UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 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 333-376-17
DELTA MILLS, INC.
--------------------------------------
(Exact name of registrant as specified in its charter)
DELAWARE 13-2677657
- ------------------------------- --------------------
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
700 North Woods Drive
Fountain Inn, South Carolina 29644
------------------------------------------------ -------------
(Address of principal executive offices) (Zip Code)
864 862-3557
---------------------------
(Registrant's telephone number, including area code)
P.O. Box 6126, 100 Augusta Street, Greenville, South Carolina 29606
--------------------------------------------------------------------
(Former name, former address and former fiscal year,
if changed since last report.)
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. Yes [X] No [ ].
Indicate by check mark if 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, $.01 Par Value -
100 shares as of February 11, 2005.
DELTA MILLS, INC.
INDEX
PART I. FINANCIAL INFORMATION
Page
Item 1. Financial Statements (Unaudited)
Condensed consolidated balance sheets--January 1, 2005 and July 3, 2004 3
Condensed consolidated statements of operations--
Three and six months ended January 1, 2005 and December 27, 2003 4
Condensed consolidated statements of cash flows--
Six months ended January 1, 2005 and December 27, 2003 5
Notes to condensed consolidated financial statements 6-9
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations 10-21
Item 3. Quantitative and Qualitative Disclosures about Market Risk 22
Item 4. Controls and Procedures 22-23
PART II. OTHER INFORMATION
Item 1. Legal Proceedings 24
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds 24
Item 3. Defaults upon Senior Securities 24
Item 4. Submission of Matters to a Vote of Security Holders 24
Item 5. Other Information 24
Item 6. Exhibits 24
SIGNATURES 24
CERTIFICATIONS 25-32
2
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
CONDENSED CONSOLIDATED BALANCE SHEETS (UNAUDITED)
Delta Mills, Inc.
(In Thousands)
January 1, 2005 July 3, 2004
----------------- -------------
ASSETS
CURRENT ASSETS
Cash and cash equivalents $ 868 $ 585
Accounts receivable:
Factor 36,465 38,613
Less allowances for returns 1 20
----------------- -------------
36,464 38,593
Inventories
Finished goods 7,649 6,613
Work in process 20,649 18,877
Raw materials and supplies 6,092 6,889
----------------- -------------
34,390 32,379
Deferred income taxes 1,659 1,113
Other assets 498 302
----------------- -------------
TOTAL CURRENT ASSETS 73,879 72,972
ASSETS HELD FOR SALE 8,857 2,495
PROPERTY, PLANT AND EQUIPMENT, at cost 123,350 163,032
Less accumulated depreciation 74,592 99,907
----------------- -------------
48,758 63,125
DEFERRED LOAN COSTS 292 347
----------------- -------------
$ 131,786 $ 138,939
================= =============
LIABILITIES AND SHAREHOLDERS' EQUITY
CURRENT LIABILITIES
Trade accounts payable $ 12,667 $ 7,879
Revolving credit facility 24,079 21,388
Accrued income taxes payable 13,692 13,698
Payable to affiliates 3,721 3,686
Accrued employee compensation 3,056 3,179
Accrued restructuring 2,536
Accrued and sundry liabilities 4,464 5,543
----------------- -------------
TOTAL CURRENT LIABILITIES 64,215 55,373
LONG-TERM DEBT 31,941 31,941
NON-CURRENT DEFERRED INCOME TAXES 1,662 4,853
DEFERRED COMPENSATION 2,070 2,328
SHAREHOLDERS' EQUITY
Common Stock -- par value $0.01 a share -- authorized
3,000 shares, issued and outstanding 100 shares
Additional paid-in capital 51,792 51,792
Accumulated deficit (19,894) (7,348)
----------------- -------------
31,898 44,444
COMMITMENTS AND CONTINGENCIES
----------------- -------------
$ 131,786 $ 138,939
================= =============
3
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED)
Delta Mills, Inc.
(In Thousands)
3 Mths Ended 3 Mths Ended 6 Mths Ended 6 Mths Ended
January 1, December 27, January 1, December 27,
2005 2003 2005 2003
---------------- ----------------- ----------------- ----------------
Net sales $ 39,310 $ 48,500 $ 74,750 $ 91,081
Cost of goods sold 40,735 44,087 75,866 86,049
---------------- ----------------- ----------------- ----------------
GROSS PROFIT (LOSS) (1,425) 4,413 (1,116) 5,032
Selling, general and administrative expenses 2,608 2,959 5,328 5,787
Impairment and restructuring expenses 7,350 7,350
Other income 25 411 61 701
---------------- ----------------- ----------------- ----------------
OPERATING PROFIT (LOSS) (11,358) 1,865 (13,733) (54)
Interest expense (1,265) (1,161) (2,556) (2,368)
---------------- ----------------- ----------------- ----------------
INCOME (LOSS) BEFORE INCOME TAXES (12,623) 704 (16,289) (2,422)
Income tax expense (benefit) (2,399) 417 (3,743) (732)
---------------- ----------------- ----------------- ----------------
NET INCOME (LOSS) $ (10,224) $ 287 $ (12,546) $ (1,690)
================ ================= ================= ================
See notes to condensed consolidated financial statements.
4
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
Delta Mills, Inc.
(In Thousands)
6 Mths Ended 6 Mths Ended
January 1, 2005 December 27, 2003
----------------------- ------------------------
OPERATING ACTIVITIES
Net loss $ (12,546) $ (1,690)
Adjustments to reconcile net loss to net cash
provided by operating activities:
Depreciation 4,381 4,396
Amortization 55 55
Impairment and restructuring expenses 7,350
Gains on disposition of property
and equipment (253)
Change in deferred income taxes (3,737) (5,488)
Deferred compensation (258) 418
Changes in operating assets and liabilities 2,568 10,376
----------------------- ------------------------
NET CASH (USED IN) PROVIDED BY
OPERATING ACTIVITIES (2,187) 7,814
----------------------- ------------------------
INVESTING ACTIVITIES
Property, plant and equipment:
Purchases (221) (2,795)
Proceeds of dispositions 424
----------------------- ------------------------
NET CASH USED IN
INVESTING ACTIVITIES (221) (2,371)
----------------------- ------------------------
FINANCING ACTIVITIES
Proceeds from revolving lines of credit 80,075 91,571
Repayments on revolving lines of credit (77,384) (96,940)
----------------------- ------------------------
NET CASH PROVIDED BY (USED IN)
FINANCING ACTIVITIES 2,691 (5,369)
----------------------- ------------------------
INCREASE IN CASH
AND CASH EQUIVALENTS 283 74
Cash and cash equivalents at beginning of period 585 520
----------------------- ------------------------
CASH AND CASH EQUIVALENTS
AT END OF PERIOD $ 868 $ 594
======================= ========================
See notes to condensed consolidated financial statements.
5
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
NOTE A--BASIS OF PRESENTATION
The accompanying unaudited condensed consolidated financial statements of Delta
Mills, Inc. and subsidiary ("the Company") have been prepared in accordance with
U.S. generally accepted accounting principles for interim financial information
and with the instructions to Form 10-Q and Article 10 of Regulation S-X.
Accordingly, they do not include all of the information and footnotes required
by U.S. generally accepted accounting principles for complete financial
statements. In the opinion of management, all adjustments (consisting of only
normal recurring accruals) considered necessary for a fair presentation have
been included. Operating results for the six months ended January 1, 2005 are
not necessarily indicative of the results that may be expected for the year
ending July 2, 2005. For further information, refer to the consolidated
financial statements and footnotes thereto included in the Company's annual
report on Form 10-K for the year ended July 3, 2004.
