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 1, 2005.
---------------
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) 693-3200
----------------------------------------------------
(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, 2005.
1
GFSI, INC. AND SUBSIDIARIES
Quarterly Report on Form 10-Q
For the Quarter Ended January 1, 2005
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 17
ITEM 4 - CONTROLS AND PROCEDURES 17
PART II - OTHER INFORMATION 18
SIGNATURE PAGE 19
2
GFSI, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(In thousands, except share data)
January 1, July 3,
2005 2004
----------- ----------
ASSETS (unaudited)
Current assets:
Cash and cash equivalents $ 745 $ 911
Accounts receivable, net 25,873 32,831
Inventories, net 41,063 45,616
Prepaid expenses and other current assets 1,793 1,667
Deferred income taxes 1,099 1,077
----------- ----------
Total current assets 70,573 82,102
Property, plant and equipment, net 23,504 22,990
Other assets:
Deferred financing costs, net 1,675 2,073
Other 170 122
----------- ----------
Total assets $ 95,922 $ 107,287
=========== ==========
LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIENCY)
Current liabilities:
Accounts payable $ 4,152 $ 12,304
Accrued interest expense 4,542 4,424
Accrued expenses 7,847 7,245
Income taxes payable 11,180 10,478
Current portion of long-term debt 155 190
----------- ----------
Total current liabilities 27,876 34,641
Deferred income taxes 1,432 1,501
Other long-term obligations 452 452
Long-term debt, less current portion 154,430 160,629
Stockholders' equity (deficiency):
Common stock, $.01 par value, 10,000 shares authorized, one share
issued and outstanding at January 1, 2005 and July 3, 2004 -- --
Additional paid-in capital 71,442 71,442
Parent company bonds acquired (24,995) (24,995)
Accumulated deficiency (134,715) (136,383)
----------- ----------
Total stockholders' deficiency (88,268) (89,936)
----------- ----------
Total liabilities and stockholders' equity (deficiency) $ 95,922 $ 107,287
=========== ==========
See notes to consolidated financial statements.
3
GFSI, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
(UNAUDITED) (In thousands)
Quarter Ended Six Months Ended
January 1, January 3, January 1, January 3,
2005 2004 2005 2004
---------- ---------- ---------- ----------
Net sales $ 44,161 $ 49,701 $ 97,600 $103,519
Cost of sales 27,969 30,635 60,728 63,387
-------- -------- -------- --------
Gross profit 16,192 19,066 36,872 40,132
Operating expenses:
Selling 6,797 6,721 14,154 13,494
General and administrative 6,117 6,762 12,130 12,744
-------- -------- -------- --------
12,914 13,483 26,284 26,238
-------- -------- -------- --------
Operating income 3,278 5,583 10,588 13,894
Other income (expense):
Interest expense (3,868) (3,975) (7,708) (7,706)
Gain (loss) on sale of
Property, plant and equipment (18) -- 3 939
-------- -------- -------- --------
(3,886) (3,975) (7,705) (6,767)
-------- -------- -------- --------
Income (loss) before income taxes (608) 1,608 2,883 7,127
Income tax expense (benefit) (233) 628 (1,125) 2,780
-------- -------- -------- --------
Net income (loss) $ (375) $ 980 $ 1,758 $ 4,347
======== ======== ======== ========
See notes to consolidated financial statements.
