CAPTION>
----------------------------------------------------------------------
Nine Months Ended September 25, 1999
USA Canada Europe Japan Totals
------------- -------------- -------------- ---------- ---------------
Revenues: (in thousands)
<S> <C> <C> <C> <C> <C>
Softgoods $ 194 $ 1,129 $ 1,377 $ 164 $ 2,864
Retail 364 2,091 - - 2,455
------------- -------------- -------------- ------------ -------------
Total Revenues 558 3,220 1,377 164 5,319
Segment operating profit / (loss) (4,047) 476 (262) - (3,833)
Interest Expense 73 - - - 73
Depreciation and Amortization 359 58 21 - 438
Segment continuing operation assets 5,181 4,346 341 - 9,868
Segment asset expenditures for continuing
operations 127 4 8 - 139
------------------------------------------------------------------------
Nine Months Ended September 26, 1998
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USA Canada Europe Japan Totals
------------- -------------- -------------- ------------- --------------
Revenues: (in thousands)
Softgoods $ 474 $ 1,781 $827 $ 1,186 $ 4,268
Retail 290 1,713 - - 2,003
------------- -------------- -------------- ------------- --------------
Total Revenues 764 3,494 827 1,186 6,271
Segment operating profit / (loss) (3,165) 229 (314) - (3,250)
Interest Expense 379 - - - 379
Depreciation and amortization 538 51 6 - 595
Segment continuing operation assets 14,162 4,901 578 - 19,641
Segment asset expenditures for continuing
operations - 48 - - 48
</TABLE>
6. DISCONTINUED OPERATIONS
On March 26, 1999, the Company sold all of its right, title and
interest in and to the "Morrow" and "Morrow Snowboards" names and the other
trademarks, trade names and service marks to K2 Acquisitions, Inc. (K2). In
addition, K2 purchased all of the machinery, equipment and tooling used for the
manufacture of snowboards and bindings; rights to the machinery, equipment and
tooling that is leased by the Company; all of the Company's snowboard inventory
for the 1999/2000 season; purchase orders reflecting sales orders received and
accepted by the company prior to the date of sale; trademark licensing agreement
and international distribution agreement and all of the Company's rights,
claims, credits, causes of action or rights of set-off against third parties
relating to the assets. In consideration of the sale, conveyance, assignment,
transfer and delivery of the assets the Company was paid $3.2 million.
As a result of this transaction, the net book value of the assets
purchased and liabilities assumed by K2 at December 26, 1998 have been shown as
net current and non-current assets of discontinued operations in the
Consolidated Balance Sheets.
Operating results of the snowboard operations for the first nine months
and the third quarter of 1998 are shown separately in the Consolidated
Statements of Operations as income (loss) from discontinued snowboard
operations, net of tax. The loss from discontinued operations from year-end to
the date of the sale was accrued as of December 26, 1998. The discontinued
snowboard operating results include an allocation of consolidated net interest
expense based on net assets. The Consolidated Statements of Cash Flows have not
been restated to reflect discontinued operations presentation.
7. SUBSEQUENT EVENTS
Common Stock
On September 30, 1999, Capitol Bay Management, Inc. ("Capitol Bay")
exercised its option to acquire 1,000,000 shares of the Company's Common Stock
for $250,000 ($0.25 per share) and on October 9, 1999, Capitol Bay exercised its
right to convert $500,000 of the Company's credit facility to 2,000,000 shares
of the Company's Common Stock (also at $0.25 per share). Following such
transactions, the Company will have outstanding 9,176,556 shares of its voting
Common Stock. Following such purchases, Capitol Bay holds 3,000,000 shares of
the Company's common stock (32.69% of the Company's outstanding voting
securities) and an affiliate, Capitol Bay Securities, Inc. ("CBS") holds 232,900
shares (2.54% of the Company's outstanding voting securities); collectively,
3,232,900 shares constituting 35.23% of the Company's outstanding voting
securities. See the Company's Form 8-K for September 30, 1999 filed October 15,
1999, and Item 5 herein.
Bellevue, Washington Retail Store Sale
14
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The Company is in the process of finalizing the sale of its Bellevue,
Washington retail store lease, inventory and trade fixtures for approximately
$196,000. The payment consideration involved the assumption of the Company's
accounts payable related to that store's merchandise, assumption of the lease
for that location (with a release of the Company) and the payment of the
remaining balance of the purchase price of approximately $48,000 payable in
installments without interest based on subsequent store sales on January 5, 2000
and December 31, 2000.
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations
OVERVIEW
Since its formation, the Company has focused its business activities on
designing, manufacturing and marketing premium snowboards and related products
under the "Morrow" brand name. The Company acquired Westbeach, a merchandiser of
snowboarding apparel and casual clothing through the "Westbeach" brand name, and
the operator of three Westbeach retail stores which feature snowboards,
skateboards and related apparel and accessories, on November 12,1997. In March
1999, the Company sold its "Morrow" intellectual property, along with all
1999/2000 inventories and its snowboard and binding production equipment to K2
and discontinued manufacturing and marketing snowboards, boots and bindings. The
Company's consolidated net sales were $5,319,000 for continuing operations for
the nine months ended September 25, 1999. This compares to $6,271,000 for the
nine months ended September 26, 1998.
