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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
-------------------------------------
FORM 10-K
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE FISCAL YEAR ENDED DECEMBER 26, 1998
COMMISSION FILE NUMBER 0-27002
------------------------------------------
MORROW SNOWBOARDS, INC.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
OREGON 93-1011046
(STATE OR OTHER JURISDICTION OF (I.R.S. EMPLOYER IDENTIFICATION NO.)
INCORPORATION OR ORGANIZATION)
---------------------------------------------------------------
2600 PRINGLE ROAD, S.E.
SALEM, OREGON 97302
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES)
REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE:
(503) 375-9300
SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT:
(TITLE OF EACH CLASS) (NAME OF EACH EXCHANGE ON WHICH REGISTERED)
None N/A
SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT:
(TITLE OF CLASS)
Common Stock, no par value (registered December 13, 1995)
Indicate by check mark whether the Registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
Registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. / / yes /X/ no
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of the Registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. / /
The aggregate market value of voting shares held by non-affiliates of the
registrant's common stock on March 31, 1999 was approximately $2,316,000 (based
on last sale price of such stock as reported by Nasdaq National Market).
The number of shares outstanding of the registrant's common stock, no par
value, as of March 31, 1999 was 6,176,556.
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CONTENTS
PART I
Item 1. Business ............................................................................... 1
Item 2. Properties ............................................................................. 12
Item 3. Legal Proceedings ...................................................................... 13
Item 4. Submission of Matters to a Vote of Security Holders .................................... 15
PART II ........................................................................................ 16
Item 5. Market for Registrant's Common Equity and Related Stockholder Matters .................. 16
Item 6. Selected Consolidated Financial Data ................................................... 17
Item 7. Management's Discussion and Analysis of Financial Condition and Results
of Operations .......................................................................... 19
Item 8. Financial Statements and Supplementary Data ............................................ 30
Item 9. Changes In and Disagreements With Accountants on Accounting and
Financial Disclosure ................................................................... 55
PART III ........................................................................................ 56
Item 10. Directors and Executive Officers of the Registrant...................................... 56
Item 11. Executive Compensation.................................................................. 58
Item 12. Security Ownership of Certain Beneficial Owners and Management ......................... 63
Item 13. Certain Relationships and Related Transactions ......................................... 64
PART IV ........................................................................................ 65
Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K........................ 65
SIGNATURES ........................................................................................ 66
PART I
ITEM 1. BUSINESS
INTRODUCTION
Morrow Snowboards, Inc. (the Company) is engaged principally in the surf,
skate and snowboard industry. The Company's Westbeach-TM- clothing line is well
recognized for its design of apparel and casual clothing targeting participants
in those sports. The Company's retail stores provide an outlet for the
Westbeach-TM- brand as well as other brands of clothing, snowboards,
skateboards, surfboards and accessories. In March 1999, the Company announced it
had sold its Morrow-TM- intellectual property, along with all 1999/2000
inventories and its snowboard and binding production equipment to K2
Acquisitions Inc. (K2) and discontinued the manufacturing and marketing of
snowboards, boots and bindings. The sale of this business was completed on March
26, 1999, and the snowboard, boot and binding results for 1996, 1997 and 1998
have been shown as discontinued operations. This form 10-K, in particular, this
"Item 1. Business," outlines the Company's current business, as conducted and
expected to be conducted, assuming adequate financing. As outlined in "Item 7.
Management's Discussion and Analysis of Financial Condition and Results of
Operations," there is serious question as to the Company's ability to receive
adequate financing, both as to timing and amounts, to continue the business as
described herein. To preserve the value of the Company's businesses, the Company
is considering selling those businesses currently to avoid the loss in value
that would result in attempting to operate its business lines without adequate
financing.
The Company, an Oregon corporation, was originally incorporated in 1989 and
through the 1990's developed itself to be a well recognized designer,
manufacturer and marketer of premium snowboards, bindings, boots and related
accessories. In November 1997, the Company acquired all of the outstanding
securities of Westbeach Snowboard Canada Ltd., a British Columbia company
established in 1979 as a merchandiser of clothing products. Westbeach was
subsequently amalgamated with two acquisition entities to form Morrow Westbeach
Canada ULC (Westbeach), a Nova Scotia unlimited liability company.
Westbeach is known for its Westbeach-TM- brand apparel and retail outlets.
Westbeach designs, manufactures and wholesales its own Westbeach-TM- brand of
snowboarding apparel and casual clothing. Westbeach-TM- brand products are sold
in 19 countries through a network of distributors and sales representatives.
Westbeach also sells snowboards, boots, bindings, skateboards, surfboards and a
full line of apparel and accessories through its three retail stores in Canada
and the U.S. Westbeach has three subsidiaries: an Austrian corporation whose
principal activity consists of a European sales and warehousing operation, a
United Kingdom corporation whose principal activity consists of European sales
and a Washington corporation whose principal activity is U.S. retail sales. The
Company also has a Guam foreign sales corporation, Morrow International, Inc.
1
The Company has established an integrated distribution network targeting
the respective home markets of the Company in the U.S., Westbeach in Canada and
efforts by both entities on a global basis. This strategy is expected to
increase penetration in targeted existing markets.
Unless otherwise indicated, all financial numbers and operating results
presented for the Company for 1998 include information for the consolidated
Company for the entire fiscal year December 28, 1997 through December 26, 1998.
On a comparison basis, prior year financial numbers and operating results
include information for Morrow Snowboards, Inc. for the entire fiscal year
January 1, 1997 through December 27, 1997 and Westbeach only for the period
since the acquisition of Westbeach (November 13, 1997 through December 27,
1997). All financial results related to the snowboard operations sold to K2 have
been reflected as discontinued operations. Further, all pro forma Westbeach
financial information for the periods ended November 12, 1997 and December 31,
1996, which is normally expressed in Canadian dollars, has been converted to
U.S. dollars at the assumed exchange rate of 1.384 (except as otherwise
indicated herein). Financial information for the fiscal year ended December 26,
1998 is expressed based on the weighting of monthly currency averages.
INDUSTRY
In the early 1980's, Westbeach grew as the first Canadian manufacturer
and retailer in the action sports industry. Early production was limited to a
few styles of surf shorts and t-shirts. The demand for Westbeach-TM- branded
products at wholesale and retail continued to grow and the line was expanded to
be a complete program of shorts, tops, pants and jackets for summer and winter.
During the 1970's and 1980's, the sports of surfing and skateboarding attracted
mass appeal in the 12 to 24 year old youth market. The lifestyle clothing and
accessories that were associated with surfing and skateboarding experienced
significant growth during this period. Today, the action sports industry is a
multi-billion dollar industry. It has expanded to include sales of clothing,
shoes, sunglasses, swimwear and accessories for men and women. Distribution has
matured to the point that sales of the larger brands like Quicksilver, Billabong
and Rusty are in demand at the local specialty retail level and department store
chains like Nordstrom.
In the late 1980's and early 1990's, the sport of snowboarding became
popular. The demographics of the snowboarders were the same as the surf and
skateboard industry, so there was a natural crossover for many of the
manufacturers and retailers. Westbeach was one of the first manufacturers of
snowboard outerwear. This established a year-round presence in specialty
retailers for streetwear and outerwear.
Over the years, snowboarding has seen a continuous increase in
mainstream acceptance. With the debut of the sport in the Olympic Games in
Nagano, Japan, snowboarding was broadcast into millions of living rooms across
the globe. According to American Sports Data, the sport surged by 33% in the
number of participants from 1996 to 1997. Males 12 to 24 continue to comprise
the majority of the snowboard population. However, the fastest growing segment
is in women and men of all ages trying the sport for the first time. In fact,
the growth in snowboarding during 1997 was generated almost exclusively by those
aged 18-34, as the number of snowboarders aged 25-34 surged by 207% and the
18-24 division posted a 94% gain. The same
2
growth pattern was seen in the skiing industry, which is currently
experiencing a decline.
According to American Sports Data, snowboarding is now 34% the size of the
skiing population, steadily increasing since 1988, when snowboarders represented
only 8% of the total skiing population.
The Westbeach-TM- brand competes with more than 100 other companies in
the snowboard apparel industry. A recent Transworld Snowboarding Magazine survey
ranks Westbeach-TM- seventh among snowboard apparel brands in North America for
1998. The Westbeach-TM- streetwear program continues to be popular in Canada and
Europe. The streetwear line is currently not available to the U.S. market. The
three Westbeach stores operate as flagship stores for the Westbeach-TM- brand
and represent all the major brands for snowboarding, surfing and skateboarding.
OPERATING STRATEGY
The Company has implemented its operating strategy based on the
following statements:
LISTEN - Listen to and understand what our customers want; make that
information known to all employees and act on that information; analyze results,
make adjustments and repeat.
HUNGRY - Be a hungry, lean, performance-oriented organization in which
we work toward a common purpose and produce extraordinary results.
QUALITY - Produce quality products and continuously improve that
quality. Ship products on time at competitive prices, in all markets.
REDUCE - Reduce the cost of our products continuously and control all
of our costs tightly.
AGGRESSIVE - Market and sell our products aggressively and give our
customers incredible service.
VISION STATEMENT
The Company is committed to the pursuit of perfection. Our culture is
one of quality -- we are never satisfied. We push ourselves to ever-higher
standards of performance, always exceeding the expectations of our customers.
The pursuit never ends...
MISSION STATEMENT
Our mission is to constantly exceed the expectations of our customers
in the design, manufacturing, marketing, sales and distribution of top quality
apparel, accessories and related services, and by delivering on a timely basis
at competitive prices.
3
GROWTH STRATEGY
The Company has gained momentum by positioning its Westbeach-TM- brand
to take advantage of expansion in the industry. The Company's continued growth
strategy is to: (i) increase visibility and distribution of the brand in the
U.S. market; (ii) continue the pursuit of direct distribution in Europe; (iii)
target the specialty shop market in Japan; (iv) develop further efficiencies
with apparel contractors; (v) increase the commitment to women's apparel; and
(vi) increase the number of retail stores owned by the Company.
U.S. MARKET - The Company will continue to focus on growth through
marketing to the U.S. market in recognition that all export markets also benefit
from this strategy.
DIRECT DISTRIBUTION IN EUROPE - The Westbeach-TM- brand has been sold
directly to retailers from the Company's subsidiary in Innsbruck for four years.
The focus is on competitive pricing with superior customer service, and the
Company will continue to benefit from this strategy.
JAPAN MARKET - The Company will focus on growth in the specialty market
in Japan, capitalizing on the marketing efforts already in place within the U.S
EFFICIENCIES WITH CONTRACTORS - The Company will continue to develop
relationships with apparel contractors to improve efficiencies in the
manufacture of Westbeach apparel. The Company will benefit from better pricing
and terms, which can be used to enhance the selling efforts in all markets.
WOMEN'S MARKET - The women's category is the fastest growing part of
the snowboard market and the Company will increase its product offering and
marketing efforts to capitalize on this.
RETAIL STORES - The Company will grow in this area by adding one or
more Westbeach retail outlets in 1999. The Company has the ability to stay in
tune with the snowboard and lifestyle apparel markets by owning and operating
retail outlets.
TECHNOLOGY AND DESIGN
APPAREL
The Company's Westbeach-TM- brand clothing line, founded in Canada in
1979, has always targeted snowboarders, offering features that allow for a
better experience on the mountain. One of the core strengths of the line is
"built to last" construction techniques combined with a unique, rugged outdoor
design.
The Westbeach-TM- outerwear line uses adjustable hood technology to
allow custom fit at eye level for better visibility, lining compatible shells,
and a custom-flow-through system to create free air flow which carries away
perspiration while exhaust vents provide cooling-down ability.
4
The fleece product line incorporates both Power Dry-TM- and fleece
fabrics. These fabrics are designed to wick moisture away from the body, leaving
the wearer dry. Power Dry-TM- is a lightweight fabric engineered with micro-ban,
an anti-microbial built into the molecular structure so that it does not wash
out. The fleece groups consist of a 200-weight fleece for mid-weight layering
and a 100-weight series for lighter insulation. Both categories provide
insulation against cold and are breathable and quick drying.
ACCESSORIES
Under the Westbeach-TM- brand name, the Company also markets a line of
accessories, including t-shirts, sweatshirts, hats, caps, backpacks, gear bags,
watchbands and key chains to support and promote the brand name.
PRODUCTS
The following table sets forth the contribution to net sales
attributable to each of the Company's product groups for the years ended
December 26, 1998, December 27, 1997 and December 31, 1996.
---------------------------- ------------------------------------ -----------------------------
1998 1997 1996
---------------------------- ---------------------------------- ------------------------------
Net Sales Percentage of Net Sales Percentage of Net Sales Percentage of
(in thousands) Net Sales (in thousands) Net Sales (in thousands) Net Sales
----------------------------- ----------------------------------- ------------------------------
Wholesale - Accessories
and apparel $ 5,905 62.6% $ 969 53.5% $ - - %
Retail 3,523 37.4 841 46.5 - -
============================= ================================ ==============================
Total $ 9,428 100.0% $ 1,810 100.0% $ - - %
============================= ================================ ==============================
As discussed previously, in March 1999, the Company sold its snowboard,
boot and binding business to K2. The snowboard business results for 1998, 1997
and 1996 are reflected as discontinued operations in the accompanying
consolidated financial statements. Revenues for the discontinued snowboard
business, which are excluded from the table above, were $16.0 million, $18.4
million and $31.7 million, respectively.
The following table sets forth Westbeach's unaudited pro forma sales by
product group for the periods ending prior to its acquisition by Morrow
Snowboards, Inc.:
---------------------------------- ---------------------------------
1/1/97 - 11/12/97 1/1/96 - 12/31/96
--------------------------------- ----------------------------------
Net Sales Percentage of Net Sales Percentage of
(in thousands) Net Sales (in thousands) Net Sales
---------------------------------- ---------------------------------
PRODUCT GROUP
Wholesale accessories and $ 5,275 72.4% $ 6,018 68.4%
apparel
Retail 2,010 27.6 2,777 31.6
================================== =================================
Total $ 7,285 100.0% $ 8,795 100.0%
================================== =================================
The Company promotes three groupings of apparel outerwear lines with a
variety of performance and design characteristics. For the 1999/2000 model year,
the Company offers 28
5
outerwear pieces for men and 14 outerwear pieces for women in three
performance categories under the "Westbeach"-TM- brand name. The line is
extensive and offers price points from high to low with looks and features
that appeal to riders of all skill levels. All have the distinctive
"Westbeach"-TM- look and logos.
WESTBEACH OUTERWEAR AND STREETWEAR LINE
GROUP NAME STYLE DESCRIPTION
- -----------------------------------------------------------------------------------------------------------------
Elevation Men's/Women's Jackets & Pants High-end technical group, fully seam sealed,
highly waterproof & breathable
Summit Men's/Women's Jackets & Pants Middle-range group, critically seam sealed,
3M Thinsulate-TM- insulation, highly
Waterproof & breathable
Base Camp Men's/Women's Jackets, Vests & Pants Low-range group, critically seam sealed,
very waterproof & breathable
Down Men's/Women's Jackets, Vests Down-proof nylon, gray duck down, duck
friendly
Fleece Men's/Women's Jackets, Pants, Vests Second & first layer insulation offerings
Thermal Men's/Women's Pull-overs & Pants Power Dry-TM- First layer wicking thermal
Sweaters Men's/Women's Crews, zips, v-necks, hooded
Yarn-Dye Men's Shirts Short & long-sleeve
Jerseys Men's/Women's Fashion pull-overs, 100% cotton
Fashion Fleece Men's/Women's Jackets 90% cotton/10% polyester
Denim Men's Jeans Denim jeans
Twill Men's/Women's Pants Fashion pants, 100% cotton
Polyester Jersey Women's Dress, Skirt, Tops Fashion apparel, 100% polyester
Accessories Westbeach Tee shirts, sweatshirts, hats, stickers,
neck gaitors, key-chains, leashes, bags
SALES AND DISTRIBUTION
SALES
The Company's promotion and sales strategy for Westbeach-TM- brand
products is to emphasize penetration into the growing Canadian and
international markets, especially at the mid-range to high-end price points.
Domestic penetration will continue through the specialty retail distribution
channel, while international sales will be further developed through the
6
Company's international dealer and distributor network. The Company and its
distributors participate in North American, European and Japanese trade shows
and advertise in global trade publications. Due to the seasonal nature of the
snowboard industry, a significant portion of the Company's wholesale apparel
sales occur in the third and fourth quarters. In 1998, 74% of the Company's
sales for continuing operations were made in the last six months of the
fiscal year. Typically, there are limited amounts of sales occurring during
the first quarter. These sales are comprised primarily of the Westbeach
spring/summer program in Canada and Europe, plus closeout sales, as well as
sales from the three retail stores. The second quarter sales are comprised
largely of international sales, a limited amount of domestic sales and retail
sales. The last six months of the year are comprised of continuing retail
sales and domestic sales, typically occurring from August through the end of
the year, with the balance of international sales typically shipped by the
end of the third quarter.
The Company's promotion and sales strategy is to emphasize penetration
in the U.S. and European markets, as well as to expand Westbeach-TM- presence in
the casual wear market. North American and European market penetration will
continue through specialty retail distribution channels. International sales
will be developed through sales representatives and dealer and distributor
networks. Since the acquisition, Morrow and Westbeach sales and distribution
networks have been combined to create 25 commissioned sales representatives. The
Company's movement to focus on direct distribution through profitable
distributors has decreased its distributor network from 20 distributors covering
17 countries to 18 distributors in 15 countries, including the United States and
Canada.
DISTRIBUTION
The primary distribution channels for Westbeach-TM- brand products are
specialty retailers and Westbeach's three retail stores in the U.S. and Canada.
Specialty retailers cater to experienced and novice surfers, skateboarders and
snowboarders, existing skiers and other summer and winter sport enthusiasts.
These distribution channels allow the Company to achieve the higher margins
associated with premium markets and enhance the appeal of the Westbeach-TM-
brand name. Within such distribution channels, the Company will continue to
focus on and enhance customer service, including timely delivery of products,
high-quality product information materials and increased access to customer
service representatives.
In the U.S. and Canadian markets, the Company sells its Westbeach-TM-
products through independent sales representatives, who in some cases may be
subject to a standard three-year written sales representative agreement that is
cancelable on 30 days' written notice by either party.
In Europe, the Company operates through two different types of
networks, through distributors and directly to retailers. Through its Austrian
subsidiary, the Company markets its Westbeach-TM- product line directly to
specialty retailers utilizing its independent sales representatives covering the
UK, Holland, Austria, Germany and France. Through its distributor network,
Westbeach-TM- products are marketed in the Czech Republic, Greece, Sweden,
Norway, Finland and Switzerland.
7
In addition, the Company sells its Westbeach-TM- brands though separate
distributors in Australia and New Zealand.
Levante, Inc., the exclusive distributor of Westbeach-TM- brand
products in Japan, accounted for approximately 7% of the Company's sales for the
year ended December 26, 1998 and 21% of Westbeach net sales for the year ended
December 27, 1997. The decline in Japanese sales is a result of the larger ski
companies that are dominating the market utilizing a Japanese fit with a
perceived higher quality product, utilization of consignment selling terms and
better pricing. Westbeach has an exclusive distributorship agreement with
Levante through 2000. While Levante has been required to purchase certain
minimum quantities of Westbeach-TM- products in the past, the minimum purchase
requirements, if any, are currently being discussed and renegotiated. The
contract may be canceled if minimum orders are not received. Westbeach has no
economic interest in Levante.
No customers accounted for more than 10% of the Company's net sales for
the continuing operations in 1998 or 1997.
The Company's U.S., Canadian and export net sales for continuing
operations are set forth below for the years ended December 26, 1998, December
27, 1997 and December 31, 1996.
