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 2, 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
May 1, 2005.
1
GFSI, INC. AND SUBSIDIARIES
Quarterly Report on Form 10-Q
For the Quarter Ended April 2, 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)
April 2, July 3,
2005 2004
----------- ----------
ASSETS (unaudited)
Current assets:
Cash and cash equivalents $ 1,267 $ 911
Accounts receivable, net 24,994 32,831
Inventories, net 39,805 45,616
Prepaid expenses and other current assets 1,717 1,667
Deferred income taxes 1,158 1,077
----------- ----------
Total current assets 68,941 82,102
Property, plant and equipment, net 23,361 22,990
Other assets:
Deferred financing costs, net 1,555 2,073
Other 171 122
----------- ----------
Total assets $ 94,028 $ 107,287
=========== ==========
LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIENCY)
Current liabilities:
Accounts payable $ 8,556 $ 12,304
Accrued interest expense 1,242 4,424
Accrued expenses 7,652 7,245
Income taxes payable 10,472 10,478
Current portion of long-term debt 132 190
----------- ----------
Total current liabilities 28,054 34,641
Deferred income taxes 1,419 1,501
Other long-term obligations 452 452
Long-term debt, less current portion 154,558 160,629
Stockholders' equity (deficiency):
Common stock, $.01 par value, 10,000 shares authorized, one share
issued and outstanding at April 2, 2005 and July 3, 2004 -- --
Additional paid-in capital 71,442 71,442
Parent company bonds acquired (24,995) (24,995)
Accumulated deficiency (136,902) (136,383)
----------- ----------
Total stockholders' deficiency (90,455) (89,936)
----------- ----------
Total liabilities and stockholders' equity (deficiency) $ 94,028 $ 107,287
=========== ==========
See notes to consolidated financial statements.
3
GFSI, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
(UNAUDITED) (In thousands)
Quarter Ended Nine Months Ended
April 2, April 3, April 2, April 3,
2005 2004 2005 2004
---------- ---------- ---------- ----------
Net sales $ 40,392 $ 37,196 $137,992 $140,715
Cost of sales 24,201 21,776 84,929 85,163
-------- -------- -------- --------
Gross profit 16,191 15,420 53,063 55,552
Operating expenses:
Selling 7,341 6,447 21,495 19,941
General and administrative 6,357 6,336 18,487 19,080
-------- -------- -------- --------
13,698 12,783 39,982 39,021
-------- -------- -------- --------
Operating income 2,493 2,637 13,081 16,531
Other income (expense):
Interest expense (3,796) (3,662) (11,504) (11,368)
Gain (loss) on sale of
property, plant and equipment 9 (27) 12 912
-------- -------- -------- --------
(3,787) (3,689) (11,492) (10,456)
-------- -------- -------- --------
Income (loss) before income taxes (1,294) (1,052) 1,589 6,075
Income tax expense (benefit) (505) (411) 620 2,369
-------- -------- -------- --------
Net income (loss) $ (789) $ (641) $ 969 $ 3,706
======== ======== ======== ========
See notes to consolidated financial statements.
4
GFSI, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED) (In thousands)
Nine Months Ended
April 2, April 3,
2005 2004
---------- ----------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $ 969 $ 3,706
Adjustments to reconcile net income to net cash provided by
operating activities:
Depreciation 2,420 2,007
Amortization of deferred financing costs 604 679
Gain on sale or disposal of property, plant and equipment (10) (912)
Deferred income taxes (163) 472
Changes in operating assets and liabilities:
Accounts receivable, net 7,837 11,843
Inventories, net 5,811 4,727
Prepaid expenses, other current assets and other assets (99) (578)
Income taxes payable (6) 273
Accounts payable, accrued expenses and other
long-term obligations (6,522) (222)
-------- --------
Net cash provided by operating activities 10,841 21,995
-------- --------
CASH FLOWS FROM INVESTING ACTIVITIES:
Proceeds from sales of property, plant and equipment 79 2,797
Purchases of property, plant and equipment (2,860) (5,552)
-------- --------
Net cash used in investing activities (2,781) (2,755)
-------- --------
CASH FLOWS FROM FINANCING ACTIVITIES:
Net change in revolving credit agreement borrowings (6,002) (6,609)
Purchase of parent company bonds -- (12,265)
Distributions to GFSI Holdings, Inc. (1,584) (258)
Issuance of long-term debt -- 82
Payments on long-term debt (128) (226)
Other (86) (1)
-------- --------
Net cash used in financing activities (7,800) (19,277)
-------- --------
Effect of foreign exchange rate changes on cash 96 38
-------- --------
Net increase in cash and cash equivalents 356 1
Cash and cash equivalents at beginning of period 911 1,387
-------- --------
Cash and cash equivalents at end of period $ 1,267 $ 1,388
======== ========
Supplemental cash flow information:
Interest paid $ 14,082 $ 13,853
======== ========
Income taxes paid $ 788 $ 1,618
======== ========
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 2, 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. Therefore, the nine month fiscal period ended
April 3, 2004 has one more week of operations than the comparable period 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 April 2, 2005 and July 3,
2004:
(in thousands) April 2, July 3,
2005 2004
---------- ----------
(unaudited)
Undecorated apparel ("blanks") and supplies $ 37,687 $ 42,857
Work in process 344 314
Finished goods 2,219 3,340
--------- ---------
40,250 46,511
Allowance for markdowns (445) (895)
--------- ---------
Total $ 39,805 $ 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 April 2, 2005 (in thousands) (unaudited):
Parent Subsidiary Consolidating Consolidated
Obligor Guarantors Adjustments GFSI, Inc.
