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 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 333-376-17
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
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(Address of principal executive offices) (Zip Code)
864 255-4100
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(Registrant's telephone number, including area code)
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(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 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, $.01 Par Value -
100 shares as of May 13, 2005.
DELTA MILLS, INC.
INDEX
PART I. FINANCIAL INFORMATION
Page
Item 1. Financial Statements (Unaudited)
Condensed consolidated balance sheets--April 2, 2005 and July 3, 2004 3
Condensed consolidated statements of operations--
Three and nine months ended April 2, 2005 and March 27, 2004 4
Condensed consolidated statements of cash flows--
Nine months ended April 2, 2005 and March 27, 2004 5
Notes to condensed consolidated financial statements 6-10
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations 11-23
Item 3. Quantitative and Qualitative Disclosures about Market Risk 23-24
Item 4. Controls and Procedures 24
PART II. OTHER INFORMATION
Item 1. Legal Proceedings 25
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds 25
Item 3. Defaults upon Senior Securities 25
Item 4. Submission of Matters to a Vote of Security Holders 25
Item 5. Other Information 25
Item 6. Exhibits 25
SIGNATURES 26
CERTIFICATIONS 27-34
2
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
CONDENSED CONSOLIDATED BALANCE SHEETS (UNAUDITED)
Delta Mills, Inc.
(In Thousands)
April 2, 2005 July 3, 2004
----------------- -------------
ASSETS
CURRENT ASSETS
Cash and cash equivalents $ 109 $ 585
Accounts receivable:
Factor 36,470 38,613
Less allowances for returns 324 20
----------------- -------------
36,146 38,593
Inventories
Finished goods 8,785 6,613
Work in process 23,983 18,877
Raw materials and supplies 6,117 6,889
----------------- -------------
38,885 32,379
Deferred income taxes 1,760 1,113
Other assets 1,289 302
----------------- -------------
TOTAL CURRENT ASSETS 78,189 72,972
ASSETS HELD FOR SALE 2,900 2,495
PROPERTY, PLANT AND EQUIPMENT, at cost 123,492 163,032
Less accumulated depreciation 76,241 99,907
----------------- -------------
47,251 63,125
DEFERRED LOAN COSTS 265 347
----------------- -------------
$ 128,605 $ 138,939
================= =============
LIABILITIES AND SHAREHOLDERS' EQUITY
CURRENT LIABILITIES
Trade accounts payable $ 11,126 $ 7,879
Revolving credit facility 27,884 21,388
Accrued income taxes payable 13,692 13,698
Payable to affiliates 3,752 3,686
Accrued employee compensation 4,462 3,179
Accrued restructuring 1,736
Accrued and sundry liabilities 3,792 5,543
----------------- -------------
TOTAL CURRENT LIABILITIES 66,444 55,373
LONG-TERM DEBT 30,941 31,941
NON-CURRENT DEFERRED INCOME TAXES 1,760 4,853
DEFERRED COMPENSATION 617 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 (22,949) (7,348)
----------------- -------------
28,843 44,444
COMMITMENTS AND CONTINGENCIES
----------------- -------------
$ 128,605 $ 138,939
================= =============
See notes to condensed consolidated financial statements.
3
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED)
Delta Mills, Inc.
(In Thousands)
3 Mths Ended 3 Mths Ended 9 Mths Ended 9 Mths Ended
April 2, March 27, April 2, March 27,
2005 2004 2005 2004
---------------- ----------------- ----------------- ----------------
Net sales $ 40,064 $ 37,919 $ 114,814 $ 129,000
Cost of goods sold 40,192 36,242 116,058 122,291
---------------- ----------------- ----------------- ----------------
GROSS PROFIT (LOSS) (128) 1,677 (1,244) 6,709
Selling, general and administrative expenses 2,396 2,926 7,724 8,713
Impairment and restructuring expenses 7,350
Other income 321 28 382 729
---------------- ----------------- ----------------- ----------------
OPERATING LOSS (2,203) (1,221) (15,936) (1,275)
Interest expense (1,352) (1,171) (3,908) (3,539)
Gain on extinguishment of debt 500 500
---------------- ----------------- ----------------- ----------------
LOSS BEFORE INCOME TAXES (3,055) (2,392) (19,344) (4,814)
Income tax benefit (1,154) (3,743) (1,886)
---------------- ----------------- ----------------- ----------------
NET LOSS $ (3,055) $ (1,238) $ (15,601) $ (2,928)
================ ================= ================= ================
See notes to condensed consolidated financial statements.
4
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
Delta Mills, Inc.