--------------------------- ---------------------------------- -------------------------------
1998 1997 1996 (1)
--------------------------- ---------------------------------- -------------------------------
Net Sales Percentage of Net Sales Percentage of Net Sales Percentage of
(in thousands) Net Sales (in thousands) Net Sales (in thousands) Net Sales
--------------------------- ---------------------------------- -------------------------------
Wholesale
United States $ 1,039 11.0% $ 288 15.9% $ - -%
Canada 2,382 25.3 355 19.6 - -
Japan 833 8.8 1 0.1
Europe and other 1,651 17.5 325 18.0 - -
Retail
Canada 2,966 31.5 687 38.0 - -
United States 557 5.9 154 8.4 - -
=========================== ================================= ================================
Total $ 9,428 100.0% $ 1,810 100.0% $ - 0.0%
=========================== ================================= ================================
(1) Net sales of $31,699,000 in 1996 were all from discontinued operations.
The following table sets forth Westbeach's unaudited pro forma sales
prior to the acquisition by Morrow for Canada, U.S., Japan and Europe for the
periods ended November 12, 1997 and December 31, 1996.
8
--------------------------------------- --------------------------------------
1/1/97 - 11/12/97 1/1/96 - 12/31/96
-------------------------------------- --------------------------------------
Net Sales Percentage of Net Sales Percentage of
(in thousands) Net Sales (in thousands) Net Sales
-------------------------------------- --------------------------------------
Wholesale
Canada $ 1,686 23.1% $ 1,615 18.4%
United States 784 10.8 1,031 11.7
Japan 1,914 26.3 2,751 31.3
Europe 891 12.2 621 7.1
Retail
Canada 1,732 23.8 2,369 26.9
United States 278 3.8 408 4.6
-------------------------------------- --------------------------------------
Total $ 7,285 100.0% $ 8,795 100.0%
-------------------------------------- --------------------------------------
Westbeach opened its first retail store in Vancouver, British Columbia
in 1984 and currently operates three retail stores. Two of the stores are in
British Columbia at locations in Vancouver and Whistler. The third store is
located in Bellevue, Washington, and is operated through Westbeach's wholly
owned subsidiary, Westbeach Snowboard U.S.A. Inc. Westbeach closed a North
Vancouver, B.C. store in April 1996 to concentrate on the then four remaining
stores and closed its Richmond, B.C. store in January 1997. Retail sales
represented approximately 37.4% of the Company's total sales in 1998 and
approximately 46.4% of total sales on a combined proforma basis in 1997.
In the retail stores, Westbeach-TM- brand products account for
approximately 25% of sales. Clothing from other manufacturers also account for
approximately 30% of sales, with snowboards and other accessories representing
the balance. Westbeach has historically carried between five and eight brands of
snowboards, plus several brands of boots and bindings, in each of its retail
stores.
All store locations are leased. A breakdown of unaudited pro forma
sales by store for the years ended December 26, 1998, December 27, 1997 and
December 31, 1996 is as follows:
------------------------------ -------------------------------- -------------------------------
1998 1997 1996
------------------------------ -------------------------------- -------------------------------
Net Sales Percentage of Net Sales Percentage of Net Sales Percentage of
(in thousands) Net Sales (in thousands) Net Sales (in thousands) Net Sales
------------------------------ -------------------------------- -----------------------------
Cdn Currency Exchange 1.503 1.384 1.384
------------------------------ -------------------------------- -----------------------------
Vancouver $ 1,898 53.9% $ 1,525 53.5% $ 1,379 49.7%
North Vancouver (1) - - - - 90 3.2
Richmond (2) - - 2 0.1 243 8.8
Whistler 1,068 30.3 894 31.3 656 23.6
Bellevue (Washington) 557 15.8 430 15.1 409 14.7
------------------------------ -------------------------------- -----------------------------
Total $ 3,523 100.0% $ 2,851 100.0% $ 2,777 100.0%
============================== ================================ ==============================
(1) The North Vancouver store was closed at the end of April 1996.
(2) The Richmond store was closed at the end of January 1997.
9
The Whistler store has been in operation since December 1993 and the
Bellevue store and related warehouse space opened in August 1993. The Vancouver
store is the original store and flagship of the group. The Vancouver store
underwent major renovations in 1996, 1997 and 1998. The Whistler store underwent
expansion and major renovations in 1998. Margins in the retail stores averaged
36.9% in 1998, including Westbeach-TM- and non-Westbeach goods.
The retail stores enhance the image of the Company with their support
of the Westbeach products. At the same time, the stores provide customers with a
complete selection of products in the industry. The stores are able to support
themselves through high profitability and year-round sales. The Company plans to
continue to support the retail division.
PRODUCT DEVELOPMENT
The Company strives to be a technology leader in the snowboard industry
by drawing on the expertise of its in-house product development team, outside
design consultants, sales representatives, distributors and retailers to develop
high-performance characteristics in the design and construction of its snowboard
apparel. In addition, the Company has integrated its professional team riders
into its product development and design processes, allowing regular testing of
both prototypes and finished products. This collaboration continues to produce
new products, current designs and enhancements to existing technology.
MARKETING
The Company's marketing goal for apparel is to build the Westbeach-TM-
image into one of the leading high-performance, design-driven snowboard apparel
brands in the specialty retail channel. With its roots in the Canadian market
and a strong presence in that country, Westbeach-TM- has a strong image
foundation to use in penetrating the U.S. market. Here again, the Company
recognizes a growing snowboard demographic and will be marketing an expanded
women's line. The Company employs print advertising, tradeshow presence, a
professional snowboard team and promotional partnerships, as with the "Morrow"
brand, to increase visibility and build brand awareness.
CUSTOMER AND RETAILER SUPPORT
The Company provides customer support through its field staff and
in-house personnel, with a focus on enhancing end-user and retailer
satisfaction. The Company's customer service group facilitates order entry,
tracking and delivery, and is responsible for oversight of the Company's
warranty policy. The Company provides a one-year warranty on all of its products
against defects in materials and workmanship. The Company repairs or replaces a
defective product promptly at no cost to the owner during the warranty period.
SUPPLIERS
Apparel products are subcontracted on a finished goods contract basis
to independent clothing manufacturers. Westbeach-TM- outerwear is divided almost
evenly between three large
10
manufacturers located in China, Taiwan and Korea. Most of the casual woven
bottoms are contracted with manufacturers in Cambodia and Vietnam. The
balance of the apparel and related accessory products are manufactured in
Canada and the U.S. The Company is continually sourcing new manufacturers in
order to fulfill its goal of high quality construction at the highest
possible margin. The Company contracts with a quality control specialist
assigned to assess the facilities of potential manufacturers and check the
quality of the production worldwide during all stages of the production
process. While there are no written contracts with any of these
manufacturers, relations with such manufacturers are good and the Company
expects to continue to source products from these and other manufacturers.
The Company imports finished goods (apparel and accessories) into the
U.S. under multilateral and bilateral trade agreements between the U.S. and
China. These agreements impose import quotas on the amount and types of textile
and products that can be imported into the U.S. from the source country. To
expand U.S. sales, the Company must ensure its manufacturing sources have
adequate import quotas for the goods. The Company does not anticipate these
restrictions will adversely affect the expected growth of Westbeach since the
Company could meet its demands within the U.S. from countries not affected by
the restrictions. Similarly, European sales are primarily subject to European
Union rules. Under those rules, there are few internal trade barriers but many
goods imported to Europe are subject to constraints, including quotas and duty
charges. The Company does not anticipate these restrictions will materially or
adversely affect projected growth.
COMPETITION
The market for snowboarding apparel and casual clothing is highly
competitive and the Company expects competition to increase as market interest
in snowboards continues to grow. The Burton Corporation is currently the leader
in the snowboard apparel industry, with several other companies, including the
Company's Westbeach-TM- brand name, having smaller but significant market
shares, and many smaller manufacturers and distributors sharing the remainder of
the market. Other significant competitors in the apparel area include Sessions,
Sims, Bonfire, Special Blend and ACG (Nike, Inc.) in the high-end specialty
markets. The Company believes its strongest markets are Canada and Europe, and
that Westbeach-TM- is not yet a major competitor in the U.S. market. The Company
competes with a number of established manufacturers and distributors. In
addition, other established manufacturers could introduce additional competition
by introducing snowboard apparel under existing brands, developing new sports
apparel brands or acquiring other snowboard apparel brands.
INTELLECTUAL PROPERTY
The Company does not generally rely on proprietary rights associated
with its technology. The Company believes its product development and marketing
capabilities have been of greater importance to its business than patent or
trademark protection. Due in part to rapid technological changes in
snowboarding, the Company does not believe that its business depends on
obtaining and enforcing broad protection of its intellectual property, although
it believes that obtaining patent and other intellectual property protection may
provide it with benefits. In addition, the Company anticipates that it will seek
patent protection for future
11
innovations, where available.
The Company has trademark protection for the Westbeach-TM- name in 17
countries, including Japan, the U.S. and Canada, and is seeking protection in
all of the European Union and eight additional countries for the Westbeach-TM-
brand for use with snowboarding apparel and, to a lesser degree, trademark
protection for the "3 surfer" and other marks. The Company also claims common
law rights to the foregoing and various other trademarks arising out of its use
of such marks.
From time to time, the Company has received, and may in the future
receive, third-party claims asserting intellectual property rights relating to
the Company's products and product features. The Company investigates any such
claims and determines an appropriate response depending on the claim's strength,
its significance to the Company's business, and financial considerations. The
Company has incurred no material liabilities as a result of any such third-party
claims.
EMPLOYEES
As of December 26, 1998, the Company had 232 employees world-wide,
including 126 in manufacturing; 25 in general and administrative; 33 in sales,
marketing and customer service; 8 in product engineering, research and
development; and 40 in Westbeach's retail sales operations. With the sale of the
snowboard, boot and binding operations, the Company significantly reduced its
work force to 13 in general and administrative, 16 in sales, marketing and
customer service and eliminated its product engineering and research and
development departments. The Westbeach retail operations were unaffected by this
transaction. The Company's employees are not subject to a collective bargaining
agreement. The Company considers its employee relations to be good.
The Company also engages the services of 25 independent sales
representatives who are responsible for selling the Company's products to
retailers in the U.S. and Canada, one independent field representative in the
U.S. and nine professional team riders in Europe, Canada and the U. S., all
of whom the Company considers to be independent contractors. The number of
professional riders is under review.
ENVIRONMENTAL
Based on a review of its manufacturing practices and activities, the
Company believes that it is currently in substantial compliance with
environmental laws and regulations, and does not believe that it will be
required to make significant capital expenditures in order to comply with such
laws and regulations as they currently exist.
ITEM 2. PROPERTIES
The Company owns its approximately 103,000 square foot administrative
and manufacturing facility in Salem, Oregon. Prior to March 1996, the Company
leased the space. The building is currently for sale.
12
The Company leases 2,200 square feet in the building adjacent to the
Company's manufacturing facility under a lease expiring September 30, 2000. The
Company is currently negotiating the termination of this lease.
The Company also holds various leases to maintain the operations of its
subsidiaries.
Westbeach leases administrative and warehouse space in Vancouver,
British Columbia of approximately 10,000 square feet through March 31, 2002, and
in Innsbruck, Austria of approximately 2,500 square feet on a month-to-month
basis. Use of approximately 1,000 square feet of additional warehouse storage
space near Munich, Germany is leased on a month-to-month basis.
Westbeach also leases warehouse and retail space of approximately 3,500
square feet in Bellevue, Washington under a lease expiring July 31, 2003 with a
three-year renewal option.
Finally, Westbeach leases retail space in Whistler Mountain, British
Columbia under a lease expiring December 11, 2008 with a ten-year renewal
option, and in Vancouver, British Columbia under a lease expiring March 31, 2005
with a five-year renewal option.
ITEM 3. LEGAL PROCEEDINGS
The Company is currently involved in the litigation and proceedings
described below.
There are seven pending legal matters before the Company besides the
involuntary bankruptcy petition. While not all matters are material on an
individual basis, they would be material to the Company, if considered together.
In general, all litigation against the company, but not foreign subsidiaries, is
currently stayed pending resolution of the involuntary bankruptcy petition
described above.
1. SANDRA TEAL v. MORROW SNOWBOARDS, INC. (United States District Court,
District of Oregon, No. 99-6005-HO). The lawsuit filed by a former employee is a
civil action for declaratory injunctive relief, damages and attorneys' fees for
federal claims pursuant to the Family and Medical Leave Act of 1993, 29 U.S.C.
(S) 2601-2619 (1994) ("FMLA Claims"). The action also includes supplemental
claims under the Oregon Family Leave Act, ORS 659.470 to 659.494 ("OFLA Claims")
and ORS 659.030 (prohibiting employment discrimination based on sex). The FMLA
Claims allege that Morrow violated the plaintiff's leave and re-employment
rights. For the FMLA Claims, the plaintiff seeks reinstatement to her former
position, compensatory damages estimated to exceed $50,000, and equivalent
liquidated damages, plus attorneys' fees. The OFLA Claims are similar to the
FMLA Claims. For the OFLA Claims, the plaintiff seeks reinstatement to her
former position, compensatory damages estimated to exceed $50,000, plus
attorneys' fees. Additionally, under Oregon law, the plaintiff seeks damages for
Morrow's alleged sex discrimination in hiring new employees to perform duties
that plaintiff performed, reinstatement to her former position, compensatory
damages estimated to exceed $50,000, and punitive damages in excess of $50,000,
plus attorneys' fees. The Company believes it has a reasonable basis for
defending against such claims, but there can be no assurance the Company will be
successful in its defense. Because a jury may award significant compensatory
13
damages, liquidated damages and punitive damages for these types of claims if
the jury finds the allegations to be true, a judgment against the Company could
be material and could have a material adverse impact upon the Company, its
financial condition and continued operations. The Company intends to vigorously
defend against these claims.
2. VENDOR CLAIM. Pama Limited, a Hong Kong company ("Pama") was an agent of
Westbeach for fall 1997 production and fall 1998 sales samples. Pama claims
approximately $84,000 was owing for services provided. Westbeach claims Pama
failed to perform given that fall 1998 samples were not timely delivered and
that certain surcharges were not agreed to. The parties are in discussions to
settle this matter.
3. VENDOR CLAIM. Northwest Precision Castparts has filed a small claims court
lawsuit for $3,500 in Douglas County. The Company is handling this matter.
4. MICHAEL JOSEPH FASHION AGENCY, INC. v. MORROW SNOWBOARDS, INC. (Supreme
Court, Province of British Columbia, No. C981832). Michael Joseph Fashion Agency
Inc. ("Michael Joseph"), the Company's former Western Canadian sales
representative, filed a suit in Vancouver, British Columbia claiming damages of
approximately $127,000 ( U.S. Dollars), together with interest, attorneys' fees
and certain litigation costs. Michael Joseph is seeking approximately $60,000
for lost sales commissions due to the alleged termination of its sales
representative relationship without adequate notice under Canadian common law
principles, approximately $60,000 for alleged lost sales commissions on gray
market goods shipped through unauthorized distribution channels in its exclusive
sales territory and the balance for certain expenses incurred. The Company has
retained legal counsel in Vancouver, British Columbia to defend this action. The
Company believes it has a reasonable basis for defending against any such claim,
but there can be no assurance the Company will be successful in this defense.
5. INVOLUNTARY PETITION UNDER CHAPTER 7 BANKRUPTCY (United States Bankruptcy
Court for the District of Oregon, No. 699-61663-fra7). On March 30, 1999,
certain of the Company's trade creditors filed an involuntary petition for
relief under Chapter 7 of the United States Bankruptcy Code in the United States
Bankruptcy Court for the District of Oregon.
The Company has negotiated a tentative settlement with the creditors
that filed the Involuntary Petition as described under "Tentative Settlement of
Involuntary Petition" in the May 3, 1999 Form 8-K. In general, under the terms
of the proposed settlement, creditors holding undisputed, non-contingent,
liquidated claims against the Company (approximately $2.5 million in the
aggregate) will receive payments from the Company as follows: $250,000 within 60
days after an order dismissing the Involuntary Petition becomes final; $200,000
each calendar quarter after the first payment is made; and the remaining unpaid
balance of such claims, without interest, all due and payable in one year. Such
payments will be secured by a lien against the Company's improved real property
located in Salem, Oregon, subject to a senior lien to secure financing for the
Company up to a maximum amount of $500,000 which may be increased to $750,000 if
the $250,000 initial payment is made to such creditors. Alternatively, at the
Company's option, such creditors will receive payments of 85% of the amount of
their claims, in full satisfaction, within 60 days after an order dismissing the
Involuntary Petition (Dismissal) becomes final. The Company's agreement to make
such payments and to grant such a lien is conditioned upon both at least 90% in
dollar value of creditors holding claims on these terms and the dismissal of the
Involuntary Petition. The settlement was submitted to the Company's creditors
and approved by over 90% of the Company's creditors (by number and dollar amount
14
of claims) with undisputed claims. Most, but not all creditors, would be
covered by the settlement.
The Dismissal is subject to approval of the bankruptcy court which
approval was received on June 16, 1999. Such bankruptcy court approval is
subject to a 10-day appeal period following the approval in which the Company's
creditors may object. There is no assurance that the Dismissal will not be
challenged or that the Company will be able to comply with the terms of the
involuntary settlement and make the payments required thereunder.
6. MARMOT MOUNTAIN LTD. v. MORROW SNOWBOARDS, INC. (United States District Court
for the Northern District of California, No. C99-1786). Marmot Mountain Ltd.
(MML) is seeking payment of damages in the amount of $130,000 plus interest at
the legal rate on $60,000 of such amount from January 15, 1998, and on $70,000
of such amount from January 15, 1999. In its complaint, MML alleges breach of a
contract whereby MML agreed to provide the Company with design, manufacturing
and merchandising services related to snowboard apparel. A tentative settlement
of $35,500 has been reached.
7. AMERI-TOOL INDUSTRIES, INC. v. MORROW SNOWBOARDS, INC. (Marion County, Oregon
Circuit Court, No. 98C19786). Ameri-Tool is seeking payment for molded plastic
products and related goods furnished to the Company in the amount of $169,405,
together with interest. The Company believes that the Company and Ameri-Tool,
subsequent to their initial agreement for the sale of such goods, entered into a
revised payment arrangement with regard to such products, in addition to other
agreements regarding the delivery by Ameri-Tool of additional products and
tooling. The Company has filed an answer containing a counterclaim for alleged
damage incurred by the Company due to Ameri-Tool's failure to deliver the
products and tooling in accordance with the revised agreement. Morrow does not
disagree with the amount claimed by Ameri-Tool.
8. EMPIRE OF CAROLINA, INC. ("EMPIRE") v. MORROW SNOWBOARDS, INC. Empire has
asserted rights to a breakage fee of $500,000 and reimbursement of its costs
under the Letter of Intent with the Company dated March 2, 1999. The Company has
responded that it believes the Letter of Intent was terminated without any
obligation on the Company's part to pay such a fee or reimburse any costs. The
Company believes it has a reasonable basis for that position and will vigorously
defend against any action by Empire seeking such fee.
An award of damages or the expenditure of significant sums in some or a
combination of some of the matters described above could have a material adverse
effect on the Company's financial condition and results of operations. The
Company's financial condition and capital resources may also adversely affect
its ability to vigorously defend any action.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
NOT APPLICABLE.
15
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
Since December 14, 1995, the Company's Common Stock has been trading on
the Nasdaq National Market under the symbol "MRRW." On April 27, 1999, the
Company was delisted from the Nasdaq National Market. The Company is currently
traded under the symbol "MRRWE". Due to the delisting, the trading market for
the Company's shares may be reduced compared to the Nasdaq National Market. As
of February 27, 1999, there were 552 holders of the Common Stock of the Company.
Since certain of the shares of Common Stock are held in street name, there may
be additional beneficial holders of the Company's Common Stock. On February 27,
1999, there were 6,176,556 shares outstanding.
The following table shows the range of high and low market prices as
reported by the Nasdaq National Market for the past two calendar years:
NATIONAL MARKET SYMBOL: MRRW HIGH LOW
1st Quarter, 1997 $ 7.75 $ 4.50
2nd Quarter, 1997 $ 5.50 $ 3.25
3rd Quarter, 1997 $ 4.88 $ 3.25
4th Quarter, 1997 $ 4.00 $ 2.22
1st Quarter, 1998 $ 4.50 $ 1.38
2nd Quarter, 1998 $ 2.22 $ 1.03
3rd Quarter, 1998 $ 1.56 $ 0.88
4th Quarter, 1998 $ 1.75 $ 0.50
The Company has paid no dividends on its Common Stock since its
inception. For the foreseeable future, any earnings will be retained to finance
the growth of the Company and, accordingly, the Company does not anticipate the
payment of cash dividends.