NOTE B--SUMMARIZED FINANCIAL INFORMATION OF SUBSIDIARY
Delta Mills Marketing, Inc. (the "Guarantor") is a wholly-owned subsidiary of
the Company and has fully and unconditionally guaranteed (the "Guarantee") the
Company's payment of principal, premium, if any, interest and certain liquidated
damages, if any, on the Company's Senior Notes. The Guarantor's liability under
the Guarantee is limited to such amount, the payment of which would not have
left the Guarantor insolvent or with unreasonably small capital at the time its
Guarantee was entered into, after giving effect to the incurrence of existing
indebtedness immediately prior to such time.
The Guarantor is the sole subsidiary of the Company and does not comprise a
material portion of the Company's assets or operations. All future subsidiaries
of the Company will provide guarantees identical to the one described in the
preceding paragraph unless such future subsidiaries are Receivables Subsidiaries
(as defined in the indenture relating to the Notes). Such additional guarantees
will be joint and several with the Guarantee of the Guarantor.
The Company has not presented separate financial statements or other disclosures
concerning the Guarantor because Company management has determined that such
information is not material to investors.
Summarized financial information for the Guarantor is as follows (in thousands):
January 1, 2005 July 3, 2004
--------------- ------------
Current assets $139 $ 83
Non-current assets 1 13
Current liabilities 2,363 2,275
Non-current liabilities 712 697
Stockholders' deficit (2,935) (2,876)
Summarized results of operations for the Guarantor are as follows (in
thousands):
Six Months Ended
-------------------------------------
January 1, 2005 December 27, 2003
--------------- -----------------
Net sales - Intercompany commissions $ 1,678 $ 2,044
Cost and expenses 1,737 1,930
Net income (loss) (59) 114
6
NOTE C-LONG-TERM DEBT, CREDIT ARRANGEMENTS, AND NOTES PAYABLE
On August 25, 1997, the Company issued $150 million of unsecured ten-year Senior
Notes at an interest rate of 9.625%. These notes will mature in August 2007. At
January 1, 2005, the outstanding balance of the notes was $31,941,000, unchanged
from the balance at July 3, 2004.
The Company has a revolving credit facility with GMAC with a term lasting until
March 2007. Borrowings under this credit facility are based on eligible accounts
receivable and inventories of the Company. The facility is secured by the
accounts receivable, inventories and capital stock of the Company. The average
interest rate on the credit facility was 5.39% at January 1, 2005 and is based
on a spread over either LIBOR or a base rate. Borrowings under this facility
were $24.1 million and $21.4 million as of January 1, 2005 and July 3, 2004,
respectively. As of January 1, 2005, the revolving credit facility availability
was approximately $9.2 million, net of the $7 million availability reduction
described below.
Prior to April 19, 2004, the GMAC credit facility had financial covenants that
required the Company to comply with a maximum leverage ratio and a minimum fixed
charge coverage ratio. As a result of the operating loss in the third quarter of
fiscal year 2004, the Company was not in compliance with the maximum leverage
ratio covenant at the end of that quarter. On April 19, 2004, GMAC granted the
Company a waiver and amendment that waived the existing default with respect to
the maximum leverage ratio covenant, temporarily amended the maximum leverage
ratio covenant for the fourth quarter of fiscal year 2004, and temporarily
eliminated the fixed charge coverage ratio covenant for the fourth quarter of
fiscal year 2004. The Company was in compliance with these amended covenants at
July 3, 2004. The April 2004 waiver and amendment also reduced the Company's
availability under the credit facility by $7 million for the remaining term of
the facility and increased the interest rates under the credit facility by 125
basis points; however, the interest rates will revert to their pre-amendment
levels if the Company has net income for fiscal year 2005 and no event of
default exists under the credit facility. On August 18, 2004, the Company
entered into further amendments to the GMAC credit facility pursuant to which
the maximum availability was reduced to $38 million, and the maximum leverage
ratio and fixed charge coverage ratio covenants were replaced with a minimum
EBITDA covenant. The new covenant sets required minimum EBITDA levels for each
quarter of fiscal year 2005 and provides that it will constitute an event of
default if the Company and its lender fail to agree by the end of fiscal year
2005 to minimum EBITDA levels for the remainder of the term of the revolving
credit facility. On October 18, 2004, GMAC agreed to an amendment to the
financial covenants in the credit facility to reduce the required minimum EBITDA
levels for each quarter of fiscal year 2005. The Company was in compliance with
these amended covenants at January 1, 2005.
The Company's credit facility contains restrictive covenants that restrict
additional indebtedness, dividends, and capital expenditures. The payment of
dividends with respect to the Company's stock is permitted if there is no event
of default and there is at least $1 of availability under the facility. The
indenture pertaining to the Company's 9.625% Senior Notes also contains
restrictive covenants that restrict additional indebtedness, dividends, and
investments by the Company and its subsidiaries. The payment of dividends with
respect to the Company's stock is permitted if there is no event of default
under the indenture and after payment of the dividend, the Company could incur
at least $1 of additional indebtedness under a fixed charge coverage ratio test.
Dividends are also capped based on cumulative net income and proceeds from the
issuance of securities and liquidation of certain investments. The Company may
loan funds to Delta Woodside subject to compliance with the same conditions. At
January 1, 2005, the Company was prohibited by these covenants from paying
dividends and making loans to Delta Woodside. During the year ended July 3, 2004
and the quarter ended January 1, 2005, the Company did not pay any dividends to
Delta Woodside.
The Company assigns a substantial portion of its trade accounts receivable to
GMAC Commercial Finance LLC (the "Factor") under a factor agreement. The
assignment of these receivables is primarily without recourse, provided that
customer orders are approved by the Factor prior to shipment of goods, up to a
maximum for each individual account. The assigned trade accounts receivable are
recorded on the Company's books at full value and represent amounts due the
Company from the Factor. There are no advances from the Factor against the
assigned receivables. All factoring fees are recorded in the Company's statement
of operations as incurred as a part of selling, general and administrative
expenses.
7
NOTE D - STOCK COMPENSATION
The Company also participates in the Delta Woodside Industries, Inc. 2004 Stock
Plan, Incentive Stock Award Plan, and 2000 Stock Option Plan.
