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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 January 3, 2004.
---------------
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
February 1, 2004.
GFSI, INC. AND SUBSIDIARIES
Quarterly Report on Form 10-Q
For the Quarter Ended January 3, 2004
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 11
ITEM 3 - QUANTITATIVE AND QUALITATIVE DISCLOSURES
ABOUT MARKET RISK 16
ITEM 4 - CONTROLS AND PROCEDURES 16
PART II - OTHER INFORMATION 17
SIGNATURE PAGE 18
2
GFSI, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(UNAUDITED)
(In thousands, except share data)
January 3, June 28,
2004 2003
------------- -------------
ASSETS
Current assets:
Cash and cash equivalents $ 296 $ 1,387
Accounts receivable, net 27,911 34,357
Inventories, net 33,321 42,663
Prepaid expenses and other current assets 1,763 1,323
Deferred income taxes 1,277 1,303
------------- -------------
Total current assets 64,568 81,033
Property, plant and equipment, net 20,279 19,883
Other assets:
Deferred financing costs, net 2,495 2,959
Investment in parent company bonds -- 9,900
Other 102 9
------------- -------------
Total assets $ 87,444 $ 113,784
============= =============
LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIENCY)
Current liabilities:
Accounts payable $ 7,026 $ 7,843
Accrued interest expense 4,452 4,365
Accrued expenses 7,062 6,151
Income taxes payable 10,675 8,850
Current portion of long-term debt 342 324
------------- -------------
Total current liabilities 29,557 27,533
Deferred income taxes 1,678 1,194
Other long-term obligations 491 491
Long-term debt, less current portion 147,834 158,639
Stockholders' equity (deficiency):
Common stock, $.01 par value, 10,000 shares authorized, one share
issued and outstanding at January 3, 2004 and June 28, 2003 -- --
Additional paid-in capital 71,442 59,127
Parent company bonds acquired (34,480) --
Accumulated deficiency (129,078) (133,200)
------------- -------------
Total stockholders' deficiency (92,116) (74,073)
------------- -------------
Total liabilities and stockholders' equity (deficiency) $ 87,444 $ 113,784
============= =============
See notes to consolidated financial statements.
3
GFSI, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
(UNAUDITED) (In thousands)
Quarter Ended Six Months Ended
January 3, December 28, January 3, December 28,
2004 2002 2004 2002
------------- ------------- ------------- -------------
Net sales $ 49,701 $ 54,633 $ 103,519 $ 115,844
Cost of sales 30,635 34,404 63,387 73,553
------------- ------------- ------------- -------------
Gross profit 19,066 20,229 40,132 42,291
Operating expenses:
Selling 6,721 6,879 13,494 14,375
General and administrative 6,762 6,844 12,744 13,479
------------- ------------- ------------- -------------
13,483 13,723 26,238 27,854
------------- ------------- ------------- -------------
Operating income 5,583 6,506 13,894 14,437
Other income (expense):
Interest expense (3,975) (3,685) (7,706) (7,309)
Gain on sale of property,
plant and equipment -- 11 939 11
------------- ------------- ------------- -------------
(3,975) (3,674) (6,767) (7,298)
------------- ------------- ------------- -------------
Income before income taxes 1,608 2,832 7,127 7,139
Income tax expense 628 1,106 2,780 2,786
------------- ------------- ------------- -------------
Net income $ 980 $ 1,726 $ 4,347 $ 4,353
============= ============= ============= =============
See notes to consolidated financial statements.
