10-Q 1 form10q.txt UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, DC 20549 FORM 10-Q (X) QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended March 29, 2003. ( ) TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from ________________ to ________________ Commission file number 333-24189 -------------------- GFSI, INC. ---------- (Exact name of registrant specified in its charter) Delaware 74-2810748 ------------------------------- ------------------- (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No.) 9700 Commerce Parkway Lenexa, Kansas 66219 ---------------------------------------- (Address of principal executive offices) Registrant's telephone number, including area code (913) 888-0445 -------------- Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. (1) Yes (X) No ( ) (2) Yes (X) No ( ) Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act). Yes ( ) No (X) Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date: Common stock, $0.01 par value per share - 1 share issued and outstanding as of May 1, 2003. 1 GFSI, INC. AND SUBSIDIARIES Quarterly Report on Form 10-Q For the Quarter Ended March 29, 2003 INDEX Page ---- PART I - FINANCIAL INFORMATION ITEM 1 - CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) Consolidated Balance Sheets 3 Consolidated Statements of Income 4 Consolidated Statements of Cash Flows 5 Notes to Consolidated Financial Statements 6 ITEM 2 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS 11 ITEM 3 - QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK 15 ITEM 4 - CONTROLS AND PROCEDURES 15 PART II - OTHER INFORMATION 16 SIGNATURE PAGE 17 OFFICERS CERTIFICATION 18 2
GFSI, INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS (UNAUDITED) (In thousands, except share data) March 29, June 29, 2003 2002 -------------- ------------- ASSETS Current assets: Cash and cash equivalents $ 1,257 $ 313 Accounts receivable, net 30,299 32,626 Inventories, net 42,116 45,729 Prepaid expenses and other current assets 1,455 1,269 Deferred income taxes 1,132 845 ----------- ---------- Total current assets 76,259 80,782 Property, plant and equipment, net 20,219 19,671 Other assets: Deferred financing costs, net 3,191 3,873 Investment in parent company bonds 9,900 -- Other 259 1,010 ------------ ---------- Total assets $ 109,828 $ 105,336 ============ ========== LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIENCY) Current liabilities: Accounts payable $ 9,123 $ 12,010 Accrued interest expense 1,189 4,366 Accrued expenses 5,784 5,983 Income taxes payable 7,393 5,087 Current portion of long-term debt 241 177 ------------ ---------- Total current liabilities 23,730 27,623 Deferred income taxes 1,151 699 Other long-term obligations 499 527 Long-term debt, less current portion 160,578 156,132 Stockholders' equity (deficiency): Common stock, $.01 par value, 10,000 shares authorized, one share issued and outstanding at March 29, 2003 and June 29, 2002 -- -- Additional paid-in capital 59,127 59,127 Accumulated deficiency (135,257) (138,772) ------------ ---------- Total stockholders' deficiency (76,130) (79,645) ------------ ---------- Total liabilities and stockholders' equity (deficiency) $ 109,828 $ 105,336 ============ ========== See notes to consolidated financial statements. 3 GFSI, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF INCOME (UNAUDITED) (In thousands) Quarter Ended Nine Months Ended March 29, March 29, March 29, March 29, 2003 2002 2003 2002 ------------ ------------ ------------ ------------ Net sales $ 41,204 $ 41,520 $ 157,048 $ 147,897 Cost of sales 25,983 26,258 99,536 92,348 ------------ ------------ ------------ ------------ Gross profit 15,221 15,262 57,512 55,549 Operating expenses: Selling 6,047 6,603 20,422 18,553 General and administrative 6,571 6,753 20,050 19,662 ------------ ------------ ------------ ------------ 12,618 13,356 40,472 38,215 ------------ ------------ ------------ ------------ Operating income 2,603 1,906 17,040 17,334 Other income (expense): Interest expense (3,809) (3,919) (11,118) (11,999) Loss on early extinguishment of debt -- (994) -- (994) Other, net 8 2 19 13 ------------ ------------ ------------ ------------ (3,801) (4,911) (11,099) (12,980) ------------ ------------ ------------ ------------ Income (loss) before income taxes (1,198) (3,005) 5,941 4,354 Income tax expense (benefit) (468) (1,173) 2,318 1,697 ------------ ------------ ------------ ------------ Net income (loss) $ (730) $ (1,832) $ 3,623 $ 2,657 ============ ============ ============ ============ See notes to consolidated financial statements. 