Due to the seasonal nature of the snowboard industry, a majority of the
Company's sales occur in the last two quarters of the year. The three Westbeach
retail stores, which do not carry as heavy a seasonal trend, help to reduce the
Company's seasonal nature. As noted herein, the Company is finalizing the sale
of its Bellevue, Washington retail store. Gross margins vary significantly
throughout the year depending on product mix, price and the mix of wholesale
versus retail sales throughout the year.
The Company accumulates a significant backlog of sales orders in
February and March of each year as a result of preseason orders placed in
connection with winter sports trade shows. As the Company begins delivery of
pre-season orders, backlog sales orders decrease and are usually eliminated by
the end of the year. The Company has taken certain steps to position itself for
the future, including selling of the Morrow-TM- brand product line, focusing on
the core apparel line offered by the Company, maintaining an efficient
management staff with expertise in core areas of the business and implementing
appropriate additional financial and accounting controls and systems.
Based on a review of expected financing needs, availability and costs,
competition and consolidation in the snow board and winter sports industries,
current sales trends for Westbeach apparel, and other factors, the Company's
wholly-owned subsidiary, Westbeach, has determined to try and sell part or all
of its two business lines, the Westbeach apparel line and the Westbeach retail
stores. If Westbeach sells part or all of its business lines, after providing
for working capital and other expected business needs, any excess proceeds are
expected to be invested in securities or other businesses with a prospect for
generating a return to the Company's shareholders. The Company currently has
several prospective investment opportunities under review. If Westbeach's assets
are sold and so reinvested, the Company's business lines would materially change
and the Company would face a different set of risks.
FORWARD-LOOKING STATEMENTS
This report contains forward-looking statements which are made pursuant
to the safe harbor provisions of the Private Securities Litigation Reform Act of
1995. The forward-looking statements involve risks and uncertainties that could
cause actual results to differ materially from the forward-looking statements.
The Company wishes to caution readers that important factors, among others, in
15
<PAGE>
some cases have affected, and in the future could affect, the Company's actual
results and could cause actual consolidated results for the first nine months of
1999, and beyond, to differ materially from those expressed in any
forward-looking statements made by, or on behalf of, the Company. These factors
include, without limitation, the Company's ability to obtain required working
capital and other financing in the amounts and at the times needed, new
initiatives by competitors, price pressures, cancellation of preseason orders,
inventory risks due to shifts in planned costs, weather in primary winter resort
areas of the world, and the risk factors listed from time to time in the
Company's SEC reports, including but not limited to, the report on Form 10-K for
the year ended December 26, 1998.
Based on changes in the Company's Board and stock ownership, a change
in control of the Company may have occurred. Such potential change is noted in
the Company's Form 8-K for September 30, 1999, filed with the SEC on October 15,
1999 and is based on an amended Schedule 13-D filed by Capitol Bay and others
("Reporting Persons") and described in Item 5 herein. Further, such change may
result in a change in the Company's business/business lines and involve an
extraordinary transaction, such as a merger. See Part II, Item 5 herein also.
Also, as noted, Westbeach may change its business lines and/or assets.
The Company's year to date net sales of $5,319,000 and order backlog of
$3,578,000 at September 25, 1999 for continuing operations, are down slightly
from those reported at September 26, 1998, with net sales of $6,271,000 and an
order backlog of $2,729,000. This decrease is attributable to later delivery of
fall 1999 inventory compared to 1998, and due to lack of working capital to
finance production of inventory.
The snowboard market worldwide has in prior years experienced a
significant oversupply of products at both the retail and wholesale level which
contributed to soft market conditions throughout the industry. Management
believes this oversupply has been materially reduced. Management is unaware of
any other trends or conditions that could have a material adverse effect on the
Company's consolidated financial position, future results of operations, or
liquidity. However, investors should also be aware of factors which could have a
negative impact on prospects and the consistency of progress. These include
political, economic or other factors such as currency exchange rates, inflation
rates, recessionary or expansive trends, taxes, regulations and laws affecting
the advertising, promotional and pricing activity; dependence on the rate of
development and degree of acceptance of new product introductions in the
marketplace; the difficulty of forecasting sales at certain times in certain
markets; and securing financing at the times and in the amounts needed to
support and meet the Company's working capital and other financing requirements.
RESULTS OF OPERATIONS
The following table sets forth certain financial data for the periods
indicated as a percentage of net sales.
