<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 JUNE 26, 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. |_| yes |X| no
The number of shares outstanding of the registrant's common stock, no par value,
as of October 1, 1999 was 7,176,556.
<PAGE>
MORROW SNOWBOARDS, INC.
INDEX
<TABLE>
<CAPTION>
<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 Operations 15
Part II. Other Information
Item 1. Legal Proceedings 21
Item 2. Changes in Securities 22
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 25
Signatures 25
</TABLE>
<PAGE>
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
MORROW SNOWBOARDS, INC.
For the Quarter Ended
June 26, 1999
<PAGE>
MORROW SNOWBOARDS, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS, EXCEPT SHARE DATA)
(UNAUDITED)
<TABLE>
<CAPTION>
-------------------------- -------------------------
ASSETS JUNE 26, DECEMBER 26,
1999 1998
-------------------------- -------------------------
<S> <C> <C>
Current Assets:
Cash and cash equivalents $ 139 $ 1,348
Accounts receivable, less allowance for uncollectible accounts 762 4,843
Inventories 863 1,452
Prepaid expense 250 596
Refundable income taxes 53 -
Other current assets 219 119
Net current assets of discontinued operations - 2,439
-------------------------- -------------------------
Total Current Assets 2,286 10,797
Equipment and fixtures, net 460 571
Property held for sale, net 3,061 3,108
Other assets:
Goodwill, net 3,783 3,926
Net non-current assets of discontinued operations - 1,468
Other assets, net - 208
-------------------------- -------------------------
Total Other Assets 3,783 5,602
-------------------------- -------------------------
Total Assets $ 9,590 $ 20,078
-------------------------- -------------------------
-------------------------- -------------------------
LIABILITIES AND SHAREHOLDERS' EQUITY
Current Liabilities:
Line of credit $ - $ 3,698
Accounts payable 3,210 3,053
Accrued liabilities 699 2,321
Income Tax Payable 20
Accrued loss on disposal - 1,498
Current portion of long-term debt 457 2,013
-------------------------- -------------------------
Total Current Liabilities 4,386 12,583
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 (21,917) (19,602)
Other Comprehensive Gain (Loss) 5 (19)
-------------------------- -------------------------
Total Shareholders' Equity 5,204 7,495
-------------------------- -------------------------
Total Liabilities and Shareholders' Equity $ 9,590 $ 20,078
-------------------------- -------------------------
-------------------------- -------------------------
</TABLE>
The accompanying notes are an integral part of these financial statements.
4
<PAGE>
MORROW SNOWBOARDS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(IN THOUSANDS, EXCEPT SHARE DATA)
(UNAUDITED)
<TABLE>
<CAPTION>
FOR THE SIX MONTHS ENDED FOR THE THREE MONTHS ENDED
------------------------------------ -----------------------------------
JUNE 26, JUNE 27, JUNE 26, JUNE 27,
1999 1998 1999 1998
----------------- ----------------- ---------------- ----------------
<S> <C> <C> <C> <C>
Net Sales $ 3,359 $ 2,410 $ 1,414 $ 909
Cost of Goods Sold 2,102 1,615 880 577
----------------- ----------------- ---------------- ----------------
Gross Profit 1,257 795 534 332
Operating Expenses:
Selling, marketing and customer service 1,211 1,518 349 462
Engineering, advance design and product
management 283 434 109 158
General and administrative 1,986 1,909 903 918
----------------- ----------------- ---------------- ----------------
Total Operating Expenses 3,480 3,861 1,361 1,538
----------------- ----------------- ---------------- ----------------
Operating Loss (2,223) (3,066) (827) (1,206)
Other Income (Expense):
Interest expense (67) (232) (50) (147)
Other Income (Expense) 86 4 122 (63)
----------------- ----------------- ---------------- ----------------
Total Other Income (Expense) 19 (228) 72 (210)
----------------- ----------------- ---------------- ----------------
Income(Loss) from Continuing Operations (2,204) (3,294) (755) (1,416)
Income Tax Benefit 33 33
----------------- ----------------- ---------------- ----------------
Loss from Continuing Operations, Net of Taxes (2,171) (3,294) (722) (1,416)
Income(Loss) from Discontinued Operations, net of taxes 143 (1,694) (7) (136)
----------------- ----------------- ---------------- ----------------
Loss Before Extraordinary Item (2,028) (4,988) (729) (1,552)
Extraordinary Loss on Extinguishment of Debt (287) (287) 0
----------------- ----------------- ---------------- ----------------
Net Loss $ (2,315) $ (4,988) $ (1,016) $ (1,552)
----------------- ----------------- ---------------- ----------------
----------------- ----------------- ---------------- ----------------
Net Loss Per Share - Continuing Operations
Basic $ (0.35) $ (0.53) $ (0.12) $ (0.23)
----------------- ----------------- ---------------- ----------------
----------------- ----------------- ---------------- ----------------
Diluted $ (0.35) $ (0.53) $ (0.12) $ (0.23)
----------------- ----------------- ---------------- ----------------
----------------- ----------------- ---------------- ----------------
Net Income(Loss) Per Share - Discontinued Operations
Basic $ 0.02 $ (0.28) $ (0.00) $ (0.02)
----------------- ----------------- ---------------- ----------------
----------------- ----------------- ---------------- ----------------
Diluted $ 0.02 $ (0.28) $ (0.00) $ (0.02)
----------------- ----------------- ---------------- ----------------
----------------- ----------------- ---------------- ----------------
Extraordinary Loss Per Share
Basic $ (0.04) $ - $ (0.04) $ -
----------------- ----------------- ---------------- ----------------
----------------- ----------------- ---------------- ----------------