16
ITEM 6. SELECTED CONSOLIDATED FINANCIAL DATA
The following table presents a summary of selected financial data for
each of the five years in the period ended December 26, 1998.
------------------------------------------------------------------
Years Ended
------------------------------------------------------------------
December 26, December 27, December 31,
------------------------------------------------------------------
1998 1997 1996 1995 1994
------------------------------------------------------------------
(in thousands, except per share and share data)
------------------------------------------------------------------
STATEMENT OF OPERATIONS DATA:
Net sales (1) $ 9,428 $ 1,810 $ - $ - $ -
Cost of goods sold 6,288 1,018 - - -
------------------------------------------------------------------
Gross profit 3,140 792 - - -
Operating expenses:
Selling, marketing and customer 2,582 214 - - -
service
Engineering, advance design and
product management 698 28 - - -
General and administrative 4,096 446 - - -
------------------------------------------------------------------
Total operating expenses 7,376 688 - - -
------------------------------------------------------------------
Operating income (loss) (4,236) 104 - - -
Interest expense (539) (11) - - -
Other expense (459) - - - -
------------------------------------------------------------------
Income (loss) from continuing operations (5,234) 93 - - -
------------------------------------------------------------------
Income (loss) from discontinued snowboard (7,402) (7,113) 2,147 485 333
operations
Loss from discontinuance of snowboard operations (1,952) - - - -
------------------------------------------------------------------
Income (loss) from discontinued snowboard (9,354) (7,113) 2,147 485 333
operations
------------------------------------------------------------------
Net income (loss) ($14,588) ($7,020) $2,147 $485 $333
------------------------------------------------------------------
Income (loss) per share from continuing
operations (2)
Basic ($0.85) $0.02 $ - $ - $ -
Diluted ($0.85) $0.02 $ - $ - $ -
Income (loss) per share from discontinued
operations (2)
Basic ($1.51) ($1.26) $0.38 $0.15 $0.13
Diluted ($1.51) ($1.26) $0.36 $0.14 $0.12
Net income (loss) per share (2)
Basic ($2.36) ($1.24) $0.38 $0.15 $0.13
Diluted ($2.36) ($1.24) $0.36 $0.14 $0.12
------------------------------------------------------------------
Weighted average number of shares outstanding (2)
Basic 6,176,556 5,671,634 5,684,053 3,130,636 2,592,411
Diluted 6,176,556 5,752,098 5,929,674 3,822,569 2,837,545
------------------------------------------------------------------
17
----------------------------------------------------------------------------------
----------------------------------------------------------------------------------
December 26, December 27, December 31,
----------------------------------------------------------------------------------
1998 1997 1996 (4) 1995 (4) 1994 (4)
----------------------------------------------------------------------------------
(in thousands)
----------------------------------------------------------------------------------
BALANCE SHEET DATA:
Cash and cash equivalents $1,348 $855 $5,062 $15,026 $509
Short term investments - - 3,700 - -
Net current assets from continuing
operations 8,358 9,790 23,017 24,200 5,645
Net current assets of discontinued
operations 2,439 4,006 - - -
Equipment, fixtures, and property held
for sale, net 3,679 3,980 9,183 6,936 6,140
Total assets from continuing operations 16,171 17,965 32,243 31,179 11,821
Total net assets from discontinued
operations 3,907 9,332 - - -
Current liabilities 12,583 5,196 3,789 5,478 4,845
Long-term debt and capital lease
obligations, net of current portion - 13 258 475 2,688
Shareholders' equity (3) 7,495 22,058 27,892 25,150 3,975
(1) The Company acquired Westbeach on November 13, 1997, thus the 1997
statement of operations represents the continuing Westbeach results of
operations for the period from acquisition through year-end.
(2) Common share equivalents included in the computation of per share amounts
represent shares issuable upon assumed exercise of stock options and warrants
using the treasury stock method.
(3) In December 1995, the Company completed an initial public offering of
1,919,500 shares of common stock at $11.00 per share. Net proceeds to the
Company were $18,517,000.
(4) In November, 1997, Morrow acquired Westbeach, whose brand survives as
continuing operations. Since the 1994, 1995 and 1996 balance sheets consist
entirely of the Company's discontinued operations, these amounts have not
been restated to reflect continuing vs. discontinued net assets.
18
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
OVERVIEW
Since its formation, the Company has focused its business activities on
designing, manufacturing and marketing premium snowboards and related products
under the "Morrow" brand name. The Company acquired Westbeach, a merchandiser of
snowboarding apparel and casual clothing, on November 13, 1997. In March 1999,
the Company sold its "Morrow" intellectual property, along with all 1999/2000
inventories and its snowboard and binding production equipment to K2. The
Company's consolidated net sales were $9,428,000 for continuing operations
during the fiscal year ended December 26, 1998 and $15,991,000 for the
discontinued operations. These compare to $1,810,000 for continuing operations
at an average Canadian exchange rate of 1.4227 U.S. dollars during the prior
fiscal period ended December 27, 1997, which includes only a six-week period
after the acquisition of Westbeach, and $18,443,000 for the discontinued
operations during the fiscal year ended December 27, 1997.
Due to the seasonal nature of the snowboard industry, a majority of the
Company's sales occur in the last two quarters of the year. The three Westbeach
retail stores, which do not experience as heavy a seasonal trend, helps to
somewhat reduce the seasonal nature of the Company's sales. Gross margins vary
significantly throughout the year depending on product mix, price and the mix of
wholesale versus retail sales throughout the year.
The Company accumulates a significant backlog of sales orders in
February and March of each year as a result of preseason orders placed in
connection with winter sports trade shows. As the Company begins delivery of
pre-season orders, backlog sales orders decrease and are usually eliminated by
the end of the year.
The Company has taken certain steps to position itself for the future,
including selling of the Morrow-TM- brand product line, focusing on the core
apparel line offered by the Company, maintaining an efficient management staff
with expertise in core areas of the business and implementing financial and
accounting controls and systems.
19
RESULTS OF OPERATIONS
The following table sets forth certain financial data for the periods
indicated as a percentage of net sales.
------------------------------------------------
Years Ended
------------------------------------------------
December 26, December 27, December 31,
------------------------------------------------
1998 1997 1996
------------------------------------------------
Net sales 100.0% 100.0% - %
Cost of goods sold 66.7 56.2 -
------------------------------------------------
Gross profit 33.3 43.8 -
Operating expenses:
Selling, marketing and customer service 27.4 11.8 -
Engineering, advance design and product management 7.4 1.6 -
General and administrative 43.4 24.6 -
------------------------------------------------
Total operating expenses 78.2 38.0 -
------------------------------------------------
Operating income (loss) (44.9) 5.8 -
Interest expense (5.7) (.6) -
Other expense (4.9) - -
Income (loss) from continuing operations (55.5) 5.2 -
Income (loss) from discontinued operations, net of income taxes (78.5) (393.0) 100.0
Loss from discontinuance of operations (20.7) - -
------------------------------------------------
Net income (loss) (154.7)% (387.8)% 100.0%
================================================
COMPARISON OF THE YEARS ENDED DECEMBER 26, 1998, (FISCAL 1998) AND DECEMBER
27, 1997, (FISCAL 1997)
CONTINUING OPERATIONS. The Company's continuing operations consist of
the Westbeach-TM- brand apparel and accessory lines and its three retail stores.
These continuing operations stem from the acquisition of Westbeach on November
13, 1997. As a result, comparisons of Fiscal 1998 activity to Fiscal 1997
activity consist of a twelve month and a six week comparison, respectively.
NET SALES. Net sales for continuing operations in Fiscal 1998 increased
to $9,428,000, from $1,810,000 for Fiscal 1997. This increase is a result of
recognition of twelve months of sales during 1998 compared to six weeks in
Fiscal 1997 with the acquisition of Westbeach on November 13, 1997. All sales
prior to this acquisition were a part of the Company's discontinued operations
and therefore not reflected in this comparison. Sales for continuing operations
include Westbeach-TMbrand apparel of $5,905,000 for the year ended December 26,
1998 and $969,000 for the year ended December 27, 1997. Retail sales for the
year ended December 26, 1998 in the amount of $3,523,000 and $841,000 for the
year ended December 27, 1997 are also included in sales for continuing
operations.
GROSS PROFIT. Gross profit for continuing operations in Fiscal 1998
increased to $3,140,000 from $792,000 for Fiscal 1997 as a result of the
recognition of twelve months of
20
activity in Fiscal 1998 versus six weeks in Fiscal 1997. Total gross margin
as a percentage of net sales for 1998 decreased 23.9% in Fiscal 1998 to 33.3%
down from 43.8% in Fiscal 1997. This is mainly a result of the lack of
closeout sales recognized in Fiscal 1997, which are generally recorded in the
first half of the year.
OPERATING EXPENSES. Operating expenses for continuing operations
consist of selling, marketing and customer service costs, engineering, advance
design and product management costs and general and administrative costs. These
costs increased to $7,376,000 for the year ended December 26, 1998 from $688,000
for the year ended December 27, 1997. This increase is a result of the
acquisition of Westbeach in November 1997. As a percentage of sales the costs
increased 105.8 % to 78.2% for the year ended December 26, 1998, from 38.0% for
the year ended December 27, 1997. Many of the annual costs related to product
development, shareholder business, sales commissions and corporate compliance
issues are incurred during the first three quarters of the year. As a result,
the year ended December 26, 1998 will reflect normalized activity, while the
year ended December 27, 1997 does not incorporate these costs in continuing
operations.
INTEREST EXPENSE. Interest expense increased to $539,000 for the year
ended December 26, 1998 from $11,000 for the year ended December 27, 1997. The
Company's need to partially fund the acquisition of Westbeach in November 13,
1997 and its continued borrowings to fund continuing and discontinued operations
during Fiscal 1998 created an increase in interest charges of $528,000. Related
amortization for allocated deferred financing fees of $115,000 are included in
interest expense, whereas in Fiscal 1997 no such fees were incurred. In May
1998, the Company terminated its financing agreement with LaSalle Business
Credit, Inc. and as a result $62,000 of deferred financing fees related to this
agreement were allocated to continuing operations.
OTHER INCOME / EXPENSE. Other expense was $459,000 for the year ended
December 26, 1998 compared to $0 for the year ended December 27, 1997. The
Company's need to utilize secured financing throughout Fiscal 1998 resulted in
loan expenses of $301,000, compared to no such expenses in Fiscal 1997. Also,
due to the acquisition of Westbeach, the Company enters into transactions
denominated in foreign currencies and as a result of unfavorable currency
fluctuations has recognized foreign currency losses throughout the year ended
Fiscal 1998.
DISCONTINUED OPERATIONS. On March 26, 1999, the Company sold all of its
snowboard, boot and binding assets to K2 for $3.2 million. The Company retained
all of the related receivables and liabilities, except for capital lease
obligations and certain contract team rider obligations.
During 1998, the Company continued to incur losses related to the
oversupply of products produced in 1996 by a highly fragmented, over-populated
and under-capitalized industry. Net sales of the discontinued operations
decreased 13.3% in Fiscal 1998 to $15,991,000 from $18,443,000 in Fiscal 1997.
Corresponding gross profits decreased 48.5% to $1,799,000 in Fiscal 1998 from
$3,490,000 in Fiscal 1997. The soft market in 1997 continued through 1998. This
market effect on the Company, its ability to compete under the current corporate
structure and its need for an infusion of cash to continue operations on some
front
21
provided a need to evaluate its current and future involvement in the
snowboard, boot and binding business. This evaluation resulted in the sale of
the snowboard, boot and binding business to K2 in March 1999. As a result of
decreased sales and management's decisions to write down the value of certain
equipment related to future usage, as well as other factors, the discontinued
operations generated a net loss on discontinued operations of $7,402,000 in
Fiscal 1998 compared to $7,113,000 in Fiscal 1997. The Company recognized a
loss on the discontinuance of $1,952,000 in Fiscal 1998, which is comprised
of a $454,000 loss on the sale to K2 and $1,498,000 in accruals related to
discontinued snowboard operations in the first quarter of Fiscal 1999.
NET (LOSS) INCOME. Net loss for Fiscal 1998 was $14,588,000 compared to
net loss of $7,020,000 for Fiscal 1997 due to lower than projected sales revenue
and related net income, including cancellations of approximately $2,300,000 in
pre-booked orders, lower gross profit margins on certain products, write-down in
fixed assets of $2,745,000 and other factors.
COMPARISON OF THE YEARS ENDED DECEMBER 27, 1997 (FISCAL 1997) AND DECEMBER
31, 1996 (FISCAL 1996)
WESTBEACH OPERATIONS. On November 13, 1997, the Company acquired all of
the outstanding securities of Westbeach, including the Westbeach-TM- brand name,
its apparel product line and three specialty retail stores. Post acquisition net
revenues for the year ended December 1997 were $1,810,000, with a gross profit
of $792,000 or 43.8%. Corresponding net income of $93,000 was recognized. The
Westbeach operations were not owned by the Company in 1996. Therefore, there are
no applicable comparisons for Fiscal 1996.
DISCONTINUED OPERATIONS. On March 26, 1999, the Company sold all of its
snowboard, boot and binding assets to K2 for $3.2 million. The Company retained
all of the related receivables and liabilities, except for capital lease
obligations and certain contract team rider obligations.
During Fiscal 1997 and Fiscal 1996, the Company incurred significant
losses related to the considerable oversupply of products produced in 1996 and
1997 by a highly fragmented, over-populated and under-capitalized industry. Net
sales of the discontinued operations decreased 41.8% in Fiscal 1997 to
$18,443,000 from $31,699,000 in Fiscal 1996. Corresponding gross profits
decreased 67.9% to $3,490,000 in Fiscal 1997 from $10,856,000 in Fiscal 1996.
During 1997, while selling, marketing and customer service costs remained fairly
consistent with the prior year, other overhead costs were increasing. During
Fiscal 1997, the Company increased product development expenses in support of
its development towards a proprietary step-in boot and binding system. In
addition, the oversupply of products created a soft market in Fiscal 1997
compared to Fiscal1996. This market effect on the Company's customers created
significant hardships, with the write-off of $960,000 in bad debt compared to
$110,000 in Fiscal 1996 and the need to evaluate its current and future use of
equipment for snowboards, boots and bindings. This evaluation resulted in a
$1,568,000 write-down to reflect equipment at its net realizable value. All of
this resulted in a net loss of $7,113,000 in Fiscal 1997 compared to net income
of $2,147,000 in Fiscal 1996 for the discontinued operations.
22
YEAR 2000
The Company is undertaking an assessment of both its internal Year 2000
compliance issues and its key vendors, and customers, Year 2000 compliance
status.
INTERNAL YEAR 2000 COMPLIANCE. During 1998, the Company has continued
to assess its Year 2000 readiness by evaluating its computer hardware and
software and any services to the Company controlled by computer, such as its
fire and security alarm, telephone system and HVAC system. As a result of this
assessment, the Company has determined that upgrades are required to its voice
mail system; e-mail system; the software for its payroll records, time clocks
and manifesting program; and a few PC work stations. Management estimates the
cost of these upgrades, which it expects to complete by September 1999, will be
approximately $15,000.
EXTERNAL YEAR 2000 COMPLIANCE. In addition to its internal assessment,
the Company will survey each of its vendors and its top 20 customers to
determine their Year 2000 readiness. Based on the results of those surveys, the
Company will develop a contingency plan for any suppliers of critical materials
not expected to be Year 2000 compliant, including identifying alternate sources
of materials and, subject to available financing, possibly purchasing excess
inventory before the 1999 fiscal year-end. The Company generally has alternate
sources for all of its key products and raw materials/inventories. However,
problems with or delays in obtaining key products or raw materials/inventory or
higher costs due to vendor or shipper Year 2000 compliance problems could
adversely impact the Company's ability to timely deliver products, the
manufacturing/component costs for such products and related gross profit
margins. The financial disruption of key distributors/retailers' operations or
shipping/transportation channels due to Year 2000 compliance problems could
adversely impact the Company's sales, costs and related gross profit margins on
products.
MARKET RISK
The Company accumulates foreign currency in payment of accounts
(principally Canadian dollars) which it then uses to pay its foreign vendors or
converts to U.S. dollars, exposing the Company to fluctuations in currency
exchange rates. The Company currently holds foreign currencies which are
translated into U.S. dollars using the year-end exchange rate, for a total of
$218,503. The potential loss in fair value resulting from an adverse change in
quoted foreign currency exchange rates of 10% amounts to $18,320. Actual results
may differ. The Company does not hold other market sensitive instruments and
therefore does not expect to be affected by any adverse changes in commodity
prices, or marketable equity security prices. The Company may be exposed to
future interest rate changes on its debt. The Company does not believe that a
hypothetical 10 percent change in interest rates would have a material effect on
the Company's cash flow.
23
LIQUIDITY AND CAPITAL RESOURCES
The Company requires capital to procure raw materials and other
supplies. At December 26, 1998, the Company had $1,348,000 in cash and revolving
loans of $3,698,000, compared to $855,000 in cash and revolving loans of
$1,923,000 outstanding at December 27, 1997. As discussed below, the Company
will require additional working capital to implement its current Business Plan
for the 1999-2000 season for its Westbeach apparel line and to sustain
operations of its Westbeach retail stores. Based on discussions to date with
potential financing sources, there is concern whether the Company can raise
working capital in the amounts and at the time needed to fully implement its
Business Plan for the 1999-2000 winter sports season. As a result, the Company
and its subsidiaries are considering a sale of part or all of its business lines
or the assets thereof, if continued operation would jeopardize the value of
those assets. Further, even if additional working capital is obtained, there are
a number of contingencies that could adversely affect the Company, the adequacy
of any working capital obtained and the Company's ability to implement its
Business Plan and continue operations.
Net cash used in operating activities for 1998 was $2,297,000 resulting
primarily from net loss from continuing operations of $5,234,000, net loss from
discontinued operations of $9,354,000 with add backs for depreciation and
amortization of $2,209,000, loss on write-off of fixed assets of $2,745,000,
loss on asset retirements of $89,000, loss on forgiveness of shareholder notes
receivable of $94,000, decreases in accounts receivable of $1,215,000, decreases
in inventories of $1,757,000, decreases in prepaid expenses of $32,000 and
increases in accounts payable and accrued liabilities of $2,304,000.
Net cash used in investing activities for 1998 was $843,000 of which
$924,000 was used for the acquisition of property and equipment, offset by
$81,000 from the proceeds of sales of property and equipment.
Net cash provided by financing activities in 1998 was $3,633,000,
consisting of $1,775,000 from net borrowings under the revolving credit
facility, proceeds of $2,000,000 from a term loan and repayments of $142,000
from payments on long-term borrowings.
On May 7, 1998, the Company entered into a new credit facility with
Foothill Capital Corporation ("Lender") which credit facility replaces the
Company's prior credit facility with LaSalle Business Credit, Inc., which has
been fully repaid. The Company's line of credit under the new credit facility is
up to $10,000,000, including an inventory subline of up to $3,500,000, a letter
of credit subline up to $5,000,000, a term loan of up to $2,000,000 and a
one-time over-advance subline of up to $750,000. Borrowings available under the
revolving credit facility and line are reduced by borrowings from time to time
under the other credit facilities. The amount that may be borrowed is also
limited to the value of certain eligible inventory, accounts receivable and
other assets. At December 26, 1998 the Company had borrowed approximately
$5,698,000 under the credit facility, including a $2,000,000 term loan and
$3,698,000 under the revolving line of credit. In addition, the Company has
issued letters of credit for $331,000 under the letter of credit subline. At
December 26, 1998 the Company had utilized the full extent of its revolving line
of credit and the one-time advance subline had been repaid in full.
