-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, L4rwCRZWTrjrx3+eyRC1kNwm7tIQQx5tdz1uNmJfGQ8LMu9vyCsvDYppXUJAqdrm 8jWruaiCmhIKg2mCYrNVhQ== 0000902561-05-000140.txt : 20050505 0000902561-05-000140.hdr.sgml : 20050505 20050505153036 ACCESSION NUMBER: 0000902561-05-000140 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 3 CONFORMED PERIOD OF REPORT: 20050402 FILED AS OF DATE: 20050505 DATE AS OF CHANGE: 20050505 FILER: COMPANY DATA: COMPANY CONFORMED NAME: GFSI INC CENTRAL INDEX KEY: 0001036327 STANDARD INDUSTRIAL CLASSIFICATION: MISCELLANEOUS FABRICATED TEXTILE PRODUCTS [2390] IRS NUMBER: 742810748 STATE OF INCORPORATION: DE FISCAL YEAR END: 0627 FILING VALUES: FORM TYPE: 10-Q SEC ACT: 1934 Act SEC FILE NUMBER: 333-24189 FILM NUMBER: 05803405 BUSINESS ADDRESS: STREET 1: 9700 COMMERCE PARKWAY CITY: LENEXA STATE: KS ZIP: 66219 BUSINESS PHONE: 9138880445 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 April 2, 2005. --------------- OR ( ) TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from ________________ to ________________ Commission file number 333-24189 --------- GFSI, INC. --------------------------------------------------- (Exact name of registrant specified in its charter) Delaware 74-2810748 ------------------------------- ------------------------------------ (State or other jurisdiction of (I.R.S. Employer Identification No.) incorporation or organization) 9700 Commerce Parkway Lenexa, Kansas 66219 ---------------------------------------- (Address of principal executive offices) (913) 693-3200 ---------------------------------------------------- (Registrant's telephone number, including area code) Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. (1) Yes (X) No ( ) (2) Yes (X) No ( ) Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act). Yes ( ) No (X) Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date: Common stock, $0.01 par value per share - 1 share issued and outstanding as of May 1, 2005. 1 GFSI, INC. AND SUBSIDIARIES Quarterly Report on Form 10-Q For the Quarter Ended April 2, 2005 INDEX Page ---- PART I - FINANCIAL INFORMATION ITEM 1 - CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) Consolidated Balance Sheets 3 Consolidated Statements of Income 4 Consolidated Statements of Cash Flows 5 Notes to Consolidated Financial Statements 6 ITEM 2 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS 11 ITEM 3 - QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK 17 ITEM 4 - CONTROLS AND PROCEDURES 17 PART II - OTHER INFORMATION 18 SIGNATURE PAGE 19 2 GFSI, INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS (In thousands, except share data)
April 2, July 3, 2005 2004 ----------- ---------- ASSETS (unaudited) Current assets: Cash and cash equivalents $ 1,267 $ 911 Accounts receivable, net 24,994 32,831 Inventories, net 39,805 45,616 Prepaid expenses and other current assets 1,717 1,667 Deferred income taxes 1,158 1,077 ----------- ---------- Total current assets 68,941 82,102 Property, plant and equipment, net 23,361 22,990 Other assets: Deferred financing costs, net 1,555 2,073 Other 171 122 ----------- ---------- Total assets $ 94,028 $ 107,287 =========== ========== LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIENCY) Current liabilities: Accounts payable $ 8,556 $ 12,304 Accrued interest expense 1,242 4,424 Accrued expenses 7,652 7,245 Income taxes payable 10,472 10,478 Current portion of long-term debt 132 190 ----------- ---------- Total current liabilities 28,054 34,641 Deferred income taxes 1,419 1,501 Other long-term obligations 452 452 Long-term debt, less current portion 154,558 160,629 Stockholders' equity (deficiency): Common stock, $.01 par value, 10,000 shares authorized, one share issued and outstanding at April 2, 2005 and July 3, 2004 -- -- Additional paid-in capital 71,442 71,442 Parent company bonds acquired (24,995) (24,995) Accumulated deficiency (136,902) (136,383) ----------- ---------- Total stockholders' deficiency (90,455) (89,936) ----------- ---------- Total liabilities and stockholders' equity (deficiency) $ 94,028 $ 107,287 =========== ========== See notes to consolidated financial statements.
