Item 1. Business.
General
Bernard Chaus, Inc. (the "Company" or "Chaus") designs, arranges for the manufacture of and markets an extensive range of women's career and casual sportswear principally under the JOSEPHINE CHAUS® COLLECTION, JOSEPHINE CHAUS® SPORT, CHAUS®, CYNTHIA STEFFE®, CYNTHIA CYNTHIA STEFFE®, and FRANCES & RITA® trademarks and under private label brand names. The Company's products are sold nationwide through department store chains, specialty retailers and other retail outlets. The Company has positioned its JOSEPHINE CHAUS product line into the opening price points of the "better" category. In November 2002, the Company acquired certain assets of S.L. Danielle, Inc. ("SL Danielle"). SL Danielle designs, arranges for the manufacture of and markets women's moderately priced clothing primarily under private labels. In January 2004, the Company acquired certain assets of the Cynthia Steffe division of LF Brands Marketing, Inc., including inventory and intellectual property. In connection with such acquisition, the Company also acquired the Cynthia Steffe trademarks from Cynthia Steffe. The Cynthia Steffe business designs, arranges for the manufacture of, markets and sells an upscale modern women's apparel line, under the Cynthia Steffe trademarks. In June 2005 the Company signed a licensing agreement with Kenneth Cole Productions, Inc. to manufacture and sell women's sportswear under the Kenneth Cole Reaction ® label. The Company expects that these products will be sold nationwide through major retail department stores and select specialty stores starting in spring 2006. These products will offer high-quality fabrications and styling at "better" price points. As used herein, fiscal 2005 refers to the fiscal year ended June 30, 2005, fiscal 2004 refers to the fiscal year ended June 30, 2004 and fiscal 2003 refers to the fiscal year ended June 30, 2003.
On June 13, 2005, the Company and Kenneth Cole Productions, Inc. (the "Purchaser") entered into a Stock Purchase Agreement (the "Stock Purchase Agreement"), pursuant to which the Purchaser purchased from the Company six million shares of newly issued shares of common stock for an aggregate purchase price of $6.0 million dollars. The stock purchase agreement provides the Purchaser with one demand and one piggy-back registration right.
Products
The Company markets its products as coordinated groups of jackets, skirts, pants, blouses, sweaters and related accessories principally under the following brand names that also include products for women and petite sizes:
Josephine Chaus - a collection of better tailored career clothing that includes tailored suits, dresses, jackets, sweaters, skirts and pants.
Chaus - a line of separate items that includes skirts, pants, sweaters and knit tops.
Cynthia Steffe and Cynthia Cynthia Steffe - a collection of upscale modern clothing that includes tailored suits, dresses, jackets, skirts and pants.
Kenneth Cole Reaction - a better sportswear line focused on a contemporary customer to be launched for Spring 2006.On June 13, 2005, the Company entered into a license agreement with Kenneth Cole Productions (LIC), Inc. (the "Licensor"). The license agreement grants the Company an exclusive license to design, manufacture, sell and distribute women's sportswear under the Licensor's trademark "KENNETH COLE REACTION" in the women's better sportswear and better petite sportswear department of approved department stores and approved specialty retailers. The licensed territory is the United States. The initial term of the license expires on December 31, 2010. The Company has the option to renew the license agreement for an additional term of three years if it meets specified sales targets and is in compliance with the agreement. The license agreement provides for the payment to Licensor of specified royalties on net sales. The license agreement also requires the Company to achieve certain minimum sales levels, to pay certain minimum royalties and to maintain a minimum net worth. The Company is also obligated to pay specified percentages of net sales to support advertising and to expend a total of $4 million in the period ending December 31, 2007 to support the initial launch of the licensed products.
Private Label - the Company also sells private label apparel manufactured according to customers' specifications.
The above products, while sold as separates, are coordinated by styles, color schemes and fabrics and are designed to be merchandised and worn together. The Company believes that the target consumers for its products are women aged 25 to 65.
During fiscal 2005, the suggested retail prices of the Company's Chaus products ranged between $18.00 and $180.00. The Company's jackets ranged in price between $98.00 and $180.00, its blouses and sweaters ranged in price between $30.00 and $120.00, its skirts and pants ranged in price between $38.00 and $110.00, and its knit tops and bottoms ranged in price between $18.00 and $68.00.
During fiscal 2005, the suggested retail prices of the Company's Cynthia Steffe products ranged between $120.00 and $525.00. The Company's Cynthia Steffe jackets ranged in price between $300.00 and $525.00, its blouses and sweaters ranged in price between $150.00 and $285.00, its skirts and pants ranged in price between $120.00 and $330.00, and its knit tops and bottoms ranged in price between $150.00 and $200.00.
The following table sets forth a breakdown by percentage of the Company's net revenue by class for fiscal 2003 through fiscal 2005:
Business Segments
The Company operates in one segment, women's career and casual sportswear. In addition, less than 1% of total revenue is derived from customers outside the United States. The majority of the Company's long-lived assets are located in the United States.
Customers
The Company's products are sold nationwide in an estimated 5,000 stores operated by approximately 750 department store chains, specialty retailers and other retail outlets. The Company does not have any long-term commitments or contracts with any of its customers.
Through March 31, 2004, the Company extended credit to the majority of its customers through a factoring agreement with The CIT Group/Commercial Services, Inc. ("CIT"). Under the factoring arrangement, the Company receives payment from CIT as of the earlier of: a) the date that CIT has been paid by the Company's customers; b) the date of the customer's longest maturity if the customer is in a bankruptcy or insolvency proceeding; or c) the last day of the third month following the customer's longest maturity date if the receivable remains unpaid. CIT assumes only the risk of the Company's customers' insolvency or non-payment. All other receivable risks for customer deductions that reduce the customer receivable balances are retained by the Company, including, but not limited to, allowable customer markdowns, operational chargebacks, disputes, discounts, and returns. Effective March 31, 2004, the Company, the Company's SL Danielle subsidiary and CIT agreed to terminate the Factoring Agreements between them. In connection with the termination of those Factoring Agreements, the Company's wholly owned subsidiary, Cynthia Steffe Acquisition, LLC ("CS Acquisition") and CIT entered into an amendment of their Factoring Agreement revising only the factoring commission. Receivables related to sales of Cynthia Steffe product lines continue to be factored. Effective April 1, 2004 the Company extends credit to its customers, other than customers of CS Acquisition based upon an evaluation of the customer's financial condition and credit history.
At June 30, 2005 and 2004 approximately 86% and 95%, respectively of the Company's accounts receivable was non factored. At June 30, 2005 and 2004, approximately 60 % and 77 % respectively, of the
Company's accounts receivable were due from customers owned by three single corporate entities. During fiscal 2005, approximately 59% of the Company's net revenue was from three corporate entities - Dillard's Department Stores 22%, Sam's Club 20% and TJX Companies 17%. During fiscal 2004 approximately 70% of the Company's net revenue was from three corporate entities - Dillard's Department Stores 35%, TJX Companies 22% and Sam's Club 13%. During fiscal 2003 approximately 73% of the Company's net revenue was from three corporate entities - Dillards Department Stores 40%, TJX Companies 23% and May Department Stores 10%. As a result of the Company's dependence on its major customers, such customers may have the ability to influence the Company's business decisions. The loss of or significant decrease in business from any of its major customers could have a material adverse effect on the Company's financial position and results of operations. In addition, the Company's ability to achieve growth in revenues is dependent, in part, on its ability to identify new distribution channels.
Sales and Marketing
The Company's selling operation is highly centralized. Sales to the Company's department and specialty store customers are made primarily through the Company's New York City showrooms. As of June 30, 2005, the Company had an in-house sales force of 10, all of whom are located in the New York City showrooms. The Company's Cynthia Steffe division also employs independent sales representatives to market its products to specialty stores throughout the country.
Products are marketed to department and specialty store customers during "market weeks," generally four to five months in advance of each of the Company's selling seasons. The Company assists its customers in allocating their purchasing budgets among the items in the various product lines to enable consumers to view the full range of the Company's offerings in each collection. During the course of the retail selling seasons, the Company monitors its product sell-through at retail in order to directly assess consumer response to its products.
The Company emphasizes the development of long-term customer relationships by consulting with its customers concerning the style and coordination of clothing purchased by the store, optimal delivery schedules, floor presentation, pricing and other merchandising considerations. Frequent communications between the Company's senior management and other sales personnel and their counterparts at various levels in the buying organizations of the Company's customers is an essential element of the Company's marketing and sales efforts. These contacts allow the Company to closely monitor retail sales volume to maximize sales at acceptable profit margins for both the Company and its customers. The Company's marketing efforts attempt to build upon the success of prior selling seasons to encourage existing customers to devote greater selling space to the Company's product lines and to penetrate additional individual stores within the Company's existing customers. The Company's largest customers discuss with the Company retail trends and their plans regarding their anticipated levels of total purchases of Company products for future seasons. These discussions are intended to assist the Company in planning the production and timely delivery of its products.
Design
The Company's products and certain of the fabrics from which they are made are designed by an in-house staff of 28 fashion designers. The Company believes that its design staff is well regarded for its distinctive styling and its ability to contemporize fashion classics. Emphasis is placed on the coordination of outfits and quality of fabrics to encourage the purchase of more than one garment.
Manufacturing and Distribution
The Company does not own any manufacturing facilities; all of its products are manufactured in accordance with its design specifications and production schedules through arrangements with independent manufacturers. The Company believes that outsourcing its manufacturing maximizes its flexibility while avoiding significant capital expenditures, work-in-process buildup and the costs of a large workforce. Approximately 89% of its product is manufactured by independent suppliers located primarily in China, Hong Kong and elsewhere in the Far East and Guatemala. Approximately 11% of the Company's products are manufactured in the United States. No contractual obligations exist between the
Company and its manufacturers except on an order-by-order basis. During fiscal 2005, the Company purchased approximately 72% of its finished goods from its ten largest manufacturers, including approximately 15% of its purchases from its largest manufacturer. Contracting with foreign manufacturers enables the Company to take advantage of prevailing lower labor rates and to use a skilled labor force to produce high quality products.
Generally, each manufacturer agrees to produce finished garments on the basis of purchase orders from the Company, specifying the price and quantity of items to be produced and supported by a letter of credit naming the manufacturer as beneficiary to secure payment for the finished garments.
The Company's technical production support staff, located in New York City, coordinates the production of patterns and the production of samples from the patterns by its production staff and by overseas manufacturers. The production staff also coordinates the marking and the grading of the patterns in anticipation of production by overseas manufacturers. The overseas manufacturers produce finished garments in accordance with the production samples and obtain necessary quota allocations and other requisite customs clearances. Branch offices of the Company's subsidiaries in Korea and Hong Kong monitor production at each manufacturing facility to control quality, compliance with the Company's specifications and timely delivery of finished garments, and arrange for the shipment of finished products to the Company's New Jersey distribution center or to third party distributors shipping merchandise on behalf of the Company. During this past year approximately 70% of the Company's finished goods were shipped to the Company's New Jersey distribution center with the remaining merchandise shipped to third party distributors located on California and Florida.
The Company believes that the number and geographical diversity of its manufacturing sources minimize the risk of adverse consequences that would result from termination of its relationship with any of its larger manufacturers. The Company also believes that it would have the ability to develop, over a reasonable period of time, adequate alternate manufacturing sources should any of its existing arrangements terminate. However, should any substantial number of such manufacturers become unable or unwilling to continue to produce apparel for the Company or to meet their delivery schedules, or if the Company's present relationships with such manufacturers were otherwise materially adversely affected, there can be no assurance that the Company would find alternate manufacturers of finished goods on satisfactory terms to permit the Company to meet its commitments to its customers on a timely basis. In such event, the Company's operations could be materially disrupted, especially over the short-term. The Company believes that relationships with its major manufacturers are satisfactory.
The Company uses a broad range of fabrics in the production of its clothing, consisting of synthetic fibers (including polyester and acrylic), natural fibers (including cotton and wool), and blends of natural and synthetic fibers. The Company does not have any formal, long-term arrangements with any fabric or other raw material supplier. During fiscal 2005, most all of the fabrics used in the Company's products manufactured in the Far East were ordered from a limited number of suppliers in the Far East, which are located in China, Hong Kong and Korea. The Company selects the fabrics to be purchased for production in accordance with the Company's specifications. To date, the Company has not experienced any significant difficulty in obtaining fabrics or other raw materials and considers its sources of supply to be adequate.
The Company operates under substantial time constraints in producing each of its collections. Orders from the Company's customers generally proceed the related shipping period by up to four months. In order to make timely delivery of merchandise which reflects current style trends and tastes, the Company attempts to schedule a substantial portion of its fabric and manufacturing commitments relatively late in a production cycle. However, in order to secure adequate amounts of quality raw materials, especially greige (i.e., "undyed") goods, the Company must make some advance commitments to suppliers of such goods. Many of these early commitments are made subject to changes in colors, assortments and/or delivery dates.
Imports and Import Restrictions
The Company's arrangements with its manufacturers and suppliers are subject to the risks attendant to doing business abroad, including the availability of quota and other requisite customs clearances, the
imposition of export duties, political and social instability, currency revaluations, and restrictions on the transfer of funds. Bilateral agreements between exporting countries, including those from which the Company imports substantially all of its products, and the United States' imposition of quotas, limits the amount of certain categories of merchandise, including substantially all categories of merchandise manufactured for the Company, that may be imported into the United States. Furthermore, the majority of such agreements contain "consultation clauses" which allow the United States to impose at any time restraints on the importation of categories of merchandise which, under the terms of the agreements, are not subject to specified limits. The bilateral agreements through which quotas are imposed have been negotiated under the framework established by the Arrangement Regarding International Trade in Textiles, known as the Multifiber Arrangement ("MFA") which has been in effect since 1974. The United States has concluded international negotiations known as the "Uruguay Round" in which a variety of trade matters were reviewed and modified. Quotas established under the MFA were phased out as of December 2004, after which the textile and clothing trade were fully integrated into the General Agreement on Trade and Tariffs ("GATT") and are now subject to the same disciplines as other sections. The GATT agreement provides for expanded trade, improved market access, lower tariffs and improved safeguard mechanisms.