4
GFSI, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED) (In thousand)
Six Months Ended
January 3, December 28,
2004 2002
------------- -------------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $ 4,347 $ 4,353
Adjustments to reconcile net income to net cash provided by
operating activities:
Depreciation 1,304 1,576
Amortization of deferred financing costs 465 487
Amortization of other intangibles -- 500
Gain on sale or disposal of property, plant and equipment (939) (11)
Deferred income taxes 511 (287)
Changes in operating assets and liabilities:
Accounts receivable, net 6,446 (150)
Inventories, net 9,342 2,259
Prepaid expenses, other current assets and other assets (533) (114)
Income taxes payable 1,825 2,933
Accounts payable, accrued expenses and other
long-term obligations (158) (1,792)
------------- -------------
Net cash provided by operating activities 22,610 9,754
------------- -------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Proceeds from sales of property, plant and equipment 2,797 14
Purchases of property, plant and equipment (3,219) (2,172)
------------- -------------
Net cash used in investing activities (422) (2,158)
------------- -------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Net change in short term borrowings and revolving credit agreement (10,722) (4,422)
Purchase of parent company bonds (12,265) --
Distributions to GFSI Holdings, Inc. (258) (81)
Issuance of long-term debt 82 450
Payments on long-term debt (148) (87)
Other (1) (37)
------------- -------------
Net cash used in financing activities (23,312) (4,177)
------------- -------------
Effect of foreign exchange rate changes on cash 33 7
------------- -------------
Net increase (decrease) in cash and cash equivalents (1,091) 3,426
Cash and cash equivalents at beginning of period 1,387 313
------------- -------------
Cash and cash equivalents at end of period $ 296 $ 3,739
============= =============
Supplemental cash flow information:
Interest paid $ 7,153 $ 7,013
============= =============
Income taxes paid $ 445 $ 139
============= =============
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)
January 3, 2004
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 accounting
principles generally accepted in the United States of America 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.
The Company's fiscal year ends on the Saturday nearest June 30, which
results in a 53 week year from time to time. The fiscal year ending in June
2004 will be a 53 week period with the additional week falling in the
Company's second quarter ended January 3, 2004. Both the quarter and six month
fiscal periods ended January 3, 2004 have one more week of operations than the
comparable periods of fiscal 2003.
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.
3. Inventories:
------------
The following is a summary of inventories at January 3, 2004 and
June 28, 2003:
(in thousands) January 3, June 28,
2004 2003
------------- -------------
(unaudited)
Undecorated apparel ("blanks") and supplies $ 32,767 $ 37,924
Work in process 369 609
Finished goods 950 4,887
------------- -------------
34,086 43,420
Allowance for markdowns (765) (757)
------------- -------------
Total $ 33,321 $ 42,663
============= =============
6
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 January 3, 2004 (in thousands) (unaudited):
Parent Subsidiary Consolidating Consolidated
Obligor Guarantors Adjustments GFSI, Inc.
------------- ------------- ------------- -------------
Assets:
Current assets:
Cash and cash equivalents $ 157 $ 139 $ -- $ 296
Accounts receivable, net 15,888 23,981 (11,958) 27,911
Inventories, net 32,026 1,295 -- 33,321
Prepaid expenses and other current assets 1,597 166 -- 1,763
Deferred income taxes 1,277 -- -- 1,277
------------- ------------- ------------- -------------
Total current assets 50,945 25,581 (11,958) 64,568
Investment in equity of subsidiaries 22,745 -- (22,745) --
Property, plant and equipment, net 20,066 213 -- 20,279
Other assets 3,211 (612) (2) 2,597
------------- ------------- ------------- -------------
Total assets $ 96,967 $ 25,182 $ (34,705) $ 87,444
============= ============= ============= =============
Liabilities and stockholders' equity:
Current liabilities:
Accounts payable $ 18,634 $ 350 $ (11,958) $ 7,026
Accrued interest expense 4,452 -- -- 4,452
Accrued expenses 4,866 2,196 -- 7,062
Income taxes payable 10,784 (109) -- 10,675
Current portion of long-term debt 342 -- -- 342
------------- ------------- ------------- -------------
Total current liabilities 39,078 2,437 (11,958) 29,557
Deferred income taxes 1,678 -- -- 1,678
Other long-term obligations 491 -- -- 491
Long-term debt, less current portion 147,834 -- -- 147,834
Stockholders' equity (deficiency) (92,114) 22,745 (22,747) (92,116)
------------- ------------- ------------- -------------
Total liabilities and stockholders'
equity (deficiency) $ 96,967 $ 25,182 $ (34,705) $ 87,444
============= ============= ============= =============
7
Six months ended January 3, 2004 (in thousands) (unaudited):
Parent Subsidiary Consolidating Consolidated
Obligor Guarantors Adjustments GFSI, Inc.
