10-Q 1 a2063594z10-q.txt FORM 10-Q ================================================================================ UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 -------------------------- FORM 10-Q -------------------------- |X| QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended September 30, 2001 OR |_| TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (D) OF THE SECURITIES EXCHANGE ACT OF 1934 Commission File Number 1-11805 DONNA KARAN INTERNATIONAL INC. (Exact name of registrant as specified in its charter) Delaware 13-3882426 (State or other jurisdiction of (I.R.S. Employer Identification No.) incorporation or organization) 550 Seventh Avenue, New York, New York 10018 (Address of principal executive offices) (Zip Code) (212) 789-1500 (Registrant's telephone number, including area code) -------------------------- Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter periods that the registrant was required to file such reports) and (2) has been subject to such filing requirements for the past 90 days. YES |X| NO |_| At November 9, 2001, the Registrant had 22,266,483 shares of Common Stock outstanding.* *Does not include 18 shares of Class A Common Stock, par value $.01 per share, and two shares of Class B Common Stock, par value $.01 per share, outstanding as of such date. ================================================================================ DONNA KARAN INTERNATIONAL INC. INDEX

2 DONNA KARAN INTERNATIONAL INC. STATEMENTS OF OPERATIONS AND COMPREHENSIVE (LOSS) INCOME (UNAUDITED)

SEE NOTES TO FINANCIAL STATEMENTS 3 DONNA KARAN INTERNATIONAL INC. BALANCE SHEETS

SEE NOTES TO FINANCIAL STATEMENTS 4 DONNA KARAN INTERNATIONAL INC. STATEMENTS OF CASH FLOWS (UNAUDITED)

