UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 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 27, 2003.
------------------
OR
( ) TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the transition period from ________________ to ________________
Commission file number 333-24189
GFSI, INC.
----------
(Exact name of registrant specified in its charter)
Delaware 74-2810748
- ------------------------------------- -----------------------------------
(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
9700 Commerce Parkway
Lenexa, Kansas 66219
------------------------------------------
(Address of principal executive offices)
(913) 888-0445
------------------------------------------------------
(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 period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days.
(1)Yes (X) No ( )
(2)Yes (X) No ( )
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act).
Yes ( ) No (X)
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practicable date:
Common stock, $0.01 par value per share - 1 share issued and outstanding as of
November 1, 2003.
1
GFSI, INC. AND SUBSIDIARIES
Quarterly Report on Form 10-Q
For the Quarter Ended September 27, 2003
INDEX
Page
----
PART I - FINANCIAL INFORMATION
ITEM 1 - CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
Consolidated Balance Sheets 3
Consolidated Statements of Income 4
Consolidated Statements of Cash Flows 5
Notes to Consolidated Financial Statements 6
ITEM 2- MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF
OPERATIONS 12
ITEM 3 - QUANTITATIVE AND QUALITATIVE DISCLOSURES
ABOUT MARKET RISK 16
ITEM 4 - CONTROLS AND PROCEDURES 16
PART II - OTHER INFORMATION 17
SIGNATURE PAGE 19
2
GFSI, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(UNAUDITED)
(In thousands, except share data)
September 27, June 28,
2003 2003
------------------- ---------------
ASSETS
Current assets:
Cash and cash equivalents $ 1,383 $ 1,387
Accounts receivable, net 35,385 34,357
Inventories, net 37,739 42,663
Prepaid expenses and other current assets 1,400 1,323
Deferred income taxes 1,204 1,303
------------- ------------
Total current assets 77,111 81,033
Property, plant and equipment, net 18,697 19,883
Other assets:
Deferred financing costs, net 2,707 2,959
Investment in parent company bonds -- 9,900
Other 85 9
------------- ------------
Total assets $ 98,600 $ 113,784
============= ============
LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIENCY)
Current liabilities:
Accounts payable $ 17,908 $ 7,843
Accrued interest expense 1,012 4,365
Accrued expenses 7,883 6,151
Income taxes payable 10,928 8,850
Current portion of long-term debt 377 324
------------- ------------
Total current liabilities 38,108 27,533
Deferred income taxes 1,160 1,194
Other long-term obligations 491 491
Long-term debt, less current portion 151,934 158,639
Stockholders' equity (deficiency):
Common stock, $.01 par value, 10,000 shares authorized, one share
issued and outstanding at September 27, 2003 and June 28, 2003 -- --
Additional paid-in capital 71,442 59,127
Parent company bonds acquired (34,445) --
Accumulated deficiency (130,090) (133,200)
------------- ------------
Total stockholders' deficiency (93,093) (74,073)
------------- ------------
Total liabilities and stockholders' equity (deficiency) $ 98,600 $ 113,784
============= ============
See notes to consolidated financial statements.
3
GFSI, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
(UNAUDITED) (In thousands)
Quarter Ended
September 27, September 28,
2003 2002
------------ -------------
Net sales $ 53,818 $ 61,211
Cost of sales 32,752 39,149
----------- -----------
Gross profit 21,066 22,062
Operating expenses:
Selling 6,773 7,496
General and administrative 5,982 6,635
----------- -----------
12,755 14,131
----------- -----------
Operating income 8,311 7,931
Other income (expense):
Interest expense (3,731) (3,624)
Gain on sale of property, plant and equipment 939 --
----------- ----------
(2,792) (3,624)
----------- ----------
Income before income taxes 5,519 4,307
Income tax expense 2,152 1,680
----------- -----------
Net income $ 3,367 $ 2,627
=========== ===========
See notes to consolidated financial statements.