<TABLE>
<CAPTION>
Nine Months Ended Year Ended
-------------------------------------------------------
Sept 25, Sept 26, December 26,
1999 1998 1998
-------------------------------------------------------
<S> <C> <C> <C>
Net Sales 100.0 % 100.0 % 100.0 %
Cost of Goods Sold 62.1 59.9 66.7
------------------------------------------------------
Gross Profit 37.9 40.1 33.3
------------------------------------------------------
Operating Expenses:
Selling, marketing and customer service 30.0 36.1 27.4
Engineering, research and product development 6.9 8.3 7.4
General and administrative 51.8 47.5 43.4
Loss on impairment of assets 21.3 - -
------------------------------------------------------
Total Operating Expenses 110.0 91.9 78.2
------------------------------------------------------
16
<PAGE>
Operating Loss (72.1) (51.8) (44.9)
Other Expense:
Interest Expense (1.4) ( 6.0) (5.7)
Other Expense (0.2) ( 0.2) (4.9)
------------------------------------------------------
Loss from Continuing Operations (73.7) (58.0) (55.5)
Income Tax Benefit (Expense) 0.6 (0.9) -
Loss from Continuing Operations, net of taxes (73.1) (58.9) (55.5)
Loss from discontinuance of operations - - (20.7)
Income (Loss) from Discontinued Operations, net of 3.1 ( 6.9) (78.5)
taxes
Loss before Extraordinary Item (70.0) (65.8) (154.7)
Extraordinary Loss on Extinguishment of Debt (5.4) - -
------------------------------------------------------
Net Loss (75.4)% (65.8)% (154.7)%
------------------------------------------------------
</TABLE>
COMPARISON OF THE NINE MONTHS ENDED SEPTEMBER 25, 1999 AND SEPTEMBER 26, 1998
CONTINUING OPERATIONS. The Company's continuing operations consist of
the Westbeach-TM- brand apparel and accessory lines and its three retail stores.
These continuing operations stem from the acquisition of Westbeach in November
1997.
NET SALES. Net sales for continuing operations for the first nine
months of 1999 decreased by 15.2% to $5,319,000, from $6,271,000 for the first
nine months of 1998. Sales for continuing operations of Westbeach(TM) brand
apparel were $2,864,000 for the nine months ended September 1999 and $4,268,000
for the nine months ended September 1998. Sales through the company's retail
stores were $2,455,000 and $2,003,000 for the nine months ended September 1999
and for the nine months ended September 1998, respectively. The decrease in
sales in Westbeach brand apparel resulted from the later arrival in 1999 versus
1998 of inventory for fall shipments, caused by the Company's working capital
problems.
GROSS PROFIT. Gross profit for continuing operations in the first nine
months of 1999 decreased 19.8% to $2,016,000 from $2,513,000 in the first nine
months of 1998 as a result of the decreased sales. As a percentage of sales,
total gross margin decreased from 40.1% in 1998 to 37.9% in 1999. The decrease
in gross profit was caused by the lower sales of Westbeach brand apparel noted
above. The decrease in gross profit margin is attributable to a different
customer mix in the 1999 period versus 1998. Shipments to distributors
represented a higher percentage of the customer mix during the first nine months
of 1999 compared to 1998, which shipments typically have a lower margin than
shipments to retailers.
OPERATING EXPENSES. Operating expenses for continuing operations
consist of selling, marketing and customer service; engineering, advance design
and product development; general and administrative expenses, and loss on
impairment of assets. These expenses increased to $5,849,000 for the first nine
months of 1999 from $5,763,000 for the first nine months of 1998. This increase
is due to a loss on impairment of goodwill of $1,135,000 in September of 1999
(Note 2). As a percentage of sales, the costs increased to 110.0% in 1999, from
91.9% in 1998.
SELLING, MARKETING AND CUSTOMER SERVICE. Selling, marketing and
customer service expenses for the first nine months of 1999 decreased 29.5% to
$1,593,000 from $2,261,000 for the first nine months of 1998. As a percentage of
sales, selling, marketing and customer service expenses decreased to 30.0% in
1999, from 36.1% in 1998. Staff and employee related expenses increased $163,000
while travel expenses decreased $73,000, trade show expenses decreased $52,000,
advertising decreased $323,000, distribution of promotional products decreased
$63,000 and all other expenses decreased by $320,000.
ENGINEERING, ADVANCE DESIGN AND PRODUCT MANAGEMENT. Engineering,
Advance Design and Product Management expenses for the first nine months of 1999
decreased 29.5% to $368,000 from
17
<PAGE>
$522,000 for the first nine months of 1998. As a percentage of sales,
engineering, advance design and product management decreased to 6.9% in 1999
from 8.3% in 1998. These expenses relate to the product development of the
Westbeach-TM- brand apparel and accessories. This decrease was the result of
a reduction in the cost of product testing, design consulting, and apparel
samples.
GENERAL AND ADMINISTRATIVE. General and administrative expenses for the
first nine months of 1999 decreased 7.6% to $2,753,000 from $2,980,000 for the
first nine months of 1998, representing 51.8% and 47.5% of net sales,
respectively. This decrease was primarily due to staff related expenditure
decreases in the first nine months of 1999 to $907,000 from $1,255,000 in 1998,
resulting from the integration of Morrow and Westbeach to generate a more
efficient use of general and administrative staff, and to a reduction in staff
following the sale of the "Morrow" brand and related products.