SEE NOTES TO FINANCIAL STATEMENTS 5 DONNA KARAN INTERNATIONAL INC. NOTES TO FINANCIAL STATEMENTS NOTE 1 -- SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES BASIS OF PRESENTATION The accompanying unaudited consolidated financial statements include the results of operations of Donna Karan International Inc. and its subsidiaries (collectively, the "Company"). All significant intercompany balances and transactions have been eliminated in consolidation. On December 18, 2000, the Company announced that it had received a proposal from a corporation owned by LVMH Moet Henessey Louis Vuitton Inc., a Delaware corporation ("LVMH") and a subsidiary of LVMH Moet Henessey Louis Vuitton, S.A., a French corporation, to enter into merger negotiations (the "LVMH Merger Offer") to acquire all of the outstanding shares of common stock of the Company for a price of $8.50 per share in cash. On April 2, 2001, the Company and LVMH announced that they had entered into an Agreement and Plan of Merger, dated as of March 31, 2001 (as amended, the "Merger Agreement"), which sets forth the terms and conditions of the proposed acquisition of the Company by LVMH. Pursuant to the Merger Agreement, an indirect subsidiary of LVMH will be merged with and into the Company (the "Merger") and the Company will survive the Merger as an indirect subsidiary of LVMH. The Merger Agreement provides that the stockholders of the Company will receive $10.75 in cash for each share of common stock of the Company. The Merger is subject to the approval of the stockholders of the Company and the satisfaction of other customary closing conditions, including the receipt of required regulatory approvals. The stockholders' meeting to vote on the approval and adoption of the Merger Agreement and the Merger is scheduled to be held on November 27, 2001. If stockholders' approve and adopt the Merger Agreement and the Merger, it is expected that the Merger will be completed as soon as practicable after the stockholders' meeting. Concurrently with the execution of the Merger Agreement, stockholders who collectively beneficially own approximately 46.8% of the Company's outstanding common stock entered into voting agreements with LVMH. Under the terms of these voting agreements, these stockholders have agreed to vote all shares of common stock, that they beneficially own, in favor of the adoption of the Merger Agreement and the approval of the Merger. In addition, these stockholders have also agreed, among other things, to vote against any other transaction the consummation of which could reasonably be expected to prevent or materially delay the Merger. During the three and nine month periods ended September 30, 2001, the Company incurred $8.2 million and $10.5 million, respectively, in expenses related to the LVMH Merger Offer, which have been classified as selling, general and administrative expenses. These amounts include for the three month period ended September 30, 2001, $6.3 million in severance and $1.2 million in accelerated restricted stock amortization, both related to the resignation of the Company's former chief executive officer (see "Recent Developments" below), $600,000 in legal and accounting fees, and $100,000 in other merger related expenses, and for the nine month period ended September 30, 2001, $6.3 million in severance and $1.2 million in accelerated restricted stock amortization, both related to the resignation of the Company's former chief executive officer, $1,928,000 in legal and accounting fees, a net $500,000 accrual related to the putative class action suits described below under "Commitments and Contingencies," $150,000 in special committee fees, a special bonus of $150,000 payable to an executive officer, and $272,000 in other merger related expenses. The unaudited consolidated financial statements have been prepared in accordance with generally accepted accounting principles for interim financial information and with the instructions to Form 10-Q and Rule 10-01 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by accounting principles generally accepted in the United States for complete financial statements. In the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation have been included. On a quarterly basis, the Company's operations may vary as a result of, among other things, production and shipping schedules, the introduction of new products, the timing of opening and closing Company-owned retail stores, and variations in the timing of certain holidays from year to year. The results of operations for any interim period are not necessarily indicative of the results of operations to be expected for a full year. For further information, refer to the consolidated financial statements and accompanying footnotes included in the Company's Annual Report on Form 10-K for the year ended December 31, 2000. Certain amounts in the financial statements of prior years have been reclassified to conform to the current year presentation. 6 DONNA KARAN INTERNATIONAL INC. NOTES TO FINANCIAL STATEMENTS RECENT DEVELOPMENTS The Company's results of operations in the second and third quarters of fiscal 2001, having been affected by business and economic conditions, are below forecast and are expected to continue below forecast for the balance of the fiscal year. In August 2001, the Company entered into an agreement with Gabrielle Studio, Inc. (an LVMH affiliate) pursuant to which Gabrielle Studio, Inc. agreed to defer until June 30, 2002 the payment of royalties owed by the Company for the second, third and fourth quarters of 2001. In August 2001, the Company also amended its credit facility. The August 2001 credit facility amendment provides (i) that an event of default will occur on January 7, 2002 if the Merger with LVMH has not occurred, (ii) for changes in the application of credit facility covenant calculations so as to exclude from such calculations, the royalty payments deferred by the above referenced agreement with Gabrielle Studio, Inc., together with certain unpaid severance and merger expenses, and (iii) that the Company must maintain a minimum of $20 million in availability under the credit facility from December 15, 2001 through the expiration of the credit facility. In October 2001, the Company further amended its credit facility. The October amendment, while waiving the need for the Company to meet certain financial covenants as of the end of the third quarter, also reduced the amount the Company can borrow under the facility to $102 million for the month of November 2001, $90 million for the period from December 1, 2001 through December 14, 2001 and $85 million thereafter. It also requires that the Company maintain a minimum credit availability of $4 million for the period from October 22, 2001 through October 31, 2001, $8 million for the period from November 1, 2001 through November 14, 2001, and $11 million for the period from November 15, 2001 through December 14, 2001, in addition to the $20 million requirement for the period subsequent to December 14, 2001 that was contained in the August amendment. In addition to the October 2001 and August 2001 credit facility amendments, in June 2001 the Company also entered into an amendment of its credit facility which enabled the Company to borrow amounts in excess of its calculated borrowing base during the months of June, July and August 2001. The Company believes that its results of operations for the balance of the fiscal year will cause it to violate several year-end financial covenants of its most recently amended credit facility. The failure of the Merger with LVMH to close by January 7, 2002 will cause an event of default under the credit agreement. The Company believes that the Merger will occur prior to January 7, 2002, and if not, that it will be required to amend its existing credit facility (which expires May, 2003), or obtain an alternate source of long-term financing. However, there can be no assurances that an amended credit facility or any new financing will be available and, if available, that the terms will be as favorable as the existing terms in the current credit facility. Effective as of July 13, 2001, John D. Idol resigned as Chief Executive Officer and a director of the Company and Giuseppe Brusone, the former Senior Vice President, Acquisitions and Brand Development of the LVMH Fashion Group, was appointed President and Chief Executive Officer of the Company. However, Mr. Idol will continue as an employee of the Company until the earlier of (1) November 15, 2001 and (2) the closing of the Merger, and in that capacity will assist and advise the Company's board of directors in connection with the Company's transition to a new Chief Executive Officer and the Merger. In exchange for these services, Mr. Idol will receive a monthly salary of $5,000, but will not be entitled to any other compensation, benefits or severance payments except as specified below. Mr. Idol is entitled to receive the following payments and benefits in connection with his resignation, consistent