ST JOHN KNITS INTERNATIONAL INC - 10-Q Quarterly Report

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 30, 2005

¨	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 333-73107

ST. JOHN KNITS INTERNATIONAL, INCORPORATED

(Exact name of registrant as specified in its charter)


Delaware		52-2303510
(State or other jurisdiction of incorporation or organization)		(I.R.S. Employer Identification Number)

17622 Armstrong Avenue Irvine, California		92614
(Address of principal executive offices)		(Zip Code)

Registrant’s telephone number, including area code: (949) 863-1171

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 Exchange Act Rule 12b-2). Yes ¨ No x

The number of outstanding shares of Registrant’s Common Stock, par value $0.01 per share, was 6,289,953 shares as of March 15, 2005.

PART I. FINANCIAL INFORMATION

Item 1. Financial Statements

ST. JOHN KNITS INTERNATIONAL, INCORPORATED

CONSOLIDATED BALANCE SHEETS

(unaudited)


	January 30, 2005			October 31, 2004
A S S E T S
Current assets:
Cash and cash equivalents	$	33,559,040		$	17,849,345
Accounts receivable, net		19,405,942			28,781,108
Inventories		67,270,435			71,345,303
Deferred income tax benefit		16,300,707			16,300,707
Other		5,646,015			4,628,858

Total current assets		142,182,139			138,905,321

Property and equipment:
Machinery and equipment		71,777,608			71,506,561
Leasehold improvements		57,600,946			50,517,924
Buildings		5,914,519			5,886,369
Furniture and fixtures		18,599,069			18,445,000
Land		1,729,891			1,729,891
Construction in progress		1,059,872			1,619,851

		156,681,905			149,705,596
Less - Accumulated depreciation and amortization		100,483,256			94,994,072

		56,198,649			54,711,524

Deferred financing costs, net		4,451,450			4,930,633
Deferred income tax benefit		2,973,150			3,473,541
Other assets		7,097,698			5,975,857

	$	212,903,086		$	207,996,876

LIABILITIES AND STOCKHOLDERS’ DEFICIT
Current liabilities:
Accounts payable	$	7,579,656		$	13,454,759
Accrued expenses		27,154,838			25,373,965
Current portion of long-term debt		18,180,507			18,180,507
Accrued interest expense		2,545,968			4,120,612
Income taxes payable		6,356,890			4,867,728

Total current liabilities		61,817,859			65,997,571

Long-term debt, net of current portion (Note 5)		189,098,699			189,062,174
Other liabilities		13,560,584			9,559,774

Total liabilities		264,477,142			264,619,519

Redeemable common stock, par value $0.01 per share; issued and outstanding - 712,696 shares		30,289,580			26,369,752

Commitments and contingencies (Note 8)
Stockholders’ deficit:
Common stock, par value $0.01 per share; authorized - 10,000,000 shares, issued and outstanding - 5,577,257 shares		55,772			55,772
Additional paid-in capital		106,863,305			110,783,133
Cumulative foreign currency translation adjustment		1,057,058			1,014,980
Unrealized loss on hedging transactions		(80,319	)		(106,258	)
Accumulated deficit		(189,759,452	)		(194,740,022	)

Total stockholders’ deficit		(81,863,636	)		(82,992,395	)

	$	212,903,086		$	207,996,876

See accompanying notes.

ST. JOHN KNITS INTERNATIONAL, INCORPORATED

CONSOLIDATED STATEMENTS OF INCOME AND COMPREHENSIVE INCOME

(unaudited)


	Thirteen Weeks Ended
	January 30, 2005			February 1, 2004
Net sales	$	99,934,321		$	103,626,353
Cost of sales		43,757,806			47,330,955

Gross profit		56,176,515			56,295,398
Selling, general and administrative expenses		42,597,092			43,233,143

Operating income		13,579,423			13,062,255
Interest expense		5,198,754			5,556,564
Other income (expense)		(181,561	)		114,021

Income before income taxes		8,199,108			7,619,712
Income taxes		3,218,538			1,546,194

Net income	$	4,980,570		$	6,073,518

Comprehensive income, net of tax:

Net income	$	4,980,570		$	6,073,518
Foreign currency translation adjustments		443,283			357,636
Unrealized loss on hedging transactions		(31,552	)		—

Comprehensive income	$	5,392,301		$	6,431,154

Net income per common share:
Basic	$	0.79		$	0.94

Diluted	$	0.77		$	0.94

Shares used in the calculation of net income per common share:
Basic		6,289,953			6,456,619

Diluted		6,438,342			6,456,619

See accompanying notes.

ST. JOHN KNITS INTERNATIONAL, INCORPORATED

CONSOLIDATED STATEMENTS OF CASH FLOWS

(unaudited)


	Thirteen Weeks Ended
	January 30, 2005			February 1, 2004
Cash flows from operating activities:
Net income	$	4,980,570		$	6,073,518
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization		3,766,232			4,253,362
Amortization of discount on 12.5% notes due 2009		34,600			34,600
Amortization of deferred financing costs		479,183			550,438
Deferred income tax benefit		500,391			—
Loss (gain) on disposal of property and equipment		93,990			(87,701	)
Partnership losses		294,417			215,542
Changes in operating assets and liabilities:
Decrease in accounts receivable		9,375,166			7,606,712
(Increase) decrease in inventories		4,074,868			(4,556,223	)
Increase in other current assets		(1,017,157	)		(580,539	)
Increase in other assets		(1,505,006	)		(71,559	)
Decrease in accounts payable		(5,875,103	)		(627,500	)
Increase in accrued expenses		1,148,847			169,240
Decrease in accrued interest expense		(1,574,644	)		(3,073,206	)
Increase in income taxes payable		1,489,162			12,638
Increase in other liabilities		136,818			143,258

Net cash provided by operating activities		16,402,334			10,062,580

Cash flows from investing activities:
Proceeds from sale of property and equipment		2,500			2,147,820
Purchase of property and equipment		(683,003	)		(1,603,834	)
Capital distributions from partnership		85,000			120,000

Net cash (used in) provided by investing activities		(595,503	)		663,986

Cash flows from financing activities:
Principal payments of long-term debt		—			(5,548,712	)

Net cash used in financing activities		—			(5,548,712	)

Effect of exchange rate changes		(97,136	)		270,251

Net increase in cash and cash equivalents		15,709,695			5,448,105
Beginning balance, cash and cash equivalents		17,849,345			19,265,499

Ending balance, cash and cash equivalents	$	33,559,040		$	24,713,604

ST. JOHN KNITS INTERNATIONAL, INCORPORATED

CONSOLIDATED STATEMENTS OF CASH FLOWS (CONTINUED)

(unaudited)


	Thirteen Weeks Ended
	January 30, 2005		February 1, 2004
Supplemental disclosures of cash flow information:
Cash received for interest income	$	93,175	$	85,566

Cash paid for:
Interest expense	$	6,250,657	$	8,031,312

Income taxes	$	1,831,935	$	1,554,459

Supplemental disclosures of noncash financing and investing activities:
Adjustment of redeemable common stock to fair value	$	3,919,828	$	(1,978,565	)

Unrealized loss on hedging transactions	$	25,939	$	—

See accompanying notes.