24
The credit facility bears interest at the Lender's Reference Rate plus
.5% to 1.5% depending on the principal amount outstanding. The Company is
required to pay a monthly fee equal to .25% per annum on the average unused
amount of the revolving credit facility. The credit facility was issued based on
a loan fee of $200,000, payable in installments and monthly servicing fees of
$4,000 per month. The one-time over-advance subline was used to fund peak
seasonal needs in spring 1998. The one-time advance subline began on May 31,
1998 and was fully repaid by August 1998. The term loan provides for
interest-only payments in the first year and monthly principal payments of
$41,667 thereafter, with the remaining principal balance of $542,000 due May 8,
2002. A fee of 1.5% per annum is payable on the undrawn amount of outstanding
letters of credit.
The credit facility is secured by substantially all of the Company's
assets. The facility requires the Company to comply with certain financial
covenants, including, among other things, a tangible net worth value and an
"EBITDA" test as defined in the credit facility. The Company's tangible net
worth is currently at $2,973,000, compared to the required value of $10,500,000.
The Company's "EBITDA" for the nine months ended December 26, 1998 was a loss of
$9,781,000 compared to the $3,000,000 "EBITDA" requirement. The Company's
failure to meet both the tangible net worth covenant and the "EBITDA" covenant
results principally from lower than projected sales revenue and related net
income, including cancellations of approximately $2,300,000 in pre-booked
orders, lower gross profit margins on certain products, write-down of fixed
assets of $2,745,000, and other factors.
This credit facility was acquired by Capitol Bay Management, Inc.
(Capitol Bay) from the Lender on May 7, 1999 pursuant to an Assignment and
Acceptance among Capitol Bay, Morrow Snowboards, Inc. and certain other parties.
At the time, the amount owing under the credit facility was $217,722, which
amount was increased to $451,055, reflecting a reduced Termination Fee (as
defined in the credit facility) of $100,000 and an unpaid closing fee of
$133,333. At May 7, 1999, the Company was in default of the over-advance funding
limitation under Section 2.5 of the Credit Agreement. As a result of such
default, the Lender is entitled to exercise its rights and remedies in
accordance with the Credit Agreement. The Lender reserved all of its rights to
enforce the Credit Agreement as a result of that event of default, effective
March 12, 1999, and invoked its right to charge interest at the default rate of
5.5% above the Lender's prime rate as specified in the Credit Agreement. In
addition, the Company is out of compliance with its tangible net worth and
EBITDA covenants. No default has been declared in these compliance issues.
Capitol Bay, as successor to the Lender under the credit facility, has not
waived these defaults or the increased interest rate.
25
The Company's debt structure is comprised of the following:
December 26,
1998
------------------
Short-term debt:
Borrowings under revolving line of credit $ 3,698,000
Current portion of term loan 2,000,000
Current portion of capital lease obligations 13,000
------------------
Total short-term debt $ 5,711,000
==================
Long-term debt:
Capital lease obligations $ 13,000
Less current portion 13,000
------------------
Total long-term debt, net of current portion $ -0-
==================
On March 30, 1999, certain of the Company's trade creditors filed an
Involuntary Petition ("Involuntary Petition") for relief under Chapter 7 of the
United States Bankruptcy Code in the United States Bankruptcy Court for the
District of Oregon (Case No. 699-61663-FRA7). On March 30, 1999, the Company's
accounts payable were approximately $2,500,000, with all overdue more than 90
days. The Company has retained insolvency counsel to assist it in responding to
the Involuntary Petition. A motion to dismiss the Involuntary Petition has been
filed. See "Item 3. Legal Proceedings."
On April 27, 1999, the Company's Board of Directors authorized the
Company to enter into a binding Memorandum of Understanding ("MOU") with Capitol
Bay whereby Capitol Bay will provide the Company with additional financing to be
used as working capital, as previously reported in detail in the Form 8-K filed
May 3, 1999. Pursuant to the MOU, Capitol Bay acquired Foothill's secured lender
position under the credit facility on May 7, 1999. While there is no written
agreement to provide additional working capital under the credit facility, the
Company believes that Capitol Bay may be less restrictive in releasing funds
under the credit facility and that some additional limited working capital may
be available under the credit facility. Under the MOU, Capitol Bay also intends
to obtain and fund a loan to be secured by the Company's real estate to provide
additional working capital. The proposed settlement with certain creditors
outlined below and in "Item 3. Legal Proceedings" will limit the aggregate
amount secured to $500,000, thereby limiting the amount that may be raised.
Pursuant to the MOU, the Company has negotiated a tentative settlement
with its creditors as outlined in "Item 3. Legal Proceedings." The tentative
settlement has been approved by over 90% of the Company's creditors (by number
and dollar amount of claims) with undisputed claims. There is no assurance that
the Company will be able to make the payments provided under such plan. Based on
discussion with potential financing sources to date, the Company has serious
concerns about its ability to raise adequate working capital in the amount or at
the times needed to fund its business lines for the 1999-2000 winter sports
season. To protect the value of the Company's business lines, the Company's
subsidiaries are currently considering selling part or all of those business
lines or the assets thereof.
26
Under the MOU, the Company, if certain conditions are met, has agreed
to allow Capitol Bay to convert up to $500,000 of the credit facility into up to
2,000,000 shares (as presently constituted) of the Company's Common Stock (no
par value) at the conversion rate of $.25 per share. The Conversion right would
run for a one-year period from the date the Dismissal becomes final. Until
consummation of the financings under the MOU or, if earlier, the termination of
the MOU, the Company has agreed not to issue any securities without the prior
written consent of Capitol Bay. The Company has further agreed, that until the
Dismissal becomes final, to refrain from filing a petition under the bankruptcy
laws provided the proposed agreement with creditors is reached and approved. The
closing of the financing is contingent upon a number of material conditions,
including obtaining approval of the bankruptcy court of the Dismissal and the
creditors agreement to the tentative settlement agreement. There is no assurance
that such conditions will be satisfied or that the financings will be
consummated.
At the close of business on April 26, 1999 the Company was delisted
from the NASDAQ Stock Market. Because the Company has been delinquent in its
filings under the Securities Exchange Act of 1934, trading in the Company's
securities will be reported in the pink sheets until the Company has filed its
Quarterly Report on Form 10-Q for the fiscal quarter ended March 26, 1999 and a
requisite number of market makers have applied for a listing on the OTC Bulletin
Board on the Company's behalf. The Company anticipates it will file such Form
10Q by July 23, 1999 and be listed on the OTC Bulletin Board shortly thereafter.
Due to the lack of borrowing capacity under the credit facility, the
Company's limited working capital, the Involuntary Petition, the Company's
debts, including accounts payable, and other factors as outlined herein, the
Company has a liquidity problem. After reviewing its working capital needs, the
Company has determined it will need additional working capital for 1999. The
Company is working on reducing the amount of working capital needed and pursuing
alternatives to raise that capital without raising additional equity, except for
the right to convert part of the credit facility extended to Capitol Bay.
The Company estimates that it will require a minimum of $500,000 in
additional working capital to implement its Business Plan for the 1999-2000
winter sports season. Further, such minimum working capital does not include any
reserves for contingencies. Such minimum number is also based on a number of
assumptions about orders of the Company's products, follow-up orders and retail
store sales, based on historical numbers. The minimum amount required could
increase significantly if the Company is unsuccessful in negotiating acceptable
settlements to the numerous pending lawsuits and/or successfully prevailing in
such litigation. Further, the Company will need to obtain part or all of such
financing at certain dates to maintain adequate working capital and liquidity to
fund and continue its operations, as well as place and ship orders for apparel
for distribution under its Westbeach brand and acquire inventory for its
Westbeach retail stores.
Based on response to date from potential financing sources, there is
significant risk the Company will be unable to obtain adequate working capital
at the time or in the amount needed. As a result, the Company is currently
considering selling part or all of its business lines. Besides considering a
potential sale of part or all of its business lines, the Company will continue
to seek
27
additional working capital to continue and maintain the business lines as
part of the Company. There is no assurance that the Company will be able to
obtain adequate working capital in the amounts needed or at the times needed
to sustain its operations or sell its business lines in a timely fashion.
The Company's ability to survive and potentially attract working
capital also depends on reaching tentative settlement with its creditors and
dismissing the Involuntary Petition filed by certain creditors under Chapter 7
of the United States Bankruptcy Code (See Note 18). The tentative settlement has
been approved by over 90% of the Company's creditors (by number and dollar
amount of claims) with undisputed claims. Further, dismissal of the Involuntary
Petition was approved by the bankruptcy court on June 16, 1999, subject to a
10-day appeal period. If the dismissal of the Involuntary Petition is challenged
during the appeal period with extended delays resulting, or, if challenged,
overturned on appeal, the Company would attempt to convert the proceeding to a
Chapter 11 bankruptcy proceeding. The Company's ability to convert to a Chapter
11 proceeding may depend on its ability to attract additional working capital to
implement the cash management plan it presents to the bankruptcy court in such
event. If unsuccessful in such efforts, the Company's assets could be liquidated
in a Chapter 7 bankruptcy proceeding by a bankruptcy trustee and the value of
its operating businesses, due to the nature of such proceedings, could be
seriously diminished in selling those assets. There is no assurance that the
dismissal of the Involuntary Petition will not be challenged and delayed and, if
challenged, overruled. The settlement covers most, but not all, creditors.
If the Company is successful in effecting a dismissal of the
Involuntary Petition and obtaining working capital to continue operations, there
is no assurance that the Company will not encounter future financial problems
due to unexpected contingencies, unsuccessful results or negotiations in the
pending litigation, or other factors and will not again be faced with an
involuntary bankruptcy proceeding. Further, there is no assurance the Company
will successfully resolve the pending litigation, either through negotiations or
prevailing on the merits at trial.
To provide capital to pay its creditors, the Company is seeking to sell
its principal property, the approximate 103,000 square foot office/manufacturing
facility in Salem, Oregon. As noted, the Company is also considering selling its
retail stores and/or its apparel line. There remains a significant risk that the
Company will be unsuccessful in obtaining dismissal of the Involuntary Petition
and raising sufficient working capital to sustain its operations and that the
Company could face a liquidation, either voluntarily or involuntarily. Based on
the Company's condition, there is no assurance that investors will be able to
realize a return on their investment in the Company.
The above matters raise substantial doubt about the Company's ability
to continue as a going concern.
28
FACTORS THAT MAY AFFECT FUTURE RESULTS
This report contains forward-looking statements which are made pursuant
to the safe harbor provisions of the Private Securities Litigation Reform Act of
1995. The forward-looking statements involve risks and uncertainties that could
cause actual results to differ materially from the forward-looking statements.
The Company wishes to caution readers that important factors, among others, in
some cases have affected, and in the future could affect, the Company's actual
results and could cause actual consolidated results in the future to differ
materially from those expressed in any forward-looking statements made by, or on
behalf of, the Company. These factors include, without limitation, the Company's
ability to obtain adequate financing, address lenders' concerns, achieve
dismissal of the Involuntary Petition or successful conversion to a Chapter 11
Company reorganization under U.S. Bankruptcy Code, cure or waiver of the
existing bank line default, adequate sales volume, new initiatives by
competitors, price pressures, cancellation of preseason orders, inventory risks
due to shifts in market demand, raw materials costs, the ability to manufacture
product at planned costs, weather in primary resort areas of the world, and the
ability to achieve sufficient sales levels and the risk factors listed from time
to time in the Company's SEC reports, including, but not limited to, this
report.
Management is unaware of any other trends or conditions that could have
a material adverse effect on the Company's consolidated financial position,
future results of operations or liquidity. However, investors should also be
aware of factors which could have a negative impact on prospects and the
consistency of progress. These include political, economic or other factors such
as currency exchange rates, inflation rates, recessionary or expansive trends,
taxes and regulations and laws affecting the worldwide business in each of the
Company's markets; competitive product, advertising, promotional and pricing
activity; dependence on the rate of development and degree of acceptance of new
product introductions in the marketplace; and the difficulty of forecasting
sales at certain times in certain markets.
29
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTAL DATA
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To the Board of Directors of Morrow Snowboards, Inc.:
We have audited the accompanying consolidated balance sheets of Morrow
Snowboards, Inc. (an Oregon corporation) and subsidiaries (the "Company") as of
December 26, 1998 and December 27, 1997 and the related consolidated statements
of operations, shareholders' equity and cash flows for each of the three years
in the period ended December 26, 1998. These financial statements and the
schedule referred to below are the responsibility of the Company's management.
Our responsibility is to express an opinion on these financial statements and
schedule based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. 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, the financial statements referred to above present
fairly, in all material respects, the financial position of Morrow Snowboards,
Inc. and subsidiaries as of December 26, 1998 and December 27, 1997, and the
results of their operations and their cash flows for each of the three years in
the period ended December 26, 1998 in conformity with generally accepted
accounting principles.
The accompanying financial statements have been prepared assuming that
the Company will continue as a going concern. As discussed in Note 1 to the
financial statements, the Company has incurred significant losses in 1998 and is
out of compliance with its EBITDA and Tangible Net Worth covenants. Also, the
Company's secured creditor has issued a letter of default related to continued
over-advances on collateral limitations which are required to maintain the
Company's line of credit. In addition, certain of the Company's unsecured trade
creditors filed an involuntary petition for relief under Chapter 7 of the United
States Bankruptcy Code. A tentative settlement with the Company's creditors has
received required approval, and the dismissal of the involuntary petition was
approved by the bankruptcy court on June 16, 1999, subject to a 10-day appeal
period. There is no assurance that the dismissal of the Involuntary Petition
will not be challenged and delayed and, if challenged, overruled. These matters
raise substantial doubt about the Company's ability to continue as a going
concern. Management's plans in regard to these matters are described in Note 1.
The financial statements do not include any adjustments relating to the
recoverability and classification of asset carrying amounts or the amount and
classification of liabilities that might result should the Company be unable
to continue as a going concern.
Our audits were made for the purpose of forming an opinion on the basic
consolidated financial statements taken as a whole. The Schedule of Valuation
and Qualifying Accounts is presented for purposes of complying with the
Securities and Exchange Commission's rules and is not a part of the basic
consolidated financial statements. This information has been subjected to the
auditing procedures applied in our audit of the basic consolidated financial
statements and, in our opinion, fairly states in all material respects the
financial data required to be set forth therein, in relation to the basic
consolidated financial statements taken as a whole.
ARTHUR ANDERSEN LLP
Portland, Oregon
June 17, 1999
30
MORROW SNOWBOARDS, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS, EXCEPT SHARE DATA)
-------------- --------------
ASSETS DECEMBER 26, DECEMBER 27,
1998 1997
-------------- --------------
Current Assets:
Cash and cash equivalents $ 1,348 $ 855
Accounts receivable, less allowance for doubtful 4,843 6,058
accounts of $1,066 and $659, respectively
Inventories 1,452 1,805
Prepaid expense 596 628
Refundable income taxes - 285
Other current assets, net 119 159
Net current assets of discontinued operations 2,439 4,006
-------------- -----------
Total Current Assets 10,797 13,796
Equipment and fixtures, net 571 779
Property held for sale, net 3,108 3,201
Other assets:
Goodwill, net 3,926 4,061
Other non-current assets, net 208 134
Net non-current assets of discontinued operations 1,468 5,326
-------------- -----------
Total Other Assets 5,602 9,521
-------------- -----------
Total Assets $ 20,078 $ 27,297
============== ===========
LIABILITIES AND SHAREHOLDERS' EQUITY
Current Liabilities:
Line of credit $ 3,698 $ 1,923
Accounts payable 3,053 1,648
Accrued liabilities 2,321 1,601
Accrued loss on disposal 1,498 -
Current portion of long-term debt and capital lease obligations 2,013 24
-------------- -----------
Total Current Liabilities 12,583 5,196
Long-Term Liabilities:
Capital lease obligations, net of current portion - 13
Deferred income taxes - 30
-------------- -----------
Total Long-Term Liabilities - 43
Commitments and contingencies (Note 9)
Shareholders' Equity
Preferred stock, no par, 10,000,000 shares authorized,
no shares issued or outstanding - -
Common stock, no par, 20,000,000 shares authorized,
6,176,556 and 6,176,556 shares issued and outstanding 27,116 27,116
Notes receivable for common stock - (94)
Accumulated deficit (19,602) (5,014)
Other comprehensive income (loss) (19) 50
-------------- -----------
Total Shareholders' Equity 7,495 22,058
-------------- -----------
Total Liabilities and Shareholders' Equity $ 20,078 $ 27,297
============== ===========
The accompanying notes are an integral part of
these consolidated financial statements.
31
MORROW SNOWBOARDS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
YEAR ENDED
--------------------------------------------
DECEMBER 26, DECEMBER 27, DECEMBER 31,
1998 1997 1996
------------- ----------- ------------
Net Sales $ 9,428 $ 1,810 $ -
Cost of Goods Sold 6,288 1,018 -
------------- ----------- ------------
Gross Profit 3,140 792 -
Operating Expenses:
Selling, marketing and customer service 2,582 214 -
Engineering, advance design and product management 698 28 -
General and administrative 4,096 446 -
------------- ----------- ------------
Total Operating Expenses 7,376 688 -
------------- ----------- ------------
Operating income (loss) (4,236) 104 -
Other Expense:
Interest expense (539) (11) -
Other expense (459) - -
------------- ----------- ------------
Total Other Expense (998) (11) -
Income (loss) from continuing operations before income taxes (5,234) 93 -
Income taxes - - -
------------- ----------- ------------
Income (loss) from continuing operations (5,234) 93 -
------------- ----------- ------------
Income (loss) from discontinued snowboard operations (7,402) (7,113) 2,147
Loss from discontinuance of snowboard operations (1,952) - -
------------- ----------- ------------
Income (loss) from discontinued operations (9,354) (7,113) 2,147
------------- ----------- ------------
Net income (loss) $ (14,588) $ (7,020) $ 2,147
============= =========== ============
Net income (loss) per common share:
Income (loss) from continuing operations - basic $ (0.85) $ 0.02 $ -
Income (loss) from continuing operations - diluted (0.85) 0.02 -
Income (loss) from discontinued operations - basic (1.51) (1.26) 0.38
Income (loss) from discontinued operations - diluted (1.51) (1.26) 0.36
Net income (loss) - basic (2.36) (1.24) 0.38
Net income (loss) - diluted (2.36) (1.24) 0.36
Weighted Average Number of Shares Used in
Computing Per Share Amounts:
Basic 6,176,556 5,671,634 5,684,053
============ ============ ============
Diluted 6,176,556 5,752,098 5,929,674
============ ============ ============
The accompanying notes are an integral part of
these consolidated financial statements.
32
MORROW SNOWBOARDS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF SHAREHOLDERS' EQUITY
(IN THOUSANDS, EXCEPT SHARE DATA)
NOTES RETAINED OTHER
COMMON STOCK RECEIVABLE EARNINGS COMPREHENSIVE
--------------------- FOR COMMON (ACCUMULATED INCOME
SHARES AMOUNT STOCK DEFICIT) (LOSS) TOTAL
---------- --------- ----------- ------------- ------------- ---------
Balance, December 31,1995 5,500,448 $ 25,385 $ (94) $ (141) $ - $ 25,150
Common stock options exercised 114,953 318 - - - 318
Repurchase of common stock (92,500) (657) - - - (657)
Warrant activity 144,848 211 - - - 211
Tax benefit for exercise of non-
qualified stock options - 723 - - - 723
Comprehensive income:
Net income - - - 2,147 - 2,147
---------- --------- ---------- ----------- ---------- ----------
Balance, December 31,1996 5,667,749 25,980 (94) 2,006 - 27,892
Stock issued for acquisition 584,240 1,680 - - - 1,680
Common stock options exercised 12,250 40 - - - 40
Repurchase of common stock (92,583) (596) - - - (596)
Warrant activity 4,900 12 - - - 12
Comprehensive income (loss):
Net loss - - - (7,020) - (7,020)
Change in translation adjustment - - - - 50 50
-----------
Total comprehensive loss (6,970)
---------- --------- ---------- ----------- ------------ -----------
Balance, December 27,1997 6,176,556 27,116 (94) $ (5,014) 50 22,058
Forgiveness of shareholder notes receivable - - 94 - - 94
Comprehensive loss:
Net loss - - - (14,588) - (14,588)
Change in translation adjustment - - - - (69) (69)
-----------
Total comprehensive loss (14,657)
---------- --------- ---------- ----------- ------------ -----------
Balance, December 26, 1998 6,176,556 $ 27,116 $ - $ (19,602) $ (19) $ 7,495
========== ========= ========== =========== ============ ===========
The accompanying notes are an integral part of
these consolidated financial statements.