with the intent of his employment agreement as amended: o $6.3 million, consisting of (1) $5.1 million, which represents the sum of three times his current base salary plus three times his total bonus compensation for fiscal 2000, (2) a transaction bonus of $0.75 million and (3) $0.4 million, which represents his pro-rated performance bonus for fiscal 2001. These amounts are payable on the earlier of (A) November 15, 2001 and (B) the closing of the Merger, and have been expensed during the quarter ended September 30, 2001. o Full vesting of all 548,503 unvested shares of restricted common stock he holds. These shares of restricted common stock will vest on the earlier of (1) November 15, 2001 and (2) the closing of the Merger. However, these shares will not vest if Mr. Idol voluntarily terminates his employment or is terminated for cause prior to the earlier of (A) November 15, 2001 and (B) the closing of the Merger. Under a separate agreement between LVMH 7 DONNA KARAN INTERNATIONAL INC. NOTES TO FINANCIAL STATEMENTS and Mr. Idol, LVMH has agreed that, if the Merger is not consummated by November 15, 2001, LVMH will purchase on that date Mr. Idol's shares of restricted common stock at a price of $4.875 per share in cash, for an aggregate purchase price of $2.7 million. If the Merger is consummated after November 15, 2001, Mr. Idol will be entitled to receive from LVMH or its affiliates, within five days of consummation, an amount per share equal to the difference between (1) the $10.75 per share Merger consideration and (2) the $4.875 per share previously paid to him, for an aggregate purchase price $5.9 million. This will result in Mr. Idol receiving the full $10.75 per share Merger consideration for his shares of restricted common stock, for total consideration of $5.9 million. The Company recognized $1.4 million of compensation expense related to these shares during the three month period ended September 30, 2001, and will recognize an additional $0.8 million during the fourth fiscal quarter of 2001. o Continued health, long-term disability and life insurance at the level in effect on July 13, 2001 for 36 months, or the economic equivalent of that coverage in cash. However, if Mr. Idol commences other full-time employment that offers substantially similar or improved coverage, this continued coverage will cease. o Outplacement services, up to $50,000, for a period of one year, commencing on July 13, 2001, but in no event beyond the date on which Mr. Idol commences other full-time employment. o Any salary and expenses that are accrued but unpaid as of July 13, 2001. Accordingly, under these arrangements, Mr. Idol will receive a total of $12.2 million, plus continued health, long-term disability and life insurance. Of this amount, (1) $6.3 million is payable by the Company under Mr. Idol's resignation arrangement and (2) $5.9 million is payable by LVMH under its separate agreement with Mr. Idol relating to LVMH's purchase of his shares of restricted common stock. Payment of these amounts to Mr. Idol is not contingent upon the consummation of the Merger, except for LVMH's payment to Mr. Idol of $5.9 million in respect of his shares of restricted common stock. In addition, if the payments and benefits relating to Mr. Idol's resignation arrangement are subject to the 20% excise tax under the Internal Revenue Code of 1986 as "excess parachute payments," Mr. Idol will receive a tax gross-up so that he is in the same after-tax position as if there were no excise tax. In connection with the resignation of Mr. Idol and the appointment of Mr. Brusone as the President and Chief Executive Officer, the Company agreed that Mr. Brusone will, for the period prior to the consummation of the Merger, be entitled to receive a monthly salary of $58,333.33 plus a discretionary bonus and participate, when eligible, in all plans and benefits generally given to the Company's senior executives. During this interim period, Mr. Brusone's employment will be "at will," terminable by either the Company or him with or without cause. ADOPTION OF NEW ACCOUNTING STANDARDS In June 1998, the Financial Accounting Standards Board ("FASB") issued Statement No. 133, "Accounting for Derivative Instruments and Hedging Activities," as amended, which is required to be adopted in fiscal years beginning after June 15, 2000. The Company has adopted the provisions of this Statement effective January 1, 2001. This Statement requires that all derivatives be recorded in the balance sheet as either an asset or liability measured at fair value and that changes in fair value be recognized currently in earnings unless specific hedge accounting criteria are met. If the derivative is a hedge, depending on the nature of the hedge, changes in the fair value of derivatives will either be offset against the change in fair value of the hedged assets, liabilities, or firm commitments through earnings or recognized in other comprehensive income until the hedged item is recognized in earnings. The ineffective portion of a derivative's change in fair value will be immediately recognized in earnings. The Company's cumulative effect of adoption of this Statement was not material to the Company's results of operations or financial condition. The transition adjustment from adopting this Statement resulted in reclassifying a cumulative unrecognized loss of $0.9 million from accrued expenses to other comprehensive income. The Company uses derivative financial instruments for the purpose of managing its exposure to adverse fluctuations in foreign currency exchange rates. The Company conducts business in many foreign currencies. As a result, it is subject to foreign currency exchange rate risk due to the effects that foreign exchange rate movements of these currencies have on the Company's costs and cash flows. The Company addresses its risks through a program of risk management that includes the use of derivative financial instruments, the principal objective of which is to minimize the effect of foreign exchange rate movements on the Company's operating activities. 8 DONNA KARAN INTERNATIONAL INC. NOTES TO FINANCIAL STATEMENTS The Company enters into forward exchange contracts to hedge foreign currency denominated sales and inventory purchases, and the resulting accounts receivable and payable. Such forward exchange contracts are for periods consistent with the identified exposures. These contracts are effective hedges of these exposures, and are designated as dual-purpose hedges -- cash flow hedges until the anticipated transaction occurs, and fair value hedges until the related receivable or payable settles. As cash flow hedges, changes in the effective portion of the fair value of these forward contracts are included in other comprehensive income and recognized in revenues and cost of sales, as applicable, when the underlying hedged transaction occurs. Once the sale or inventory purchase occurs, gains and losses on the fair value hedge of the resulting asset or liability are recognized in other income and expense and are offset by gains and losses on the mark-to-market of the underlying receivable or payable. Foreign currency transactions that do not qualify as hedges are marked-to- market on a current basis with gains and losses recognized through income and reflected in operating expenses. In addition, any previously deferred gains and losses on hedges that are terminated prior to the transaction date are recognized in current income when the hedge is terminated. The contracts have varying maturities with none exceeding 24 months. Included in other comprehensive income is a net unrealized loss of $4.3 million related to forward contracts outstanding as of September 30, 2001. As a matter of policy, the Company enters into forward exchange contracts with parties that are major international banks and financial institutions that have at least an "A" (or equivalent) credit rating. The Company's exposure to credit loss in the event of nonperformance by any of the counterparties is limited to only the recognized, but not realized, gains attributable to the contracts. Management believes risk of loss is remote and in any event would be immaterial. NET LOSS PER COMMON SHARE In accordance with the requirements of Statement of Financial Accounting Standards ("SFAS") No. 128, "Earnings per Share," net loss per common share amounts ("basic EPS") were computed by dividing net loss by the weighted average number of common shares outstanding and contingently issuable shares (which satisfy certain conditions) and excluded any potential dilution. Net loss per common share amounts assuming dilution ("diluted EPS") were computed by reflecting potential dilution from the issuance of restricted stock and the exercise of stock options. SFAS No. 128 requires the presentation of both basic EPS and diluted EPS on the face of the statements of income. A reconciliation between the numerators and denominators of the basic and diluted EPS computations for net (loss) income is as follows:

9 DONNA KARAN INTERNATIONAL INC. NOTES TO FINANCIAL STATEMENTS INVENTORIES Inventory is stated at the lower of cost or market, with cost being determined on the first-in, first-out method. Inventories consist of the following:

PROPERTY AND EQUIPMENT Property and equipment are carried at cost less accumulated depreciation. Depreciation is computed primarily on the straight-line basis over the estimated useful lives of the assets ranging from 5 to 7 years. Leasehold improvements are amortized on a straight-line basis over the shorter of the expected useful lives or the lease term, which in certain instances include the anticipated renewal period. Property and equipment consist of the following:

ACCRUED EXPENSES AND OTHER CURRENT LIABILITIES Accrued expenses and other current liabilities are comprised of the following:

10 DONNA KARAN INTERNATIONAL INC. NOTES TO FINANCIAL STATEMENTS COMMITMENTS AND CONTINGENCIES In December 2000, several putative class actions were filed in state court in Delaware and New York (collectively, the "LVMH Actions") in connection with the offer of LVMH to acquire the outstanding shares of the Company for a price of $8.50 per share (the "LVMH Offer"). All of the complaints name the Company, its Chairman, its former Vice Chairman and its former Chief Executive Officer as defendants. Two of the complaints also name the Company's outside Board members as defendants and three of the complaints also name LVMH as a defendant. The LVMH Actions allege, INTER ALIA, that the $8.50 price initially offered by LVMH to purchase the Company's common stock is inadequate, that the individual defendants breached their fiduciary duties in connection with the LVMH Offer and that the Chairman and former Vice Chairman of the Company furthered their own interests, at the expense of the Company's interests, in allegedly negotiating with LVMH concerning the proposed sale of the Company to LVMH. These actions sought injunctive relief against the acquisition of Gabrielle Studio by LVMH and the Merger, monetary damages and an award of plaintiffs' costs and attorneys' fees. Plaintiffs did not file a motion for a preliminary injunction. None of the lawsuits specifies any amount of damages sought and, therefore, it is not practicable to estimate a range of possible loss in connection with this litigation. As of May 11, 2001, all parties to the class actions filed in Delaware entered into a memorandum of understanding setting forth an agreement in principle for the proposed settlement of all of the actions. Under the memorandum of understanding: o LVMH acknowledged that the existence and prosecution of the actions and the positions advocated by plaintiffs' counsel and financial advisor were among the factors taken into consideration in increasing the per share consideration offered to our stockholders from $8.50 per share to $10.75 per share; o The members of the special committee of the Company's board of directors acknowledged that the special committee was aware of the actions and the views of plaintiff's counsel and financial advisor concerning the adequacy of the $10.75 per share price offered by LVMH in reaching the special committee's final determination to recommend that our board of directors enter into the merger agreement; and o The Company and LVMH agreed to provide a draft of the Merger proxy statement to plaintiffs' counsel for its review and to consider any comments provided by plaintiffs' counsel concerning the adequacy of the disclosures contained in the proxy statement. The proposed settlement contemplated in the memorandum of understanding is subject to a number of conditions, including consummation of the Merger, completion of confirmatory discovery by plaintiffs' counsel and final approval by the Delaware Court of Chancery. Counsel for the parties in the class actions filed in New York have stipulated to stay all proceedings in those actions and to be bound by the outcome of the class actions filed in Delaware. Accordingly, an order of the Delaware Court of Chancery approving the settlement will be binding on all of the class actions in New York and Delaware. If the Court approves the proposed settlement, plaintiffs' counsel intends to apply to the Court for an award of fees and expenses. Defendants have agreed not to oppose such an application in an aggregate amount not to exceed $925,000, to be paid by the Company or the Company's successor(s) in interest in the amount awarded by the Court. During the nine month period ended September 30, 2001, the Company accrued this $925,000 settlement, as well as an asset of $425,000, representing expected proceeds from insurance coverage. The Company's insurance carriers have initially denied coverage on this settlement. The Company currently is in the process of disputing this decision. If the proposed settlement is not given final approval by the Court, and any subsequent negotiations with plaintiffs' counsel are not successful, the Company would expect to mount a vigorous defense to the class actions. The Company anticipates that the Merger will close prior to a hearing in the Delaware Court of Chancery on final approval of the proposed settlement and thus does not anticipate that the outcome of the settlement hearing would affect the consummation of the Merger or otherwise cause a delay in the Company stockholders' receipt of the Merger consideration. However, if, at any time, plaintiffs did seek any injunctive relief with respect to the Merger, the Company believes that any such application would be without merit and would oppose it vigorously. If the settlement is not approved, plaintiffs' could seek to unwind the Merger. Given the consequences of such an action to stockholders, however, courts have been reluctant to grant this type of relief. 11 DONNA KARAN INTERNATIONAL INC. NOTES TO FINANCIAL STATEMENTS RESTRUCTURING AND OTHER CHARGES For the nine months ended September 30, 2001, the Company utilized approximately $0.3 million of reserves previously established in connection with its fiscal 1999 restructuring plan. The Company anticipates utilizing the remaining balance of its reserves during fiscal 2001. The balance of the fiscal 1999 restructuring and other charges are as follows:

PROVISION FOR INCOME TAXES The provision for income taxes represents Federal, foreign, state and local income taxes. The effective income tax rate was 205.0% and 41.0% for the nine months ended September 30, 2001 and October 1, 2000, respectively. This rate reflects the effect of state and local taxes, tax rates in certain foreign jurisdictions, and certain nondeductible expenses. Realization of the future tax benefits related to the deferred tax assets is dependent on many factors including the Company's ability to generate sufficient taxable income within the net operating loss carry forward period and potential limitations imposed by the Internal Revenue Code. A full valuation allowance of $48.4 million was recorded at September 30, 2001 based on current operating results and therefore management's assessment that it is more likely than not that all the net deferred tax assets will be not realized through future taxable earnings or implementation of tax planning strategies, if the Company were to continue as a stand-alone entity. However, the Company believes that the Merger will occur during fiscal 2001. STATEMENTS OF CASH FLOWS Supplemental disclosures of cash flow information:

MANAGEMENT ESTIMATES The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenues and expenses reported in those financial statements. Actual results could differ from those based upon such estimates and assumptions. 12 DONNA KARAN INTERNATIONAL INC. NOTES TO FINANCIAL STATEMENTS NOTE 2 -- COMPREHENSIVE (LOSS) INCOME Comprehensive (loss) income and its components, are as follows:

On January 1, 2001, the Company adopted the provisions of Statement of Financial Accounting Standards ("SFAS") No. 133, "Accounting for Derivative Instruments and Hedging Activities." Accordingly, a net unrealized loss on foreign currency forward contracts for the three and nine months ended September 30, 2001 of $4.6 million and $2.6 million, respectively, is included in other comprehensive income. The unrealized loss on forward exchange contracts included in other comprehensive income for the three and nine months ended September 30, 2001 is net of reclassification adjustments for realized gains on forward exchange contracts. Accumulated other comprehensive income (loss) is as follows:

13 DONNA KARAN INTERNATIONAL INC. NOTES TO FINANCIAL STATEMENTS NOTE 3 -- SEGMENT INFORMATION Information related to the Company's reportable business segments are as follows:

(a) Includes $8.2 million and $10.5 million in transaction costs related to the proposed LVMH Merger for the three and nine months ended September 30, 2001, respectively. Information related to the Company's geographic segments are as follows:

14 DONNA KARAN INTERNATIONAL INC. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS OVERVIEW Donna Karan International Inc. (together with its subsidiaries, the "Company") is one of the world's leading international fashion design houses. The Company designs, contracts for the manufacture of, markets, retails and distributes collections of men's and women's clothing, sportswear, accessories, and shoes under the DONNA KARAN NEW YORK, DKNY, DKNY JEANS and DKNY ACTIVE brand names. The Company also selectively has granted licenses for the manufacture and distribution of certain other products under its brand names, including beauty and beauty-related products, jeanswear, activewear, hosiery, intimate apparel, eyewear, and children's apparel. RESULTS OF OPERATIONS The Company's business is comprised of wholesale, licensing, and retail activities. The Company utilizes a 52- or 53-week fiscal year ending on the Sunday nearest December 31. The following discussion provides information and analysis of the Company's results of operations for the three and nine months ended September 30, 2001 and October 1, 2000. The following tables set forth certain segment data:

(a) Includes $8.2 million and $10.5 million in transaction costs related to the proposed LVMH Merger for the three and nine months ended September 30, 2001, respectively. 15 DONNA KARAN INTERNATIONAL INC. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The following tables set forth certain condensed statement of income data:

THIRD QUARTER FISCAL 2001 COMPARED WITH THIRD QUARTER FISCAL 2000 NET REVENUES Net revenues for the three months ended September 30, 2001 decreased $26.5 million, or 13.0%, to $177.2 million as compared to net revenues of $203.7 million in the corresponding prior-year period. On an overall basis, the Company's revenues have been negatively impacted by the generally worsening economic conditions, which deteriorated further after the tragic events of September 11, 2001. Wholesale revenues for the three months ended September 30, 2001 decreased $28.5 million, or 18.0%, to $129.9 million as compared to $158.4 million in the corresponding prior-year period. The decrease was attributable to decreases in sales from the womens and menswear businesses, partially offset by an increase in the accessories business. Licensing revenues for the three months ended September 30, 2001 increased $2.7 million, or 21.4%, to $15.4 million as compared to $12.7 million in the corresponding prior-year period. The increase was primarily due to royalties from the Company's new regional license in Asia and growth in sales of certain other new and existing licensed products. Retail revenues for the three months ended September 30, 2001 decreased $0.7 million, or 2.2%, to $31.9 million as compared to $32.6 million in the corresponding prior-year period. The decrease was primarily attributable to a 14.0% overall decrease in outlet store sales, partially offset by a 19.1% overall increase in full-price retail store sales. Overall, comparable store sales decreased 6.9% from the corresponding prior-year period. GEOGRAPHIC Net revenues for the United States for the three months ended September 30, 2001 decreased $23.7 million, or 18.9%, to $101.7 million as compared to $125.4 million in the corresponding prior-year period. The decrease was primarily attributable to decreased wholesale revenues and, to a lesser extent, decreased retail revenues, partially offset by an increase in licensing revenues. Net revenues for Japan for the three months ended September 30, 2001 decreased $0.8 million, or 11.7%, to $6.2 million as compared to $7.0 million in the corresponding prior-year period. The decrease was primarily attributable to decreased wholesale revenues to Japan, partially offset by increased royalties from the Company's Japanese licensee. Net revenues for other geographic areas for the three months ended September 30, 2001 decreased $2.0 million, or 2.9%, to $69.3 million as compared to $71.3 million in the corresponding prior-year period. The decrease was primarily attributable to decreased wholesale revenues, partially offset by increased retail and licensing revenues. 16 DONNA KARAN INTERNATIONAL INC. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS GROSS PROFIT Gross profit as a percentage of net revenues for the three months ended September 30, 2001 was 30.4%, as compared to 35.7% in the corresponding prior-year period. The decrease in gross profit primarily reflected lower margins in the wholesale and retail segments, partially offset by an increase in the higher margin licensing business. The decrease in both the wholesale and retail segments continued to be impacted by lower margins on the liquidation of prior and current seasons' inventory. SELLING, GENERAL AND ADMINISTRATIVE EXPENSES Selling, general and administrative expenses were $57.9 million, or 32.7% of net revenues for the three months ended September 30, 2001, as compared to $47.9 million, or 23.5% in the corresponding prior-year period. Included in these costs during the three months ended September 30, 2001, was $8.2 million in transaction costs related to the proposed LVMH Merger. Exclusive of these costs, selling, general and administrative expenses were $49.7 million or 28.1% of net revenues for the three months ended September 30, 2001. The increase was primarily a result of increased costs associated with the growth in the number of full-price free-standing retail stores, partially offset by lower selling and administrative expenses in the wholesale segment, as compared to the prior year. OPERATING (LOSS) INCOME Operating loss for the three months ended September 30, 2001 was $4.0 million as compared to operating income of $24.7 million in the corresponding prior-year period, a decrease of $28.7 million, or 116.2%. Included in the operating loss during the three months ended September 30, 2001, is $8.2 million in transaction costs related to the proposed LVMH Merger. Exclusive of these costs, operating income decreased $20.5 million, or 83.1%, to $4.2 million for the three months ended September 30, 2001. The decrease was attributable to decreased operating income in the wholesale segment and increased operating losses in the retail segment, both partially offset by increased operating profit in the licensing segment. INTEREST EXPENSE, NET Interest expense, net was $1.3 million for the three months ended September 30, 2001 as compared to $1.0 million for the corresponding prior-year period. The increase was primarily attributable to an increase in average borrowings offset by lower interest rates during the three months ended September 30, 2001, as compared to the corresponding prior-year period. PROVISION FOR INCOME TAXES The provision for income taxes represents Federal, foreign, state and local income taxes. The effective income tax rate was 921.0% and 41.0% for the three months ended September 30, 2001 and October 1, 2000, respectively. This rate reflects the effect of state and local taxes, tax rates in certain foreign jurisdictions, and certain nondeductible expenses. Realization of the future tax benefits related to the deferred tax assets is dependent on many factors including the Company's ability to generate sufficient taxable income within the net operating loss carry forward period and potential limitations imposed by the Internal Revenue Code. A full valuation allowance of $48.4 million was recorded at September 30, 2001 based on current operating results and therefore management's assessment that it is more likely than not that all the net deferred tax assets will be not realized through future taxable earnings or implementation of tax planning strategies, if the Company were to continue as a stand-alone entity. However, the Company believes that the Merger will occur during fiscal 2001. NET (LOSS) INCOME Net loss for the three months ended September 30, 2001 was $53.7 million, as compared to net income of $14.0 million in the corresponding prior-year period, a decrease of $67.7 million, or 484.2%. Included in net loss during the three months ended September 30, 2001, was $5.0 million, net of income taxes, in transaction costs related to the proposed LVMH Merger. Exclusive of these costs, net income decreased $62.7 million, or 448.6%, to $48.7 million for the three months ended September 30, 2001. The decrease was primarily attributable to significantly lower net revenues in the Company's wholesale segment, decreased gross margins in the wholesale and retail segments and higher interest expense, partially offset by an increase in the higher margin licensing business. In addition, no income tax benefit was recognized, and an valuation allowance of $48.4 million on deferred tax assets was recorded during the three months ended September 30, 2001. 