4
GFSI, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED) (In thousands)
Six Months Ended
January 1, January 3,
2005 2004
---------- ------------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $ 1,758 $ 4,347
Adjustments to reconcile net income to net cash provided by
operating activities:
Depreciation 1,582 1,304
Amortization of deferred financing costs 406 465
Gain on sale or disposal of property, plant and equipment -- (939)
Deferred income taxes (91) 511
Changes in operating assets and liabilities:
Accounts receivable, net 6,958 6,446
Inventories, net 4,553 9,342
Prepaid expenses, other current assets and other assets (174) (533)
Income taxes payable 702 1,825
Accounts payable, accrued expenses and other
long-term obligations (7,432) (158)
-------- --------
Net cash provided by operating activities 8,262 22,610
-------- --------
CASH FLOWS FROM INVESTING ACTIVITIES:
Proceeds from sales of property, plant and equipment 69 2,797
Purchases of property, plant and equipment (2,165) (3,219)
-------- --------
Net cash used in investing activities (2,096) (422)
-------- --------
CASH FLOWS FROM FINANCING ACTIVITIES:
Net change in revolving credit agreement borrowing (6,150) (10,722)
Purchase of parent company bonds -- (12,265)
Distributions to GFSI Holdings, Inc. (191) (258)
Issuance of long-term debt -- 82
Payments on long-term debt (84) (148)
Other (8) (1)
-------- --------
Net cash used in financing activities (6,433) (23,312)
-------- --------
Effect of foreign exchange rate changes on cash 101 33
-------- --------
Net decrease in cash and cash equivalents (166) (1,091)
Cash and cash equivalents at beginning of period 911 1,387
-------- --------
Cash and cash equivalents at end of period $ 745 $ 296
======== ========
Supplemental cash flow information:
Interest paid $ 7,184 $ 7,153
======== ========
Income taxes paid $ 366 $ 445
======== ========
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 1, 2005
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.
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 ended July 3,
2004 was a 53 week period. The additional week fell 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 2005.
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 1, 2005 and July 3,
2004:
(in thousands) January 1, July 3,
2005 2004
---------- ----------
(unaudited)
Undecorated apparel ("blanks") and supplies $ 39,911 $ 42,857
Work in process 234 314
Finished goods 1,313 3,340
--------- ---------
41,458 46,511
Allowance for markdowns (395) (895)
--------- ---------
Total $ 41,063 $ 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 January 1, 2005 (in thousands) (unaudited):
Parent Subsidiary Consolidating Consolidated
Obligor Guarantors Adjustments GFSI, Inc.
--------- ---------- ------------- ------------
Assets:
Current assets:
Cash and cash equivalents $ 525 $ 220 $ -- $ 745
Accounts receivable, net 14,726 34,576 (23,429) 25,873
Inventories, net 39,479 1,584 -- 41,063
Prepaid expenses and other current assets 1,582 211 -- 1,793
Deferred income taxes 1,099 -- -- 1,099
-------- -------- -------- ---------
Total current assets 57,411 36,591 (23,429) 70,573
Investment in equity of subsidiaries 33,346 -- (33,346) --
Property, plant and equipment, net 23,323 181 -- 23,504
Other assets 2,494 (649) -- 1,845
-------- -------- -------- ---------
Total assets $116,574 $ 36,123 $(56,775) $ 95,922
======== ======== ======== =========
Liabilities and stockholders' equity:
Current liabilities:
Accounts payable $ 26,893 $ 688 $(23,429) $ 4,152
Accrued interest expense 4,542 -- -- 4,542
Accrued expenses 5,604 2,243 -- 7,847
Income taxes payable (receivable) 11,334 (154) -- 11,180
Current portion of long-term debt 155 -- -- 155
-------- -------- -------- ---------
Total current liabilities 48,528 2,777 (23,429) 27,876
Deferred income taxes 1,432 -- -- 1,432
Other long-term obligations 452 -- -- 452
Long-term debt, less current portion 154,430 -- -- 154,430
Stockholders' equity (deficiency) (88,268) 33,346 (33,346) (88,268)
-------- -------- -------- ---------
Total liabilities and stockholders' equity (deficiency) $116,574 $ 36,123 $(56,775) $ 95,922
======== ======== ======== =========
7
Six months ended January 1, 2005 (in thousands) (unaudited):
Parent Subsidiary Consolidating Consolidated
Obligor Guarantors Adjustments GFSI, Inc.