33
MORROW SNOWBOARDS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
YEAR ENDED
---------------------------------------------
DECEMBER 26, DECEMBER 27, DECEMBER 31,
1998 1997 1996
------------ ------------- ------------
Cash Flows from Operating Activities:
Net income (loss) $ (14,588) $ (7,020) $ 2,147
Adjustments to reconcile net income (loss) to net cash
used in operating activities:
Loss from discontinuance of snowboard operations 1,952 - -
Depreciation and amortization 2,209 1,593 1,205
Loss on write-down of fixed assets 2,745 1,568 -
Loss on retirement of fixed assets 89 - -
Deferred income taxes (30) 146 67
Effect on income tax from exercise of
stock options - - 723
Loss on forgiveness of shareholder notes receivable 94 - -
Other (69) 28 26
Changes in operating assets and liabilities:
(Increase) Decrease in accounts receivable 1,215 5,155 (2,850)
(Increase) Decrease in inventories 1,757 732 (1,786)
(Increase) Decrease in prepaid expenses 32 18 (284)
(Increase) Decrease in refundable income taxes 285 (285) -
Increase in other assets (292) (252) -
Increase (Decrease) in accounts payable 1,405 (1,486) (305)
Increase (Decrease) in accrued liabilities 899 (408) 1,045
------------ ----------- ----------
Net Cash Used in Operating Activities (2,297) (211) (12)
Cash Flows From Investing Activities:
Redemption of short-term investments - 3,700 -
Purchase of short-term investments - - (3,700)
Acquisition of Westbeach, net of cash acquired - (2,554) -
Acquisition of property and equipment (924) (2,975) (3,481)
Proceeds from sale of equipment 81 - 3
------------ ----------- ----------
Net Cash Used In Investing Activities (843) (1,829) (7,178)
Cash Flows From Financing Activities:
Proceeds from issuance of common stock - 52 529
Payments for repurchase of common stock - (596) (657)
Proceeds from issuance of term loan 2,000 - -
Principal payments on debt assumed from Westbeach - (3,271) -
Principal payments on long-term liabilities (142) (275) (2,646)
Line of credit borrowings, net 1,775 1,923 -
------------ ----------- ----------
Net Cash Provided By (Used In)
Financing Activities 3,633 (2,167) (2,774)
------------ ----------- ----------
Net Increase (Decrease) In Cash and Cash Equivalents 493 (4,207) (9,964)
Cash and Cash Equivalents at Beginning of Year 855 5,062 15,026
------------ ----------- ----------
Cash and Cash Equivalents at End of Year $ 1,348 $ 855 $ 5,062
============ =========== ==========
The accompanying notes are an integral part of
these consolidated financial statements.
34
MORROW SNOWBOARDS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. ORGANIZATION AND CURRENT EVENTS
DESCRIPTION OF BUSINESS
Morrow Snowboards, Inc., and subsidiaries (the "Company"),
headquartered in Salem, Oregon, was organized in October 1989 to design,
manufacture and market snowboards, boots, bindings, apparel and accessories to
retail outlets in the United States as well as international distributors in
several foreign countries. On November 13, 1997, the Company acquired all of the
outstanding securities of Westbeach Snowboard Canada Ltd., a manufacturer,
wholesaler and retailer of snowboarding apparel and casual clothing. Westbeach
has three subsidiaries, an Austrian organization whose principal activity
consists of a European sales warehousing operation, a United Kingdom
organization consisting of European sales and a Washington State corporation
whose principal activity is U.S. retail sales. On March 26, 1999, the Company
sold all of its "Morrow" intellectual property, along with all 1999/2000
snowboard inventories and its snowboard and binding production equipment to K2
Acquisitions Inc. (K2). The results of operations for the snowboard, boot and
binding business have been reflected as discontinued operations in the
accompanying Consolidated Statements of Operations. See Note 17 for further
discussion.
The consolidated financial statements include the wholly owned
subsidiaries, Morrow Westbeach Canada ULC, a Canadian Corporation and Morrow
International, Inc., a Guam foreign sales corporation. All significant
intercompany accounts and transactions have been eliminated.
The Company operates in a relatively new and rapidly growing segment of
the action sports industry that is highly seasonal. Further, the Company has
undergone significant expansion since its inception in 1989, related to its
manufacturing, marketing and sales activities with subsequent discontinuance of
its snowboard, boot and binding operations. These and other factors present
certain risks to the future operations of the Company.
CURRENT EVENTS
In 1998 the Company experienced a significant increase in operating
expenses due to higher costs related to the Westbeach merger and further debt
and organizational restructuring charges, among other factors, which resulted in
a significant loss. The Company evaluated its equipment used in the manufacture
of snowboards, boots, and bindings in light of current and future usage, as well
as expected market demand, and the realization of certain other of its assets,
and thus provided write-downs in the 1998 and 1997 statements of operations,
primarily related to discontinued operations, of $2,745,000 and $1,568,000,
respectively, to reflect the equipment and other assets at net realizable value.
In addition, the Company evaluated its ability to continue under the current
corporate structure and its need for an infusion of cash to continue operations
(see Note 17 for further discussion). This evaluation resulted in the sale of
the snowboard, boot and binding business in March of 1999.
As a result of the 1998 loss, effective March 12, 1999, the Company is
in default of overadvance funding under Section 2.5 of the Company's line of
Credit Agreement ("the Agreement"). As a result of such default, the lender is
entitled to exercise its rights and remedies in accordance with the Agreement.
The lender reserves all of its rights to enforce the Agreement as the result of
the event of default. Also, the lender will
35
charge interest on the obligation at the default rate of 5.5% above the
lender's prime rate as specified in the Agreement. In addition, the Company
is out of compliance with its tangible net worth and EBITDA covenants. No
default has been declared for these compliance issues. The Company's
operations are very seasonal with the majority of the revenue recorded in the
third and fourth quarters. Due to the lack of borrowing capacity under the
credit facility, the Company's limited working capital, the Involuntary
Petition, the Company's debts, including accounts payable, and other factors
as outlined herein, the Company has a liquidity problem. After reviewing its
working capital needs, the Company has determined it will need additional
working capital for 1999. The Company is working on reducing the amount of
working capital needed and pursuing alternatives to raise that capital
without raising additional equity, except for the right to convert part of
the credit facility extended to Capitol Bay Management, Inc. (See Note 18 for
further discussion.)
The Company estimates that it will require a minimum of $500,000 in
additional working capital to implement its Business Plan for the 1999-2000
winter sports season. Further, such minimum working capital does not include any
reserves for contingencies. Such minimum number is also based on a number of
assumptions about orders of the Company's products, follow-up orders and retail
store sales, based on historical numbers. The minimum amount required could
increase significantly if the Company is unsuccessful in negotiating acceptable
settlements to the numerous pending lawsuits and/or successfully prevailing in
such litigation (See Note 9). Further, the Company will need to obtain part or
all of such financing at certain dates to maintain adequate working capital and
liquidity to fund and continue its operations, as well as place and ship orders
for apparel for distribution under its Westbeach brand and acquire inventory for
its Westbeach retail stores.
Based on response to date from potential financing sources, management
believes there is significant risk the Company will be unable to obtain adequate
working capital at the time or in the amount needed. As a result, the Company is
currently considering selling part or all of its business lines. Besides
considering a potential sale of part or all of its business lines, the Company
will continue to seek additional working capital to continue and maintain the
business lines as part of the Company. There is no assurance that the Company
will be able to obtain adequate working capital in the amounts needed or at the
times needed to sustain its operations or sell its business lines in a timely
fashion.
The Company's ability to survive and potentially attract working
capital also depends on reaching tentative settlement with its creditors and
dismissing the Involuntary Petition filed by certain creditors under Chapter
7 of the United States Bankruptcy Code. (See Note 18). The tentative
settlement has been approved by over 90% of the Company's creditors (by
number and dollar amount of claims) with undisputed claims. Further,
dismissal of the Involuntary Petition was approved by the bankruptcy court on
June 16, 1999, subject to a 10-day appeal period. If the dismissal of the
Involuntary Petition is challenged during the appeal period with extended
delays resulting or, if challenged, overturned on appeal, the Company would
attempt to convert the proceeding to a Chapter 11 bankruptcy proceeding. The
Company's ability to convert to a Chapter 11 proceeding may depend on its
ability to attract additional working capital to implement the cash
management plan it presents to the bankruptcy court in such event. If
unsuccessful in such efforts, the Company's assets could be liquidated in a
Chapter 7 bankruptcy proceeding by a bankruptcy trustee and the value of its
operating businesses, due to the nature of such proceedings, could be
seriously diminished in selling those assets. There is no assurance that the
dismissal of the Involuntary Petition will not be challenged and delayed and,
if challenged, overruled. The settlement covers most, but not all, creditors.
If the Company is successful in effecting a dismissal of the
Involuntary Petition and obtaining working
36
capital to continue operations, there is no assurance that the Company will
not encounter future financial problems due to unexpected contingencies,
unsuccessful results or negotiations in the pending litigation, or other
factors, and will not again be faced with an involuntary bankruptcy
proceeding. Further, there is no assurance the Company will successfully
resolve the pending litigation, either through negotiations or prevailing on
the merits at trial.
To provide capital to pay its creditors, the Company is seeking to sell
its principal office/manufacturing facility in Salem, Oregon, which has been
shown in the financial statements as property held for sale. As noted, the
Company is also considering selling its retail stores and/or its apparel line.
However, no decision to sell such stores or apparel line has been made. There
remains a significant risk that the Company will be unsuccessful in obtaining
dismissal of the Involuntary Petition and raising sufficient working capital to
sustain its operations and that the Company could face a liquidation, either
voluntarily or involuntarily.
The above matters raise a substantial doubt about the Company's ability
to continue as a going concern. The financial statements do not include any
adjustments relating to the recoverability and classification of asset carrying
amounts or the amount and classification of liabilities that might result should
the Company be unable to continue as a going concern.
2. WESTBEACH ACQUISITION
On November 13, 1997, the Company acquired all of the outstanding
securities of Westbeach Snowboard Canada Ltd. (Westbeach) in exchange for
584,240 newly-issued shares of the Company's common stock valued at $1,680,000,
cash of approximately $2,251,000 and fees and expenses of $425,000. Subsequent
to the acquisition, Westbeach was merged into Morrow Westbeach Canada ULC, a
wholly owned subsidiary of the Company. The transaction has been accounted for
as a purchase with the excess of the purchase price over the fair value (which
approximated historical carrying value) of the net assets acquired allocated to
goodwill. The operations of Westbeach have been included in the accompanying
financial statements since the date of acquisition.
Summarized unaudited 1997 and 1996 pro forma results of continuing
operations, assuming the Westbeach acquisition took place on January 1 of each
year, are as follows:
YEARS ENDED
(in thousands)
--------------------------------------
DECEMBER 27, DECEMBER 31,
----------------- -----------------
1997 1996
----------------- -----------------
Net Sales $ 9,095 $ 8,795
Net income (loss) from
continuing operations $ (590) $ (206)
Net income (loss) from
continuing operations per share:
Basic $ (.10) $ (.04)
Diluted $ (.10) $ (.04)
37
3. SIGNIFICANT ACCOUNTING POLICIES
FISCAL YEAR
Effective January 1, 1997, the Company changed its year-end from a
calendar year end to a 52 or 53 week fiscal year ending on the Saturday nearest
December 31st. Accordingly, the 1998 fiscal year ended on December 26th, whereas
the prior fiscal year ended on December 27th.
CASH AND CASH EQUIVALENTS
Cash and cash equivalents consist of cash on hand and on deposit and
highly liquid investments purchased with a maturity of three months or less.
FINANCIAL INSTRUMENTS
A financial instrument is cash or a contract that imposes or conveys a
contractual obligation, or right, to deliver or receive cash or another
financial instrument. The fair value of financial instruments approximated their
carrying value as of December 26, 1998 and December 27, 1997.
INVENTORIES
Inventories for continuing operations, including retail inventories,
are stated at the lower of average cost or market. Inventories for discontinued
operations are stated at the lower of cost or market using standard costs, which
approximate the first-in, first-out (FIFO) method. Costs for valuation of
manufacturing inventory are comprised of labor, materials (including freight and
duty) and manufacturing overhead.
DEPRECIATION AND AMORTIZATION
Property, plant and equipment are carried at cost. Depreciation of
property, plant and equipment is provided using the straight-line method over
the estimated useful lives of the assets, which are 10-35 years for buildings
and improvements and 3-12 years for equipment, fixtures and other. As of
December 28, 1997, the Company prospectively revised the lives of certain
equipment and tooling. This change increased the loss for discontinued
operations for the year ended December 26, 1998 by $349,000 or $.06 per share.
Amortization of leasehold improvements and equipment under capital leases is
provided using the straight-line method over the expected useful lives of the
assets or the initial term of the lease (including periods related to renewal
options which are expected to be exercised), whichever is shorter. Amortization
is included in depreciation expense.
GOODWILL AND OTHER LONG LIVED ASSETS
Goodwill resulting from the Westbeach acquisition is being amortized
over 15 years using the straight-line method and is net of amortization of
$312,000 and $34,000 at December 26, 1998 and December 27, 1997, respectively.
Goodwill and other long-lived assets are periodically evaluated when facts and
circumstances indicate that the value of such assets may be impaired.
Evaluations are based on non-discounted projected earnings. If the valuation
indicates that non-discounted earnings are insufficient to recover the recorded
assets, then the projected earnings are discounted to determine the revised
carrying value and a write-down for the difference is recorded. Management has
evaluated the realizability of the Westbeach goodwill and believes it is
realizable from future continuing operations.
38
DEFERRED LOAN COSTS
Deferred loan costs included in other assets are amortized over the
life of the related debt on a straight-line basis, which does not differ
materially from the effective rate method.
WARRANTY COSTS
The Company offers a one-year warranty on its products. The Company
provides for anticipated warranty expense related to products sold.
ADVERTISING AND PROMOTION COSTS
Advertising and promotion costs are expensed as incurred and included
in selling, marketing and customer service expenses. Advertising and promotion
expenses for continuing operations totaled $1,037,000 in 1998. These same
expenses related to discontinued operations were, $419,000, $1,440,000, and
$1,284,000 in 1998, 1997 and 1996 respectively.
REVENUE RECOGNITION
The Company recognizes revenue from the sale of its products when the
products are shipped to customers or for retail sales when the customer takes
the product.
INCOME TAXES
The Company accounts for income taxes under the provisions of Statement
of Financial Accounting Standards No. 109, "Accounting for Income Taxes" (SFAS
109). SFAS 109 uses the liability method so that deferred taxes are determined
based on the estimated future tax effects of differences between the financial
statement and tax bases of assets and liabilities given the provisions of
enacted tax laws and tax rates. Deferred income tax expenses or credits are
based on the changes in the financial statement bases versus the tax bases in
the Company's assets or liabilities from period to period.
STOCK-BASED COMPENSATION PLANS
The Company accounts for its stock-based plans under Accounting
Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees" (APB
25). In 1996, the Company adopted the disclosure provisions of Statement of
Financial Accounting Standards No. 123, "Accounting for Stock-Based
Compensation" (SFAS 123), as described in Note 10.
39
PRODUCT DEVELOPMENT COSTS
Expenditures associated with the development of new products and
improvements to existing products are expensed as incurred. Product development
expenses for continuing operations totaled $629,000 in 1998. These same expenses
related to discontinued operations were, $1,568,000, $932,000, and $589,000 in
1998, 1997, and 1996 respectively.
NET INCOME PER SHARE
Effective December 27, 1997, the Company adopted SFAS 128, "Earnings
Per Share". SFAS 128 prescribes new calculations for Basic and Diluted Earnings
Per Share (EPS), which replaces the former calculations for Primary and Fully
Diluted EPS. Basic EPS is computed by dividing net income (loss) by the weighted
average shares outstanding; no dilution for any potentially dilutive securities
is included. Diluted EPS is calculated differently than the Fully Diluted EPS
calculation under the old rules. When applying the treasury stock method for
Diluted EPS to compute dilution for options, SFAS 128 requires use of the
average share price for the period, rather than the greater of the average share
price or end-of-period share price. The shares are computed as follows:
YEAR ENDED
-------------------------------------------------
DECEMBER 26, DECEMBER 27, DECEMBER 31,
-------------- --------------- ----------------
1998 1997 1996
-------------- --------------- ----------------
Shares:
Weighted average shares outstanding for Basic EPS 6,176,556 5,671,634 5,684,053
Stock option and convertible debenture dilution (1) - 80,464 245,621
--------------------------------------------------
Weighted average shares outstanding for Diluted EPS 6,176,556 5,752,098 5,929,674
==================================================
(1) The effect of potential common securities of 398,998 shares is excluded
from the dilutive calculation in 1998 as their effect would be antidilutive.
FOREIGN CURRENCY TRANSLATION
The financial statements of the Company's foreign subsidiaries are
translated into U. S. dollars using exchange rates at the balance sheet date for
assets and liabilities, and average exchange rates for the period for revenues
and expenses. Adjustments resulting from translating foreign functional currency
balance sheet components into U.S. dollars are included in Other Comprehensive
Income (Loss) in the Consolidated Statement of Shareholders' Equity.
USE OF ESTIMATES
The preparation of financial statements in conformity with generally
accepted accounting principles
40
requires management to make estimates and assumptions that affect the
reported amounts of assets and liabilities, disclosure of contingent assets
and liabilities at the date of the financial statements and the reported
amounts of revenues and expenses during the reporting period. Actual results
could differ from those estimates.
4. INVENTORIES
Inventories consisted of the following:
DECEMBER 26, DECEMBER 27,
------------ ------------
1998 1997
------------ ------------
(in thousands)
Finished goods $ 846 $ 431
Retail goods 787 818
Work-in-process 13 5
Raw materials 247 551
------------ ------------
1,893 1,805
Less reserve for obsolete inventory (441) -
------------ ------------
Total continuing operations inventories, net $ 1,452 $ 1,805
============ ============
Total discontinued operations inventory, net $ 2,717 $ 4,121
============ ============
5. EQUIPMENT AND FIXTURES
Equipment and fixtures consisted of the following:
DECEMBER 26, DECEMBER 27,
------------ ------------
1998 1997
------------ ------------
(in thousands)
Equipment and fixtures $ 997 $ 950
Less accumulated depreciation, amortization and
reserve for write-down (426) (171)
------------ ------------
Equipment and fixtures for continuing operations, net $ 571 $ 779
============ ============
Equipment, fixtures and other assets for discontinued
operations, net $ 1,607 $ 5,567
============ ============
Included in equipment from discontinued operations was $479,000
and $795,000 of equipment under capital lease as of December 26, 1998 and
December 27, 1997, respectively.
As more fully discussed in Note 1, the Company performed an
evaluation of its machinery, equipment and other assets and, as a result,
recognized a write-down primarily related to discontinued operations of
$2,745,000 and $1,568,000, in 1998 and 1997 respectively.
As a result of the sale of its snowboard, binding, and boot business
lines, the Company has decided to sell its manufacturing facility and
improvements. Such assets are reflected as property held for sale in the
accompanying Consolidated Balance Sheets.
