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 October 2, 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
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GFSI, INC.
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(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) 693-3200
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(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, 2004.
1
GFSI, INC. AND SUBSIDIARIES
Quarterly Report on Form 10-Q
For the Quarter Ended October 2, 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)
October 2, July 3,
2004 2004
----------- ----------
ASSETS
Current assets:
Cash and cash equivalents $ 1,291 $ 911
Accounts receivable, net 33,641 32,831
Inventories, net 46,331 45,616
Prepaid expenses and other current assets 1,483 1,667
Deferred income taxes 997 1,077
----------- ----------
Total current assets 83,743 82,102
Property, plant and equipment, net 23,379 22,990
Other assets:
Deferred financing costs, net 1,862 2,073
Other 124 122
----------- ----------
Total assets $ 109,108 $ 107,287
=========== ==========
LIABILITIES AND STOCKHOLDERS' EQUITY
(DEFICIENCY)
Current liabilities:
Accounts payable $ 8,648 $ 12,304
Accrued interest expense 1,179 4,424
Accrued expenses 7,439 7,245
Income taxes payable 11,839 10,478
Current portion of long-term debt 174 190
----------- ----------
Total current liabilities 29,279 34,641
Deferred income taxes 1,357 1,501
Other long-term obligations 452 452
Long-term debt, less current portion 165,963 160,629
Stockholders' equity (deficiency):
Common stock, $.01 par value, 10,000 shares
authorized, one share issued
and outstanding at October 2, 2004
and July 3, 2004 -- --
Additional paid-in capital 71,442 71,442
Parent company bonds acquired (24,995) (24,995)
Accumulated deficiency (134,390) (136,383)
----------- ----------
Total stockholders' deficiency (87,943) (89,936)
----------- ----------
Total liabilities and stockholders' equity
(deficiency) $ 109,108 $ 107,287
=========== ==========
See notes to consolidated financial statements.
3
GFSI, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
(UNAUDITED) (In thousands)
Quarter Ended
October 2, September 27,
2004 2003
---------- ------------
Net sales $ 53,439 $ 53,818
Cost of sales 32,759 32,752
---------- ----------
Gross profit 20,680 21,066
Operating expenses:
Selling 7,357 6,773
General and administrative 6,013 5,982
---------- ----------
13,370 12,755
---------- ----------
Operating income 7,310 8,311
Other income (expense):
Interest expense (3,840) (3,731)
Gain on sale of property, plant and equipment 21 939
---------- ----------
(3,819) (2,792)
---------- ----------
Income before income taxes 3,491 5,519
Income tax expense 1,358 2,152
---------- ----------
Net income $ 2,133 $ 3,367
========== ==========
See notes to consolidated financial statements.
4
GFSI, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED) (In thousand)
Quarter Ended
October 2, September 27,
2004 2003
---------- -------------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $ 2,133 $ 3,367
Adjustments to reconcile net income to net
cash provided by (used in) operating activities:
Depreciation 792 657
Amortization of deferred financing costs 214 253
Gain on sale or disposal of property, plant and equipment (20) (939)
Deferred income taxes (64) 66
Changes in operating assets and liabilities:
Accounts receivable, net (810) (1,028)
Inventories, net (715) 4,924
Prepaid expenses, other current assets and other assets 182 (153)
Income taxes payable 1,361 2,078
Accounts payable, accrued expenses and other
long-term obligations (6,707) 8,105
-------- --------
Net cash provided by (used in) operating activities (3,634) 17,330
-------- --------
CASH FLOWS FROM INVESTING ACTIVITIES:
Proceeds from sales of property, plant and equipment 25 2,797
Purchases of property, plant and equipment (1,186) (990)
-------- --------
Net cash provided by (used in) investing activities (1,161) 1,807
-------- --------
CASH FLOWS FROM FINANCING ACTIVITIES:
Net change in revolving credit agreement borrowing 5,360 (6,663)
Purchase of parent company bonds -- (12,230)
Distributions to GFSI Holdings, Inc. (191) (240)
Issuance of long-term debt -- 82
Payments on long-term debt (42) (72)
Other (3) (1)
-------- --------
Net cash provided by (used in) financing activities 5,124 (19,124)
-------- --------
Effect of foreign exchange rate changes on cash 51 (17)
-------- --------
Net increase (decrease) in cash and cash equivalents 380 (4)
Cash and cash equivalents at beginning of period 911 1,387
-------- --------
Cash and cash equivalents at end of period $ 1,291 $ 1,383
======== ========
Supplemental cash flow information:
Interest paid $ 6,762 $ 6,832
======== ========
Income taxes paid $ 64 $ 9
======== ========
Non-cash financing activities:
Bonds contributed from parent company $ -- $ 12,315
======== ========
See notes to consolidated financial statements.