ST. JOHN KNITS INTERNATIONAL, INCORPORATED

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)

1. Basis of Presentation and Company Operations

The accompanying unaudited consolidated financial statements of St. John Knits International, Incorporated (“SJKI”) and its subsidiaries, including St. John Knits, Inc. (“St. John”), reflect all adjustments (which include only normal recurring adjustments) considered necessary to present fairly the financial position, results of operations and cash flows for the periods presented. SJKI and its subsidiaries are collectively referred to herein as “the Company”. The accompanying unaudited consolidated financial statements and notes thereto should be read in conjunction with the financial statements and notes included in the Company’s Annual Report on Form 10-K for the year ended October 31, 2004 as filed with the Securities and Exchange Commission on January 31, 2005.

The results of operations for the periods presented are not necessarily indicative of the operating results that may be expected for the year ending October 30, 2005.

Company Operations

The Company is a leading designer, manufacturer and marketer of women’s clothing and accessories. The Company’s products are distributed primarily through specialty retailers and company-owned retail boutiques and outlet stores in the United States and internationally. All intercompany and interdivisional transactions and accounts have been eliminated.

Definition of Fiscal Year

The Company utilizes a 52-53 week fiscal year whereby the fiscal year ends on the Sunday nearest to October 31. The quarters also end on the Sunday nearest the end of the quarter, which accordingly were January 30, 2005 and February 1, 2004.

Dividends

SJKI has not paid any cash dividends to its common stockholders since 1999 and does not anticipate the payment of any cash dividends on its common stock in the future.

Reclassifications

During the first quarter of fiscal 2005, the Company reclassified the unamortized balance of its tenant improvement allowances received from landlords from leasehold improvements to other liabilities and accrued expenses on the accompanying balance sheet. The Company had previously reported leasehold improvements net of any tenant improvement allowances received. The Company reclassified approximately $4.6 million in net tenant allowances from leasehold improvements. The current portion of the deferred rent liability of approximately $0.7 million was recorded as an addition to accrued expenses, while the balance of $3.9 million was included in other long-term liabilities. Future amortization of the deferred rent liability balance will be recorded as a reduction to rent expense and will be offset by a similar increase to amortization expense for leasehold improvements. This reclassification had no impact on the Company’s statements of income and management determined that such adjustment was not significant to its statements of cash flows and balance sheets for its prior fiscal years.

2. Stock Option Plan

The Company has one stock-based employee compensation plan, the 1999 St. John Knits International, Incorporated Stock Option Plan (the “Plan”). Options granted under the Plan are

ST. JOHN KNITS INTERNATIONAL, INCORPORATED

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

(unaudited)

nonstatutory stock options. Stock options are granted with an exercise price equal to or greater than the fair market value of the stock on the date of grant. The Company accounts for the Plan under the recognition and measurement principles of Accounting Principles Board (“APB”) Opinion No. 25 “Accounting for Stock Issued to Employees, and Related Interpretations”. No stock-based employee compensation cost is reflected in net income, as all options granted under the Plan have an exercise price equal to or greater than the estimated fair market value of the underlying common stock on the date of grant. The following table illustrates the effect on net income and earnings per common share if the Company had applied the fair value recognition provisions of Statement of Financial Accounting Standards (“SFAS”) No. 123, “Accounting for Stock-Based Compensation”.


	Thirteen Weeks Ended
	January 30, 2005		February 1, 2004
Net income, as reported	$	4,980,570	$	6,073,518

Less: total stock-based employee compensation expense determined under the fair value method for all awards, net of related tax effects		146,391		112,287

Pro forma net income	$	4,834,179	$	5,961,231

Earnings per common share:
Basic – as reported	$	0.79	$	0.94
Basic – pro forma	$	0.77	$	0.92
Diluted – as reported	$	0.77	$	0.94
Diluted – pro forma	$	0.75	$	0.92

3. Earnings Per Common Share

Basic earnings per common share is computed by dividing income allocated to common stockholders by the weighted average number of common shares outstanding, excluding the dilutive effect of common stock equivalents, including stock options. Diluted earnings per common share includes all dilutive items and is calculated based upon the treasury stock method, which assumes that all dilutive securities were exercised and that the proceeds received were applied to repurchase outstanding shares at the average market price during the period.

The following is a reconciliation of the Company’s weighted average shares outstanding for the purpose of calculating basic and diluted earnings per common share for all periods presented:


	Thirteen Weeks Ended
	January 30, 2005	February 1, 2004
Weighted average shares outstanding	6,289,953	6,456,619
Add: dilutive effect of stock options	148,389	—

Shares used to calculate diluted earnings per share	6,438,342	6,456,619

ST. JOHN KNITS INTERNATIONAL, INCORPORATED

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

(unaudited)

4. Inventories

Inventories are comprised of the following:


	January 30, 2005		October 31, 2004
Raw materials	$	14,418,635	$	15,686,238
Work-in-process		10,437,943		11,904,165
Finished products		42,413,857		43,754,900

	$	67,270,435	$	71,345,303

5. Long-term Debt


	January 30, 2005		October 31, 2004
Long-term debt consists of the following:
Senior credit facility:
Tranche A	$	—	$	—
Tranche B		107,837,799		107,837,799

		107,837,799		107,837,799
Senior subordinated 12.5% notes, net of discount		99,392,666		99,358,066
Other		48,741		46,816

		207,279,206		207,242,681
Less – Current portion		18,180,507		18,180,507

	$	189,098,699	$	189,062,174

6. Debt Refinancing

The Company is currently finalizing its negotiations with lenders to refinance its outstanding indebtedness, including redeeming its 12.5% Senior Subordinated Notes due 2009. In addition, the Company plans to use up to $13.5 million of the proceeds to purchase shares of common stock from trusts controlled by the Gray Family.

7. Recent Accounting Pronouncements

In November 2004, the Financial Accounting Standards Board (“FASB”) issued SFAS No. 151, “Inventory Costs, an amendment of ARB No. 43, Chapter 4,” to clarify that abnormal amounts of idle facility expense, freight, handling costs and wasted material (spoilage) should be recognized as current period charges, and that fixed production overheads should be allocated to inventory based on normal capacity of production facilities. This statement is effective for the Company’s fiscal year 2006. The Company is in the process of evaluating whether the adoption of SFAS 151 will have a significant impact on its overall results of operations or financial position.

In December 2004, the FASB issued SFAS No. 123(R) “Share-Based Payment.” SFAS 123(R) requires the recognition of compensation cost relating to share-based payment transactions in financial statements. That cost will be measured based on the fair value of the equity or liability instruments issued as of the grant date, based on the estimated number of awards that are expected to vest. SFAS 123(R) covers a wide range of share-based compensation arrangements including share options, restricted share

ST. JOHN KNITS INTERNATIONAL, INCORPORATED

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

(unaudited)

plans, performance-based awards, share appreciation rights, and employee share purchase plans. SFAS 123(R) replaces SFAS No. 123, “Accounting for Stock-Based Compensation,” and supersedes APB Opinion No. 25, “Accounting for Stock Issued to Employees.” SFAS 123(R) is effective for interim periods that begin after June 15, 2005. The Company is allowed to select from three alternative transition methods, each having different reporting implications. The Company has not completed its evaluation or determined the impact of adopting SFAS 123(R).