--------- ---------- ------------- ------------
Net sales $ 55,578 $ 43,594 $ (1,572) $ 97,600
Cost of sales 36,543 25,757 (1,572) 60,728
Selling expenses 7,223 6,931 -- 14,154
General and administrative expense 10,167 1,963 -- 12,130
--------- ---------- --------- ---------
Total costs and expenses 53,933 34,651 (1,572) 87,012
--------- ---------- --------- ---------
Operating income 1,645 8,943 -- 10,588
Equity in net earnings of subsidiaries 5,454 -- (5,454) --
Interest expense (7,707) (1) -- (7,708)
Gain on sale of property, plant and equipment 3 -- -- 3
--------- ---------- --------- ---------
Income (loss) before income taxes (605) 8,942 (5,454) 2,883
Income tax expense (benefit) (2,363) 3,488 1,125
--------- ---------- --------- ---------
Net income $ 1,758 $ 5,454 $ (5,454) $ 1,758
========= ========== ========= =========
Six months ended January 1, 2005 (in thousands) (unaudited):
Parent Subsidiary Consolidating Consolidated
Obligor Guarantors Adjustments GFSI, Inc.
---------- ---------- ------------- ------------
Net cash flows provided by operating activities $ 8,173 $ 89 $ -- $ 8,262
Net cash flows used in investing activities (2,085) (11) -- (2,096)
Cash flows from financing activities:
Net change in revolving credit agreements (6,150) -- -- (6,150)
Payments on long-term debt (84) -- -- (84)
Distributions to GFSI Holdings, Inc. (191) -- -- (191)
Other (8) -- -- (8)
--------- ---------- --------- ----------
Net cash provided by financing activities (6,433) -- -- (6,433)
--------- ---------- --------- ----------
Effect of foreign exchange rate changes on cash -- 101 -- 101
--------- ---------- --------- ----------
Net increase (decrease) in cash and cash equivalents (345) 179 -- (166)
Cash and cash equivalents at beginning of period 870 41 -- 911
--------- ---------- --------- ----------
Cash and cash equivalents at end of period $ 525 $ 220 $ -- $ 745
========= ========== ========= ==========
8
As of July 3, 2004 (in thousands):
Parent Subsidiary Consolidating Consolidated
Obligor Guarantors Adjustments GFSI, Inc.
---------- ---------- ------------- ------------
Assets:
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 (deficiency) $ 118,534 $ 30,029 $ (41,276) $ 107,287
========= ========= ========= ==========
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 expense 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 (659) 3,439 -- 2,780
-------- --------- --------- ----------
Net income $ 4,347 $ 5,380 $ (5,380) $ 4,347
======== ========= ========= ==========
9
Six months ended January 3, 2004 (in thousands) (audited):
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 change in revolving credit agreements (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 end of period $ 157 $ 139 $ -- $ 296
========= ========= ========= ========
5. Financing and Recapitalization
------------------------------
On October 4, 2004 the Company amended its existing revolving bank credit
agreement ("RBCA"). Under the terms of amendment, the term of the RBCA 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 pledged the Notes as collateral under the RBCA.
In September 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 pledged the 11.375% Notes as collateral under the RBCA.
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 January 1, 2005 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.
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
11
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 1, 2005 and July 3, 2004
were net of allowance for doubtful accounts of $619,000 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.
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
ended July 3, 2004 was a 53 week period. The additional week fell 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 2005. 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 1, 2005 AND
JANUARY 3, 2004
System Conversion. During the last ten days of December 2004 the Company
changed out its information and technology systems. The conversion involved an
upgrade to its enterprise application software as well as to its central
processing hardware installed in 1998. To affect the conversion the Company
idled its decoration and warehousing facilities, its international purchasing
offices, its headquarters, its customer service capabilities and its automated
nationwide order acquisition and processing functions. The conversion effort
successfully concluded on January 2, 2005 and the Company returned to its
normal operations.