The United States and the countries in which the Company's products are manufactured may, from time to time, impose new quotas, duties, tariffs or other restrictions, or adversely adjust presently prevailing quotas, duty or tariff levels, with the result that the Company's operations and its ability to continue to import products at current or increased levels could be adversely affected. The Company cannot predict the likelihood or frequency of any such events occurring. The Company monitors duty, tariff and quota-related developments, and seeks continually to minimize its potential exposure to quota-related risks through, among other measures, geographical diversification of its manufacturing sources, allocation of production of merchandise categories where more quota is available and shifts of production among countries and manufacturers. The expansion in the past few years of the Company's varied manufacturing sources and the variety of countries in which it has potential manufacturing arrangements, although not the result of specific import restrictions, have had the result of reducing the potential adverse effect of any increase in such restrictions. In addition, substantially all of the Company's products are subject to United States customs duties. Due to the large portion of the Company's products, which are produced abroad, any substantial disruption of its foreign suppliers could have a material adverse effect on the Company's operations and financial condition.
Backlog
As of August 26, 2005 and 2004, the Company's order book reflected unfilled customer orders for approximately $58.9 million and $48.3 million of merchandise, respectively. Order book data at any date are materially affected by the timing of the initial showing of collections to the trade, as well as by the timing of recording of orders and of shipments. The order book represents customer orders prior to discounts. Accordingly, a comparison of unfilled orders from period to period is not necessarily meaningful and may not be indicative of eventual actual shipments.
Trademarks
CHAUS, CHAUS & CO., CHAUS SPORT, CHAUS WOMAN, MS. CHAUS, JOSEPHINE, JOSEPHINE CHAUS, CYNTHIA STEFFE, CYNTHIA CYNTHIA STEFFE and FRANCES & RITA are registered trademarks of the Company for use on ladies' garments. The Company considers its trademarks to be strong and highly recognized, and to have significant value in the marketing of its products.
The Company has an exclusive license with Kenneth Cole Productions (LIC), Inc. to design, manufacture and distribute wholesale women's sportswear bearing the mark Kenneth Cole Reaction® for sale on women's better sportswear and or better petite sportswear of approved department stores and approved specialty retailers. See "Products-Kenneth Cole Reaction".
The Company has also registered its CHAUS, CHAUS SPORT, CHAUS WOMAN, JOSEPHINE CHAUS and JOSEPHINE trademarks for women's apparel in certain foreign countries. JOSEPHINE CHAUS for clothing, accessories and cosmetics is a registered trademark in the European Economic Community.
Competition
The women's apparel industry is highly competitive, both within the United States and abroad. The Company competes with many apparel companies, some of which are larger, and have better established brand names and greater resources than the Company. In some cases the Company also competes with private-label brands of its department store customers.
The Company believes that an ability to effectively anticipate, gauge and respond to changing consumer demand and taste relatively far in advance, as well as an ability to operate within substantial production and delivery constraints (including obtaining necessary quota allocations), is necessary to compete successfully in the women's apparel industry. Consumer and customer acceptance and support, which depend primarily upon styling, pricing, quality (both in material and production), and product identity, are also important aspects of competition in this industry. The Company believes that its success will depend upon its ability to remain competitive in these areas.
Furthermore, the Company's traditional department store customers, which account for a substantial portion of the Company's business, encounter intense competition from off-price and discount retailers, mass merchandisers and specialty stores. The Company believes that its ability to increase its present levels of sales will depend on such customers' ability to maintain their competitive position and the Company's ability to increase its market share of sales to department stores and other retailers.
Employees
At June 30, 2005, the Company employed 286 employees as compared with 282 employees at June 30, 2004. This total includes 53 in managerial and administrative positions, approximately 96 in design, production and production administration, 19 in marketing, merchandising and sales and 64 in distribution. Of the Company's total employees, 54 were located in the Far East. The Company was a party to a collective bargaining agreement with the Amalgamated Workers Union, Local 88, covering 71 full-time employees. This agreement expired August 31, 2005 and was not renewed for the union employees located at the Secaucus distribution facility. The company has arranged for third party contractors that specialize in logistics to handle the Company's distribution needs after the union agreement expired on September 1, 2005. The collective bargaining agreement was renegotiated for the remaining 14 union employees located at our technical production support facility at 519 Eighth Avenue in New York City. The new agreement expires on August 31, 2008. The Company is also party to an agreement with the New York Metropolitan Joint Board Local 89-22-1 and Local 10 Unite here, AFL-CIO covering 12 full-time employees. This agreement expires on September 1, 2007.
The Company considers its relations with its employees to be satisfactory and has not experienced any business interruptions as a result of labor disagreements with its employees.
Executive Officers
The executive officers of the Company are:
Name
Age
Position
Josephine Chaus
Chairwoman of the Board and Chief Executive Officer
David Panitz
Chief Operating Officer
Barton Heminover
Chief Financial Officer
Executive officers serve at the discretion of the Board of Directors.
Josephine Chaus is a co founder of the Company and has held various positions with the Company since its inception. She has been a director of the Company since 1977, President from 1980 through February 1993, Chief Executive Officer from July 1991 through September 1994 and again since December 1998, Chairwoman of the Board since 1991 and member of the Office of the Chairman since September 1994.
David Panitz was appointed Chief Operating Officer in October 2004 . Prior to joining the Company he served in numerous executive positions from 2002 to 2004 with Marc Ecko Enterprises, an apparel
company, initially as its Executive Vice President, Sales and Operations and last serving as Chief Operating Officer. From 1999 to 2002, Mr. Panitz served in various executive positions with C-bridge/eXcelon Corp., a business and technology solutions company, initially as its Vice President of Operations and last serving as President, Strategic Business Unit. From 1994 through 1999, he served in various positions in sales and marketing and last served as director of Retail Analysis and Planning of Polo Ralph Lauren Corp., an apparel Company.
Barton Heminover was appointed Chief Financial Officer in August 2002 and served as Vice President of Finance from January 2000 through August 2002 and as Vice President - Corporate Controller from July 1996 to January 2000. From January 1983 to July 1996 he was employed by Petrie Retail, Inc. (formerly Petrie Stores Corporation), a woman's retail apparel chain, serving as Vice President/Treasurer from 1986 to 1994 and as Vice President/Financial Controller from 1994 to 1996.
Forward Looking Statements
Certain statements contained herein are forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934 that have been made pursuant to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. Such statements are indicated by words or phrases such as "anticipate," "estimate," "project," "expect," "believe" and similar words or phrases. Such statements are based on current expectations and are subject to certain risks, uncertainties and assumptions, including, but not limited to, the overall level of consumer spending on apparel; the financial strength of the retail industry, generally and the Company's customers in particular; changes in trends in the market segments in which the Company competes and the Company's ability to gauge and respond to changing consumer demands and fashion trends; the level of demand for the Company's products; the Company's dependence on its major department store customers; the success of the Kenneth Cole license agreement; the highly competitive nature of the fashion industry; the Company's ability to satisfy its cash flow needs, including the cash requirements under the Kenneth Cole license agreement, by meeting its business plan and satisfying the financial covenants in its credit facility; the Company's ability to operate within production and delivery constraints, including the risk of failure of manufacturers to deliver products in a timely manner or to quality standards; the Company's ability to meet the requirements of the Kenneth Cole license agreement; the Company's ability to operate effectively in the new quota environment, including changes in sourcing patterns resulting from the elimination of quota on apparel products; the Company's ability to attract and retain qualified personnel; and changes in economic or political conditions in the markets where the Company sells or sources its products, including war and terrorist activities and their effects on shopping patterns, as well as other risks and uncertainties set forth in the Company's publicly-filed documents, including this Annual Report on Form 10-K. Should one or more of these risks or uncertainties materialize, or should underlying assumptions prove incorrect, actual results may vary materially from those anticipated, estimated or projected. The Company disclaims any intention or obligation to update or revise any forward-looking statements, whether as a result of new information, future events or otherwise.
Item 2.
Item 2. Properties.
The Company's principal executive office is located at 530 Seventh Avenue in New York City where the Company leases approximately 28,000 square feet. This lease expires in May 2009. This facility also houses the Company's Chaus and SL Danielle showrooms and its sales, design, production and merchandising staffs. The Kenneth Cole Reaction showroom will also be located at this facility. Net base rental expense for the executive offices aggregated approximately $0.9 million in each of fiscal 2005, fiscal 2004 and fiscal 2003.
The Company's Cynthia Steffe subsidiary is located at 550 Seventh Avenue in New York City where the Company leases approximately 12,000 square feet. This lease expires in October 2013 and the net base rental expense is approximately $0.3 million a year.
The Company's technical production support facility (including its sample and patternmakers) is located at 519 Eighth Avenue in New York City where the Company leases approximately 15,000 square
feet. This lease expires in August 2009. Net base rental expense for the technical production support facilities aggregated approximately $0.3 million in each of fiscal 2005, fiscal 2004, and fiscal 2003.
The Company's distribution center is located in Secaucus, New Jersey where the Company leases approximately 276,000 square feet. This facility also houses the Company's administrative and finance personnel, and its computer operations. This space is occupied under a lease expiring December 31, 2005 which the Company has determined that it will not renew. The Company has arranged for third party contractors that specialize in logistics to handle the company's distribution needs at the same location effective September 1, 2005. The Company will sublease office space in the facility for its office personnel currently in the facility effective January 1, 2006. The Company's one retail outlet store in the center was closed in July 2005. Base rental expense for the Secaucus facility aggregated approximately $1.2 million in each of fiscal 2005, fiscal 2004, and fiscal 2003. It is anticipated that the Company will realize cost savings from outsourcing its distribution needs.
Office locations are also leased in Hong Kong and Korea, with annual aggregate rental expense of approximately $0.1 million for each of fiscal 2005, fiscal 2004, and fiscal 2003.
Item 3.
Item 3. Legal Proceedings.
The Company is involved in legal proceedings from time to time arising out of the ordinary conduct of its business. The Company believes that the outcome of these proceedings will not have a material adverse effect on the Company's financial condition or results of operations.
Item 4.
Item 4. Submission of Matters to a Vote of Security Holders.
None.
PART II
Item 5.
Item 5. Market for the Registrant's Equity and Related Stockholder Matters.
The Company's common stock, par value $0.01 per share (the "Common Stock"), is currently traded in the over the counter market and quotations are available on the Over the Counter Bulletin Board (OTC BB: CHBD).
The following table sets forth for each of the Company's fiscal periods indicated the high and low bid prices for the Common Stock as reported on the OTC BB. These prices reflect inter-dealer prices, without retail mark-up, mark-down or commission and may not necessarily represent actual transactions.
As of August 26, 2005, the Company had approximately 436 stockholders of record.
The Company has not declared or paid cash dividends or made other distributions on the Common Stock since prior to its 1986 initial public offering. The payment of dividends, if any, in the future is within the discretion of the Board of Directors and will depend on the Company's earnings, capital requirements
and financial condition. It is the present intention of the Board of Directors to retain all earnings, if any, for use in the Company's business operations and, accordingly, the Board of Directors does not expect to declare or pay any dividends in the foreseeable future. In addition, the Company's Financing Agreement prohibits the Company from declaring dividends or making other distributions on its capital stock, without the consent of the lender. See "Management's Discussion and Analysis of Financial Condition and Results of Operations - Financial Condition, Liquidity and Capital Resources."
Item 6.
Item 6. Selected Financial Data.
The following financial information is qualified by reference to, and should be read in conjunction with, the Consolidated Financial Statements of the Company and the notes thereto, as well as Management's Discussion and Analysis of Financial Condition and Results of Operations contained elsewhere herein.
Statement of Operations Data:
(1) Computed by dividing the applicable net income(loss) by the weighted average number of shares of Common Stock outstanding during the year.
(2) Computed by dividing the applicable net income (loss) by the weighted average number of common shares outstanding and common stock equivalents outstanding during the year.
Item 7.
Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations.
Overview
The Company has expanded its product mix over the past few years mainly through its acquisition of S.L. Danielle and Cynthia Steffe. In November 2002, the Company acquired certain assets of S.L. Danielle Inc. S.L. Danielle designs, arranges for the manufacture of, markets and sells a women's apparel line, principally under private and exclusive labels. In January 2004 the Company purchased certain assets of the Cynthia Steffe, a division of LF Brands Marketing, Inc., including inventory and intellectual property. In connection with the acquisition, the Company also acquired Cynthia Steffe trademarks from Cynthia Steffe. The Cynthia Steffe business designs, arranges for the manufacture of, markets and sells an upscale modern women apparel line, under the Cynthia Steffe trademarks. The results of Cynthia Steffe's operations are included in the consolidated financial statements commencing January 2, 2004. In June 2005 the Company signed a licensing agreement with Kenneth Cole Productions, Inc. to manufacture and sell women's sportswear under the Kenneth Cole Reaction® label. We expect that these products will be sold nationwide through major retail department stores and select specialty stores starting in spring 2006. These products will offer high-quality fabrications and styling at "better" price points.
Results of Operations
The following table sets forth, for the years indicated, certain items expressed as a percentage of net revenue.
