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 April 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
May 1, 2004.
1
GFSI, INC. AND SUBSIDIARIES
Quarterly Report on Form 10-Q
For the Quarter Ended April 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)
April 3, June 28,
2004 2003
----------------- ----------------
ASSETS
Current assets:
Cash and cash equivalents $ 1,388 $ 1,387
Accounts receivable, net 22,514 34,357
Inventories, net 37,936 42,663
Prepaid expenses and other current assets 1,805 1,323
Deferred income taxes 1,062 1,303
-------------- -------------
Total current assets 64,705 81,033
Property, plant and equipment, net 21,882 19,883
Other assets:
Deferred financing costs, net 2,281 2,959
Investment in parent company bonds -- 9,900
Other 105 9
-------------- -------------
Total assets $ 88,973 $ 113,784
============== =============
LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIENCY)
Current liabilities:
Accounts payable $ 11,322 $ 7,843
Accrued interest expense 1,200 4,365
Accrued expenses 5,954 6,151
Income taxes payable 9,123 8,850
Current portion of long-term debt 307 324
-------------- -------------
Total current liabilities 27,906 27,533
Deferred income taxes 1,424 1,194
Other long-term obligations 491 491
Long-term debt, less current portion 151,904 158,639
Stockholders' equity (deficiency):
Common stock, $.01 par value, 10,000 shares authorized, one
share issued and outstanding at April 3, 2004 and June 28, 2003 -- --
Additional paid-in capital 71,442 59,127
Parent company bonds acquired (24,995) --
Accumulated deficiency (139,199) (133,200)
-------------- -------------
Total stockholders' deficiency (92,752) (74,073)
-------------- -------------
Total liabilities and stockholders' equity (deficiency) $ 88,973 $ 113,784
============== =============
See notes to consolidated financial statements.
3
GFSI, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
(UNAUDITED) (In thousands)
Quarter Ended Nine Months Ended
April 3, March 29, April 3, March 29,
2004 2003 2004 2003
------------ ------------ ------------ ------------
Net sales $ 37,196 $ 41,204 $ 140,715 $ 157,048
Cost of sales 21,776 25,983 85,163 99,536
------------ ------------ ------------ ------------
Gross profit 15,420 15,221 55,552 57,512
Operating expenses:
Selling 6,447 6,047 19,941 20,422
General and administrative 6,336 6,571 19,080 20,050
------------ ------------ ------------ ------------
12,783 12,618 39,021 40,472
------------ ------------ ------------ ------------
Operating income 2,637 2,603 16,531 17,040
Other income (expense):
Interest expense (3,662) (3,809) (11,368) (11,118)
Gain on sale of property,
plant and equipment (27) 8 912 19
------------ ------------ ------------ ------------
(3,689) (3,801) (10,456) (11,099)
------------ ------------ ------------ ------------
Income (loss) before income taxes (1,052) (1,198) 6,075 5,941
Income tax expense (benefit) (411) (468) 2,369 2,318
------------ ------------ ------------ ------------
Net income (loss) $ (641) $ (730) $ 3,706 $ 3,623
============ ============ ============ ============
See notes to consolidated financial statements.
