LINDA DOES THE MATH, SAYS CALVIN’S FIGURES ON DEBT DON’T ADD UP

Byline: Vicki M. Young / Arnold J. Karr

NEW YORK — Hold on a second, Calvin. You need to check your math.
That was the implicit message delivered by Warnaco chief executive Linda Wachner in response to Calvin Klein Inc.’s attempted termination of Warnaco’s Calvin Klein jeanswear license.
With their long-awaited federal trial slated to start on Monday, Warnaco Wednesday challenged CKI’s claim that the jeanswear license could be ended because, in breach of its terms, Warnaco’s debt-to-equity ratio had exceeded 5-to-1. The license allows for termination of the pact if that threshold is exceeded at the end of any fiscal quarter.
As reported in these columns, Warnaco’s unaudited financial results for the third quarter ended Sept. 30, based on information furnished in a press release, listed long-term debt of $1.79 billion and shareholders’ equity of $348 million, yielding a ratio of 5.15.
But those numbers don’t hold up under more careful scrutiny, Warnaco officials argued Wednesday. The numbers filed with Form 10-Q to the Securities and Exchange Commission, while still unaudited, tell a different story.
They list a figure nearly $200 million lower for long-term debt — $1.6 billion. The current portion of long-term debt ($79.2 million) added to short-term debt ($768,000) brings the debt figure — the numerator, in mathematical parlance — to $1.681 billion.
Dividing by the denominator of shareholders’ equity — $348 million on both the quarterly press release and Form 10-Q — yields a more Warnaco-friendly result of 4.83, hardly grounds for admission into the Balance Sheet Hall of Fame, but below the critical 5-to-1 requirement in the license.
CKI declined comment Wednesday. However, the battle isn’t so clear cut. The parties are really disputing what is appropriate under generally accepted accounting principles, or GAAP. According to the letters sent to Warnaco and its two subsidiaries Tuesday, as well as the declaratory judgment request filed Tuesday with a New York state court in Manhattan, CKI is charging that Warnaco violated GAAP procedures by setting off cash assets against debts on its balance sheet. Warnaco has 30 days to file a response.
In one of the CKI letters, the company said that Warnaco’s chief financial officer, William Finkelstein, was unable to explain Warnaco’s setoff in a mid-November deposition — a legal proceeding to gather information in preparation for trial — and that the company relied on the opinion of its auditors, Deloitte & Touche, regarding the propriety of the cash setoff. CKI continued by stating in the letter that the auditing firm in turn relied on representations made by Warnaco.
According to Warnaco and its independent auditors, there was an appropriate setoff.
In the state court document, CKI stated: “A company is not permitted to set off cash against liabilities. Under GAAP, a setoff of assets against liabilities is only permitted between mutual debtors and if specific conditions are met.” CKI said that those conditions were not met and Warnaco had no right of setoff.
CKI further said in the legal document: “Even if the setoff of cash against liabilities were proper under GAAP (which it was not), the total debt of Warnaco Group listed in the 10-Q financial statement, including long-term debt, the current portion of long-term debt, short-term debt, accounts payable and other liabilities, was greater than five times the properly calculated net worth of Warnaco Group.”
CKI explained that $200 million of Warnaco’s accounts payable in the 10-Q filed on Nov. 14 — the total amount listed was $320.4 million — included borrowings from a trade credit facility with Warnaco’s banks. CKI stated that because the borrowings are interest-bearing debt from commercial financial institutions used to purchase inventory and goods, the borrowings or trade debt “are defined as ‘debt’ and as part of the material debt burden of Warnaco Group in notes to Warnaco’s Group’s financial statements, credit agreements and SEC filings and are part of Warnaco Group’s ‘debt’ for purposes of the debt-equity covenant of the Jeanswear License.”
Adding $200 million from accounts payable to the long-term debt numbers pushes the debt-equity ratio up to 5.17 from 4.83.
According to Warnaco, accounts payable is current liability, which is secured by inventory and is never counted as debt. GAAP debt is comprised of just three pieces: long-term debt, current portion of debt and short-term debt. If the portion of accounts payable representing the trade credit facility is just a liability that is properly excluded from what GAAP defines as debt, then Warnaco would be under the requisite 5-to-1 threshold at 4.83.
According to one of the CKI letters, Warnaco was put on notice about a possible termination of the jeanswear license since Nov. 13, when CKI sent a draft termination notice to the apparel manufacturer inviting Warnaco to contact CKI to provide additional facts on the alleged financial covenant breach for CKI to consider. In the same letter, CKI said Warnaco responded by indicating that no breach had occurred and that Warnaco had a right to “cure” a default.
CKI explained in the same letter that Warnaco did not have a right to “cure,” and that the license doesn’t even provide for a “cure period.”
Klein’s move to discontinue the license was released Tuesday, just six days prior to the start of the federal trial on CKI’s May 2000 trademark infringement lawsuit against Warnaco.

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