Diluted $ (0.04) $ - $ (0.04) $ -
----------------- ----------------- ---------------- ----------------
----------------- ----------------- ---------------- ----------------
Net Loss Per Share - Total
Basic $ (0.37) $ (0.81) $ (0.16) $ (0.25)
----------------- ----------------- ----------------- ----------------
----------------- ----------------- ----------------- ----------------
Diluted $ (0.37) $ (0.81) $ (0.16) $ (0.25)
----------------- ----------------- ----------------- ----------------
----------------- ----------------- ----------------- ----------------
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 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 INCOME (LOSS) TOTAL
--------- ---------- ----------- ------------ ----------
<S> <C> <C> <C> <C> <C>
Balance, December 26, 1998 6,176,556 $ 27,116 $ (19,602) $ (19) $ 7,495
Comprehensive Income (Loss):
Net Loss -- -- (2,315) -- (2,315)
Change in translation adjustment -- -- -- 24 24
----------
Total Comprehensive Loss (2,291)
---------- ---------- ---------- ---------- ----------
Balance, June 26, 1999 6,176,556 $ 27,116 $ (21,917) $ 5 $ 5,204
---------- ---------- ---------- ---------- ----------
---------- ---------- ---------- ---------- ----------
</TABLE>
The accompanying notes are an integral part of these financial statements.
6
<PAGE>
MORROW SNOWBOARDS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
(UNAUDITED)
<TABLE>
<CAPTION>
YEAR TO DATE
-------------------------------------------------
JUNE 26, JUNE 27,
1999 1998
----------------------- -----------------------
<S> <C> <C>
Cash Flows from Operating Activities:
Net loss $ (2,315) $ (4,988)
Adjustments to reconcile net loss to net cash provided by
(used in) operating activities:
Depreciation and amortization 569 1,158
Gain/(Loss) on Retirement of Fixed Assets 48 (1)
Other 24 (90)
Changes in operating assets and liabilities
Decrease in accounts receivable 4,081 3,231
(Increase) Decrease in inventories 3,306 (1,947)
Decrease in prepaid expenses 346 291
Increase in refundable income taxes (53) -
(Increase) Decrease in other assets 1,068 (203)
Increase in accounts payable 157 444
Decrease in accrued liabilities (1,801) (381)
Increase in income tax payable 20 -
Decrease in accrued loss on disposal (1,498) -
----------------------- -----------------------
Net Cash Provided By (Used In)
Operating Activities 3,952 (2,486)
Cash Flows From Investing Activities:
Acquisition of property and equipment (139) (971)
Proceeds from sale of equipment 470 35
----------------------- -----------------------
Net Cash Provided By (Used In)
Investing Activities 331 (936)
Cash Flows From Financing Activities:
Proceeds from issuance of long-term liabilities 457 2,000
Principal payments on long-term liabilities (2,251) (58)
Line of credit borrowings (payments), net (3,698) 932
----------------------- -----------------------
Net Cash Provided By (Used In)
Financing Activities (5,492) 2,874
----------------------- -----------------------
Decrease In Cash and Cash Equivalents (1,209) (548)
Cash and Cash Equivalents at Beginning of Period 1,348 855
----------------------- -----------------------
Cash and Cash Equivalents at End of Period $ 139 $ 307
----------------------- -----------------------
----------------------- -----------------------
Supplemental disclosure:
Cash paid for interest $ 67 $ 140
</TABLE>
The accompanying notes are an integral part of these 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 unaudited 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 June 26, 1999, and for the quarters and six months ended June
26, 1999 and June 27, 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 June 26, 1999, are
not necessarily indicative of the results that may be expected for the full
year.
CURRENT EVENTS
As a result of the Fiscal 1998 loss, effective March 12, 1999, the
Company was in default of certain covenants of its credit facility with Foothill
Capital Corporation ("Foothill"), with Foothill declaring a default on March 12,
1999. The Company entered into an agreement with Capitol Bay Management, Inc.
("Capitol Bay") pursuant to which Capitol Bay purchased the existing credit
facility
<PAGE>
from Foothill. 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. 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.
To address its working capital needs, the Company on August 25, 1999
borrowed $675,000 on a one-year bridge loan and raised an additional $250,000
through the sale of its Common Stock in September 1999. See the Company's Form
8-K for August 25, 1999 and "Liquidity and Capital Resources" under Management's
Discussion and Analysis" in Item 2 of this Form 10-Q.
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. As a result, the
Company is considering selling part or all of its business lines. 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 the next
paragraph. Besides considering a potential sale of part or all of its 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 continue to
seek to reduce or defer expenses wherever possible.
Certain of the Company's creditors filed an involuntary petition under
Chapter 7 of the United States Bankruptcy code. Dismissal of the involuntary
petition was approved by the bankruptcy court on June 16, 1999. The settlement
with the creditors was approved by over 90% of the creditors (by number and
dollar amount of claims) with undisputed claims. The settlement covers most, but
not all, creditors. The settlement agreement with those creditors is reflected
in a Payment Agreement and the payment obligations thereunder are secured by a
security interest in the Company's office/manufacturing facility in Salem,
Oregon. See the Company's Form 8-K's for May 3, 1999 and June 28, 1999.