4
GFSI, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED) (In thousand)
Nine Months Ended
April 3, March 29,
2004 2003
------------ -----------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $ 3,706 $ 3,623
Adjustments to reconcile net income to net cash provided by
operating activities:
Depreciation 2,007 2,377
Amortization of deferred financing costs 679 732
Amortization of other intangibles -- 750
Gain on sale or disposal of property, plant and equipment (912) (11)
Deferred income taxes 472 165
Changes in operating assets and liabilities:
Accounts receivable, net 11,843 2,327
Inventories, net 4,727 3,613
Prepaid expenses, other current assets and other assets (578) (186)
Income taxes payable 273 2,306
Accounts payable, accrued expenses and other
long-term obligations (222) (6,262)
----------- -----------
Net cash provided by operating activities 21,995 9,434
----------- -----------
CASH FLOWS FROM INVESTING ACTIVITIES:
Proceeds from sales of property, plant and equipment 2,797 22
Purchases of property, plant and equipment (5,552) (2,936)
----------- -----------
Net cash used in investing activities (2,755) (2,914)
----------- -----------
CASH FLOWS FROM FINANCING ACTIVITIES:
Net change in short term borrowings and revolving credit agreement (6,609) (5,738)
Purchase of parent company bonds (12,265) --
Distributions to GFSI Holdings, Inc. (258) (174)
Issuance of long-term debt 82 450
Payments on long-term debt (226) (130)
Other (1) (50)
----------- -----------
Net cash used in financing activities (19,277) (5,642)
----------- -----------
Effect of foreign exchange rate changes on cash 38 66
----------- -----------
Net increase in cash and cash equivalents 1 944
Cash and cash equivalents at beginning of period 1,387 313
----------- -----------
Cash and cash equivalents at end of period $ 1,388 $ 1,257
=========== ===========
Supplemental cash flow information:
Interest paid $ 13,853 $ 13,561
=========== ===========
Income taxes paid (refunded) $ 1,618 $ (153)
=========== ===========
Non-cash financing activities:
Parent company bonds contributed $ 12,315 $ --
=========== ===========
Bonds distributed to parent company $ 9,485 $ --
=========== ===========
See notes to consolidated financial statements.
5
GFSI, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
April 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 third quarter of fiscal 2004 and
the third quarter of fiscal 2003 contain 13 weeks of operations while the nine
month fiscal period ended April 3, 2004 has one more week of operations than the
comparable period 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 April 3, 2004 and June 28,
2003:
(in thousands) April 3, June 28,
2004 2003
---------------- ---------------
(unaudited)
Undecorated apparel ("blanks")
and supplies $ 36,803 $ 37,924
Work in process 193 609
Finished goods 1,685 4,887
-------------- ------------
38,681 43,420
Allowance for markdowns (745) (757)
------------- ------------
Total $ 37,936 $ 42,663
============== ============
6
4. Dividend
--------
During the third quarter of fiscal 2004, upon the recommendation of its
Dividend Committee, the Company's Board of Directors declared a non-cash
dividend payable to Holdings. Holdings 11 3/8% Senior Discount Notes due 2009
with a value at maturity of $21.8 million were distributed to Holdings in
anticipation of Holdings retiring the Notes.
5. 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 April 3, 2004 (in thousands) (unaudited): Parent Subsidiary Consolidating Consolidated
Obligor Guarantors Adjustments GFSI, Inc.
------- ---------- ----------- ----------
Assets:
Current assets:
Cash and cash equivalents $ 1,338 $ 50 $ -- $ 1,388
Accounts receivable, net 12,823 25,243 (15,552) 22,514
Inventories, net 36,213 1,723 -- 37,936
Prepaid expenses and other current assets 1,529 276 -- 1,805
Deferred income taxes 1,062 -- -- 1,062
---------- ---------- --------- ----------
Total current assets 52,965 27,292 (15,552) 64,705
Investment in equity of subsidiaries 24,766 -- (24,766) --
Property, plant and equipment, net 21,683 199 -- 21,882
Other assets 3,010 (624) -- 2,386
---------- ---------- ---------- ----------
Total assets $ 102,424 $ 26,867 $ (40,318) $ 88,973
========== ========== ========== ==========
Liabilities and stockholders' equity (deficiency):
Current liabilities:
Accounts payable $ 26,068 $ 806 $ (15,552) $ 11,322
Accrued interest expense 1,200 -- -- 1,200
Accrued expenses 4,546 1,408 -- 5,954
Income taxes payable 9,236 (113) -- 9,123
Current portion of long-term debt 307 -- -- 307
---------- ---------- ---------- ----------
Total current liabilities 41,357 2,101 (15,552) 27,906
Deferred income taxes 1,424 -- -- 1,424
Other long-term obligations 491 -- -- 491
Long-term debt, less current portion 151,904 -- -- 151,904
Stockholders' equity (deficiency) (92,752) 24,766 (24,766) (92,752)
---------- ---------- ---------- ----------
Total liabilities and stockholders' equity $ 102,424 $ 26,867 $ (40,318) $ 88,973
(deficiency) ========== ========== ========== ==========
7
Nine months ended April 3, 2004 (in thousands) (unaudited):
Parent Subsidiary Consolidating Consolidated
Obligor Guarantors Adjustments GFSI, Inc.