17 DONNA KARAN INTERNATIONAL INC. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS NINE MONTHS FISCAL 2001 COMPARED TO NINE MONTHS FISCAL 2000 NET REVENUES Net revenues for the nine months ended September 30, 2001 decreased $22.8 million, or 4.6%, to $474.2 million as compared to net revenues of $497.0 million in the corresponding prior-year period. Wholesale revenues for the nine months ended September 30, 2001 decreased $28.1 million, or 7.5%, to $346.4 million as compared to $374.5 million in the corresponding prior-year period. The decrease was attributable to decreases in sales from the womens, menswear and accessories businesses, partially offset by an increase in sales from the international DKNY JEANS business. Licensing revenues for the nine months ended September 30, 2001 increased $9.6 million, or 29.7%, to $42.0 million as compared to $32.4 million in the corresponding prior-year period. The increase was primarily due to royalties from the Company's new regional license in Asia and growth in sales of certain other new and existing licensed products. Retail revenues for the nine months ended September 30, 2001 decreased $4.3 million, or 4.8%, to $85.8 million as compared to $90.1 million in the corresponding prior-year period. The decrease was primarily attributable to a 14.5% decrease in outlet store sales, partially offset by a 12.3% increase in full-priced retail store sales. Overall, comparable store sales decreased 9.4% from the corresponding prior-year period. GEOGRAPHIC Net revenues for the United States for the nine months ended September 30, 2001 decreased $34.5 million, or 10.8%, to $285.3 million as compared to $319.8 million in the corresponding prior-year period. The decrease was primarily attributable to decreased wholesale revenues and, to a lessor extent, decreased retail revenues, partially offset by an increase in licensing revenues. Net revenues for Japan for the nine months ended September 30, 2001 increased $1.9 million, or 11.6%, to $17.9 million as compared to $16.0 million in the corresponding prior-year period. The increase was attributable to both increased wholesale revenues to Japan and increased royalties from the Company's Japanese licensee. Net revenues for other geographic areas for the nine months ended September 30, 2001 increased $9.8 million, or 6.1%, to $171.0 million as compared to $161.2 million in the corresponding prior-year period. The increase was primarily attributable to increased wholesale and licensing revenues, and to a lesser extent, increased retail revenues. GROSS PROFIT Gross profit as a percentage of net revenues for the nine months ended September 30, 2001 was 28.6%, as compared to 32.4% for the corresponding prior-year period. In June 2000, the Company reversed $0.8 million of restructuring reserves classified in cost of sales, determined no longer to be necessary. Exclusive of the restructuring credit, gross profit as a percentage of net revenues for the nine months ended October 1, 2000 was 32.2%. The decrease in gross profit primarily reflected lower margins in the wholesale and retail segments, partially offset by an increase in the higher margin licensing business. The decrease in the wholesale segment was impacted by higher dilution, and both the wholesale and retail segments were impacted by lower margins on the liquidation of prior seasons inventory. SELLING, GENERAL AND ADMINISTRATIVE EXPENSES Selling, general and administrative expenses were $153.1 million, or 32.3% of net revenues for the nine months ended September 30, 2001, as compared to $141.9 million or 28.5% in the corresponding prior-year period. Included in these costs, during the nine months ended September 30, 2001, is $10.5 million in transaction costs related to the proposed LVMH Merger. Exclusive of these costs, selling, general and administrative expenses were $142.6 million or 30.1% of net revenues for the nine months ended September 30, 2001. The increase was primarily a result of increased costs associated with the growth in the number of full-price free-standing retail stores, partially offset by lower selling and administrative expenses in the wholesale segment, as compared to the prior year. 18 DONNA KARAN INTERNATIONAL INC. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS OPERATING (LOSS) INCOME Operating loss for the nine months ended September 30, 2001 was $17.6 million as compared to operating income of $19.3 million in the corresponding prior-year period, a decrease of $36.9 million, or 191.2%. Included in the operating loss during the nine months ended September 30, 2001, was $10.5 million in transaction costs related to the proposed LVMH Merger. Exclusive of these costs, operating income decreased $26.4 million, or 136.8%, to an operating loss of $7.1 million for the nine months ended September 30, 2001. The decrease was attributable to increased operating losses in the wholesale and retail segments, partially offset by increased operating profit in the licensing segment. INTEREST EXPENSE, NET Interest expense, net was $3.1 million for the nine months ended September 30, 2001 as compared to $1.8 million for the corresponding prior-year period. The increase was primarily attributable to an increase in average borrowings offset by lower interest rates during the nine months ended September 30, 2001, as compared to the corresponding prior-year period. PROVISION FOR INCOME TAXES The provision for income taxes represents Federal, foreign, state and local income taxes. The effective income tax rate was 205.0% and 41.0% for the nine months ended September 30, 2001 and October 1, 2000, respectively. This rate reflects the effect of state and local taxes, tax rates in certain foreign jurisdictions, and certain nondeductible expenses. Realization of the future tax benefits related to the deferred tax assets is dependent on many factors including the Company's ability to generate sufficient taxable income within the net operating loss carry forward period and potential limitations imposed by the Internal Revenue Code. A full valuation allowance of $48.4 million was recorded at September 30, 2001 based on current operating results and therefore management's assessment that it is more likely than not that all the net deferred tax assets will be not realized through future taxable earnings or implementation of tax planning strategies, if the Company were to continue as a stand-alone entity. However, the Company believes that the Merger will occur during fiscal 2001. NET (LOSS) INCOME Net loss for the nine months ended September 30, 2001 was $63.1 million, as compared to net income of $10.3 million in the corresponding prior-year period, a decrease of $73.4 million, or 711.3%. Included in net loss, during the nine months ended September 30, 2001, was $6.4 million, net of income taxes, in transaction costs related to the proposed LVMH Merger. Exclusive of these costs, net income decreased $67.0 million, or 649.4%, to a net loss of $56.7 million for the nine months ended September 30, 2001. The decrease was primarily attributable to lower net revenues and decreased gross margins in both the wholesale and retail segments and higher interest expense, partially offset