Fiscal 2005 Compared to Fiscal 2004
Net revenues for fiscal 2005 decreased 8.8% or $13.8 million to $143.3 million as compared to $157.1 million for fiscal 2004. Units sold decreased by 13.9% and the overall price per unit increased by approximately 6%. The decrease in net revenue was primarily due to the decrease in sales associated with Chaus product lines of approximately $33.5 million partially offset by an increase in Cynthia Steffe product lines of approximately $20.5 million. The decrease in the Chaus product lines reflected decreased sales to department stores and discounters. The increase in Cynthia Steffe net revenues is primarily due to the inclusion of a full twelve months of sales this year compared to six months last year. See table of percentage of net revenue by class on page 2 for additional information.
Gross profit for fiscal 2005 decreased $0.1 million to $39.6 million as compared to $39.7 million for fiscal 2004. As a percentage of sales, gross profit increased to 27.6% for fiscal 2005 from 25.2% for fiscal 2004. The decrease in gross profit dollars was primarily attributable to the decrease of approximately $9.0 million in gross profit of the Company's Chaus product lines due to the decrease in net revenues partially offset by an increase in gross profit of $8.9 million associated with the Cynthia Steffe product lines. The increase in Cynthia Steffe gross profit dollars was primarily due to the increase in net revenues. The increase in gross profit percentage was primarily due to the higher gross profit percentage associated with the Company's Cynthia Steffe product lines which represented approximately 20% of net revenues this year as compared to 5% of net revenues last year.
Selling, general and administrative ("SG&A") expenses increased by $4.3 million to $39.2 million for fiscal 2005 as compared to $34.9 million in fiscal 2004. As a percentage of net revenue, SG&A expenses increased to 27.4% in fiscal 2005 as compared to 22.2% in fiscal 2004. These increases were primarily attributable to the inclusion of a full twelve months of expenses of the Cynthia Steffe product lines
acquired in January 2004 which accounted for a $6.1 million increase in SG&A expenses. This increase was partially offset by a $1.9 million decrease in SG&A expenses associated with Chaus products lines and private label. The increase in SG&A expenses was primarily due to SG&A expenses related to payroll and payroll related costs ($3.3 million), design related costs ($0.7 million), professional fees ($0.5 million), marketing and advertising costs ($0.2 million) partially offset by a decrease in factoring fees ($0.4 million). The increase in SG&A expense as a percentage of net revenue was due to the decrease in sales volume of the Company's Chaus product lines sold to department stores which reduced the Company's leverage on SG&A expenses and the higher SG&A expenses as a percentage of net revenue associated with the Cynthia Steffe product lines.
Interest expense was approximately the same for fiscal 2005 as it was in to fiscal 2004. The increase in interest rates was offset by lower bank borrowings.
The Company's income tax provision for fiscal 2005, includes federal alternative minimum taxes (AMT) resulting from the use of the Company's net operating loss (NOL) carryforward from prior years and provisions for state and local taxes. New Jersey enacted tax legislation temporarily suspending the use of net operating loss (NOL) carryforwards against income for fiscal 2004 and allowing 50% use of net operating loss (NOL) carryforwards against income for fiscal 2005.
The Company periodically reviews its historical and projected taxable income and considers available information and evidence to determine if it is more likely than not that a portion of the deferred tax assets will be realized. A valuation allowance is established to reduce the deferred tax assets to the amount that is more likely than not to be realized. As of June 30, 2005 and 2004, based upon its evaluation of taxable income and the current business environment, the Company recorded a full valuation allowance on its deferred tax assets including NOL's. In fiscal 2005, the valuation allowance was reduced by $1.8 million to $41.0 million at June 30, 2005 from $42.8 million at June 30, 2004 to primarily reflect the utilization of NOL's to offset taxes otherwise payable on current taxable income and to reflect changes in deferred tax assets. If the Company determines that a portion of the deferred tax assets will be realized in the future, a portion of the valuation allowance will be reduced and the Company will provide for income tax expense (benefit) in its Statement of Operations at its estimated effective tax rate. See discussion below under Critical Accounting Policies and Estimates regarding income taxes and the Company's federal net operating loss carryforward.
Fiscal 2004 Compared to Fiscal 2003
Net revenues for fiscal 2004 increased 12.1% or $16.9 million to $157.1 million as compared to $140.2 million for fiscal 2003. Units sold increased by 11.7% and the overall price per unit remained relatively the same. The increase in net revenue was primarily due to the inclusion of a full twelve months of sales for the Company's S.L. Danielle division acquired in November 2002 and the sales of the Company's Cynthia Steffe product lines acquired in January 2004. These acquisitions contributed $31.0 million to the increase in fiscal 2004 revenues. This increase was partially offset by a decrease of $14.0 million in sales principally consisting of Chaus product lines to department stores and discount stores. See table of percentage of net revenue by class on page 2 for additional information.
Gross profit for fiscal 2004 increased $3.9 million to $39.7 million as compared to $35.8 million for fiscal 2003. As a percentage of sales, gross profit decreased to 25.2% for fiscal 2004 from 25.5% for fiscal 2003. The increase in gross profit dollars was attributable to the gross profit of the Company's S.L. Danielle and Cynthia Steffe divisions. The increase in gross profit dollars of $9.4 million from these divisions more than offset a decrease in gross profit dollars of $5.6 million associated with the decrease in sales principally consisting of Chaus product lines sold to department stores and discount stores. The decrease in gross profit percentage was primarily due to the lower gross profit percentage associated with the Company's Chaus product lines.
Selling, general and administrative ("SG&A") expenses increased by $5.2 million to $34.9 million for fiscal 2004 as compared to $29.6 million in fiscal 2003. As a percentage of net revenue, SG&A expenses increased to 22.2% in fiscal 2004 as compared to 21.1% in fiscal 2003. These increases were primarily attributable to the Cynthia Steffe product lines acquired in January 2004 and the inclusion of a full twelve months of expenses of the S.L. Danielle product lines acquired in November 2002. The increase in SG&A
expenses was primarily due to SG&A expenses related to payroll and payroll related costs ($1.9 million), design related costs ($0.8 million), and marketing and advertising costs ($0.7 million). The increase in SG&A expense as a percentage of net revenue was due to the decrease in sales volume of the Company's Chaus product lines sold to department stores and discount stores which reduced the Company's leverage on SG&A expenses in addition to the higher SG&A expenses as a percentage of net revenue associated with the Cynthia Steffe product lines.
Interest expense increased by approximately $0.3 million to $1.4 million for fiscal 2004 as compared to $1.1 million for fiscal 2003. The increase was due to higher bank borrowings partially offset by lower interest rates.
The provision for income taxes for fiscal 2004 reflects a provision for certain federal, state and local taxes. For fiscal 2004, the Company's income tax provision includes federal alternative minimum taxes (AMT) that are not offset by the Company's net operating loss (NOL) carryforward from prior years. New Jersey enacted new tax legislation in fiscal 2003 temporarily suspending the use of net operating loss (NOL) carryforwards against income. Accordingly, for fiscal 2004, the Company has made provisions for state income taxes, including New Jersey.
The Company periodically reviews its historical and projected taxable income and considers available information and evidence to determine if it is more likely than not that a portion of the deferred tax assets will be realized. A valuation allowance is established to reduce the deferred tax assets to the amount that is more likely than not to be realized. As of June 30, 2004 and 2003, based upon its evaluation of taxable income and the current business environment, the Company recorded a full valuation allowance on its deferred tax assets including NOL's. In fiscal 2004, the valuation allowance was reduced by $2.5 million to $42.8 million at June 30, 2004 from $45.3 million at June 30, 2003 to reflect the utilization of NOL's to offset taxes otherwise payable on current taxable income. If the Company determines that a portion of the deferred tax assets will be realized in the future, a portion of the valuation allowance will be reduced and the Company will provide for income tax expense (benefit) in its Statement of Operations at its estimated effective tax rate. See discussion below under Critical Accounting Policies and Estimates regarding income taxes and the Company's federal net operating loss carryforward.
Financial Condition, Liquidity and Capital Resources
General
Net cash provided by operating activities was $11.8 million for fiscal 2005 as compared to net cash used in operating activities of $7.1 million for fiscal 2004, and net cash provided by operating activities of $12.2 million for fiscal 2003. Net cash provided by operating activities for fiscal 2005 resulted primarily from a decrease in accounts receivable ($11.8 million), an increase in accounts payable ($1.6 million), partially offset by an increase in inventory ($2.0 million). The decrease in accounts receivable of $11.8 million was predominately due to the decrease in sales during the fourth quarter of fiscal 2005 as compared to fiscal 2004. The increase in accounts payable of $1.6 million was attributable to the increase in inventory of $2.0 million offset by an increase of $0.4 million in the timing of payment for inventory. The change in the mix of suppliers and the Company's purchase of higher levels of raw materials than in prior periods has required an earlier payment schedule. The Company does not currently anticipate that these changes in accounts receivable or accounts payable will adversely affect its cash flows for fiscal 2006.
Net cash used in operating activities for fiscal 2004 resulted primarily from, an increase in accounts receivable and accounts receivable due from factor ($9.0 million), a decrease in accounts payable ($4.8 million), partially offset by a decrease in inventory ($2.6 million), and net income ($3.1million). The increase in the Company's accounts receivable and accounts receivable due from factor of $9.0 million was primarily due to a change in the mix of customers, relative to the prior year, to a mix consisting of customers with typically longer payment terms, such as discounters. To a lesser extent, the increase also resulted from an increase in sales of $6.4 million during the fourth quarter of fiscal 2004 as compared to the same quarter in fiscal 2003. The decrease in accounts payable of $4.8 million was primarily attributable to lower inventories in fiscal 2004 as compared to fiscal 2003 and the timing of payment for purchases of inventory. The decrease was also due to a change in the mix of suppliers, with the Company purchasing higher levels of raw materials than in prior periods, which required earlier payments.
Cash used in investing activities was $0.3 million in fiscal 2005 compared to $3.9 million in fiscal 2004 and $5.0 million in fiscal 2003. The investing activities in fiscal 2005 consisted of $0.3 million for the purchases of fixed assets. The investing activities in fiscal 2004 consisted of $3.0 million primarily for the acquisition of Cynthia Steffe product lines and $1.0 million for the purchase of fixed assets. In fiscal 2003 investing activities consisted of $4.7 million for the acquisition of the S.L. Danielle product lines and $0.3 million for the purchase of fixed assets. The purchases of fixed assets for all years presented consisted primarily of purchases of computer hardware and software systems. In fiscal 2006, the Company anticipates capital expenditures of approximately $1.3 million, primarily for the Kenneth Cole showroom ($0.6 million), Kenneth Cole store fixtures ($0.3 million), and Management Information System upgrades ($0.2 million).
Cash used in financing activities for fiscal 2005 resulted from net payments of $8.6 million for short-term bank borrowings and principal payments of $1.7 million on the term loan partially offset by net proceeds of $6.4 million from the issuance of common stock. The net proceeds from the issuance of common stock consisted of (i) a $6.0 million equity investment less $0.4 million of transaction fees from the issuance of six million shares of the Company's common stock to Kenneth Cole Productions, Inc in June 2005; and (ii) net proceeds of $0.8 million from the exercise of stock options. Cash used in financing activities for fiscal 2004 resulted from net borrowing of $8.6 million for short-term bank borrowings and $0.3 million from net proceeds from the issuance of stock offset by net principal payments of $0.4 million on the term loan. Cash used in financing activities for fiscal 2003 resulted from net repayments of $3.6 million for short-term bank borrowings and principal payments of $1.0 million on the term loan.
Kenneth Cole License Agreement
The Company entered into a license agreement with Kenneth Cole Productions (LIC) in June 2005. Under the license agreement the Company is required to achieve certain minimum sales levels, to pay certain minimum royalties and to maintain a minimum net worth. The Company is also obligated to pay specified percentages of net sales to support advertising and to expend a total of $4 million in the period ending December 31, 2007 to support the initial launch of the licensed products.
Contractual Obligations and Commercial Commitments
The following table summarizes as of June 30, 2005, the Company's contractual obligations and commercial commitments by future period:
Financing Agreement
On September 27, 2002, the Company and certain of its subsidiaries entered into a new three-year financing agreement (the "Financing Agreement") with The CIT Group/Commercial Services, Inc. ("CIT"), to replace the Former Financing Agreement discussed below. The Financing Agreement provides the Company with a $50.5 million facility comprised of (i) a $40 million revolving line of credit (the "Revolving Facility") with a $25 million sublimit for letters of credit, a $3 million seasonal overadvance and certain other overadvances at the discretion of CIT, and (ii) a $10.5 million term loan (the "Term Loan").
At the option of the Company, the Revolving Facility and the Term Loan each may bear interest either at the JP Morgan Chase Bank Rate ("Prime Rate") or the London Interbank Offered Rate ("LIBOR"). If the Company chooses the Prime Rate, the interest (i) on the Revolving Facility accrues at a rate of ½ of 1% above the Prime Rate (ii) on the Term Loan accrues at a rate of 1% above the Prime Rate. If the Company chooses LIBOR, the interest (i) on the Revolving Facility accrues at a rate of 3¼% above LIBOR (2.75% above LIBOR from and after November 2004) (ii) on the Term Loan accrues at a rate of 3¾% above LIBOR. From the inception of the financing agreement through June 30, 2005, the Company has elected the Prime Rate option. Pursuant to the November 2004 amendment to the Financing Agreement described below, each of the foregoing interest rates is subject to an annual upward or downward adjustment by ¼ of 1%, commencing with the month following delivery of the Company's consolidated financial statements to CIT for fiscal 2005, fiscal 2006 and fiscal 2007 based upon the Company's borrowing availability, fixed charge coverage ratio and leverage ratio as in effect at each such adjustment period. The interest rate as of June 30, 2005 on the Revolving Facility was 6.50% and on the Term Loan was 7.0%.