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.
CASH AND CASH EQUIVALENTS
<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 June 26, 1999, and June 27, 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 of
$454,000 at June 26, 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.
Management has evaluated the Westbeach goodwill and believes it is realizable
from future continuing operations.
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
<PAGE>
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 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.
<PAGE>
<TABLE>
<CAPTION>
SIX MONTHS ENDED
----------------
Shares JUNE 26, 1999 JUNE 27, 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>
(1) The effect of potential common securities of 2,182,248 shares and
525,777 shares are excluded from the dilutive calculation for periods
ending June 26, 1999 and June 27, 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.
3. INVENTORIES
Inventories consisted of the following:
<TABLE>
<CAPTION>
June 26, Dec 26,
1999 1998
--------------- ---------------
(in thousands)
<S> <C> <C>
Finished goods $ 335 $ 846
Retail goods 496 787
Work-in-process - 13
Raw materials 78 247
--------------- ---------------
909 1,893
Less reserve for obsolete inventory ( 46) (441)
--------------- ---------------
Total continuing operations inventories, net $ 863 $ 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. The Company's line of credit under the credit facility is for up to
$10,000,000, including an inventory subline of up to $3,500,000, a
<PAGE>
letter of credit subline of up to $5,000,000, a term loan of up to $2,000,000
and a one-time over-advance subline of up to $750,000. Borrowings available
under the revolving credit facility and line are reduced by borrowings from time
to time under the other credit facilities. The amount that may be borrowed is
also limited to the value of certain eligible inventory, accounts receivable and
other assets.
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 (Note 1). The credit facility requires the Company to
comply with certain financial covenants, including, among other things, a
tangible net worth value and an "EBITDA" test as defined in the credit facility.
The Company failed to meet the tangible net worth value and EBITDA tests for
Fiscal 1998 and has not met such tests since then. The Company's tangible net
worth at June 26, 1999 was $1,171,000, compared to the required value of
$10,500,000. The Company's "EBITDA" for the six months ended June 26, 1999, was
a loss of $1,712,000 compared to the $3,000,000 "EBITDA" requirement. The
Company's failure to meet both the tangible net worth covenant and the "EBITDA"
covenant results principally from lower than projected sales revenue and related
net income. No default has been declared on these financial covenants.
At March 12, 1999, the Company was in default of the over-advance
funding limitation under Section 2.5 of the Credit Agreement. As a result of
such default, the Lender was entitled to exercise its rights and remedies in
accordance with the Credit Agreement. The Lender reserved all of its rights to
enforce the Credit Agreement as a result of that event of default, effective
March 12, 1999, and invoked its right to charge interest at the default rate of
5.5% above the Lender's prime rate. Capitol Bay, as the successor Lender under
the credit facility, has not waived any of these defaults or decreased the
interest rate.
At March 27, 1999, the Company's borrowings under the credit facility
approximated $742,000, consisting of a $742,000 term loan and $0 under the
revolving line of credit. On May 7, 1999, when Capitol Bay acquired the credit
facility, the amount owing under the credit facility was $217,722, which amount
was increased to $451,055, reflecting a reduced Termination Fee (as defined in
the credit facility) of $100,000 and an unpaid closing fee of $133,333. Such
fees, in addition to the unamortized portion of deferred financing fees are
reflected in the extraordinary loss on extinguishment of debt in the
consolidated statements of operations for the period ending June 26, 1999. On
June 26, 1999, the Company's borrowings under the credit facility approximated
$457,000, consisting of a $457,000 term loan and $0 under the revolving line of
credit.
On August 25, 1999, Morrow Snowboards, Inc. (the "Company") borrowed
$675,000 (the "Bridge Loan") secured by a first lien against the Company's real
property located in Salem, Oregon. The Company received net proceeds for working
capital purposes of approximately $327,000 after payment of loan costs and fees
of approximately $60,000, payment of certain personal property taxes of
approximately $38,000, and payment of $250,000 to creditors under the Payment
Agreement outlined in the Company's Form 8-K dated June 28, 1999 and filed on
July 13, 1999. The Bridge Loan bears interest at the rate of 12%, requires
monthly payments of interest only of $6,750 and is payable in full on June 28,
2000. The loan is secured by a first lien against the Company's approximately
103,000 square foot offices and warehouse in Salem, Oregon and related real
estate
<PAGE>
("Real Property"). The loan is evidenced by a Promissory Note and Trust Deed
(collectively, the "Loan Documents"). Besides payment of the amounts owing from
time to time under the Promissory Note, the Loan Documents impose a number of
obligations on the Company related to the Real Property, including without
limitation, obligations to maintain and insure the Real Property, pay property
taxes on the Real Property, and keep the Real Property free of liens. The Loan
Documents contain provisions that provide for acceleration of the loan in the
event monthly payments are not made within certain grace periods or other
required actions under the Promissory Note or Trust Deed are not undertaken.
Under Oregon law, the security interest in the property could be foreclosed
judicially or non-judicially. If the Company were to default on the Bridge Loan
and the security interest foreclosed, the sales proceeds from a foreclosure
would likely be less than the fair market value realized upon an orderly
liquidation of the real property. The Company is currently attempting to sell
the Real Property. Any sales proceeds would be applied first to payment of the
Bridge Loan and, after such payment, to amounts owing to creditors under the
Payment Agreement. The amounts owing under the Payment Agreement are secured by
a trust deed against the Real Property that is subordinate to up to $750,000
secured by the Trust Deed signed in connection with the Bridge Loan.