4 GFSI, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED) (In thousand) Nine Months Ended March 29, March 29, 2003 2002 ---------- ---------- CASH FLOWS FROM OPERATING ACTIVITIES: Net income $ 3,623 $ 2,657 Adjustments to reconcile net income to net cash provided by (used in) operating activities: Depreciation 2,377 2,338 Amortization of deferred financing costs 732 909 Amortization of other intangibles 750 750 (Gain) loss on sale or disposal of property, plant and equipment (11) 6 Deferred income taxes 165 (414) (Gain) loss on early extinguishment of debt -- 994 Gain (loss) on foreign currency translation 66 -- Changes in operating assets and liabilities: Accounts receivable, net 2,327 (5,837) Inventories, net 3,613 (2,917) Prepaid expenses, other current assets and other assets (186) (82) Income taxes payable 2,306 4,166 Accounts payable, accrued expenses and other long-term obligations (6,262) (5,199) ---------- ---------- Net cash provided by (used in) operating activities 9,500 (2,629) ---------- ---------- CASH FLOWS FROM INVESTING ACTIVITIES: Proceeds from sales of property, plant and equipment 22 3 Purchases of property, plant and equipment (2,936) (3,622) ---------- ---------- Net cash used in investing activities (2,914) (3,619) ---------- ---------- CASH FLOWS FROM FINANCING ACTIVITIES: Net change in revolving credit agreement (5,738) 29,262 Cash paid for financing costs (50) (683) Distributions to GFSI Holdings, Inc. (174) (123) Issuance of long-term debt 450 300 Payments on long-term debt (130) (26,804) ---------- ---------- Net cash provided by (used in) financing activities (5,642) 1,952 ---------- ---------- Net increase (decrease) in cash and cash equivalents 944 (4,296) Cash and cash equivalents at beginning of period 313 5,309 ---------- ---------- Cash and cash equivalents at end of period $ 1,257 $ 1,013 ========== ========== Supplemental cash flow information: Interest paid $ 13,561 $ 13,865 ========== ========== Income taxes paid (refunded) $ (153) $ (2,053) ========== ========== See notes to consolidated financial statements.
5 GFSI, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) March 29, 2003 1. Basis of Presentation The accompanying unaudited consolidated financial statements of GFSI, Inc. (the "Company") include the accounts of the Company and the accounts of its wholly-owned subsidiaries, Event 1, Inc. ("Event 1"), CC Products, Inc. ("CCP") and GFSI Canada Company. All intercompany balances and transactions have been eliminated. The unaudited consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X promulgated by the Securities and Exchange Commission. Accordingly, they do not include all of the information and footnotes required by generally accepted accounting principles for annual financial statement reporting purposes. In the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation of the financial position, operations and cash flows of the Company have been included. Operating results for the interim periods are not necessarily indicative of the results that may be expected for the entire fiscal year. The consolidated balance sheet information as of June 29, 2002 has been derived from the audited consolidated financial statements at that date, but does not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements. For further information, refer to the consolidated financial statements and footnotes thereto for the year ended June 29, 2002 included in the Company's Annual Report on Form 10-K. The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. 2. Commitments and Contingencies The Company, in the normal course of business, may be threatened with or named as a defendant in various lawsuits. It is not possible to determine the ultimate disposition of these matters, however, management is of the opinion that there are no known claims or known contingent claims that are likely to have a material adverse effect on the results of operations, financial condition, or cash flows of the Company. 3. Inventories The following is a summary of inventories at March 29, 2003 and June 29, 2002: Unaudited (in thousands) March 29, 2003 June 29, 2002 -------------- ------------- Undecorated apparel ("blanks") and supplies $ 39,661 $ 41,976 Work in process 557 1,114 Finished goods 1,898 2,639 ---------- ---------- Total $ 42,116 $ 45,729 ========== ========== 6
4. Condensed Consolidating Financial Information The accompanying condensed consolidating financial information has been prepared and presented pursuant to SEC Regulation S-X Rule 3-10 "Financial statements of guarantors and issuers of guaranteed securities registered or being registered." This information is not necessarily intended to present the financial position, results of operations and cash flows of the individual companies or groups of companies in accordance with accounting principles generally accepted in the United States of America. Each of the subsidiary guarantors are 100% owned by GFSI, Inc. The subsidiary guarantees of GFSI, Inc.'s debts are full and unconditional and joint and several. As of March 29, 2003 (in thousands) (unaudited): Parent Subsidiary Consolidating Consolidated Obligor Guarantors Adjustments GFSI, Inc. ----------- ---------- ------------- ------------ Assets: Current assets Cash and cash equivalents $ 1,152 $ 105 $ -- $ 1,257 Accounts receivable, net 20,187 16,082 (5,970) 30,299 Inventories, net 40,468 1,648 -- 42,116 Prepaid expenses and other current assets 1,343 112 -- 1,455 Deferred income taxes 1,132 -- -- 1,132 ---------- ---------- ---------- ---------- Total current assets 64,282 17,947 (5,970) 76,259 Investment in equity of subsidiaries 15,293 -- (15,293) -- Property, plant and equipment, net 19,908 311 -- 20,219 Investment in parent company bonds 9,900 -- -- 9,900 Other assets 4,479 (1,027) (2) 3,450 ---------- ---------- ---------- ---------- Total assets $ 113,862 $ 17,231 $ (21,265) $ 109,828 ========== ========== ========== ========== Liabilities and stockholders' equity: Current liabilities Accounts payable $ 14,088 $ 1,005 $ (5,970) $ 9,123 