On September 27, 2002, the Company borrowed $18.3 million under the Revolving Facility and $10.5 million under the Term Loan. These borrowings were used to pay off the balances under the former financing agreement of $18.3 million and the former term loan of $10.5 million and for working capital purposes. Commencing October 1, 2002, amortization payments in the amount of $375,000 (increased to $425,000 by the January 2004 amendment to the Financing Agreement described below) are payable quarterly in arrears in connection with the Term Loan. A balloon payment of $1.8 million is due on October 1, 2008 under the Term Loan. The Company's obligations under the Financing Agreement are secured by a first priority lien on substantially all of the Company's assets, including the Company's accounts receivable, inventory, intangibles, equipment, and trademarks, and a pledge of the Company's equity interest in its subsidiaries.
The Financing Agreement contains numerous financial and operational covenants, including limitations on additional indebtedness, liens, dividends, stock repurchases and capital expenditures. In addition, the Company is required to maintain (i) specified levels of tangible net worth, (ii) minimum EBITDA (earnings before interest, taxes, depreciation and amortization), (iii) certain fixed charge coverage ratios, (iv) certain leverage ratios, and (v) specified levels of minimum borrowing availability under the Revolving Facility. At June 30, 2005, the Company was in compliance with all of its covenants. In the event of the early termination by the Company of the Financing Agreement, the Company will be liable for termination fees of $150,000 if termination occurs prior to November 11, 2007. The Company may prepay at any time, in whole or in part, the Term Loan without penalty. A fee of $125,000 was paid in connection with the original Financing Agreement. The expiration of the Financing Agreement was initially set for September 27, 2005 and was extended to October 1, 2008 by an amendment dated November 11, 2004.
On November 27, 2002, the Company and CIT agreed to an amendment to the Financing Agreement in order to facilitate the S.L. Danielle acquisition. The Company and CIT agreed to add the Company's newly formed wholly-owned subsidiary, S.L. Danielle Acquisition, LLC (the "Additional Borrower"), as a co-borrower under the Financing Agreement and related Factoring Agreement. Accordingly, the Company and CIT (i) amended the Financing Agreement pursuant to a joinder agreement, which also constitutes Amendment No. 1 to the Financing Agreement (the "Amended Financing Agreement") and (ii) entered into a new factoring agreement with the Additional Borrower, to add the Additional Borrower as a co-borrower. The Company's and the Additional Borrower's obligations under the Amended Financing Agreement are secured by a first priority lien on substantially all of the Company's and the Additional Borrower's assets, including the Company's and the Additional Borrower's accounts receivable, inventory, intangibles, equipment, and trademarks and a pledge of the Company's stock interest and membership interest in the Company's subsidiaries, including the Additional Borrower.
On January 30, 2004, the Company and CIT agreed to an amendment to the Financing Agreement in order to facilitate the Cynthia Steffe acquisition discussed below. The Company and CIT agreed to add the Company's wholly-owned subsidiary, Cynthia Steffe Acquisition, LLC ("CS Acquisition") as a co-borrower under the Financing Agreement and related Factoring Agreement. Accordingly, the Company and CIT (i) amended the Financing Agreement pursuant to a joinder agreement, which also
constitutes Amendment No. 2 to the Financing Agreement (the "Second Amended Financing Agreement") and (ii) entered into a new factoring agreement with CS Acquisition, to add CS Acquisition as a co-borrower. The obligations of the Company, S.L. Danielle and CS Acquisition under the Second Amended Financing Agreement are secured by a first priority lien on substantially all of the assets of the Company, S.L. Danielle and CS Acquisition, including their respective accounts receivables, inventory, intangibles, equipment, and trademarks and a pledge of the Company's stock interest and membership interest in the Company's subsidiaries. The Second Amended Financing Agreement also provided, among other things for (i) an increase in the amount of the Term Loan by $1.2 million to cover a portion of the purchase price of the Cynthia Steffe assets which had initially been paid for through revolving credit borrowings under the Revolving Facility; (ii) an increase in the quarterly amortization payments on the Term Loan from $375,000 to $425,000; and (iii) the amendment of certain financial covenants for fiscal 2004 (including the fixed charge coverage ratio and the minimum borrowing availability covenants) to provide for the Cynthia Steffe operations and to be consistent with the Company's latest business plan for fiscal 2004.
On September 15, 2004 the Company and CIT agreed to further amend the Financing Agreement to modify the financial covenants to be consistent with the Company's then latest business plan for fiscal 2005.
On November 11, 2004 the Company and CIT agreed to further amend the Financing Agreement to extend the term of the agreement to October 1, 2008. In conjunction with this amendment, the Company and CIT 1) revised interest rates as described above; 2) revised the borrowing availability calculation under the agreement; and 3) revised certain financial covenants for fiscal 2005 and established financial covenants for fiscal 2006. A facility fee of $100,000 was paid in connection with the amendment.
On May 12, 2005, the Company and CIT agreed to further amend the Financing Agreement to reset certain financial covenants regarding tangible net worth, fixed charge coverage ratio and minimum borrowing availability for the fourth quarter of fiscal 2005.
On September 15, 2005, the Company and CIT agreed to further amend the Financing Agreement to reset or establish certain financial covenants regarding tangible net worth, EBITDA and minimum borrowing availability to be consistent with the Company's latest business plan for fiscal 2006.
On June 30, 2005, the Company had $6.2 million of outstanding letters of credit under the Revolving Facility, total availability of approximately $20.9 million under the Amended Financing Agreement, a balance of $7.3 million on the Term Loan and no revolving credit borrowings. At June 30, 2004, the Company had $8.0 million of outstanding letters of credit, total availability of approximately $11.6 million, a balance of $9.0 million on the Term Loan and $8.6 in revolving credit borrowings.
Factoring Agreement
On September 27, 2002 the Company also entered into a factoring agreement with CIT (the "Factoring Agreement"). The Factoring Agreement provided for a factoring commission equal to 4/10 of 1% of the gross face amount of all accounts factored by CIT, plus certain customary charges. The minimum factoring commission fee per year was $500,000. The Factoring Agreement provided that it would be terminated after eighteen months if there were no events of default under the Factoring Agreement at such time.
Effective March 31, 2004, the Company, S.L. Danielle and CIT agreed to terminate the Factoring Agreements between them. Pursuant to the terms of the original agreement, the Company is now obligated to pay to CIT a collateral management fee of $5,000 a month. Receivables related to sales of Cynthia Steffe product lines continue to be factored. In connection with the termination of those Factoring Agreements, CS Acquisition and CIT entered into an amendment of their Factoring Agreement which provides for a factoring commission equal to 6/10 of 1% of the gross face amount of all accounts factored by CIT up to $10 million ratably declining to a commission between .55% and .45% of the gross amount of the receivables in excess of $10 million. The Factoring Agreement between CS Acquisition and CIT, as most recently amended in November 2004, has a term ending on March 31, 2006.
Future Financing Requirements
At June 30, 2005, the Company had working capital of $21.6 million as compared with working capital of $17.2 million at June 30, 2004. On June 13, 2005, the Company and Kenneth Cole Productions, Inc. ("Purchaser") entered into a Stock Purchase Agreement, pursuant to which the Purchaser purchased from the Company six million (6,000,000) shares of common stock of the Company for an aggregate purchase price of six million dollars ($6,000,000). The Company's business plan requires the availability of sufficient cash flow and borrowing capacity to finance its product lines and to meet its cash needs for the launch and support of the Kenneth Cole product lines. The Company expects to satisfy such requirements through cash on hand, cash flow from operations and borrowings under its financing agreements. The Company believes that it has adequate resources to meet its needs for the foreseeable future assuming that it meets its business plan and satisfies the covenants set forth in the Financing Agreement.
The foregoing discussion contains forward-looking statements which are based upon current expectations and involve a number of uncertainties, including the Company's ability to maintain its borrowing capabilities under the Financing Agreement, retail market conditions, and consumer acceptance of the Company's products.
Off-Balance Sheet Arrangements
The Company does not have any off-balance sheet arrangements except for inventory purchase orders and letters of credit under the Financing Agreement. See "Financing Agreement".
Inflation
The Company does not believe that the relatively moderate rates of inflation which recently have been experienced in the United States, where it competes, have had a significant effect on its net revenue or profitability.
Seasonality of Business and Fashion Risk
The Company's principal products are organized into seasonal lines for resale at the retail level during the Spring, Summer, Fall and Holiday Seasons. Typically, the Company's products are designed as much as one year in advance and manufactured approximately one season in advance of the related retail selling season. Accordingly, the success of the Company's products is often dependent on the ability to successfully anticipate the needs of retail customers and the tastes of the ultimate consumer up to a year prior to the relevant selling season.
Historically, the Company's sales and operating results fluctuate by quarter, with the greatest sales occurring in the Company's first and third fiscal quarters. It is in these quarters that the Company's Fall and Spring product lines, which traditionally have had the highest volume of net sales, are shipped to customers, with revenues recognized at the time of shipment. As a result, the Company experiences significant variability in its quarterly results and working capital requirements. Moreover, delays in shipping can cause revenues to be recognized in a later quarter, resulting in further variability in such quarterly results.
Foreign Operations
The Company's foreign sourcing operations are subject to various risks of doing business abroad and any substantial disruption of its relationships with its foreign suppliers could adversely affect the Company's operations. Any material increase in duty levels, material decrease in quota levels or material decrease in available quota allocation could adversely affect the Company's operations. Approximately 89% of the products sold by the Company in fiscal 2005 were manufactured in Asia and Central America.
Critical Accounting Policies and Estimates
The Company's significant accounting policies are more fully described in Note 2 to the consolidated financial statements. Certain of the Company's accounting policies require the application of significant
judgment by management in selecting the appropriate assumptions for calculating financial estimates. By their nature, these judgments are subject to an inherent degree of uncertainty. These judgments are based on historical experience, observation of trends in the industry, information provided by customers and information available from other outside sources, as appropriate. Significant accounting policies include:
Revenue Recognition - The Company recognizes sales upon shipment of products to customers since title and risk of loss passes upon shipment. Provisions for estimated uncollectible accounts, discounts and returns and allowances are provided when sales are recorded based upon historical experience and current trends. While such amounts have been within expectations and the provisions established, the Company cannot guarantee that it will continue to experience the same rates as in the past. Design revenue, which is less than 1% of total revenue, is recognized when designs are manufactured and shipped.
Accounts Receivable - Accounts Receivable are net of allowances and anticipated discounts. An allowance for doubtful accounts is determined through analysis of the aging of accounts receivable at the date of the financial statements, assessments of collectibility based on historical trends and an evaluation of the impact of economic conditions. This amount is not significant primarily due to the Company's history of minimal bad debts. An allowance for discounts is based on those discounts relating to open invoices where trade discounts have been extended to customers. Costs associated with potential returns of products as well as allowable customer markdowns and operational charge backs, net of expected recoveries, are included as a reduction to net revenue and are part of the provision for allowances included in Accounts Receivable. These provisions result from seasonal negotiations as well as historic deduction trends, net expected recoveries and the evaluation of current market conditions. As of June 30, 2005 and June 30, 2004, Account Receivable was net of allowances of $1.8 million, and $1.2 million, respectively.
Inventories - Inventories are stated at the lower of cost or market, cost being determined on the first-in, first-out method. The majority of the Company's inventory purchases are shipped FOB shipping point from the Company's suppliers. The Company takes title and assumes the risk of loss when the merchandise is received at the boat or airplane overseas. The Company records inventory at the point of such receipt at the boat or airplane overseas. Reserves for slow moving and aged merchandise are provided to adjust inventory costs based on historical experience and current product demand. Inventory reserves were $1.5 million at June 30, 2005, and $0.8 million at June 30, 2004. Inventory reserves are based upon the level of excess and aged inventory and the Company's estimated recoveries on the sale of the inventory. While markdowns have been within expectations and the provisions established, the Company cannot guarantee that it will continue to experience the same level of markdowns as in the past.
Valuation of Long-Lived Assets, Trademarks and Goodwill - The Company periodically reviews the carrying value of its long-lived assets for continued appropriateness. This review is based upon projections of anticipated future undiscounted cash flows. While the Company believes that its estimates of future cash flows are reasonable, different assumptions regarding such cash flows could materially affect evaluations. The Company evaluates goodwill whenever events and changes in circumstances suggest that the carrying amount may not be recoverable from its estimated future cash flows. To the extent these future projections or the Company's strategies change, the conclusion regarding impairment may differ from the current estimates.
Income Taxes - The Company's results of operations have generated a federal tax net operating loss ("NOL") carryforward of approximately $96.0 million as of June 30, 2005. Generally accepted accounting principles require that the Company record a valuation allowance against the deferred tax asset associated with this NOL if it is "more likely than not" that the Company will not be able to utilize it to offset future taxes. As of June 30, 2005, based upon its evaluation of the Company's historical and projected results of operations, the current business environment and the magnitude of the NOL, the Company recorded a full valuation allowance on its deferred tax assets including NOL's. The provision for income taxes primarily relates to federal alternative minimum taxes (AMT) and state and local taxes. It is possible, however, that the Company could be profitable in the future at levels which cause management to conclude that it is more likely than not that the Company will realize all or a portion of the NOL carryforward. Upon reaching such a conclusion, the Company would record the estimated net realizable value of the deferred tax asset at that time and would then provide for income taxes at a rate equal to its
combined federal and state effective rates. Subsequent revisions to the estimated net realizable value of the deferred tax asset could cause the Company's provision for income taxes to vary from period to period, although its cash tax payments would remain unaffected until the benefit of the NOL is utilized.
Item 7A.
Item 7A. Quantitative and Qualitative Disclosures About Market Risk.