(In Thousands)
9 Mths Ended 9 Mths Ended
April 2, 2005 March 27, 2004
----------------------- ------------------------
OPERATING ACTIVITIES
Net loss $ (15,601) $ (2,928)
Adjustments to reconcile net loss to net cash
provided by (used in) operating activities:
Depreciation 6,030 6,595
Amortization 82 83
Impairment and restructuring expenses 7,350
Gains on disposition of property
and equipment (245) (253)
Change in deferred income taxes (3,740) (1,887)
Gain on early retirement of debt (500)
Deferred compensation (527) (2,780)
Changes in operating assets and liabilities (5,159) 6,789
----------------------- ------------------------
NET CASH PROVIDED BY (USED IN)
OPERATING ACTIVITIES (12,310) 5,619
----------------------- ------------------------
INVESTING ACTIVITIES
Property, plant and equipment:
Purchases (364) (3,858)
Proceeds of dispositions 6,202 424
----------------------- ------------------------
NET CASH USED IN (PROVIDED BY)
INVESTING ACTIVITIES 5,838 (3,434)
----------------------- ------------------------
FINANCING ACTIVITIES
Proceeds from revolving lines of credit 129,579 136,497
Repayments on revolving lines of credit (123,083) (138,619)
Repurchase and retirement of long-term debt (500)
----------------------- ------------------------
NET CASH PROVIDED BY (USED IN)
FINANCING ACTIVITIES 5,996 (2,122)
----------------------- ------------------------
(DECREASE) INCREASE IN CASH
AND CASH EQUIVALENTS (476) 63
Cash and cash equivalents at beginning of period 585 520
----------------------- ------------------------
CASH AND CASH EQUIVALENTS
AT END OF PERIOD $ 109 $ 583
======================= ========================
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 nine months ended April 2, 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):
April 2, 2005 July 3, 2004
------------- ------------
Current assets $158 $ 83
Non-current assets 1 13
Current liabilities 2,461 2,275
Non-current liabilities 397 697
Stockholders' deficit (2,699) (2,876)
Summarized results of operations for the Guarantor are as follows (in
thousands):
Nine Months Ended
--------------------------------
April 2, 2005 March 27, 2004
------------- --------------
Net sales - Intercompany commissions $ 2,586 $ 2,893
Cost and expenses 2,409 2,969
Net income (loss) 177 (76)
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
April 2, 2005, the outstanding balance of the notes was $30,941,000, a decrease
of $1.0 million from the balance of $31,941,000 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 limited to the lesser of
$38 million or a "formula amount" based on eligible accounts receivable and
inventories of the Company minus a $7 million availability block. The facility
is secured by the accounts receivable, inventories and capital stock of the
Company. The average interest rate on the credit facility was 5.870% at April 2,
2005 and is based on a spread over either LIBOR or a base rate. Borrowings under
this facility were $27.9 million and $21.4 million as of April 2, 2005 and July
3, 2004, respectively. As of April 2, 2005, the revolving credit facility
availability was approximately $7.9 million, net of the $7 million availability
reduction described above.
The GMAC credit facility has financial covenants that require the Company to
achieve minimum Earnings Before Interest, Taxes, Depreciation and Amortization
(EBITDA) (as defined in the agreement) levels for each quarter of fiscal year
2005 and provides that it will constitute an event of default if the Company and
GMAC 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. If the Company has
net income for fiscal year 2005 and no event of default exists under the credit
facility, interest rates under the credit facility will be reduced by 125 basis
points. The Company was not in compliance with the minimum EBITDA covenant at
April 2, 2005 but has obtained a waiver of this violation from GMAC.
Additionally, GMAC has granted Delta Mills a conditional waiver for the fourth
quarter of fiscal 2005. The conditions of this waiver include achieving trailing
twelve months EBITDA as of fiscal 2005 year-end of negative $700,000 and
maintaining undrawn availability of at least $2.5 million for thirty consecutive
days immediately prior to and immediately subsequent to the date on which the
Company delivers to GMAC its draft financial statements for fiscal 2005. The
trailing twelve months EBITDA number of negative $700,000 is based upon the most
recent fourth quarter projection provided to GMAC with minimal tolerance for
any negative miss. Since March 27, 2004, GMAC previously granted the Company a
waiver (with respect to a predecessor covenant) and amendment on April 19, 2004
and granted the Company additional amendments on August 18, 2004 and October 18,
2004. The Company expects to negotiate additional amendments to its credit
facility with GMAC during the fourth quarter of fiscal 2005. The Company's
Senior Note Indenture provides that a payment default or an acceleration prior
to maturity due to a default under any indebtedness for money borrowed involving
a principal amount of $5 million or more (such as the Company's revolving credit
facility) would constitute an event of default under the Indenture.
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 the Company's Parent, Delta Woodside Industries, Inc. (Delta
Woodside), subject to compliance with the same conditions. At April 2, 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 nine months ended
April 2, 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
compensation plans, in accordance with the provisions of Accounting Principles
Board (APB) Opinion No. 25, "Accounting for Stock Issued to Employees," and
related interpretations. Under this method, compensation expense is recorded on
the date of the grant only if the current market price of the underlying stock
exceeded the exercise price. If the Company had determined compensation expense
at fair value, as under Statement of Financial Accounting Standards No. 123
"Accounting for Stock-Based Compensation", the Company's net loss would have
been as follows:
(In thousands) 3 Months 3 Months 9 Months 9 Months
Ended Ended Ended Ended
4/2/2005 3/27/2004 4/2/2005 3/27/2004
------------- ------------- ------------- -------------
Net loss, as reported $ (3,055) $ (1,238) $ (15,601) $ (2,928)
Add stock-based employee compensation expense
included in reported net loss, net of tax 11 26 35 47
Less total stock-based employee compensation
expense determined under fair value based
method, net of related tax effects (11) (26) (35) (47)
------------- ------------- ------------- -------------
Pro forma net loss $ (3,055) $ (1,238) $ (15,601) $ (2,928)
============= ============= ============= =============
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 Delta
Woodside 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 Delta Woodside could pay the
assessment amount for Delta Woodside's 1994 - 1997 tax years plus interest
totaling approximately $1.4 million. Under the Program, the Department would
waive all penalties provided Delta Woodside paid the tax and interest and waived
all rights to a refund. Delta Woodside rejected the Department's offers 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 the Company meeting the fixed charge coverage ratio test as defined 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 as a condition to the Company
taking certain actions (such as the incurrence of indebtedness or the issuance
of preferred stock) in certain circumstances; however, the amendment of the
deferred compensation plan adopted by the Board requires satisfaction of the
fixed charge coverage ratio test before scheduled payments are made. As a result
of this amendment to the deferred compensation plan, approximately $3.5 million,
which represents the scheduled February 15, 2005 and February 15, 2006 payments,
plus distributions anticipated to occur in the next twelve months due to
participant retirements, is classified on the consolidated balance sheet at
April 2, 2005 as 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 did not meet, for the purpose of the scheduled payment,
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 all conditions to such payment can be met.