8. Commitments and Contingencies

During the normal course of business, the Company has made certain indemnities, commitments and guarantees under which it may be required to make payments in relation to certain transactions. These indemnities include those given to various lessors in connection with facility leases for certain claims arising from such facility or lease. The Company has also issued guarantees, in the form of letters of credit, to cover contractual commitments, including merchandise purchases from foreign vendors and to secure the payment for potential future workers’ compensation claims. The Company had $16.5 million of letters of credit outstanding at January 30, 2005. Of this total, $15.6 million is related to potential future workers’ compensation claims. The Company has accrued a liability for the estimated claims, both reported and incurred but not yet reported, on the accompanying consolidated balance sheets. The duration of these indemnities, commitments and guarantees varies and in certain cases is indefinite. The majority of these indemnities, commitments and guarantees do not provide for any limitation of the maximum potential future payments the Company could be obligated to make. The Company has not recorded any significant liabilities for these indemnities, commitments and guarantees in the accompanying consolidated balance sheets other than as noted.

The Company is involved from time to time in litigation incidental to its business. Management believes that the outcome of any current litigation will not have a material effect upon the results of operations or financial condition of the Company.

9. Segment Information

The Company has two reportable business segments, wholesale and retail sales. The Company’s wholesale sales business consists primarily of six product lines; Knitwear, Sport, Shoes, Jewelry, Accessories and Home Accessories. Retail sales were primarily generated through the Company’s boutiques and outlet stores. Management evaluates segment performance based primarily on revenue and earnings from operations. Inter-segment sales are recorded at the Company’s wholesale selling prices and eliminated, along with any profit in ending inventory, through the eliminations column. Interest expense, the equity in the net income of investees accounted for by the equity method and income taxes are not allocated to the segments. The Company’s chief operational decision making group is presently comprised of the Chief Executive Officer and the Chief Financial Officer.

ST. JOHN KNITS INTERNATIONAL, INCORPORATED

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

(unaudited)

Segment information is summarized as follows for the periods indicated:


	Wholesale		Retail		Eliminations			Total
	(in thousands)
First Quarter Fiscal 2005
Net sales	$	77,736	$	42,611	$	(20,413	)	$	99,934
Operating income		12,766		1,797		(984	)		13,579
Capital expenditures		469		214		—			683
Depreciation and amortization		2,241		1,525		—			3,766

First Quarter Fiscal 2004
Net sales	$	84,219	$	46,177	$	(26,770	)	$	103,626
Operating income		17,279		607		(4,824	)		13,062
Capital expenditures		759		845		—			1,604
Depreciation and amortization		2,428		1,825		—			4,253

10. Supplemental Condensed Consolidated Financial Information

The Company’s payment obligations under the senior subordinated notes are guaranteed by certain of the Company’s wholly-owned subsidiaries (the “Guarantor Subsidiaries”). Such guarantees are full, unconditional and joint and several. Except for restrictions under applicable law, there are no material restrictions on distributions from the Guarantor Subsidiaries to SJKI. Separate financial statements of the Guarantor Subsidiaries are not presented because the Company’s management has determined that they would not be material to investors. The following supplemental financial information sets forth, on an unconsolidated basis, balance sheet, statement of income, and statement of cash flow information for the Parent Company (consisting of SJKI and St. John), for the Guarantor Subsidiaries and for the Company’s other subsidiaries (the “Non-Guarantor Subsidiaries”). During the third quarter of fiscal 2003, the Company set up a new entity to hold its retail operations. The new company operates under the name of St. John Apparel, LLC and is a Guarantor Subsidiary. The supplemental financial information reflects the investments of the Parent Company in the Guarantor Subsidiaries and Non-Guarantor Subsidiaries using the equity method of accounting. The supplemental financial information is presented for the periods as of January 30, 2005 and October 31, 2004, and for the 13 weeks ended January 30, 2005 and February 1, 2004.

ST. JOHN KNITS INTERNATIONAL, INCORPORATED

SUPPLEMENTAL CONDENSED CONSOLIDATING BALANCE SHEET

JANUARY 30, 2005

(UNAUDITED)


(Amounts in thousands)	PARENT COMPANY			GUARANTOR SUBSIDIARIES		NON-GUARANTOR SUBSIDIARIES			ELIMINATIONS			CONSOLIDATED
ASSETS

Current assets:
Cash and cash equivalents	$	31,969		$	428	$	1,162		$	—		$	33,559
Accounts receivable, net		15,560			2,093		1,753						19,406
Inventories (1)		22,617			38,799		5,854						67,270
Deferred income tax benefit		16,301					—						16,301
Other		4,935			532		179						5,646
Intercompany accounts receivable		11,520			—					(11,520	)		—

Total current assets		102,902			41,852		8,948			(11,520	)		142,182

Property and equipment, net		21,851			25,504		8,844						56,199
Investment in subsidiaries		53,649					—			(53,649	)		—
Receivable from consolidated subsidiaries		21,984					—			(21,984	)		—
Deferred financing costs		4,451					—						4,451
Deferred income tax benefit		2,973											2,973
Other assets		4,105			947		2,046						7,098

Total assets	$	211,915		$	68,303	$	19,838		$	(87,153	)	$	212,903

LIABILITIES AND STOCKHOLDERS’ EQUITY (DEFICIT)

Current liabilities:
Accounts payable	$	7,363		$	—	$	216		$	—		$	7,579
Accrued expenses		23,056			3,986		113						27,155
Current portion of long-term debt		18,180					—						18,180
Accrued interest expense		2,546											2,546
Intercompany accounts payable					—		11,520			(11,520	)		—
Income taxes payable		10,593					(4,236	)					6,357

Total current liabilities		61,738			3,986		7,613			(11,520	)		61,817

Intercompany payable					9,599		12,385			(21,984	)		—
Long-term debt, net of current portion		189,051					48						189,099
Other liabilities		12,700			861								13,561
Deferred income tax liability		—			—		—						—

Total liabilities		263,489			14,446		20,046			(33,504	)		264,477

Redeemable common stock		30,290					—						30,290

Total stockholders’ equity (deficit)		(81,864	)		53,857		(208	)		(53,649	)		(81,864	)

Total liabilities and stockholders’ equity (deficit)	$	211,915		$	68,303	$	19,838		$	(87,153	)	$	212,903

(1)	Inventories are shown at cost (without intercompany profits) for all entities

ST. JOHN KNITS INTERNATIONAL, INCORPORATED

SUPPLEMENTAL CONDENSED CONSOLIDATING BALANCE SHEET

OCTOBER 31, 2004


(Amounts in thousands)	PARENT COMPANY			GUARANTOR SUBSIDIARIES		NON-GUARANTOR SUBSIDIARIES			ELIMINATIONS			CONSOLIDATED
ASSETS

Current assets:
Cash, cash equivalents and investments	$	16,677		$	483	$	689		$	—		$	17,849
Accounts receivable, net		23,230			3,517		2,034						28,781
Inventories (1)		24,026			41,880		5,439						71,345
Deferred income tax benefit		16,301											16,301
Prepaid expenses and other		3,976			495		158						4,629
Intercompany accounts receivable		9,750								(9,750	)		—

Total current assets		93,960			46,375		8,320			(9,750	)		138,905

Property and equipment, net		18,927			26,908		8,876						54,711
Investment in subsidiaries		54,757								(54,757	)		—
Receivable from consolidated subsidiaries		28,265								(28,265	)		—
Deferred financing costs		4,931											4,931
Deferred income tax benefit		3,474											3,474
Other assets		2,966			1,036		1,974						5,976