Accrued interest expense 1,189 -- -- 1,189 Accrued expenses 4,760 1,024 -- 5,784 Income taxes payable 7,508 (115) -- 7,393 Current portion of long-term debt 241 -- -- 241 ---------- ---------- ---------- ---------- Total current liabilities 27,786 1,914 (5,970) 23,730 Deferred income taxes 1,127 24 -- 1,151 Other long-term obligations 499 -- -- 499 Long-term debt, less current portion 160,578 -- -- 160,578 Stockholders' equity (deficiency) (76,128) 15,293 (15,295) (76,130) ---------- ---------- ---------- ---------- Total liabilities and stockholders' equity (deficiency) $ 113,862 $ 17,231 $ (21,265) $ 109,828 ========== ========== ========== ========== Nine months ended March 29, 2003 (in thousands) (unaudited): Parent Subsidiary Consolidating Consolidated Obligor Guarantors Adjustments GFSI, Inc. ----------- ---------- ------------- ------------ Net sales $ 105,116 $ 55,413 $ (3,481) $ 157,048 Cost of sales 69,342 33,675 (3,481) 99,536 Selling expenses 12,681 7,741 -- 20,422 General and administrative expense 16,655 3,395 -- 20,050 ---------- ---------- ---------- ---------- Total costs and expenses 98,678 44,811 (3,481) 140,008 Operating Income 6,438 10,602 -- 17,040 Equity in net earnings of subsidiaries 6,451 (6,451) -- Interest expense (11,092) (26) -- (11,118) Other, net 19 -- -- 19 ---------- ---------- ---------- ---------- Income before income taxes 1,816 10,576 (6,451) 5,941 Income tax expense (benefit) (1,807) 4,125 -- 2,318 ---------- ---------- ---------- ---------- Net income $ 3,623 $ 6,451 $ (6,451) $ 3,623 ========== ========== ========== ========== 7 Nine months ended March 29, 2003 (in thousands) (unaudited): Parent Subsidiary Consolidating Consolidated Obligor Guarantors Adjustments GFSI, Inc. ----------- ---------- ------------- ------------ Net cash flows provided by (used in) operating activities $ 10,373 $ (873) $ -- $ 9,500 Cash flows from investing activities: Intercompany loan (1,033) -- 1,033 -- Purchases of property, plant and equipment, net (2,881) (33) -- (2,914) ---------- ---------- ---------- ---------- Net cash flows used in investing activities (3,914) (33) 1,033 (2,914) Cash flows from financing activities: Net change in revolving credit agreement (5,738) -- -- (5,738) Payments on long-term debt (130) -- -- (130) Intercompany borrowings -- 1,033 (1,033) -- Cash paid for financing costs (50) -- -- (50) Issuance of long-term debt 450 -- -- 450 Distributions to GFSI Holdings, Inc. (174) -- -- (174) ---------- ---------- ---------- ---------- Net cash provided (used) by financing activities (5,642) 1,033 (1,033) (5,642) ---------- ---------- ---------- ---------- Net change in cash and cash equivalents: 817 127 -- 944 Cash and cash equivalents at beginning of period 334 (21) -- 313 ---------- ---------- ---------- ---------- Cash and cash equivalents end of period $ 1,151 $ 106 $ -- $ 1,257 ========== ========== ========== ========== As of June 29, 2002 (in thousands): Parent Subsidiary Consolidating Consolidated Obligor Guarantors Adjustments GFSI, Inc. ----------- ---------- ------------- ------------ Assets: Current assets Cash and cash equivalents $ 334 $ (21) $ -- $ 313 Accounts receivable, net 25,199 8,511 (1,084) 32,626 Inventories, net 43,402 2,327 -- 45,729 Prepaid expenses and other current assets 1,163 106 -- 1,269 Deferred income taxes 845 -- -- 845 ---------- ---------- ---------- ---------- Total current assets 70,943 10,923 (1,084) 80,782 Investment in equity of subsidiaries 8,773 -- (8,773) -- Property, plant and equipment, net 19,120 551 -- 19,671 Other assets 4,881 4 (2) 4,883 ---------- ---------- ---------- ---------- Total assets $ 103,717 $ 11,478 $ (9,859) $ 105,336 ========== ========== ========== ========== Liabilities and stockholders' equity: Current liabilities Accounts payable $ 11,466 $ 1,630 $ (1,086) $ 12,010 Accrued interest expense 4,366 -- -- 4,366 Accrued expenses 5,034 949 -- 5,983 Income taxes payable 5,156 (69) -- 5,087 Current portion of long-term debt 177 -- -- 177 ---------- ---------- ---------- ---------- Total current liabilities 26,199 2,510 (1,086) 27,623 Deferred income taxes 504 195 -- 699 Long-term debt, less current portion 156,132 -- -- 156,132 Other long-term obligations 527 -- -- 527 Stockholders' equity (deficiency) (79,645) 8,773 (8,773) (79,645) ---------- ---------- ---------- ---------- Total liabilities and stockholders' equity (deficiency) $ 103,717 $ 11,478 $ (9,859) $ 105,336 ========== ========== ========== ========== 8 Nine months ended March 29, 2002 (in thousands) (unaudited): Parent Subsidiary Consolidating Consolidated Obligor Guarantors Adjustments GFSI, Inc. ----------- ---------- ------------- ------------ Net sales $ 108,849 $ 42,336 $ (3,288) $ 147,897 Cost of sales 70,403 25,233 (3,288) 92,348 Selling expenses 12,309 6,244 -- 18,553 General and administrative expense 16,037 3,625 -- 19,662 ---------- ---------- ---------- ---------- Total costs and expenses 98,749 35,102 (3,288) 130,563 Operating Income 10,100 7,234 -- 17,334 Equity in net earnings of subsidiaries 4,412 -- (4,412) -- Interest expense (11,999) -- -- (11,999) Loss on early extinguishment of debt (994) -- -- (994) Other income (expense) 13 -- -- 13 ---------- ---------- ---------- ---------- Income before income taxes 1,532 7,234 (4,412) 4,354 Income tax expense (benefit) (1,125) 