The Compensation Committee of Delta Woodside's Board of Directors is exploring
the possibility of the Board terminating the deferred compensation plan causing
all amounts payable thereunder (approximately $4.1 million as of April 2, 2005)
to be paid to the participants at such time as the Company's financial condition
and prospects and the covenants in the GMAC credit facility and the Senior Note
Indenture make this course of action feasible. The Compensation Committee is
considering this course of action because of federal legislation enacted in late
2004 that has modified the US income tax rules governing deferred compensation
plans and as a measure to retain key employees who, in light of the general
difficulties in the textile industry, have expressed a desire to diversify their
retirement assets.
NOTE G - IMPAIRMENT AND RESTRUCTURING CHARGES
During the second quarter of fiscal 2005, the Delta Woodside Board of Directors
approved a comprehensive realignment plan. The plan was announced on October 20,
2004 with the closing of the Estes weaving facility and capacity reductions in
the Company's commercial synthetics business and the elimination of yarn
manufacturing at the Beattie plant. The Company recorded asset impairment and
restructuring charges of $7,350,000, on a pretax basis, associated with its
realignment plan during the quarter ended January 1, 2005.
ASSET IMPAIRMENT
In the second quarter of fiscal 2005, the Company recorded a $3,845,000 non-cash
asset impairment charge to write down assets to be disposed of, including real
estate and machinery, to its estimated fair value, less selling costs, of
$8,857,000. The impaired assets met the criteria under SFAS No. 144 to be
classified as assets held for sale and were reclassified as such in the
consolidated financial statements as of January 1, 2005. The valuation of these
assets was derived from asset sales agreements with third parties executed in
January 2005.
During the quarter ended April 2, 2005, the Company closed sales under certain
of the agreements for cash proceeds of $6,202,000, resulting in a decrease in
the assets held for sale to $2,900,000 at April 2, 2005 and a gain on the
disposal of assets, primarily at the Pamplico facility, of $245,000. The
remaining assets held for sale at April 2, 2005 include the Estes and Furman
plants, for which the Company has asset sales agreements that subsequently
closed in the fourth quarter of fiscal 2005 or are expected to close in fiscal
2006, respectively. There were no changes in the estimated fair value of the
impaired properties during the quarter ended April 2, 2005, and consequently, no
impairment charges were recognized during the quarter ended April 2, 2005.
9
RESTRUCTURING
The remainder of the charge recognized by the Company during the second quarter
of fiscal 2005 was for restructuring costs, which included employee termination
costs principally for separation pay and benefit costs for the approximately 400
terminated employees, as well as other expenses which included primarily
estimated contract termination costs. These expenses are expected to be paid
over eighteen months beginning in November 2004.
A roll forward of the Company's liability for restructuring is as follows:
Employee
Termination Other
Costs Expenses Total
--------------- --------------- -----------------
Restructuring charge recognized during
the quarter ended January 1, 2005 $ 3,154,229 $ 350,000 $ 3,504,229
Less payments made during the quarter
ended January 1, 2005 959,166 9,059 968,225
Less payments made during the quarter
ended April 2, 2005 754,440 45,324 799,764
--------------- --------------- -----------------
Restructuring liability at April 2, 2005 $ 1,440,623 $ 295,617 $ 1,736,240
=============== =============== =================
No restructuring charges were recognized during the quarter ended April 2, 2005.
In addition to the restructuring and impairment charges recognized by the
Company, during the quarter ended January 1, 2005 the Company recorded $781,000
in costs of goods sold for the write-off of certain supply inventories
associated with equipment to be sold.
NOTE H - GAIN ON EXTINGUISHMENT OF DEBT
For the quarter and nine month periods ended March 27, 2004, the Company did not
recognize any gains from the repurchase of debt. For the three months ended
April 2, 2005, the Company purchased $1,000,000 face amount of its 9.625% Senior
Notes for $500,000. The Company recognized a gain of $500,000 as a result of
this purchase. This gain from the repurchase of debt is included in loss before
income taxes in the accompanying 2005 condensed consolidated statement of
operations.
10
Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
Delta Mills sells a broad range of woven, finished apparel fabric, 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 to apparel manufacturers for their use in manufacturing apparel
for the United States Department of Defense. We refer to this as our "government
business" (however, Delta Mills itself has no direct contracts with the
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 federal government funding and the timing of such funding for the
purchase of military fabrics
o competitive conditions in the apparel and textile industries
o the cost of raw materials
o escalating energy costs
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 federal government policy respecting US sourcing requirements for
military fabrics
o the discovery of unknown conditions, such as environmental matters and
similar items
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.