--------- ---------- ------------- ------------
Assets:
Current assets:
Cash and cash equivalents $ 1,216 $ 51 $ -- $ 1,267
Accounts receivable, net 14,128 36,799 (25,933) 24,994
Inventories, net 37,948 1,857 -- 39,805
Prepaid expenses and other current assets 1,449 268 -- 1,717
Deferred income taxes 1,158 -- -- 1,158
-------- -------- -------- ---------
Total current assets 55,899 38,975 (25,933) 68,941
Investment in equity of subsidiaries 35,725 -- (35,725) --
Property, plant and equipment, net 23,195 166 -- 23,361
Other assets 2,654 (928) -- 1,726
-------- -------- -------- ---------
Total assets $117,473 $ 38,213 $(61,658) $ 94,028
======== ======== ======== =========
Liabilities and stockholders' equity:
Current liabilities:
Accounts payable $ 33,847 $ 642 $(25,933) $ 8,556
Accrued interest expense 1,242 -- -- 1,242
Accrued expenses 5,659 1,993 -- 7,652
Income taxes payable (receivable) 10,619 (147) -- 10,472
Current portion of long-term debt 132 -- -- 132
-------- -------- -------- ---------
Total current liabilities 51,499 2,488 (25,933) 28,054
Deferred income taxes 1,419 -- -- 1,419
Other long-term obligations 452 -- -- 452
Long-term debt, less current portion 154,558 -- -- 154,558
Stockholders' equity (deficiency) (90,455) 35,725 (35,725) (90,455)
-------- -------- -------- ---------
Total liabilities and stockholders' equity (deficiency) $117,473 $ 38,213 $(61,658) $ 94,028
======== ======== ======== =========
7
Nine months ended April 2, 2005 (in thousands) (unaudited):
Parent Subsidiary Consolidating Consolidated
Obligor Guarantors Adjustments GFSI, Inc.
--------- ---------- ------------- ------------
Net sales $ 78,994 $ 62,379 $ (3,381) $ 137,992
Cost of sales 52,198 36,112 (3,381) 84,929
Selling expenses 10,958 10,537 -- 21,495
General and administrative expense 15,611 2,876 -- 18,487
--------- ---------- --------- ---------
Total costs and expenses 78,767 49,525 (3,381) 124,911
--------- ---------- --------- ---------
Operating income 227 12,854 -- 13,081
Equity in net earnings of subsidiaries 7,838 -- (7,838) --
Interest expense (11,501) (3) -- (11,504)
Gain on sale of property, plant and equipment 12 -- -- 12
--------- ---------- --------- ---------
Income (loss) before income taxes (3,424) 12,851 (7,838) 1,589
Income tax expense (benefit) (4,393) 5,013 -- 620
--------- ---------- --------- ---------
Net income $ 969 $ 7,838 $ (7,838) $ 969
========= ========== ========= =========
Nine months ended April 2, 2005 (in thousands) (unaudited):
Parent Subsidiary Consolidating Consolidated
Obligor Guarantors Adjustments GFSI, Inc.