2,822 -- 1,697 ---------- ---------- ---------- ---------- Net income $ 2,657 $ 4,412 $ (4,412) $ 2,657 ========== ========== ========== ========== Nine months ended March 29, 2002 (in thousands) (unaudited): Parent Subsidiary Consolidating Consolidated Obligor Guarantors Adjustments GFSI, Inc. ----------- ---------- ------------- ------------ Net cash flows provided by (used in) operating activities $ (3,127) $ 498 $ -- $ (2,629) Net cash flows used in investing activities (3,383) (236) -- (3,619) Cash flows from financing activities: Net change in revolving credit agreement 29,262 -- -- 29,262 Cash paid for financing costs (683) -- -- (683) Distributions to GFSI Holdings, Inc. (123) -- -- (123) Issuance of long-term debt 300 -- -- 300 Payments on long-term debt (26,804) -- -- (26,804) ---------- ---------- ---------- ---------- Net cash flows provided by financing activities 1,952 -- -- 1,952 ---------- ---------- ---------- ---------- Net change in cash and cash equivalents (4,558) 262 -- (4,296) Cash and cash equivalents at beginning of period 5,263 46 -- 5,309 ---------- ---------- ---------- ---------- Cash and cash equivalents end of period $ 705 $ 308 $ -- $ 1,013 ========== ========== ========== ==========
5. Reclassifications Certain reclassifications have been made to the fiscal 2002 consolidated and condensed consolidating financial statements to conform to the fiscal 2003 presentation. In April 2002, the Financial Accounting Standards Board ("FASB") issued SFAS No. 145 "Rescission of FASB Statements Nos. 4, 44 and 64, Amendment of FASB Statement No. 13, and Technical Corrections." The new standard eliminates the requirement to classify gains and losses related to early debt extinguishments as extraordinary items. SFAS No. 145 is effective for fiscal years beginning after May 15, 2002. In the third quarter of fiscal 2003, GFSI elected to early adopt SFAS No. 145 and has accordingly reclassified the 2002 loss on extinguishment of debt, previously presented as an extraordinary item, net of income taxes, as other income (expense) in accordance with the provisions of SFAS No. 145. Net income, shareholders' equity or cash flows were not impacted by the adoption of this new standard. 9 6. Investment in Parent Company Bonds On December 31, 2002, the Company completed the private placement of $9.9 million of unregistered 9.625% senior subordinated notes ("Exchange Notes") in exchange for $24 million aggregate principal amount at maturity of GFSI Holdings, Inc. 11.375% Senior Discount Notes (the "Holdings Discount Notes") with an accreted book value of $19.9 million. The Exchange Notes are unsecured obligations of the Company, mature on March 1, 2007, pay interest semi-annually on March 1 and September 1, and were issued under an indenture with substantially identical terms as the indenture governing the $125 million aggregate principal amount at maturity of the Company's Senior Subordinated Notes issued on February 27, 1997. The Exchange Notes were guaranteed by each of the Company's wholly-owned subsidiaries (Event 1, CCP, and GFSI Canada Company). The Exchange Notes were issued to an "accredited investor" and were exempt from registration under Rule 144 of the Securities Act of 1933, as amended. The Company has filed an exchange offer registration statement with the Securities and Exchange Commission to enable the holder of the Exchange Notes to exchange them for publicly registered notes having terms substantially identical to the Exchange Notes. As a result of the completion on December 31, 2002 of the private placement of $9.9 million of Exchange Notes for $24 million aggregate principal amount at maturity of Holdings Discount Notes with an accreted book value of $19.9 million, GFSI's financial statements for the periods after December 31, 2002, on a pro forma basis, will initially reflect additional long-term debt of $9.9 million and a corresponding non-current investment in Holdings Discount Notes. In future periods, GFSI's financial statements will reflect additional annual interest expense of approximately $1.0 million. The Company's non-current investment in Holdings Discount Notes is recorded at its purchase cost, reflecting fair value at its acquisition date. Trading activity in this security has been and is expected to continue to be infrequent, and consequently, the Company has determined that it will recognize interest income on the Holdings Discount Notes when it is received commencing in March 2005 and to recognize the accretion of the purchase discount should a more established market materialize. The Company would have recognized interest income and accreted purchase discount of approximately $962,000 as of March 29, 2003, had a more liquid market existed for this security. 