11
MANAGEMENT OVERVIEW AND COMPANY OUTLOOK
THE CURRENT ENVIRONMENT. The WTO phased out textile and apparel quotas as of the
end of calendar year 2004 and imports of textile and apparel products surged in
many categories. The phase-out has had some negative effect on our commercial
synthetics business but it is too soon to determine what long term effect it
will have on our commercial cotton 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 quarter, we completed the implementation of substantially all of the
realignment plan that started in October of 2004. We also successfully completed
a number of the cost savings initiatives that were started during the second
quarter of fiscal 2005. However, we experienced some disappointments during the
initial implementation phase of the plan associated with product flow, operating
schedules, raw material costs, the escalating cost of energy and certain
chemical costs increases. The net result was that, while we were able to achieve
much of the savings that we anticipated from our realignment plan, other factors
caused us to have a disappointing third quarter. We will discuss this and the
expectations for the coming quarter later in this overview under the Realignment
Plan section.
THIRD QUARTER OF FISCAL YEAR 2005. Sales volume was $40.1 million for the
quarter and was slightly up over the second quarter of fiscal 2005 but fell
short of our expectations. Our commercial cotton volume improved due to higher
demand from our major customers. We believe the increase represents an increase
in market share rather than domestic growth for this business. The increase was
somewhat offset by a decline in our commercial synthetics products due to what
we believe to be timing of seasonal adjustments. Our commercial synthetics
customers' orders and assortments have been inconsistent and we are monitoring
our commercial synthetics business very closely. Our government business was
flat comparing last quarter and the prior year quarter, and we fell short of our
expectation. Federal funding for uniform purchases has been delayed, and the
transition to the new uniform has been problematic for some of our garment
manufacturer customers, causing some volatility in the order flow. However, our
order position with government products supports our expectations of future
improvements, and the fundamental indicators in our government business remain
strong. The government procurement agency (DPSC) has made significant long-term
awards in support of its program to equip the standing army adequately during
these troubled times. This coupled with its transitioning into the new uniform
for the Armed Services leads us to believe that our current military business
expectations will materialize.
We reported an operating loss of $2.2 million for the third quarter, which
compared to an operating loss of $1.2 million in the same quarter last year.
With our realignment plan, we had expected to overcome the prior year loss and
report a profit in the third quarter of this year. While we did achieve a
significant portion of our projected savings, the lack of pick-up in our
government business, the shortfall in our synthetics volume, an inability to
meet the customer's specifications for a new program for a key customer, and
significant increases in energy costs more than offset our savings for the
quarter. Also contributing to our shortfall were higher than expected raw
material costs. These losses resulted in a default under the EBITDA covenant in
our GMAC revolving credit facility and, combined with increases in inventory,
resulted in an increase in borrowings under the credit facility. GMAC has waived
this default for the third quarter and has provided a conditional waiver for the
fourth quarter; however, this increased pressure on our liquidity is an added
concern of management and has caused us to delay our planned capital
expenditures at our Delta 3 cotton finishing plant.
There is no assurance that all of these problems are behind us; however, except
for escalating energy and raw material costs and the uncertainties in our
commercial synthetic business, we expect to overcome the majority of the
problems and return to profitability in the foreseeable future. We also estimate
that our improved results will improve liquidity in order to move forward with
our planned capital expenditures at our Delta 3 finishing plant.
We expect over capacity of the domestic textile manufacturing base to continue
to affect pricing, and we expect Asia to continue to disrupt the sourcing
patterns of U. S. retailers and brands. We therefore remain diligent in our
efforts to understand the globally competitive market place and to look within
our Company in order to lower our costs and improve performance.
12
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; however, we recognize
the risks that continue to threaten the success of our future plans, namely in
the following areas:
o continued pressure from foreign imports, primarily from China
o the high level of over capacity in the domestic textile industry
o the strength of the U. S. dollar against other currencies
o the federal government policy respecting U. S. sourcing requirements for
military fabrics
o the federal government funding and the timing of such funding for the
purchase of military fabrics
o the Company's 9.625% Senior Notes' outstanding balance of $30,941,000 due
in August 2007
o the continued financial support from our vendors and GMAC
o the realignment plan's dependence on predictable plant operating schedules
supported by timely customer orders in both commercial and government
product lines
o continued high energy costs and the associated effect on the U. S. economy
o the realignment plan's dependence on the ability of the Company to retain
employees notwithstanding 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 Delta Woodside Board of
Directors approved a comprehensive realignment plan (the Plan) that streamlines
the Company's operations and will 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 staff throughout the organization. Other critical
aspects of the Plan that were initiated beginning in January 2005 are the
reduction in fixed manufacturing costs, benefit costs reductions, salary pay
adjustments and reduced administrative costs.
The Plan resulted in a second quarter charge of $8,863,000 as follows:
Asset Restructuring Cost of
Total Impairment Reserve Goods Sold
-------------------------------------------------------------
Asset impairment charge $3,845,000 $3,845,000
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 upon 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.
The restructuring portion of the charge, estimated to be approximately $3.5
million, 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.
13
Third Quarter Update.
Actual cash restructuring costs that have been paid to date are generally
consistent with our projections and total $1.8 million through the end of the
third quarter. This leaves a balance of $1.7 million that is estimated to be
paid over the next five quarters. The asset sales have also generally occurred
as expected. We signed asset sales contracts for all of the assets to be
disposed of and collected sales proceeds totaling $6.2 million during the third
quarter. To date during the fourth quarter we have collected another $1.0
million in sales proceeds. The last remaining asset to be disposed of is the
Furman plant, which is under contract to be sold for $1.9 million and is
expected to close during fiscal year 2006 pending resolution of certain
environmental issues related to an underground storage tank. Activities to date
suggest that we are on plan and do not estimate further adjustments regarding
impairment.