Total assets	$	207,280		$	74,319	$	19,170		$	(92,772	)	$	207,997

LIABILITIES AND STOCKHOLDERS’ EQUITY (DEFICIT)

Current liabilities:
Accounts payable	$	12,768		$	—	$	687		$	—		$	13,455
Accrued expenses		22,278			3,084		12						25,374
Current portion of long-term debt		18,180											18,180
Accrued interest expense		4,120											4,120
Intercompany accounts payable							9,750			(9,750	)		—
Income taxes payable		8,689					(3,821	)					4,868

Total current liabilities		66,035			3,084		6,628			(9,750	)		65,997

Intercompany payable		—			16,147		12,118			(28,265	)		—
Long-term debt, net of current portion		189,015					47						189,062
Other liabilities		8,852			708								9,560

Total liabilities		263,902			19,939		18,793			(38,015	)		264,619

Redeemable common stock		26,370											26,370

Total stockholders’ equity (deficit)		(82,992	)		54,380		377			(54,757	)		(82,992	)

Total liabilities and stockholders’ equity (deficit)	$	207,280		$	74,319	$	19,170		$	(92,772	)	$	207,997

(1)	Inventories are shown at cost (without intercompany profits) for all entities

ST. JOHN KNITS INTERNATIONAL, INCORPORATED

SUPPLEMENTAL CONDENSED CONSOLIDATING STATEMENT OF INCOME

THIRTEEN WEEKS ENDED JANUARY 30, 2005

(UNAUDITED)


(Amounts in thousands)	PARENT COMPANY			GUARANTOR SUBSIDIARIES			NON-GUARANTOR SUBSIDIARIES			ELIMINATIONS		CONSOLIDATED
Net sales	$	53,505		$	42,148		$	4,281		$	—	$	99,934
Cost of sales		19,475			22,100			2,183					43,758

Gross profit		34,030			20,048			2,098			—		56,176
Selling, general and administrative expenses		19,288			20,549			2,760					42,597

Operating income (loss)		14,742			(501	)		(662	)		—		13,579
Interest expense		5,199											5,199
Other income (expense)		(136	)		(21	)		(25	)				(182	)

Income (loss) before income taxes		9,407			(522	)		(687	)		—		8,198
Income taxes		3,525			—			(307	)				3,218

Income (loss) before equity in loss of consolidated subsidiaries		5,882			(522	)		(380	)		—		4,980
Equity in loss of consolidated subsidiaries		(902	)								902		—

Net income (loss)	$	4,980		$	(522	)	$	(380	)	$	902	$	4,980

ST. JOHN KNITS INTERNATIONAL, INCORPORATED

SUPPLEMENTAL CONDENSED CONSOLIDATING STATEMENT OF INCOME

THIRTEEN WEEKS ENDED FEBRUARY 1, 2004

(UNAUDITED)


(Amounts in thousands)	PARENT COMPANY			GUARANTOR SUBSIDIARIES			NON-GUARANTOR SUBSIDIARIES			ELIMINATIONS		CONSOLIDATED
Net sales	$	54,179		$	45,747		$	3,700		$	—	$	103,626
Cost of sales		21,035			24,452			1,844					47,331

Gross profit		33,144			21,295			1,856			—		56,295

Selling, general and administrative expenses		17,722			23,134			2,377					43,233

Operating income (loss)		15,422			(1,839	)		(521	)		—		13,062

Interest expense		5,556											5,556
Other income (expense)		185			(40	)		(31	)				114

Income (loss) before income taxes		10,051			(1,879	)		(552	)		—		7,620
Income taxes		1,890			—			(344	)				1,546

Income (loss) before equity in loss of consolidated subsidiaries		8,161			(1,879	)		(208	)		—		6,074
Equity in loss of consolidated subsidiaries		(2,087	)								2,087		—

Net income (loss)	$	6,074		$	(1,879	)	$	(208	)	$	2,087	$	6,074

ST. JOHN KNITS INTERNATIONAL, INCORPORATED

SUPPLEMENTAL CONDENSED CONSOLIDATING STATEMENT OF CASH FLOWS

THIRTEEN WEEKS ENDED JANUARY 30, 2005

(UNAUDITED)


(Amounts in thousands)	PARENT COMPANY			GUARANTOR SUBSIDIARIES			NON-GUARANTOR SUBSIDIARIES			ELIMINATIONS			CONSOLIDATED
OPERATING ACTIVITIES:

Net income (loss)	$	4,980		$	(522	)	$	(380	)	$	902		$	4,980
Adjustments to reconcile net income (loss) to net cash provided by operating activities:
Depreciation and amortization		2,010			1,499			257						3,766
Amortization of discount on 12.5% notes due 2009		35												35
Amortization of deferred loan costs		479												479
Increase in deferred income tax benefit		500												500
(Gain) loss on disposal of property and equipment		73			21			—						94
Partnership losses		294												294
Equity in loss of consolidated subsidiaries		902									(902	)		—
Changes in operating assets and liabilities:
Accounts receivable		7,675			1,423			277						9,375
Intercompany receivables (net)		4,759			(6,549	)		1,790						—
Inventories		1,408			3,082			(415	)					4,075
Other current assets		(960	)		(37	)		(20	)					(1,017	)
Other assets		(1,523	)		89			(71	)					(1,505	)
Accounts payable		(5,404	)					(471	)					(5,875	)
Accrued expenses		145			903			101						1,149
Accrued interest expense		(1,574	)											(1,574	)
Income taxes payable		1,905						(416	)					1,489
Other liabilities		(16	)		153									137

Net cash provided by operating activities		15,688			62			652			—			16,402


INVESTING ACTIVITIES:

Proceeds from sale of prperty and equipment		—			3									3
Purchase of property and equipment		(434	)		(120	)		(129	)					(683	)
Capital distributions from partnership		85						—						85

Net cash used in investing activities		(349	)		(117	)		(129	)		—			(595	)

FINANCING ACTIVITIES:
Net cash used in financing activities		—			—			—			—			—

Effect of exchange rate changes		(47	)					(50	)					(97	)

Net increase in cash and cash equivalents		15,292			(55	)		473						15,710
Beginning balance, cash and cash equivalents		16,677			483			689						17,849

Ending balance, cash and cash equivalents	$	31,969		$	428		$	1,162		$	—		$	33,559

Supplemental disclosures of cash flow information:
Cash received for interest income	$	93		$	—		$	—		$	—		$	93

Cash paid for:
Interest expense	$	6,251		$	—		$	—		$	—		$	6,251

Income taxes	$	1,832		$	—		$	—		$	—		$	1,832

Supplemental disclosures of noncash financing activities:

Unrealized loss on hedging transactions	$	(26	)	$	—		$	—		$	—		$	(26	)

Adjustment of redeemable common stock to fair value	$	3,920		$	—		$	—		$	—		$	3,920

ST. JOHN KNITS INTERNATIONAL, INCORPORATED

SUPPLEMENTAL CONDENSED CONSOLIDATING STATEMENT OF CASH FLOWS

THIRTEEN WEEKS ENDED FEBRUARY 1, 2004

(UNAUDITED)


(Amounts in thousands)	PARENT COMPANY			GUARANTOR SUBSIDIARIES			NON-GUARANTOR SUBSIDIARIES			ELIMINATIONS			CONSOLIDATED
OPERATING ACTIVITIES:

Net income (loss)	$	10,248		$	(1,879	)	$	(208	)	$	(2,087	)	$	6,074
Adjustments to reconcile net income (loss) to net cash provided by operating activities:
Depreciation and amortization		2,166			1,801			286						4,253
Amortization of discount on 12.5% notes due 2009		35												35
Amortization of deferred loan costs		550												550
(Gain) loss on disposal of property and equipment		(132	)		44									(88	)
Partnership losses		215												215
Equity in loss of consolidated subsidiaries		(2,087	)								2,087			—
Changes in operating assets and liabilities:
Accounts receivable		7,471			1			135						7,607
Intercompany receivables (net)		1,130			(1,043	)		(87	)					—
Inventories		(5,486	)		1,442			(512	)					(4,556	)
Other current assets		(688	)		128			(21	)					(581	)
Other assets		(7	)		(5	)		(59	)					(71	)
Accounts payable		(627	)											(627	)
Accrued expenses		(1,685	)		341			1,513						169
Accrued interest expense		(3,073	)											(3,073	)
Income taxes payable		357						(344	)					13
Other liabilities		(59	)		202									143

Net cash provided by operating activities		8,328			1,032			703			—			10,063

INVESTING ACTIVITIES:

Proceeds from sale of property and equipment		2,148												2,148
Purchase of property and equipment		(584	)		(813	)		(207	)					(1,604	)
Capital distributions from partnership		120												120

Net cash used in investing activities		1,684			(813	)		(207	)		—			664

FINANCING ACTIVITIES:

Principal payments of long-term debt		(5,549	)											(5,549	)

Net cash used in financing activities		(5,549	)		—			—			—			(5,549	)

Effect of exchange rate changes		217						53						270

Net increase in cash and cash equivalents		4,680			219			549						5,448
Beginning balance, cash and cash equivalents		18,492			306			467						19,265

Ending balance, cash and cash equivalents	$	23,172		$	525		$	1,016		$	—		$	24,713

Supplemental disclosures of cash flow information:
Cash received for interest income	$	86		$	—		$	—		$	—		$	86

Cash paid for:
Interest expense	$	8,028		$	—		$	3		$	—		$	8,031

Income taxes	$	1,554		$	—		$	—		$	—		$	1,554

Supplemental disclosures of noncash financing activities:
Adjustment of redeemable common stock to fair value	$	(1,979	)	$	—		$	—		$	—		$	(1,979	)

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

Management’s discussion and analysis should be read in conjunction with the Company’s consolidated financial statements and the notes related thereto.

Results of Operations

The following table is derived from the Company’s Consolidated Statements of Income and sets forth, for the periods indicated, the results of operations as a percentage of net sales:


	Percentage of Net Sales Thirteen Weeks Ended (“First Quarter”)
	January 30, 2005		February 1, 2004
Net sales	100.0	%	100.0	%
Cost of sales	43.8		45.7

Gross profit	56.2		54.3
Selling, general and administrative expenses	42.6		41.7

Operating income	13.6		12.6
Interest expense	5.2		5.4
Other income (expense)	(0.2	)	0.1

Income before income taxes	8.2		7.3
Income taxes	3.2		1.5

Net income	5.0	%	5.8	%

First Quarter Fiscal 2005 Compared to First Quarter Fiscal 2004

Net sales for the first quarter of fiscal 2005 decreased by $3.7 million, or 3.6% as compared to the first quarter of fiscal 2004. This decrease was principally attributable to (i) a decrease in sales by company-owned retail outlet stores of approximately $3.0 million, primarily due to the postponement of the Company’s annual warehouse sale from November 2004 to February 2005, (ii) a decrease in sales to domestic wholesale customers of approximately $1.9 million, primarily due to a decrease in the sale of non-apparel products resulting from the decision during the fourth quarter of fiscal 2004 to stop selling the non-apparel product lines to wholesale customers and a decrease in sales to Saks due to the closure of 11 Saks stores during the first quarter of fiscal 2005 and (iii) a decrease in sales by company-owned retail boutiques of approximately $0.6 million, due to a reduction in the sale of non-apparel merchandise resulting from lower non-apparel inventory levels during the period. These decreases were partially offset by an increase in international sales of approximately $1.5 million, primarily due to increased sales to wholesale customers in Europe and expanding operations in Hong Kong and Japan. Net sales for company-owned retail boutiques open at least one year decreased by 2.3% for the first quarter of fiscal 2005 as compared to the first quarter of fiscal 2004. The decrease in net sales was primarily due to a decrease in the units sold during the first quarter of fiscal 2005 as compared to the same period of the prior year.

Gross profit for the first quarter of fiscal 2005 decreased by $0.1 million, or 0.2% as compared with the first quarter of fiscal 2004, but increased as a percentage of net sales to 56.2% from 54.3%. This increase as a percentage of net sales was primarily due to (i) an increase in the gross profit margin for the Sport product line, due to a change in the mix of products being manufactured and sold, (ii) an increase in the gross profit margin for sales at the company-owned retail outlets due to the postponement of the Company’s annual warehouse sale and (iii) an increase in the percentage of net sales contributed by the company-owned retail boutiques, which on a consolidated basis have a higher gross profit margin than sales to wholesale customers.

Selling, general and administrative expenses for the first quarter of fiscal 2005 decreased by $0.6 million, or 1.5% from the first quarter of fiscal 2004, but increased as a percentage of net sales to 42.6% from 41.7%. Selling, general and administrative expenses decreased during the period primarily due to a decrease in advertising and promotion expenses of approximately $0.9 million.

Operating income for the first quarter of fiscal 2005 increased by $0.5 million, or 4.0% as compared to the first quarter of fiscal 2004. Operating income as a percentage of net sales increased to 13.6% from 12.6% during the same period. This increase in operating income as a percentage of net sales was due to an increase in the gross profit margin for the period which was partially offset by an increase in selling, general and administrative expenses as a percentage of net sales.

Interest expense for the first quarter of fiscal 2005 decreased by $0.4 million, or 6.4% from the first quarter of fiscal 2004. This decrease was primarily due to a decrease in the average debt balance from the first quarter of fiscal 2004.

Income taxes for the first quarter of fiscal 2005 increased by $1.7 million over the first quarter of fiscal 2004. The tax rate increased from 20.3% to 39.3% during the same period. The tax rate for the first quarter of fiscal 2004 was lower than usual due to an adjustment recorded during that period to reduce the Company’s tax liability for potential income tax audit issues which were resolved during the period.

Liquidity and Capital Resources

The Company’s primary cash requirements are to fund payments required to service the Company’s debt, to fund the Company’s working capital needs, primarily inventory and accounts receivable, and for the purchase of property and equipment. During the first quarter of fiscal 2005, cash provided by operating activities was $16.4 million. Cash provided by operating activities was primarily generated by net income, a decrease in accounts receivable and inventories, while cash used in operating activities was primarily used to fund a decrease in accounts payable. The decrease in accounts receivable was due to lower wholesale sales in January 2005 as compared to October 2004. The decrease in inventories was primarily due to a decrease in both raw materials and work in process for the Knits division. The Company has been working to reduce its raw material and work in process inventories from the balances on hand at the end of fiscal 2004. Cash used in investing activities was $0.6 million during the first quarter of fiscal 2005. The principal use of cash in investing activities was for upgrades to the Company’s manufacturing operations, including the purchase of electronic knitting machines.

