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ble accounts receivable, inventory, and letters of credit.
The credit agreement provided for various borrowing rate options including borrowing
rates based on a ¬xed spread over the London Interbank Offered Rate (“LIBOR”).
Donna Karan International




With the proceeds of the Offering, the Company repaid all amounts due under its exist-
ing credit facility, and in September 1996, the Company entered into a new $150 million,
three-year revolving Credit Facility as amended in March 1997 (the “New Facility”).
Direct borrowings under the New Facility bear interest at the lead bank™s prime rate or, at
the option of the Company, at a ¬xed spread over the LIBOR and are limited to a borrow-
ing base calculated on eligible accounts receivable, inventory, and letters of credit. The
New Facility is secured by accounts receivable, inventory and certain intangibles of the
Company , as well as a pledge of all equity interests of the subsidiaries of the Company.
The New Facility also contains certain restrictive covenants which, among other things,
require the Company to maintain certain ¬nancial ratios and restrict investments, addi-
tional indebtedness, and payment of dividends. No amounts were outstanding under the
New Facility at December 29, 1996.
In connection with these facilities, the Company incurred certain ¬nancing costs which
were deferred and are being amortized over the remaining term of the New Facility. At
December 29, 1996, unamortized ¬nancing costs of approximately $952,000 are
included in “Deposits and other noncurrent assets” in the accompanying balance sheet.
Amortization of deferred ¬nancing costs of approximately $0.8 million and $3.5 million
in 1995 and 1996, respectively, are included in interest expense.
The Company leases certain property and equipment under long-term noncancellable
lease agreements which are accounted for as capital leases. These leases expire at vari-
ous dates through 1998. Future minimum lease payments as of December 29, 1996 are
as follows (in thousands):

1997 $299
1998 37
$336
Amount representing interest 18
Present value of total future minimum lease payments $318
Less current portion 282
Long-term portion of capital obligation $ 36


Letters of credit and acceptances outstanding were approximately $33,934,000 at
December 31, 1995 and $43,594,000 at December 29, 1996.
947
Case: Donna Karan International Inc.




217
Part 4 Additional Cases




5. Accrued Expenses and Other Current Liabilities

Accrued expenses and other current liabilities are comprised of the following (in thou-
sands):
December 31, December 29,
1995 1996

Accrued operating expenses $ 8,590 $12,779
Accrued income taxes 2,351 8,010




Donna Karan International
Accrued compensation 885 6,260
Accrued royalty ” 5,133
Accrued taxes other than income taxes 2,244 948
Other 1,696 1,062
$15,766 $34,192



7. Leases

Future minimum annual rental commitments under noncancellable operating leases
for of¬ce, warehouse and retail facilities, and equipment as of December 29, 1996 are
as follows (in thousands):

1997 $14,531
1998 13,942
1999 12,491
2000 10,490
2001 9,455
Thereafter 30,139
$91,048


In addition, certain of the leases contain options to renew for periods up to 10 years
and others include contingent payments based on sales.
Rent expense amounted to approximately $12,498,000, $14,105,000 and
$15,037,000 for the years ended January 1, 1995, December 31, 1995 and December
29, 1996, respectively.

8. Sale of Interests in Affiliates

The Company conducts operations in Japan through Donna Karan Japan. DSTF Japan
Company has a pro¬t-sharing agreement (the “DSTF Agreement”) with Donna Karan
Japan whereby 90% of the income before taxes of Donna Karan Japan is allocated to
DSTF Japan Company. On March 31, 1995, the Company sold 70% of its interest in the
DSTF Agreement and 70% of the stock of Donna Karan Japan to a nonaf¬liated party.
The Company recognized a gain on this transaction, net of transaction costs, of
$18,673,000. Subsequent to the sale, the Company records a 27% interest in the opera-
tions of Donna Karan Japan through its 30% interest in the DSTF Agreement and a 3%
interest in the operations of Donna Karan Japan through its remaining interest in Donna
Karan Japan. As a result, the Company has accounted for its combined 30% interest in
948 Case: Donna Karan International Inc.




218 Part 4 Additional Cases




the operations of Donna Karan Japan using the equity method of accounting. Equity
earnings for the years ended December 31, 1995 and December 29, 1996 amounted to
approximately $2,519,000 and $3,089,000, respectively. Simultaneously with the sales
transaction, the Company entered into an agreement with Donna Karan Japan which
provides for a fee based upon net sales of Donna Karan Japan. Management fee
income, as an offset of selling, general, and administrative expenses, amounted to
approximately $1,130,000 and $1,790,000 during the years ended December 31, 1995
and December 29, 1996, respectively. The equity investment in Donna Karan Japan of
Donna Karan International




$2,531,000 and $3,076,000 at December 31, 1995 and December 29, 1996, respec-
tively, is included in “Deposits and other noncurrent assets” in the accompanying balance
sheet.