Using fiscal year 2004 as a base line, the realignment plan projections
consisted of $13.6 million of annual cost reduction items and $2.8 million of
annual operational improvements. Our third quarter results, on an annualized
basis, indicate that we accomplished approximately $9.7 million of the cost
reduction initiatives leaving approximately $3.9 million in annualized cost
reduction initiatives that have not materialized as of the end of the third
quarter. Our third quarter represents the first full quarter after adoption of
the realignment plan, and we expect to achieve in the fourth quarter additional
cost reductions of approximately $2.8 million on an annualized basis. On an
annualized basis, this would bring our aggregate costs reductions to $12.5
million representing a shortfall of approximately $1.1 million compared to our
original projections. This shortfall is primarily associated with timing on
expected raw material costs decreases.
Offsetting these cost reduction initiatives were operational losses in the third
quarter attributed to lower than expected operating schedules for the synthetics
product lines, a sales volume shortfall primarily due to the timing of military
fabric purchases, substantial energy cost increases, higher than expected
chemical costs and higher than expected costs to run out the operations of the
Estes weaving facility that closed in October of 2004. These negative forces
more than offset the projected savings in the third quarter.
We originally estimated our aggressive cost reduction initiative would improve
pretax earnings on an annualized basis by $11.0 to $16.0 million when compared
to fiscal 2004 results. As noted above, we believe that the measures included in
the Plan will provide us an aggregate of approximately $12.5 million of
annualized savings. However, the additional factors described above that
affected us during the third quarter will likely offset a portion of the savings
provided by the Plan. We currently estimate that the net effect of the Plan and
the other factors described above will be a net annualized improvement of
approximately $4.0 to $8.0 million although there can be no assurance to this
effect. The uncertainty associated with these anticipated cost reductions
primarily relates to the Company's manufacturing performance, the timing of
funding of military fabric purchases, improvement in the synthetics products
volume, rising energy prices, rising chemical prices, and increased raw material
costs.
We are grateful for the effort and support put forth by our employees. We are
equally grateful for the support of our lenders, shareholders, customers and
suppliers. We are committed to the success of our realignment plan and will
continue to put forth every effort to achieve our goals with respect to those
items that are under management's control.
14
RESULTS OF OPERATIONS
THIRD QUARTER OF FISCAL 2005 VERSUS THIRD QUARTER OF FISCAL 2004
The following table summarizes the Company's results for the third quarter of
Fiscal 2005 versus the third quarter of Fiscal 2004. Amounts are in thousands
except for percentages.
3 Months 3 Months Increase/ (Decrease)
Ended Ended From 2004 to 2005
-----------------------
4/2/2005 3/27/2004 $ %
--------------------------------------------------------
Net Sales $ 40,064 $ 37,919 $ 2,145 5.66%
% of Net Sales 100.00% 100.00%
Gross Profit (Loss) (128) 1,677 (1,805) (107.63)%
% of Net Sales (0.32)% 4.42%
Selling, General and Administrative Expenses 2,396 2,926 (530) (18.11)%
% of Net Sales 5.98% 7.72%
Other Income 321 28 293 1046.43%
Operating Loss (2,203) (1,221) 982 80.43%
% of Net Sales (5.50)% (3.22)%
Interest Expense (1,352) (1,171) (181) 15.46%
% of Net Sales (3.37)% (3.09)%
Gain on extinguishment of debt 500
Loss Before Income Taxes (3,055) (2,392) 663 27.72%
% of Net Sales (7.63)% (6.31)%
Income Tax Benefit (1,154) 1,154 100.00%
% of Net Sales 0.00 % (3.04)%
Net Loss $ (3,055) $ (1,238) (1,817) (146.77)%
% of Net Sales (7.63)% (3.26)%
15
NET SALES:
The 5.7% increase in net sales was the result of a 7.7% increase in unit sales
partially offset by a 1.9% decline in average sales price. The increase in unit
sales was primarily due to an increase in the Company's commercial cotton
products brought on by higher demand from our major customers. This increase in
unit sales was somewhat offset by a decline in unit sales of the Company's
commercial synthetics business. The increase 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 decline.
GROSS PROFIT (LOSS):
The decline in gross profit was primarily due to a decline in profit margins in
all commercial 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, the Company incurred a loss of
approximately $750,000 associated with an inability to meet the customer's
specifications for a new product to be produced for Levi Strauss. Also
contributing to the decline in gross profit were increased energy costs of
approximately $600,000 as well as increased raw material costs, including
certain chemicals used in dyeing and finishing. These factors were somewhat
offset by the cost reductions associated with the Company's realignment plan.
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.
OTHER INCOME:
Other income for the third quarter of fiscal 2005 was primarily associated with
the disposal of assets at the Company's Pamplico facility for cash proceeds in
excess of the carrying value of the assets. Other income for the prior year
quarter consisted primarily of discounts taken for early payment of accounts
payable invoices.
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
Company's revolving credit facility and increases in LIBOR due to changes in
market rates. Also contributing to the increase in interest expense was a higher
outstanding balance on the Company's credit facility. The average interest rate
on the revolving credit facility was 2.84% as of March 27, 2004, compared to an
average interest rate of 5.87% as of April 2, 2005.