The Company applies the intrinsic value-based method of accounting for the stock
option plans, in accordance with the provisions of Accounting Principles Board
Opinion No. 25, "Accounting for Stock Issued to Employees," (APB 25), and
related interpretations. Under this method, compensation expense for stock
options is recorded on the date of the grant only if the current market price of
the underlying stock exceeded the exercise price. Compensation expense for the
incentive stock award plan is approximately the same under APB 25 as it would be
under Statement of Financial Accounting Standards No. 123, "Accounting for
Stock-Based Compensation" (SFAS No. 123). If the Company had determined
compensation expense at fair value for stock options, as under SFAS No. 123, the
Company's net income (loss) would have been as follows:
(In thousands) 3 Months 3 Months 6 Months 6 Months
Ended Ended Ended Ended
1/1/2005 12/27/2003 1/1/2005 12/27/2003
------------- ------------- ------------- -------------
Net income (loss), as reported $ (10,224) $ 287 $ (12,546) $ (1,690)
Add stock based employee compensation expense
included in reported net income (loss), net of tax 16 0 33 26
Less total stock based employee compensation
expense determined under fair value based
method, net of related tax effects (16) (0) (33) (26)
------------- ------------- ------------- -------------
Pro forma net income (loss) $ (10,224) $ 287 $ (12,546) $ (1,690)
============= ============= ============= =============
NOTE E - COMMITMENTS AND CONTINGENCIES
During 1998, Delta Woodside received notices from the State of North Carolina
asserting deficiencies in state corporate income and franchise taxes for the
Delta Woodside's 1994 - 1997 tax years. The total assessment proposed by the
State amounted to $1.5 million, which included interest and penalties at that
time. The assessment was delayed pending an administrative review of the case by
the State. In October 2002, the State proposed a settlement in which Delta
Woodside would have paid approximately 90% of the assessed amount plus a portion
of certain penalties for Delta Woodside's tax years 1994 - 2000. In January 2005
the North Carolina Department of Revenue (the Department) notified the Company
that the North Carolina Court of Appeals unanimously upheld the Department's
assessment of corporate income and franchise tax against A&F Trademark and eight
other holding company subsidiaries of the Limited Stores, Inc. (the Limited
Stores Case), ruling that the trademark holding companies were doing business in
the state of North Carolina for corporate income tax purposes. As a result of
the Limited Stores Case ruling, the Department proposed a Voluntary Compliance
Program (the Program) whereby the Company could pay the assessment amount for
the Company's 1994 - 1997 tax years plus interest totaling approximately $1.4
million. Under the Program, the Department would waive all penalties provided
the Company pays the tax and interest and waives all rights to a refund. Delta
Woodside rejected this offer and continued with its appeal due to management's
belief that the State's legal position is in conflict with established
principles of federal constitutional law. Delta Woodside considers all exposures
in determining probable amounts of payment; therefore, any payment in settlement
of this matter is not expected to result in a material impact on the Company's
results of operations.
8
NOTE F - DEFERRED COMPENSATION
On January 16, 2004, based on the recommendation of Delta Woodside's
Compensation Committee, the Board (with Mr. Garrett abstaining) approved an
amendment of the Company's deferred compensation plan. The deferred compensation
plan amendment provided that each participant's deferred compensation account
will be paid to the participant upon the earlier of the participant's
termination of employment or in accordance with a schedule of payment that will
pay approximately 40%, 30%, 20% and 10% of the participant's total pre-amendment
account on February 15 of 2004, 2005, 2006 and 2007, respectively. Any such
February 15 payment will be conditioned on there being no default under the
Company's Senior Note Indenture or the Company's revolving credit facility and
on compliance with the fixed charge coverage ratio test in the Senior Note
Indenture for the most recently ended four full fiscal quarters, determined on a
pro forma basis. Compliance with the fixed charge coverage ratio test is
required by the Senior Note Indenture only for the incurrence of indebtedness or
the issuance of preferred stock in certain circumstances; however, the amendment
of the deferred compensation plan requires compliance for the scheduled
payments. As a result of this amendment to the deferred compensation plan,
approximately $2.3 million, which represents the scheduled February 15, 2005
payment, plus distributions anticipated to occur in the next twelve months due
to participant retirements, has been reclassified on the consolidated balance
sheet at January 1, 2005 from deferred compensation to accrued employee
compensation in current liabilities. The first payment of approximately $3.1
million was made in February 2004. As of February 15, 2005, the Company was not
in compliance, for the purpose of the scheduled payment, with the fixed charge
coverage ratio test in the Senior Note Indenture for the most recently ended
four full fiscal quarters, determined on a pro forma basis. Accordingly, any
future payment in accordance with the schedule in the amendment will be delayed
until compliance is achieved.
NOTE G -IMPAIRMENT AND RESTRUCTURING CHARGES
During the quarter ended January 1, 2005, the Company recorded an impairment and
restructuring charge of $7.4 million, on a pretax basis, associated with its
2005 realignment plan as announced on October 20, 2004. The Company recorded a
$3.8 million non-cash asset impairment charge to reflect the write down of
property and equipment to its estimated fair value, less selling costs. These
assets are recorded on the consolidated financial statements as Assets Held for
Sale. The carrying amount of Assets Held for Sale, including the Catawba and
Furman plants which were previously classified in this category, was
approximately $8,857,000 at January 1, 2005. The Company has entered asset sales
agreements covering the Catawba, Furman, and Estes plants and equipment located
at these closed plants as well as some impaired equipment located at the Beattie
and Pamplico plants.
The remainder of the charge relates to restructuring costs of $3.5 million, as
noted below:
Employee
Termination Costs Other Expenses Total
----------------- -------------- -----
Restructuring Accrual $3,154,229 $350,000 $3,504,229
Less: Charges Paid Year to Date 959,166 9,059 968,225
Remaining Liability as of January 1, 2005 $2,195,063 $340,941 $2,536,004
The employee termination costs are principally for separation pay and benefits
costs for the approximately 400 terminated employees and are expected to be paid
over 18 months beginning in November 2004. The other expenses are primarily
estimated contract termination costs.
In addition to the restructuring and impairment charges, the Company recorded in
cost of goods sold $781,000 for the write-off of certain supply inventories
associated with equipment to be sold.
9
Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
Delta Mills sells a broad range of finished apparel fabrics primarily to branded
apparel manufacturers and resellers, including Haggar Corp., the Wrangler(R) and
Lee(R) labels of V.F. Corporation, Liz Claiborne, Inc., Levi Strauss and their
respective subcontractors, and private label apparel manufacturers for J.C.
Penney Company, Inc., Sears, Roebuck & Co., Wal-Mart Stores, Inc., and other
retailers. Delta Mills also sells camouflage fabric and other fabrics used in
apparel for the United States Department of Defense.
CAUTIONARY STATEMENT CONCERNING FORWARD-LOOKING INFORMATION
The following discussion contains various "forward-looking statements". All
statements, other than statements of historical fact, which address activities,
events or developments that the Company expects or anticipates will or may occur
in the future are forward-looking statements. Examples are statements that
concern future revenues, future costs, future capital expenditures, business
strategy, competitive strengths, competitive weaknesses, goals, plans,
references to future success or difficulties and other similar information. The
words "estimate", "project", "forecast", "anticipate", "expect", "intend",
"believe" and similar expressions, and discussions of strategy or intentions,
are intended to identify forward-looking statements.
The forward-looking statements in this document are based on the Company's
expectations and are necessarily dependent upon assumptions, estimates and data
that the Company believes are reasonable and accurate but may be incorrect,
incomplete or imprecise. Forward-looking statements are also subject to a number
of business risks and uncertainties, any of which could cause actual results to
differ materially from those set forth in or implied by the forward-looking
statements. These risks and uncertainties include, but are not limited to:
o changes in the retail demand for apparel products
o the cost of raw materials
o competitive conditions in the apparel and textile industries
o the relative strength of the United States dollar as against other
currencies
o changes in United States and international trade regulations, including
without limitation the end of quotas on textile and apparel products
amongst WTO member states in 2005
o the discovery of unknown conditions, such as environmental matters and
similar items
o escalating energy costs
o the federal government policy respecting US sourcing requirements for
military fabrics
Accordingly, any forward-looking statements do not purport to be predictions of
future events or circumstances and may not be realized. You should also review
the other cautionary statements we make in this quarterly report and in other
reports and other documents the Company files with the Securities and Exchange
Commission. All forward-looking statements attributable to us, or persons acting
for us, are expressly qualified in their entirety by our cautionary statements.
The Company does not undertake publicly to update or revise the forward-looking
statements even if it becomes clear that any projected results will not be
realized.