9. DKNY® Jeans Licensing Agreement

On September 27, 1996, the Company entered into a 30-year licensing agreement
with subsidiaries of Designer Holdings Ltd. (the “Licensee”) for the exclusive production,
sale and distribution of men™s, women™s, and, with certain exceptions, children™s jeans-
wear under the DKNY® Jeans label (the “Jeans License”). Under the terms of the agree-
ment, the Company received an initial payment of $6.0 million from the Licensee to
reimburse the Company for certain costs related to the start-up and development of the
DKNY® Jeans label. The Company was also entitled to receive additional payments
aggregating $54.0 million over a four-year period, through the year 2000, and annual
royalties, as well as administrative fees on net sales.
Subsequent to year-end, the Company and the Licensee agreed to terminate this
agreement. In connection with this termination, the Company repaid the initial $6.0 mil-
lion payment and a $1.3 million advance royalty payment previously received. Addition-
ally, in order to assure a smooth transition for the DKNY® Jeanswear business, the
Company purchased for $3.2 million all sales and marketing plans, patterns, samples,
fabrics and other materials developed by the Licensee in connection with the jeanswear
business, the cost of which had been accrued at December 29, 1996 and is included in
selling, general and administrative expenses in the accompanying ¬nancial statements.

10. Related Party Transactions

As of July 3, 1996, the Company entered into a licensing agreement (the “Gabrielle
License”) with Gabrielle Studio, Inc. (“Gabrielle Studio”), a corporation owned by two of
the Company™s principal stockholders and their af¬liated trusts, which grants the Com-
pany the exclusive rights, in perpetuity, to use the trademarks “Donna Karan,” “Donna
Karan New York,” “DKNY,” “DK,” and all variations thereof. Under the Gabrielle License,
the Company pays Gabrielle Studio a royalty on net sales of products bearing the
licensed mark. During the six-month period ended December 29, 1996, the Company
incurred $9.3 million in royalty expense, which is included in cost of sales. In addition, the
Company made a one-time payment of $4.6 million to Gabrielle Studio in connection
with entering into the Gabrielle License, which is also included in cost of sales.
949
Case: Donna Karan International Inc.




219
Part 4 Additional Cases




15. Income Taxes

The entities in the Predecessor Company were partnerships or corporations that had
elected to be taxed as S corporations pursuant to the Internal Revenue Code. Therefore,
for the years ended January 1, 1995 and December 31, 1995, and for the six-month
period ended July 2, 1996 (the day prior to the Offering), no provision has been made in
the accompanying ¬nancial statements for such periods for Federal income taxes, since
such taxes were the liability of the partners. In connection with the Offering, the Company




Donna Karan International
became subject to Federal and additional state income tax.
The Company accounts for income taxes under Statement of Financial Accounting
Standards (“SFAS”) No. 109, “Accounting for Income Taxes” which requires the asset and
liability method of accounting for income taxes. Under the asset and liability method,
deferred income taxes are recognized for the tax consequences of “temporary differ-
ences” by applying enacted statutory tax rates applicable to future years to differences
between the ¬nancial carrying amounts and the tax bases of existing assets and liabilities.
Concurrent with becoming subject to Federal and additional state income taxes, the
Company recorded a deferred tax asset and a corresponding tax bene¬t in the statement
of income in accordance with the provisions of SFAS No. 109. The actual amount, which
was determined upon completion of the ¬nal tax returns of the Predecessor Company,
was approximately $19.0 million, and, as of the date of the Offering, resulted in a total
deferred tax asset of approximately $20.7 million which includes certain state and local
tax assets recorded on an historical basis.
The income tax provision consists of the following (in thousands):
Year Ended

January 1, December 31, December 29,
1995 1995 1996

Current income taxes:
Federal taxes $” $” $ 8,605
State and local taxes 1,113 2,242 2,717
Foreign taxes 386 278 1,130
$1,499 $2,520 $12,452
Deferred income taxes (360) (122) (29,631)
$1,139 $2,398 ($17,179)


Deferred income taxes re¬‚ect the net effects of temporary differences between the car-
rying amounts of assets and liabilities for ¬nancial reporting purposes and the amounts
used for income tax purposes. Signi¬cant items comprising the Company™s net deferred
tax asset are as follows (in thousands):
950 Case: Donna Karan International Inc.




220 Part 4 Additional Cases




December 31, December 29,
1995 1996

Current:
Uniform inventory capitalization $ 70 $ 1,046
Allowance for doubtful accounts and other
receivable related reserves 270 14,430
Inventory reserves ” 2,990
Other book accruals 962 6,741
$1,302 $25,207
Donna Karan International




Noncurrent:
Depreciation 380 6,106
$1,682 $31,313


The pro forma provision for income taxes represents the income tax provisions that
would have been reported had the Company been subject to Federal and additional state
income taxes for the entire period. The pro forma income tax provision has been pre-
pared according to SFAS No. 109.
The foreign and domestic components of pro forma income before pro forma income
taxes were as follows (in thousands):
Year Ended

December 31, December 29,
1995 1996

Domestic $26,676 $ 1,565
Foreign 5,454 4,856
$32,130 $ 6,421

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