GAIN ON EXTINGUISHMENT OF DEBT:
During the third quarter of fiscal 2005, the Company purchased $1,000,000 face
amount of its 9.625% Senior Notes for $500,000. The Company recognized a gain of
$500,000 as a result of this purchase. There were no such purchases in the prior
year quarter.
INCOME TAX BENEFIT:
The Company's net deferred tax assets at April 2, 2005 are reduced by valuation
allowances. As a result of the Company's having provided these valuation
allowances for any income tax expense (benefit) that would result from the
application of a statutory tax rate to the Company's net operating losses, no
significant income tax expense (benefit) was recognized in the third quarter of
the current year.
NET LOSS:
The increase in net loss for the third quarter of fiscal year 2005 was primarily
due to the deterioration in gross profit as described above.
16
RESULTS OF OPERATIONS
NINE MONTHS OF FISCAL 2005 VERSUS FISCAL 2004
The following table summarizes the Company's results for the nine months ended
April 2, 2005 versus the nine months ended March 27, 2004. Amounts are in
thousands except for percentages.
9 Months 9 Months Increase/ (Decrease)
Ended Ended From 2004 to 2005
-----------------------
4/2/2005 3/27/2004 $ %
--------------------------------------------------------
Net Sales $114,814 $ 129,000 $(14,186) (11.00)%
% of Net Sales 100.00% 100.00%
Gross Profit (Loss) (1,244) 6,709 (7,953) (118.54)%
% of Net Sales (1.08)% 5.20%
Selling, General and Administrative Expenses 7,724 8,713 (989) (11.35)%
% of Net Sales 6.73% 6.75%
Impairment and restructuring expenses 7,350 7,350 100.00%
Other Income 382 729 (347) (47.60)%
Operating Loss (15,936) (1,275) 14,661 1149.88%
% of Net Sales (13.88)% (0.99)%
Interest Expense (3,908) (3,539) 369 10.43%
% of Net Sales (3.40)% (2.74)%
Gain on extinguishment of debt 500
Loss Before Income Taxes (19,344) (4,814) (14,530) (301.83)%
% of Net Sales (16.85)% (3.73)%
Income Tax Benefit (3,743) (1,886) 1,857 98.46%
% of Net Sales (3.26)% (1.46)%
Net Loss $(15,601) $ (2,928) (12,673) (432.82)%
% of Net Sales (13.59)% (2.27)%
Order Backlog $ 61,930 $ 50,958 $ 10,972 21.53%
17
NET SALES:
The 11.0% decline in net sales was the result of a 12.8% decline in unit sales
partially offset by a 2.0% 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. In addition, the Company incurred a loss of
approximately $750,000 associated with an inability to meet the customer's
specifications for a new product to be produced for Levi Strauss. Also
contributing to the decline in gross profit were increased raw material costs,
including certain chemicals used in dyeing and finishing, and energy costs.
These factors were somewhat offset by the cost reductions associated with the
Company's realignment plan.
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 first nine months of fiscal 2005 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 nine months of fiscal 2005 was primarily associated with
the disposal of assets at the Company's Pamplico facility for cash proceeds in
excess of the carrying value of the assets. Other income for the prior year nine
months was primarily attributable to 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
Company's revolving credit facility and increases in LIBOR due to changes in
market rates. The average interest rate on the revolving credit facility was
2.84% as of March 27, 2004, compared to an average interest rate of 5.87% as of
April 2, 2005.
GAIN ON EXTINGUISHMENT OF DEBT:
During the nine months of fiscal 2005, the Company purchased $1,000,000 face
amount of its 9.625% Senior Notes for $500,000. The Company recognized a gain of
$500,000 as a result of this purchase. There were no such purchases in the prior
year nine months.
INCOME TAX BENEFIT:
The Company's net deferred tax assets at April 2, 2005 are reduced by valuation
allowances. As a result of the Company's having provided these valuation
allowances for any income tax expense (benefit) that would result from the
application of a statutory tax rate to the Company's net operating losses, no
significant income tax expense (benefit) was recognized in the nine months of
the current.
NET LOSS:
The increase in net loss for the nine months of fiscal year 2005 was primarily
due to the deterioration in gross profit and impairment and restructuring
expenses as described above.
18
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 fabrics in our government business.
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.
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
nine months of fiscal year 2005, the Company used $12.3 million in cash from
operating activities principally as the result of the $15.6 million net loss
discussed above, net of the non-cash asset impairment charge of $3.8 million and
$6.1 million in depreciation and amortization expense. Additionally, $1.8
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 increases of $6.5 million in inventories due primarily to customer
delays in assortments and shipments of Government fabrics, decreases of $1.8
million in accrued liabilities due to the payment of accrued interest and
property taxes on their respective due dates, somewhat offset by an increase of
$3.2 million in trade accounts payable due primarily to the outsourcing of yarn
manufacturing associated with the closing of the Estes Plant.
Availability on the revolving credit facility was $7.9 million at April 2, 2005.
The Company was not in compliance with the credit facility's financial covenant
at April 2, 2005; however the Company's credit facility lender GMAC has granted
the Company a waiver with respect to this default. Additionally, GMAC has
granted Delta Mills a conditional waiver for the fourth quarter of fiscal 2005.