3 GFSI, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF INCOME (UNAUDITED) (In thousands)
Quarter Ended Nine Months Ended April 2, April 3, April 2, April 3, 2005 2004 2005 2004 ---------- ---------- ---------- ---------- Net sales $ 40,392 $ 37,196 $137,992 $140,715 Cost of sales 24,201 21,776 84,929 85,163 -------- -------- -------- -------- Gross profit 16,191 15,420 53,063 55,552 Operating expenses: Selling 7,341 6,447 21,495 19,941 General and administrative 6,357 6,336 18,487 19,080 -------- -------- -------- -------- 13,698 12,783 39,982 39,021 -------- -------- -------- -------- Operating income 2,493 2,637 13,081 16,531 Other income (expense): Interest expense (3,796) (3,662) (11,504) (11,368) Gain (loss) on sale of property, plant and equipment 9 (27) 12 912 -------- -------- -------- -------- (3,787) (3,689) (11,492) (10,456) -------- -------- -------- -------- Income (loss) before income taxes (1,294) (1,052) 1,589 6,075 Income tax expense (benefit) (505) (411) 620 2,369 -------- -------- -------- -------- Net income (loss) $ (789) $ (641) $ 969 $ 3,706 ======== ======== ======== ========
See notes to consolidated financial statements. 4 GFSI, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED) (In thousands)
Nine Months Ended April 2, April 3, 2005 2004 ---------- ---------- CASH FLOWS FROM OPERATING ACTIVITIES: Net income $ 969 $ 3,706 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation 2,420 2,007 Amortization of deferred financing costs 604 679 Gain on sale or disposal of property, plant and equipment (10) (912) Deferred income taxes (163) 472 Changes in operating assets and liabilities: Accounts receivable, net 7,837 11,843 Inventories, net 5,811 4,727 Prepaid expenses, other current assets and other assets (99) (578) Income taxes payable (6) 273 Accounts payable, accrued expenses and other long-term obligations (6,522) (222) -------- -------- Net cash provided by operating activities 10,841 21,995 -------- -------- CASH FLOWS FROM INVESTING ACTIVITIES: Proceeds from sales of property, plant and equipment 79 2,797 Purchases of property, plant and equipment (2,860) (5,552) -------- -------- Net cash used in investing activities (2,781) (2,755) -------- -------- CASH FLOWS FROM FINANCING ACTIVITIES: Net change in revolving credit agreement borrowings (6,002) (6,609) Purchase of parent company bonds -- (12,265) Distributions to GFSI Holdings, Inc. (1,584) (258) Issuance of long-term debt -- 82 Payments on long-term debt (128) (226) Other (86) (1) -------- -------- Net cash used in financing activities (7,800) (19,277) -------- -------- Effect of foreign exchange rate changes on cash 96 38 -------- -------- Net increase in cash and cash equivalents 356 1 Cash and cash equivalents at beginning of period 911 1,387 -------- -------- Cash and cash equivalents at end of period $ 1,267 $ 1,388 ======== ======== Supplemental cash flow information: Interest paid $ 14,082 $ 13,853 ======== ======== Income taxes paid $ 788 $ 1,618 ======== ======== Non-cash financing activities: Parent company bonds contributed $ -- $ 12,315 ======== ======== Bonds distributed to parent company $ -- $ 9,485 ======== ======== See notes to consolidated financial statements.
5 GFSI, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) April 2, 2005 1. Basis of Presentation --------------------- The accompanying unaudited consolidated financial statements of GFSI, Inc. (the "Company") include the accounts of the Company and the accounts of its wholly-owned subsidiaries, Event 1, Inc. ("Event 1"), CC Products, Inc. ("CCP") and GFSI Canada Company. All intercompany balances and transactions have been eliminated. The unaudited consolidated financial statements have been prepared in accordance with generally accepted accounting principles for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X promulgated by the Securities and Exchange Commission. Accordingly, they do not include all of the information and footnotes required by generally accepted accounting principles for annual financial statement reporting purposes. In the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation of the financial position, operations and cash flows of the Company have been included. Operating results for the interim periods are not necessarily indicative of the results that may be expected for the entire fiscal year. The consolidated balance sheet information as of July 3, 2004 has been derived from the audited consolidated financial statements at that date, but does not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements. For further information, refer to the consolidated financial statements and footnotes thereto for the year ended July 3, 2004 included in the Company's Annual Report on Form 10-K. The Company is a wholly owned subsidiary of GFSI Holdings, Inc. ("Holdings"). The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. The Company's fiscal year ends on the Saturday nearest June 30, which results in a 53 week year from time to time. The fiscal year ended July 3, 2004 was a 53 week period. The additional week fell in the Company's second quarter ended January 3, 2004. Therefore, the nine month fiscal period ended April 3, 2004 has one more week of operations than the comparable period of fiscal 2005. 