LOSS ON IMPAIRMENT OF ASSETS. Loss on Impairment of Assets increased in
the first nine months of 1999 to $1,135,000 from zero for the first nine months
of 1998. This loss resulted from management's reevaluation of Westbeach goodwill
(Note 2).
INTEREST EXPENSE. Interest expense decreased to $73,000 for the first
nine months of 1999 from $379,000 for the first nine months of 1998. This
decrease resulted from lower levels of borrowing required to support lower
inventory production levels in 1999 versus 1998.
OTHER INCOME / EXPENSE. Other expense was $13,000 for the first nine
months of 1999 compared to other expense of $14,000 for the first nine months of
1998.
INCOME TAX BENEFIT. The company carried back the 1998 year-end
non-capital losses for subsidiary Morrow Westbeach Canada ULC and applied them
against the previous year's taxable income. As a result, the company expects to
receive net refunds related to previous taxation years in the amount of $33,000.
NET LOSS. Net loss for continuing operations for the first nine months
of 1999 was $3,886,000 compared to a net loss of $3,698,000 for the first nine
months of 1998, an increase in loss of 5.1%. The loss from discontinued
operations from year-end to the date of the sale was accrued as of December 26,
1998.
DISCONTINUED OPERATIONS. Based on continued declining unit sales and
losses on its snowboard, boot and binding products, caused by oversupply of such
products, increased competition and other factors, and the Company's working
capital needs to continue such operations, the Company decided to sell its
snowboard, boot and bindings business and assets. On March 26, 1999, the Company
sold all of its snowboard, boot and binding assets to K2 for $3.2 million. The
Company retained all of the related receivables and liabilities, except for
capital lease obligations and certain contract team rider obligations. This
transaction generated a net loss on discontinued operations of $7,402,000 in
fiscal year 1998 compared to $7,113,000 in fiscal year 1997. In addition, as of
December 26, 1998, the Company recognized a loss on the discontinuance of
$1,952,000 which is comprised of a $454,000 loss on the sale to K2 and
$1,498,000 in accruals related to discontinued snowboard operations in the first
quarter of 1999.
For the nine months ended September 25, 1999, the Company had an income
from discontinued operations of $166,000. This income resulted from a revision
of certain warranty and commission accruals, accounts receivable allowances, and
a gain from a property tax refund from over-assessments in 1995 to 1997. This
income was not included in the accrual for loss on discontinued operations that
was recognized as of December 26, 1998. For the three months ended September 25,
1999, the Company had income of $23,000 from discontinued operations.
There is no basis to compare net sales of discontinued operations in
the first nine months of Fiscal 1999 to the first nine months of 1998, due to
the discontinuance of the Company's snowboard operation as of March 26, 1999, as
any comparison would be misleading.
18
<PAGE>
COMPARISON OF THE THREE MONTHS ENDED SEPTEMBER 25, 1999 AND SEPTEMBER 26, 1998
NET SALES. Net sales for continuing operations for the three months
ended September 25, 1999 were $1,960,000, down 49.2% from $3,861,000 during the
three months ended September 26, 1998. This decrease resulted from the later
arrival of inventory compared to 1998 for fall shipments, caused by the
Company's working capital problems.
GROSS PROFIT. Gross profit decreased by 55.8% from $1,718,000 for the
three month period ended September 26, 1998, to $759,000 for the three month
period ended September 25, 1999. As a percentage of sales, gross profit in the
three month period ended September 25, 1999 was 38.7%, down from 44.5% in the
three month period ended September 26, 1998. The decrease in gross profit is
attributable to the lower sales noted above. The decrease in gross profit
margins is attributable to customer mix during the period in 1999 versus 1998.
OPERATING EXPENSES. Total Operating Expenses increased 24.6%, from
$1,902,000 for the three months ended September 26, 1998 to $2,368,000 for the
three months ended September 25, 1999. Total Operating Expenses consist of
Selling, Marketing & Customer Service; Engineering, Advance Design & Product
Management; General and Administrative, and Loss on Impairment of Assets. This
increase is due to a loss on impairment of goodwill of $1,135,000 in the quarter
ending September 25, 1999 (Note 2).
SELLING, MARKETING & CUSTOMER SERVICE. Selling, Marketing & Customer
Service expenses decreased from $743,000 for the three months ended September
26, 1998, to $382,000 for the three months ended September 25, 1999. This
decrease of $361,000 or 48.6% resulted from staff reductions throughout the
quarter and other cost controls.
ENGINEERING, ADVANCE DESIGN & PRODUCT MANAGEMENT. Engineering, Advance
Design & Product Management expenses decreased from $88,000 for the three months
ended September 26, 1998, to $84,000 for the three months ended September 25,
1999.