As of January 30, 2005, the Company had approximately $80.4 million in working capital and $33.6 million in cash and cash equivalents. The Company’s principal source of liquidity is internally generated funds. As part of its credit facility with a syndicate of banks, the Company also has a $25.0 million revolving commitment, which expires on July 31, 2005. The revolving commitment is secured and borrowings thereunder bear interest at the Company’s choice of the bank’s borrowing rate (5.25% at January 30, 2005) plus 1.75% or LIBOR (2.56% at January 30, 2005) plus 2.75%. The availability of funds under the revolving commitment is subject to the Company’s continued compliance with certain covenants, including a covenant that sets the maximum amount the Company can spend annually on the

acquisition of fixed or capital assets, and certain financial covenants, including a maximum leverage ratio, a minimum fixed charge coverage ratio and a minimum interest expense coverage ratio. As of January 30, 2005, the Company was in compliance with all covenants and no amounts were outstanding under the revolving commitment. The Company had $16.5 million of letters of credit outstanding at January 30, 2005 which reduces the amount available under the revolving commitment by a corresponding amount. The Company is currently finalizing its negotiations with lenders to replace its revolving commitment. The Company invests its excess cash in a money market fund.

Total debt outstanding remained constant during the period at $207.3. The Company’s outstanding debt was comprised of bank borrowings of $107.8 million and senior subordinated 12.5% notes (“12.5% notes”) of $100.0 million, excluding the unamortized issue discount of $0.6 million.

The Company’s primary ongoing cash expenditures are for debt service and the purchase of property and equipment. The Company’s debt service requirements consist primarily of principal and interest payments on bank borrowings and interest on the 12.5% notes. The Company believes it will be able to finance its debt service and capital investment requirements with internally generated funds and availability under the revolving credit facility through fiscal 2005. Beyond fiscal 2005, the Company will have a significant increase in the principal payments required on its bank borrowings resulting from the maturity of its senior credit facilities. As a result, the Company will probably need to raise additional capital or refinance such debt in order to satisfy its obligations. The Company’s ability to fund its primary ongoing cash expenditures and to comply with all of the financial covenants under its debt agreements depends on its future operating performance and cash flow, which in turn are subject to prevailing economic conditions and to financial, business and other factors, some of which are beyond the Company’s control. The Company is currently finalizing its negotiations with lenders to refinance its outstanding indebtedness, including redeeming its 12.5% notes.

During the normal course of business, the Company has made certain indemnities, commitments and guarantees under which it may be required to make payments in relation to certain transactions. These indemnities include those given to various lessors in connection with facility leases for certain claims arising from such facility or lease. The Company has also issued guarantees, in the form of letters of credit, to cover contractual commitments, including merchandise purchases from foreign vendors and to secure the payment for potential future workers’ compensation claims. The Company had $16.5 million of letters of credit outstanding at January 30, 2005. Of this total, $15.6 million is related to potential future workers’ compensation claims. The Company has accrued a liability for the estimated claims, both reported and incurred but not yet reported. The duration of these indemnities, commitments and guarantees varies and in certain cases is indefinite. The majority of these indemnities, commitments and guarantees do not provide for any limitation of the maximum potential future payments the Company could be obligated to make. The Company has not recorded any significant liabilities for these indemnities, commitments and guarantees in the accompanying consolidated balance sheets other than as noted.

The Company anticipates purchasing property and equipment of approximately $13.9 million during the remainder of fiscal 2005, but is not contractually committed to do so. The $13.9 million will be used principally for (i) the purchase and implementation of a new point of sale computer system for the retail division, (ii) upgrades to the Company’s manufacturing operations, including the purchase of electronic knitting machines, (iii) remodeling and refurbishment costs related to the Company’s retail locations and (iv) upgrades to the Company’s computer systems.

SJKI must rely on distributions, loans and other intercompany cash flows from its subsidiaries to generate the funds necessary to satisfy the repayment of its outstanding loans. There are no material restrictions on distributions to the Company from the Company’s wholly owned subsidiaries that have guaranteed the Company’s payment obligations under its 12.5% notes.

The Company is currently finalizing its negotiations with lenders to refinance its outstanding indebtedness, including redeeming its 12.5% notes due 2009. In addition, the Company plans to use up to $13.5 million of the proceeds to purchase shares of common stock from trusts controlled by the Gray Family. Following the redemption of the 12.5% notes, the Company will no longer file with the Securities and Exchange Commission the reports required to be filed under Section 15(d) of the Securities Exchange Act of 1934, as amended. Accordingly, it is expected that the Company’s common stock will cease to be eligible for quotation on the OTC Bulletin Board.

SJKI has not paid any cash dividends since 1999 and does not anticipate the payment of any cash dividends on its common stock in the future. SJKI’s ability to pay dividends is restricted by the terms of its senior secured credit facilities and 12.5% notes.

The Company’s debt covenant EBITDA (“EBITDA” which is defined in the Company’s credit agreement for its senior secured credit facilities as net income, excluding the effects of interest expense, income taxes, depreciation and a majority of the items included in other income and expense) was approximately $17.8 million and $17.7 million for the first quarter of fiscal 2005 and 2004, respectively. EBITDA as defined by the Company may not be consistent with similarly titled measures of other companies. EBITDA is not a defined term under generally accepted accounting principles (“GAAP”) and is not an alternative to operating income or cash flow from operations as determined under GAAP. EBITDA is used to calculate certain covenants under the Company’s credit agreement, including a maximum leverage ratio and minimum fixed charge and interest expense coverage ratios. The Company believes that EBITDA provides additional information for determining its ability to meet future debt service requirements; however, EBITDA should not be construed as an indication of the Company’s operating performance or as a measure of liquidity.

The table below shows the reconciliation from net income to EBITDA (as adjusted per the terms of the credit agreement) for the first quarter of fiscal years 2005 and 2004:


	Thirteen Weeks Ended
	January 30, 2005		February 1, 2004
	(in thousands)
Net income	$	4,981	$	6,074
Income taxes		3,219		1,546
Interest expense		5,199		5,557
Other (income) expense		182		(114	)
Depreciation and amortization		3,766		4,253
Deferred rent expense		199		143
Licensing income		125		142
Accrued letter of credit fees		120		113

Debt covenant EBITDA	$	17,791	$	17,714

Off-Balance Sheet Arrangements

The Company does not have any off-balance sheet arrangements within the meaning of Securities and Exchange Commission regulation S-K Item 303(a)(4).

Credit Facility

The Company is a party to a credit agreement with a syndicate of banks, which initially provided for an aggregate principal amount of loans totaling $215.0 million. The credit agreement consists of three facilities: (i) tranche A facility totaling $75.0 million, (ii) tranche B facility totaling $115.0 million which matures July 31, 2007 and (iii) the revolving credit facility totaling $25.0 million which matures July 31, 2005.

Borrowings under the tranche A facility and the revolving credit facility bear interest at a floating rate, which is based upon the leverage ratio of the Company, but cannot exceed the bank’s borrowing rate plus 1.75% or LIBOR plus 2.75%. Borrowings under the tranche B facility bear interest at a floating rate, which is also based upon the leverage ratio of the Company, but cannot exceed the bank’s borrowing rate plus 2.75% or LIBOR plus 3.75%. In addition, the Company is required to pay a commitment fee on the unused portion of the revolving credit facility of up to 0.5% per year.