2. Commitments and Contingencies ----------------------------- The Company, in the normal course of business, may be threatened with or named as a defendant in various lawsuits. It is not possible to determine the ultimate disposition of these matters, however, management is of the opinion that there are no known claims or known contingent claims that are likely to have a material adverse effect on the results of operations, financial condition, or cash flows of the Company. 3. Inventories: ----------- The following is a summary of inventories at April 2, 2005 and July 3, 2004: (in thousands) April 2, July 3, 2005 2004 ---------- ---------- (unaudited) Undecorated apparel ("blanks") and supplies $ 37,687 $ 42,857 Work in process 344 314 Finished goods 2,219 3,340 --------- --------- 40,250 46,511 Allowance for markdowns (445) (895) --------- --------- Total $ 39,805 $ 45,616 ========= ========= 6 4. Condensed Consolidating Financial Information --------------------------------------------- The accompanying condensed consolidating financial information has been prepared and presented pursuant to SEC Regulation S-X Rule 3-10 "Financial statements of guarantors and issuers of guaranteed securities registered or being registered." This information is not necessarily intended to present the financial position, results of operations and cash flows of the individual companies or groups of companies in accordance with accounting principles generally accepted in the United States of America. Each of the subsidiary guarantors are 100% owned by GFSI, Inc. The subsidiary guarantees of GFSI, Inc.'s debts are full and unconditional and joint and several.
As of April 2, 2005 (in thousands) (unaudited): Parent Subsidiary Consolidating Consolidated Obligor Guarantors Adjustments GFSI, Inc. --------- ---------- ------------- ------------ Assets: Current assets: Cash and cash equivalents $ 1,216 $ 51 $ -- $ 1,267 Accounts receivable, net 14,128 36,799 (25,933) 24,994 Inventories, net 37,948 1,857 -- 39,805 Prepaid expenses and other current assets 1,449 268 -- 1,717 Deferred income taxes 1,158 -- -- 1,158 -------- -------- -------- --------- Total current assets 55,899 38,975 (25,933) 68,941 Investment in equity of subsidiaries 35,725 -- (35,725) -- Property, plant and equipment, net 23,195 166 -- 23,361 Other assets 2,654 (928) -- 1,726 -------- -------- -------- --------- Total assets $117,473 $ 38,213 $(61,658) $ 94,028 ======== ======== ======== ========= Liabilities and stockholders' equity: Current liabilities: Accounts payable $ 33,847 $ 642 $(25,933) $ 8,556 Accrued interest expense 1,242 -- -- 1,242 Accrued expenses 5,659 1,993 -- 7,652 Income taxes payable (receivable) 10,619 (147) -- 10,472 Current portion of long-term debt 132 -- -- 132 -------- -------- -------- --------- Total current liabilities 51,499 2,488 (25,933) 28,054 Deferred income taxes 1,419 -- -- 1,419 Other long-term obligations 452 -- -- 452 Long-term debt, less current portion 154,558 -- -- 154,558 Stockholders' equity (deficiency) (90,455) 35,725 (35,725) (90,455) -------- -------- -------- --------- Total liabilities and stockholders' equity (deficiency) $117,473 $ 38,213 $(61,658) $ 94,028 ======== ======== ======== =========
7
Nine months ended April 2, 2005 (in thousands) (unaudited): Parent Subsidiary Consolidating Consolidated Obligor Guarantors Adjustments GFSI, Inc. --------- ---------- ------------- ------------ Net sales $ 78,994 $ 62,379 $ (3,381) $ 137,992 Cost of sales 52,198 36,112 (3,381) 84,929 Selling expenses 10,958 10,537 -- 21,495 General and administrative expense 15,611 2,876 -- 18,487 --------- ---------- --------- --------- Total costs and expenses 78,767 49,525 (3,381) 124,911 --------- ---------- --------- --------- Operating income 227 12,854 -- 13,081 Equity in net earnings of subsidiaries 7,838 -- (7,838) -- Interest expense (11,501) (3) -- (11,504) Gain on sale of property, plant and equipment 12 -- -- 12 --------- ---------- --------- --------- Income (loss) before income taxes (3,424) 12,851 (7,838) 1,589 Income tax expense (benefit) (4,393) 5,013 -- 620 --------- ---------- --------- --------- Net income $ 969 $ 7,838 $ (7,838) $ 969 ========= ========== ========= =========
Nine months ended April 2, 2005 (in thousands) (unaudited): Parent Subsidiary Consolidating Consolidated Obligor Guarantors Adjustments GFSI, Inc. ---------- ---------- ------------- ------------ Net cash flows provided by operating activities $ 10,922 $ (81) $ -- $ 10,841 Net cash flows used in investing activities (2,776) (5) -- (2,781) Cash flows from financing activities: Net change in revolving credit agreement borrowings (6,002) -- -- (6,002) Payments on long-term debt (128) -- -- (128) Distributions to GFSI Holdings, Inc. (1,584) -- -- (1,584) Other (86) -- -- (86) --------- ---------- --------- ---------- Net cash used in financing activities (7,800) -- -- (7,800) --------- ---------- --------- ---------- Effect of foreign exchange rate changes on cash -- 96 -- 96 --------- ---------- --------- ---------- Net increase in cash and cash equivalents 346 10 -- 356 Cash and cash equivalents at beginning of period 870 41 -- 911 --------- ---------- --------- ---------- Cash and cash equivalents at end of period $ 1,216 $ 51 $ -- $ 1,267 ========= ========== ========= ==========