GENERAL AND ADMINISTRATIVE. General and administrative costs decreased
from $1,071,000 for the three-month period ended September 26, 1998, to $767,000
for the three month period ended September 25, 1999, resulting from cost cutting
programs implemented throughout the company.
LOSS ON IMPAIRMENT OF ASSETS. Loss on Impairment of Assets increased in
the first nine months of 1999 to $1,135,000 from zero for the first nine months
of 1998. This loss is due to management's reevaluation of Westbeach goodwill
(Note 2).
INTEREST EXPENSE. Interest expense decreased for the three-month period
by 95.2% or $140,000, from $147,000 for the three month period ended September
26, 1998 to $7,000 for the three month period ended September 25, 1999. This
decrease resulted from reduced working capital borrowing needed in 1999 versus
1998 to support lower inventory production.
OTHER INCOME / EXPENSE. Other Income/expense changed from an expense of
$18,000 in the three month period ended September 26, 1998 to an expense in the
three month period ended September 25, 1999 of $99,000, resulting mainly from
loan fees and foreign currency exchange loss.
NET LOSS. The net loss on continuing operations increased in the three
month period ended September 25, 1999 to a net loss of $1,715,000 from a net
loss of $404,000 in the three month period ended September 26, 1998, a change of
$1,311,000. This increase in net loss is attributable to the decrease in sales
noted above and the loss on impairment of assets due to management's
reevaluation of Westbeach goodwill (Note 2).
YEAR 2000
The Company is undertaking an assessment of both its internal Year 2000
compliance issues and its key vendors', and customers', Year 2000 compliance
status.
19
<PAGE>
INTERNAL YEAR 2000 COMPLIANCE. During 1999, the Company continued to
assess its Year 2000 readiness. As a result of this assessment, and preparations
to date, the Company has determined that upgrades are required to its voice mail
system and payroll software. Management estimates the cost of these upgrades,
which it expects to complete by November, 1999, will be approximately $5,000.
EXTERNAL YEAR 2000 COMPLIANCE. In addition to its internal assessment,
the Company is surveying its vendors and its top 20 customers to determine their
Year 2000 readiness. Based on the results of those surveys, the Company will
develop a contingency plan for any suppliers of critical materials not expected
to be Year 2000 compliant, including identifying alternate sources of materials.
The Company generally has alternate sources for all of its key products.
However, problems with or delays in obtaining key products or higher costs due
to vendor or shipper Year 2000 compliance problems could adversely impact the
Company's ability to timely deliver products, the costs of such products and
related gross profit margins. The financial disruption of key
distributors/retailers' operations or shipping/transportation channels due to
Year 2000 compliance problems could adversely impact the Company's sales, costs
and related gross profit margins on products.
MARKET RISK
The Company accumulates foreign currency in payment of accounts
(principally Canadian dollars) which it then uses to pay its foreign vendors or
converts to U.S. dollars, exposing the Company to fluctuations in currency
exchange rates. The Company currently holds foreign currencies which are
translated into U.S. dollars using the quarter-end exchange rate, for a total of
$206,604. The potential loss in fair value resulting from an adverse change in
quoted foreign currency exchange rates of 10% amounts to $20,660. Actual results
may differ. The Company does not hold other market sensitive instruments and
therefore does not expect to be affected by any adverse changes in commodity
prices, or marketable equity security prices. The Company may be exposed to
future interest rate changes on its debt. The Company does not believe that a
hypothetical 10 percent change in interest rates would have a material effect on
the Company's cash flow.
LIQUIDITY AND CAPITAL RESOURCES
The Company requires capital for the purchase and shipment of finished
good apparel and accessory items used in the Westbeach apparel and accessory
product line; and also, to purchase sporting goods and apparel and accessory
items for the three retail stores. At September 25, 1999, the Company had
$97,000 in cash and revolving loans of $0, compared to $360,000 in cash and
revolving loans of $3,822,000 outstanding at September 26, 1998. The Company has
received additional financing through the Bridge Loan for $675,000 and a
subsequent sale of Company Common Stock for $250,000 as described in Item 5 of
this report. As of September 25, 1999, and based on such additional financing,
the Company estimated it needed at least an additional minimum of $350,000 in
working capital to implement its Business Plan for the 1999-2000 winter sports
season. The Company may require additional working capital to support future
operations.
Net cash provided by operating activities through the third quarter of
1999 was $2,942,000, resulting primarily from the discontinued snowboard
operations. The following is a detailed account of the operating activity
affecting cash flows for the nine months ended September 25, 1999: depreciation
and amortization provided $700,000, loss on retirement of fixed assets of
$48,000, an increase in "other" used $16,000, which is mostly comprised of
differences in currency exchange. The following represents changes in operating
assets and liabilities as of September 25, 1999 (as compared to December 26,
1998). There was a decrease in accounts receivable by $3,980,000, due, in large
part, to the collections of accounts for the 98/99 season products. Also, there
was a decrease in inventories of $2,491,000, due to the sale of the snowboard
operations to K2. There was a decrease in prepaid expenses of $415,000, an
increase in refundable deposits of $679,000 and refundable income taxes of
$53,000, and a decrease in other assets by $2,143,000. There was an increase in
accounts payable of $1,186,000, a decrease in accrued liabilities of $1,788,000,
an increase in income taxes payable of $20,000, and finally, a decrease in
accrued loss on disposal of $1,498,000, which is also attributed to the sale of
snowboard assets to K2.