Borrowings under the tranche A facility began to mature quarterly on November 2, 1999, while borrowings under the tranche B facility began to mature quarterly on November 2, 2000. The credit agreement permits the Company to prepay loans and to permanently reduce revolving credit commitments, in whole or in part, at any time. In addition, the Company is required to make mandatory prepayments of the tranche A and B facilities, subject to certain exceptions, in amounts equal to (i) 75% of excess cash flow (as defined in the Company’s credit agreement); (ii) 75% of the net cash proceeds of a permitted asset sale (as defined in the Company’s credit agreement) and (iii) 100% of the net cash proceeds of certain dispositions of assets or issuances of debt or equity of the Company or any of its subsidiaries (in each case, subject to certain exceptions and subject to a reduction to zero based upon the Company’s financial performance). The tranche A facility was retired in July 2004.

The obligations of the Company under the credit agreement are guaranteed by each domestic subsidiary of the Company, and to the extent no adverse tax consequences would result from such guarantees, each foreign subsidiary of the Company. The credit agreement and the related guarantees are secured by (i) a pledge of 100% of the capital stock of each domestic subsidiary of the Company and 65% of each foreign subsidiary of the Company and (ii) a security interest in, and mortgage on, substantially all the assets of the Company and each domestic subsidiary of the Company and to the extent no adverse tax consequences would result therefrom, each foreign subsidiary of the Company.

The credit agreement requires the Company to comply with specified financial ratios, including a minimum interest coverage ratio, a maximum leverage ratio and a minimum fixed charge coverage ratio. Each ratio is calculated using EBITDA. In the event of non-compliance with any of these ratios, the Company would be in default under the credit agreement. The credit agreement also contains additional covenants that, among other things, restrict the ability of the Company to dispose of assets, incur additional indebtedness, pay dividends, create liens on assets, make investments, loans or advances and engage in mergers or consolidations. The credit agreement prohibits the Company from declaring or paying any dividends or making any payments with respect to the Company’s 12.5% notes if it fails to perform its obligations under, or fails to meet the conditions of, the credit agreement or if such payment creates a default under the credit agreement. The credit agreement contains customary events of default. In the event of default, the total amount of the outstanding debt plus any accrued interest would become immediately due and payable. At January 30, 2005, the Company was in compliance with all covenants.

Senior Subordinated 12.5% Notes

In addition to the credit facilities described above, the Company has $100.0 million of 12.5% notes outstanding. The 12.5% notes are unsecured and mature on July 1, 2009. The 12.5% notes bear interest at a rate of 12.5% per year and were issued at 98.616% of the actual face value. Interest on such notes is payable semiannually to the holders of record. The notes are subject to redemption by the Company on or after July 1, 2004 at a premium starting at 6.25% and decreasing to zero at July 1, 2008. The indenture governing the notes limits, among other things, the payment of dividends, the incurrence of additional indebtedness and other restricted payments. The indenture contains customary events of default.

Redeemable Common Stock

SJKI is a party to a stockholders’ agreement with Vestar/Gray Investors, LLC, Vestar Capital Partners III, L.P. and the Gray family, which states, among other things, that prior to a public offering of SJKI common stock, if Bob Gray ceases to serve as Chairman or Chief Executive Officer of St. John or SJKI or if the employment with SJKI of Marie Gray or Kelly Gray ceases for any reason, then he or she will have the right to require SJKI to purchase the shares of SJKI common stock beneficially owned by them, at fair value, up to a maximum of $5.0 million of such common stock for all the Grays during any 12 month period. If any of the Grays are terminated without “cause” or resigns for “good reason,” as these terms are defined in their employment agreements with the Company, then he or she will have the right to require SJKI to purchase the shares of SJKI common stock beneficially owned by them, up to a maximum of 25% of the total shares held by such terminated or resigning Gray employee during any 12 month period. This agreement may be limited by the terms of the agreements related to the credit facilities and the senior subordinated notes.

The value of the Company’s redeemable common stock, as reported on the Company’s Consolidated Balance Sheets, is based upon the quoted market price on the OTC Bulletin Board quotation system. The increase from $26.4 million at October 31, 2004 to $30.3 million at January 30, 2005 is a result of an increase in the quoted price.

Critical Accounting Policies

The Company’s consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States. As such, the Company is required to make estimates and assumptions that affect the reported amounts of assets and liabilities at the balance sheet dates and the reported amounts of revenue and expense during the reporting periods. Actual results could significantly differ from such estimates.

The Company believes that the following accounting policies are among the most critical because they involve significant judgments and uncertainties and could potentially result in materially different results under different assumptions and conditions.

Inventories

Inventories are stated at the lower of the cost to purchase and/or manufacture the inventory or the current estimated market value (lower of cost or market). The Company regularly reviews its inventory quantities on hand and records a provision for excess and obsolete inventory based primarily on the Company’s estimated forecast of product demand and production requirements. Any significant change in the anticipated demand for the Company’s products could cause the Company to revise its estimate of excess and obsolete inventory, which could affect the Company’s reported results.

Revenue Recognition

Sales to the Company’s wholesale customers are recognized when the goods are shipped and title passes. Sales are recognized upon purchase by customers at the Company’s retail store locations at the point of sale. The Company has recorded reserves to estimate sales returns by customers based on historical sales return results. Actual return rates have historically been within management’s expectations and the reserves established. However, in the unlikely event that the actual rate of sales returns by customers changes significantly, the Company’s reported results could be affected.

Wholesale Markdowns

The Company has arrangements with some of its major wholesale customers which may result in the Company reimbursing them for markdowns. The Company records an estimate of its liability under these arrangements at the time of sale, based upon historical experience. These estimates are based in part on projected sales and markdowns for these customers. While historical experience has been within management’s expectations, any significant variation from the projected sales or markdowns could cause the Company to change its estimates. Any such change in the Company’s estimates could affect the Company’s reported results.

Long-lived Assets

During the normal course of business, the Company acquires tangible long-lived assets. The Company periodically evaluates the recoverability of the carrying amount of these assets. An impairment is assessed when the undiscounted expected future cash flows derived from an asset are less than its carrying amount. Impairments are recognized in operating income as they are realized. The Company uses its best judgment, based upon the most current facts and circumstances surrounding the specific assets, when applying these impairment rules. Changes in the assumptions used could have a significant impact on the Company’s assessments of the recoverability. Many factors, including changes to the Company’s business and the global economy, could significantly impact management’s decision to retain or dispose of certain of its long-lived assets.

Foreign Currency Translation

The Company sells its products to wholesale customers located in various parts of Europe in the customers’ local currencies, Euros and British Pounds. The Company also purchases its shoes, leather goods and various other raw material items from vendors located in Europe in Euros. Fluctuations in the exchange rates can have an effect on the sales revenues and expenses recorded in connection with such transactions. For fiscal years 2004 and 2003, the Company made the decision to allow its sales and purchases to act as a natural hedge. This decision was based upon the fact that the sales and purchases made in the foreign currencies were similar in amounts over each of the fiscal years. The Company has made a decision to hedge its sales made in Euros and Pounds for the first six months of fiscal 2005 through the purchase of forward contracts. The forward contracts were purchased based upon a percentage of the estimated sales for the period. The Company has not hedged any of its purchases to be made in Euros. Future changes in the exchange rates will continue to affect the Company’s reported results.