4
GFSI, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED) (In thousand)
Quarter Ended
September 27, September 28,
2003 2002
CASH FLOWS FROM OPERATING ACTIVITIES: ------------- -------------
Net income $ 3,367 $ 2,627
Adjustments to reconcile net income to net cash provided by
operating activities:
Depreciation 657 780
Amortization of deferred financing costs 253 243
Amortization of other intangibles -- 250
(Gain) loss on sale or disposal of property, plant and equipment (939) --
Deferred income taxes 66 (15)
Changes in operating assets and liabilities:
Accounts receivable, net (1,028) (8,034)
Inventories, net 4,924 (3,102)
Prepaid expenses, other current assets and other assets (153) (55)
Income taxes payable 2,078 (1,166)
Accounts payable, accrued expenses and other
long-term obligations 8,105 1,638
---------- --------
Net cash provided by (used in) operating activities 17,330 (6,834)
---------- --------
CASH FLOWS FROM INVESTING ACTIVITIES:
Proceeds from sales of property, plant and equipment 2,797 --
Purchases of property, plant and equipment (990) (861)
---------- --------
Net cash provided by (used in) investing activities 1,807 (861)
---------- --------
CASH FLOWS FROM FINANCING ACTIVITIES:
Net change in short term borrowings and revolving credit agreement (6,663) 8,321
Purchase of parent company bonds (12,230) --
Distributions to GFSI Holdings, Inc. (240) (128)
Issuance of long-term debt 82 450
Payments on long-term debt (72) (46)
Other (1) (13)
---------- --------
Net cash provided by (used in) financing activities (19,124) 8,584
---------- --------
Effect of foreign exchange rate changes on cash (17) (6)
---------- --------
Net increase (decrease) in cash and cash equivalents (4) 883
Cash and cash equivalents at beginning of period 1,387 313
---------- --------
Cash and cash equivalents at end of period 1,383 $ 1,196
========== ========
Supplemental cash flow information:
Interest paid $ 6,832 $ 6,499
========== ========
Income taxes paid $ 9 $ 57
========== ========
Non-cash financing activities:
Parent company bonds contributed $ 12,315 $ --
========== ========
See notes to consolidated financial statements.
5
GFSI, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
September 27, 2003
1. Basis of Presentation
---------------------
The accompanying unaudited consolidated financial statements of GFSI,
Inc. (the "Company") include the accounts of the Company and the accounts of its
wholly-owned subsidiaries, Event 1, Inc. ("Event 1"), CC Products, Inc. ("CCP")
and GFSI Canada Company. All intercompany balances and transactions have been
eliminated. 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 Article 10 of
Regulation S-X promulgated by the Securities and Exchange Commission.
Accordingly, they do not include all of the information and footnotes required
by generally accepted accounting principles for annual financial statement
reporting purposes. In the opinion of management, all adjustments (consisting of
normal recurring accruals) considered necessary for a fair presentation of the
financial position, operations and cash flows of the Company have been included.
Operating results for the interim periods are not necessarily indicative of the
results that may be expected for the entire fiscal year. The consolidated
balance sheet information as of June 28, 2003 has been derived from the audited
consolidated financial statements at that date, but does not include all of the
information and footnotes required by generally accepted accounting principles
for complete financial statements. For further information, refer to the
consolidated financial statements and footnotes thereto for the year ended June
28, 2003 included in the Company's Annual Report on Form 10-K. The Company is a
wholly owned subsidiary of GFSI Holdings, Inc. ("Holdings").
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 and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the
reporting period. Actual results could differ from those estimates.
2. Commitments and Contingencies
-----------------------------
The Company, in the normal course of business, may be threatened with
or named as a defendant in various lawsuits. It is not possible to determine the
ultimate disposition of these matters, however, management is of the opinion
that there are no known claims or known contingent claims that are likely to
have a material adverse effect on the results of operations, financial
condition, or cash flows of the Company.
6
3. Inventories:
-----------
The following is a summary of inventories at September 27, 2003 and
June 28, 2003:
(in thousands) September 27, June 28,
2003 2003
-------------- -----------
(unaudited)
Undecorated apparel ("blanks") and supplies $ 35,893 $ 37,924
Work in process 466 609
Finished goods 2,145 4,887
------------ ----------
38,504 43,420
Allowance for markdowns (765) (757)
------------ ----------
Total $ 37,739 $ 42,663
============ ==========
7
4. Condensed Consolidating Financial Information
---------------------------------------------
The accompanying condensed consolidating financial information has been
prepared and presented pursuant to SEC Regulation S-X Rule 3-10 "Financial
statements of guarantors and issuers of guaranteed securities registered or being
registered." This information is not necessarily intended to present the financial
position, results of operations and cash flows of the individual companies or
groups of companies in accordance with accounting principles generally accepted in
the United States of America. Each of the subsidiary guarantors are 100% owned by
GFSI, Inc. The subsidiary guarantees of GFSI, Inc.'s debts are full and
unconditional and joint and several.