---------- ---------- ------------- ------------
Net cash flows provided by operating activities $ 10,922 $ (81) $ -- $ 10,841
Net cash flows used in investing activities (2,776) (5) -- (2,781)
Cash flows from financing activities:
Net change in revolving credit agreement borrowings (6,002) -- -- (6,002)
Payments on long-term debt (128) -- -- (128)
Distributions to GFSI Holdings, Inc. (1,584) -- -- (1,584)
Other (86) -- -- (86)
--------- ---------- --------- ----------
Net cash used in financing activities (7,800) -- -- (7,800)
--------- ---------- --------- ----------
Effect of foreign exchange rate changes on cash -- 96 -- 96
--------- ---------- --------- ----------
Net increase in cash and cash equivalents 346 10 -- 356
Cash and cash equivalents at beginning of period 870 41 -- 911
--------- ---------- --------- ----------
Cash and cash equivalents at end of period $ 1,216 $ 51 $ -- $ 1,267
========= ========== ========= ==========
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 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
========= ========= ========= ==========
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 expense 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
======== ========= ========= ==========
9
Nine months ended April 3, 2004 (in thousands) (audited):
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 end of period $ 1,338 $ 50 $ -- $ 1,388
========= ========= ========= ========
5. Financing and Recapitalization
------------------------------
On October 4, 2004 the Company and Holdings amended their 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.
On March 1, 2005 the Company and Holdings amended their existing
revolving bank credit agreement. The terms of the amendment reduced the
interest rates in effect at the time of the amendment and revised certain
restrictive financial covenant requirements. Under the amended RBCA, Holdings
is required to maintain a minimum of $5 million of borrowing availability, as
defined in the agreement. Should borrowing availability be less than $10
million but more than $5 million, Holdings is required to maintain a fixed
charge coverage ratio of not less than 1.05 to 1.0, as defined in the
agreement. Under the previous agreement, at its most restrictive level,
Holdings was required to maintain a fixed charge coverage ratio of not less
than 1.15 to 1.0.
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
10
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 the 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 April 2, 2005 stockholders' equity
(deficiency) included a reduction of $25.0 million representing the
acquisition cost of the remaining 11.375% Notes held by the Company.
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
cash dividend obligations to Holdings to enable it to pay interest on
the 11.375% Notes from $12.3 million to $2.7 million annually.
In March 2005, the Company made a net $1.4 million distribution to
Holdings to enable Holdings to pay interest on the 11.375% Notes.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The discussions set forth in this Form 10-Q should be read in conjunction
with the financial information included herein and the Company's Annual Report
on Form 10-K for the year ended 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.
11
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 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 2, 2005 and July 3, 2004 were net of
allowance for doubtful accounts of $559,000 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. Therefore, the nine month
fiscal period ended April 3, 2004 has one more week of operations than the
comparable period 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.
12
COMPARISON OF OPERATING RESULTS FOR THE QUARTERS ENDED APRIL 2, 2005 AND
APRIL 3, 2004
Net Sales. Net sales for the quarter ended April 2, 2005 increased
$3.2 million or 9% to $40.4 million compared to $37.2 million last year.
Sales of Gear branded products to collegiate, resort and golf customers and
sales of Champion branded products increased over the third quarter of last
year. Sales of Champion branded products were 20% higher than last year
principally due to a greater penetration with resort customers. Sales of Gear
branded products 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 April 2, 2005 increased
5% to $16.2 million compared to $15.4 million last year. Higher sales created
the increase in gross profit. Gross profit as a percentage of net sales
decreased to 40% for the quarter compared to 41% last year. The gross profit
percentage declined due to lowered selling prices to liquidate inventory
overstocks. The Company anticipates it will continue to move through its
inventory overstocks during the remainder of fiscal 2005. The Company has
been working to reduce its higher than desired inventory level with price
reductions.
Operating Expenses. Operating expenses for the quarter ended April 2,
2005 increased 7% to $13.7 million from $12.8 million last year. The increase
in operating expenses was principally due to higher selling expense.
Increased royalty fees and new brand development costs created the increase
in selling expense. 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 of approximately $450,000
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 expenses as a percentage of net sales were 34% in the third
quarter of fiscal 2005 approximately the same as last year.
Operating Income. Operating income decreased 5% to $2.5 million in the
third quarter of fiscal 2005 compared to $2.6 million last year. Operating
income as a percentage of net sales decreased to 6% in the third quarter of
fiscal 2005 from 7% in the third quarter of fiscal 2004. The decrease in
operating income resulted from higher selling expenses for royalty fees and
new brand launches.
Interest Expense. Interest expense in the third quarter of fiscal 2005
was $3.8 million compared to $3.7 million last year. Higher bank borrowings
at higher interest rates created the increase in interest expense.
Net Loss. Net loss for the third quarter of fiscal 2005 was ($789,000)
compared to net loss of ($641,000) for the third quarter of fiscal 2004.
The decrease in operating income resulted in the $148,000 increase in net
loss.
COMPARISON OF OPERATING RESULTS FOR THE NINE MONTHS ENDED APRIL 2, 2005 AND
APRIL 3, 2004
Net Sales. Net sales for the nine months ended April 2, 2005 decreased
2% to $138.0 million compared to $140.7 million last year. The decrease in
net sales was due to reduced sales of Gear branded products while sales of
Champion branded products increased over the comparable period last year.