Interest Rate Risk - The Company is subject to market risk from exposure to changes in interest rates based primarily on its financing activities. The market risk inherent in the financial instruments represents the potential loss in earnings or cash flows arising from adverse changes in interest rates. These debt obligations with interest rates tied to the prime rate are described in "Liquidity and Capital Resources", as well as Note 6 of the Notes to the Consolidated Financial Statements. The Company manages these exposures through regular operating and financing activities. The Company has not entered into any derivative financial instruments for hedging or other purposes. The following quantitative disclosures are based on the prevailing prime rate. These quantitative disclosures do not represent the maximum possible loss or any expected loss that may occur, since actual results may differ from these estimates.
At June 30, 2005 and 2004, the carrying amounts of the Company's revolving credit borrowings and term loan approximated fair value. As of June 30, 2005, the Company's revolving credit interest rate was 6.5% and the term loan bore interest at 7.0%. As of June 30, 2005, a hypothetical immediate 10% adverse change in prime interest rates relating to the Company's revolving credit borrowings and term loan would have a $0.1 million unfavorable impact on its earnings and cash flows over a one-year period.
Item 8.
Item 8. Financial Statements and Supplementary Data.
The Company's consolidated financial statements are included herein commencing on page.
Item 9.
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure.
None.
Item 9A.
Item 9A. Controls and Procedures.
The Company maintains disclosure controls and procedures that are designed to ensure that information required to be disclosed by the Company in the reports filed or submitted by it under the Securities Exchange Act of 1934, as amended (the "Exchange Act"), is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission's rules and forms, and include controls and procedures designed to ensure that information required to be disclosed by the Company in such reports is accumulated and communicated to the Company's management, including the Company's Chairwoman and Chief Executive Officer and the Company's Chief Financial Officer, as appropriate to allow timely decisions regarding required disclosure.
Each fiscal quarter the Company carries out an evaluation, under the supervision and with the participation of the Company's management, including Company's Chairwoman and Chief Executive Officer along with the Company's Chief Financial Officer, of the effectiveness of the design and operation of the Company's disclosure controls and procedures pursuant to Exchange Act Rule 13a-15. Based upon the foregoing, the Company's Chairwoman and Chief Executive Officer along with the Company's Chief Financial Officer, concluded that, as of June 30, 2005, the Company's disclosure controls and procedures are effective in timely alerting them to material information relating to the Company (including its consolidated subsidiaries) required to be included in the Company's Exchange Act reports.
During the fiscal year ended June 30, 2005, there has been no change in the Company's internal control over financial reporting that has materially affected, or is reasonably likely to materially affect, the Company's internal control over financial reporting.
Item 9B.
Item 9B. Other Information
None
PART III
Item 10.
Item 10. Directors and Executive Officers of the Registrant.
Information with respect to the executive officers of the Company is set forth in Part I of this Annual Report on Form 10-K.
Information with respect to the directors of the Company is incorporated by reference to the information to be set forth under the heading "Election of Directors" in the Company's definitive proxy statement relating to its 2005 Annual Meeting of Shareholders to be filed pursuant to Regulation 14A (the "2005 Proxy Statement").
Item 11.
Item 11. Executive Compensation.
Information called for by Item 11 is incorporated by reference to the information to be set forth under the heading "Executive Compensation" in the Company's 2005 Proxy Statement.
Item 12.
Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholders matters.
Information called for by Item 12 is incorporated by reference to the information to be set forth under the heading "Security Ownership of Certain Beneficial Owners and Management" in the Company's 2005 Proxy Statement.
Information with respect to securities authorized for issuance under equity compensation plans is incorporated by reference to the information to be set forth under the heading "Compensation Program Components" in the Company's 2005 Proxy Statement.
Item 13.
Item 13. Certain Relationships and Related Transactions.
Information called for by Item 13 is incorporated by reference to the information to be set forth under the headings "Executive Compensation" and "Certain Transactions" in the Company's 2005 Proxy Statement.
Item 14.
Item 14. Principal Accounting Fees and Services.
Information called for by Item 14 is incorporated by reference to the information to be set forth under the headings "Report of the Audit Committee" and "Auditors" in the Company's 2005 Proxy Statement.
PART IV
Item 15.
Item 15. Exhibits, Financial Statement Schedule
(a) Financial Statements and Financial Statement Schedule: See List of Financial Statements and Financial Statement Schedule on page.
(b) Exhibits
3.1 Restated Certificate of Incorporation (the "Restated Certificate") of the Company (incorporated by reference to Exhibit 3.1 of the Company's Registration Statement on Form S-1, Registration No. 33-5954 (the "1986 Registration Statement")).
3.2 Amendment dated November 18, 1987 to the Restated Certificate (incorporated by reference to Exhibit 3.11 of the Company's Registration Statement on Form S-2, Registration No. 33-63317 (the "1995 Registration Statement")).
3.3 Amendment dated November 15, 1995 to the Restated Certificate (incorporated by reference to Exhibit 3.12 of Amendment No. 1 to the 1995 Registration Statement).
3.4 Amendment dated December 9, 1998 to the Restated Certificate (incorporated by reference to Exhibit 3.13 of the Company's Form 10-K for the year ended June 30, 1998 (the "1998 Form 10-K")).
3.5 By-Laws of the Company, as amended (incorporated by reference to exhibit 3.1 of the Company's Form 10-Q for the quarter ended December 31, 1987).
3.6 Amendment dated September 13, 1994 to the By-Laws (incorporated by reference to Exhibit 10.105 of the Company's Form 10-Q for the quarter ended September 30, 1994).
†10.77 1998 Stock Option Plan, as amended by Amendment No.1 thereto including form of related stock option agreement (incorporated by reference to Exhibit A and Exhibit B of the Company's Proxy Statement filed with the Commission on October 17, 2000).
10.81 Collective Bargaining Agreement between the Company and Amalgamated Workers Union, Local 88 effective as of September 24, 1999 (incorporated by reference to Exhibit 10.81 of the Company's Form 10-K for the year ended June 30, 1999 (the "1999 Form 10-K")).
10.82 Lease between the Company and Adler Realty Company, dated June 1, 1999 with respect to the Company's executive offices and showroom at 530 Seventh Avenue, New York City (incorporated by reference to Exhibit 10.82 of the 1999 Form 10-K).
10.83 Lease between the Company and Kaufman Eighth Avenue Associates, dated September 11, 1999 with respect to the Company's technical support facilities at 519 Eighth Avenue, New York City (incorporated by reference to Exhibit of the Company's Form 10-K for the year ended June 30, 2000 (the "2000 Form 10-K")).
†10.87 Employment Agreement dated January 10, 2001 between the Company and Nicholas DiPaolo (incorporated by reference to Exhibit 10.87 of the Company's Form 10-Q for the quarter ended December 31, 2000).
10.90
Lease modification agreement between the Company and Hartz Mountain Industries, Inc., dated August 30, 1999 with respect to the Company's distribution and office facilities in Secaucus, NJ. (incorporated by reference to Exhibit 10.90 of the Company's Form 10-K for the year ended June 30, 2001 (the "2001 Form 10-K")).
10.100 Financing Agreement between the Company and CIT/Commercial Services, Inc., as Agent, dated September 27, 2002. (incorporated by reference to Exhibit 10.100 of the 2002 Form 10-K).
10.101 Factoring Agreement between the Company and CIT/Commercial Services, Inc., dated September 27, 2002. (incorporated by reference to Exhibit 10.101 of the 2002 Form 10-K).
10.102 Joinder and Amendment No. 1 to Financing Agreement by and among the Company, S.L. Danielle and The CIT Group/Commercial Services, Inc., as agent, dated November 27, 2002. (incorporated by reference to Exhibit 10.102 of the Company's Form 10-Q for the quarter ended December 31, 2002).
10.103 Amendment No. 1 to Factoring Agreement between the Company and The CIT Group/Commercial Services, Inc., dated November 27, 2002. (incorporated by reference to Exhibit 10.103 of the Company's Form 10-Q for the quarter ended December 31, 2002).
10.104 Factoring Agreement between S.L. Danielle and The CIT Group/Commercial Services, Inc., dated November 27, 2002. (incorporated by reference to Exhibit 10.104 of the Company's Form 10-Q for the quarter ended December 31, 2002).
10.105 Asset Purchase Agreement between S.L. Danielle and S.L. Danielle, Inc., dated November 27, 2002. (incorporated by reference to Exhibit 10.105 of the Company's Form 10-Q for the quarter ended December 31, 2002).
10.106 Joinder and Amendment No. 2 to Financing Agreement by and among the Company, S.L. Danielle, Cynthia Steffe Acquisition, LLC and The CIT Group/Commercial Services, Inc., as agent, dated January 30, 2004. (incorporated by reference to Exhibit 10.106 of the Company's Form 10-Q for the quarter ended December 31, 2003).
10.107 Amendment No. 2 to Factoring Agreement between the Company and The CIT Group/Commercial Services, Inc., dated January 30, 2004. (incorporated by reference to Exhibit 10.107 of the Company's Form 10-Q for the quarter ended December 31, 2003).
10.108
Amendment No. 1 to Factoring Agreement between S.L. Danielle and The CIT Group/Commercial Services, Inc., dated January 30, 2004. (incorporated by reference to Exhibit 10.108 of the Company's Form 10-Q for the quarter ended December 31, 2003).
10.109 Factoring Agreement between Cynthia Steffe Acquisition, LLC and The CIT Group/Commercial Services, Inc., dated January 15, 2004. (incorporated by reference to Exhibit 10.109 of the Company's Form 10-Q for the quarter ended December 31, 2003).
10.111 Amendment to Employment Agreement between Nicholas DiPaolo and Bernard Chaus, Inc., effective as of December 1, 2003. (incorporated by reference to Exhibit 10.111 of the Company's Form 10-Q for the quarter ended March 31, 2004).
10.112 Notice of Defactoring among Bernard Chaus, Inc., S.L. Danielle Acquisition, LLC and the CIT Group/Commercial Services, Inc., dated March 31, 2004. (incorporated by reference to Exhibit 10.112 of the Company's Form 10-Q for the quarter ended March 31, 2004).
10.113
Amendment No. 1 to Factoring Agreement between Cynthia Steffe Acquisition LLC and the CIT Group/Commercial Services, Inc., dated April1, 2004. (incorporated by reference to Exhibit 10.113 of the Company's Form 10-Q for the quarter ended March 31, 2004).
10.114 Amendment No. 3 to Financing Agreement among the Company, S.L. Danielle, Cynthia Steffe Acquisition, LLC and the CIT Group/Commercial Services, Inc. as agent, dated September 15, 2004 (incorporated by reference to Exhibit 10.114 of the 2004 Form 10-K).
†10.115
Amendment to Employment Agreement dated October 18, 2004 between the Company and Nicholas DiPaolo. (incorporated by reference to Exhibit 10.115 of the Company's form 10-Q the quarter ended December 31, 2004).
†10.116
Employment Agreement dated October 18, 2004 between the Company and David Panitz. (incorporated by reference to Exhibit 10.116 of the Company's form 10-Q the quarter ended December 31, 2004).
10.117 Amendment No. 4 to Financing Agreement among the Company, S.L. Danielle, Cynthia Steffe Acquisition, LLC and the CIT Group/Commercial Services, Inc. as agent, dated November 11, 2004. (incorporated by reference to Exhibit 10.117 of the Company's form 10-Q the quarter ended December 31, 2004).
10.118 Amendment No. 2 to Factoring Agreement between Cynthia Steffe Acquisition LLC and the CIT Group/Commercial Services, Inc., dated November 11, 2004. (incorporated by reference to Exhibit 10.118 of the Company's form 10-Q the quarter ended December 31, 2004).
*10.119
Amendment No.5 to Financing Agreement among the Company, S.L. Danielle, Cynthia Steffe Acquisition, LLC and the CIT Group/Commercial Services, Inc. dated May 12, 2005.
*10.120 Stock Purchase Agreement between Bernard Chaus, Inc. and Kenneth Cole Productions, Inc. dated June 13, 2005.
*10.121 License Agreement between Kenneth Cole Productions (LIC), Inc. and Bernard Chaus, Inc. dated June 13, 2005 (filed in redacted form since confidential treatment was requested pursuant to Rule 246-2 for certain portions thereof).
*10.122 Amendment No.6 to Financing Agreement among the Company, S.L. Danielle, Cynthia Steffe Acquisition, LLC and the CIT Group/Commercial Services, Inc. dated September 15, 2005.
*21 List of Subsidiaries of the Company.
*23.1
Consent of Mahoney Cohen & Company, CPA,P.C., Independent Registered Public Accounting Firm.
*23.2
Consent of Deloitte & Touche LLP., Independent Registered Public Accounting Firm.
*31.1
Certification Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 for Josephine Chaus.
*31.2
Certification Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 for Barton Heminover.
*32.1
Certification Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 for Josephine Chaus.
*32.2 Certification Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 for Barton Heminover.
† Management agreement or compensatory plan or arrangement required to be filed as an exhibit.
* Filed herewith.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this Report to be signed on its behalf by the undersigned, thereunto duly authorized.
Pursuant to the requirements of the Securities Exchange Act of 1934, this Report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.
BERNARD CHAUS, INC. AND SUBSIDIARIES
INDEX TO FINANCIAL STATEMENTS AND FINANCIAL STATEMENT SCHEDULE
The following consolidated financial statements of Bernard Chaus, Inc. and subsidiaries are included in Item 8:
The following consolidated financial statement schedule of Bernard Chaus, Inc. and subsidiaries is included in Item 15:
The other schedules for which provision is made in the applicable accounting regulation of the Securities and Exchange Commission are not required under the related instructions or are inapplicable and, therefore, have been omitted.
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors and Stockholders of
Bernard Chaus, Inc.
New York, New York
We have audited the accompanying consolidated balance sheet of Bernard Chaus, Inc. and subsidiaries as of June 30, 2005 and the related consolidated statements of operations, stockholders' equity and comprehensive income (loss) and cash flows for the year then ended. Our audit also included the financial statement schedule listed in the Index at item 15 for the year ended June 30, 2005. These financial statements and financial statement schedule are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements and financial statement schedule based on our audit.