8
As of July 3, 2004 (in thousands): Parent Subsidiary Consolidating Consolidated Obligor Guarantors Adjustments GFSI, Inc. ---------- ---------- ------------- ------------ Assets: Current assets: Cash and cash equivalents $ 870 $ 41 $ -- $ 911 Accounts receivable, net 18,978 27,338 (13,485) 32,831 Inventories, net 42,724 2,892 -- 45,616 Prepaid expenses and other current assets 1,453 214 -- 1,667 Deferred income taxes 1,077 -- -- 1,077 --------- --------- --------- ---------- Total current assets 65,102 30,485 (13,485) 82,102 Investment in equity of subsidiaries 27,791 -- (27,791) -- Property, plant and equipment, net 22,799 191 -- 22,990 Other assets 2,842 (647) 2,195 --------- --------- --------- ---------- Total assets $ 118,534 $ 30,029 $ (41,276) $ 107,287 ========= ========= ========= ========== Liabilities and stockholders' equity: Current liabilities: Accounts payable $ 25,261 $ 528 $ (13,485) $ 12,304 Accrued interest expense 4,424 -- -- 4,424 Accrued expenses 5,414 1,831 -- 7,245 Income taxes payable 10,599 (121) -- 10,478 Current portion of long-term debt 190 -- -- 190 --------- --------- --------- ---------- Total current liabilities 45,888 2,238 (13,485) 34,641 Deferred income taxes 1,501 -- -- 1,501 Other long-term obligations 452 -- -- 452 Long-term debt, less current portion 160,629 -- -- 160,629 Stockholders' equity (deficiency) (89,936) 27,791 (27,791) (89,936) --------- --------- --------- ---------- Total liabilities and stockholders' equity (deficiency) $ 118,534 $ 30,029 $ (41,276) $ 107,287 ========= ========= ========= ==========
Nine months ended April 3, 2004 (in thousands) (unaudited): Parent Subsidiary Consolidating Consolidated Obligor Guarantors Adjustments GFSI, Inc. ---------- ---------- ------------- ------------ Net sales $ 83,813 $ 60,534 $ (3,632) $ 140,715 Cost of sales 53,436 35,359 (3,632) 85,163 Selling expenses 10,156 9,785 -- 19,941 General and administrative expense 15,821 3,259 -- 19,080 -------- --------- --------- ---------- Total costs and expenses 79,413 48,403 (3,632) 124,184 -------- --------- --------- ---------- Operating income 4,400 12,131 -- 16,531 Equity in net earnings of subsidiaries 7,396 -- (7,396) -- Interest expense (11,364) (7) 3 (11,368) Gain on sale of property, plant and equipment 915 -- (3) 912 -------- --------- --------- ---------- Income before income taxes 1,347 12,124 (7,396) 6,075 Income tax expense (benefit) (2,359) 4,728 -- 2,369 -------- --------- --------- ---------- Net income $ 3,706 $ 7,396 $ (7,396) $ 3,706 ======== ========= ========= ==========
9 Nine months ended April 3, 2004 (in thousands) (audited):
Parent Subsidiary Consolidating Consolidated Obligor Guarantors Adjustments GFSI, Inc. ---------- ---------- ------------- ------------ Net cash flows provided by operating activities $ 21,681 $ 314 $ -- $ 21,995 Net cash flows used in investing activities (2,389) (6) (360) (2,755) Cash flows from financing activities: Net repayments under revolving credit agreement (6,609) -- -- (6,609) Purchase of parent company bonds (12,265) -- -- (12,265) Payments on long-term debt (226) -- -- (226) Repayment of intercompany debt -- (360) 360 -- Issuance of long-term debt 82 -- -- 82 Distributions to GFSI Holdings, Inc. (258) -- -- (258) Other (1) -- -- (1) --------- --------- --------- -------- Net cash used in financing activities (19,277) (360) 360 (19,277) --------- --------- --------- -------- Effect of foreign exchange rate changes on cash -- 38 -- 38 --------- --------- --------- -------- Net increase (decrease) in cash and cash equivalents 15 (14) -- 1 Cash and cash equivalents at beginning of period 1,323 64 -- 1,387 --------- --------- --------- -------- Cash and cash equivalents end of period $ 1,338 $ 50 $ -- $ 1,388 ========= ========= ========= ========
5. Financing and Recapitalization ------------------------------ On October 4, 2004 the Company and Holdings amended their existing revolving bank credit agreement ("RBCA"). Under the terms of amendment, the term of the RBCA was extended by one year to January 15, 2007. On March 1, 2005 the Company and Holdings amended their existing revolving bank credit agreement. The terms of the amendment reduced the interest rates in effect at the time of the amendment and revised certain restrictive financial covenant requirements. Under the amended RBCA, Holdings is required to maintain a minimum of $5 million of borrowing availability, as defined in the agreement. Should borrowing availability be less than $10 million but more than $5 million, Holdings is required to maintain a fixed charge coverage ratio of not less than 1.05 to 1.0, as defined in the agreement. Under the previous agreement, at its most restrictive level, Holdings was required to maintain a fixed charge coverage ratio of not less than 1.15 to 1.0. In September 2003, Company management