------------- ------------- ------------- -------------
Net sales $ 61,111 $ 44,332 $ (1,924) $ 103,519
Cost of sales 38,779 26,532 (1,924) 63,387
Selling expenses 6,783 6,711 -- 13,494
General and administrative expenses 10,480 2,264 -- 12,744
------------- ------------- ------------- -------------
Total costs and expenses 56,042 35,507 (1,924) 89,625
------------- ------------- ------------- -------------
Operating income 5,069 8,825 -- 13,894
Equity in net earnings of subsidiaries 5,380 -- (5,380) --
Interest expense (7,703) (6) 3 (7,706)
Gain on sale of property, plant and equipment 942 -- (3) 939
------------- ------------- ------------- -------------
Income before income taxes 3,688 8,819 (5,380) 7,127
Income tax expense (benefit) (659) 3,439 -- 2,780
------------- ------------- ------------- -------------
Net income $ 4,347 $ 5,380 $ (5,380) $ 4,347
============= ============= ============= =============
Six months ended January 3, 2004 (in thousands) (unaudited):
Parent Subsidiary Consolidating Consolidated
Obligor Guarantors Adjustments GFSI, Inc.
------------- ------------- ------------- -------------
Net cash flows provided by operating activities $ 22,191 $ 419 $ -- $ 22,610
Net cash flows used in investing activities (45) (2) (375) (422)
Cash flows from financing activities:
Net repayments under revolving credit agreement (10,722) -- -- (10,722)
Purchase of parent company bonds (12,265) -- -- (12,265)
Payments on long-term debt (148) -- -- (148)
Repayment of intercompany debt -- (375) 375 --
Issuance of long-term debt 82 -- -- 82
Distributions to GFSI Holdings, Inc. (258) -- -- (258)
Other (1) -- -- (1)
------------- ------------- ------------- -------------
Net cash used in financing activities (23,312) (375) 375 (23,312)
------------- ------------- ------------- -------------
Effect of foreign exchange rate changes on cash -- 33 -- 33
------------- ------------- ------------- -------------
Net increase (decrease) in cash and cash
equivalents (1,166) 75 -- (1,091)
Cash and cash equivalents at beginning of period 1,323 64 -- 1,387
------------- ------------- ------------- -------------
Cash and cash equivalents at end of period $ 157 $ 139 $ -- $ 296
============= ============= ============= =============
8
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'
equity (deficiency) $ 118,030 $ 19,057 $ (23,303) $ 113,784
============= ============= ============= =============
Six months ended December 28, 2002 (in thousands) (unaudited):
Parent Subsidiary Consolidating Consolidated
Obligor Guarantors Adjustments GFSI, Inc.
------------- ------------- ------------- -------------
Net sales $ 76,832 $ 41,052 $ (2,040) $ 115,844
Cost of sales 49,887 25,706 (2,040) 73,553
Selling expenses 9,215 5,160 -- 14,375
General and administrative expenses 11,197 2,282 -- 13,479
------------- ------------- ------------- -------------
Total costs and expenses 70,299 33,148 (2,040) 101,407
------------- ------------- ------------- -------------
Operating income 6,533 7,904 -- 14,437
Equity in net earnings of subsidiaries 4,812 -- (4,812) --
Interest expense (7,285) (13) -- (7,298)
------------- ------------- ------------- -------------
Income before income taxes 4,060 7,891 (4,812) 7,139
Income tax expense (benefit) (293) 3,079 -- 2,786
------------- ------------- ------------- -------------
Net income $ 4,353 $ 4,812 $ (4,812) $ 4,353
============= ============= ============= =============
9
Six months ended December 28, 2002 (in thousands) (unaudited):
Parent Subsidiary Consolidating Consolidated
Obligor Guarantors Adjustments GFSI, Inc.
------------- ------------- ------------- -------------
Net cash flows provided by (used in) operating
activities $ 10,637 $ (883) $ -- $ 9,754
Net cash flows provided by (used in) investing
activities (2,126) 940 (972) (2,158)
Cash flows from financing activities:
Net repayments under revolving credit agreement (4,422) -- -- (4,422)
Payments on long-term debt (87) -- -- (87)
Repayment of intercompany debt (972) -- 972 --
Other (37) -- -- (37)
Issuance of long-term debt 450 -- -- 450
Distributions to GFSI Holdings, Inc. (81) -- -- (81)
------------- ------------- ------------- -------------
Net cash flows provided by (used in) financing (5,149) -- 972 (4,177)
------------- ------------- ------------- -------------
activities
Effect of foreign exchange rate changes on cash -- 7 -- 7
------------- ------------- ------------- -------------
Net increase in cash and cash equivalents 3,362 64 -- 3,426
Cash and cash equivalents at beginning of period 334 (21) -- 313
------------- ------------- ------------- -------------
Cash and cash equivalents at end of period $ 3,696 $ 43 $ -- $ 3,739
============= ============= ============= =============
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 effect 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 million at September 27, 2003 for approximately $12.2
million. The Company intends to pledge the Notes as collateral under the RBCA.