We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. The Company has determined that it is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audit provides a reasonable basis for our opinion.
In our opinion, such consolidated financial statements present fairly, in all material respects, the financial position of Bernard Chaus, Inc. and subsidiaries at June 30, 2005, and the results of their operations and their cash flows for the year then ended in conformity with accounting principles generally accepted in the United States of America. Also, in our opinion, such financial statement schedule, when considered in relation to the basic consolidated financial statements taken as a whole, presents fairly in all material respects the information set forth therein.
/s/ Mahoney Cohen & Company, CPA, P.C.
New York, New York
August 31,
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors and Stockholders of
Bernard Chaus, Inc.
New York, New York
We have audited the accompanying consolidated balance sheet of Bernard Chaus, Inc. and subsidiaries as of June 30, 2004 and the related consolidated statements of operations, stockholders' equity and cash flows for each of the two years in the period ended June 30, 2004. Our audits also included the financial statement schedule listed in the Index at item 15 for the two years in the period ended June 30, 2004. These financial statements and financial statement schedule are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements and financial statement schedule based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, such consolidated financial statements present fairly, in all material respects, the financial position of Bernard Chaus, Inc. and subsidiaries at June 30, 2004, and the results of their operations and their cash flows for each of the two years in the period ended June 30, 2004 in conformity with accounting principles generally accepted in the United States of America. Also, in our opinion, such financial statement schedule, when considered in relation to the basic consolidated financial statements taken as a whole, presents fairly in all material respects the information set forth therein.
/s/ Deloitte & Touche LLP
Parsippany, New Jersey
September 28, 2004
BERNARD CHAUS, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(In thousands, except number of shares and per share amounts)
See accompanying notes to consolidated financial statements.
BERNARD CHAUS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands, except number of shares and per share amounts)
See accompanying notes to consolidated financial statements.
BERNARD CHAUS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
AND COMPREHENSIVE INCOME (LOSS)
(In thousands, except number of shares)
See accompanying notes to consolidated financial statements
BERNARD CHAUS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
See accompanying notes to consolidated financial statements.
BERNARD CHAUS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED JUNE 30, 2005, 2004 AND 2003
1. Business
Bernard Chaus, Inc. (the "Company" or "Chaus") designs, arranges for the manufacture of and markets an extensive range of women's career and casual sportswear principally under the JOSEPHINE CHAUS® COLLECTION, JOSEPHINE CHAUS® SPORT, CHAUS®, CYNTHIA STEFFE®, CYNTHIA CYNTHIA STEFFE®, and FRANCES & RITA® trademarks and under private label brand names. The Company's products are sold nationwide through department store chains, specialty retailers and other retail outlets. The Company has positioned its JOSEPHINE CHAUS product line into the opening price points of the "better" category. In November 2002, the Company acquired certain assets of S.L. Danielle, Inc. ("SL Danielle"). SL Danielle designs, arranges for the manufacture of and markets women's moderately priced clothing primarily under private labels. In January 2004, the Company acquired certain assets of the Cynthia Steffe division of LF Brands Marketing, Inc., including inventory and showroom fixtures. In connection with such acquisition, the Company also acquired the Cynthia Steffe trademarks from Cynthia Steffe. The Cynthia Steffe business designs, arranges for the manufacture of, markets and sells an upscale modern women's apparel line, under the Cynthia Steffe trademarks. In June 2005 the Company signed a licensing agreement with Kenneth Cole Productions, Inc. to manufacture and sell women's sportswear under the Kenneth Cole Reaction label. The Company expects that these products will be sold nationwide through major retail department stores and select specialty stores starting in spring 2006. These products will offer high-quality fabrications and styling at "better" price points. As used herein, fiscal 2005 refers to the fiscal year ended June 30, 2005, fiscal 2004 refers to the fiscal year ended June 30, 2004 and fiscal 2003 refers to the fiscal year ended June 30, 2003.
2. Summary of Significant Accounting Policies
Principles of Consolidation:
The consolidated financial statements include the accounts of the Company and its subsidiaries. Intercompany accounts and transactions have been eliminated.
Use of Estimates:
The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and 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.
Revenue Recognition:
The Company recognizes sales upon shipment of products to customers since title and risk of loss passes upon shipment. Provisions for estimated uncollectible accounts, discounts and returns and allowances are provided when sales are recorded based upon historical experience and current trends. While such amounts have been within expectations and the provisions established, the Company cannot guarantee that it will continue to experience the same rates as in the past. Design revenue, which is less than 1% of total revenue, is recognized when designs are manufactured and shipped.
Shipping and Handling:
Shipping and handling costs charged to customers is recorded as a component of net revenue. For all periods presented shipping and handling costs charged to customers was less than $0.1 million. Shipping and handling costs are included as a component of selling, general and administrative expenses in the consolidated statements of operations. In fiscal year 2005, 2004 and 2003 shipping and handling costs approximated $0.6 million, $0.7 million and $0.4 million, respectively.
Cooperative Advertising:
Cooperative advertising allowances are recorded in selling, general and administrative expenses in the period in which the costs are incurred. In fiscal years ended June 30, 2005, June 2004 and June 2003 cooperative advertising expenses were approximately $0.5 million, $0.3 million, and $0.3 million respectively.
Credit Terms:
Through March 31, 2004, the Company extended credit to the majority of its customers through a factoring agreement with The CIT Group/Commercial Services, Inc. ("CIT"). Under the factoring arrangement, the Company receives payment from CIT as of the earlier of: a) the date that CIT has been paid by the Company's customers; b) the date of the customer's longest maturity if the customer is in a bankruptcy or insolvency proceeding; or c) the last day of the third month following the customer's longest maturity date if the receivable remains unpaid. CIT assumes only the risk of the Company's customers' insolvency or non-payment. All other receivable risks for customer deductions that reduce the customer receivable balances are retained by the Company, including, but not limited to, allowable customer markdowns, operational chargebacks, disputes, discounts, and returns. Effective March 31, 2004, the Company, the Company's SL Danielle subsidiary and CIT agreed to terminate the Factoring Agreements between them. In connection with the termination of those Factoring Agreements, the Company's wholly owned subsidiary, Cynthia Steffe Acquisition, LLC ("CS Acquisition") and CIT entered into an amendment of their Factoring Agreement revising only the factoring commission. Receivables related to sales of Cynthia Steffe product lines continue to be factored. Effective April 1, 2004 the Company extends credit to its customers, other than customers of CS Acquisition based upon an evaluation of the customer's financial condition and credit history.
At June 30, 2005 and 2004, approximately 86% and 95% respectively, of the Company's accounts receivable was non factored. At June 30, 2005 and 2004, approximately 60 % and 77 % respectively, of the Company's accounts receivable were due from customers owned by three single corporate entities. During fiscal 2005, approximately 59% of the Company's net revenue was from three corporate entities - Dillard's Department Stores 22%, Sam's Club 20% and TJX Companies 17%. During fiscal 2004 approximately 70% of the Company's net revenue was from three corporate entities - Dillard's Department Stores 35%, TJX Companies 22% and Sam's Club 13%. During fiscal 2003 approximately 73% of the Company's net revenue was from three corporate entities - Dillards Department Stores 40%, TJX Companies 23% and May Department Stores 10%. As a result of the Company's dependence on its major customers, such customers may have the ability to influence the Company's business decisions. The loss of or significant decrease in business from any of its major customers could have a material adverse effect on the Company's financial position and results of operations.
Accounts Receivable:
Accounts Receivable are net of allowances and anticipated discounts. An allowance for doubtful accounts is determined through analysis of the aging of accounts receivable at the date of the financial statements, assessments of collectibility based on historical trends and an evaluation of the impact of economic conditions. This amount is not significant primarily due to the Company's history of minimal bad debts. An allowance for discounts is based on those discounts relating to open invoices where trade discounts have been extended to customers. Costs associated with potential returns of products as well as allowable customer markdowns and operational charge backs, net of expected recoveries, are included as a reduction to net revenue and are part of the provision for allowances included in Accounts Receivable. These provisions result from seasonal negotiations as well as historic deduction trends, net expected recoveries and the evaluation of current market conditions. As of June 30, 2005 and June 30, 2004, Account Receivable was net of allowances of $1.8 million, and $1.2 million, respectively.
Inventories:
Inventories are stated at the lower of cost or market, cost being determined on the first-in, first-out method. The majority of the Company's inventory purchases are shipped FOB shipping point from the
Company's suppliers. The Company takes title and assumes the risk of loss when the merchandise is received at the boat or airplane overseas. The Company records inventory at the point of such receipt at the boat or airplane overseas. Reserves for slow moving and aged merchandise are provided to writedown inventory costs to net realizable value based on historical experience and current product demand. Inventory reserves were $1.5 million at June 30, 2005, and $0.8 million at June 30, 2004. Inventory reserves are based upon the level of excess and aged inventory and the Company's estimated recoveries on the sale of the inventory. While markdowns have been within expectations and the provisions established, the Company cannot guarantee that it will continue to experience the same level of markdowns as in the past.
Cost of goods sold:
Cost of goods sold includes the costs incurred to acquire and produce inventory for sale, including product costs, freight-in, duty costs, commission cost and provisions for inventory losses. During fiscal 2005, the Company purchased approximately 72% of its finished goods from its ten largest manufacturers, including approximately 15% of its purchases from its largest manufacturer. The Company believes that the number and geographical diversity of its manufacturing sources minimize the risk of adverse consequences that would result from termination of its relationship with any of its larger manufacturers. The Company also believes that it would have the ability to develop, over a reasonable period of time, adequate alternate manufacturing sources should any of its existing arrangements terminate. However, should any substantial number of such manufacturers become unable or unwilling to continue to produce apparel for the Company or to meet their delivery schedules, or if the Company's present relationships with such manufacturers were otherwise materially adversely affected, there can be no assurance that the Company would find alternate manufacturers of finished goods on satisfactory terms to permit the Company to meet its commitments to its customers on a timely basis. In such event, the Company's operations could be materially disrupted, especially over the short-term.
Cash and Cash Equivalents:
All highly liquid investments with an original maturity of three months or less at the date of purchase are classified as cash equivalents.
Goodwill and Trademarks
Goodwill represents the excess of purchase price over the fair value of net assets acquired in business combinations accounted for under the purchase method of accounting. Trademarks relate to the Cynthia Steffe trademarks and were determined to have an indefinite life. Pursuant to the provisions of SFAS No. 142, "Goodwill and Other Intangible Assets" the Company does not amortize assets with indefinite lives and conducts impairment testing annually in the fourth quarter of each fiscal year, or sooner if events and changes in circumstances suggest that the carrying amount may not be recoverable from its estimated future cash flows. No amortization expense or impairment charges related to goodwill and trademarks have been recorded for the fiscal years ended June 30, 2005, 2004, and 2003.
Long-Lived Assets
The Company reviews certain long-lived assets for impairment whenever events or changes in circumstances indicate that the carrying amount may not be recoverable. In that regard, the Company assesses the recoverability of such assets based upon estimated undiscounted cash flow forecasts. While the Company believes that its estimates of future cash flows are reasonable, different assumptions regarding such cash flows could materially affect evaluations. To the extent these future projections or the Company's strategies change, the conclusion regarding impairment may differ from the current estimates. As of June 30, 2005, no impairments of long-lived assets have been recognized.
Income Taxes:
The Company accounts for income taxes under the asset and liability method in accordance with Statement of Financial Accounting Standards ("SFAS") No. 109, Accounting for Income Taxes. Deferred
income taxes reflect the future tax consequences of differences between the tax bases of assets and liabilities and their financial reporting amounts at year-end. The Company periodically reviews its historical and projected taxable income and considers available information and evidence to determine if it is more likely than not that a portion of the deferred tax assets will be realized. A valuation allowance is established to reduce the deferred tax assets to the amount that is more likely than not to be realized. As of June 30, 2005 and 2004, based upon its evaluation, the Company recorded a full valuation allowance on its deferred tax assets. See Note 5. If the Company determines that a portion of the deferred tax assets will be realized in the future, a portion of the valuation allowance will be reduced and the Company will provide for income tax expense (benefit) in its Statement of Operations at its estimated effective tax rate.
Stock-based Compensation:
The Company has a Stock Option Plan and accounts for the plan under the recognition and measurement principles of APB 25, "Accounting for Stock Issued to Employees", and related interpretations. Under this method, compensation cost is the excess, if any, of the quoted market price of the stock at the grant date or other measurement date over the amount an employee must pay to acquire the stock. No stock-based employee compensation cost is reflected in the Statement of Operations, as options granted under the plan had an exercise price equal to the market value of the underlying common stock on the date of grant. Had compensation costs for the Company's stock option grants been determined based on the fair value at the grant dates for awards under these plans in accordance with SFAS No. 123, the Company's net income (loss) and earnings (loss) per share would have been reduced to the pro forma amounts as follows (Dollars in thousands, except share data):
The following assumptions were used in the Black Scholes option pricing model that was utilized to determine stock-based employee compensation expense under the fair value based method:
Earnings Per Share:
Basic earnings (loss) per share has been computed by dividing the applicable net income (loss) by the weighted average number of common shares outstanding. Diluted earnings per share has been computed by dividing the applicable net income by the weighted average number of common shares outstanding and common share equivalents. Potentially dilutive shares of 1,384,994 were not included in the calculation of diluted loss per share for the year ended June 30, 2005, as their inclusion would have been antidilutive.
Advertising Expense:
Advertising costs are expensed when incurred. Advertising expenses including coop advertising of $0.6 million, $0.4 million and $0.3 million, were included in selling, general and administrative expenses for the years ended June 30, 2005, 2004 and 2003 respectively.