formed a Delaware limited liability company named Gearcap LLC ("Gearcap") to affect the Recapitalization of Holdings. Gearcap purchased 11.375% Senior Discount Notes of Holdings ("11.375% Notes") with an aggregate principal amount at maturity of approximately $30.5 million (the "Contributed Notes") for approximately $12.3 million in cash. Gearcap and Holdings subsequently entered into an Exchange Agreement under which they exchanged 8,250 shares of newly authorized Holdings Class C common stock and 11,490 shares of newly authorized Series E 10% Cumulative Preferred Stock for the Contributed Notes. The Company and Holdings entered into a Contribution Agreement under which Holdings contributed the Contributed Notes it received from Gearcap to the Company as a capital contribution. The Company pledged the Notes as collateral under the RBCA. In September 2003, the Company purchased Notes with an aggregate principal amount at maturity of approximately $29.5 million and an accreted book value of $26.5 million at September 27, 2003 for approximately $12.2 million. The Company pledged the 11.375% Notes as collateral under the RBCA. The Company had acquired 11.375% Notes of Holdings with an aggregate maturity value of $84 million representing 78% of the issued 11.375% Notes of Holdings. The Company has elected to record its investment in the 11.375% Notes as a reduction of stockholders' equity at the acquisition cost of the 10 11.375% Notes. In fiscal 2004 the Company distributed a dividend to Holdings in the form of 11.375% Notes with a cost of $9.5 million and a value at maturity of $21.8 million. At a future date the Company intends to distribute to Holdings the remaining 11.375% Notes it holds to permit the parent company to formally retire these notes. The Company is currently restricted under its various long-term debt agreements from making a full distribution of the remaining 11.375% Notes it holds. At April 2, 2005 stockholders' equity (deficiency) included a reduction of $25.0 million representing the acquisition cost of the remaining 11.375% Notes held by the Company. The Company's and Gearcap's purchases of the 11.375% Notes has reduced the Company's future cash dividend obligations to Holdings to enable it to retire the 11.375% Notes in 2009 from $108 million to $24 million. Additionally, the purchases of the 11.375% Notes has reduced the Company's cash dividend obligations to Holdings to enable it to pay interest on the 11.375% Notes from $12.3 million to $2.7 million annually. In March 2005, the Company made a net $1.4 million distribution to Holdings to enable Holdings to pay interest on the 11.375% Notes. ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The discussions set forth in this Form 10-Q should be read in conjunction with the financial information included herein and the Company's Annual Report on Form 10-K for the year ended July 3, 2004. Management's discussion and analysis of financial condition and results of operations and other sections of this report contain forward-looking statements relating to future results of the Company. Such forward-looking statements are identified by use of forward-looking words such as "anticipates", "believes", "plans", "estimates", "expects", and "intends" or words or phrases of similar expression. These forward-looking statements are subject to various assumptions, risks and uncertainties, including but not limited to, changes in political and economic conditions, demand for the Company's products, acceptance of new products, developments affecting the Company's products and to those discussed in the Company's filings with the Securities and Exchange Commission. Accordingly, actual results could differ materially from those contemplated by the forward- looking statements. CRITICAL ACCOUNTING POLICIES The following discussion and analysis of financial condition, results of operations, liquidity and capital resources is based upon the Company's consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States. Generally accepted accounting principles require estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities. On an ongoing basis, the Company evaluates its estimates, including those related to bad debts, inventories, intangible assets, long-lived assets, deferred income taxes, accrued expenses, contingencies and litigation. The Company bases its estimates on historical experience and on various other assumptions that it believes are reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ materially from these estimates under different assumptions or conditions. The Company's management believes that some of its significant accounting policies involve a higher degree of judgment or complexity than other accounting policies. Identified below are the policies deemed critical to its business and the understanding of its results of operations. 