5
GFSI, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
October 2, 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 July 3, 2004 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 July 3, 2004 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.
3. Inventories:
-----------
The following is a summary of inventories at October 2, 2004 and July 3,
2004:
(in thousands) October 2, July 3,
2004 2004
----------- -------
(unaudited)
Undecorated apparel ("blanks")
and supplies $ 44,678 $ 42,857
Work in process 184 314
Finished goods 1,864 3,340
-------- --------
46,726 46,511
Allowance for markdowns (395) (895)
-------- --------
Total $ 46,331 $ 45,616
======== ========
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 October 2, 2004 (in thousands) (unaudited):
Parent Subsidiary Consolidating Consolidated
Obligor Guarantors Adjustments GFSI, Inc.
--------- ---------- ------------- ------------
Assets:
Current assets:
Cash and cash equivalents $ 1,203 $ 88 $ -- $ 1,291
Accounts receivable, net 18,660 31,686 (16,705) 33,641
Inventories, net 44,338 1,993 -- 46,331
Prepaid expenses and other current assets 1,274 209 -- 1,483
Deferred income taxes 997 -- -- 997
-------- -------- -------- ---------
Total current assets 66,472 33,976 (16,705) 83,743
Investment in equity of subsidiaries 30,996 -- (30,996) --
Property, plant and equipment, net 23,188 191 -- 23,379
Other assets 2,634 (648) -- 1,986
-------- -------- -------- ---------
Total assets $123,290 $ 33,519 $(47,701) $ 109,108
======== ======== ======== =========
Liabilities and stockholders' equity:
Current liabilities:
Accounts payable $ 25,140 $ 213 $(16,705) $ 8,648
Accrued interest expense 1,179 -- -- 1,179
Accrued expenses 4,984 2,455 -- 7,439
Income taxes payable 11,984 (145) -- 11,839
Current portion of long-term debt 174 -- -- 174
-------- -------- -------- ---------
Total current liabilities 43,461 2,523 (16,705) 29,279
Deferred income taxes 1,357 -- -- 1,357
Other long-term obligations 452 -- -- 452
Long-term debt, less current portion 165,963 -- -- 165,963
Stockholders' equity (deficiency) (87,943) 30,996 (30,996) (87,943)
-------- -------- -------- ---------
Total liabilities and stockholders' equity $123,290 $ 33,519 $(47,701) $ 109,108
(deficiency) ======== ======== ======== =========
7
Quarter ended October 2, 2004 (in thousands) (unaudited):
Parent Subsidiary Consolidating Consolidated
Obligor Guarantors Adjustments GFSI, Inc.
--------- ---------- ------------- ------------
Net sales $ 30,573 $ 22,990 $ (124) $ 53,439
Cost of sales 19,465 13,418 (124) 32,759
Selling expenses 3,788 3,569 -- 7,357
General and administrative expense 5,177 836 -- 6,013
--------- ---------- --------- ---------
Total costs and expenses 28,430 17,823 (124) 46,129
--------- ---------- --------- ---------
Operating income 2,143 5,167 -- 7,310
Equity in net earnings of subsidiaries 3,154 -- (3,154) --
Interest expense (3,838) (2) -- (3,840)
Gain (loss) on sale of property, plant and equipment 22 (1) -- 21
--------- ---------- --------- ---------
Income before income taxes 1,481 5,164 (3,154) 3,491
Income tax expense (benefit) (652) 2,010 1,358
--------- ---------- --------- ---------
--
Net income $ 2,133 $ 3,154 $ (3,154) $ 2,133
========= ========== ========== =========
Quarter ended October 2, 2004 (in thousands) (unaudited):
Parent Subsidiary Consolidating Consolidated
Obligor Guarantors Adjustments GFSI, Inc.