The Company owned Notes with an aggregate maturity value of $84
million at January 3, 2004. The Company owns 78% of the issued Notes and has
recorded 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 January 3, 2004 Stockholders'
equity (deficiency) included a reduction of $34.5 million representing the
acquisition cost of the Notes.
10
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 causing an impairment
of their ability to make payments, additional provisions for bad debts may be
required in future periods. Accounts receivable at January 3, 2004 and June
28, 2003 were net of allowance for doubtful accounts of $918,000 and $906,000,
respectively.
11
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.
Fiscal Period. The Company's fiscal year ends on the Saturday
nearest June 30, which results in a 53 week year from time to time. The fiscal
year ending in June 2004 will be a 53 week period with the additional week
falling in the Company's second quarter ended January 3, 2004. Both the
quarter and six month fiscal periods ended January 3, 2004 have one more week
of operations than the comparable periods of fiscal 2003. Because of the
seasonal nature of the Company's business, and the timing of the additional
week, which fell during the holiday period, management believes the effect of
the additional week of operations was not significant.
COMPARISON OF OPERATING RESULTS FOR THE QUARTERS ENDED JANUARY 3, 2004
AND DECEMBER 28, 2002
Net Sales. Net sales for the quarter ended January 3, 2004 decreased
$4.9 million to $49.7 million compared to $54.6 million last year. The 9%
decrease in net sales was due to reduced sales of our Gear for Sports(R)
("Gear") branded products while sales of our Champion(R) licensed products
experienced continued growth. Sales of Gear branded products principally to
the college bookstore and corporate customer groups decreased 30% in
comparison to last year. Management believes that the Company's college
bookstore customers have shifted their purchases to lower priced apparel with
less expensive decoration which has reduced sales of higher priced Gear
products. Reductions in corporate spending on marketing and employee incentive
programs have had a negative effect on net sales of the Corporate Division.
Net sales of Champion licensed products for the second quarter of fiscal 2004
increased 16% over the comparable quarter of fiscal 2003. Champion licensed
products are more moderately priced as compared to Gear's for college
bookstore customers.
Gross Profit. Gross profit for the quarter ended January 3, 2004
decreased 6% to $19.1 million compared to $20.2 million last year. The
decrease in gross profit resulted from lower sales. Gross profit as a
percentage of net sales increased to 38% for the quarter compared to 37% 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
January 3, 2004 decreased 2% to $13.5 million from $13.7 million last year.
Beginning in fiscal 2004, the Company pays a 3% royalty on the net sales of
Champion branded apparel under its license agreement with the Sara Lee
Corporation. Lower direct sales expenses were partially offset by the
additional cost of the Champion related royalty which created the decrease in
operating expenses. Operating expenses as a percentage of net sales were 27%
in the second quarter of fiscal 2004 compared to 25% last year. The additional
royalty expense and lower sales created the increase in operating expenses as
a percentage of net sales in comparison to last year.
12
Operating Income. Operating income decreased 14% to $5.6 million in
the second quarter of fiscal 2004 compared to $6.5 million last year.
Operating income as a percentage of net sales decreased to 11% in the second
quarter of fiscal 2004 from 12% in the second quarter of fiscal 2003. The
decrease in operating income resulted from lower sales.
Interest Expense. Interest expense in the second quarter of fiscal
2004 was $4.0 million compared to $3.7 million last year. The additional week
in the second quarter of fiscal 2004 created the increase in interest expense.
Net Income. Net income for the second quarter of fiscal 2004 was $1.0
million compared to $1.7 million for the second quarter of fiscal 2003, a
decrease of $700,000. The decrease in operating income combined with higher
interest expense created the decrease in net income.
COMPARISON OF OPERATING RESULTS FOR THE SIX MONTHS ENDED JANUARY 3, 2004
AND DECEMBER 28, 2002
Net Sales. Net sales for the six months ended January 3, 2004
decreased 11% to $103.5 million compared to $115.8 million last year. The
decrease in net sales was due to reduced sales of our Gear for Sports(R)
("Gear") branded products while sales of our Champion(R) licensed products
increased 8%. Sales of Gear branded products principally to the college
bookstore and corporate customer groups decreased 27% in comparison to last
year. Management believes that the Company's college bookstore customers have
shifted their purchases to lower priced apparel with less expensive decoration
which has reduced sales of higher priced Gear products. Reductions in
corporate spending on marketing and employee incentive programs have had a
negative effect on net sales of the Corporate Division. Champion licensed
products are more moderately priced as compared to Gear's for college
bookstore customers.