11 Revenue recognition. The Company recognizes revenues when goods are shipped, title has passed, the sales price is fixed and collectibility is reasonably assured. Returns, discounts and sales allowance estimates are based on projected sales trends, historical data and other known factors. If actual returns, discounts and sales allowances are not consistent with the historical data used to calculate these estimates, net sales could either be understated or overstated. Accounts receivable. Accounts receivable consist of amounts due from customers and business partners. The Company maintains an allowance for doubtful accounts to reflect expected credit losses and generally provides for bad debts based on collection history and specific risks identified on a customer-by-customer basis. A considerable amount of judgment is required to assess the ultimate realization of accounts receivable and the credit- worthiness of each customer. Furthermore, these judgments must be continually evaluated and updated. If the historic data used to evaluate credit risk does not reflect future collections, or if the financial condition of the Company's customers were to deteriorate causing an impairment of their ability to make payments, additional provisions for bad debts may be required in future periods. Accounts receivable at April 2, 2005 and July 3, 2004 were net of allowance for doubtful accounts of $559,000 and $637,000, respectively. Reserves for self-insurance. The Company seeks to employ cost effective risk management programs. At times the Company has elected to retain a portion of insurance risk related to workers' compensation claims which are covered under insurance programs with high deductible limits. The Company also actively pursues programs intended to effectively manage the incidence of workplace injuries. Reserves for reported but unpaid losses, as well as incurred but not reported losses, related to the retained risks are calculated based upon loss development factors, as well as other assumptions considered by management, including assumptions provided by other external professionals such as insurance brokers, consultants and carriers. The factors and assumptions used are subject to change based upon historical experience, as well as changes in expected cost trends and other factors. Inventories. Inventories are carried at the lower of cost or market determined under the First-In, First-Out (FIFO) method. The Company writes down obsolete and unmarketable inventories to their estimated market value based upon, among other things, assumptions about future demand and market conditions. If actual market conditions are less favorable than projected, additional inventory write-downs may be required. The Company also records changes in valuation allowances due to changes in operating strategy, such as the discontinuances of certain product lines and other merchandising decisions related to changes in demand. It is possible that further changes in required inventory allowances may be necessary in the future as a result of market conditions and competitive pressures. Fiscal Period. The Company's fiscal year ends on the Saturday nearest June 30, which results in a 53 week year from time to time. The fiscal year ended July 3, 2004 was a 53 week period. The additional week fell in the Company's second quarter ended January 3, 2004. Therefore, the nine month fiscal period ended April 3, 2004 has one more week of operations than the comparable period of fiscal 2005. Because of the seasonal nature of the Company's business, and the timing of the additional week, which fell during the holiday period, management believes the effect of the additional week of operations was not significant. 12 COMPARISON OF OPERATING RESULTS FOR THE QUARTERS ENDED APRIL 2, 2005 AND APRIL 3, 2004 Net Sales. Net sales for the quarter ended April 2, 2005 increased $3.2 million or 9% to $40.4 million compared to $37.2 million last year. Sales of Gear branded products to collegiate, resort and golf customers and sales of Champion branded products increased over the third quarter of last year. Sales of Champion branded products were 20% higher than last year principally due to a greater penetration with resort customers. Sales of Gear branded products to military customers declined significantly in the wake of greater overseas deployment of military personnel and reduced war effort enthusiasm. Reductions in corporate spending on marketing and employee incentive programs continued to have a negative effect on net sales of the Corporate Division which also decreased from last year. Gross Profit. Gross profit for the quarter ended April 2, 2005 increased 5% to $16.2 million compared to $15.4 million last year. Higher sales created the increase in gross profit. Gross profit as a percentage of net sales decreased to 40% for the quarter compared to 41% last year. The gross profit percentage declined due to lowered selling prices to liquidate inventory overstocks. The Company anticipates it will continue to move through its inventory overstocks during the remainder of fiscal 2005. The Company has been working to reduce its higher than desired inventory level with price reductions. Operating Expenses. Operating expenses for the quarter ended April 2, 2005 increased 7% to $13.7 million from $12.8 million last year. The increase in operating expenses was principally due to higher selling