Net Sales. Net sales for the quarter ended January 1, 2005 decreased $5.5
million to $44.2 million compared to $49.7 million last year. The 11% overall
decrease in net sales was broad-based across most of the Company's customer
groups. The sales decline was more pronounced in Gear branded products. The
Company believes its sales for December 2004 were adversely affected by the
anticipation of its independent sales representatives of sales order
fulfillment delays as a consequence of the Company's announced ten day idle
time period to perform the information and technology systems' conversion. The
amount of the sales reduction attributable to this idle time event is not
reliably determinable. The Company's Golf and Resort Divisions sales were less
than last year's for the quarter due to the September 2004 hurricane damage in
the Southeastern United States and Caribbean Basin. The Company expects these
12
two Divisions to be negatively affected in these primary golf and resort
destination areas for the remainder of fiscal 2005. Sales to military
customers declined significantly in the wake of greater overseas deployment of
military personnel and reduced war effort enthusiasm. Reductions in corporate
spending on marketing and employee incentive programs continued to have a
negative effect on net sales of the Corporate Division which also decreased
from last year.
Gross Profit. Gross profit for the quarter ended January 1, 2005
decreased 15% to $16.2 million compared to $19.1 million last year. Gross
profit as a percentage of net sales decreased to 37% for the quarter compared
to 38% last year. The decrease in gross profit resulted from lower sales and
the cost of idle time at the decoration and warehousing facilities to perform
the information and technology systems' conversion in December 2004.
Operating Expenses. Operating expenses for the quarter ended January 1,
2005 decreased 4% to $12.9 million from $13.5 million last year. Operating
expenses as a percentage of net sales were 29% in the second quarter of fiscal
2005 compared to 27% last year. The percentage increase in operating expenses
was due to lower sales and higher royalty fees. The royalty obligation on
Champion(R) branded apparel in fiscal 2004 was 3% of net sales compared to 4%
for fiscal 2005. The Company also incurred marketing and preproduction costs
related to the launch of two new golf and resort brands scheduled to commence
sales in the fourth quarter of fiscal 2005 and the first quarter of fiscal
2006.
Operating Income. Operating income decreased 41% to $3.3 million in the
second quarter of fiscal 2005 compared to $5.6 million last year. Operating
income as a percentage of net sales decreased to 7% in the second quarter of
fiscal 2005 from 11% in the second quarter of fiscal 2004. The decrease in
operating income resulted from lower sales, the decrease in gross profit and
the additional selling expense related to royalty fees and new product
launches.
Interest Expense. Interest expense in the second quarter of fiscal 2005
was $3.9 million compared to $4.0 million last year. The savings derived from
having one less week in the second quarter of fiscal 2005 was partially offset
by the effect of higher bank borrowings at higher interest rates in fiscal
2005.
Net Income (loss). Net loss for the second quarter of fiscal 2005 was
($375,000) compared to net income of $980,000 for the second quarter of fiscal
2004, a decrease of $1.4 million. The decrease in operating income resulted in
the decrease in net income.
COMPARISON OF OPERATING RESULTS FOR THE SIX MONTHS ENDED JANUARY 1, 2005 AND
JANUARY 3, 2004
Net Sales. Net sales for the six months ended January 1, 2005 decreased
6% to $97.6 million compared to $103.5 million last year. The decrease in net
sales was due to reduced sales of Gear branded products while sales of
Champion licensed products increased 1%. The Company believes year-to-date
sales were adversely affected by its announced idle time to convert its
information and technology systems in the second quarter. Sales of Gear
branded products principally to the college bookstore and corporate customer
groups decreased 10% 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 and enhanced sales of its more moderately priced
Champion products. Sales to customers in the Company's Resort and Golf groups
were hurt by the economic aftermath of the hurricane damage that took place in
the Southeastern United States and the Caribbean. Sales to military customers
were down due to increased overseas troop deployment and reduced war effort
enthusiasm. Reductions in corporate spending on marketing and employee
incentive programs have had a continuing negative effect on net sales of the
Corporate Division.