41
6. ACCRUED LIABILITIES
Accrued liabilities consisted of the following:
DECEMBER 26, DECEMBER 27,
---------------- --------------
1998 1997
---------------- --------------
(in thousands)
Accrued commissions $ 361 $ 275
Accrued payroll and related liabilities 456 508
Accrued inventory purchases 504 154
Accrued warranty 464 260
Other 536 404
---------------- --------------
Total Accrued Liabilities $ 2,321 $ 1,601
================ ==============
7. DEBT
Debt consisted of the following:
DECEMBER 26, DECEMBER 27,
------------------ ----------------
1998 1997
---------------------------------
(in thousands)
Operating line of credit with LaSalle Business Credit, Inc. of $7,000,000 for
the period from October 15 through February 28 of each calendar year,
increasing to $14,000,000 for the periods March 1 through October 14 of each
calendar year, collateralized by accounts receivable, inventory, personal
property, investment property, intangibles and all deposit accounts. Monthly
interest payments were made at 0.25% above the prime rate. The agreement
was terminated on May 7, 1998. $ - $ 1,923
Operating line of credit with Foothill Capital Corporation of up to
$10,000,000 collateralized by accounts receivable, inventory, personal
property, investment property, intangibles and all deposit accounts. An unused
line fee equal to 0.25% per annum times the average unused portion of the
maximum revolving amount is assessed on the first of each month. Monthly
interest payments are made at the Lender's Reference Rate plus 0.5% to 1.5%
depending on the principal amount outstanding when combined with the term
loan, yielding a total interest rate of 8.75% as of December 26, 1998. 3,698 -
Term loan with Foothill Capital Corporation of $2,000,000, secured by land and
buildings. Monthly installments in the amount of $41,667 are due beginning
May, 1999 and bear interest at a rate of 0.5% to 1.5% over the Lender's
Reference Rate depending on the principal amount outstanding when combined
with the operating line of credit, yielding a total interest rate of 8.75%
as of December 26, 1998. 2,000 -
------------------ ----------------
$ 5,698 $ 1,923
================== ================
42
The Foothill credit facility includes a revolving line of credit up to
$10,000,000, including an inventory subline of up to $3,500,000, a letter of
credit subline up to $5,000,000, and a term loan of $2,000,000. Borrowings
available under the revolving credit facility and line are reduced by borrowings
from time to time under the other credit facilities. The amount that may be
borrowed is also limited to the value of certain eligible inventory, accounts
receivable and other assets. At December 26, 1998 the Company had borrowed
approximately $5,698,000 under the credit facility which includes the $2,000,000
term loan and $3,698,000 under the revolving line of credit. In addition, at
December 26, 1998, the Company had outstanding letters of credit of $331,000
under the letter of credit subline.
The credit facility is secured by substantially all of the Company's
assets and is available through May 6, 2002. The credit facility contains
various covenants that require the Company, among other things, to meet
certain objectives with respect to net worth, an "EBITDA" test as defined in
the credit facility and capital expenditures limitations. As of December 26,
1998, the Company was not in compliance with the "EBITDA" test or the
Tangible Net Worth test, therefore all long-term debt balances have been
classified as current. On March 12, 1999, Foothill issued a letter of default
under Section 2.5 of the loan agreement as a result of continued overadvance
of obligations owing in excess of advance limitations set forth in the loan.
Foothill reserves its rights to enforce the agreement as a result of the
event of default but is currently forbearing against any further action.
Until such time that the Company can cure this default, the Company will pay
a default interest rate of 5.5% above the Lender's Reference Rate on
outstanding balances and 5.5% above the Lender's Reference Rate on
outstanding letters of credit, as required by the loan agreement.
See Note 18 for additional discussion of subsequent events relating
to the Company's debt.
8. CAPITAL LEASE OBLIGATIONS
Substantially all of the Company's capital lease obligations related to
the snowboard operations. K2 assumed the snowboard-related obligations during
the purchase that occurred on March 26, 1999, therefore, such obligations have
been netted against the assets of discontinued operations in the accompanying
Consolidated Balance Sheets.
Capital lease obligations relating to the continuing operations
of the Company at December 26, 1998 and December 27, 1997 were $13,000 and
$37,000, respectively.
43
9. COMMITMENTS AND CONTINGENCIES
Rent expense for continuing operations totaled $219,000 in 1998. These
same expenses related to discontinued operations were, $14,000, $4,000, and $0
in 1998, 1997, and 1996, respectively.
The Company currently leases six locations to house its distribution
operations; its retail operations and its graphic department, which expire at
various time periods through the year 2005. On certain leases, the Company is
responsible for taxes and insurance.
Minimum annual real property lease obligations for continuing
operations for the 12-month period ending December are as follows (in
thousands):
1999 $ 207
2000 213
2001 203
2002 180
2003 154
Thereafter 426
---------
Minimum lease payments for real property leases $ 1,383
=========
LEGAL MATTERS
The Company is party to various legal matters which if settled
unfavorably to the Company in the aggregate would have a material effect on
the Company's financial position and results of operations. While the Company
believes it has a reasonable basis in most of these cases and intends to
vigorously defend itself, the Company cannot estimate, except as indicated
below, the probable outcome and, no assurance can be given that the Company
will be successful. The more significant legal matters are as follows:
A former employee filed a civil action claiming Morrow violated the
federal Family and Medical Leave Act, the Oregon Family Leave Act and Oregon law
prohibiting employment discrimination based on sex. A jury may award significant
damages for these types of claims. The Company intends to vigorously defend
against these claims, and believes it has a reasonable basis for defending
against such claims.
The Company's former sales representative in Western Canada is claiming
damages of approximately $127,000 together with interest, attorney's fees and
certain litigation costs for alleged termination of relationship without
adequate notice under Canadian common law principles and alleged lost
commissions for shipments into its exclusive sales territory through
unauthorized distribution channels. The Company has retained legal counsel in
British Columbia to defend this action and believes it has a reasonable basis
for defending against such claim.
44
Marmot Mountain Ltd. alleges breach of contract regarding
provisions of services related to snowboard apparel. A tentative
settlement of $35,500 has been reached, and is accrued in the Consolidated
Balance Sheet as of December 26, 1998.
Ameri-Tool Industries, Inc. is seeking payment of approximately
$169,000, together with interest, for goods furnished the Company. The
Company has filed an answer, counterclaiming alleged damages due to
Ameri-Tool's failure to deliver in accordance with a revised agreement. The
potential amount payable under this claim is accrued in the Consolidated
Balance Sheet as of December 26, 1998.
In the spring of 1999, the Company entered into a Letter of Intent
with Empire of Carolina, Inc. for the sale of the Company. Empire of Carolina
claims rights to a breakage fee of $500,000 and costs under the Letter of
Intent with the Company. The Company believes the Letter of Intent was
terminated without obligation on the Company's part for the payment of a fee
or reimbursement of any costs.
The Company also has two claims filed against it by certain vendors
for payment of approximately $87,500. The Company believes it will settle
these matters without a material effect on the Company's financial position
and results of operation.
10. SHAREHOLDERS' EQUITY
STOCK OPTION PLANS
In September 1990, the Company adopted a stock option plan (the
"Plan") for selected executives, employees and directors and reserved 490,000
shares of common stock for issuance under the Plan. In January 1995, the Plan
was amended to increase the number of shares of common stock under the Plan
to 857,500. In July 1995, the Plan was further amended to increase the number
of shares of common stock under the Plan to 1,102,500. The Plan was again
amended by the Board of Directors in 1997 to change the name of the Plan, add
certain additional types of equity grants, provide for acceleration of
vesting on certain changes in control or sale of substantially all the
Company's assets and a number of immaterial changes to update, modernize and
reorganize the Plan, which amendment was also approved by the Company's
shareholders. The Plan permits the granting of options for terms not to
exceed ten years from date of grant. The options generally vest ratably over
a four-year period and are exercisable subject to terms established in the
Plan document. The exercise price of the options granted under the Plan must
be equal to or greater than the fair market value of the shares on the date
of grant for incentive stock options and not less than 85 percent of the fair
market value for nonqualified stock options. The exercise price of the
options granted by the Company has generally been equal to or greater than
fair market value at the date of grant. Fair market value for periods prior
to the Company's initial public offering were determined by the Board of
Directors without an independent valuation. Information regarding the Plan is
as follows:
45
NUMBER WEIGHTED AVERAGE AGGREGATE
OF SHARES EXERCISE PRICE PRICE
---------- ---------------- -----------
Options outstanding at December 31, 1995 566,582 $ 3.41 $ 1,931,000
Granted 131,200 11.27 1,478,000
Lapsed (17,105) 5.39 (92,000)
Exercised (114,953) 2.77 (318,000)
------------- ------------------- ---------------
Options outstanding at December 31, 1996 565,724 5.30 2,999,000
Granted 83,750 3.90 326,000
Re-Issued 90,500 9.20 833,000
Lapsed/Canceled (183,300) 8.57 (1,570,000)
Exercised (12,250) 3.27 (40,000)
------------- ------------------- ---------------
Options outstanding at December 27, 1997 544,424 4.68 2,548,000
Granted 116,250 1.33 154,600
Lapsed/Canceled (261,676) 4.57 (1,194,600)
------------- ------------------- ---------------
Options outstanding at December 26, 1998 398,998 $ 3.78 $ 1,508,000
============= =================== ===============
In accordance with the terms of option agreements, in August 1995,
certain employees exercised their stock options in exchange for notes
receivable. The notes bore interest at 10 percent per annum and were due and
payable August 1, 1997; however, the shareholders were unable to satisfy the
notes as they became due, and thus the December 26, 1998 financial statements
reflect a $94,000 forgiveness of such notes. The notes receivable, net of any
payments received and the aforementioned forgiveness, have been reflected as a
loss to continuing operations in the accompanying consolidated financial
statements.
Effective November 1, 1995, the shareholders approved the Stock Option
Plan for Non-Employee Directors (the "Directors Plan"), which plan reserves
122,500 shares of the Company's common stock for future grants to Eligible
Directors (as defined in the Directors Plan). Options granted pursuant to the
Directors Plan reduce the number of underlying shares available under the Plan
on a one-to-one basis. The Directors Plan provides for an annual grant of 2,450
shares of common stock to each Eligible Director immediately following each
annual meeting of shareholders commencing with the 1996 annual meeting. Grants
are made at the fair market value of the common stock on the date of grant and
are fully vested after six months.
STATEMENT OF FINANCIAL ACCOUNTING STANDARDS NO. 123
During 1995, the Financial Accounting Standards Board issued Statement
of Financial Accounting Standards No. 123, "Accounting for Stock-Based
Compensation" (SFAS 123), which defines a fair value based method of accounting
for employee stock options and similar equity instruments, and encourages all
entities to adopt that method of accounting for all of their employee stock
compensation plans. However, it also allows an entity to continue to measure
compensation costs for those plans using the method of accounting prescribed by
APB 25. Entities electing to remain with the accounting in APB 25 must make pro
forma disclosures of net income and earnings per share, as if the fair value
based method of accounting defined in SFAS 123 had been adopted.
The Company has elected to account for its stock-based compensation
plans under APB 25; however, the Company has computed, for pro forma disclosure
purposes, the value of all options granted during 1998, 1997 and 1996 using the
Black-Scholes option pricing model, as prescribed by SFAS 123, using the
following weighted average assumptions for grants for the years ended:
46
December 26, December 27, December 31,
------------ ------------ ------------
1998 1997 1996
------------ ------------ ------------
Risk-free interest rate 5.3% 6.0% 6.5%
Expected dividend yield 0.0% 0.0% 0.0%
Expected lives (Years) 6.0 6.0 6.0
Expected volatility 99.1% 64.3% 57.1%
Using the Black-Scholes methodology, the total value of options granted
during 1998, 1997 and 1996 was $114,000, $ 752,000 and $918,000, respectively,
which would be amortized on a pro forma basis over the vesting period of the
options (typically four years). The weighted average fair value per share of
options granted during 1998, 1997 and 1996 was $0.98, $4.32 and $6.99,
respectively.
If the Company had accounted for its stock-based compensation plans in
accordance with SFAS 123, the Company's net income (loss) and net income (loss)
per share would approximate the pro forma disclosures below, for the years ended
December 26, 1998, December 27, 1997 and December 31, 1996 (in thousands except
per share data):
----------------------------- ----------------------------- -----------------------------
1998 1997 1996
----------------------------- ----------------------------- -----------------------------
As Reported Pro Forma As Reported Pro Forma As Reported Pro Forma
--------------- ------------- --------------- ------------- --------------- -------------
Net income (loss) $(14,588) $(14,898) $(7,020) $(7,366) $2,147 $1,901
Net income (loss) per share:
Basic $ (2.36) $ (2.41) $ (1.24) $ (1.35) $ .38 $ .34
Diluted $ (2.36) $ (2.41) $ (1.24) $ (1.35) $ .36 $ .33
The effects of applying SFAS 123 in this pro forma disclosure are
not indicative of future amounts. SFAS 123 does not apply to awards prior to
January 1, 1995, and additional awards are anticipated in future years. The
following table summarizes information about stock options outstanding at
December 26, 1998:
Options Outstanding Options Exercisable
--------------------------------------------------------- ----------------------------------------
Range of Number of Shares Weighted Average Weighted Average Number of Shares Weighted Average
Exercise Prices Outstanding Remaining Exercise Price Exercisable at Exercise Price
per Share at December 26, Contractual per Share December 26, 1998 per Share
1998 Life (Years)
- --------------------- ------------------ ------------------- ---------------------- ---------------------- -------------------
$ 0.81 - $4.50 330,148 6.6 $ 2.80 213,798 $ 3.24
$ 5.31 - $8.50 46,150 7.9 $ 7.30 44,350 $ 7.31
$10.62 - $11.50 22,700 7.7 $10.85 17,500 $10.80
------------------ ------------------- ---------------------- ---------------------- -------------------
Total/Average 398,998 6.9 $ 3.78 275,648 $ 4.38
Total options exercisable at December 26, 1998, December 27, 1997, and
December 31, 1996, were 275,648, 360,827 and 106,934, respectively, at a
weighted average exercise price per share of $4.38, $4.19, and $4.19,
respectively.
STOCK WARRANTS
The Company, from time to time, has issued stock warrants as payment
for fees, interest and services rendered. At December 26, 1998, December 27,
1997 and December 31, 1996, the Company had outstanding warrants to purchase
34,300, 58,801 and 63,701 shares of common stock, respectively. The warrants are
47
exercisable at a weighted average exercise price per share of $2.45. Warrants
are valued at the excess of the fair value of the common stock over the exercise
price at the date of the grant. Any excess of the fair value over the exercise
price of the common stock at the date of grant is recognized as a capital
contribution to warrants outstanding and corresponding expense. In 1998, no
warrants to purchase common stock were exercised. During 1997 and 1996, warrants
to purchase 4,900 and 144,848 shares of common stock were exercised at weighted
average exercise prices of $2.45 and $1.46 per share, respectively. During 1998,
24,501 warrants lapsed and none were granted. During 1997 and 1996, no warrants
were granted or lapsed.
CANCELLATION AND REISSUANCE OF STOCK OPTIONS
In February 1997, the Company canceled and reissued certain options
granted to employees during 1996 under the 1990 Stock Option Plan as amended.
The options canceled were to purchase 90,500 shares of common stock at a
weighted average exercise price of $11.41 per share. The option prices for the
reissued options were at or above market value of the stock at the date the
options were issued, therefore no compensation expense has been recognized.
REPURCHASE OF COMMON STOCK
On December 18, 1996, the Board of Directors passed a resolution to
repurchase and retire up to 300,000 shares of the Company's outstanding common
stock. During 1998 and 1997 and 1996, 0, 92,583 and 92,500 shares, respectively,
of common stock had been repurchased and retired.
11. RELATED PARTY TRANSACTIONS
During 1995, related party notes for $ 110,000 bearing interest at 10
percent per annum were issued in exchange for employee stock options. During
1998, these notes, with a balance remaining of $94,000, were forgiven, as the
shareholders were unable to satisfy the notes as they became due.
The Company, pursuant to an agreement, retained Pacific Crest
Securities, Inc. ("Pacific Crest") to act as its investment banking
representatives in connection with the Westbeach acquisition in 1997. A director
of the Company is also an officer and director of Pacific Crest. In connection
with this agreement, the Company paid Pacific Crest fees and expenses of
approximately $113,000. The Company believes that the agreement with Pacific
Crest was on terms comparable to those in the market place.
During 1998, 1997 and 1996, the Company purchased certain manufacturing
tooling and supplies from a company owned by shareholders of the Company. The
Company recorded $72,000, $105,000 and $4,000 of manufacturing expenses and
capitalized $245,000, $448,000 and $63,000 for tooling related to these
transactions, respectively. All such purchases were related to the discontinued
snowboard operations.
48
12. INCOME TAXES
The provisions for income taxes consist of taxes currently due plus
deferred taxes for the net change in items with different bases for financial
and income tax reporting purposes. The items with different bases are primarily
fixed assets, allowance for doubtful accounts, accrued liabilities for employee
vacation and sick leave, and inventory and warranty reserves. The deferred tax
assets and liabilities represent the future tax consequences of those
differences, which will either be deductible or taxable when the assets and
liabilities are recovered or settled, using enacted marginal income tax rates in
effect when the differences are expected to reverse. Deferred tax assets are
recognized for operating losses and tax credits that are available to offset
future federal income taxes. Net deferred taxes consist of the following tax
effects relating to temporary differences and carryforwards:
DECEMBER 26, DECEMBER 27,
---------------- ---------------
1998 1997
---------------- --------------
(in thousands)
Deferred Tax Assets:
Accrued expenses and reserves $ 3,043 $ 715
Net operating loss and tax credit carryforwards 5,716 3,092
---------------- --------------
Gross deferred tax assets 8,759 3,807
Less valuation allowance (8,129) (2,988)
---------------- --------------
Net deferred tax asset 630 819
Deferred Tax Liabilities:
Depreciation and amortization (630) (849)
---------------- --------------
Net deferred tax assets (liability) $ -- $ (30)
================ ==============
At December 26, 1998 and December 27, 1997, the Company had an
estimated federal net operating loss carryforward of approximately $14,585,000
and $7,928,000 , respectively, expiring through 2018. For the years ended
December 26, 1998 and December 27, 1997, the Company increased its valuation
allowance $5,141,000 and $2,988,000, respectively.
49
The components of income tax (benefit) expense for both continuing and
discontinued operations are as follows:
YEARS ENDED
------------------------------------------------
DECEMBER 26, DECEMBER 27, DECEMBER 31,
--------------- -------------- ---------------
1998 1997 1996
--------------- --------------- ---------------
(in thousands)
(Benefit) expense for income taxes:
Current:
Federal $ - $ (275) $ 1,034
State - - 179
Foreign 30 - -
--------------- --------------- ---------------
Total 30 (275) 1,213
Deferred (5,171) (2,842) 67
Valuation allowance 5,141 2,988 -
---------------- --------------- ---------------
Total (benefit) expense for income taxes $ - $ (129) $ 1,280
=============== =============== ===============
Tax (benefit) expense recorded in:
Continuing Operations $ -- $ -- $ --
Discontinued Operations $ -- $ (129) $ 1,280
A reconciliation of the income tax at the federal statutory income tax
rate to the income tax (benefit) expense as reported is as follows:
YEARS ENDED
-------------------------------------------------
DECEMBER 26, DECEMBER 27, DECEMBER 31,
---------------- ------------- --------------
1998 1997 1996
---------------- ------------- --------------
(Benefit) expense computed at statutory rates (34.0)% (34.0)% 34.0 %
State taxes, net of federal benefit (4.4) (4.4) 4.4
Change in valuation allowance 35.2 41.8 -
Other 3.2 (5.2) (1.0)
---------------- ------------- --------------
Income tax (benefit) expense as reported -- % (1.8)% 37.4 %
================ ============= ==============
50
13. CASH FLOW ACTIVITIES
YEARS ENDED
--------------------------------------------------
DECEMBER 26, DECEMBER 27, DECEMBER 31,
-------------- -------------- --------------
1998 1997 1996
--------------- -------------- --------------
(in thousands)
Supplemental Disclosure:
Cash paid for interest $ 483 $ 80 $154
Cash paid for income taxes 54 440 22
Noncash Transactions:
Assets acquired under capital lease - 182 -
Tax benefit on exercise of non-qualified stock options - - 723
In 1997, the Company purchased all of the outstanding securities of
Westbeach Snowboard Canada Ltd. for cash and common stock of $4,356,000. In
conjunction with the acquisition, liabilities were assumed as follows
(dollars in thousands):
Fair value of assets acquired, including goodwill $ 9,241
Cash paid for the securities, including expenses (2,676)
Common stock issued for the securities (1,680)
Cash received from Westbeach (122)
------------------
Liabilities assumed $ 4,763
==================
14. CONCENTRATION OF CREDIT RISK
Financial instruments, which potentially subject the Company to
concentration of credit risk, consist principally of temporary cash investments,
short-term investments and trade receivables. The Company places its temporary
cash investments and short term investments with high quality financial
institutions.