20
<PAGE>
Net cash generated from investing activities for the nine months ended
September 25, 1999 totaled $331,000, resulting from the outlay of cash for the
acquisition of property and equipment in the amount of $139,000, and the
proceeds from the sale of equipment of $470,000.
Net cash used in financing activities for the nine months was
$4,524,000, consisting of $3,698,000 in line of credit payments, $2,251,000 in
payments on long-term liabilities, and proceeds from issuance of long-term
liabilities of $1,425,000.
The Company's credit facility with Foothill Capital Corporation
("Foothill") was acquired by Capitol Bay Management, Inc. ("Capitol Bay") on May
7, l999. The term "Lender" herein refers to Foothill prior to May 7, l999 and to
Capitol Bay thereafter. As noted in Note 4 to the Financial Statements, through
repayment and/or conversion to the Company's Common Stock, the Company currently
has reduced borrowings under its credit line to zero with no additional
borrowings expected thereunder.
At September 25, 1999, the credit facility was secured by substantially
all of the Company's assets, except the Company's office/manufacturing facility
in Salem, Oregon. That real property, which the Company has listed for sale, now
secures the repayment of both the "Bridge Loan" and certain Company creditors
under the Payment Agreement described herein. Under the Payment Agreement, the
Company, and certain trade creditors holding undisputed, non-contingent,
liquidated claims against the Company (approximately $2.5 million in the
aggregate) will receive payments from the Company as follows: (i) $250,000 by
August 27, 1999 (which payment was made on August 28, 1999); (ii) $200,000 in
each of the calendar quarters ending November 25, 1999, February 23, 2000 and
May 23, 2000; and (iii) the remaining unpaid balance of such claims, without
interest, all due and payable June 28, 2000. Such payments are secured by a lien
against the Company's Real Property, subject to a senior lien up to $750,000 to
secure the Bridge Loan or replacement financing therefore. There is no assurance
that the Company will be able to make the payments provided under such plan.
Due to the lack of borrowing capacity under the credit facility, the
Company's limited working capital, the Company's debts, including accounts
payable, and other factors as outlined herein, the Company has a liquidity
problem. After reviewing its working capital needs, the Company has determined
it will need additional working capital for 1999. The Company is working on
reducing the amount of working capital needed and pursuing alternatives to raise
that capital without raising additional equity.
Based on response to date from potential financing sources, there is
significant risk the Company will be unable to obtain adequate working capital
at the time or in the amount needed to finance its existing business lines. As a
result, the Company's subsidiary, Westbeach is currently considering selling all
of its business lines. Besides considering a potential sale of part or all of
Westbeach's business lines, the Company will continue to seek additional working
capital to continue and maintain the business lines as part of the Company, as
well as seek to reduce or defer expenses wherever possible. There is no
assurance that the Company will be able to obtain adequate working capital in
the amounts needed or at the times needed to sustain its operations or sell its
business lines in a timely fashion. Further, changes in the Company's business
lines and activities may require additional working capital.
If Westbeach sells part or all of its business lines, after providing
for working capital and other expected business needs, any excess proceeds are
expected to be invested in securities or other businesses with a prospect for
generating a return to the Company's shareholders. The Company currently has
several prospective investment opportunities under review. If Westbeach's assets
are sold and so reinvested, the Company's business lines would materially change
and the Company would face a different set of risks. Such action could
materially change the Company's needs for liquidity and working capital.
At the close of business on April 26, 1999, the Company was delisted
from the NASDAQ Stock Market. Because the Company has been delinquent in its
filings under the Securities
21
<PAGE>
Exchange Act of 1934 ("1934 Act"), trading in the Company's securities have
been reported in the pink sheets. Following the filing of this 10-Q, the
Company expects the requisite number of market makers to apply for listing
the Company's Common Stock on the OTC Bulletin Board on the Company's behalf.
The Company expects to remain current in its 1934 Act filings hereafter.
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
The Company is currently involved in the litigation and proceedings
described below.
There are four pending legal matters before the Company, some of which
have been tentatively settled.