10 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The discussions set forth in this Form 10-Q should be read in conjunction with the financial information included herein and the Company's Annual Report on Form 10-K for the year ended June 29, 2002. Management's discussion and analysis of financial condition and results of operations and other sections of this report contain forward-looking statements relating to future results of the Company. Such forward-looking statements are identified by use of forward-looking words such as "anticipates", "believes", "plans", "estimates", "expects", and "intends" or words or phrases of similar expression. These forward-looking statements are subject to various assumptions, risks and uncertainties, including but not limited to, changes in political and economic conditions, demand for the Company's products, acceptance of new products, developments affecting the Company's products and to those discussed in the Company's filings with the Securities and Exchange Commission. Accordingly, actual results could differ materially from those contemplated by the forward-looking statements. Critical accounting policies The following discussion and analysis of financial condition, results of operations, liquidity and capital resources is based upon our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America. Generally accepted accounting principles require estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities. On an ongoing basis, we evaluate our estimates, including those related to bad debts, inventories, intangible assets, long-lived assets, deferred income taxes, accrued expenses, restructuring reserves, contingencies and litigation. We base our estimates on historical experience and on various other assumptions that we believe are reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ materially from these estimates under different assumptions or conditions. We believe that some of our significant accounting policies involve a higher degree of judgment or complexity than other accounting policies. Identified below are the policies deemed critical to our business and the understanding of our results of operations. Revenue recognition. We recognize revenues when goods are shipped, title has passed, the sales price is fixed and collectibility is reasonably assured. Returns, discounts and sales allowance estimates are based on projected sales trends, historical data and other known factors. If actual returns, discounts and sales allowances are not consistent with the historical data used to calculate these estimates, net sales could either be understated or overstated. Accounts receivable. Accounts receivable consist of amounts due from customers and business partners. We maintain an allowance for doubtful accounts to reflect expected credit losses and provides for bad debts based on collection history and specific risks identified on a customer-by-customer basis. A considerable amount of judgment is required to assess the ultimate realization of accounts receivable and the credit-worthiness of each customer. Furthermore, these judgments must be continually evaluated and updated. If the historic data used to evaluate credit risk does not reflect future collections, or, if the financial condition of our customers were to deteriorate causing an impairment of their ability to make payments, additional provisions for bad debts may be required in future periods. Accounts receivable at March 29, 2003 and June 28, 2002 were net of allowance for doubtful accounts of $1.0 million and $838,000, respectively. Inventories. Inventories are carried at the lower of cost or market determined under the First-In, First-Out (FIFO) method. We write down obsolete and unmarketable inventories to their estimated market value based upon, among other things, assumptions about future demand and market conditions. If actual market conditions are less favorable than projected, additional inventory write-downs may be required. We also record changes in valuation allowances due to changes in our operating strategy, such as the discontinuances of certain product lines and other merchandising decisions related to changes in demand. It is possible that further changes in required inventory allowances may be necessary in the future as a result of market conditions and competitive pressures. 11 Comparison of Operating Results for the Quarters Ended March 29, 2003 and March 29, 2002. Net Sales. Net sales for the quarter ended March 29, 2003 were $41.2 million compared to $41.5 million last year. We experienced sales decreases in the Resort division, the Corporate division and our Event 1 subsidiary, offset by sales growth from the Licensed Apparel group. The net sales growth in the Licensed Apparel group was from college bookstore customers in our Champion licensed products group (CCP) which continued to benefit from consumer preferences for moderately priced apparel. Net sales for CCP were approximately $2.9 million greater than last year. College bookstore sales represented approximately 37% of net sales for the quarter compared to 31% last year. The Corporate and Resort divisions were affected by reduced business due to decreased discretionary spending on marketing and employee incentive programs and declining business and consumer travel. Event 1 sales for the third quarter of fiscal 2003 were below last year due to the timing of the NCAA mens championship basketball tournament. The final championship games were held in the fourth quarter of fiscal 2003, compared to the third quarter of fiscal 2002. Gross Profit. Gross profit for the quarter ended March 29, 2003 was $15.2 million, approximately the same as last year. Gross profit as a percentage of net sales was comparable for both periods at 37%. Operating Expenses. Operating expenses for the quarter ended March 29, 2003 decreased 5% to $12.6 million from $13.4 million last year. Operating expenses as a percentage of net sales were 30.6% in the third quarter of fiscal 2003 compared to 32.2% last year. The decrease in operating expenses was created by the implementation of cost controls. Operating Income. Operating income increased 37% to $2.6 million in the third quarter of fiscal 2003 compared to $1.9 million last year. Operating income as a percentage of net sales increased to 6.3% in the third quarter of fiscal 2003 from 4.6% in the third quarter of fiscal 2002. The increase in operating income as a percentage of sales was the result of the decrease in operating expenses. Interest Expense. Interest expense in the third quarter of fiscal 2003 was $3.8 million, $110,000 less than the comparable period last year. The decrease in interest expense was due to lower interest rates. Loss on Early Extinguishment of Debt. In March 2002, the Company entered into a $65 million revolving bank credit facility (the "RBCA) and repaid its existing $40 million bank credit facility ahead of its scheduled expiration. A pre-tax charge of $994,000 was recorded in the third quarter of fiscal 2002 to write off deferred debt origination costs related to the previous bank credit facility. Net Income (loss). Net loss for the third quarter of fiscal 2003 was $730,000 compared to a net loss of $1.8 million last year. The decrease in net loss was created by higher operating income and the absence of a loss on early extinguishment of debt in fiscal 2003. 12 Comparison of Operating Results for the Nine Months Ended March 29, 2003 and March 29, 2002. Net Sales. Net sales for the nine months ended March 29, 2003 increased 6% to $157.0 million from $147.9 million last year. The increase in net sales was due to strong growth from the Licensed Apparel group, which was fueled by a 42% increase in revenue from CCP. The net sales increase from CCP was partially offset by a 18% decline in Corporate division sales. Net sales for CCP for the first nine months of fiscal 2003 were $13.7 million greater than last year while Corporate division sales were $4.1 million less than last year. Management believes that the Company's customers have shifted their purchases to lower priced apparel with less expensive decoration, which has enhanced the sales of CCP's more moderately priced goods. A soft economy and consequent reductions in corporate spending on marketing and employee incentive programs have had a detrimental effect on the net sales of the Corporate division. Gross Profit. Gross profit for the nine months ended March 29, 2003 increased 4% to $57.5 million from $55.5 million last year. Gross profit as a percentage of net sales decreased to 36.6% from 37.6% last year. The decrease in gross profit as a percentage of net sales was the result of a change in customer purchasing. College bookstore sales represented 51% of net sales for the nine month period ended March 29, 2003 compared to 43% last year. College bookstore sales generally provide a lower gross profit than the Company's other divisions. Operating Expenses. Operating expenses for the nine months ended March 29, 2003 increased 6% to $40.5 million from $38.2 million last year. Higher sales created the increase in operating expenses. Operating expenses as a percentage of net sales were 25.8% for the first nine months of fiscal 2003 and fiscal 2002. The favorable impact of cost control measures offset the higher royalty and distribution channel costs attributable to college bookstore sales which allowed operating expenses as a percentage of net sales to remain the same. Operating Income. Operating income decreased 2% to $17.0 million in fiscal 2003 from $17.3 million in fiscal 2002. Operating income as a percentage of net sales decreased to 10.9% in fiscal 2003 from 11.7% in fiscal 2002. The decrease in operating income as a percentage of sales was the result of a lower gross profit percentage on higher net sales. Interest Expense. Interest expense in the first nine months of fiscal 2003 was $11.1 million, $881,000 less than the comparable period last year. The decrease in interest expense was due to lower interest rates. Loss on Early Extinguishment of Debt. In March 2002, the Company entered into a $65 million RBCA and repaid its existing $40 million bank credit facility ahead of its scheduled expiration. A pre-tax charge of $994,000 was recorded in the third quarter of fiscal 2002 to write off deferred debt origination costs related to the previous bank credit facility. Net Income (loss). Net income for the first nine months of fiscal 2003 was $3.6 million, compared to $2.7 million last year. The increase in net income was created by the reduction in interest expense and the absence of the loss on early extinguishment of debt in fiscal 2003. Liquidity and Capital Resources Cash provided by operating activities in the first nine months of fiscal 2003 was $9.5 million compared to cash used by operating activities of $2.6 million last year. Fiscal 2002 operating cash flows were used to fund the increase in accounts receivable and inventory related to the addition of the CCP college bookstore business. Cash used in investing activities in the first nine months of fiscal 2003 was $2.9 million compared to $3.6 million last year. The cash used in both periods was related