by an increase in the higher margin licensing business. In addition, no income tax benefit was recognized, and an valuation allowance of $48.4 million on deferred tax assets was recorded during the nine months ended September 30, 2001. LIQUIDITY AND CAPITAL RESOURCES The Company's principal sources of funds have historically been cash flow from operations and borrowings under its revolving credit facility. As more fully described below, in order to supplement the Company's historical source of funds, Gabrielle Studio, Inc. (an LVMH affiliate) has agreed to defer until June 30, 2002 the payment of royalties owed by the Company for the second, third and fourth quarters of 2001. The Company's principal need for funds is to finance working capital (principally inventory and receivables), capital expenditures (including the construction of new shop-in-shops, outlet and full-price free-standing retail stores), and investments in the start-up of new collections and the extension of existing collections. At September 30, 2001, the Company had cash and cash equivalents of $4.2 million, as compared to $6.8 million at October 1, 2000. The Company has a $150.0 million revolving credit facility (the "Facility"). The Facility is used for working capital requirements and general corporate purposes. At September 30, 2001, $57.6 million was outstanding under the Facility, as compared to $9.5 million outstanding at October 1, 2000. The Company's results of operations in the second and third quarters of fiscal 2001, having been affected by business and economic conditions, are below forecast and are expected to continue below forecast for the balance of the fiscal year. In August, 2001 the Company entered into an agreement with Gabrielle Studio, Inc. (an LVMH affiliate) pursuant to which Gabrielle Studio, Inc. agreed to defer until June 30, 2002 the payment of royalties owed by the Company for the second, third and fourth quarters of 2001. In August 2001, the Company amended its credit facility. The August 2001 credit facility amendment provides (i) that an event of default will occur on January 7, 2002 if the merger with LVMH has not 19 DONNA KARAN INTERNATIONAL INC. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS occurred, (ii) for changes in the application of credit facility covenant calculations so as to exclude from such calculations, the royalty payments deferred by the above referenced agreement with Gabrielle Studio, Inc., together with certain unpaid severance and merger expenses, and (iii) that the Company must maintain a minimum of $20 million in availability under the credit facility from December 15, 2001 through the expiration of the credit facility. In October 2001, the Company further amended its credit facility. The October amendment, while waiving need for the Company to meet certain financial covenants as of the end of the third quarter, also reduced the amount the Company can borrow under the facility to $102 million for the month of November 2001, $90 million for the period from December 1, 2001 through December 14, 2001 and $85 million thereafter. It also requires that the Company maintain a minimum credit availability of $4 million for the period from October 22, 2001 through October 31, 2001, $8 million for the period from November 1, 2001 though November 14, 2001, and $11 million for the period from November 15, 2001 through December 14, 2001, in addition to the $20 million requirement for the period subsequent to December 14, 2001 that was contained in the August amendment. In addition to the October 2001 and August 2001 credit facility amendments, in June 2001 the Company also entered into an amendment of its credit facility which enabled the Company to borrow amounts in excess of its calculated borrowing base during the months of June, July and August 2001. The Company believes that its results of operations for the balance of the fiscal year will cause it to violate several year-end financial covenants of its most recently amended credit facility. The failure of the Merger with LVMH to close by January 7, 2002 will cause an event of default under the credit agreement. The Company believes that the Merger will occur prior to January 7, 2002, and if not, that it will be required to amend its existing credit facility (which expires on May 1, 2003), or obtain an alternate source of long-term financing. However, there can be no assurances that an amended credit facility or any new financing will be available and, if available, that the terms will be as favorable as the existing terms in the current credit facility. Net cash used for operating activities was $62.8 million for the nine months ended September 30, 2001 as compared to $13.9 million in the corresponding prior-year period. The increase in net cash used by operating activities primarily reflects, an increase in the loss incurred by the Company, an increase in accounts receivable and inventory, and a greater decrease in accounts payable, accrued expenses and other current liabilities. Net cash used for investing activities increased $2.4 million for the nine months ended September 30, 2001 as compared to the corresponding prior-year period, primarily due to the Company's increased purchases of property and equipment in the current period. Financing activities primarily reflect borrowings under the Company's Facility. Net cash provided by financing activities for the nine months ended September 30, 2001 was $57.7 million, as compared to $9.5 million provided in the corresponding prior-year period. The increase in net cash provided by financing activities was due to greater amounts outstanding under the Company's Facility during the current period in order to finance higher levels of inventory, a decrease in accounts payable, accrued expenses and other current liabilities, as well as an increase in the loss incurred by the Company. As a matter of policy, the Company enters into forward exchange contracts with parties who are major international banks and financial institutions that have at least an "A" (or equivalent) credit rating. The Company's exposure to credit loss in the event of nonperformance by any of the counterparties is limited to only the recognized, but not realized, gains attributable to the contracts. Management believes risk of loss is remote and in any event would be immaterial. Costs associated with entering into such contracts have not been material to the Company's financial results. The Company's measured value-at-risk from holding such derivative instruments, using a variance co-variance model with a 95 percent confidence level, assuming normal market conditions at September 30, 2001 was approximately $4.4 million. Capital expenditures, primarily for leasehold improvements and leasehold improvements related to outlet and full-price free-standing retail stores, equipment, machinery, computers and office furniture, were approximately $6.2 million and $3.8 million for the nine months ended September 30, 2001 and October 1, 2000, respectively. As of November 1, 2001, the Company had outstanding commitments for additional capital expenditures during fiscal 2001 of approximately $0.5 million. The Company anticipates that it will be able to satisfy its ongoing operating cash requirements through the merger with LVMH with cash flow from operations, supplemented by borrowings under its Facility, the deferral by Gabrielle Studio Inc. of royalties due by the Company for the second, third and fourth quarters of 2001 and, from time to time, amounts received in connection with strategic transactions, including licensing arrangements. Events that may impact this include, but are not limited to, future events that may have the effect of reducing available cash balances (such as unexpected operating losses or increased capital or other expenditures), as well as future circumstances that might reduce or eliminate the availability of external financing. 