1. SANDRA TEAL v. MORROW SNOWBOARDS, INC. (United States District
Court, District of Oregon, No. 99-6005-HO). The lawsuit filed by a former
employee is a civil action for declaratory injunctive relief, damages and
attorneys' fees for federal claims pursuant to the Family and Medical Leave Act
of 1993, 29 U.S.C. (S) 2601-2619 (1994) ("FMLA Claims"). The action also
includes supplemental claims under the Oregon Family Leave Act, ORS 659.470 to
659.494 ("OFLA Claims") and ORS 659.030 (prohibiting employment discrimination
based on sex). The FMLA Claims allege that Morrow violated the plaintiff's leave
and re-employment rights. For the FMLA Claims, the plaintiff seeks reinstatement
to her former position, compensatory damages estimated to exceed $50,000, and
equivalent liquidated damages, plus attorneys' fees. The OFLA Claims are similar
to the FMLA Claims. For the OFLA Claims, the plaintiff seeks reinstatement to
her former position, compensatory damages estimated to exceed $50,000, plus
attorneys' fees. Additionally, under Oregon law, the plaintiff seeks damages for
Morrow's alleged sex discrimination in hiring new employees to perform duties
that plaintiff performed, reinstatement to her former position, compensatory
damages estimated to exceed $50,000, and punitive damages in excess of $50,000,
plus attorneys' fees. The Company has orally settled this matter for $15,000,
payment of which is due in December 1999.
2. VENDOR CLAIM. Pama Limited, a Hong Kong company ("Pama") was
an agent of Westbeach for fall 1997 production and fall 1998 sales samples. Pama
claims approximately $84,000 was owing for services provided. Westbeach claims
Pama failed to perform given that fall 1998 samples were not timely delivered
and that certain surcharges were not agreed to. The parties are in discussions
to settle this matter.
3. MICHAEL JOSEPH FASHION AGENCY, INC. v. MORROW SNOWBOARDS, INC.
(Supreme Court, Province of British Columbia, No. C981832). Michael Joseph
Fashion Agency Inc. ("Michael Joseph"), the Company's former Western Canadian
sales representative, filed a suit in Vancouver, British Columbia claiming
damages of approximately $127,000 (U.S. Dollars), together with interest,
attorneys' fees and certain litigation costs. Michael Joseph is seeking
approximately $60,000 for lost sales commissions due to the alleged termination
of its sales representative relationship without adequate notice under Canadian
common law principles, approximately $60,000 for alleged lost sales commissions
on gray market goods shipped through unauthorized distribution channels in its
exclusive sales territory and the balance for certain expenses incurred. The
Company has retained legal counsel in Vancouver, British Columbia to defend this
action. The Company believes it has a reasonable basis for defending against any
such claim, but there can be no assurance the Company will be successful in this
defense.
4. EMPIRE OF CAROLINA, INC. ("EMPIRE") v. MORROW SNOWBOARDS, INC.
(Palm Beach County, Florida, Circuit Court of the Fifteenth Judicial Circuit,
No. CL99-3453-AE). Empire has filed a lawsuit claiming a breakage fee of
$500,000 and reimbursement of its costs under the Letter of Intent with the
Company dated March 2, 1999. The Company has responded that it believes the
Letter of Intent was terminated without any obligation on the Company's part to
pay such a fee or reimburse any costs. The Company believes it has a reasonable
basis for that position and will vigorously defend against any action by Empire
seeking such fee. Discovery is just commencing in this lawsuit. A motion by the
Company to dismiss the suit for lack of jurisdiction in the Florida courts
22
<PAGE>
is expected to be tried in December, 1999. If the suit if dismissed, the
plaintiff could bring the action in another jurisdiction, such as Oregon,
where jurisdiction is more likely to be found.
The previously reported AMERI-TOOL INDUSTRIES, INC. v. MORROW
SNOWBOARDS, INC. and MARMOT MOUNTAIN, LTD. v. MORROW SNOWBOARDS, INC. cases have
been or are being dismissed or settled.
An award of damages or the expenditure of significant sums in some or a
combination of some of the matters described above could have a material adverse
effect on the Company's financial condition and results of operations. The
Company's financial condition and capital resources may also adversely affect
its ability to vigorously defend any action.
ITEM 2. CHANGES IN SECURITIES.
The following sales of securities occurred after the fiscal quarter
ended September 25, 1999:
1. On September 30, 1999: The sale of one million (1,000,000)
shares of the Company's Common Stock (no par value) to Capitol Bay Management,
Inc. (Capitol Bay) was completed on September 30, 1999 at a price of $.25 per
share. The shares were sold in reliance on the exemption available under Section
4(2) of the Securities Act of 1933.
2. On October 9, 1999: The sale of two million (2,000,000) shares
of the Company's Common Stock (no par value) to Capitol Bay through conversion
of $500,000 (principal and/or interest) of the balance owing Capitol Bay by the
Company under the line of credit described in Note 4 to the Company's Financial
Statements in this Form 10-Q at a conversion rate of $.25 per share. The
conversion and sale of shares were sold in reliance upon the exception available
under Section 4(2) of the Securities Act of 1933.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
--None--
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
--None--
ITEM 5. OTHER INFORMATION
Common Stock Sales. On September 30, l999, Capitol Bay Management,
Inc. ("CBM") completed the exercise of its option to acquire 1,000,000 shares
of Morrow Snowboards, Inc. (the "Company" or "Morrow") Common Stock for
$250,000 (at a purchase price of $.25 per share) and on October 9, l999,
CBM exercised its right to convert $500,000 of the Company's credit facility
to 2,000,000 shares of the Company's Common Stock, all at $.25 per share.