As of September 27, 2003 (in thousands) (unaudited): Parent Subsidiary Consolidating Consolidated
Obligor Guarantors Adjustments GFSI, Inc.
Assets:
Current assets:
Cash and cash equivalents $ 1,303 $ 80 $ -- $ 1,383
Accounts receivable, net 20,118 20,543 (5,276) 35,385
Inventories, net 35,576 2,163 -- 37,739
Prepaid expenses and other current assets 1,270 130 -- 1,400
Deferred income taxes 1,204 -- -- 1,204
------------- ------------ ------------ ------------
Total current assets 59,471 22,916 (5,276) 77,111
Investment in equity of subsidiaries 20,069 -- (20,069) --
Property, plant and equipment, net 18,462 235 -- 18,697
Other assets 3,406 (612) (2) 2,792
------------- ------------ ------------ ------------
Total assets $ 101,408 $ 22,539 $ (25,347) $ 98,600
============= ============ ============ ============
Liabilities and stockholders' equity:
Current liabilities:
Accounts payable $ 22,921 $ 263 $ (5,276) $ 17,908
Accrued interest expense 1,012 -- -- 1,012
Accrued expenses 5,578 2,305 -- 7,883
Income taxes payable 11,026 (98) -- 10,928
Current portion of long-term debt 377 -- -- 377
------------- ------------ ------------ ------------
Total current liabilities 40,914 2,470 (5,276) 38,108
Deferred income taxes 1,160 -- -- 1,160
Other long-term obligations 491 -- -- 491
Long-term debt, less current portion 151,934 -- -- 151,934
Stockholders' equity (deficiency) (93,091) 20,069 (20,071) (93,093)
------------- ------------ ------------ ------------
Total liabilities and stockholders' equity $ 101,408 $ 22,539 $ (25,347) $ 98,600
(deficiency) ============= ============ ============ ============
8
Quarter ended September 27, 2003 (in thousands) (unaudited):
Parent Subsidiary Consolidating Consolidated
Obligor Guarantors Adjustments GFSI, Inc.
Net sales $ 32,118 $ 21,850 $ (150) $ 53,818
Cost of sales 19,751 13,151 (150) 32,752
Selling expenses 3,473 3,300 -- 6,773
General and administrative expense 5,111 871 -- 5,982
-------- --------- -------- ---------
Total costs and expenses 28,335 17,322 (150) 45,507
-------- --------- -------- ---------
Operating income 3,783 4,528 -- 8,311
Equity in net earnings of subsidiaries 2,755 -- (2,755) --
Interest expense (3,729) (12) 10 (3,731)
Gain on sale of property, plant and equipment 949 -- (10) 939
-------- --------- -------- ---------
Income before income taxes 3,758 4,516 (2,755) 5,519
Income tax expense 391 1,761 -- 2,152
-------- --------- -------- ---------
Net income $ 3,367 $ 2,755 $ (2,755) $ 3,367
======== ========= ======== =========
Quarter ended September 27, 2003 (in thousands) (unaudited):
Parent Subsidiary Consolidating Consolidated
Obligor Guarantors Adjustments GFSI, Inc.
Net cash flows provided by operating activities $ 16,922 $ 408 $ -- $ 17,330
Net cash flows provided by investing activities 1,807 -- -- 1,807
Cash flows from financing activities:
Net borrowings under revolving credit agreements (6,663) -- -- (6,663)
Purchase of parent company bonds (12,230) -- -- (12,230)
Payments on long-term debt (72) -- -- (72)
Repayment of intercompany debt 375 (375) -- --
Issuance of long-term debt 82 -- -- 82
Distributions to GFSI Holdings, Inc. (240) -- -- (240)
Other (1) -- -- (1)
----------- --------- --------- ---------
Net cash used in financing activities (18,749) (375) -- (19,124)
----------- --------- --------- ---------
Effect of foreign exchange rate changes on cash -- (17) -- (17)
----------- --------- --------- ---------
Net increase (decrease) in cash and cash equivalents (20) 16 -- (4)
Cash and cash equivalents at beginning of period 1,323 64 -- 1,387
------------ --------- --------- ---------
Cash and cash equivalents end of period $ 1,303 $ 80 $ -- $ 1,383
=========== ========= ========= =========
9
As of June 28, 2003 (in thousands) (unaudited):
Parent Subsidiary Consolidating Consolidated
Obligor Guarantors Adjustments GFSI, Inc.