Gross Profit. Gross profit for the six months ended January 3, 2004
decreased 5% to $40.1 million compared to $42.3 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 six month period compared to
37% 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 six months ended
January 3, 2004 decreased 6% to $26.2 million from $27.9 million last year.
Beginning in fiscal 2004, the Company pays a 3% royalty on the net sales of
Champion branded apparel under its license agreement with the Sara Lee
Corporation. Lower direct sales expenses were partially offset by the
additional cost of the Champion related royalty which created the decrease in
operating expenses. Operating expenses as a percentage of net sales were 25%
in fiscal 2004 compared to 24% last year. The additional royalty expense and
lower sales created the increase in operating expenses as a percentage of net
sales in comparison to last year.
Operating Income. Operating income for the six months ended January
3, 2004 decreased 4% to $13.9 million compared to $14.4 million last year.
Operating income as a percentage of net sales increased to 13% in fiscal 2004
from 12% in fiscal 2003. The decrease in operating income resulted from lower
sales.
Interest Expense. Interest expense in the first six months of fiscal
2004 was $7.7 million compared to $7.3 million last year. The additional week
in the first six months of fiscal 2004 created the increase in interest
expense.
13
Gain on sale of property, plant and equipment. During the first
quarter of fiscal 2004, the Company sold its 100,000 square foot distribution
facility located in Lenexa, Kansas, for approximately $2.8 million and
recorded a pre-tax gain of approximately $900,000 in other income. 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 six months of fiscal 2004 was
$4.3 million approximately the same as the comparable period last year. The
decrease in operating income and higher interest expense were offset by the
gain on the sale of the distribution facility.
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 effect 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 million at September 27, 2003 for approximately $12.2
million. The Company intends to pledge the Notes as collateral under the RBCA.
The Company owns Notes with an aggregate maturity value of $84
million at January 3, 2004. The Company owns 78% of the issued Notes and has
recorded 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 January 3, 2004 Stockholders'
equity (deficiency) included a reduction of $34.5 million representing the
acquisition cost of the Notes.
The Company's purchasing of the Notes has reduced its future cash
dividend obligations to Holdings to enable it to retire the Notes in 2009 from
$108 million to $24 million. Additionally, the Company's purchase of the Notes
has reduced its future annual cash dividend obligation to Holdings to enable
it to pay interest on the Notes commencing in March 2005 from $12.3 million to
$2.7 million.
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LIQUIDITY AND CAPITAL RESOURCES
Cash provided by operating activities in the first six months of
fiscal 2004 was $22.6 million compared to $9.8 million last year. Lower levels
of inventory and accounts receivable produced improved fiscal 2004 operating
cash flows.
Cash used by investing activities in the first six months of fiscal
2004 was $422,000 compared to $2.2 million last year. The $2.8 million in
proceeds from the sale of the Lenexa distribution facility in fiscal 2004
offset the capital expended on the warehouse consolidation project through
January 3, 2004. 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 six months of fiscal
2004 was $23.3 million compared to $4.2 million in the comparable period of
fiscal 2003. The purchase of Holdings Notes and the repayment of bank debt
were the primary uses of cash in fiscal 2004.
Under the Company's Revolving Bank Credit Agreement ("RBCA"), up to
$65 million of revolving credit availability is provided, of which $12.3
million was borrowed and outstanding and approximately $1.9 million was
utilized for outstanding commercial and stand-by letters of credit as of
January 3, 2004. At January 3, 2004, $32.3 million was available for future
borrowings under the RBCA. The Company was in compliance with its debt
covenants at January 3, 2004. 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 January 3, 2004, Holdings' debt to third
parties, excluding the debt of its subsidiaries, totaled approximately $23
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.
During the first quarter of fiscal 2004, 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
warehouse consolidation and 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 during the
first 5 years of the lease.
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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 January 3, 2004. 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.
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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
------- -----------
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.
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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.
February 13, 2004
/s/ J. Craig Peterson
- -------------------------------------------------
J. Craig Peterson
Senior Vice President and Chief Financial Officer
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