10
MANAGEMENT OVERVIEW AND COMPANY OUTLOOK
THE CURRENT ENVIRONMENT. As we end our second fiscal quarter and enter calendar
year 2005, we recognize that the Company faces a significant change in global
competition as a result of the WTO's phase-out of textile and apparel quotas at
the end of calendar year 2004. It is too early in the calendar year to judge the
WTO's effect on our commercial business. While we recognize our Asian
competitors will have a cost advantage as tariffs on textile/apparel products
are reduced (but not eliminated), we believe we have competitive advantages
compared to Asian competitors and we must fully utilize those advantages. Among
our advantages are our well-established relationships with our customers, our
ability to respond quickly to customer needs and the logistical advantage
associated with our manufacturing being located in North America. However, there
can be no assurance that these advantages will allow us to successfully compete
with foreign textile producers.
During the second fiscal quarter, we closed our Estes weaving facility, located
in Piedmont, South Carolina as part of the realignment plan announced October
20, 2004. The equipment run-out schedule was completed in approximately five (5)
weeks as planned. In addition to our Estes Plant, we have two other idle
facilities: the Catawba Plant located in Maiden, North Carolina was closed
during fiscal year 2003 and the Furman Plant, located in Fountain Inn, South
Carolina was closed during fiscal year 2002. We will discuss the status of these
impaired facilities and related equipment under the Realignment Plan update
later in this overview.
SECOND QUARTER AND FIRST HALF OF FISCAL YEAR 2005. Sales increased $3.9 million
from the first quarter of fiscal 2005 quarter but declined $9.2 million over
last year's second quarter and $16.3 million over the prior year's first six
months. The declines were principally a result of the decline in the commercial
cotton product category. This decline was not unexpected and current conditions
in the market place have not changed significantly. We still expect surplus
capacity in the domestic textile manufacturing base to remain in place and we
expect Asia to continue to disrupt the sourcing patterns of U.S. retailers and
brands. We remain diligent in our efforts to understand the globally competitive
market place and to look within our Company to lower our costs and improve
performance.
OUTLOOK. We continue to believe the best opportunity for improving our
performance and protecting the investment of our constituents, is to
successfully execute our Realignment Plan that was announced on October 20,
2004. +At this point in time, as planned, we have completed the workforce
reductions, reduced medical and 401k benefits, reduced salaried employees pay,
closed the Estes Plant, increased the capacity utilization of our Beattie
weaving facility, initiated fixed overhead reductions in the manufacturing and
administrative areas including the relocation of the New York and Greenville
administrative offices, and negotiated asset sales contracts on all impaired
real and personal property. With our anticipated improved manufacturing
performance and market support beginning the last half of our fiscal year, we
should see the true test of our plan's success as the effect of these
initiatives moves to the bottom line.
Our commercial cotton market has recently shown signs of improvement, although
we cannot pinpoint the exact reason nor can we assume the improvement in this
business to be long term. Some of the possible reasons are that some domestic
capacity rationalization has taken place, the supply chain inventory has moved
to a lower than usual level or that our customers, even though they continue to
look for new opportunities, are comfortable with their current domestic supply
chain.
On the other hand, our commercial synthetic product categories are not enjoying
the same trend as we are experiencing in the commercial cotton product
categories. In this business, we are suffering through what we hope is the usual
seasonal adjustment.
Our government business remains strong. The government procurement agency (DPSC)
has made significant long-term awards in support of its program to adequately
equip the standing army during these troubled times. This coupled with its
transitioning into the new uniform for the Armed Services should bring comfort
that our current military business expectations will materialize.
In the third fiscal quarter we expect to realize the first results of our
realignment plan cost reductions. As we stated earlier, there are no apparent
obstacles on the horizon, however, we recognize the risks that continue to
threaten the success of our future plans, namely:
11
o the high level of over capacity in the domestic textile industry
o the relative strength of the US dollar against other currencies
o the federal government policy respecting U. S. sourcing requirements for
military fabrics
o the Company's 9.625% Senior Notes outstanding balance of $31,941,000 due in
August 2007
o the realignment plan's dependence on predictable plant operating schedules
supported by timely customer orders in both commercial and government
product lines
o the realignment plan's dependence on the ability of the Company to retain
employees in light of the plan's pay and benefit reductions
o the realignment plan's dependence on the ability of the Company to acquire
adequate supplies of yarn and greige fabric at favorable prices
Management believes we can succeed with our realignment plan and return the
Company to profitability provided the negative consequences associated with the
above risks do not become insurmountable.
OUR 2005 REALIGNMENT PLAN.
During the second quarter of fiscal year 2005, the Company's Board of Directors
approved a comprehensive realignment plan (the Plan) that will streamline the
Company's operations and provide for significant cost reductions. The Plan was
announced on October 20, 2004 with the closing of the Estes weaving facility and
the reduction in staffing throughout the organization. The Plan also includes
capacity reductions in our commercial synthetics business and the elimination of
yarn manufacturing at our Beattie plant. Other critical aspects of the Plan that
were implemented beginning in January 2005 are the reduction in fixed
manufacturing costs, benefit cost reductions, salary pay adjustments and reduced
administrative costs.
The Plan resulted in a charge to earnings of $8,863,000 as follows:
Asset Restructuring Cost of
Total Impairment Costs Goods Sold
-------------------------------------------------------------
Asset impairment costs $3,845,000 $3,845,000
Cash restructuring costs 3,504,000 3,504,000
Estes and Beattie run-out
costs
and inventory write-down 1,514,000 1,514,000
-------------------------------------------------------------
Total $8,863,000 $3,845,000 $3,504,000 $1,514,000
-------------------------------------------------------------
The asset impairment portion of the charge was determined based on estimated
proceeds of $8,857,000 associated with asset sales agreements covering our
Catawba, Furman, and Estes plants and equipment located at these closed plants
as well as some impaired equipment located at our Beattie and Pamplico plants.
Closings for equipment sales agreements totaling $4,038,000 have been completed
through February 15, 2005. The closings for the remaining asset sales agreements
are scheduled during the third quarter of fiscal 2005 for the remaining
equipment sales and during the fourth quarter of fiscal 2005 for the real
property sales. As reported in Form 8-K filed on February 2, 2005, the larger of
the asset purchase agreements was with Gibbs International, Inc. for $7,000,000
covering the Company's Furman, Catawba and Estes plants and a portion of the
equipment located at those plants as well as equipment associated with yarn
production at the Beattie plant. The various closings for these asset purchase
agreements are subject to customary closing conditions. The closing of the sale
of the plants is further subject to completion by Gibbs of due diligence with
respect to title, survey and environmental matters. The restructuring portion of
the charge is principally for separation pay and benefits costs for the
approximately 400 terminated employees and is expected to be paid over 18 months
beginning in November 2004. The charges recorded in cost of goods sold include
$733,000 of run-out costs at the Estes plant and $781,000 for the write-off of
certain supply inventories associated with equipment to be sold.
We estimate that this aggressive cost reduction initiative will improve pretax
earnings on an annual basis by $11.0 to $16.0 million when compared to fiscal
2004 results, although there can be no assurance to this effect. The uncertainty
associated with these anticipated costs reductions relates to the Company's
performance and the industry risks described above as the detailed plan unfolds.