------- ---------- ----------- ---------
Net sales $ 83,813 $ 60,534 $ (3,632) $ 140,715
Cost of sales 53,436 35,359 (3,632) 85,163
Selling expenses 10,156 9,785 -- 19,941
General and administrative expenses 15,821 3,259 -- 19,080
------------ ------------ ------------ -------------
Total costs and expenses 79,413 48,403 (3,632) 124,184
------------ ------------ ------------ -------------
Operating income 4,400 12,131 -- 16,531
Equity in net earnings of subsidiaries 7,396 -- (7,396) --
Interest expense (11,364) (7) 3 (11,368)
Gain on sale of property, plant and equipment 915 -- (3) 912
------------ ------------ ------------ -------------
Income before income taxes 1,347 12,124 (7,396) 6,075
Income tax expense (benefit) (2,359) 4,728 -- 2,369
------------ ------------ ------------ -------------
Net income $ 3,706 $ 7,396 $ (7,396) $ 3,706
============ ============ ============ =============
Nine months ended April 3, 2004 (in thousands) (unaudited):
Parent Subsidiary Consolidating Consolidated
Obligor Guarantors Adjustments GFSI, Inc.
------- ---------- ----------- -----------
Net cash flows provided by operating activities $ 21,681 $ 314 $ -- $ 21,995
Net cash flows used in investing activities (2,389) (6) (360) (2,755)
Cash flows from financing activities:
Net repayments under revolving credit agreement (6,609) -- -- (6,609)
Purchase of parent company bonds (12,265) -- -- (12,265)
Payments on long-term debt (226) -- -- (226)
Repayment of intercompany debt -- (360) 360 --
Issuance of long-term debt 82 -- -- 82
Distributions to GFSI Holdings, Inc. (258) -- -- (258)
Other (1) -- -- (1)
------------ ----------- --------- ----------
Net cash used in financing activities (19,277) (360) 360 (19,277)
------------ ----------- --------- ----------
Effect of foreign exchange rate changes on cash -- 38 -- 38
------------ ----------- --------- ----------
Net increase (decrease) in cash and cash equivalents 15 (14) -- 1
Cash and cash equivalents at beginning of period 1,323 64 -- 1,387
------------ ----------- --------- ----------
Cash and cash equivalents at end of period $ 1,338 $ 50 $ -- $ 1,388
============ =========== ========= ==========
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 (deficiency):
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 $ 118,030 $ 19,057 $ (23,303) $ 113,784
(deficiency) ============ =========== =========== ==========
Nine months ended March 29, 2003 (in thousands) (unaudited):
Parent Subsidiary Consolidating Consolidated
Obligor Guarantors Adjustments GFSI, Inc.
------- ---------- ----------- ----------
Net sales $ 105,116 $ 55,413 $ (3,481) $ 157,048
Cost of sales 69,342 33,675 (3,481) 99,536
Selling expenses 12,681 7,741 -- 20,422
General and administrative expenses 16,655 3,395 -- 20,050
----------- ---------- ----------- ----------
Total costs and expenses 98,678 44,811 (3,481) 140,008
----------- ---------- ----------- ----------
Operating income 6,438 10,602 -- 17,040
Equity in net earnings of subsidiaries 6,451 -- (6,451) --
Interest expense (11,092) (26) __ (11,118)
Other, net 19 -- -- 19
----------- ---------- ----------- ----------
Income before income taxes 1,816 10,576 (6,451) 5,941
Income tax expense (benefit) (1,807) 4,125 -- 2,318
----------- ---------- ----------- ----------
Net income $ 3,623 $ 6,451 $ (6,451) $ 3,623
=========== ========== =========== ==========
9
Nine months ended March 29, 2003 (in thousands) (unaudited):
Parent Subsidiary Consolidating Consolidated
Obligor Guarantors Adjustments GFSI, Inc.