Capitol Bay has exercised its option to acquire 1,000,000 shares of the
Company's Common Stock for $250,000 ($0.25 per share). When issued, Capitol Bay
and its affiliates will hold 16.45% of the outstanding shares of the Company's
Common Stock. Capitol Bay also has the right to convert $500,000 of Company's
borrowings into 2,000,000 shares of the Company's Common Stock which conversion
right has not been exercised to date. See the Company's Current Report on Form
8-K for June 28, 1999, and filed with the SEC on July 13, 1999, regarding
Capitol Bay and its right to acquire the Company's Common Stock. See also the
Schedule 13-D filed July 19, 1999, and the Form 3 dated July 22, 1999, filed by
Capitol Bay and its affiliates regarding their beneficial ownership of the
Company's securities.
5. SEGMENT AND GEOGRAPHIC REPORTING
Under Statement of Financial Accounting Standards No. 131, "Disclosures
about Segments of an Enterprise and Related Information" (SFAS 131), public
companies are required to disclose certain information about the enterprise's
reportable segments. The Company has two continuing reportable product segments
within four major geographic territories. The product segments are categorized
as softgoods and retail. Softgoods consist of apparel and accessories. The
geographic territories are the United States, Canada, Europe and Japan. The
accounting policies of the segments are the same as those described in the
summary of significant accounting policies. The Company's territorial segments
market, sell and distribute essentially the same products with the exception of
its retail stores, which additionally market and sell competitor products. The
following represents continuing operations segment and geographical data.
<TABLE>
<CAPTION>
----------------------------------------------------------------------
Six Months Ended June 26, 1999
USA Canada Europe Japan Totals
------------- -------------- -------------- ---------- ---------------
Revenues: ($ thousands)
<S> <C> <C> <C> <C> <C>
Softgoods 79 919 626 45 1,679
Retail 212 1,478 - - 1,690
------------- -------------- -------------- ---------- ---------------
Total Revenues 291 2,397 626 45 3,359
Segment operating profit / (loss) (2,433) 198 (201) - (2,436)
</TABLE>
<TABLE>
<CAPTION>
------------------------------------------------------------------------
Six Months Ended June 27, 1998
USA Canada Europe Japan Totals
------------- -------------- -------------- ------------- --------------
Revenues: ($ thousands)
<S> <C> <C> <C> <C> <C>
Softgoods 49 672 303 - 1,024
Retail 191 1,195 - - 1,386
------------- -------------- -------------- ------------- --------------
<PAGE>
Total Revenues 240 1,867 303 - 2,410
Segment operating profit / (loss) (2,596) (91) (379) - (3,066)
</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 second quarter of
1998 are shown separately in the Consolidated Statements of Operations as 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
BRIDGE LOAN
On August 25, 1999, the Company closed a bridge loan in the principal
amount of $675,000 (the "Bridge Loan") secured by a first lien against the
Company's real property located in Salem, Oregon.
COMMON STOCK
In September 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). When issued, Capitol Bay and its affiliates will
hold 16.45% of the outstanding shares of the Company's Common Stock.
See discussion under Item 5 of this report for information regarding
the Bridge Loan of $675,000 to the Company on August 25,1999 and the sale of
1,000,000 shares of the Company's Common Stock.
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
<PAGE>
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 $3,359,000 for continuing operations for the six months ended June
26, 1999. This compares to $2,410,000 for the six months ended June 27, 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. 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.
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.
Morrow Snowboards wishes to caution readers that important factors, among
others, in some cases have affected, and in the future could affect, Morrow
Snowboards' actual results and could cause actual consolidated results for the
first six 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.
The Company's year to date net sales of $3,359,000 and order backlog of
$5,345,000 at June 26, 1999 for continuing operations, are up from those
reported at June 27, 1998, with net sales of $2,410,000 and an order backlog of
$4,974,000. The increase is attributable to stronger sales from the Canadian
retail stores and sales of the spring/summer season product line in the European
market.
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
<PAGE>
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>
Six Months Ended Year Ended
-------------------------------------------------------
June 26, June 27, December 26,
1999 1998 1998
-------------------------------------------------------
<S> <C> <C> <C>
Net Sales 100.0 % 100.0 % 100.0 %
Cost of Goods Sold 62.6 67.0 66.7
------------------------------------------------------
Gross Profit 37.4 33.0 33.3
------------------------------------------------------
Operating Expenses:
Selling, marketing and customer service 36.1 63.0 27.4
Engineering, research and product development 8.4 18.0 7.4
General and administrative 59.1 79.2 43.4
--------------------------------- ------------------
Total Operating Expenses 103.6 160.2 78.2
--------------------------------- ------------------
Operating Loss (66.2) (127.2) (44.9)
Other Income (Expense):
Interest Expense (2.0) ( 9.6) (5.7)
Other Income (Expense) 2.6 0.2 (4.9)
------------------------------------------------------
Loss from Continuing Operations (65.6) (136.6) (55.5)
Income Tax Benefit (Expense) 1.0 - -
Loss from Continuing Operations, net of taxes (64.6) (136.6) (55.5)
Loss from discontinuance of operations 0 - (20.7)
Income (Loss) from Discontinued Operations, net of
taxes 4.3 (70.3) (78.5)
Loss before Extraordinary Item (60.3) (206.9) (154.7)
Extraordinary Loss on Extinguishment of Debt (8.6) - -
------------------------------------------------------
Net Loss (68.9)% (206.9)% (154.7)%
------------------------------------------------------
</TABLE>
COMPARISON OF THE SIX MONTHS ENDED JUNE 26, 1999 AND JUNE 27, 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 six months
of 1999 increased by 39.4% to $3,359,000, from $2,410,000 for the first six
months of 1998. This increase is a result of stronger sales from the Canadian
retail stores and the sales of the spring/summer season in the European market.