12
DEVELOPMENTS SINCE QUARTER END
On January 27, 2005, the Board of Directors of Delta Woodside, upon the
recommendation of the Compensation Committee of the Board, adopted a Fiscal Year
2005 Incentive Bonus Plan pursuant to which cash bonuses will, subject to
conditions set forth in the plan, be awarded to employees if Delta Mills exceeds
a minimum EBITDA target during fiscal year 2005. If Delta Mills exceeds the
minimum EBITDA target, a bonus pool is established, the amount of which is
calculated based on varying portions of the amount of EBITDA in excess of the
target, from which bonus pool cash bonuses will, subject to conditions set forth
in the plan, be paid to employees, including Delta Woodside's executive
officers, in the discretion of the Compensation Committee of the Board (as to
the executive officers) or the Company's chief executive officer (as to other
employees). For purposes of the bonus plan, EBITDA will be calculated in
accordance with the definition of that term set forth in Delta Mills' Revolving
Credit and Security Agreement dated as of March 31, 2000, as amended.
13
RESULTS OF OPERATIONS
SECOND QUARTER OF FISCAL 2005 VERSUS SECOND QUARTER OF FISCAL 2004
The following table summarizes the Company's results for the second quarter of
Fiscal 2005 versus the second quarter of Fiscal 2004. Amounts are in thousands
except for percentages.
Increase/(Decrease)
3 Months 3 Months From 2004 to 2005
Ended Ended -----------------------
1/1/2005 12/27/2003 $ %
------------------------------------------------------------
Net Sales $ 39,310 $ 48,500 $ (9,190) (18.95)%
% of Net Sales 100.00 % 100.00%
Gross Profit (Loss) (1,425) 4,413 (5,838) (132.29)%
% of Net Sales (3.63)% 9.10%
Selling, General and Administrative Expenses 2,608 2,959 (351) (11.86)%
% of Net Sales 6.63 % 6.10%
Impairment and restructuring expenses 7,350 7,350
Other Income 25 411 (386) (93.92)%
Operating Profit (Loss) (11,358) 1,865 (13,223) (709.01)%
% of Net Sales (28.89)% 3.85%
Interest Expense (1,265) (1,161) 104 8.96 %
% of Net Sales (3.22)% (2.39)%
Income (Loss) Before Income Taxes (12,623) 704 (13,327) (1893.04)%
% of Net Sales (32.11)% 1.45%
Income Tax Expense (benefit) (2,399) 417 (2,816) (675.30)%
% of Net Sales (6.10)% 0.86%
Net Income (Loss) (10,224) 287 (10,511) (3662.37)%
% of Net Sales (26.01)% 0.59%
14
NET SALES:
The 19.0% decline in net sales was the result of a 22.8% decline in unit sales
partially offset by a 5.0% increase in average sales price. The decline in unit
sales was primarily due to a decline in the Company's commercial cotton products
brought on by the high level of over capacity in the textile industry, pressure
from foreign imports and inconsistent demand at retail. The decline in unit
sales of commercial cotton products, which is the Company's lowest price product
category, accounted for the majority of the average sales price increase.
GROSS PROFIT (LOSS):
The decline in gross profit was primarily due to a decline in profit margins in
the commercial cotton and synthetic product categories. The high level of over
capacity in the textile industry, pressure from foreign imports and inconsistent
demand at retail were the primary factors contributing to the declines in profit
margin in the commercial product categories. Additionally, run-out costs and
inventory write-downs associated with the closing of the Estes plant and the
Beattie plant yarn manufacturing totaling approximately $1.5 million are
included in the 2005 gross loss. Also contributing to the decline in gross
profit were increased raw material and energy costs combined with declining cost
absorption due to lower unit volume.
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES:
The decline in selling, general and administrative expenses was primarily due to
lower salary and benefit costs due to staff reductions related to the
realignment plan and lower distribution costs associated with reduced unit
sales.
IMPAIRMENT AND RESTRUCTURING EXPENSES:
Impairment and restructuring expenses related to the Company's Realignment plan
for the current year quarter include asset impairment charges of $3.8 million
and cash restructuring expenses, primarily related to employee termination
costs, of $3.5 million.
OTHER INCOME:
Other income for the second quarter of fiscal 2005 consisted primarily of
discounts taken for early payment of accounts payable invoices. Other income for
the prior year quarter was primarily associated with asset disposals associated
with the Company's closed Furman and Catawba facilities.
OPERATING PROFIT (LOSS):
The increase in the operating loss was primarily the result of the items
discussed above.
INTEREST EXPENSE:
The average interest rate on the Company's credit facility is based on a spread
over either LIBOR or a base rate. The increase in interest expense was primarily
due to increases in interest rates in connection with the amendment of the Delta
Mills' revolving credit facility and increases in LIBOR due to changes in market
rates. The average interest rate on the revolving credit facility was 2.91% as
of December 27, 2003, compared to an average interest rate of 5.39% as of
January 1, 2005.
INCOME TAX EXPENSE (BENEFIT): The Company's net deferred tax assets at January
1, 2005 are reduced by valuation allowances. The necessity to establish
valuation allowances during the period reduces the expected income tax benefit
as a percentage of pre-tax losses.
NET INCOME (LOSS):
The increase in net loss for the second quarter of fiscal year 2005 was
primarily due to the deterioration in gross profit and impairment and
restructuring expenses as described above.
15
RESULTS OF OPERATIONS
FIRST SIX MONTHS OF FISCAL 2005 VERSUS FISCAL 2004
The following table summarizes the Company's results for the six months ended
January 1, 2005 versus the six months ended December 27, 2003. Amounts are in
thousands except for percentages.
Increase/ (Decrease)
6 Months 6 Months From 2004 to 2005
Ended Ended --------------------------
1/1/2005 12/27/2003 $ %
--------------------------------------------------------------
Net Sales $ 74,750 $ 91,081 $ (16,331) (17.93)%
% of Net Sales 100.00% 100.00%
Gross Profit (Loss) (1,116) 5,032 (6,148) (122.18)%
% of Net Sales (1.49)% 5.52%
Selling, General and Administrative Expenses 5,328 5,787 (459) (7.93)%
% of Net Sales 7.13% 6.35%
Impairment and restructuring expenses 7,350 7,350
Other Income 61 701 (640) (91.30)%
Operating Loss (13,733) (54) (13,679) (25331.48)%
% of Net Sales (18.37)% (0.06)%
Interest Expense (2,556) (2,368) 188 7.94 %
% of Net Sales (3.42)% (2.60)%
Loss Before Income Taxes (16,289) (2,422) (13,867) (572.54)%
% of Net Sales (21.79)% (2.66)%
Income Tax Benefit (3,743) (732) (3,011) (411.34)%
% of Net Sales (5.01)% (0.80)%
Net Loss (12,546) (1,690) (10,856) (642.37)%
% of Net Sales (16.78)% (1.86)%
Order Backlog $ 59,840 $ 49,489 $10,351 20.92 %
16
NET SALES:
The 17.9% decline in net sales was the result of a 20.8% decline in unit sales
partially offset by a 3.7% increase in average sales price. The decline in unit
sales was primarily due to a decline in the Company's commercial cotton products
brought on by the high level of over capacity in the textile industry, pressure
from foreign imports and inconsistent demand at retail. The decline in unit
sales of commercial cotton products, which is the Company's lowest price product
category, accounted for the majority of the average sales price increase.
GROSS PROFIT (LOSS):
The decline in gross profit was primarily due to a decline in profit margins in
the commercial cotton and synthetic product categories. The high level of over
capacity in the textile industry, pressure from foreign imports and inconsistent
demand at retail were the primary factors contributing to the declines in profit
margin in the commercial product categories. Additionally, run-out costs and
inventory write-downs associated with the closing of the Estes plant and the
Beattie plant yarn manufacturing totaling approximately $1.5 million are
included in the 2005 gross loss. Also contributing to the decline in gross
profit were increased raw material and energy costs.