Assets:
Current assets:
Cash and cash equivalents $ 1,323 $ 64 $ -- $ 1,387
Accounts receivable, net 25,027 15,300 (5,970) 34,357
Inventories, net 38,367 4,296 -- 42,663
Prepaid expenses and other current assets 1,198 125 -- 1,323
Deferred income taxes 1,303 -- -- 1,303
----------- ---------- ----------- -----------
Total current assets 67,218 19,785 (5,970) 81,033
Investment in equity of subsidiaries 17,331 -- (17,331) --
Property, plant and equipment, net 19,624 259 -- 19,883
Investment in parent company bonds 9,900 -- -- 9,900
Other assets 3,957 (987) (2) 2,968
----------- ---------- ----------- -----------
Total assets $ 118,030 $ 19,057 $ (23,303) $ 113,784
=========== ========== =========== ===========
Liabilities and stockholders' equity:
Current liabilities:
Accounts payable $ 13,263 $ 550 $ (5,970) $ 7,843
Accrued interest expense 4,365 -- -- 4,365
Accrued expenses 4,877 1,274 -- 6,151
Income taxes payable 8,948 (98) -- 8,850
Current portion of long-term debt 324 -- -- 324
----------- ---------- ----------- -----------
Total current liabilities 31,777 1,726 (5,970) 27,533
Deferred income taxes 1,194 -- -- 1,194
Other long-term obligations 491 -- -- 491
Long-term debt, less current portion 158,639 -- -- 158,639
Stockholders' equity (deficiency) (74,071) 17,331 (17,333) (74,073)
----------- ---------- ----------- -----------
Total liabilities and stockholders' $ 118,030 $ 19,057 $ (23,303) $ 113,784
equity (defiency) =========== ========== =========== ===========
Quarter ended September 28, 2002 (in thousands) (unaudited):
Parent Subsidiary Consolidating Consolidated
Obligor Guarantors Adjustments GFSI, Inc.
Net sales $ 39,969 $ 21,420 $ (178) $ 61,211
Cost of sales 25,461 13,866 178) 39,149
Selling expenses 4,929 2,567 -- 7,496
General and administrative expense 5,659 976 -- 6,635
----------- ---------- ----------- -----------
Total costs and expenses 36,049 17,409 (178) 53,280
----------- ---------- ----------- -----------
Operating income 3,920 4,011 -- 7,931
Equity in net earnings of subsidiaries 2,446 -- (2,446) --
Interest expense (3,622) (2) -- (3,624)
----------- ---------- ----------- -----------
Income before income taxes 2,744 4,009 (2,446) 4,307
Income tax expense 117 1,563 -- 1,680
----------- ---------- ----------- -----------
Net income $ 2,627 $ 2,446 $ (2,446) $ 2,627
=========== ========== =========== ===========
10
Quarter ended September 28, 2002 (in thousands) (unaudited):
Parent Subsidiary Consolidating Consolidated
Obligor Guarantors Adjustments GFSI, Inc.
Net cash flows provided by (used in) operating
activities $ (6,945) $ 111 $ -- $ (6,834)
Net cash flows used in investing activities (833) (28) -- (861)
Cash flows from financing activities:
Net borrowings under revolving credit agreement 8,321 -- -- 8,321
Payments on long-term debt (46) -- -- (46)
Other (13) -- -- (13)
Issuance of long-term debt 450 -- -- 450
Distributions to GFSI Holdings, Inc. (128) -- -- (128)
----------- ---------- ---------- -----------
Net cash flows provided by financing activities 8,584 -- -- 8,584
----------- ---------- ---------- -----------
Effect of foreign exchange rate changes on cash -- (6) -- (6)
----------- ---------- ---------- -----------
Net increase in cash and cash equivalents 806 77 -- 883
Cash and cash equivalents at beginning of period 334 (21) -- 313
----------- ---------- ---------- -----------
Cash and cash equivalents end of period $ 1,140 $ 56 $ -- $ 1,196
=========== ========== ========== ===========
5. Financing and Recapitalization
On September 8, 2003, the Company amended its existing revolving bank
credit agreement ("RBCA"). Under the terms of amendment, the RBCA lenders
consented to the series of transactions described below (the "Recapitalization")
and extended the term of the RBCA by one year to January 15, 2006.