Sales for continuing operations of Westbeach-TM- brand apparel were $1,669,000
for the six months ended June 1999 and $1,024,000 for the six months ended June
1998. Sales through the company's retail stores were $1,690,000 and $1,386,000
for the six months ended June 1999 and for the six months ended June 1998,
respectively.
<PAGE>
GROSS PROFIT. Gross profit for continuing operations in the first six
months of 1999 increased 58.1% to $1,257,000 from $795,000 in the first six
months of 1998 as a result of the increased retail and European sales. As a
percentage of sales, total gross margin increased from 33.0% in 1998 to 37.4% in
1999. This improvement in margins is a result of growth in direct to dealer
sales in Europe and stronger retail margins.
OPERATING EXPENSES. Operating expenses for continuing operations
consist of selling, marketing and customer service; engineering, advance design
and product development; and general and administrative expenses. These expenses
decreased to $3,480,000 for the six months of 1999 from $3,861,000 for the first
six months of 1998. This decrease is due to cost reductions implemented
throughout the company. As a percentage of sales, the costs decreased to 103.6%
in 1999, from 160.2% in 1998.
SELLING, MARKETING AND CUSTOMER SERVICE. Selling, marketing and
customer service expenses for the first six months of 1999 decreased 20.2% to
$1,211,000 from $1,518,000 for the first six months of 1998. As a percentage of
sales, selling, marketing and customer service expenses decreased to 36.1% in
1999, from 63.0% in 1998. Staff and employee related expenses increased $123,000
while travel expenses decreased $61,000, trade show expenses decreased $63,000,
advertising decreased $121,000, distribution of promotional products decreased
$39,000 and all other expenses decreased by $146,000.
ENGINEERING, ADVANCE DESIGN AND PRODUCT MANAGEMENT. Engineering,
Advance Design and Product Management expenses for the first six months of 1999
decreased 34.8% to $283,000 from $434,000 for the first six months of 1998. As a
percentage of sales, engineering, advance design and product management
decreased to 8.4% in 1999 from 18.0% 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 and
apparel samples.
GENERAL AND ADMINISTRATIVE. General and administrative expenses for the
first six months of 1999 increased 4.0% to $1,986,000 from $1,909,000 for the
first six months of 1998, representing 59.1% and 79.2% of net sales,
respectively. This increase was primarily due to the recognition of bad debt
expense, which increased in the first six months of 1999 to $168,000 from
$37,000 in 1998. Staff related expenditures decreased in the first six months of
1999 to $628,000 from $877,000 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.
INTEREST EXPENSE. Interest expense decreased to $67,000 for the first
six months of 1999 from $232,000 for the first six months of 1998. This decrease
resulted from lower levels of borrowing required to support inventory production
in 1999 versus 1998.
OTHER INCOME / EXPENSE. Other income was $86,000 for the first six
months of 1999 compared to other income of $4,000 for the first six months of
1998. This change in other income/expense is primarily due to foreign exchange
gains.
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 six months
of 1999 was $2,171,000 compared to a net loss of $3,294,000 for the first six
months of 1998, a decrease of 34.1%. The loss
<PAGE>
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 six months ended June 26, 1999, the Company had an income from
discontinued operations of $143,000. 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 June 26,
1999, the Company had a $7,000 loss from discontinued operations.
There is no basis to compare net sales of discontinued operations in
the first six months of Fiscal 1999 to the first six months of 1998, due to the
discontinuance of the Company's snowboard operation as of March 26, 1999, as any
comparison would be misleading.
COMPARISON OF THE THREE MONTHS ENDED JUNE 26, 1999 AND JUNE 27, 1998
NET SALES. Net sales for continuing operations for the three months
ended June 26, 1999 were $1,414,000, up 55.6% from $909,000 during the three
months ended June 27, 1998. This increase is due to an increase in sales in
Europe and in the retail operation.
GROSS PROFIT. Gross profit increased by 60.8% from $332,000 for the
three month period ended June 27, 1998, to $534,000 for the three month period
ended June 26, 1999. As a percentage of sales, gross profit in the three month
period ended June 26, 1999 was 37.8%, up from 36.5% in the three month period
ended June 27, 1998.
OPERATING EXPENSES. Total Operating Expenses decreased in the three
months ending June 26, 1999 by 11.5% or $177,000 from $1,538,000 for the three
months ended June 27, 1998 to $1,361,000 for the three months ended June 26,
1999. Total Operating Expenses consist of Selling, Marketing & Customer Service;
Engineering, Advance Design & Product Management; and General and
Administrative.