to the acquisition of property, plant and equipment. Cash used in financing activities in the first nine months of fiscal 2003 was $5.6 million compared cash to provided by financing activities of $2.0 million in the comparable period of fiscal 2002. Payments of bank debt was the primary use of cash in fiscal 2003. In fiscal 2002, the Company used borrowings under its RCBA to repay long-term debt. 13 On December 31, 2002, the Company completed the private placement of $9.9 million of unregistered 9.625% senior subordinated notes ("Exchange Notes") in exchange for $24 million aggregate principal amount at maturity of GFSI Holdings' 11.375% Senior Discount Notes ("Holdings Discount Notes") with an accreted book value of $19.9 million. The Company recorded its investment in the Holdings Discount Notes at its purchase cost. The Exchange Notes are unsecured obligations of GFSI, Inc., mature on March 1, 2007, pay interest semi-annually on March 1 and September 1, and were issued under an indenture with substantially identical terms as the indenture governing the $125 million aggregate principal amount at maturity of GFSI, Inc. Senior Subordinated Notes issued on February 27, 1997. The Exchange Notes were guaranteed by each of GFSI, Inc.'s wholly-owned subsidiaries (Event 1, CCP, and GFSI Canada Company). GFSI, Inc. filed an exchange offer registration statement with the Securities and Exchange Commission to enable the holder of the Exchange Notes to exchange them for publicly registered notes having terms substantially identical to the Exchange Notes. Under the Company's RBCA up to $65 million of revolving credit availability is provided, of which $24.8 million was borrowed and outstanding and approximately $6.3 million was utilized for outstanding commercial and stand-by letters of credit as of March 29, 2003. At March 29, 2003, $25.4 million was available for future borrowings under the RBCA. The Company believes that cash flows from operating activities and borrowings under the RBCA will be adequate to meet the Company's short- term and future liquidity requirements prior to the maturity of the RBCA in fiscal 2005, although no assurance can be given in this regard. The Company anticipates paying dividends to its parent, GFSI Holdings, Inc. ("Holdings") to enable Holdings to pay corporate income taxes, interest on the Holdings Discount Notes, fees payable under consulting and non-competition agreements, preferred stock dividends and certain other ordinary course expenses incurred on behalf of The Company. Holdings is dependent upon the cash flows of the Company to provide funds to service the Holdings Discount Notes. The Holdings Discount Notes do not have an annual cash flow requirement until fiscal 2005 as they accrue interest at 11.375% per annum, compounded semi-annually to an aggregate principal amount of $84.5 million at September 15, 2004. Thereafter, the Holdings Discount Notes will accrue interest at the rate of 11.375% per annum, payable semi-annually, in cash on March 15 and September 15 of each year, commencing on March 15, 2005. Additionally, Holding's cumulative non-cash preferred stock ("Holdings Preferred Stock") dividends total approximately $400,000 annually. Holdings Preferred Stock may be redeemed at stated value (approximately $3.4 million) plus accrued dividends with mandatory redemption in fiscal 2009. Seasonality and Inflation The Company experiences seasonal fluctuations in its sales and profitability, with generally higher sales and gross profit in the first and second quarters of its fiscal year. The seasonality of sales and profitability is primarily due to higher college bookstore sales during the first two fiscal quarters. Sales at the Company's Resort and Corporate divisions typically show little seasonal variations. The impact of inflation on the Company's operations has not been significant to date. However, there can be no assurance that a high rate of inflation in the future would not have an adverse effect on the Company's operating results. 14 ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK DERIVATIVE AND MARKET RISK DISCLOSURE The Company's market risk exposure is primarily due to possible fluctuations in interest rates. The fixed rate portion of the Company's long-term debt does not bear significant interest rate risk. An immediate 10% change in interest rates would not have a material effect on the Company's results of operations over the next fiscal year, although there can be no assurances that interest rates will not significantly change. ITEM 4. CONTROLS AND PROCEDURES Within the 90 days prior to the date of filing this Quarterly Report on From 10-Q, an evaluation was performed under the supervision and with the participation of the Company's management, including the Chief Executive Officer and the Chief Financial Officer, of the effectiveness of the design and operation of the Company's disclosure controls and procedures (as defined in Exchange Act Rules 13a-14(c) and 15d-14(c)). Based on that evaluation, the Company's management, including the Chief Executive Officer and the Chief Financial Officer, concluded that the Company's disclosure controls and procedures are effective in timely alerting them to material information relating to the Company (including its consolidated subsidiaries) required to be included in the Company's periodic SEC filings. Subsequent to the date of that evaluation, there have been no significant changes in the Company's internal controls or in other factors that could significantly affect internal controls, nor were any corrective actions required with regard to significant deficiencies and material weaknesses. 