------- ---------- ----------- ----------
Net cash flows provided by (used in) operating $ 10,373 $ (939) $ -- $ 9,434
activities
Net cash flows provided by (used in) investing (3,914) (33) 1,033 (2,914)
activities
Cash flows from financing activities:
Net repayments under revolving credit agreement (5,738) -- -- (5,738)
Payments on long-term debt (130) -- -- (130)
Repayment of intercompany debt -- 1,033 (1,033) --
Other (50) -- -- (50)
Issuance of long-term debt 450 -- -- 450
Distributions to GFSI Holdings, Inc. (174) -- -- (174)
------------ ---------- ---------- ----------
Net cash flows provided by (used in) financing (5,642) 1,033 (1,033) (5,642)
activities ------------ ---------- ---------- ----------
Effect of foreign exchange rate changes on cash -- 66 -- 66
------------ ---------- ---------- ----------
Net increase in cash and cash equivalents 817 127 -- 944
Cash and cash equivalents at beginning of period 334 (21) -- 313
------------ ---------- ---------- ----------
Cash and cash equivalents at end of period $ 1,151 $ 106 $ -- $ 1,257
============ ========== ========== ==========
6. 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 previously owned Notes with an aggregate maturity value of
$84 million. The Company had owned 78% of the issued Notes and recorded its
investment in Notes as a reduction of stockholders' equity at the acquisition
cost of the Notes. During the third quarter of fiscal 2004 the Company's Board
of Directors declared a dividend payable to Holdings in Notes with a value at
maturity of $21.8 million. At a future date the Company intends to distribute to
Holdings the remaining 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 a full distribution of the remaining Notes. At April
3, 2004 Stockholders' equity (deficiency) included a reduction of $25.0 million
representing the acquisition cost of the remaining Notes.
10
In September 2003 Holdings entered into a management agreement (the
"2003 Management Agreement") with Gearcap under which Gearcap began providing
certain services to Holdings and its affiliates. Under the agreement, Larry D.
Graveel, Michael H. Gary and J. Craig Peterson (each one a director and officer
of the Company and Holdings and a beneficial stockholder of Holdings) ceased to
be employed by the Company and became employed by Gearcap. Gearcap incurs salary
expenses and life insurance costs on the executives and certain financing costs
related to the purchase of the Holdings Notes. The 2003 Management Agreement has
a 10 year term. Payments to Gearcap under the 2003 Management Agreement totaled
approximately $600,000 through April 3, 2003. The agreement provides for monthly
payment of fees and contains a provision for an annual adjustment in fees each
September 1 based upon planned services.
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.
11
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 April 3,
2004 and June 28, 2003 were net of allowances for doubtful accounts of $816,000
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.
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 third quarter of
fiscal 2004 and the third quarter of fiscal 2003 contain 13 weeks of operations
while the nine month fiscal period ended April 3, 2004 has one more week of
operations than the comparable period 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 APRIL 3, 2004 AND
MARCH 29, 2003
Net Sales. Net sales for the quarter ended April 3, 2004 decreased $4.0
million to $37.2 million compared to $41.2 million last year. The 10% decrease
in net sales was due to reduced sales of Gear for Sports(R) ("Gear") branded
products while sales of our Champion(R) licensed products experienced continued
growth. Sales of Gear branded products decreased 20% in comparison to last year.
The sales decrease was broad based across most of Gear's customer groups.
Management believes that the Company's customers have shifted their purchases to
lower priced apparel with less expensive decoration which has reduced sales of
higher priced Gear products. Net sales of Champion licensed products for the
third quarter of fiscal 2004 increased 10% over the comparable quarter of fiscal
2003. Champion licensed products are more moderately priced as compared to
Gear's products.
Gross Profit. Gross profit for the quarter ended April 3, 2004
increased 1% to $15.4 million compared to $15.2 million last year. Gross profit
as a percentage of net sales increased to 41% 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 April 3,
2004 increased 1% to $12.8 million from $12.6 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. Higher sales,
marketing and advertising costs in advance of peak Bookstore, Golf and Resort
selling seasons and the additional cost of the Sara Lee royalty created the
increase in operating expenses. Operating expenses as a percentage of net sales
were 34% in the third quarter of fiscal 2004 compared to 31% last year. The
additional expenses when divided by lower sales created the increase in
operating expenses as a percentage of net sales in comparison to last year.