In September 2003, Company management formed a Delaware limited
liability company called Gearcap LLC ("Gearcap") to affect the Recapitalization
of Holdings. Gearcap purchased 11.375% Senior Discount Notes of Holdings
("Notes") with an aggregate principal amount at maturity of approximately $30.5
million and an accreted book value of $27.4 million at September 27, 2003 (the
"Contributed Holdings Discount Notes") for approximately $12.3 million in cash.
Gearcap and Holdings subsequently entered into an Exchange Agreement under which
they exchanged 8,250 shares of newly authorized Holdings Class C common stock
and 11,490 shares of newly authorized Series E 10% Cumulative Preferred Stock
for the Contributed Holdings Discount Notes. The Company and Holdings entered
into a Contribution Agreement under which Holdings contributed the Contributed
Holdings Discount Notes it received from Gearcap to the Company as a capital
contribution. The Company intends to pledge the Notes as collateral
under the RBCA.
On September 26, 2003, the Company purchased Notes with an aggregate
principal amount at maturity of approximately $29.5 million and an accreted book
value of $26.5 at September 27, 2003 for approximately $12.2 million of which
$11.6 million was included in accounts payable. The Company intends to pledge
the Notes as collateral under the RBCA.
When combined with Notes previously acquired in December 2002, the
Company now owns Notes with an aggregate maturity value of $84 million at
September 27, 2003. The Company owns 78% of the issued Notes and has elected
to record its investment in Notes (including Notes previously acquired) as a
reduction of stockholders' equity at the acquisition cost of the Notes. At a
future date the Company intends to distribute to Holdings its acquired Notes
to permit the parent company to
11
formally retire these Notes. The Company is currently restricted under its
various long-term debt agreements from making this distribution for the next
several years. At September 27, 2003 Stockholders' equity (deficiency) included
a reduction of $34.4 million representing the acquisition cost of the Notes.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The discussions set forth in this Form 10-Q should be read in
conjunction with the financial information included herein and the Company's
Annual Report on Form 10-K for the year ended June 28, 2003. Management's
discussion and analysis of financial condition and results of operations and
other sections of this report contain forward-looking statements relating to
future results of the Company. Such forward-looking statements are identified by
use of forward-looking words such as "anticipates", "believes", "plans",
"estimates", "expects", and "intends" or words or phrases of similar expression.
These forward-looking statements are subject to various assumptions, risks and
uncertainties, including but not limited to, changes in political and economic
conditions, demand for the Company's products, acceptance of new products,
developments affecting the Company's products and to those discussed in the
Company's filings with the Securities and Exchange Commission. Accordingly,
actual results could differ materially from those contemplated by the
forward-looking statements.
CRITICAL ACCOUNTING POLICIES
The following discussion and analysis of financial condition, results
of operations, liquidity and capital resources is based upon the Company's
consolidated financial statements, which have been prepared in accordance with
accounting principles generally accepted in the United States. Generally
accepted accounting principles require estimates and judgments that affect the
reported amounts of assets, liabilities, revenues and expenses, and related
disclosure of contingent assets and liabilities. On an ongoing basis, the
Company evaluates its estimates, including those related to bad debts,
inventories, intangible assets, long-lived assets, deferred income taxes,
accrued expenses, contingencies and litigation. The Company bases its estimates
on historical experience and on various other assumptions that it believes are
reasonable under the circumstances, the results of which form the basis for
making judgments about the carrying values of assets and liabilities that are
not readily apparent from other sources. Actual results may differ materially
from these estimates under different assumptions or conditions.
The Company's management believes that some of its significant
accounting policies involve a higher degree of judgment or complexity than other
accounting policies. Identified below are the policies deemed critical to its
business and the understanding of its results of operations.
Revenue recognition. The Company recognizes revenues when goods are
shipped, title has passed, the sales price is fixed and collectibility is
reasonably assured. Returns, discounts and sales allowance estimates are based
on projected sales trends, historical data and other known factors. If actual
returns, discounts and sales allowances are not consistent with the historical
data used to calculate these estimates, net sales could either be understated or
overstated.
Accounts receivable. Accounts receivable consist of amounts due from
customers and business partners. The Company maintains an allowance for doubtful
accounts to reflect expected credit losses and provides for bad debts based on
collection history and specific risks identified on a customer-by-customer
basis. A considerable amount of judgment is required to assess the ultimate
realization of accounts receivable and the credit-worthiness of each customer.