20 DONNA KARAN INTERNATIONAL INC. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS FORWARD-LOOKING STATEMENTS Certain statements contained herein are forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934 that have been made pursuant to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. The words and phrases "will likely result," "are expected to," "will continue," "is anticipated," "estimates," "projects," "believes," "plans" or similar expressions, are intended to identify "forward-looking statements" include, without limitation, the Company's expectations regarding sales, earnings, or other future financial performance and liquidity, and general statements about future operations and operating results. Although the Company believes that its expectations are based on reasonable assumptions within the bounds of its knowledge of its business and operations, there can be no assurance that actual results will not differ materially from its expectations. Factors that could cause actual results to differ from expectations include, without limitation: (i) the failure of certain key members of the Company's design teams or management, including Ms. Karan, to continue to be active in the business of the Company; (ii) the failure to consummate the proposed Merger with LVMH at all due to the failure of a condition in the merger agreement or to consummate the Merger on a timely basis due to delays in the process of satisfying the conditions contained therein, the possibility of a termination of the Company's license with Gabrielle Studio, Inc., a bankruptcy of Gabrielle Studio, Inc., or transfer of the stock of Gabrielle Studio, Inc. or a change in the relationship under the agreement with Gabrielle Studio, Inc. following LVMH's purchase of Gabrielle Studio Inc.; (iii) political and economic instability resulting from acts of terrorism or war that may disproportionately adversely affect luxury goods manufacturers and retailers; (iv) the timing and expense associated with, and effects of, the strategic initiatives being implemented by the Company; (v) risks associated with the receipt, pricing, and timing of customer orders; (vi) general competitive factors and the overall financial condition of the apparel industry, the retail industry, and the general economy; (vii) timing of and costs associated with new stores openings and the Company's economic ability to continue to open new stores; (viii) risks associated with the Company's increasing royalty revenues as a percent of the Company's total revenues and net income and risks associated with a lack of operational or financial control over the Company's licensees; (ix) risks to the Company's existing wholesale businesses from the Company's licensing of related products; (x) a change in retailer or consumer acceptance of the Company's products; (xi) the variability of the Company's results in any period due to the seasonal nature of the business, the timing and level of the Company's sales, the timing of launch of new products and collections and opening of new doors, fashion trends, and the timing, terms, consummation, or success of any joint ventures, licenses, or other dispositions of product lines; (xii) consolidation and restructuring in the retail industry causing a decrease in the number of stores that sell the Company's products, or an increase in the ownership concentration within the retail industry; (xiii) social, political and economic risks to the Company's foreign operations and customers, including changes in foreign investment and trade policies and regulations of the host countries and of the United States; (xiv) changes in laws, regulations, and policies, including changes in accounting standards, that affect, or will affect, the Company in the United States and abroad; (xv) foreign currency fluctuations affecting the Company's results of operations and value of its foreign assets, the relative price at which the Company and foreign competitors sell their products in the same markets, and the Company's operating and manufacturing costs outside of the United States; (xvi) shipment delays, depletion of inventory, and increased production costs resulting from disruption at any of the Company's facilities or other causes; (xvii) changes in product mix to ones which are less profitable; (xviii) infringements of the Company's trademarks and other proprietary rights, imitations or diversions of the Company's products, or inability to obtain trademark protection outside the United States for one or more of the Company's marks; (xix) political or economic instability resulting in the disruption of trade from the countries in which the Company's contractors, suppliers, licensees, or customers are located, the imposition of additional regulations relating to imports, the imposition of additional duties, taxes, and other charges on imports, significant fluctuations of the value of the dollar against foreign currencies, or restriction on transfer of funds; (xx) the inability of a contractor to deliver the Company's products in a timely manner thereby causing the Company to miss the delivery date requirements of its customers, which in turn could result in the cancellation of orders, refusal to accept deliveries, or a reduction in the selling price; or (xxi) the violation of labor or other laws by the Company, any independent manufacturer, or any licensee. The Company undertakes no obligation to publicly update or revise any forward-looking statements made herein or elsewhere whether as a result of new information, future events or otherwise. 21 DONNA KARAN INTERNATIONAL INC. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK. There have been no material changes in information reported since the fiscal year ended December 31, 2000. PART II. OTHER INFORMATION Item 6. Exhibits and Reports on Form 8-K. (a) Exhibits None (b) Reports on Form 8-K The Company filed a Current Report on Form 8-K dated July 16, 2001, relating to the appointment of Giuseppe Brusone as Chief Executive Officer, succeeding John D. Idol. Included in such report were a letter agreement between Mr. Idol and the Company, amending Mr. Idol's employment arrangements, a letter agreement between Mr. Idol and LVMH whereby LVMH agrees to purchase Mr. Idol's stock on November 15, 2001 if the merger has not theretofore been consummated, a letter agreement between LVMH, Gabrielle Studio, Inc., the Company and certain other parties related to deferred royalty payments, an amendment to the Agreement and Plan of Merger, dated as of July 13, 2001, and the press release, dated as of July 16, 2001, announcing the appointment of Mr. Brusone. 22 SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. DONNA KARAN INTERNATIONAL INC. (Registrant) Date: November 14, 2001 By: /s/ James G. Thompson ------------------------- James G. Thompson Senior Vice President - Finance 23

DONNA KARAN INTERNATIONAL INC 10-Q