SELLING, MARKETING & CUSTOMER SERVICE. Selling, Marketing & Customer
Service expenses decreased from $462,000 for the three months ended June 27,
1998, to $349,000 for the three months ended June 26, 1999. This decrease of
$113,000 or 24.5% resulted from staff reductions throughout the quarter and
other cost controls.
ENGINEERING, ADVANCE DESIGN & PRODUCT MANAGEMENT. Engineering, Advance
Design & Product Management expenses decreased from $158,000 for the three
months ended June 27, 1998, to $109,000 for the three months ended June 26,
1999. This decrease of 31% or $49,000 resulted from reduced apparel product
sample expense.
<PAGE>
GENERAL AND ADMINISTRATIVE. General and administrative costs decreased
from $918,000 for the three-month period ended June 27, 1998, to $903,000 for
the three month period ended June 26, 1999, resulting from cost cutting programs
implemented throughout the company.
INTEREST EXPENSE. Interest expense decreased for the three-month period
by 66% or $97,000, from $147,000 for the three month period ended June 27, 1998
to $50,000 for the three month period ended June 26, 1999. This decrease
resulted from reduced working capital borrowing needed in 1999 versus 1998 to
support inventory production.
OTHER INCOME / EXPENSE. Other Income/expense changed from an expense of
$63,000 in the three month period ended June 26, 1998 to income in the three
month period ended June 27, 1999 of $122,000, resulting from foreign exchange
gains and lower than anticipated settlements on certain disputed liabilities.
NET LOSS. The net loss on continuing operations decreased in the three
month period ended June 26, 1999 to $722,000 from $1,416,000 in the three month
period ended June 27, 1998, a decrease of 49.0%.
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.
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
$107,060. The potential loss in fair value resulting from an adverse change in
quoted foreign currency exchange rates of 10% amounts to $10,706. 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
<PAGE>
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 June 26, 1999, the Company had $139,000 in
cash and revolving loans of $0, compared to $307,000 in cash and revolving loans
of $2,855,000 outstanding at June 27, 1998. As of June 26, 1999, the Company
estimated it needed at least an additional $1,000,000 in working capital to
implement its Business Plan for the 1999-2000 winter sports season. The Company
has received additional financing through the Bridge Loan for $675,000 and a
sale of Company Common Stock for $250,000 as described in Item 4 of this report.
Based on such additional financing, the Company currently estimates it needs
additional working capital of at least $350,000 for such purposes. The Company
may require additional working capital to support future operations.
Net cash provided by operating activities through the second quarter of
1999, was $3,952,000, resulting primarily from the discontinued snowboard
operations. The following is a detailed account of the operating activity
affecting cash flows for the six months ended June 26, 1999: depreciation and
amortization provided $569,000, gain on retirement of fixed assets of $48,000,
an increase in "other" provided $24,000, which is mostly comprised of
differences in currency exchange. The following represents changes in operating
assets and liabilities as of June 26, 1999 (as compared to December 26, 1998).
There was a decrease in accounts receivable by $4,081,000, due, in large part,
to the collections of accounts for the 98/99 season products. Also, there was a
decrease in inventories of $3,306,000, due to the sale of the snowboard
operations to K2, and a decrease in both prepaid expenses for $346,000 and in
other assets by $1,068,000. There was an increase in accounts payable of
$157,000, a decrease in accrued liabilities of $1,801,000 and finally, an
increase in income tax payable of $20,000, and a decrease in accrued loss on
disposal of $1,498,000, which is also attributed to the sale of snowboard assets
to K2.
Net cash generated from investing activities for the six months ended
June 26, 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 six months was
$5,492,000, consisting of $3,698,000 in line of credit payments, $2,251,000 in
payments on long-term liabilities, and proceeds from issuance on long-term
liabilities of $457,000.
On May 7, 1998, the Company entered into a new credit facility with
Foothill Capital Corporation ("Foothill") which credit facility was acquired by
Capitol Bay Management, Inc. ("Capitol Bay") on May 7, l999 pursuant to an
Assignment and Acceptance among Capitol Bay, Morrow Snowboards, Inc. and certain
other parties. The term "Lender" herein refers to Foothill prior to May 7, l999
and to Capitol Bay thereafter The history and terms of that credit facility are
described in detail in Note 4 (Long Term Debt) in the Notes to Financial
Statements in this quarterly report.
Capitol Bay purchased the credit facility pursuant to a Memorandum of
Understanding dated April 27, 1999, ("MOU") with the Company which gave Capitol
Bay, the right to convert $500,000 of such debt into up to 2,000,000 shares of
the Company's Common Stock at a conversion price of $0.25 per share. At the
time, the amount owing under the credit facility was $217,722, which amount was
increased to $451,055, reflecting a reduced Termination Fee (as defined in the
credit facility) of $100,000 and an unpaid closing fee of $133,333. Under the
MOU, the Company has agreed not to issue any securities and agreed not to file a
petition under the bankruptcy laws without the prior written consent of Capitol
Bay.
As noted in Note 4 to the Financial Statements, the Company continues
to be in default under that credit facility, including the financial covenants
regarding minimum "EBITDA" and the "tangible net worth" ratio and the
over-advance funding limitation, and is currently paying interest on that loan
at
<PAGE>
a default interest rate of 5.5% above the Lender's prime rate as specified in
the Credit Agreement. The Company does not expect to correct such defaults in
the foreseeable future or be able to borrow sufficient working capital under the
credit facility to fund its working capital needs. The Lender had reserved all
its rights to enforce the Credit Agreement as a result of such defaults.