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES:
The decline in selling, general and administrative expenses was primarily due to
lower salary and benefit costs due to staff reductions related to the
realignment plan and lower distribution costs associated with reduced unit
sales.
OTHER INCOME:
Other income for the first six months of fiscal 2005 consisted primarily of
discounts taken for early payment of accounts payable invoices. Other income for
the prior year six months was primarily associated with asset disposals
associated with the Company's closed Furman and Catawba facilities.
OPERATING LOSS:
The increase in the operating loss was primarily the result of the items
discussed above.
INTEREST EXPENSE:
The average interest rate on the Company's credit facility is based on a spread
over either LIBOR or a base rate. The increase in interest expense was primarily
due to increases in interest rates in connection with the amendment of the Delta
Mills' revolving credit facility and increases in LIBOR due to changes in market
rates. The average interest rate on the revolving credit facility was 2.91% as
of December 27, 2003, compared to an average interest rate of 5.39% as of
January 1, 2005.
INCOME TAX BENEFIT:
The Company's net deferred tax assets at January 1, 2005 are reduced by
valuation allowances. The necessity to establish valuation allowances during the
period reduces the expected income tax benefit as a percentage of pre-tax
losses.
NET LOSS:
The increase in net loss for the six months of fiscal year 2005 was primarily
due to the deterioration in gross profit and impairment and restructuring
expenses as described above.
ORDER BACKLOG:
The increase in the order backlog was primarily due to a recent increase in the
demand for the Company's commercial cotton products, as well as an increase in
the demand for uniform fabrics used in apparel sold to the United States
Department of Defense.
Over the last several years many of the Company's commercial customers have
shortened lead times for delivery requirements. Because of shortened lead time
coupled with inconsistent demand at retail, management believes that the order
backlog at any given point in time may not be an indication of future sales.
17
LIQUIDITY AND SOURCES OF CAPITAL
SOURCES AND USES OF CASH. The Company's primary sources of liquidity are cash
flows from operations and its revolving credit facility with GMAC. In the first
six months of fiscal year 2005, the Company used $2.2 million in cash from
operating activities principally as the result of the $12.5 million net loss
discussed above, net of non-cash impairment charges of $3.8 million.
Additionally, $1.0 million of the $3.5 million cash restructuring costs were
actually paid during the period. The changes in operating assets and liabilities
were principally the result of a $4.8 million increase in trade payables due to
the outsourcing of yarn manufacturing associated with the closing of the Estes
Plant.
Availability on the revolving credit facility was $9.2 million at January 1,
2005, and the Company was in compliance with the credit facility's financial
covenants as amended at January 1, 2005.
Capital expenditures during the first six months of fiscal years 2004 and 2005
were primarily used for the second phase of the modernization of the Company's
Delta 3 cotton finishing plant. On November 6, 2002, the Company announced that
it had started a major capital project to modernize its Delta 3 cotton finishing
plant in Wallace, S.C. This plan was divided into three phases. The first phase
consisted of the installation of a new dye range that was completed in June of
fiscal year 2003. The majority of the $6.4 million in capital expenditures for
fiscal year 2003 were for this project. The second phase consisted of the
installation of a new print range and a new prep range that was completed in
early fiscal year 2005. The majority of the $5.1 million in capital expenditures
for fiscal year 2004 were for this project. The third phase will start in fiscal
year 2005 and consists of the installation of a new dye range that will be
designed for wide fabric finishing. The majority of the $4.0 million capital
expenditures planned for fiscal year 2005 will be spent on this project,
primarily in the third and fourth quarters of fiscal year 2005, which ends on
July 2, 2005. With the completion of phases one and two of this modernization
plan, the Company is positioned to provide long-term support for its government
business and long-term support for an improved quality product for its
commercial cotton business. The completion of phase three will further enhance
the Company's ability to meet the needs of its cotton business on a cost
effective and profitable basis and compete more effectively in the industry in
2005 and beyond.
With the October 2004 amendment to the GMAC revolving credit agreement described
below and subject to completion of the Company's 2005 realignment plan discussed
above, the Company believes that the cash flows generated by its operations and
funds available under Delta Mills' credit facility should be sufficient to
service its debt, to satisfy its day-to-day working capital needs and to fund
its planned capital expenditures for the next twelve months and beyond.
DELTA MILLS' 9.625% SENIOR NOTES. On August 25, 1997, the Company issued $150
million of unsecured ten-year Senior Notes at an interest rate of 9.625%. These
notes will mature in August 2007. At January 1, 2005, the outstanding balance of
the notes was $31,941,000, unchanged from the balance at July 3, 2004.
THE GMAC REVOLVING CREDIT FACILITY. The Company has a revolving credit facility
with GMAC with a term lasting until March 2007. Borrowings under this credit
facility are based on eligible accounts receivable and inventories of the
Company. The facility is secured by the accounts receivable, inventories and
capital stock of the Company. The average interest rate on the credit facility
was 5.39% at January 1, 2005 and is based on a spread over either LIBOR or a
base rate. Borrowings under this facility were $24.1 million and $21.4 million
as of January 1, 2005 and July 3, 2004, respectively. As of January 1, 2005, the
revolver availability was approximately $9.2 million, net of the $7 million
availability reduction described below.
Prior to April 19, 2004, the GMAC credit facility had financial covenants that
required the Company to comply with a maximum leverage ratio and a minimum fixed
charge coverage ratio. As a result of the operating loss in the third quarter of
fiscal year 2004, the Company was not in compliance with the maximum leverage
ratio covenant at the end of that quarter. On April 19, 2004, GMAC granted the
Company a waiver and amendment that waived the existing default with respect to
the maximum leverage ratio covenant, temporarily amended the maximum leverage
18
ratio covenant for the fourth quarter of fiscal year 2004, and temporarily
eliminated the fixed charge coverage ratio covenant for the fourth quarter of
fiscal year 2004. The Company was in compliance with these amended covenants at
July 3, 2004. The April 2004 waiver and amendment also reduced the Company's
availability under the credit facility by $7 million for the remaining term of
the facility and increased the interest rates under the credit facility by 125
basis points; however, the interest rates will revert to their pre-amendment
levels if the Company has net income for fiscal year 2005 and no event of
default exists under the credit facility. On August 18, 2004, the Company
entered into further amendments to the GMAC credit facility pursuant to which
the maximum availability was reduced to $38 million, and the maximum leverage
ratio and fixed charge coverage ratio covenants were replaced with a minimum
EBITDA covenant. The new covenant sets required minimum EBITDA levels for each
quarter of fiscal year 2005 and provides that it will constitute an event of
default if the Company and its lender fail to agree by the end of fiscal year
2005 to minimum EBITDA levels for the remainder of the term of the revolving
credit facility. On October 18, 2004, GMAC, the lender under the Company's
revolving credit facility, agreed to an amendment to the financial covenants in
the credit facility to reduce the required minimum EBITDA levels for each
quarter of fiscal year 2005. The Company was in compliance with these amended
covenants at January 1, 2005.
RESTRICTIVE COVENANTS. The Company's credit facility contains restrictive
covenants that restrict additional indebtedness, dividends, and capital
expenditures. The payment of dividends with respect to the Company's stock is
permitted if there is no event of default and there is at least $1 of
availability under the facility. The indenture pertaining to the Company's
9.625% Senior Notes also contains restrictive covenants that restrict additional
indebtedness, dividends, and investments by the Company and its subsidiaries.