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Operating Income. Operating income of $2.6 million in the third quarter
of fiscal 2004 was the same as last year. Operating income as a percentage of
net sales increased to 7% in the third quarter of fiscal 2004 from 6% in the
third quarter of fiscal 2003. The increase in operating income as a percentage
of sales resulted from higher gross profit on lower sales volume.
Interest Expense. Interest expense in the third quarter of fiscal 2004
was $3.7 million compared to $3.8 million last year. Lower borrowings under the
Company's bank credit facility in fiscal 2004 created the decrease in interest
expense.
Net Loss. Net loss for the third quarter of fiscal 2004 was $641,000
compared to a net loss of $730,000 for the third quarter of fiscal 2003. The
decrease in interest expense created the improvement in net loss over the
comparable period of last year.
COMPARISON OF OPERATING RESULTS FOR THE NINE MONTHS ENDED APRIL 3, 2004 AND
MARCH 29, 2003
Net Sales. Net sales for the nine months ended April 3, 2004 decreased
10% to $140.7 million compared to $157.0 million last year. The decrease in net
sales was due to reduced sales of Gear for Sports(R) ("Gear") branded products
while sales of Champion(R) licensed products increased 8%. Sales of Gear branded
products principally to the college bookstore and corporate customer groups
decreased 24% 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 nine months ended April 3, 2004
decreased 3% to $55.6 million compared to $57.5 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 nine 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 nine months ended April
3, 2004 decreased 4% to $39.0 million from $40.5 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 28% in fiscal 2004 compared to 26%
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 nine months ended April 3,
2004 decreased 3% to $16.5 million compared to $17.0 million last year.
Operating income as a percentage of net sales increased to 12% in fiscal 2004
from 11% in fiscal 2003. The decrease in operating income resulted from lower
sales. The increase in operating income as a percentage of sales resulted from
higher gross profit on lower sales volume.
Interest Expense. Interest expense in the first nine months of fiscal
2004 was $11.4 million compared to $11.1 million last year. The additional week
in the first nine months of fiscal 2004 compared to fiscal 2003 created the
increase in interest expense.
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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 combined distribution
operations into a larger, renovated facility and will eliminate several smaller
warehouses. The final phase of the warehouse consolidation project is expected
to be completed in the fourth quarter of fiscal 2004.
Net Income. Net income for the first nine months of fiscal 2004 was
$3.7 million compared to $3.6 million last year. The decrease in operating
income and higher interest expense were offset by the gain on the sale of the
distribution facility to produce 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 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 previously owned Notes with an aggregate maturity value of
$84 million. The Company had owned 78% of the issued Notes and recorded its
investment in Notes as a reduction of stockholders' equity at the acquisition
cost of the Notes. During the third quarter of fiscal 2004 the Company's Board
of Directors declared a dividend payable to Holdings in Notes with a value at
maturity of $21.8 million. At a future date the Company intends to distribute to
Holdings the remaining 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 a full distribution of the remaining Notes. At April
3, 2004 Stockholders' equity (deficiency) included a reduction of $25.0 million
representing the acquisition cost of the remaining 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 nine months of
fiscal 2004 was $22.0 million compared to $9.4 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 nine months of fiscal
2004 was $2.8 million compared to $2.9 million last year. The $2.8 million in
proceeds from the sale of the Lenexa distribution facility in fiscal 2004
partially offset the capital expended on the warehouse consolidation project
through April 3, 2004. The Company anticipates fiscal 2004 capital expenditures
to approximate $6.0 million.
Cash used in financing activities in the first nine months of fiscal
2004 was $19.3 million compared to $5.6 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 $16.4 million was
borrowed and outstanding and approximately $2.9 million was utilized for
outstanding commercial and stand-by letters of credit as of April 3, 2004. At
April 3, 2004, $23.1 million was available for future borrowings under the RBCA.
The Company was in compliance with its debt covenants at April 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 April 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
commenced 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
third 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
April 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
None.
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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.
May 7, 2004
/s/ J. Craig Peterson
- -------------------------------------------------
J. Craig Peterson
Senior Vice President and Chief Financial Officer
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