Furthermore, these judgments must be continually evaluated and updated. If the
historic data used to evaluate credit risk does not reflect future collections,
or, if the financial condition of the Company's customers were to deteriorate
12
causing an impairment of their ability to make payments, additional provisions
for bad debts may be required in future periods. Accounts receivable at
September 27, 2003 and June 28, 2003 were net of allowance for doubtful accounts
of $918,000 and $906,000, respectively.
Inventories. Inventories are carried at the lower of cost or market
determined under the First-In, First-Out (FIFO) method. The Company writes down
obsolete and unmarketable inventories to their estimated market value based
upon, among other things, assumptions about future demand and market conditions.
If actual market conditions are less favorable than projected, additional
inventory write-downs may be required. The Company also records changes in
valuation allowances due to changes in operating strategy, such as the
discontinuances of certain product lines and other merchandising decisions
related to changes in demand. It is possible that further changes in required
inventory allowances may be necessary in the future as a result of market
conditions and competitive pressures.
COMPARISON OF OPERATING RESULTS FOR THE QUARTERS ENDED SEPTEMBER 27, 2003
AND SEPEMBER 28, 2002
Net Sales. Net sales for the quarter ended September 27, 2003 decreased
12% to $53.8 million compared to $61.2 million last year. The decrease in net
sales was primarily due to reduced sales of our higher priced Gear for Sports(R)
branded products while sales of our moderately priced Champion(R) licensed
products experienced modest growth. The sales decrease in Gear for Sports(R)
branded products was experienced in the college bookstore, resort and corporate
customer groups. Management believes that the Company's customers have shifted
their purchases to lower priced apparel with less expensive decoration which has
enhanced the sales of Champion's more moderately priced goods. Reductions in
corporate spending on marketing and employee incentive programs have had a
detrimental effect on net sales of the Corporate and Resort Divisions.
Gross Profit. Gross profit for the quarter ended September 27, 2003
decreased 5% to $21.1 million compared to $22.1 million last year. The decrease
in gross profit resulted from lower sales. Gross profit as a percentage of net
sales increased to 39% for the quarter compared to 36% last year. The benefits
of lower cost of product sourcing and improved efficiencies in garment
decoration created the increase in gross profit as a percentage of net sales.
Operating Expenses. Operating expenses for the quarter ended September
27, 2003 decreased 10% to $12.8 million from $14.1 million last year. Operating
expenses as a percentage of net sales were 24% in the first quarter of fiscal
2004 compared to 23% last year. Operating expenses decreased due to lower direct
sales related expenses. During the first quarter of fiscal 2004 the Company
began to incur a 3% royalty obligation on the net sales of Champion branded
apparel under its license agreement with the Sara Lee Corporation. The
additional royalty expense related to the Champion license created the increase
in operating expenses as a percentage of net sales in comparison to last year.
Operating Income. Operating income increased 5% to $8.3 million in the
first quarter of fiscal 2004 compared to $7.9 million last year. Operating
income as a percentage of net sales increased to 15% in the first quarter of
fiscal 2004 from 13% in the first quarter of fiscal 2003. Improved gross profit
margin percentage along with decreased operating expenses produced the increase
in operating income.
Interest Expense. Interest expense in the first quarter of fiscal 2004
was $3.7 million compared to $3.6 million last year. Higher borrowings created
the increase in interest expense.
Gain on sale of property, plant and equipment. During the first quarter
of fiscal 2003, the Company sold its 100,000 square foot distribution facility
13
located in Lenexa, Kansas, for approximately $2.8 million and recorded a pre-tax
gain of approximately $900,000 in other income during the three month period
ended September 27, 2003. The facility was sold as part of a warehouse
consolidation and automation initiative which will combine future distribution
operations into a larger, renovated facility eliminating several smaller
warehouses.
Net Income. Net income for the first quarter of fiscal 2004 was $3.4
million compared to $2.6 million for the first quarter of fiscal 2003, an
increase of 28%. The increase in operating income combined with the gain on the
sale of the distribution facility produced the increase in net income.
FINANCING AND RECAPITALIZTION
On September 8, 2003, the Company amended its existing revolving bank
credit agreement ("RBCA"). Under the terms of amendment, the RBCA lenders
consented to the series of transactions described below (the "Recapitalization")
and extended the term of the RBCA by one year.
In September 2003, Company management formed a Delaware limited
liability company called Gearcap LLC ("Gearcap") to affect the Recapitalization
of Holdings. Gearcap purchased 11.375% Senior Discount Notes of Holdings
("Notes") with an aggregate principal amount at maturity of approximately $30.5
million and an accreted book value of $27.4 million at September 27, 2003 (the
"Contributed Holdings Discount Notes") for approximately $12.3 million in cash.