The conditions of this waiver include achieving trailing twelve months EBITDA as
of fiscal 2005 year-end of negative $700,000 and maintaining undrawn
availability of at least $2.5 million for thirty consectutive days immediately
prior to and immediately subsequent to the date on which the Company delivers to
GMAC its draft financial statements for fiscal 2005. The trailing twelve months
EBITDA number of negative $700,000 is based upon the most recent fourth quarter
projection provided to GMAC with minimal tolerance for any negative miss.
Capital expenditures during the first nine 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. 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 third phase
consists of the installation of a new dye range that will be designed for wide
fabric finishing. The third phase, previously scheduled to start during the
third and fourth quarters of fiscal year 2005, has been deferred due to
operating cash requirements projected for the fourth quarter of fiscal 2005 and
the first fiscal quarter of 2006. 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. The
Company has not yet determined the exact timing of the implementation of phase
three.
For the fourth fiscal quarter of 2005, the Company anticipates increased sales
and production volumes relative to recent periods. Attainment of this increased
volume will be largely dependent on government garment manufacturers working
through the problems experienced with the transition to the new uniform and
there being no further delays in federal funding for uniform purchases. This
anticipated increase in volume is projected to occur toward the latter part of
the fourth quarter requiring an increase in working capital. The net effect of
this projected increase in volume on liquidity is a projected increase in
borrowings and a corresponding decrease in availability under the credit
facility. Availability at the end of June is estimated to be in a range of $3.0
to $5.0 million as compared to $7.9 million at April 2, 2005. Although a
material operating loss in the fourth quarter could lead to further tightening
of liquidity, the Company believes that the cash flows generated by its
operations and funds available under its credit facility should be sufficient to
service its debt and satisfy its day-to-day working capital needs.
19
During the fourth fiscal quarter of 2005, the Company expects to negotiate
amendments to its revolving credit facility with GMAC for the purpose of, among
other matters, establishing financial covenants for fiscal year 2006. Based on
discussions it has had with GMAC concerning the likely terms of these amendments
and assuming that the Company's government business achieves the anticipated
levels, for fiscal year 2006 the Company estimates that cash flows generated by
its operations and funds available under its 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 that were delayed during the third
and fourth quarters of fiscal year 2005. This expectation by the Company could
be adversely affected if the Company is unable to obtain the anticipated
amendments to its revolving credit facility or if the Company's operating
results do not improve as anticipated.
THE COMPANY'S 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 April 2, 2005, the outstanding balance of
the notes was $30,941,000, a reduction of $1,000,000 from the balance at July 3,
2004. This reduction is the result of a purchase by the Company of $1,000,000
face amount of its 9.625% Senior Notes for $500,000 during the third fiscal
quarter of 2005.
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 limited to the lesser of $38 million or a "formula amount" based on
eligible accounts receivable and inventories of the Company minus a $7 million
availability block. The facility is secured by the accounts receivable,
inventories and capital stock of the Company. The average interest rate on the
credit facility was 5.870% at April 2, 2005 and is based on a spread over either
LIBOR or a base rate. Borrowings under this facility were $27.9 million and
$21.4 million as of April 2, 2005 and July 3, 2004, respectively. As of April 2,
2005, the revolver availability was approximately $7.9 million, net of the $7
million availability reduction described above.
The GMAC credit facility has financial covenants that require the Company to
achieve minimum EBITDA levels for each quarter of fiscal year 2005 and provides
that it will constitute an event of default if the Company and GMAC 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. If the Company has net income for
fiscal year 2005 and no event of default exists under the credit facility,
interest rates under the credit facility will be reduced by 125 basis points.
The Company was not in compliance with the minimum EBITDA covenant at April 2,
2005 but has obtained a waiver of this violation from GMAC. Since March 27,
2004, GMAC previously granted the Company a waiver (with respect to a
predecessor covenant) and amendment on April 19, 2004 and granted the Company
additional amendments on August 18, 2004 and October 18, 2004. The Company
expects to negotiate additional amendments to its credit facility with GMAC
during the fourth quarter of fiscal 2005. The Company's Senior Note Indenture
provides that a payment default or an acceleration prior to maturity due to a
default under any indebtedness for money borrowed involving a principal amount
of $5 million or more (such as the Company's revolving credit facility) would
constitute an event of default under the Indenture.
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 April 2, 2005, the Company was
prohibited by these covenants from paying dividends and making loans to Delta
Woodside. During the nine months ended April 2, 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.
20
The Company has entered into agreements, and has fixed prices, to purchase
cotton for use in its manufacturing operations. At April 2, 2005, minimum
payments under these contracts with non-cancelable contract terms were $0.9
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 Delta
Woodside 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 Delta Woodside could pay the
assessment amount for Delta Woodside's 1994 - 1997 tax years plus interest
totaling approximately $1.4 million. Under the Program, the Department would
waive all penalties provided Delta Woodside paid the tax and interest and waived
all rights to a refund. Delta Woodside has rejected the Department's offers 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 the Company's results of operations.
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 the Company meeting the fixed charge coverage ratio test as defined 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 as a condition to the Company
taking certain actions (such as the incurrence of indebtedness or the issuance
of preferred stock) in certain circumstances; however, the amendment of the
deferred compensation plan adopted by the Board requires satisfaction of the
fixed charge coverage ratio test before scheduled payments are made. As a result
of this amendment to the deferred compensation plan, approximately $3.5 million,
which represents the scheduled February 15, 2005 and February 15, 2006 payments,
plus distributions anticipated to occur in the next twelve months due to
participant retirements, is classified on the consolidated balance sheet at
April 2, 2005 as 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 did not meet, for the purpose of the scheduled payment,
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 all conditions to such payment can be met.