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Gross Profit. Gross profit for the six months ended January 1, 2005
decreased 8% to $36.9 million compared to $40.1 million last year. Gross
profit as a percentage of net sales decreased to 38% for the six month period
compared to 39% last year. Gross profit as a percentage of sales decreased due
to the costs of idle time at the decoration and warehousing facilities from
the conversion of information technology systems in the second quarter of
fiscal 2005. The gross profit percentage also declined due to excess costs
related to handling and storage of inventory overstocks. The Company has been
working to reduce its higher than desired inventory level with price
reductions. The Company anticipates it will continue to move through its
inventory overstocks during the remainder of fiscal 2005.
Operating Expenses. Operating expenses for the six months ended January 1,
2005 were $26.3 million compared to $26.2 million as last year. Increased
selling expense created the increase in operating expenses. During the first
six months of fiscal 2005 the Company sold more licensed apparel at higher
royalty rates than in the comparable period 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 Company also incurred marketing and
preproduction costs related to the launch of two new golf and resort brands.
Operating expenses as a percentage of net sales were 27% in fiscal 2005
compared to 25% last year. Lower sales, additional royalty expense and product
launch costs 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 1,
2005 decreased 24% to $10.6 million compared to $13.9 million last year.
Operating income as a percentage of net sales decreased to 11% in fiscal 2005
from 13% in fiscal 2004. The decrease in operating income resulted from lower
sales, the decrease in gross profit and higher selling costs.
Interest Expense. Interest expense in the first six months of fiscal 2005
was $7.7 million, the same as last year. The savings derived from having one
less week in the first six months of fiscal 2005 compared to the first six
months of fiscal 2004 was offset by the effect of higher bank borrowings at
higher interest rates in fiscal 2005.
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 eliminating several
smaller warehouses.
Net Income. Net income for the first six months of fiscal 2005 was $1.8
million compared to $4.3 million last year. The decrease in operating income
and last year's gain on the sale of the distribution facility resulted in the
$2.6 million decrease in net income in comparison to last year.
NEW LICENSE AGREEMENTS
During the first six months of fiscal 2005 the Company entered into
license agreements for two new apparel brands. Product produced under the
Robert Trent Jones License and brand will be targeted at the high-end casual
sportswear resort and golf markets. Technical outerwear products produced
under the Sunice License and brand will be targeted at the high-end golf
market. Sales for these brands are not expected to be significant in fiscal
2005. The Company incurred $350,000 in product launch and preproduction
expenses during the six months ended January 1, 2005. The Company expects to
incur product launch and preproduction expenses related to these brands of
approximately $500,000 during the remainder of fiscal 2005.
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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.
On 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 11.375% Notes as
collateral under the RBCA.
The Company had acquired 78% of the issued 11.375% Notes of Holdings.
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 January 1, 2005 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 provided by operating activities in the first six months of fiscal
2005 was $8.3 million compared to $22.6 million last year. Higher inventory
levels, lower accounts payable and lower net income produced the decrease in
fiscal 2005 operating cash flows compared to last year.
Cash used in investing activities in the first six months of fiscal
2005 was $2.1 million compared to $422,000 last year. In the first six months 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 used in financing activities in the first six months of fiscal
2005 was $6.4 million compared to $23.3 million in the comparable period of
fiscal 2004. In the first six months of fiscal 2005 cash flows from operations
were used to repay bank debt under the RBCA. In the first six months of fiscal
2004 borrowings under the Company's RBCA were used to finance higher levels of
inventory. The purchase of Holdings 11.375% Notes and borrowings of bank debt
were the primary uses of cash in financing activities 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 $19.0 million was borrowed and
outstanding and approximately $3.5 million was utilized for outstanding
commercial and stand-by letters of credit as of January 1, 2005. At January 1,
2005, $23.3 million was available for future borrowings under the RBCA. The
15
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 January 1, 2005, 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.
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.
16
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 1, 2005. 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.
17
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.
February 14, 2005
/s/ J. Craig Peterson
- -------------------------------------------------
J. Craig Peterson
Senior Vice President and Chief Financial Officer
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