---------- ---------- ------------- ------------
Net cash flows provided by (used in) operating
activities $ (3,640) $ 6 $ -- $ (3,634)
Net cash flows provided by (used in) investing
activities (1,151) (10) -- (1,161)
Cash flows from financing activities:
Net borrowings under revolving credit agreements 5,360 -- -- 5,360
Payments on long-term debt (42) -- -- (42)
Distributions to GFSI Holdings, Inc. (191) -- -- (191)
Other (3) -- -- (3)
--------- ---------- --------- ----------
Net cash provided by financing activities 5,124 -- -- 5,124
--------- ---------- --------- ----------
Effect of foreign exchange rate changes on cash -- 51 -- 51
--------- ---------- --------- ----------
Net increase in cash and cash equivalents 333 47 -- 380
Cash and cash equivalents at beginning of period 870 41 -- 911
--------- ---------- --------- ----------
Cash and cash equivalents at end of period $ 1,203 $ 88 $ -- $ 1,291
========= ========== ========= ==========
8
As of July 3, 2004 (in thousands): Parent Subsidiary Consolidating Consolidated
Obligor Guarantors Adjustments GFSI, Inc.
---------- ---------- ------------- ------------
Current assets:
Cash and cash equivalents $ 870 $ 41 $ -- $ 911
Accounts receivable, net 18,978 27,338 (13,485) 32,831
Inventories, net 42,724 2,892 -- 45,616
Prepaid expenses and other current assets 1,453 214 -- 1,667
Deferred income taxes 1,077 -- -- 1,077
--------- --------- --------- ----------
Total current assets 65,102 30,485 (13,485) 82,102
Investment in equity of subsidiaries 27,791 -- (27,791) --
Property, plant and equipment, net 22,799 191 -- 22,990
Other assets 2,842 (647) 2,195
--------- --------- --------- ----------
Total assets $ 118,534 $ 30,029 $ (41,276) $ 107,287
========= ========= ========= ==========
Liabilities and stockholders' equity:
Current liabilities:
Accounts payable $ 25,261 $ 528 $ (13,485) $ 12,304
Accrued interest expense 4,424 -- -- 4,424
Accrued expenses 5,414 1,831 -- 7,245
Income taxes payable (receivable) 10,599 (121) -- 10,478
Current portion of long-term debt 190 -- -- 190
--------- --------- --------- ----------
Total current liabilities 45,888 2,238 (13,485) 34,641
Deferred income taxes 1,501 -- -- 1,501
Other long-term obligations 452 -- -- 452
Long-term debt, less current portion 160,629 -- -- 160,629
Stockholders' equity (deficiency) (89,936) 27,791 (27,791) (89,936)
--------- --------- --------- ----------
Total liabilities and stockholders' equity $ 118,534 $ 30,029 $ (41,276) $ 107,287
(deficiency) ========= ========= ========== ==========
Quarter ended September 27, 2003 (in thousands) (audited):
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
========= ========== ========== ==========
9
Quarter ended September 27, 2003 (in thousands) (audited):
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
========= ========= ========= ========
5. Financing and Recapitalization
------------------------------
On October 4, 2004, the Company amended its existing $65 million
Revolving Bank Credit Agreement ("RBCA"). Under the terms of amendment, the
term of the credit agreement was extended by one year to January 15, 2007.
In September 2003, Company management formed a Delaware limited liability
company named Gearcap LLC ("Gearcap") to affect the Recapitalization of
Holdings. Gearcap purchased 11.375% Senior Discount Notes of Holdings
("11.375% Notes") with an aggregate principal amount at maturity of
approximately $30.5 million (the "Contributed 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 Notes. The Company and Holdings
entered into a Contribution Agreement under which Holdings contributed the
Contributed Notes it received from Gearcap to the Company as a capital
contribution. The Company subsequently pledged the 11.375% Notes as collateral
under the RBCA.
In September 2003, the Company purchased 11.375% Notes with an aggregate
principal amount at maturity of approximately $29.5 million for approximately
$12.2 million. The Company subsequently pledged the Notes as collateral under
the RBCA.
When combined with 11.375% Notes previously acquired, the Company had
acquired 11.375% Notes of Holdings with an aggregate maturity value of $84
million representing 78% of the issued 11.375% Notes of Holdings. The Company
has elected to record its investment in the 11.375% Notes as a reduction of
stockholders' equity at the acquisition cost of the 11.375% Notes. In fiscal
2004 the Company distributed a dividend to Holdings in the form of 11.375%
Notes with a cost of $9.5 million and a value at maturity of $21.8 million. At
a future date the Company intends to distribute to Holdings its remaining
11.375% Notes it holds 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 11.375% Notes it
holds. At October 2, 2004 stockholders' equity (deficiency) included a
reduction of $25.0 million representing the remaining acquisition cost of the
11.375% Notes held by the Company.