Following such transactions, the Company will have outstanding 9,176,556
shares of its voting Common Stock. Following such purchases, CBM holds
3,000,000 shares of the Company's common stock (32.69% of the Company's
outstanding voting securities) and an affiliate, Capitol Bay Securities, Inc.
("CBS") holds 232,900 shares (2.54% of the Company's outstanding voting
securities), collectively, 3,232,900 shares constituting 35.23% of the
Company's outstanding voting securities. As reported on Schedule 13D and
amendments thereto filed by CBM, CBS, Capitol Bay Group, Inc. ("CBG") and
Stephen C. Kircher, CBM and CBS are wholly-owned subsidiaries of CBG and
Stephen C. Kircher holds a majority interest in CBG (collectively, the
"Reporting Persons"). Mr. Kircher and CBG are each the beneficial owner of
such 3,232,900 shares of the Company's Common Stock. See Schedule 13D filed
with the SEC on July 19, l999, as amended on October 12, l999, regarding
their beneficial ownership of the Company's securities. The mailing address
for CBM, CBS, CBG and Steve Kircher is 2424 Professional Drive, Roseville,
California 95661. The shares of the Company's Common Stock held by the
Reporting Persons, if voted together may have sufficient voting power to
approve matters
23
<PAGE>
submitted to the Company's shareholders for approval, including the election
of the Company's Board of Directors.
The information contained herein is based on the Schedule 13-D filed by
CBM, CBS and Steve Kircher on July 19, 1999, as amended October 12, l999. In
such initial Schedule 13-D, the Reporting Persons noted that the shares were
acquired for investment purposes in the ordinary course of business. In the
Schedule 13-D, as amended on October 12, l999, the Reporting Persons stated that
CBM is currently negotiating (i) with potential candidates to merge into Morrow
or a subsidiary thereof; (ii) for the infusion of additional capital in an
attempt to maintain the financial stability of Morrow: and/or (iii) a
transaction utilizing the status of Morrow as a public company. Any or all of
the foregoing may result in an extraordinary transaction. Further, it is likely
that if any of the foregoing are negotiated on behalf of Morrow that Morrow will
issue additional shares of capital stock, amend its articles of incorporation,
effect a further change in the Morrow Board of Directors and management and/ or
change its business plan, any or all of which would likely create a material
change in the business or corporate structure of Morrow. Most of such actions
will require shareholder approval. Generally, under Oregon law, any action
requiring shareholder approval would have to be approved at a meeting at which a
quorum is present (a majority of the outstanding shareholders in person or by
proxy) and be approved by a majority of the shares represented (in person or by
proxy) and voting at such meeting. Directors are normally elected by a plurality
of the shares represented (in person or by proxy) and voting at the shareholder
meeting for the director position to be filled. Depending on the nature of the
transaction dissenters rights may or may not apply.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
Exhibits: 27.1 - Financial Data Schedule
Reports on Form 8-K
A current report on Form 8-K dated June 28, 1999 was filed on July 13,
1999 to report the termination of the involuntary bankruptcy proceeding, the
Payment Agreement and the right of Capitol Bay to acquire the Company's Common
Stock.
A current report on Form 8-K dated August 25, 1999 was filed September
9, 1999 to report a $675,000 bridge loan and Capitol Bay's oral exercise of its
option to acquire 1,000,000 shares of the Company's Common Stock.
A current report on Form 8-K dated September 30, 1999 was filed on
October 15, 1999 to report a potential change in control of the Company based on
the stock sales of 3,000,000 shares of the Company's Common Stock and change in
directors and the adoption of the Morrow Snowboards, Inc. 1999 Stock Option Plan
for Non-Employee Directors which provides for the issuance of 300,000 shares of
the Company's Common Stock (as presently constituted).
24
<PAGE>
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities exchange
Act of 1934, as amended, the Registrant has duly caused this report to be signed
on its behalf by the undersigned, thereunto duly authorized, in the City of
Salem, State of Oregon, on November 4, 1999.
MORROW SNOWBOARDS, INC.
By: /s/ P. Blair Mullin
---------------------------------
P. Blair Mullin
PRESIDENT (1)
(PRINCIPAL EXECUTIVE OFFICER)
By: /s/ P. Blair Mullin
---------------------------------
P. Blair Mullin
CHIEF FINANCIAL OFFICER
(PRINCIPAL FINANCIAL OFFICER AND
ACCOUNTING OFFICER)
(1) No Chief Executive Officer is appointed. Under the Company's
Bylaws, if no Chief Executive Officer is appointed, the President acts in such
capacity and has the authority of a Chief Executive Officer.
25
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