The Compensation Committee of Delta Woodside's Board of Directors is exploring
the possibility of the Board terminating the deferred compensation plan, causing
all amounts payable thereunder (approximately $4.1 million as of April 2, 2005)
to be paid to the participants at such time as the Company's financial condition
and prospects and the covenants in the GMAC credit facility and the Senior Note
Indenture make this course of action feasible. The Compensation Committee is
considering this course of action because of federal legislation enacted in late
2004 that has modified the US income tax rules governing deferred compensation
plans and as a measure to retain key employees who, in light of the general
difficulties in the textile industry, have expressed a desire to diversify their
retirement assets.
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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 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 estimated undiscounted future cash flows expected to be generated by
the asset. If the carrying amount of an asset exceeds its estimated future cash
flows, an impairment charge is recognized as the amount by which the carrying
amount of the asset exceeds the fair value of the asset. 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.
In estimating the future undiscounted cash flows expected to be generated by
long-lived assets to be held and used, major assumptions and estimates include
expected period of operation, projected future product pricing, future raw
material costs and market supply and demand. Changes in any of these estimates
and assumptions could have a material effect on the estimated future cash flows
to be generated by the Company's assets. With the deterioration of the
competitive conditions in the textile industry, we have had changes in these
estimates and assumptions based on strategic changes in management's plan of
operations, including the planned closure and sale of three facilities: Furman,
Catawba, and Estes. As management planned for closure of each of these
facilities, it was necessary to first analyze held-for-use or held-for sale
status of the assets and project future cash flows accordingly. These changes in
assumptions have resulted in asset impairment charges in each of the last three
fiscal years. It is reasonably likely that these assumptions could change in the
future. Estimates of future cash flows and asset selling prices are inherently
uncertain. Different estimates could result in materially different carrying
amounts.
For example, when management decided to close the Furman plant in fiscal 2002,
an $8.2 million impairment charge was recognized reducing the carrying amount of
this asset from $12.1 million to $3.9 million. When the Company entered into a
contract to sell the Furman Plant real property in August 2004, the sales price,
net of selling costs, was approximately $847,000 less than the then carrying
amount resulting in an additional impairment charge of $847,000. When the
Company announced its 2005 realignment plan in November 2004, it estimated its
non-cash impairment charge would range from $5.0 to $8.0 million. The Company
revised this estimate upward in its 10-Q for the first quarter of fiscal 2005;
however, the Company subsequently contracted to sell its facilities at more
favorable sales prices for certain of its property, plant and equipment than it
initially expected, and the actual impairment charge was $3.8 million. There can
be no assurance that these numbers will represent the final charges until the
consummation of the sales of these assets, which are expected to occur in the
fourth quarter of fiscal 2005 and in fiscal 2006. If any sale does not close,
the actual net sales proceeds received in a subsequent transaction could be
lower resulting in an increase in the corresponding impairment charge.
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 April 2, 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
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 each of 2004, 2003 and
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2002 represent negative evidence, which is difficult to overcome under SFAS 109,
with respect to the realizability of the Company's deferred tax assets.
The Company's net deferred tax assets at April 2, 2005 are reduced by valuation
allowances. As a result of the Company's having provided these valuation
allowances for any income tax expense (benefit) that would result from the
application of a statutory tax rate to the Company's net operating losses, no
material income tax expense (benefit) has been recognized in the first nine
months of fiscal year 2005.
If the body of evidence considered by management in determining the valuation
allowance, including the generation of pre-tax income, were to improve, the
Company would consider reversal of the valuation allowance and record a net
deferred tax asset on its balance sheet, resulting in tax benefit on its
statement of operations for the period in which the reversal occurs. The Company
believes consummation of its restructuring plan will return it to profitability;
however, there can be no assurance to this effect.
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.
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 annual
reporting period beginning after June 15, 2005. The Company is currently
evaluating the impact that the adoption by the Company 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 statement
of operations on the date of adoption.
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 April 2, 2005, a 10% decline in market price of the Company's fixed price
contracts would have had a negative impact of approximately $0.1 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 April 2, 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 its
yarn manufacturing at the Beattie plant.
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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 April 2, 2005, an increase in the
interest rate of 1% on the amount then outstanding would have a negative impact
of approximately $279,000 annually. As of July 3, 2004, an increase in the
interest rate of 1% on the amount then outstanding would have had a negative
impact of approximately $214,000 annually. The increase in the potential
negative impact from July 3, 2004 to April 2, 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 April 2, 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
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)
Item 6. Exhibits
Listing of Exhibits
4.3.1.10 Waiver dated May 12, 2005 from GMAC Commercial Finance LLC as lender and agent to Delta Mills, Inc.
4.3.1.11 Waiver dated May 17, 2005 from GMAC Commercial Finance LLC as lender and agent to Delta Mills, Inc.
10.1.1 Resolution of the Compensation Committee of the Delta Woodside Board of Directors dated February 11, 2005
respecting Fiscal Year 2005 Incentive Bonus Plan.
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.
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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.
Delta Mills, Inc.
------------------------------------
(Registrant)
Date May 17, 2005 By: /s/ W.H. Hardman, Jr
------------------------- -------------------------------
W.H. Hardman, Jr.
Chief Financial Officer
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