10
The Company's and Gearcap's purchases of the 11.375% Notes has reduced
the Company's future cash dividend obligations to Holdings to enable it to
retire the 11.375% Notes in 2009 from $108 million to $24 million.
Additionally, the purchases of the 11.375% Notes has reduced the Company's
future cash dividend obligations to Holdings to enable it to pay interest on
the 11.375% Notes (commencing in March 2005) from $12.3 million to $2.7
million annually.
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 July 3, 2004. 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.
11
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 generally 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 October 2, 2004 and July 3,
2004 were net of allowance for doubtful accounts of $577,000 and $637,000,
respectively.
Reserves for self-insurance. The Company seeks to employ cost effective
risk management programs. At times the Company has elected to retain a portion
of insurance risk related to workers' compensation claims which are covered
under insurance programs with high deductible limits. The Company also
actively pursues programs intended to effectively manage the incidence of
workplace injuries. Reserves for reported but unpaid losses, as well as
incurred but not reported losses, related to the retained risks are calculated
based upon loss development factors, as well as other assumptions considered
by management, including assumptions provided by other external professionals
such as insurance brokers, consultants and carriers. The factors and
assumptions used are subject to change based upon historical experience, as
well as changes in expected cost trends and other factors.
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 OCTOBER 2, 2004 AND
SEPEMBER 27, 2003
Net Sales. Net sales for the quarter ended October 2, 2004 were $53.4
million compared to $53.8 million last year, a 1% decline. Certain customer
groups produced sales gains off-set by sales declines in other areas. Sales of
Champion(R) licensed products continued to experience growth of 6%. This sales
increase was offset by sales decreases in Gear branded products. Sales of Gear
branded products to Resort and Golf customers increased 13% over last year.
This growth was offset by declines of 31% in sales to Corporate and Military
customer groups. The Company expects sales in the Resort and Golf markets to
soften for the remainder of fiscal 2005 due to the consequences of the recent
disastrous weather in Florida, a prime winter and spring golf and resort
destination.
Gross Profit. Gross profit for the quarter ended October 2, 2004
decreased 2% to $20.7 million compared to $21.1 million last year. Gross
profit as a percentage of net sales at 39% was approximately the same for both
periods. The decrease in gross profit resulted from an increased volume of
off-price sales. The Company is currently working to reduce its higher than
desired level of inventory. The Company anticipates it will continue to move
through its inventory overstocks during the second and third quarters of
fiscal 2005 which may reduce gross profit as compared to last year.
Operating Expenses. Operating expenses for the quarter ended October 2,
2004 increased 5% to $13.4 million from $12.8 million last year. Operating
expenses as a percentage of net sales were 25% in the first quarter of fiscal
12
2005 compared to 24% last year. Operating expenses increased due to higher
selling expenses. During the first quarter of fiscal 2005 the Company sold
more licensed apparel at higher royalty rates than in the first quarter of
fiscal 2004. The royalty obligation on Champion(R) branded apparel in fiscal
2004 was 3% of net sales compared to 4% for fiscal 2005. The increased royalty
expense related to the Champion(R) license and other licensed apparel sales
created the increase in operating expenses as a percentage of net sales in
comparison to last year.
Operating Income. Operating income decreased 12% to $7.3 million in the
first quarter of fiscal 2005 compared to $8.3 million last year. Operating
income as a percentage of net sales decreased to 14% in the first quarter of
fiscal 2005 from 15% in the first quarter of fiscal 2004. Lower sales along
with increased operating expenses created the decrease in operating income.
Interest Expense. Interest expense in the first quarter of fiscal 2005
was $3.8 million compared to $3.7 million last year. Higher borrowings and
higher interest rates created the increase in interest expense. 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 during the first quarter of last year.
The facility was sold as part of a warehouse consolidation and automation
initiative completed in fiscal 2004 which combined distribution operations
into a larger, renovated facility and eliminated several smaller warehouses.
Net Income. Net income for the first quarter of fiscal 2005 was $2.1
million compared to $3.4 million for the first quarter of fiscal 2004, a
decrease of $1.3 million or 37%. The current year's decrease in operating
income combined with last year's gain on the sale of the distribution facility
to produce the comparative decrease in net income.
NEW LICENSE AGREEMENTS
During the first quarter of fiscal 2005 the Company entered into license
agreements for two new apparel brands. The two new brands will be targeted at
the high-end casual and technical outerwear golf markets. Sales for these
brands are not expected to be significant in fiscal 2005. The Company expects
to incur product launch and preproduction expenses related to these brands of
approximately $750,000 in the remainder of fiscal 2005.