Gearcap and Holdings subsequently entered into an Exchange Agreement under which
they exchanged 8,250 shares of newly authorized Holdings Class C common stock
and 11,490 shares of newly authorized Series E 10% Cumulative Preferred Stock
for the Contributed Holdings Discount Notes. The Company and Holdings entered
into a Contribution Agreement under which Holdings contributed the Contributed
Holdings Discount Notes it received from Gearcap to the Company as a capital
contribution. The Company intends to pledge the Notes as collateral
under the RBCA.
On September 26, 2003, the Company purchased Notes with an aggregate
principal amount at maturity of approximately $29.5 million and an accreted
book value of $26.5 at September 27, 2003 for approximately $12.2 million of
which $11.6 million was included in accounts payable. The Company intends to
pledge the Notes as collateral under the RBCA.
When combined with Notes previously acquired in December 2002, the
Company now owns Notes with an aggregate maturity value of $84 million at
September 27, 2003. The Company owns 78% of the issued Notes and has elected
to record its investment in Notes (including Notes previously acquired) as a
reduction of stockholders' equity at the acquisition cost of the Notes. At a
future date the Company intends to distribute to Holdings its acquired Notes
to permit the parent company to formally retire these Notes. The Company is
currently restricted under its various long-term debt agreements from making
this distribution for the next several years. At September 27, 2003
Stockholders' equity (deficiency) included a reduction of $34.4 million
representing the acquisition cost of the Notes.
14
LIQUIDITY AND CAPITAL RESOURCES
Cash provided by operating activities in the first quarter of fiscal
2004 was $17.3 million compared to cash used by operating activities of $6.8
million last year. Higher net income, lower inventory levels and increased
income tax and accounts payable produced improved fiscal 2004 operating cash
flows. Accounts payable at September 27, 2003 included $11.6 million in unpaid
funds to settle the Recapitalization transaction. These funds were subsequently
expended using borrowings under the RBCA. Fiscal 2003 operating cash flows were
used to fund the increase in accounts receivable and inventory related to the
addition of the Champion(R) college bookstore business.
Cash provided by investing activities in the first quarter of fiscal
2004 was $1.8 million compared to cash used in investing activities of $861,000
last year. The $2.8 million in proceeds from the sale of the Lenexa distribution
facility in fiscal 2004 created the cash provided by investing activities
compared to last year. The Company anticipates fiscal 2004 capital expenditures
to approximate $5.9 million, which includes the acquisition of equipment related
to its warehouse consolidation and automation initiative.
Cash used in financing activities in the first quarter of fiscal 2004
was $19.1 million compared to cash provided by financing activities of $8.6
million in the comparable period of fiscal 2003. The purchase of Holdings Notes
and the repayment of bank debt was the primary use of cash in fiscal 2004. In
the first quarter of fiscal 2003 borrowings under the Company's bank credit
facility to finance higher levels of inventory and accounts receivable was the
principal source of cash provided by financing activities.
Under the Company's Revolving Bank Credit Agreement ("RBCA") up to $65
million of revolving credit availability is provided, of which $16.3 million was
borrowed and outstanding and approximately $3.9 million was utilized for
outstanding commercial and stand-by letters of credit as of September 27, 2003.
At September 27, 2003, $36.4 million was available for future borrowings under
the RBCA. The Company believes that cash flows from operating activities and
borrowings under the RBCA will be adequate to meet the Company's short-term and
future liquidity requirements prior to the maturity of the RBCA in fiscal 2006,
although no assurance can be given in this regard.
The Company anticipates paying dividends to its parent to enable
Holdings to pay corporate income taxes, interest on the remaining 11.375% Senior
Discount Notes ("Holdings Discount Notes'), fees payable under consulting
agreements, preferred stock dividends and certain other ordinary course expenses
incurred on behalf of the Company. Holdings is dependent upon the cash flows of
the Company to provide funds to service its debt and meet its contractual
obligations. At September 27, 2003, Holdings' debt to third parties, excluding
the debt of its subsidiaries, totaled approximately $22 million. Holdings
Discount Notes do not have an annual cash flow requirement until fiscal 2005
as they accrue interest at 11.375% per annum, compounded semi-annually to an
aggregate principal amount of $24.5 million at September 15, 2004. Thereafter,
the Holdings Discount Notes will accrue interest at the rate of 11.375% per
annum, payable semi-annually, in cash on March 15 and September 15 of each
year, commencing on March 15, 2005. Additionally, Holdings' cumulative
non-cash preferred stock ("Holdings Preferred Stock") dividends total
approximately $1.5 million annually.