expense. Increased royalty fees and new brand development costs created the increase in selling expense. The royalty obligation on Champion(R) branded apparel in fiscal 2004 was 3% of net sales compared to 4% for fiscal 2005. The Company also incurred marketing and preproduction costs of approximately $450,000 related to the launch of two new golf and resort brands scheduled to commence sales in the fourth quarter of fiscal 2005 and the first quarter of fiscal 2006. Operating expenses as a percentage of net sales were 34% in the third quarter of fiscal 2005 approximately the same as last year. Operating Income. Operating income decreased 5% to $2.5 million in the third quarter of fiscal 2005 compared to $2.6 million last year. Operating income as a percentage of net sales decreased to 6% in the third quarter of fiscal 2005 from 7% in the third quarter of fiscal 2004. The decrease in operating income resulted from higher selling expenses for royalty fees and new brand launches. Interest Expense. Interest expense in the third quarter of fiscal 2005 was $3.8 million compared to $3.7 million last year. Higher bank borrowings at higher interest rates created the increase in interest expense. Net Loss. Net loss for the third quarter of fiscal 2005 was ($789,000) compared to net loss of ($641,000) for the third quarter of fiscal 2004. The decrease in operating income resulted in the $148,000 increase in net loss. COMPARISON OF OPERATING RESULTS FOR THE NINE MONTHS ENDED APRIL 2, 2005 AND APRIL 3, 2004 Net Sales. Net sales for the nine months ended April 2, 2005 decreased 2% to $138.0 million compared to $140.7 million last year. The decrease in net sales was due to reduced sales of Gear branded products while sales of Champion branded products increased over the comparable period last year. The sales decrease in Gear branded products was most pronounced in the Military and Corporate customer groups. Sales to military customers were down due to increased overseas troop deployment and reduced war effort enthusiasm. Reductions in corporate spending on marketing and employee incentive programs have had a continuing negative effect on net sales of the Corporate Division. Sales of Gear products within the Resort and Golf Divisions recovered from the economic aftermath of the hurricane damage that took place in the Southeastern United States and the Caribbean during the first half of fiscal 2005. Sales of Champion branded products were 5% higher than last year principally due to a greater penetration with resort customers. 13 Gross Profit. Gross profit for the nine months ended April 2, 2005 decreased 5% to $53.1 million compared to $55.6 million last year. Gross profit as a percentage of net sales decreased to 38% for the nine month period compared to 39% last year. Gross profit as a percentage of sales decreased due to the costs of idle time at the decoration and warehousing facilities from the conversion of information technology systems in the second quarter of fiscal 2005. The gross profit percentage also declined due to excess costs related to handling, storage and liquidation of inventory overstocks. The Company has been working to reduce its higher than desired inventory level with price reductions. The Company anticipates it will continue to move through its inventory overstocks during the remainder of fiscal 2005. Operating Expenses. Operating expenses for the nine months ended April 2, 2005 were $40.0 million compared to $39.0 million last year. Increased selling expense created the increase in operating expenses. During the first nine months of fiscal 2005 the Company sold more licensed apparel at higher royalty rates than in the comparable period of fiscal 2004. The royalty obligation on Champion(R) branded apparel in fiscal 2004 was 3% of net sales compared to 4% for fiscal 2005. The Company also incurred marketing and preproduction costs of approximately $800,000 related to the launch of two new golf and resort brands scheduled to commence sales in the fourth quarter of 2005 and the first quarter of fiscal 2006. Operating expenses as a percentage of net sales were 29% in fiscal 2005 compared to 28% last year. Higer royalty expenses and product launch costs created the increase in operating expenses as a percentage of net sales in comparison to last year. Operating Income. Operating income for the nine months ended April 2, 2005 decreased 21% to $13.1 million compared to $16.5 million last year. Operating income as a percentage of net sales decreased to 10% in fiscal 2005 from 12% in fiscal 2004. The decrease in operating income resulted from lower sales, the decrease in gross profit and higher selling costs. Interest Expense. Interest expense in the first nine months of fiscal 2005 was $11.5 million compared to $11.4 million last year. Higher bank borrowings at higher interest rates in fiscal 2005 offset the savings derived from having one less week in the first nine months of fiscal 2005 compared to the first nine months of fiscal 2004. Gain on Sale of Property, Plant and Equipment. During the first quarter of fiscal 2004, the Company sold its 100,000 square foot distribution