FINANCING AND RECAPITALIZTION
In September 2003, Company management formed a Delaware limited liability
company named Gearcap LLC ("Gearcap") to affect the Recapitalization of
Holdings. Gearcap purchased 11.375% Senior Discount Notes of Holdings
("11.375% Notes") with an aggregate principal amount at maturity of
approximately $30.5 million (the "Contributed 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 Notes. The Company and Holdings
entered into a Contribution Agreement under which Holdings contributed the
Contributed Notes it received from Gearcap to the Company as a capital
contribution. The Company subsequently pledged the 11.375% Notes as collateral
under the RBCA.
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On September 26, 2003, the Company purchased 11.375% Notes with an
aggregate principal amount at maturity of approximately $29.5 million for
approximately $12.2 million. The Company subsequently pledged the Notes as
collateral under the RBCA.
When combined with the 11.375% Notes previously acquired, the Company had
acquired 78% of the issued 11.375% Notes of Holdings. The Company has elected
to record its investment in the 11.375% Notes as a reduction of stockholders'
equity at the acquisition cost of the 11.375% Notes. In fiscal 2004 the
Company distributed a dividend to Holdings in the form of 11.375% Notes with a
cost of $9.5 million and a value at maturity of $21.8 million. At a future
date the Company intends to distribute to Holdings its remaining 11.375% Notes
it holds 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 11.375% Notes it holds. At
October 2, 2004 stockholders' equity (deficiency) included a reduction of
$25.0 million representing the remaining acquisition cost of the 11.375% Notes
held by the Company.
LIQUIDITY AND CAPITAL RESOURCES
Cash used in operating activities in the first quarter of fiscal 2005 was
$3.6 million compared to cash provided by operating activities of $17.3
million last year. Higher inventory levels, lower accounts payable and lower
net income produced the decrease in the first quarter's fiscal 2005 operating
cash flows. Accounts payable at September 27, 2003 included $11.6 million in
unpaid funds to settle the Recapitalization transaction.
Cash used in investing activities in the first quarter of fiscal 2005 was
$1.2 million compared to cash provided by investing activities of $1.8 million
last year. In the first quarter of fiscal 2004, $2.8 million in proceeds were
received from the sale of the Company's Lenexa distribution facility. The
Company anticipates fiscal 2005 capital expenditures to approximate $3
million.
Cash provided by financing activities in the first quarter of fiscal 2005
was $5.1 million compared to cash used in financing activities of $19.1
million in the comparable period of fiscal 2004. In the first quarter of
fiscal 2005 borrowings under the Company's RBCA were used to finance higher
levels of inventory. The purchase of Holdings 11.375% Notes and the repayment
of bank debt was the primary use of cash in fiscal 2004.
On October 4, 2004 the Company amended its $65 million Revolving Bank
Credit Agreement ("RBCA") to extend the term of the credit agreement to
January 15, 2007. Under the Company's RBCA up to $65 million of revolving
credit availability is provided, of which $30.5 million was borrowed and
outstanding and approximately $4.5 million was utilized for outstanding
commercial and stand-by letters of credit as of October 2, 2004. At October 2,
2004, $22.0 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 2007,
although no assurance can be given in this regard.
The Company anticipates paying dividends to Holdings to enable Holdings
to pay corporate income taxes, pursuant to a Tax Sharing Agreement, interest
on the 11.375% Notes, fees payable under management agreements, fees payable
under a non-competition agreement, and certain other ordinary course expenses.
Holdings is dependent upon the cash flows of the Company to provide funds to
service the 11.375% Notes. At October 2, 2004, Holdings' debt to third parties
totaled approximately $24.5 million. The 11.375% Notes annual cash flow
requirements commence in March 2005 with semi-annual cash installments of
approximately $1.4 million on March 15 and September 15 of each year.
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Additionally, Holdings' cumulative non-cash preferred stock ("Holdings
Preferred Stock") dividends total approximately $1.5 million annually.
Dividends on the Holdings Preferred Stock have been accumulating and not paid
in cash. Mandatory redemption of the Holdings Preferred Stock is required in
fiscal 2009 and fiscal 2017.
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.
15
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 October 2, 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
Exhibit
Number Description
------- -----------
31.1 Certification of Principal Executive Officer.
31.2 Certification of Principal Financial Officer.
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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.
November 11, 2004
/s/ J. Craig Peterson
----------------------------------------------------
J. Craig Peterson, Sr. Vice President of Finance and
Principal Accounting Officer
18