At June 26, 1999, the credit facility was secured by substantially all
of the Company's assets. In August 1999, the Lender released its security
interest in 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.
On March 30, 1999, certain of the Company's trade creditors filed an
Involuntary Petition ("Involuntary Petition") for relief under Chapter 7 of the
United States Bankruptcy Code in the United States Bankruptcy Court for the
District of Oregon (Case No. 699-61663-FRA7). On March 30, 1999, the Company's
accounts payable were approximately $2,500,000 with all overdue more than 90
days. The Company negotiated a settlement with substantially all those
creditors and the Involuntary Petition was dismissed on June 16, 1999. The
settlement was accepted by over 90% of the Company's creditors (by number and
dollar amount of claims) with undisputed claims. Under the terms of the
settlement, as reflected in the Payment Agreement among the Company, certain
creditors and others, certain 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: $250,000 within 60
days after the order dismissing the Involuntary Petition (which payment was made
on August 28, 1999); $200,000 each calendar quarter after the first payment is
made; and the remaining unpaid balance of such claims, without interest, all due
and payable in one year. 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.
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 Exchange Act of 1934 ("1934 Act"), trading in the
Company's securities will be 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 become current in its 1934 Act filings
thereafter.
Due to the lack of borrowing capacity under the credit facility, the
Company's limited working capital, the Involuntary Petition, 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, except for
the right to convert part of the credit facility extended to Capitol Bay.
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. As a result, the Company is currently
considering selling part or all of its business lines. Besides considering a
potential sale of part or all of its 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.
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
<PAGE>
The Company is currently involved in the litigation and proceedings
described below.
There are seven pending legal matters before the Company. While not all
matters are material on an individual basis, they would be material to the
Company, if considered together. In general, all litigation against the company,
but not foreign subsidiaries, was stayed during the involuntary bankruptcy
petition described above, but with the dismissal of such petition, that stay was
lifted.
1. INVOLUNTARY PETITION UNDER CHAPTER 7 BANKRUPTCY (United States
Bankruptcy Court for the District of Oregon, No. 699-61663-fra7). On March 30,
1999, certain of the Company's trade creditors filed an involuntary petition for
relief under Chapter 7 of the United States Bankruptcy Code in the United States
Bankruptcy Court for the District of Oregon. The Company subsequently negotiated
a settlement with the creditors that filed the Involuntary Petition as described
under "Tentative Settlement of Involuntary Petition" in the May 3, 1999 Form 8-K
and under "Payment Agreement" in the June 28, 1999 Form 8-K. Pursuant to that
settlement, the involuntary petition was dismissed on June 16, 1999.
2. 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 believes it has a reasonable basis for
defending against such claims, but there can be no assurance the Company will be
successful in its defense. Because a jury may award significant compensatory
damages, liquidated damages and punitive damages for these types of claims if
the jury finds the allegations to be true, a judgment against the Company could
be material and could have a material adverse impact upon the Company, its
financial condition and continued operations. The Company intends to vigorously
defend against these claims.
3. 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.
4. 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.
<PAGE>
5. MARMOT MOUNTAIN LTD. V. MORROW SNOWBOARDS, INC. (United States District
Court for the Northern District of California, No. C99-1786). Marmot Mountain
Ltd. (MML) is seeking payment of damages in the amount of $130,000 plus interest
at the legal rate on $60,000 of such amount from January 15, 1998, and on
$70,000 of such amount from January 15, 1999. In its complaint, MML alleges
breach of a contract whereby MML agreed to provide the Company with design,
manufacturing and merchandising services related to snowboard apparel. A
settlement of $35,500 has been reached with Marmot Mountain Ltd. with payment
provided under the Payment Agreement.
6. AMERI-TOOL INDUSTRIES, INC. V. MORROW SNOWBOARDS, INC. (Marion County,
Oregon Circuit Court, No. 98C19786). Ameri-Tool is seeking payment for molded
plastic products and related goods furnished to the Company in the amount of
$169,405, together with interest. The Company believes that the Company and
Ameri-Tool, subsequent to their initial agreement for the sale of such goods,
entered into a revised payment arrangement with regard to such products, in
addition to other agreements regarding the delivery by Ameri-Tool of additional
products and tooling. The Company has filed an answer containing a counterclaim
for alleged damage incurred by the Company due to Ameri-Tool's failure to
deliver the products and tooling in accordance with the revised agreement.
Morrow does not disagree with the amount claimed by Ameri-Tool. This matter is
believed resolved by the agreement with Ameri-Tool to receive payment under the
Payment Agreement with creditors, which includes Ameri-Tool, with Ameri-Tool
scheduled to receive payment of such amounts under the Payment Agreement.
7. 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.