Fixed Assets:
Furniture and equipment are depreciated principally using the straight-line method over eight years. Leasehold improvements are amortized using the straight-line method over either the term of the lease or the estimated useful life of the improvement, whichever period is shorter. Computer hardware and software is depreciated using the straight-line method over three to five years.
Other Assets:
Other assets primarily consist of security deposits for real estate leases and deferred financing costs, which are being amortized over the remaining life of the finance agreement.
Foreign Currency Transactions:
The Company negotiates substantially all of its purchase orders with foreign manufacturers in United States dollars. The Company considers the United States dollar to be the functional currency of its overseas subsidiaries. All foreign currency gains and losses are recorded in the Consolidated Statement of Operations.
Fair Value of Financial Instruments:
For financial instruments, including accounts receivable, accounts payable, revolving credit borrowings and term loans, the carrying amounts approximated fair value due to their short-term maturity or variable interest rate.
Deferred Rent Obligations:
The Company accounts for rent expense under noncancelable operating leases with scheduled rent increases on a straight-line basis over the lease term. The excess of straight-line rent expense over scheduled payment amounts is recorded as a deferred liability included in long-term liabilities. Deferred rent obligations amounted to $0.5 million at June 30, 2005 and 2004.
Other Comprehensive Income (Loss):
Other comprehensive income (loss) is reflected in the consolidated statements of stockholders' equity. Other comprehensive income (loss) reflects adjustments for minimum pension liability.
Reclassifications:
Certain reclassifications related to accounts receivable have been made to conform to the current period presentation.
Segment Reporting:
SFAS No. 131, Disclosures about Segments of an Enterprise and Related Information requires enterprises to report certain information about products and services, activities in different geographic areas and reliance on major customers and to disclose certain segment information in their financial statements. The basis for determining an enterprise's operating segments is the manner in which financial information is used internally by the enterprise's chief operating decision maker. The Company has determined that it operates in one segment, women's career and casual sportswear. In addition, less than 1% of total revenue is derived from customers outside the United States. The majority of the Company's long-lived assets are located in the United States.
New Accounting Pronouncements:
In November 2004, the FASB issued SFAS No. 151, "Inventory Costs, an amendment of ARB No. 43, Chapter 4". SFAS No. 151 retains the general principle of ARB 43, Chapter 4, "Inventory Pricing (AC Section I78)", that inventories are presumed to be stated at cost; however, it amends ARB 43 to clarify that abnormal amounts of idle facility expense, freight, handling costs, and wasted materials (spoilage) should be recognized as current-period charges and require the allocation of fixed production overheads to inventories based on the normal capacity of the production facilities. The guidance is effective for inventory costs incurred during fiscal years beginning after June 15, 2005. Earlier application is permitted for inventory costs incurred during fiscal years beginning after November 23, 2004. The Company does not anticipate that SFAS No. 151 will have a significant impact on the Company's overall results of operations or financial position.
In December 2004, the FASB issued SFAS No. 123 (revised 2004), "Share-Based Payment". SFAS 123(R) requires that the compensation cost relating to share-based payment transactions be recognized in financial statements. The amount of compensation cost will be measured based on the grant-date fair value of the equity or liability instruments issued. SFAS 123(R) covers a wide range of share-based compensation arrangements including share options, restricted share plans, performance-based awards, share appreciation rights, and employee share purchase plans. SFAS 123(R) replaces SFAS No. 123, "Accounting for Stock-Based Compensation" and supersedes APB Opinion No. 25, "Accounting for Stock Issued to Employees". This statement is effective as of the first interim or annual reporting period that begins after June 15, 2005. The Company is required to implement this new standard in the quarter ending September 30, 2005. The impact of this new standard, if it had been in effect, on the net earnings and related per share amounts of our fiscal years ended in June 2005, 2004 and 2003 is disclosed above in Note 2, Summary of Significant Accounting Policies, Stock-Based Compensation. The impact of this new standard on the Company's net earnings for fiscal 2006 is estimated to be approximately $0.2 million before the grant of any new options.
In May 2005, the FASB issued SFAS No. 154, "Accounting for Changes and Error Corrections - a replacement of APB Opinion No. 20 and FASB Statement No. 3" ("SFAS No. 154"). SFAS No.
replaces APB Opinion No. 20, Accounting Changes, and FASB Statement No. 3, Reporting Accounting Changes in Interim Financial Statements, and changes the requirements for the accounting for and reporting of a change in accounting principle. This Statement applies to all voluntary changes in accounting principle. It also applies to changes required by an accounting pronouncement in the unusual instance that the pronouncement does not include specific transition provisions. When a pronouncement includes specific transition provisions, those provisions should be followed. SFAS No. 154 becomes effective for accounting changes and corrections of errors made in fiscal years beginning after December 15, 2005.
3. Inventories - net
Inventories are stated at the lower of cost, using the first-in first-out (FIFO) method, or market. Included in inventories is merchandise in transit of approximately $5.1 million at June 30, 2005 and $5.2 million at June 30, 2004.
4. Fixed Assets
5.
Income Taxes
The following are the major components of the provision for income taxes (In thousands):
Significant components of the Company's net deferred tax assets and deferred tax liabilities are as follows:
The Company accounts for income taxes under the asset and liability method in accordance with SFAS No. 109, Accounting for Income Taxes. Deferred income taxes reflect the future tax consequences of differences between the tax bases of assets and liabilities and their financial reporting amounts at year-end. The Company periodically reviews its historical and projected taxable income and considers available information and evidence to determine if it is more likely than not that a portion of the deferred tax assets will be realized. A valuation allowance is established to reduce the deferred tax assets to the amount that is more likely than not to be realized. As of June 30, 2005 and 2004, based upon its evaluation of historical and projected results of operation and the current business environment, the Company recorded a full valuation allowance on its deferred tax assets. In fiscal 2005, the valuation allowance was reduced by $1.8 million to $41.0 million at June 30, 2005 from $42.8 million at June 30, 2004 to primarily reflect the utilization of NOL's to offset taxes otherwise payable on current taxable income and to reflect changes in deferred tax assets. If the Company determines that it is more likely than not that a portion of the deferred tax assets will be realized in the future, that portion of the valuation allowance will be reduced with a corresponding decrease in income tax expense. At such time that the valuation allowance is eliminated and the Company has operating income, the Company will provide for income tax expense in its Statement of Operations at its effective tax rate.
The Company has provided a deferred tax liability in the amount of $179,000 on the temporary differences associated with its indefinite-lived intangibles. The Company's indefinite lived intangibles are not amortized for book purposes. As the Company continues to amortize these intangible assets for tax purposes, it will provide a deferred tax liability on the temporary difference. The temporary difference will not reverse until such time as the assets are impaired or sold therefore the likelihood of being offset by the Company's net operating loss carryforward is uncertain. There were no sales or impairments during the years ended June 30, 2005 and 2004.
At June 30, 2005, the Company has a federal net operating loss carryforward for income tax purposes of approximately $96.0 million, which will expire between fiscal 2010 and 2023. None of the operating loss carryforwards relate to the exercise of nonqualified stock options.
6. Financing Agreements
On September 27, 2002, the Company and certain of its subsidiaries entered into a new three-year financing agreement (the "Financing Agreement") with The CIT Group/Commercial Services, Inc. ("CIT"), to replace the Former Financing Agreement discussed below. The Financing Agreement provides the Company with a $50.5 million facility comprised of (i) a $40 million revolving line of credit (the "Revolving Facility") with a $25 million sublimit for letters of credit, a $3 million seasonal overadvance and certain other overadvances at the discretion of CIT, and (ii) a $10.5 million term loan (the "Term Loan").
At the option of the Company, the Revolving Facility and the Term Loan each may bear interest either at the JP Morgan Chase Bank Rate ("Prime Rate") or the London Interbank Offered Rate ("LIBOR"). If the Company chooses the Prime Rate, the interest (i) on the Revolving Facility accrues at a rate of ½ of 1% above the Prime Rate (ii) on the Term Loan accrues at a rate of 1% above the Prime Rate. If the Company chooses LIBOR, the interest (i) on the Revolving Facility accrues at a rate of 3¼% above LIBOR (2.75% above LIBOR from and after November 2004) (ii) on the Term Loan accrues at a rate of 3¾% above LIBOR. From the inception of the financing agreement through June 30, 2005, the Company has elected the Prime Rate option. Pursuant to the November 2004 amendment to the Financing Agreement described below, each of the foregoing interest rates is subject to an annual upward or downward adjustment by ¼ of 1%, commencing with the month following delivery of the Company's consolidated financial statements to CIT for fiscal 2005, fiscal 2006 and fiscal 2007 based upon the Company's borrowing availability, fixed charge coverage ratio and leverage ratio as in effect at each such adjustment period. The interest rate as of June 30, 2005 on the Revolving Facility was 6.5% and on the Term Loan was 7.0%.
On September 27, 2002, the Company borrowed $18.3 million under the Revolving Facility and $10.5 million under the Term Loan. These borrowings were used to pay off the balances under the former financing agreement of $18.3 million and the former term loan of $10.5 million and for working capital purposes. Commencing October 1, 2002, amortization payments in the amount of $375,000 (increased to $425,000 by the January 2004 amendment to the Financing Agreement described below) are payable quarterly in arrears in connection with the Term Loan. A balloon payment of $1.8 million is due on October 1, 2008 under the Term Loan. The Company's obligations under the Financing Agreement are secured by a first priority lien on substantially all of the Company's assets, including the Company's accounts receivable, inventory, intangibles, equipment, and trademarks, and a pledge of the Company's equity interest in its subsidiaries.
The Financing Agreement contains numerous financial and operational covenants, including limitations on additional indebtedness, liens, dividends, stock repurchases and capital expenditures. In addition, the Company is required to maintain (i) specified levels of tangible net worth, (ii) minimum EBITDA (earnings before interest , taxes, depreciation and amortization),certain fixed charge coverage ratios, (iii) certain leverage ratios, and (iv) specified levels of minimum borrowing availability under the Revolving Facility. At June 30, 2005, the Company was in compliance with all of its covenants. In the event of the early termination by the Company of the Financing Agreement, the Company will be liable for termination fees of $150,000 if termination occurs prior to November 11, 2007. The Company may prepay at any time, in whole or in part, the Term Loan without penalty. A fee of $125,000 was paid in
connection with the original Financing Agreement. The expiration of the Financing Agreement was initially set for September 27, 2005 and was extended to October 1, 2008 by an amendment dated November 11, 2004.
On November 27, 2002, the Company and CIT agreed to an amendment to the Financing Agreement in order to facilitate the S.L. Danielle acquisition. The Company and CIT agreed to add the Company's newly formed wholly-owned subsidiary, S.L. Danielle Acquisition, LLC (the "Additional Borrower"), as a co-borrower under the Financing Agreement and related Factoring Agreement. Accordingly, the Company and CIT (i) amended the Financing Agreement pursuant to a joinder agreement, which also constitutes Amendment No. 1 to the Financing Agreement (the "Amended Financing Agreement") and (ii) entered into a new factoring agreement with the Additional Borrower, to add the Additional Borrower as a co-borrower. The Company's and the Additional Borrower's obligations under the Amended Financing Agreement are secured by a first priority lien on substantially all of the Company's and the Additional Borrower's assets, including the Company's and the Additional Borrower's accounts receivable, inventory, intangibles, equipment, and trademarks and a pledge of the Company's stock interest and membership interest in the Company's subsidiaries, including the Additional Borrower.
On January 30, 2004, the Company and CIT agreed to an amendment to the Financing Agreement in order to facilitate the Cynthia Steffe acquisition discussed below. The Company and CIT agreed to add the Company's wholly-owned subsidiary, CS Acquisition as a co-borrower under the Financing Agreement and related Factoring Agreement. Accordingly, the Company and CIT (i) amended the Financing Agreement pursuant to a joinder agreement, which also constitutes Amendment No. 2 to the Financing Agreement (the "Second Amended Financing Agreement") and (ii) entered into a new factoring agreement with CS Acquisition, to add CS Acquisition as a co-borrower. The obligations of the Company, S.L. Danielle and CS Acquisition under the Second Amended Financing Agreement are secured by a first priority lien on substantially all of the assets of the Company, S.L. Danielle and CS Acquisition, including their respective accounts receivables, inventory, intangibles, equipment, and trademarks and a pledge of the Company's stock interest and membership interest in the Company's subsidiaries. The Second Amended Financing Agreement also provided, among other things for (i) an increase in the amount of the Term Loan by $1.2 million to cover a portion of the purchase price of the Cynthia Steffe assets which had initially been paid for through revolving credit borrowings under the Revolving Facility; (ii) an increase in the quarterly amortization payments on the Term Loan from $375,000 to $425,000; and (iii) the amendment of certain financial covenants for fiscal 2004 (including the fixed charge coverage ratio and the minimum borrowing availability covenants) to provide for the Cynthia Steffe operations and to be consistent with the Company's latest business plan for fiscal 2004.
On September 15, 2004 the Company and CIT agreed to further amend the Financing Agreement to modify the financial covenants to be consistent with the Company's then latest business plan for fiscal 2005.
On November 11, 2004 the Company and CIT agreed to further amend the Financing Agreement to extend the term of the agreement to October 1, 2008. In conjunction with this amendment, the Company and CIT 1) revised interest rates as described above; 2) revised the borrowing availability calculation under the agreement; and 3) revised certain financial covenants for fiscal 2005 and established financial covenants for fiscal 2006. A facility fee of $100,000 was paid in connection with the amendment.
On May 12, 2005, the Company and CIT agreed to further amend the Financing Agreement to reset certain financial covenants regarding tangible net worth, fixed charge coverage ratio and minimum borrowing availability for the fourth quarter of fiscal 2005.