The Company sells to customers located predominantly throughout the
United States, Japan, Canada and Europe. The concentrations of credit risk with
respect to trade receivables are, in management's opinion, considered not
significant due to the Company's ongoing performance of credit evaluations of
its customers' financial condition and the fact that a significant portion of
export sales are made on a letter-of-credit basis. The Company generally does
not require collateral from its domestic branded-label customers. The Company
maintains policies and procedures to continually monitor the reserves for
potential credit losses. In 1998 and 1997, due to adverse market conditions, the
Company recognized additional reserves on certain outstanding accounts
receivable balances primarily related to its discontinued operations. Such
reserves are reflected in Accounts Receivable in the Consolidated Balance
Sheets. Total bad debt expense for 1998, 1997 and 1996 was $550,000, $960,000
and $110,000, respectively.
51
15. EMPLOYEE SAVINGS PLAN
The company created an employee savings plan on July 1, 1996, under the
provisions of Section 401(k) of the Internal Revenue Code. The plan covers
substantially all full-time employees. The Company's matching contributions take
two forms; a basic matching contribution of 30 percent of employee
contributions, and a discretionary supplemental matching contribution based upon
parameters set by management on an annual basis. The basic matching contribution
is allocable each month to participants who have made contributions for that
month, and who remain employed as of the end of that month. Supplemental
matching contributions are allocable to participants who are actually employed
by the Company as of the last day of the plan year. Participants are fully
vested in their 401(k) contributions and basic matching contribution accounts.
Supplemental matching contributions are subject to a three year (one-third per
year) vesting schedule. Company matching contributions expensed in 1998, 1997
and 1996 were $27,000, $36,000 and $26,000, respectively.
16. SEGMENT AND GEOGRAPHIC REPORTING
Under Statement of Financial Accounting Standards No. 131,
"Disclosures about Segments of an Enterprise and Related Information" (SFAS
131), public companies are required to disclose certain information about the
enterprise's reportable segments. The Company has two continuing reportable
product segments within four major geographic territories. The product segments
are categorized as softgoods and retail. Softgoods consist of apparel and
accessories. The geographic territories are the United States, Canada, Europe
and Japan. The accounting policies of the segments are the same as those
described in the summary of significant accounting policies. The Company's
territorial segments market, sell and distribute essentially the same products
with the exception of its retail stores, which additionally market and sell
competitor products. The following represents continuing operations segment and
geographical data for 1998. Prior periods were not material for continuing
operations.
-------------------------------------------------------------------
Year Ended December 26, 1998 (in thousands)
-------------------------------------------------------------------
US CANADA EUROPE JAPAN TOTALS
--------------------------------------------------------------------
Revenues:
Softgoods $ 1,039 $ 2,382 $ 1,651 $ 833 $ 5,905
Retail 557 2,966 - - 3,523
---------- ----------- ----------- ---------- -----------
Total revenues 1,596 5,348 1,651 833 9,428
Loss from continuing operations (4,827) (160) (247) - (5,234)
Interest expense 539 - - - 539
Depreciation and amortization 654 67 8 - 729
Assets for continuing operations 10,935 4,497 739 - 16,171
Asset expenditures for continuing
operations 125 161 - - 286
52
17. DISCONTINUED OPERATIONS
On March 26, 1999, the Company sold all of its right, title and
interest in and to the "Morrow" and "Morrow Snowboards" names and the other
trademarks, trade names and service marks to K2 Acquisitions, Inc. (K2). In
addition, K2 purchased all of the machinery, equipment and tooling used for
manufacture of snowboards and bindings; rights to the machinery, equipment and
tooling that is leased by the Company; all of the Company's snowboard inventory
for the 1999/2000 season; purchase orders reflecting sales orders received and
accepted by the company prior to the date of sale; trademark licensing agreement
and international distribution agreement and all of the Company's rights,
claims, credits, causes of action or rights of set-off against third parties
relating to the assets. In consideration of the sale, conveyance, assignment,
transfer and delivery of the assets the Company was paid $3.2 million.
As a result of this transaction, the net book value of the assets
purchased and liabilities assumed by K2 at December 26, 1998 and December 27,
1997 have been shown as net current and non-current assets of discontinued
operations in the Consolidated Balance Sheets, and include the following:
December 26, 1998 December 27, 1997
---------------------- -----------------------
(in thousands)
------------------------------------------------
Inventory $ 2,717 $ 4,121
Current capital lease obligations (99) (115)
Accrued liabilities (179) -
--------------------- ----------------------
Net current assets of discontinued operations 2,439 4,006
Equipment, fixtures, and other assets (net of accumulated
depreciation and reserve for write-downs of $6,035 and
$3,466) 1,607 5,567
Long-term capital lease obligations (139) (241)
--------------------- ----------------------
Net non-current assets of discontinued operations 1,468 5,326
--------------------- ----------------------
Total net assets of discontinued operations $ 3,907 $ 9,332
===================== ======================
Operating results of the snowboard operations for 1998, 1997 and 1996
are shown separately in the Consolidated Statements of Operations as income
(loss) from discontinued snowboard operations, net of tax. The net loss on the
sale has been reflected in the 1998 consolidated statement of operations as loss
from discontinuance of snowboard operations as has the accrued operating loss of
the snowboard segment for the period from year-end to the date of the sale. The
discontinued snowboard operating results include an allocation of consolidated
net interest expense based on net assets. The net interest expense allocated was
$132,000, $76,000 and $153,000 in 1998, 1997 and 1996, respectively. Sales of
discontinued operations of $15,991,000, $18,443,000 and $31,699,000 in 1998,
1997 and 1996, respectively, were excluded from revenues in the Consolidated
Statement of Operations. The Consolidated Statements of Cash Flows have not been
restated to reflect discontinued operations presentation.
53
18. SUBSEQUENT EVENTS
As previously disclosed in Note 1, certain of the Company's trade
creditors filed for an involuntary petition under Chapter 7 of the United States
Bankruptcy Code. The Company has negotiated a tentative settlement with the
creditors. In general, the proposed terms provide for the creditors holding
undisputed, non-contingent, liquidated claims against the Company to receive a
series of payments from the Company, beginning 60 days after dismissal of the
Involuntary Petition over the course of one year. Such payments are to be
secured by a lien against the Company's improved real property in Salem, Oregon,
subject to a senior lien to secure financing for the Company. The Company, at
its option, may pay a reduced, lump sum amount within 60 days of dismissal of
the Involuntary Petition becoming final. The agreement is conditioned upon at
least 90% in dollar value of creditors holding claims in excess of $10,000
agreeing to settle their claims on these terms and the dismissal of the
Involuntary Petition. The settlement has been submitted to the Company's
creditors and has received the required approval. Further, dismissal of the
Involuntary Petition was approved by the bankruptcy court on June 16, 1999,
subject to a 10-day appeal period.
The Company has entered into an agreement with Capitol Bay Management,
Inc. whereby Capitol Bay has provided the Company with $500,000 of financing to
be used as working capital. Capitol Bay has purchased from Morrow's former
lender, Foothill Capital Corporation, its secured lender position. Capitol Bay
has an election under which it may convert $500,000 of its loan into 2,000,000
shares of Morrow common stock.
In April, 1999, the Company listed its real estate property in Salem,
Oregon for sale. The property had been used for snowboard production prior to
the sale of the snowboard business to K2, Inc. and as a result of that sale was
deemed surplus to the Company's current needs. The property is comprised of land
and a 103,000 square foot building. The building, land, and improvements are
reflected in property held for sale in the Consolidated Balance Sheet as of
December 26, 1998.
19. IMPACT OF RECENT ACCOUNTING PRONOUNCEMENTS
In June 1997, the FASB issued Statement of Financial Accounting
Standards No. 130, "Reporting Comprehensive Income" (SFAS 130). This statement
establishes standards for reporting and displaying comprehensive income and its
components in a full set of general-purpose financial statements. The objective
of SFAS 130 is to report a measure of all changes in equity of an enterprise
that result from transactions and other economic events of the period other than
transactions with owners. The Company adopted SFAS 130 at the beginning of 1998.
Comprehensive income is reflected in the accompanying Consolidated Statements of
Shareholders' Equity.
In June 1998, the FASB issued SFAS No. 133 "Accounting for Derivative
Instruments and Hedging Activities" (SFAS 133). This statement establishes
accounting and reporting standards requiring that every derivative instrument be
recorded in the balance sheet as either an asset or liability measured at its
fair value. SFAS 133 also required that changes in the derivative instrument's
fair value be recognized currently in results of operations unless specific
hedge accounting criteria are met. SFAS 133 is effective for fiscal years
beginning after June 15, 2000. The Company expects that adoption of SFAS 133
will not have a material impact on the Company's financial condition or results
of operations.
54
SCHEDULE II
MORROW SNOWBOARDS, INC. AND SUBSIDIARIES
VALUATION AND QUALIFYING ACCOUNTS
(IN THOUSANDS)
The following schedule has not been restated to conform to discontinued
operations presentation:
BALANCE AT CHARGED TO BALANCE
BEGINNING COSTS AND AT END
DESCRIPTION OF PERIOD EXPENSES DEDUCTIONS OF PERIOD
- ------------------------------------------- ------------ ------------ ------------- -----------
DECEMBER 31, 1996
Reserves deducted from asset accounts:
Allowance for doubtful accounts $ 50 $ 110 $ (26)(a) $ 134
Obsolete inventory reserve 66 221 (151)(a) 136
DECEMBER 27, 1997
Reserves deducted from asset accounts:
Allowance for doubtful accounts 134 960 (435)(a) 659
Obsolete inventory reserve 136 888 (489)(a) 535
DECEMBER 26, 1998
Reserves deducted from asset accounts:
Allowance for doubtful accounts 659 550 (143)(a) 1,066
Obsolete inventory reserve 535 2,806 (549)(a) 2,792
(a) Balances written off, net of recoveries
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
- NONE -
55
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
DIRECTORS
On May 7, 1999, the Company reduced the size of its Board from
seven (7) to four (4) directors. Set forth below is information on the
current directors of the Company:
Maurice C. Bickert (age 76) has served as a director of the Company
since February 1996. Mr. Bickert served as President and Chief Executive
Officer of Marquis Corp. from August 1985 to December 1993. From 1955 to
1985, Mr. Bickert had over 30 years management experience with ITT
Corporation and spent his last 12 years with ITT doing merger and
acquisition, licensing and turnaround work.
Erik J. Krieger (age 39) has served as a director of the Company
since April 1994. Since 1989, Mr. Krieger has held various management
positions with Pacific Crest Securities, Inc. ("Pacific Crest"), an
investment banking firm. He has been Chairman and Chief Executive Officer of
Pacific Crest since January 1997, and was Executive Managing Director from
February to December 1996 and a Managing Director prior thereto. Mr. Krieger
currently serves as a director of Molded Container Corporation, an injection
plastics manufacturer, and Applied Research, Inc., a specialty chemical
manufacturing company, and as a general partner of Diversified Opportunities
Group, a private investment partnership.
Ray E. Morrow, Jr. (age 54) has served as a director of the Company
since the Company's inception in October 1989. Mr. Morrow served as Chairman
of the Board of the Company from June 1990 until January 1998 and as Chief
Executive Officer of the Company from the Company's inception until May 1995.
From January 1995 to April 1995, he served as President of the Company. In
August 1996, Mr. Morrow founded Morrow Aircraft Corporation, a proposed
manufacturer of aircraft incorporating composite materials technology, and
has served as a director and Chairman of the Board of Directors since that
company's inception. In March 1982, Mr. Morrow founded II Morrow, Inc.,
served as its Chairman of the Board and Chief Executive Officer until its
acquisition by United Parcel Service ("UPS") in 1986, and continued as Chief
Executive Officer until 1987. Mr. Morrow was a founder and currently serves
as a director of American Blimp Corporation, a manufacturer of airships used
worldwide for advertising and surveillance. Mr. Morrow was a director of
Lightship America, Inc., which leased airships for commercial advertising
purposes and was acquired by American Blimp Corporation in December 1996.
56
P. Blair Mullin (age 45) has served as a director of the Company
since October 1998 and as Chairman of the Board since April 1999. Mr. Mullin
has also served as President of the Company since May 1998 and as Chief
Financial Officer since the Company's acquisition of Westbeach Snowboard
Canada Ltd. ("Westbeach") in November 1997. In addition, he has served as
Treasurer and Secretary of the Company since January 1998. Mr. Mullin served
as President and Chief Executive Officer of Westbeach from July 1995 to
November 1997. From 1992 to 1995, Mr. Mullin was a private business
consultant. From 1988 to 1992, Mr. Mullin served as Chief Financial Officer
of Bradbury International Equities Ltd., a holding company, and as General
Manager of Padovano Foods, Inc., a food processing company, from 1990 to 1992.
EXECUTIVE OFFICERS AND SIGNIFICANT EMPLOYEES
Set forth below is information on the executive officers of the
Company:
Name Age Position
---- --- --------
P. Blair Mullin (1) 45 Chairman of the Board, President, Chief Financial
Officer, Treasurer and Secretary
J. Scott Sibley 44 Vice President, Global Sales
Georell Bracelin 38 Vice President, Marketing
(1) For information regarding Mr. Mullin, see Item 10. Directors and
Executive Officers of the Registrant
J. Scott Sibley has served as Vice President, Global Sales of the
Company since January 1998. Mr. Sibley was President of Westbeach from 1985
to July 1995, and was Vice President, Sales from July 1994 to November 1997
and a director of Westbeach from 1985 to May 1997.
Georell Bracelin has served as Vice President, Marketing of the
Company since January 1998. She was Vice President, Senior Account Director
at the Ralston Group, an advertising agency based in Bend, Oregon, from
November 1993 to December 1997 and prior thereto she worked with advertising
agencies in Portland, Oregon and Billings, Montana. She has received
statewide and regional "Addy" awards for ads for clients in various
industries.
57
BENEFICIAL OWNERSHIP REPORTING COMPLIANCE
Section 16(a) of the Securities Exchange Act of 1934, as amended
(the Exchange Act), requires the Company's executive officers, directors and
persons who own 10% of the Common Stock to file with the Securities and
Exchange Commission (the SEC) initial reports of beneficial ownership on Form
3 and reports of changes in beneficial ownership of Common Stock and other
equity securities of the Company on Forms 4 and 5. Reporting persons are
required by SEC regulations to furnish the Company with copies of all Section
16(a) reports they file. To the Company's knowledge, based solely on
reviewing copies of such reports furnished to the Company and written
representations from reporting persons, all Section 16(a) reports due during
or with respect to fiscal 1998 were filed on a timely basis, except those set
forth below.
The following executive officers failed to timely file Form 3s in
fiscal 1998: Georell Bracelin, Marsha Richardson (former Assistant
Secretary), J. Scott Sibley and Dennis Wilson (former Vice President, Advance
Design, Soft Goods) (1 transaction each). In addition, Erik J. Krieger failed
to timely file a Form 4 for January 1998 (1 transaction).
The late filings all occurred in January and February 1998, before
the Company reimplemented procedures designed to periodically remind its
officers and directors of their Section 16(a) filing requirements. Since the
new procedures were reimplemented in March 1998, to the Company's knowledge
there have been no late Section 16(a) filings.
ITEM 11. EXECUTIVE COMPENSATION
COMPENSATION SUMMARY
The following table sets forth certain information regarding the
compensation paid in the last three fiscal years to P. Blair Mullin, the
current President and Chief Financial Officer of the Company, and to David E.
Calapp, the former Chief Executive Officer of the Company, for services
rendered in all capacities to the Company. Messrs. Mullin and Calapp are
referred to herein as the "Named Executive Officers." No other executive
officer of the Company was paid compensation in excess of $100,000 in the
1998 fiscal year.
SUMMARY COMPENSATION TABLE
--------------------------
LONG-TERM COMPENSATION
ANNUAL ---------------------------------------
SALARY SECURITIES
NAME AND ------------------------------------------ UNDERLYING OTHER
PRINCIPAL POSITION YEAR ($) BONUS OPTIONS (#) COMPENSATION
- -------------------------------- ------ ------------------- ------------ --------------- -----------------
David E. Calapp (1) 1998 $ 131,651 $ - - $ 1,000
Chairman of the Board, Chief 1997 157,692 - 50,000 (2) -
Executive Officer and President 1996 46,154 35,000 50,000 13,857 (3)
P. Blair Mullin (4) 1998 118,218 - 75,000 2,402 (3)
Chairman of the Board, 1997 - - - -
President and Chief 1996 - - - -
Financial Officer
(1) David E. Calapp resigned as an officer and director of the Company
effective May 18, 1998. Mr. Calapp served as the Company's Chief Executive
Officer from August 20, 1996 and as President from November 1996. He also
served as Chairman of the Board from January 1998.
58
(2) Replaced an option granted August 20, 1996 for 50,000 shares, which
option was cancelled.
(3) Represents reimbursement of moving expenses.
(4) P. Blair Mullin was appointed President of the Company effective May 18,
1998 and Chairman of the Board effective April 1, 1999.
GRANT OF STOCK OPTIONS
The following table sets forth certain information regarding options
granted to the Named Executive Officers during the fiscal year ended December
26, 1998:
OPTIONS GRANTS IN FISCAL 1998
INDIVIDUAL GRANTS
--------------------------------------------
POTENTIAL REALIZABLE
VALUE OF ASSURED RATES
NUMBER OF OF STOCK PRICE
SHARES PERCENT OF TOTAL APPRECIATION FOR OPTIONS
UNDERLYING OPTIONS GRANTED EXERCISE TERM
OPTION TO EMPLOYEES IN PRICE EXPIRATION ----------------------------
NAME GRANTS (#) FISCAL YEAR ($/SHARE) DATE 5% 10%
- ------------------ ----------------- ------------------ ----------- ------------- ----------------------------
P. Blair Mullin 25,000 22% $1.3125 6/3/08 $ 23,181 $ 56,347
50,000 43% 0.8125 10/29/08 25,590 64,811
EXERCISE OF STOCK OPTIONS AND YEAR-END VALUES
The following table sets forth certain information regarding options of the
Named Executive Officers outstanding at fiscal 1998 year-end:
AGGREGATED OPTION EXERCISES IN FISCAL 1998
AND YEAR-END OPTION/WARRANT VALUES
----------------------------------
SHARES NUMBER OF SECURITIES
ACQUIRED UNDERLYING UNEXERCISED VALUE OF UNEXERCISED IN-THE-
ON VALUE OPTIONS/WARRANTS AT MONEY OPTIONS/WARRANTS AT
EXERCISE REALIZED DECEMBER 26, 1998 DECEMBER 26, 1998 (1)
NAME (#) ($) EXERCISABLE/UNEXERCISABLE EXERCISABLE/UNEXERCISABLE
- ----------------------- ------------ ------------ ------------------------------------ ---------------------------------
P. Blair Mullin 0 0 18,000 77,000 N/A N/A
David E. Calapp 0 0 20,000 0 N/A N/A
(1) Calculated based on the difference between the option exercise
price and closing price of the Common Stock on December 26, 1998
($0.688 per share).
59
EMPLOYMENT CONTRACTS
The Company's Employment Agreement with Ray E. Morrow, Jr. expired
in December 1996. Mr. Morrow continued as an at-will employee at a monthly
salary of $1,250 through March 26, 1999, with such duties as assigned by the
President. Mr. Morrow also entered into a Noncompete Agreement with Nicollett
Limited Partners on April 20, 1994, which agreement was assigned to the
Company and certain shareholders under an Assignment Agreement dated December
19, 1995. Pursuant to that agreement, during the period of Mr. Morrow's
employment with the Company and for two years following termination of
employment, he has agreed he will not, directly or indirectly, be connected
in any manner with any business that competes with the Company, divert any
customer of the Company or induce any employee or consultant of the Company
to terminate his or her relationship with the Company.