The payment of dividends with respect to the Company's stock is permitted if
there is no event of default under the indenture and after payment of the
dividend, the Company could incur at least $1 of additional indebtedness under a
fixed charge coverage ratio test. Dividends are also capped based on cumulative
net income and proceeds from the issuance of securities and liquidation of
certain investments. The Company may loan funds to Delta Woodside subject to
compliance with the same conditions. At January 1, 2005, the Company was
prohibited by these covenants from paying dividends and making loans to Delta
Woodside. During the quarter ended January 1, 2005 and the year ended July 3,
2004, the Company did not pay any dividends to Delta Woodside.
OTHER MATTERS. The Company assigns a substantial portion of its trade accounts
receivable to GMAC Commercial Finance LLC (the "Factor") under a factor
agreement. The assignment of these receivables is primarily without recourse,
provided that customer orders are approved by the Factor prior to shipment of
goods, up to a maximum for each individual account. The assigned trade accounts
receivable are recorded on the Company's books at full value and represent
amounts due to the Company from the Factor. There are no advances from the
Factor against the assigned receivables. All factoring fees are recorded in the
Company's statement of operations as incurred as a part of selling, general and
administrative expenses.
The Company has entered into agreements, and has fixed prices, to purchase
cotton for use in its manufacturing operations. At January 1, 2005, minimum
payments under these contracts with non-cancelable contract terms were $2.8
million.
During 1998, Delta Woodside received notices from the State of North Carolina
asserting deficiencies in state corporate income and franchise taxes for Delta
Woodside's 1994 - 1997 tax years. The total assessment proposed by the State
amounted to $1.5 million, which included interest and penalties at that time.
The assessment was delayed pending an administrative review of the case by the
State. In October 2002, the State proposed a settlement in which Delta Woodside
would have paid approximately 90% of the assessed amount plus a portion of
certain penalties for Delta Woodside's tax years 1994 - 2000. In January, 2005,
the North Carolina Department of Revenue (the Department) notified the Company
that the North Carolina Court of Appeals unanimously upheld the Department's
assessment of corporate income and franchise tax against A&F Trademark and eight
other holding company subsidiaries of the Limited Stores, Inc. (the Limited
Stores Case), ruling that the trademark holding companies were doing business in
the state of North Carolina for corporate income tax purposes. As a result of
the Limited Stores Case ruling, the Department proposed a Voluntary Compliance
Program (the Program) whereby the Company could pay the assessment amount for
the Company's 1994 - 1997 tax years plus interest totaling approximately $1.4
million. Under the Program, the Department would waive all penalties provided
the Company pays the tax and interest and waives all rights to a refund. Delta
Woodside rejected this offer and continued with its appeal due to management's
belief that the State's legal position is in conflict with established
principles of federal constitutional law. Delta Woodside considers all exposures
in determining probable amounts of payment and has determined that any likely
settlement will not exceed established reserves; therefore, any payment in
settlement of this matter is not expected to result in a material impact on
Delta Woodside's results of operations.
19
On January 16, 2004, based on the recommendation of the Delta Woodside
Compensation Committee, the Delta Woodside Board (with Mr. Garrett abstaining)
approved an amendment of the Delta Woodside deferred compensation plan. The
deferred compensation plan amendment provided that each participant's deferred
compensation account will be paid to the participant upon the earlier of the
participant's termination of employment or in accordance with a schedule of
payment that will pay approximately 40%, 30%, 20% and 10% of the participant's
total pre-amendment account on February 15 of 2004, 2005, 2006 and 2007,
respectively. Any such February 15 payment will be conditioned on there being no
default under the Company's Senior Note Indenture or the Company's revolving
credit facility and on compliance with the fixed charge coverage ratio test in
the Senior Note Indenture for the most recently ended four full fiscal quarters,
determined on a pro forma basis. Compliance with the fixed charge coverage ratio
test is required by the Senior Note Indenture only for the incurrence of
indebtedness or the issuance of preferred stock in certain circumstances;
however, the amendment of the deferred compensation plan requires compliance for
the scheduled payments. As a result of this amendment to the deferred
compensation plan, approximately $2.3 million, which represents the scheduled
February 15, 2005 payment, plus distributions anticipated to occur in the next
twelve months due to participant retirements, has been reclassified on the
consolidated balance sheet at January 1, 2005 from deferred compensation to
accrued employee compensation in current liabilities. The first payment of
approximately $3.1 million was made in February 2004. As of February 15, 2005,
the Company was not in compliance, for the purpose of the scheduled payment,
with the fixed charge coverage ratio test in the Senior Note Indenture for the
most recently ended four full fiscal quarters, determined on a pro forma basis.
Accordingly, any future payment in accordance with the schedule in the amendment
will be delayed until compliance is achieved.
CRITICAL ACCOUNTING POLICIES
Critical accounting policies are defined as those that are reflective of
significant judgments and uncertainties, and potentially result in materially
different results under different assumptions and conditions.
Impairment of Long - Lived Assets: In accordance with Statement of Financial
Accounting Standards (SFAS) No. 144, "Accounting for the Impairment or Disposal
of Long-Lived Assets," long-lived assets, such as property, plant and equipment,
are reviewed for impairment whenever events or changes in circumstances indicate
that the carrying amount of an asset may not be recoverable. Recoverability of
assets to be held and used is measured by a comparison of the carrying amount of
an asset to its fair value, which SFAS 144 defines as the estimated undiscounted
future cash flows expected to be generated by the asset. If the carrying amount
of an asset exceeds its SFAS 144 fair value, an impairment charge is recognized
equal to the amount by which the carrying amount of the asset exceeds the fair
value of the asset. Any impairment charge would reduce the value of the
Company's assets on its balance sheet and result in a corresponding non-cash
charge to earnings that would reduce the Company's net income on its
consolidated statement of operations. Assets to be disposed of by sale are
separately presented in the consolidated balance sheet and reported at the lower
of the carrying amount or fair value less costs to sell, and are no longer
depreciated. Estimates of future cash flows and asset selling prices are
inherently uncertain. Different estimates could result in materially different
carrying amounts.
Income Taxes: The Company accounts for income taxes under the asset and
liability method in accordance with Statement of Financial Accounting Standards
No. 109, Accounting for Income Taxes ("SFAS 109"). The Company recognizes
deferred income taxes, net of any valuation allowances, for the estimated future
tax effects of temporary differences between the financial statement carrying
amounts of existing assets and liabilities and their tax bases and net operating
loss and tax credit carryforwards. Deferred tax assets and liabilities are
measured using enacted tax rates expected to apply to taxable income in the
years in which those temporary differences are expected to be recovered or
settled. The effect on deferred tax assets and liabilities of a change in tax
rates is recognized in income in the period that includes the enactment date.
Changes in deferred tax assets and liabilities are recorded in the provision for
income taxes. As of July 3, 2004, the Company had approximately $3.7 million in
net deferred tax liabilities. As of January 1, 2005, the Company did not have
any deferred tax assets, net of valuation allowances and deferred tax
liabilities.