Accounts Receivable

The Company performs ongoing credit evaluations of its wholesale customers and adjusts credit limits based upon payment history and the customer’s current financial status. The Company continuously monitors its customer payments and maintains a provision for estimated credit losses based upon the Company’s historical experience and any specific customer collection issues that have been identified. The Company’s accounts receivable are concentrated in the apparel industry, primarily with

its three major wholesale customers. The risk of collection is concentrated within this industry and with these specific customers. As a result of this concentration, a change in the creditworthiness of the companies within the apparel industry could cause the Company to revise its estimate of credit losses, which could affect the Company’s reported results.

Insurance Program

The Company is partially self-insured for its workers’ compensation insurance coverage. Under this insurance program the Company is liable for a deductible of $500,000 for each individual claim. The Company records a liability for the estimated cost of claims both reported and incurred but not reported based upon its historical experience. The estimated costs include the estimated future cost of all open claims. The Company will continue to adjust the estimates as the actual experience dictates. A significant change in the number or dollar amount of claims could cause the Company to revise its estimate of potential losses and affect its reported results.

Inflation

The Company does not believe that inflation had a material impact on the sales reported for the first quarter of fiscal year 2005.

Forward Looking Statements

This Quarterly Report on Form 10-Q contains certain statements which describe the Company’s beliefs concerning future business conditions and the outlook for the Company based on currently available information. Wherever possible, the Company has identified these “forward looking” statements (as defined in Section 21E of the Securities Exchange Act of 1934) by words such as “anticipates”, “believes”, “estimates”, “expects” and other similar expressions. The forward looking statements and associated risks set forth herein may include or relate to: (i) the Company’s anticipated purchases of property and equipment during the remainder of fiscal 2005, (ii) the Company’s belief that it will be able to fund its debt service, working capital and capital expenditure requirements with internally generated funds and the use of its revolving credit facility through fiscal 2005, (iii) the Company’s anticipation that it will not pay cash dividends on its common stock in the future and (iv) the Company’s expectations regarding its ability to refinance its long-term debt during the first half of fiscal 2005.

These forward looking statements are subject to risks, uncertainties and other factors which could cause the Company’s actual results, performance or achievements to differ materially from those expressed in, or implied by, these statements. In addition to the factors that may be described in this report, the following factors could cause actual results to differ from those expressed in any forward looking statements made by the Company: (i) the financial strength of the retail industry and the level of consumer spending for apparel and accessories, (ii) the financial health of the Company’s principal customers, (iii) the Company’s ability to develop, market and sell its products, (iv) competition from other manufacturers and retailers of women’s clothing and accessories, (v) general economic conditions and (vi) the ability of the Company to meet the financial covenants under its credit facilities and indenture. The Company undertakes no obligation to review or update publicly any forward looking statement.

Item 3. Quantitative and Qualitative Disclosures About Market Risk

The Company has exposure to fluctuations in foreign currency exchange rates for the revenues derived from sales to its foreign customers denominated in foreign currency. In order to reduce the effects of such fluctuations, under established risk management practices, the Company may enter into foreign exchange forward contracts. These contractual arrangements are entered into with a major financial institution. The Company does not hold derivative financial instruments for speculative trading. The primary business objective of this program is to secure the anticipated profit on sales denominated in foreign currencies. The Company’s primary exposure to foreign exchange fluctuation is on the Euro and British Pound. At January 30, 2005, the Company held contracts maturing to May 31, 2005 to sell 1.3 million Euros and 400,000 Pounds at an average exchange rate of 1.21 U.S. dollars to the Euro and 1.78 U.S. dollars to the Pound. The total tax effected fair value at January 30, 2005 was $(80,000) which was recorded as a component of stockholders’ equity and comprehensive income.

The Company also purchases its shoes and leather goods, as well as various other raw materials, from companies located in Europe. The purchase of these items is completed in Euros. In order to reduce the effect of the fluctuation in the exchange rate between the Euro and the U.S. dollar, the Company may enter into forward contracts. The Company did not hold any forward contracts to purchase Euros at January 30, 2005.

The Company is also exposed to market risks related to fluctuations in interest rates on its bank borrowings under the credit agreement. The Company also holds fixed rate subordinated notes. For fixed rate debt, changes in interest rates generally affect the fair market value, but not earnings or cash flows. Conversely, for variable rate debt, changes in interest rates generally do not influence fair market value, but do affect future earnings and cash flows. The Company has managed its exposure to changes in interest rates by issuing part of its debt with a fixed interest rate. Assuming that the balance of variable rate debt remains constant, a one percentage point increase in the interest rate from the first day of the year would result in an annual increase in interest expense of approximately $1.1 million.

Item 4. Controls and Procedures

The Company maintains disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended (the “Exchange Act”)) that are designed to ensure that information required to be disclosed in the Company’s reports filed under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission rules and forms, and that such information is accumulated and communicated to the Company’s management, including the Company’s Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure. In designing and evaluating the disclosure controls and procedures, management recognized that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives, and management necessarily was required to apply its judgment in evaluating the cost-benefit relationship of possible controls and procedures.

The Company carried out an evaluation under the supervision and with the participation of management, including its Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of its disclosure controls and procedures as of January 30, 2005, the end of the period covered by this report. Based on that evaluation, the Company’s Chief Executive Officer and Chief Financial Officer concluded that the Company’s disclosure controls and procedures were effective at the reasonable assurance level as of January 30, 2005.

There have been no changes in the Company’s internal control over financial reporting (as defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) during the quarter ended January 30, 2005 that materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.

PART II. OTHER INFORMATION

Item 1. Legal Proceedings

None

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds

None

Item 3. Defaults upon Senior Securities

None

Item 4. Submission of Matters to a Vote of Security Holders

None

Item 5. Other Information

None

Item 6. Exhibits

(a) Exhibits required by Item 601 of Regulation S-K.


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 Pursuant to 18 U.S.C. Section 1350, As Adopted Pursuant to Section 906 of The Sarbanes-Oxley Act of 2002 – Chief Executive Officer

32.2		Certification Pursuant to 18 U.S.C. Section 1350, As Adopted Pursuant to Section 906 of The Sarbanes-Oxley Act of 2002 – Chief Financial Officer

SIGNATURES

Pursuant to the requirements of Section 13 or 15(d) 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.

Date: March 15, 2005


ST. JOHN KNITS INTERNATIONAL, INCORPORATED (REGISTRANT)

By:		/s/ RICHARD COHEN
		Richard Cohen
		Chief Executive Officer
		(Principal Executive Officer)

By:		/s/ ROGER G. RUPPERT
		Roger G. Ruppert
		Executive Vice President-Finance and Chief Financial Officer (Principal Financial Officer and Principal Accounting Officer)

EXHIBIT INDEX


Exhibit Number		Description of Exhibit
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 Pursuant to 18 U.S.C. Section 1350, As Adopted Pursuant to Section 906 of The Sarbanes-Oxley Act of 2002 – Chief Executive Officer

32.2		Certification Pursuant to 18 U.S.C. Section 1350, As Adopted Pursuant to Section 906 of The Sarbanes-Oxley Act of 2002 – Chief Financial Officer