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 during the fiscal quarter
ended June 26, 1999:
1. 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. Capitol Bay also has the right to convert up to $500,000
(principal and/or interest) of the balance owing to 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 into up to 2,000,000 shares of the Company's Common
Stock (no par value). Such conversion right and any securities issued
upon its conversion will be issued under Section 4(2) of the
Securities Act of 1933. Such right is in addition to the right
described in the preceding paragraph. See Item 5 below for additional
information.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
--None--
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
--None--
ITEM 5. OTHER INFORMATION
BRIDGE LOAN. On August 25, 1999, Morrow Snowboards, Inc. (the
"Company") closed a bridge loan in the principal amount of $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 Company received net proceeds for working capital
purposes of approximately $327,000 after payment of loan costs and fees of
approximately $60,000, payment of certain personal property taxes of
approximately $38,000 and payment of $250,000 to creditors under the Payment
Agreement outlined in the Company's Form 8-K dated June 28, 1999 and filed on
July
<PAGE>
13, 1999. The Bridge Loan bears interest at the rate of 12%, requires monthly
payments of interest only of $6,750 and is payable in full on June 28, 2000. The
loan is evidenced by a Promissory Note and Trust Deed (collectively, the "Loan
Documents"). Besides payment of the amounts owing from time to time under the
Promissory Note, the Loan Documents impose a number of obligations on the
Company related to the Real Property, including without limitation, obligations
to maintain and insure the Real Property, pay property taxes on the Real
Property, and keep the Real Property free of liens. The Loan Documents contain
provisions that provide for acceleration of the loan in the event monthly
payments are not made within certain grace periods or other required actions
under the Promissory Note or Trust Deed are not undertaken. Under Oregon law,
the security interest in the property could be foreclosed judicially or
non-judicially. If the Company were to default on the Bridge Loan and the
security interest foreclosed, the sales proceeds from a foreclosure would likely
be less than the fair market value realized upon an orderly liquidation of the
real property. The Company is currently attempting to sell the Real Property.
Any sales proceeds would be applied first to payment of the Bridge Loan and,
after such payment, to amounts owing to creditors under the Payment Agreement.
The amounts owing under the Payment Agreement are secured by a trust deed
against the Real Property that is subordinate to up to $750,000 secured by the
Trust Deed signed in connection with the Bridge Loan.
COMMON STOCK SALES. In September l999, Capitol Bay exercised its option
to acquire 1,000,000 shares of the Company's Common Stock for $250,000, at $0.25
per share. Following issuance of shares, Capitol Bay and its affiliates will
hold 1,180,400 shares of the Company's Common Stock. See the Company's Current
Report on Form 8-K for June 28, 1999, and filed with the SEC on July 13, 1999,
regarding CBM and its right to acquire the Company's Common Stock. See also the
Schedule 13-D filed July 19, 1999, and the Form 3 dated July 22, 1999, filed by
Capitol Bay ("CBM") and its affiliates, Steven Kircher, Capitol Bay Group,
Inc. ("CBG") and Capital Bay Securities, Inc. ("CBS") (collectively, the
"Reporting Persons") regarding their beneficial ownership of the Company's
securities.
Such Form 8-K and Schedule 13D note CBM's right to convert up to
$500,000 of the existing credit line with the Company at a rate of $.25 per
share into up to 2,000,000 shares of the Company's Common Stock. If fully
converted, CBM would own beneficially and of record 3,180,400 shares of the
outstanding 9,176,556 shares of the Company's Common Stock outstanding, or
34.66% of the total outstanding Common Stock. Further, 180,400 shares of
Common Stock reported on such Form 8-K as owned by CBM are actually owned of
record and beneficially by CBS. Further, Steve Kircher is the sole owner of
CBM and CBS, and may be deemed to be the beneficial owner of all 3,180,400
shares of Common Stock held or to be acquired by CBM and CBS. Further, the
mailing address for CBM, CBS, and Steve Kircher is 2424 Professional Drive,
Roseville, California 95661. As previously noted, if such rights to acquire
Common Stock were fully exercised, such outstanding shares if voted together
may have sufficient voting power to control matters submitted to the Company's
shareholders for approval, including the election of the Company's Board of
Directors. See the Form 8-K for June 28, 1999 filed July 13, 1999.
The information contained herein is based on the Schedule 13-D filed by
CBM, CBS and Steve Kircher on July 19, 1999. In such schedule 13-D, the
Reporting Persons noted that the shares were acquired for investment purposes in
the ordinary course of business. They further noted that the Reporting Persons
have no present plan or proposal as to any specific actions regarding such
shares currently or actions related to the Company, its policies or its Board of
Directors. The Reporting Persons noted they may decide in the future, should
they believe that the Common Stock continues to be undervalued, to increase
their overall ownership of shares through, among other things, the purchase of
additional shares on the open market or in private transactions, through tender
offer or otherwise, on such terms and at such times as the Reporting Persons may
deem advisable and/or to propose a transaction pursuant to which all or a
portion of the Company shall be sold, and in connection therewith Reporting
Persons may seek to acquire control of the Company and negotiate transactions or
otherwise. The Schedule 13-D also noted that the Reporting Persons may also seek
in the future to have one or more of their representatives appointed to the
Company's Board of Directors, by agreement or otherwise, including running its
own slate of nominees at an annual or special meeting of the Company. Further,
the Schedule noted that the Reporting Persons may in the
<PAGE>
future propose other matters for consideration and approval by the Company's
shareholders or Board of Directors, but have not identified any such matters at
this time.
<PAGE>
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 on
September 9, 1999 to report the acceptance of a bridge loan agreement and
Capitol Bay has exercised its option to acquire 1,000,000 shares of the
Company's Common Stock for $250,000, $.25 per share.
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 October 5, 1999.
MORROW SNOWBOARDS, INC.
/s/ P. Blair Mullin
--------------------
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.
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