The Company has an Employment Agreement with P. Blair Mullin
expiring June 30, 1999. Unless Mr. Mullin is terminated for cause, following
termination of employment he will receive severance pay from the Company for
the lesser of (a) four months or (b) until he secures new employment.
PERFORMANCE GRAPH
The following graph compares the cumulative total return to holders
of the Company's Common Stock with the cumulative total return of the Nasdaq
US Stock Market, the Standard & Poor's Small Cap Index and the Standard &
Poor's Consumer Index for the period beginning December 14, 1995, the first
trading day of the Common Stock, and ending March 31, 1999.
[graph]
The following table assumes $100 invested in Morrow Snowboards, Inc.
Common Stock, the Nasdaq US Stock Market, the Standard & Poor's Small Cap
Index and the Standard & Poor's Consumer Index, with all dividends
reinvested. Stock price shown above for the Common Stock is historical and
not necessarily indicative of future price performance.
60
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S&P INDUSTRIAL
MORROW NASDAQ SMALL CAP S&P CONSUMER
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14-Dec-95 $ 100.00 $ 100.00 $ 100.00 $ 100.00
31-Mar-96 78.85 106.09 106.56 103.40
30-Jun-96 80.77 114.14 111.84 109.08
30-Sep-96 90.38 118.18 115.14 111.18
31-Dec-96 50.96 124.35 121.40 116.11
31-Mar-97 36.54 117.68 114.39 121.05
30-Jun-97 36.54 138.90 134.80 142.72
30-Sep-97 27.88 162.37 156.30 145.27
31-Dec-97 18.27 151.26 151.17 156.75
31-Mar-98 12.50 176.82 167.59 179.50
30-Jun-98 10.10 182.50 147.19 191.53
30-Sep-98 9.14 163.15 113.48 171.07
31-Dec-98 6.25 211.20 134.67 208.20
31-Mar-99 2.88 237.09 121.03 212.91
COMPENSATION COMMITTEE REPORT ON EXECUTIVE COMPENSATION
The executive compensation policies and programs developed by the
Company are designed to retain and motivate executive officers and to ensure
that their interests are aligned with the interests of the Company's
shareholders. The Company's policy is to offer competitive compensation
opportunities for its employees based on a combination of factors, including
Company growth, corporate performance and the individual's personal
contribution to the business.
The Company's compensation programs are implemented by the
Compensation Committee of the Board of Directors and consist of base salary,
annual incentives and long-term incentives. The Company's President
recommends to the Compensation Committee annual salary adjustments and
incentive grants for the Company's executive officers other than himself. All
members of the Board of Directors participate in the deliberations concerning
executive compensation. Executive officers who are also directors do not
participate in decisions affecting their own compensation.
BASE SALARY
In reaching a determination concerning fiscal 1998 executive officer
base salaries, the Compensation Committee considered the recommendations of
the President, which were based in part on a review of competitive
compensation information published by the National Executive Compensation
Survey and information provided by independent compensation consultants. In
making recommendations, the President compared the Company to a selected
group of companies of similar size and business niche, specifically the
sporting goods retail market and manufacturing, and considered compensation
only for executives with similar job descriptions. Compensation
recommendations were targeted to fall at the mid-point of the comparative
group.
In addition to the President's recommendations, the Compensation
Committee considered its own assessment of the individual performances of
each executive officer and its own subjective assessment of the Company's
overall financial performance. There is no fixed relationship between base
salary and corporate
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performance or between base salary and the competitive range of salaries that
may be offered by competitive companies. The Compensation Committee members
considered their business judgment in light of their experience to be an
important factor in establishing executive compensation.
ANNUAL INCENTIVES
On an annual basis, the Compensation Committee considers the grant
of annual incentive bonuses to each executive officer. Incentive bonuses are
discretionary and are determined subjectively, with the Compensation
Committee taking into consideration the individual's performance,
contribution and accomplishments during the past fiscal year and the
Company's financial performance. Neither the decision to award a bonus, nor
the specific size of the incentive bonus, is based on any specific measure of
corporate performance. In fiscal 1998, no incentive bonuses were awarded to
any executive officer.
STOCK INCENTIVE COMPENSATION
The Board of Directors believes that stock ownership by executive
officers and key employees provides valuable incentives for those persons to
benefit as the Company's Common Stock price increases, and that stock
option-based incentive compensation arrangements help align the interests of
executives, employees and shareholders. To facilitate these objectives, the
Board of Directors has granted stock options to executives and key employees
through the Company's Employee Equity Incentive Plan (formerly, the 1990
Amended and Restated Stock Option Plan) (the "Plan"), approved by the
shareholders in 1991. The Plan was amended by the Board of Directors in 1995
to increase the number of shares available under the Plan to 1,102,500, which
amendment was approved by the Company's shareholders. The Plan was again
amended by the Board of Directors in 1997 to change the name of the Plan, add
certain additional types of equity grants, provide for acceleration of
vesting on certain changes in control or sale of substantially all the
Company's assets and a number of immaterial changes to update, modernize and
reorganize the Plan, which amendment was also approved by the Company's
shareholders.
Pursuant to the Plan, in fiscal 1998 the following options to
purchase the Company's Common Stock were granted to executive officers under
the Plan at a price believed to equal or exceed the fair market value at the
date of grant:
Name of Executive Officer No. of Shares Price Date of Grant
- ------------------------- -------------- ------- -------------
P. Blair Mullin 25,000 $1.3125 6/3/98
50,000 .8125 10/29/98
In determining the number of options granted to executive officers
and key employees, the Board of Directors considered the person's opportunity
to affect the share price of the Company's Common Stock, the level of the
person's performance based on past performance, future contribution to the
Company and the anticipated incentive effect of the number of options granted.
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The Board of Directors believes that the policies and plans
described above provide competitive levels of compensation and effectively
link executives and shareholder interests. Moreover, the Board of Directors
believes such policies and plans are consistent with the long-term investment
objectives appropriate to the business in which the Company is engaged.
Board of Directors
Maurice C. Bickert Ray E. Morrow
Erik J. Krieger P. Blair Mullin
COMPENSATION OF DIRECTORS
During 1998, nonmanagement directors were entitled to receive $750
per month for serving as directors, together with reimbursement for
reasonable travel and related expenses incurred in attending Board and
Management Committee meetings, although such compensation has not been paid
for periods after September, 1998. Under the Company's Stock Option Plan for
Non-Employee Directors, each nonemployee director, upon joining the Board,
and following his or her election or reelection at each annual meeting of
shareholders, receives an option to purchase 2,450 shares of Common Stock of
the Company.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The following table sets forth certain information regarding the
beneficial ownership, as of March 31, 1999, of the Common Stock by (i) each
person known by the Company to own beneficially more than 5% of the Common
Stock, (ii) each Named Executive Officer, (iii) each director and director
nominee of the Company and (iv) all directors and executive officers as a
group. Except as otherwise noted, the Company believes the persons listed
below, based on information furnished by those persons, have sole investment
and voting power with respect to the Common Stock owned by them. The mailing
address of each person listed below is the Company's principal executive
office.
Name Shares Beneficially Owned(1) Percent of Class
- ---- ---------------------------- ----------------
Ray E. Morrow, Jr. (2) 133,574 2.2
Erik J. Krieger (3) 95,601 1.5
Maurice C. Bickert (4) 45,521 *
P. Blair Mullin (5) 32,797 *
All directors and executive officers 433,231 7.0
as a group (6 persons) (6)
- -------------------
* Less than 1% of the shares outstanding.
(1) "Beneficial Ownership" is defined pursuant to Rule 13d-3 of the
Exchange Act, and generally means any person who directly or indirectly
has or shares voting or investment power with respect to a security. A
person shall be deemed to be the
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beneficial owner of a security if that person has the right to
acquire beneficial ownership of the security within 60 days,
including, but not limited to, any right to acquire the security
through the exercise of any option or warrant or through the
conversion of a security. Any securities not outstanding that are
subject to options or warrants shall be deemed to be outstanding for
the purpose of computing the percentage of outstanding securities of
the class owned by that person, but shall not be deemed to be
outstanding for the purpose of computing the percentage of the class
owned by any other person.
(2) Includes 32,450 shares subject to options exercisable within 60 days
after March 31, 1999. Excludes an aggregate 120,090 shares beneficially
owned by Mr. Morrow's wife, Sharon R. Morrow, of which shares Mr.
Morrow disclaims beneficial ownership.
(3) Includes 16,615 shares owned through a 401(k) profit sharing plan,
9,800 shares subject to options exercisable within 60 days after March
31, 1999 and 12,250 shares issuable within 60 days after March 31, 1999
upon the exercise of a warrant to purchase Common Stock. Also includes
27,218 shares issued to Diversified Opportunities Group. By virtue of
being a general partner of Diversified Opportunities Group, Mr. Krieger
may be deemed to beneficially own those shares.
(4) Includes 9,800 shares subject to options exercisable within 60 days
after March 31, 1999.
(5) Includes 23,000 shares subject to options exercisable within 60 days
after March 31, 1999.
(6) Includes 82,050 shares subject to options exercisable within 60 days
after March 31, 1999 and 12,250 shares issuable within 60 days after
March 31, 1999, upon the exercise of warrants to purchase Common Stock.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
In August 1995, in connection with each exercising options for
61,250 shares of Common Stock, Neil E. Morrow and Robert J. Morrow, both
officers of the Company until March 26, 1999, each executed a promissory note
in the principal amount of $55,000 in payment of the exercise price for those
shares (collectively, the "Option Notes"). To date, Neil Morrow has made
principal payments of $16,500 and Robert Morrow has made no principal
payments under the Option Notes. The Option Notes were due in full on August
1, 1998.
From October 1996 through May 1999, the Company has purchased
manufacturing tooling and supplies ("tooling") from Morrow Aircraft
Corporation. Those purchases were through a series of separate independent
purchase orders. Purchases through December 26, 1998 totaled approximately
$317,000, compared to $553,000 in 1997. The Company believes the tooling was
acquired on terms as favorable or better than available from other vendors.
Additionally, the Company believes it was receiving its tooling in a more
timely fashion and with the devotion of less Company resources to ensuring
the tooling complied with the Company's bid and specification requirements.
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PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
(a) The following documents are filed as part of this report:
1. Financial Statements (see Item 8.)
- Report of Independent Public Accountants
- Consolidated Balance Sheets - December 26, 1998 and December 27,
1997
- Consolidated Statements of Operations - Years Ended
December 26, 1998, December 27, 1997 and December 31, 1996
- Consolidated Statements of Shareholders' Equity - Years Ended
December 26, 1998, December 27, 1997 and December 31, 1996
- Consolidated Statements of Cash Flows - Years Ended December 26,
1998, December 27, 1997 and December 31, 1996
- Notes to Consolidated Financial Statements
2. Financial Statement Schedules
- Schedule II - Valuation and Qualifying Accounts (accounts not
required or not material have been omitted)
3. Exhibits
See Exhibit Index.
(b) Reports on Form 8-K
A Current Report on Form 8-K dated November 10, 1998, was filed on
November 25, 1998, to report a claim filed by Ameri-Tools Industries against the
Company.
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SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the
Securities Exchange Act of 1934, as amended, the Registrant has duly caused
this report to be signed on its behalf by the undersigned, thereunto duly
authorized, in the City of Salem, State of Oregon, on May 14, 1999.
MORROW SNOWBOARDS, INC.
By: /s/ P. Blair Mullin
-----------------------
P. Blair Mullin
PRESIDENT (1)
(PRINCIPAL EXECUTIVE OFFICER)
Pursuant to the requirements of the Securities Exchange Act of 1934, as
amended, this report has been signed by the following persons in the capacities
indicated on May 14,1999.
/s/ P. BLAIR MULLIN President
- ---------------------
P. Blair Mullin (principal executive officer)
/s/ P. BLAIR MULLIN Chief Financial Officer
- ---------------------
P. Blair Mullin (principal financial officer and
principal accounting officer)
/s/ RAY E. MORROW JR. Chairman Emeritus
- ----------------------
Ray E. Morrow, Jr.
/s/ ERIK J. KRIEGER Director
- ----------------------
Erik J. Krieger
/s/ MAURICE C. BICKERT Director
- -----------------------
Maurice C. Bickert
(1) No Chief Executive Officer is appointed. Under the Company's
Bylaws, if no Chief Executive Officer is appointed, the President acts in such
capacity and has the authority of a Chief Executive Officer.
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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
--------------------------
EXHIBITS
FILED WITH THE
ANNUAL REPORT ON
FORM 10-K
FOR THE FISCAL YEAR ENDED DECEMBER 26, 1998
UNDER
THE SECURITIES EXCHANGE ACT OF 1934
--------------------------
MORROW SNOWBOARDS, INC.
EXHIBIT INDEX
EXHIBIT
NO. DESCRIPTION
------- -----------
3.1 Amended and Restated Articles of Incorporation (Note 1)
3.2 Amended and Restated Bylaws (Note 1)
4 Registration Rights Agreement dated April 20, 1994 among the
Registrant and the investors named therein (Note 1)
4.2 Securities Purchase Agreement dated October 31, 1997 among the
Registrant, Morrow, LLC, Morrow Snowboards ULC, Westbeach
Snowboard Canada Ltd. and the security holders of Westbeach
Snowboard Canada Ltd. listed therein (Note 4)
10.1 Lease and Option Agreement among PR Investors Limited Liability
Company, the Registrant, Ray E. Morrow, Jr. and Sharon Morrow
dated July 25, 1994, as amended by Amendment to Lease and Option
Agreement dated August 1, 1995 (Note 1)
10.2 Forms of Warrant (Note 1)
10.3 Employment Agreement between Ray E. Morrow, Jr. and the Registrant
dated April 20, 1994, as amended (Notes 1 & 2)
10.4 Noncompete Agreement between Ray E. Morrow, Jr. and Nicollett
Limited Partners Partnership dated April 20, 1994 (Note 1)
10.5 Assignment Agreement by and among the Registrant, Nicollett
Limited Partners, James V. Zaccaro, Gregory M. Eide, Dennis R.
Shelton and Erik J. Krieger dated December 19, 1995 (Note 3)
10.6 Morrow Snowboards, Inc. Employee Equity Incentive Plan as amended
and restated February 13, 1997 (Note 2)
10.7 Form of Nonqualified Stock Option Agreement (Notes 1 & 2)
10.8 Form of Incentive Stock Option Agreement (Notes 1 & 2)
10.9 Manufacturing Agreement between the Registrant and Plasticos
Duramas, S.A., dated July 20, 1995 (Note 1)
10.10 Form of Sales Representative Agreement (Note 1)
10.11 Letter Agreements between the Registrant and Pacific Crest
Securities Inc. dated February 22, 1994, January 27, 1995, August
4, 1995 and October 4, 1995 (Note 1)
10.12 Form of Indemnification Agreement (Notes 1 & 2)
10.13 Stock Option Plan for Non-Employee Directors (Notes 1 & 2)
10.14 Purchase and Sales Agreement dated February 29, 1996 (Note 3)
10.15 Securities Purchase Agreement dated October 31, 1997 among the
Registrant, Morrow, LLC, Morrow Snowboards ULC, Westbeach
Snowboard Canada Ltd. and the Security holders of Westbeach
Snowboard Canada Ltd. listed therein (Note 4)
10.16 Loan and Security Agreement dated as of May 7, 1998 among the
Registrant and Westbeach Snowboard U.S. A., Inc., as Borrower, and
Foothill Capital Corporation as Lender (as assigned to Capitol Bay
Management, Inc.) (Note 7).
10.17 Guarantee and Postponement of Claim by Morrow Westbeach Canada ULC
in favor of Foothill Capital Corporation dated as of May 7, 1998
(as assigned to Capitol Bay Management, Inc.)
10.18 Intellectual Property and Security Agreement dated as of May 7,
1998, between Morrow Snowboards, Inc. and Foothill Capital
Corporation (as assigned to Capitol Bay Management, Inc.)
10.19 General Security Agreement dated as of May 7, 1998, between Morrow
Westbeach Canada ULC and Foothill Capital Corporation (as assigned
to Capitol Bay Management, Inc.)
10.20 Security Agreement-Stock Pledge dated as of May 7, 1998, between
Morrow Snowboards, Inc. and Foothill Capital Corporation (as
assigned to Capitol Management, Inc.)
10.21 Assignment and Acknowledgement Agreement dated May 7, 1999,
between Capitol Bay Management, Inc. and Foothill Capital
Corporation, the Registrant and Westbeach Snowboard U.S.A. Inc.
10.22 Apparel Design and Manufacturing Agreement dated December 31,
1996, between the Registrant and Marmot Mountain Ltd. (Note 5)
10.23 "Terms of Instrument - Part 2", dated April 1, 1994, as amended by
"Terms of Instrument - Part 2", Modification Agreement, dated
October 17, 1997, between Westbeach Snowboard Canada Ltd. (now
Morrow Westbeach Canada ULC) and Western IMMO Holdings Inc. (Note
6)
10.24 International Distribution Agreement dated as of January 1, 1998,
between the Registrant and K.K. Morrow Japan (Note 6).
10.25 Acquisition Agreement dated as of March 26, 1999, by and between
K2 Acquisitions, Inc. and the Registrant (Note 8).
10.26 Memorandum of Understanding between Capitol Bay Management, Inc.
and the Company (Note 9)
21 Subsidiaries of the Registrant
23 Consent of Independent Public Accountants
27 Financial Data Schedule
(1) INCORPORATED HEREIN BY REFERENCE FROM THE COMPANY'S REGISTRATION STATEMENT
ON FORM S-1 (FILE NO. 33-97800). (2) MANAGEMENT CONTRACT OR COMPENSATORY PLAN OR
ARRANGEMENT. (3) INCORPORATED HEREIN BY REFERENCE FROM THE COMPANY'S 1995 ANNUAL
REPORT ON FORM 10-K (FILE NO. 0-27002). (4) INCORPORATED BY REFERENCE FROM THE
COMPANY'S CURRENT REPORT ON FORM 8-K DATED OCTOBER 31, 1997 (FILE NO. 0-27002).
(5) INCORPORATED BY REFERENCE FROM THE COMPANY'S CURRENT REPORT ON FORM 8-K
DATED NOVEMBER 11,1997 (FILE NO. 0-27002). (6) INCORPORATED BY REFERENCE FROM
THE COMPANY'S 1997 ANNUAL REPORT ON FORM 10-K (FILE NO. 0-27002). (7)
INCORPORATED BY REFERENCE FROM THE COMPANY'S CURRENT REPORT ON FORM 8-K DATED
MAY 8, 1998 (FILE NO. 0-27002). (8) INCORPORATED BY REFERENCE FROM THE COMPANY'S
CURRENT REPORT ON FORM 8-K DATED MARCH 26, 1999 (FILE NO. 0-27002). (9)
INCORPORATED BY REFERENCE FROM THE COMPANY'S CURRENT REPORT ON FORM 8-K DATED
APRIL 27, 1999 (FILE NO. 0-27002).
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, as amended, the Registrant has duly caused this report to
be signed on its behalf by the undersigned, thereunto duly authorized, in the
City of Salem, State of Oregon, on May 14, 1999.
MORROW SNOWBOARDS, INC.
By: /s/ P. Blair Mullin
---------------------
P. Blair Mullin
PRESIDENT (1)
(PRINCIPAL EXECUTIVE OFFICER)
Pursuant to the requirements of the Securities Exchange Act of 1934, as
amended, this report has been signed by the following persons in the capacities
indicated on May 14, 1997.
- --------------------- President
P. Blair Mullin (principal executive officer)
- --------------------- Chief Financial Officer
P. Blair Mullin (principal financial officer and
principal accounting officer)
- --------------------- Chairman Emeritus
Ray E. Morrow, Jr.
- --------------------- Director
Erik J. Krieger
- --------------------- Director
Maurice C. Bickert
(1) No Chief Executive Officer is appointed. Under the Company's
Bylaws, if no Chief Executive Officer is appointed, the President acts in such
capacity and has the authority of a Chief Executive Officer.