The Company evaluates on a regular basis the realizability of its deferred tax
assets for each taxable jurisdiction. In making this assessment, management
considers whether it is more likely than not that some portion or all of its
deferred tax assets will be realized. The ultimate realization of deferred tax
20
assets is dependent on the generation of future taxable income during the
periods in which those temporary differences become deductible. Management
considers all available evidence, both positive and negative, in making this
assessment. The Company's pre-tax operating losses in fiscal 2002, fiscal 2003,
fiscal 2004 and year-to-date fiscal 2005 represent negative evidence, which is
difficult to overcome under SFAS 109, with respect to the realizability of the
Company's deferred tax assets. In addition, management monitors and assesses the
need to change estimates with respect to tax exposure reserve items, resulting
in income tax expense increases or decreases occurring in the period of changes
in estimates.
As a result of the Company's Realignment Plan and the associated restructuring
and impairment expenses, combined with the Company's continuing pre-tax
operating losses, the Company's income tax benefit in the quarter ended January
1, 2005 would have resulted in a net deferred tax asset position. Due to the
negative evidence discussed above, the Company's net deferred tax assets are
reduced by valuation allowances.
RECENT ACCOUNTING PRONOUNCEMENTS
In November 2004, the FASB issued SFAS No. 151, "Inventory Costs". This
statement amends Accounting Research Bulletin ("ARB") No. 43, Chapter 4,
"Inventory Pricing," and removes the "so abnormal" criterion that under certain
circumstances could have led to the capitalization of these items. SFAS No. 151
requires that idle facility expense, excess spoilage, double freight and
rehandling costs be recognized as current period charges regardless of whether
they meet the criterion of "so abnormal" as defined in ARB No. 43. SFAS No. 151
also requires that allocation of fixed production overhead expenses to the costs
of conversion be based on the normal capacity of the production facilities. SFAS
No. 151 is effective for all fiscal years beginning after June 15, 2005. The
Company is currently evaluating the impact that the adoption of SFAS No. 151
will have on its consolidated financial statements.
In December 2004, the FASB issued SFAS No. 123 (revised 2004), "Share-Based
Payment" ("SFAS No. 123(R)"). SFAS No. 123(R) will require companies to measure
all employee stock-based compensation awards using a fair value method and
record such expense in its financial statements. In addition, the adoption of
SFAS No. 123(R) requires additional accounting and disclosure related to the
income tax and cash flow effects resulting from share-based payment
arrangements. SFAS No. 123(R) is effective beginning as of the first interim or
annual reporting period beginning after June 15, 2005. The Company is currently
evaluating the impact that the adoption of SFAS No. 123(R) will have on its
consolidated financial statements. The cumulative effect of adoption, if any,
will be measured and recognized in the consolidated statements of operations on
the date of adoption.
21
Item 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Commodity Risk Sensitivity
As a part of the Company's business of converting fiber to finished fabric, the
Company makes raw cotton purchase commitments and then fixes prices with cotton
merchants who buy from producers and sell to textile manufacturers. Daily price
fluctuations are minimal, yet long-term trends in price movement can result in
unfavorable pricing of cotton. Before fixing prices, the Company looks at supply
and demand fundamentals, recent price trends and other factors that affect
cotton prices. The Company also reviews the backlog of orders from customers as
well as the level of fixed price cotton commitments in the industry in general.
As of January 1, 2005, a 10% decline in market price of the Company's fixed
price contracts would have had a negative impact of approximately $0.3 million
on the value of the contracts. As of July 3, 2004, such a 10% decline would have
had a negative impact of $0.7 million. The decrease in the potential negative
impact from July 3, 2004 to January 1, 2005 is due to a lower level of fixed
price cotton commitments at the more recent date. This decline in fixed price
cotton commitments is due primarily to the Company's closing of its Estes plant
and the announced closing of its yarn manufacturing at the Beattie plant.
Interest Rate Sensitivity
The Company's revolving credit facility expiring in 2007 is sensitive to changes
in interest rates. Interest is based on a spread over LIBOR or a base rate. An
interest rate increase would have a negative impact to the extent the Company
borrows against the revolving credit facility. The impact would be dependent on
the level of borrowings incurred. As of January 1, 2005, an increase in the
interest rate of 1% would have a negative impact of approximately $241,000
annually. As of July 3, 2004, an increase in the interest rate of 1% would have
had a negative impact of approximately $214,000 annually. The increase in the
potential negative impact from July 3, 2004 to January 1, 2005 is due to the
increase in borrowings under the facility.
An interest rate change would not have an impact on the payments due under the
Company's fixed rate ten year Senior Notes.
Item 4. CONTROLS AND PROCEDURES
Disclosure controls and procedures are our controls and other procedures that
are designed to ensure that information required to be disclosed by us in the
reports that we file or submit under the Exchange Act is recorded, processed,
summarized and reported within the time periods specified in the Securities and
Exchange Commission's rules and forms. Disclosure controls and procedures
include, without limitation, controls and procedures designed to ensure that
information required to be disclosed by us in the reports that we file or submit
under the Exchange Act is accumulated and communicated to our management,
including our Chief Executive Officer and Chief Financial Officer, as
appropriate to allow timely decisions regarding required disclosure.
Evaluation of Disclosure Controls and Procedures
The Company's principal executive officer and its principal financial officer,
after evaluating the effectiveness of the Company's disclosure controls and
procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)), have
concluded that, as of January 1, 2005, the Company's disclosure controls and
procedures were adequate and effective to ensure that material information
relating to the Company and its consolidated subsidiaries would be made known to
them by others within those entities.
Changes in Internal Controls
During the quarter ended January 1, 2005, as part of the Company's Realignment
Plan, staffing reductions were made throughout the Company. These reductions
affected all functional areas, including accounting, procurement, information
technology and administrative staff at the corporate and facility level. As a
result of these staffing reductions, certain duty segregations and detail review
controls previously in place are no longer possible. Although we believe we will
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be able to develop and implement higher level review controls and other controls
that are adequate, there can be no assurance that these changes will not
materially affect the Company's internal control over financial reporting.
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PART II. OTHER INFORMATION
Item 1. Legal Proceedings (not applicable)
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds (not
applicable)
Item 3. Defaults upon Senior Securities (not applicable)
Item 4. Submission of Matters to a Vote of Security Holders (not applicable)
Item 5. Other Information (not applicable)
ENTRY INTO A MATERIAL DEFINITIVE AGREEMENT
Item 6. Exhibits
Listing of Exhibits
4.3.1.9 Amendment to Credit Agreement dated October 18, 2004 between Delta
Mills, Inc. and GMAC Commercial Finance LLC as lender and agent:
incorporated by reference to Exhibit 4.3.1.9 to the Company's Annual
Report on Form 10-K for the fiscal year ended July 3, 2004 and filed
with the Securities and Exchange Commission on October 18, 2004.
10.1 Resolution of the Board of Directors dated January 27, 2005 adopting
Fiscal Year 2005 Incentive Bonus Plan.
10.2 Asset Purchase Agreement dated January 27, 2005 by and between Delta
Mills Inc. and Gibbs International Inc.
31.1 Certification of CEO Pursuant to Section 302 of the Sarbanes-Oxley
Act of 2002.
31.2 Certification of CFO Pursuant to Section 302 of the Sarbanes-Oxley
Act of 2002.
32.1 Certification of CEO Pursuant to Section 906 of the Sarbanes-Oxley
Act of 2002.
32.2 Certification of CFO Pursuant to Section 906 of the Sarbanes-Oxley
Act of 2002.
SIGNATURES
ursuant 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.
Delta Mills, Inc.
--------------------------------------
(Registrant)
Date February 15, 2005 By:/s/ W.H. Hardman, Jr.
-------------------------- --------------------------------------------
W.H. Hardman, Jr.
Chief Financial Officer
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