On September 15, 2005, the Company and CIT agreed to further amend the Financing Agreement to reset or establish certain financial covenants regarding tangible net worth, EBITDA and minimum borrowing availability to be consistent with the Company's latest business plan for fiscal 2006.
On June 30, 2005, the Company had $6.2 million of outstanding letters of credit under the Revolving Facility, total availability of approximately $20.9 million under the Amended Financing Agreement, a balance of $7.3 million on the Term Loan and no revolving credit borrowings. At June 30, 2004, the Company had $8.0 million of outstanding letters of credit, total availability of approximately $11.6 million, a balance of $9.0 million on the Term Loan and $8.6 in revolving credit borrowings.
Factoring Agreement
On September 27, 2002 the Company also entered into a factoring agreement with CIT (the "Factoring Agreement"). The Factoring Agreement provided for a factoring commission equal to 4/10 of 1% of the gross face amount of all accounts factored by CIT, plus certain customary charges. The minimum factoring commission fee per year was $500,000. The Factoring Agreement provided that it would be terminated after eighteen months if there were no events of default under the Factoring Agreement at such time.
Effective March 31, 2004, the Company, S.L. Danielle and CIT agreed to terminate the Factoring Agreements between them. Pursuant to the terms of the original agreement, the Company is now obligated to pay to CIT a collateral management fee of $5,000 a month. Receivables related to sales of Cynthia Steffe product lines continue to be factored. In connection with the termination of those Factoring Agreements, CS Acquisition and CIT entered into an amendment of their Factoring Agreement which provides for a factoring commission equal to 6/10 of 1% of the gross face amount of all accounts factored by CIT up to $10 million ratably declining to a commission between .55% and .45% of the gross amount of the receivables in excess of $10 million. The Factoring Agreement between CS Acquisition and CIT, as most recently amended in November 2004, has a term ending on March 31, 2006.
Prior Financing Agreement
Until September 27, 2002, the Company had a financing agreement with BNY Financial Corporation, a wholly owned subsidiary of General Motors Acceptance Corp. ("GMAC") (the "Former Financing Agreement"). The Former Financing Agreement consisted of two facilities: (i) the Former Revolving Facility which was a $45.5 million five-year revolving credit line (subject to an asset based borrowing formula) with a $34.0 million sublimit for letters of credit, and (ii) the Former Term Loan which was a $14.5 million term loan facility. Each facility had been amended to extend the maturity date until April 1, 2003.
Interest on the Former Revolving Facility accrued at the greater of (i) 6% or (ii) ½ of 1% above the Prime Rate (6.0% at June 30, 2002) and was payable on a monthly basis, in arrears. Interest on the Former Term Loan accrued at an interest rate equal to the greater of (i) 6.0% or (ii) a rate ranging from ½ of 1% above the Prime Rate to 1½% above the Prime Rate, which interest rate was determined, from time to time, based upon the Company's availability under the Revolving Facility. The interest rate on the Former Term Loan was 6.0% at June 30, 2002.
Future Financing Requirements
At June 30, 2005, the Company had working capital of $21.6 million as compared with working capital of $17.2 million at June 30, 2004. On June 13, 2005, the Company and Kenneth Cole Productions, Inc. ("Purchaser") entered into a Stock Purchase Agreement, pursuant to which the Purchaser purchased from the Company six million (6,000,000) shares of common stock of the Company for an aggregate purchase price of six million dollars ($6,000,000). The Company's business plan requires the availability of sufficient cash flow and borrowing capacity to finance its product lines and to meet its cash needs for the launch and support of the Kenneth Cole product lines. The Company expects to satisfy such requirements through cash on hand, cash flow from operations and borrowings under its financing agreements. The Company believes that it has adequate resources to meet its needs for the foreseeable future assuming that it meets its business plan and satisfies the covenants set forth in the Financing Agreement.
7. Acquisitions
A. S.L. Danielle Acquisition
On November 27, 2002, S.L. Danielle, a newly formed subsidiary of the Company acquired certain assets of S.L. Danielle Inc. The results of S.L. Danielle's operations have been included in the consolidated financial statements since that date. S.L. Danielle designs, arranges for the manufacture of, markets and sells a women's apparel line, principally under private labels.
The aggregate purchase price was approximately $5.1 million, including cash of $4.4 million, 100,000 shares of common stock of the Company ("Common Stock") valued at $84,000 and stock options to purchase 500,000 shares of Common Stock valued at $384,000 and transaction costs of approximately $250,000. The acquisition was funded by CIT through revolving credit borrowings of $4.6 million. The value of the 100,000 shares of Common Stock was determined based on the average market price of the Common Stock over the 3-day period before and after the date of the acquisition. The 500,000 stock options were granted at the fair market value on the date of the acquisition and were valued using the Black Scholes option pricing model. The following table summarizes the fair values of the assets acquired at the date of acquisition.
B. Cynthia Steffe Acquisition
On January 2, 2004, CS Acquisition, a newly formed subsidiary of the Company acquired certain assets of the Cynthia Steffe division of LF Brands Marketing, Inc., including inventory and showroom fixtures. The Company also acquired the Cynthia Steffe trademarks from Cynthia Steffe for consideration equal to $1.0 million under a separate agreement. The Cynthia Steffe business designs, arranges for the manufacture of, markets and sells a women's apparel line, under the Cynthia Steffe trademarks. As a result of the acquisition, the Company expects to increase its sales volume through the sale of Cynthia Steffe product lines. The results of Cynthia Steffe's operations have been included in the consolidated financial statements commencing January 2, 2004. The aggregate purchase price was approximately $2.2 million, plus the payment of $0.5 million in satisfaction of certain liabilities, plus transaction fees and related acquisition costs of $0.2 million. The acquisition was initially funded out of borrowings under the Revolving Facility of which $1.2 million was subsequently rolled into the Term Loan.
The following table summarizes the fair values of the net assets acquired and liabilities assumed at the date of acquisition.
Intangible assets include i) $1.0 million related to the Cynthia Steffe trademark, which was determined to be an indefinite lived intangible asset and thus not subject to amortization, and ii) $62,000 related to the sales order backlog which was amortized over the sales period of four months.
The following unaudited pro forma information presents financial information of the Company as though the acquisitions had been completed as of the beginning of the periods set forth below.
8. Trademarks And Goodwill
Intangible assets were as follows:
The Company owns the Cynthia Steffe and related trademarks, therefore they are classified as indefinite lived intangibles at June 30, 2005 and 2004 and not amortized.
The following table summarizes trademarks and goodwill:
9. Employee Benefit Plans
Pension Plan:
Pursuant to a collective bargaining agreement, the Company's union employees are eligible to participate in the Company's defined benefit pension plan after completion of one year of eligible service. Pension benefits are based on the number of years of service times a predetermined factor. The Company uses June 30, 2005 as its measurement date for the pension plan.
Pension expense amounted to approximately $102,000, $123,000, and $81,000 in fiscal 2005, 2004, and 2003, respectively.
Obligations and Funded Status
The reconciliation of the benefit obligation and funded status of the pension plan as of June 30, 2005 and 2004 is as follows:
The accumulated benefit obligation for the pension plan was $1,821,000 and $1,348,000 at June 30, 2005 and 2004, respectively.
Additional Information
Increase (decrease) in minimum liability included in other comprehensive (income) loss was $370,000, ($189,000), and $252,000 for the years ended June 30, 2005, 2004 and 2003, respectively.
Assumptions
The expected long-term rate of return on plan assets was determined based on long-term return analysis for equity, debt and other securities as well as historical returns. Long-term trends are evaluated relative to market factors such as inflation and interest rates.
Plan Assets
The Company's pension plan weighted-average asset allocations at June 30, 2005 and 2004, by asset category are as follows:
The Company's investment strategy for the pension plan is to invest in a diversified portfolio of assets managed by an outside portfolio manager. The Company's goal is to provide for steady growth in the pension plan assets, exceeding the Company's expected return on plan assets of 8.5%. The portfolio is balanced to maintain the Company's targeted allocation percentage by type of investment. See table below. Investments are made by the portfolio manager based upon guidelines of the Company.
The parameters maintained by the portfolio manager are as follows:
Cash Flows
Contributions
The Company expects to contribute $311,000 to the pension plan in fiscal 2006.
Estimated Future Benefit Payments
The following benefit payments, which reflect expected future service, as appropriate, are expected to be paid (In thousands):
Savings Plan:
The Company has a savings plan (the "Savings Plan") under which eligible employees may contribute a percentage of their compensation and the Company (subject to certain limitations) as of January 2003 contributes 10% of the employee's contribution. From February 2002 to January 2003 there was no employer matching contribution. Prior to February 2002 the Company matched 50% of the employee's contribution. The Company contributions are invested in investment funds selected by the participants and are subject to vesting provisions of the Savings Plan. Expense under the Savings Plan was approximately $72,000 in fiscal 2005, $68,000 in fiscal 2004 and $15,000 in fiscal 2003.
10. Stock Based Compensation:
The Company has a Stock Option Plan (the "Option Plan"). Pursuant to the Option Plan, the Company may grant to eligible individuals incentive stock options, as defined in the Internal Revenue Code of 1986, and non-incentive stock options. Generally, vesting periods range from two to five years with a maximum term of ten years. Under the Option Plan, 6,750,000 shares of Common Stock are reserved for issuance. The maximum number of Shares that any one Eligible Individual may be granted in respect of options may not exceed 4,000,000 shares of Common Stock. No stock options may be granted subsequent to October 29, 2007. The exercise price may not be less than 100% of the fair market value on the date of grant for incentive stock options.
On January 10, 2001, the Company entered into an employment agreement (the "Agreement") with Nicholas DiPaolo, who has been serving as the Company's Vice Chairman and Chief Operating Officer since November 1, 2000, the effective date of the Agreement. The Agreement had an initial term ending November 30, 2003, which was subsequently extended by an amendment to the agreement until June 30, 2005. Mr. DiPaolo retired in June 2005. Under the Agreement on November 1, 2000, Mr. DiPaolo was granted 300,000 fully vested options to purchase Common Stock at the fair market value on the date of grant. Under the Agreement on January 10, 2001, Mr. DiPaolo was granted 3,000,000 options to purchase Common Stock of the Company at the fair market value on the date of the grant (the "Put Options"). The exercise price of the Put Options is $0.375. Under certain circumstances Mr. DiPaolo would have been entitled to require the Company to purchase his Put Options for the aggregate exercise price thereof. These circumstances did not occur. All of his remaining options were fully vested at the time of Mr. DiPaolo's retirement and are exercisable until November 1, 2005.
During February 2001, employee and director options for an aggregate of 1,400,401 shares of the Company's common stock were surrendered under a stock option replacement program offered by the Company. Under the program, employees had the right to surrender their outstanding, out-of-the- money options in exchange for a commitment by the Company to grant new options to them for the same number of shares on a date, which is in excess of six months (183 days) after the surrender date. To be eligible to receive the new options, which have an exercise price equal to the fair market value on the future grant date (August 8, 2001), employees (or directors as the case may be) must have been employed by the Company (or to serve as directors) on such grant date. On August 8, 2001, 1,400,401 options were granted to employees and directors under this program. The new options vested in increments of 50% on August 8, 2002 and 50% on August 8, 2003.
Information regarding the Company's stock options is summarized below:
The following table summarizes information about the Company's outstanding and exercisable stock options at June 30, 2005:
All stock options are granted at fair market value of the Common Stock at grant date. The outstanding stock options have a weighted average contractual life of 4.39 years, 3.94 years and 4.75 years in 2005, 2004 and 2003, respectively. The number of stock options exercisable at June 30, 2005, 2004 and 2003 were 3,327,777, 4,884,327 and 3,180,916 respectively.
11. Commitments, Contingencies and Other Matters
Lease Obligations:
The Company leases showroom, distribution and office facilities, and equipment under various noncancellable operating lease agreements which expire through 2014. Rental expense for the years ended June 30, 2005, 2004 and 2003 was approximately $2.9 million, $2.7 million and $2.6 million, respectively.
The minimum aggregate rental commitments at June 30, 2005 are as follows (in thousands):
Letters of Credit:
The Company was contingently liable under letters of credit issued by banks to cover primarily contractual commitments for merchandise purchases of approximately $6.2 million and $7.8 million at June 30, 2005 and June 30, 2004, respectively.
Inventory purchase commitments:
The Company was contingently liable for contractual commitments for merchandise purchases of approximately $10.2 million and $10.7 million at June 30, 2005 and June 30, 2004, respectively.
Kenneth Cole License Agreement:
The Company entered into a license agreement with Kenneth Cole Productions (LIC) in June 2005. Under the license agreement the Company is required to achieve certain minimum sales levels, to pay certain minimum royalties and to maintain a minimum net worth. The Company is also obligated to pay specified percentages of net sales to support advertising and to expend a total of $4 million in the period ending December 31, 2007 to support the initial launch of the licensed products.
The following table summarizes as of June 30, 2005, the Company's Kenneth Cole License Agreement Commitments by future period:
Litigation:
The Company is involved in legal proceedings from time to time arising out of the ordinary conduct of its business. The Company believes that the outcome of these proceedings will not have a material adverse effect on the Company's financial condition or results of operations.
12. Unaudited Quarterly Results of Operations
Unaudited quarterly financial information for fiscal 2005 and fiscal 2004 is set forth in the table below:
The sum of the quarterly net earnings per share amounts may not equal the full-year amount since the computations of the weighted average number of common-equivalent shares outstanding for each quarter and the full year are made independently.
SCHEDULE II
BERNARD CHAUS, INC. & SUBSIDIARIES
VALUATION AND QUALIFYING ACCOUNTS
(In thousands)
Uncollectible accounts written off
Allowances charged to reserve and granted to customers
S-1
INDEX TO EXHIBITS