During first quarter, the Company entered into a ten-year operating
lease for approximately 240,000 square feet of space in an existing industrial
building near its Lenexa headquarters to support the distribution automation
initiative. Rent under the lease will commence in the third quarter of fiscal
2004. Annual rent is $730,000. The agreement provides for one ten year extension
and allows the Company an option to expand into an additional 65,000 square feet
of existing space.
15
SEASONALITY AND INFLATION
The Company experiences seasonal fluctuations in its sales and
profitability, with generally higher sales and gross profit in the first and
second quarters of its fiscal year. The seasonality of sales and profitability
is primarily due to higher college bookstore sales during the first two fiscal
quarters. Sales at the Company's Resort and Corporate divisions typically show
little seasonal variations.
The impact of inflation on the Company's operations has not been
significant to date. However, there can be no assurance that a high rate of
inflation in the future would not have an adverse effect on the Company's
operating results.
OFF-BALANCE SHEET ARRANGEMENTS
The Company does not have any off-balance sheet arrangements that have
or are reasonably likely to have a current or future material effect on the
Company's financial condition, changes in financial condition, revenues or
expenses, results of operations, liquidity, capital expenditures or capital
resources.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
DERIVATIVE AND MARKET RISK DISCLOSURE
The Company's market risk exposure is primarily due to possible
fluctuations in interest rates. The fixed rate portion of the Company's
long-term debt does not bear significant interest rate risk. An immediate 10%
change in interest rates would not have a material effect on the Company's
results of operations over the next fiscal year, although there can be no
assurances that interest rates will not significantly change.
ITEM 4. CONTROLS AND PROCEDURES
An evaluation was performed under the supervision and with the
participation of the Company's management, including the Chief Executive Officer
and the Chief Financial Officer, of the effectiveness of the design and
operation of the Company's disclosure controls and procedures (as defined in
Exchange Act Rules 13a-15(e) and 15d-15(e)) as of the end of the period ended
September 27, 2003. Based on that evaluation, the Company's management,
including the Chief Executive Officer and the Chief Financial Officer, concluded
that the Company's disclosure controls and procedures are effective in timely
alerting them to material information relating to the Company (including its
consolidated subsidiaries) required to be included in the Company's periodic SEC
filings. There have been no significant changes in the Company's internal
controls or in other factors that could significantly affect internal
controls, nor were any corrective actions required with regard to significant
deficiencies and material weaknesses.
16
PART II - OTHER INFORMATION
Item 1. Legal Proceedings
The Company is not a party to any pending legal proceeding the resolution of
which, the management of the Company believes, would have a material adverse
effect on the Company's results of operations or financial condition, nor to
any other pending legal proceedings other than ordinary, routine litigation
incidental to its business.
Item 2. Changes in Securities
None.
Item 3. Defaults Upon Senior Securities
None.
Item 4. Submission of Matters to a Vote of Security Holders
None.
Item 5. Other Information
None.
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits
Exhibit
Number Description
------ -----------
10.28 Third Consent and Amendment, dated as of September 8,
2003, to the Credit Agreement dated as of March 28,
2002.
10.29 Contribution Agreement, dated as of September 26, 2003, between
GFSI Holdings, Inc. and GFSI, Inc.
10.30 Amendment to Management Consulting Agreement, dated as of
September 26, 2003, between GFSI Holdings, Inc. and TJC
Management Corporation.
10.31 Management Agreement, dated as of October 1, 2003, between
Gearcap LLC and GFSI Holdings, Inc.
17
10.32 First Amendment to Third Consent and Amendment, dated as of
September 30, 2003.
31.1 Certification of Principal Executive Officer.
31.2 Certification of Principal Financial Officer.
(b) Reports on Form 8-K
The Company filed a Current Report on Form 8-K, announcing the acquisition of
$30 million (maturity value) of GFSI Holdings, Inc.'s 11.375% Senior Discount
Notes, on October 2, 2003.
18
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.
GFSI, INC.
November 5, 2003
/s/ J. Craig Peterson
----------------------------------------------------
J. Craig Peterson, Sr. Vice President of Finance and
Principal Accounting Officer
19