The sales decrease in Gear branded products was most pronounced in the
Military and Corporate customer groups. 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. Sales of Gear products within the Resort and Golf
Divisions recovered from the economic aftermath of the hurricane damage that
took place in the Southeastern United States and the Caribbean during the
first half of fiscal 2005. Sales of Champion branded products were 5%
higher than last year principally due to a greater penetration with resort
customers.
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Gross Profit. Gross profit for the nine months ended April 2, 2005
decreased 5% to $53.1 million compared to $55.6 million last year. Gross
profit as a percentage of net sales decreased to 38% for the nine 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, storage and liquidation 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 nine months ended April 2,
2005 were $40.0 million compared to $39.0 million last year. Increased
selling expense created the increase in operating expenses. During the first
nine 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 of approximately $800,000 related to the launch of two new
golf and resort brands scheduled to commence sales in the fourth quarter of
2005 and the first quarter of fiscal 2006. Operating expenses as a percentage
of net sales were 29% in fiscal 2005 compared to 28% last year. Higer royalty
expenses 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 nine months ended April 2,
2005 decreased 21% to $13.1 million compared to $16.5 million last year.
Operating income as a percentage of net sales decreased to 10% in fiscal 2005
from 12% 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 nine months of fiscal 2005
was $11.5 million compared to $11.4 million last year. Higher bank borrowings
at higher interest rates in fiscal 2005 offset the savings derived from having
one less week in the first nine months of fiscal 2005 compared to the first
nine months of fiscal 2004.
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 nine months of fiscal 2005 was $1.0
million compared to $3.7 million last year. The decrease in operating income
and last year's gain on the sale of the distribution facility resulted in the
$2.7 million decrease in net income in comparison to last year.
NEW LICENSE AGREEMENTS
During the first nine 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 $800,000 in product launch and preproduction
expenses during the nine months ended April 2, 2005. The Company expects to
incur product launch and preproduction expenses related to these brands of
approximately $200,000 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. 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 the
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 April 2, 2005 stockholders' equity (deficiency)
included a reduction of $25.0 million representing the acquisition cost of
the remaining 11.375% Notes held by the Company.
LIQUIDITY AND CAPITAL RESOURCES
Cash provided by operating activities in the first nine months of fiscal
2005 was $10.8 million compared to $22.0 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 nine months of fiscal 2005
was $2.8 million, approximately the same as last year. During the first nine
months of fiscal 2005 the Company's capital expenditures were principally
related to hardware and software upgrades of its enterprise information
systems. In the first nine months of fiscal 2004, $2.8 million in proceeds
were received from the sale of the Company's Lenexa distribution facility and
$3.2 million was spent building a new warehouse and distribution facility. The
Company anticipates fiscal 2005 capital expenditures to approximate $3 million.
Cash used in financing activities in the first nine months of fiscal 2005
was $7.8 million compared to $19.3 million in the comparable period of fiscal
2004. In the first nine months of fiscal 2005 cash flows from operations were
used to repay bank debt under the RBCA. In March 2005, the Company made a net
$1.4 million distribution to Holdings to enable Holdings to pay interest on
its outstanding 11.375% Notes. In the first nine 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.
15
On October 4, 2004 the Company and Holdings amended their $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 $19.1 million was
borrowed and outstanding and approximately $3.3 million was utilized for
outstanding commercial and stand-by letters of credit as of April 2, 2005.
At April 2, 2005, $19.3 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.
On March 1, 2005 the Company and Holdings amended their existing
revolving bank credit agreement. The terms of the amendment reduced the
interest rates in effect at the time of the amendment and revised certain
restrictive financial covenant requirements. Under the amended RBCA,
Holdings is required to maintain a minimum of $5 million of borrowing
availability, as defined in the agreement. Should borrowing availability be
less than $10 million but more than $5 million Holdings is required to
maintain a fixed charge coverage ratio of not less than 1.05 to 1.0, as
defined in the agreement. Under the previous agreement, at its most
restrictive level, Holdings was required to maintain a fixed charge coverage
ratio of not less than 1.15 to 1.0.
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 April 2, 2005, Holdings' debt to third parties
totaled approximately $24.5 million. The 11.375% Notes annual cash flow
requirements commenced in March 2005 with a semi-annual cash installment of
approximately $1.4 million. 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 have not been 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.
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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 2, 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.
May 3, 2005
/s/ J. Craig Peterson
- -------------------------------------------------
J. Craig Peterson
Senior Vice President and Chief Financial Officer
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