15 PART II - OTHER INFORMATION Item 1. Legal Proceedings The Company is not a party to any pending legal proceeding the resolution of which, the management of the Company believes, would have a material adverse effect on the Company's results of operations or financial condition, nor to any other pending legal proceedings other than ordinary, routine litigation incidental to its business. Item 2. Changes in Securities None. Item 3. Defaults Upon Senior Securities None. Item 4. Submission of Matters to a Vote of Security Holders None. Item 5. Other Information None. Item 6. Exhibits and Reports on Form 8-K (a) Exhibits None. (b) Reports on Form 8-K None. 16 SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. GFSI, INC. May 13, 2003 /s/ J. CRAIG PETERSON --------------------------------- J. Craig Peterson, Sr. Vice President of Finance and Principal Accounting Officer 17 CERTIFICATION OF PRINCIPAL EXECUTIVE OFFICER REGARDING GFSI, INC.'S QUARTERLY REPORT ON FORM 10-Q FOR THE FISCAL PERIOD ENDED MARCH 29, 2003 I, Robert M. Wolff, Chairman and Chief Executive Officer (Principal Executive Officer) of GFSI, Inc., certify that: 1. I have reviewed this Quarterly Report on Form 10-Q of GFSI, Inc.; 2. Based on my knowledge, this Quarterly Report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this Quarterly Report; 3. Based on my knowledge, the financial statements, and other financial information included in this Quarterly Report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods represented in this Quarterly Report; 4. The registrant's other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have: a) Designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this quarterly report is being prepared; b) Evaluated the effectiveness of the registrant's disclosure controls and procedures as of a date within 90 days prior to the filing date of this quarterly report (the "Evaluation Date"); and c) Presented in this quarterly report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date. 5. The registrant's other certifying officers and I have disclosed, based on our most recent evaluation, to the registrant's auditors and the audit committee of registrant's board of directors (or persons performing the equivalent function): a) All significant deficiencies in the design or operation of internal controls which could adversely affect the registrant's ability to record, process, summarize and report financial data and have identified for the registrant's auditors any material weaknesses in internal controls; b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal controls; and 6. The registrant's other certifying officers and I have indicated in this quarterly report whether or not these were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses. Date: May 13, 2003 /S/ ROBERT M. WOLFF -------------------------------------- Robert M. Wolff Chairman and Chief Executive Officer 18 CERTIFICATION OF PRINCIPAL FINANCIAL OFFICER REGARDING GFSI, INC.'S QUARTERLY REPORT ON FORM 10-Q FOR THE FISCAL PERIOD ENDED MARCH 29, 2003 I, J. Craig Peterson, Senior Vice President and Chief Financial Officer (Principal Financial Officer) of GFSI, Inc., certify that: 1. I have reviewed this Quarterly Report on Form 10-Q of GFSI, Inc.; 2. Based on my knowledge, this Quarterly Report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this Quarterly Report; 3. Based on my knowledge, the financial statements and other financial information included in this Quarterly Report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods represented in this Quarterly Report. 4. The registrant's other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have: a) Designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this quarterly report is being prepared; b) Evaluated the effectiveness of the registrant's disclosure controls and procedures as of a date within 90 days prior to the filing date of this quarterly report (the "Evaluation Date"); and c) Presented in this quarterly report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date. 5. The registrant's other certifying officers and I have disclosed, based on our most recent evaluation, to the registrant's auditors and the audit committee of registrant's board of directors (or persons performing the equivalent function): a) All significant deficiencies in the design or operation of internal controls which could adversely affect the registrant's ability to record, process, summarize and report financial data and have identified for the registrant's auditors any material weaknesses in internal controls; and b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal controls; and 6. The registrant's other certifying officers and I have indicated in this quarterly report whether or not these were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses. Date: May 13, 2003 /s/ J. CRAIG PETERSON ----------------------------- J. Craig Peterson Senior Vice President and Chief Financial Officer 19