facility located in Lenexa, Kansas, for approximately $2.8 million and recorded a pre-tax gain of approximately $900,000 in other income. The facility was sold as part of a warehouse consolidation and automation initiative which combined distribution operations into a larger, renovated facility eliminating several smaller warehouses. Net Income. Net income for the first nine months of fiscal 2005 was $1.0 million compared to $3.7 million last year. The decrease in operating income and last year's gain on the sale of the distribution facility resulted in the $2.7 million decrease in net income in comparison to last year. NEW LICENSE AGREEMENTS During the first nine months of fiscal 2005 the Company entered into license agreements for two new apparel brands. Product produced under the Robert Trent Jones License and brand will be targeted at the high-end casual sportswear resort and golf markets. Technical outerwear products produced under the Sunice License and brand will be targeted at the high-end golf market. Sales for these brands are not expected to be significant in fiscal 2005. The Company incurred $800,000 in product launch and preproduction expenses during the nine months ended April 2, 2005. The Company expects to incur product launch and preproduction expenses related to these brands of approximately $200,000 during the remainder of fiscal 2005. 14 FINANCING AND RECAPITALIZTION In September 2003, Company management formed a Delaware limited liability company named Gearcap LLC ("Gearcap") to affect the Recapitalization of Holdings. Gearcap purchased 11.375% Senior Discount Notes of Holdings ("11.375% Notes") with an aggregate principal amount at maturity of approximately $30.5 million (the "Contributed Notes") for approximately $12.3 million in cash. Gearcap and Holdings subsequently entered into an Exchange Agreement under which they exchanged 8,250 shares of newly authorized Holdings Class C common stock and 11,490 shares of newly authorized Series E 10% Cumulative Preferred Stock for the Contributed Notes. The Company and Holdings entered into a Contribution Agreement under which Holdings contributed the Contributed Notes it received from Gearcap to the Company as a capital contribution. The Company subsequently pledged the 11.375% Notes as collateral under the RBCA. On September 2003, the Company purchased 11.375% Notes with an aggregate principal amount at maturity of approximately $29.5 million for approximately $12.2 million. The Company subsequently pledged the 11.375% Notes as collateral under the RBCA. The Company had acquired 78% of the issued 11.375% Notes of Holdings. The Company has elected to record its investment in the 11.375% Notes as a reduction of stockholders' equity at the acquisition cost of the 11.375% Notes. In fiscal 2004 the Company distributed a dividend to Holdings in the form of 11.375% Notes with a cost of $9.5 million and a value at maturity of $21.8 million. At a future date the Company intends to distribute to Holdings the remaining 11.375% Notes it holds to permit the parent company to formally retire these notes. The Company is currently restricted under its various long-term debt agreements from making a full distribution of the remaining 11.375% Notes it holds. At April 2, 2005 stockholders' equity (deficiency) included a reduction of $25.0 million representing the acquisition cost of the remaining 11.375% Notes held by the Company. LIQUIDITY AND CAPITAL RESOURCES Cash provided by operating activities in the first nine months of fiscal 2005 was $10.8 million compared to $22.0 million last year. Higher inventory levels, lower accounts payable and lower net income produced the decrease in fiscal 2005 operating cash flows compared to last year. Cash used in investing activities in the first nine months of fiscal 2005 was $2.8 million, approximately the same as last year. During the first nine months of fiscal 2005 the Company's capital expenditures were principally related to hardware and software upgrades of its enterprise information systems. In the first nine months of fiscal 2004, $2.8 million in proceeds were received from the sale of the Company's Lenexa distribution facility and $3.2 million was spent building a new warehouse and distribution facility. The Company anticipates fiscal 2005 capital expenditures to approximate $3 million. Cash used in financing activities in the first nine months of fiscal 2005 was $7.8 million compared to $19.3 million in the comparable period of fiscal 2004. In the first nine months of fiscal 2005 cash flows from operations were used to repay bank debt under the RBCA. In March 2005, the Company made a net $1.4 million distribution to Holdings to enable Holdings to pay interest on its outstanding 11.375% Notes. In the first nine months of fiscal 2004 borrowings under the Company's RBCA were used to finance higher levels of inventory. The purchase of Holdings 11.375% Notes and borrowings of bank debt were the primary uses of cash in financing activities in fiscal 2004. 15 On October 4, 2004 the Company and Holdings amended their $65 million Revolving Bank Credit Agreement ("RBCA") to extend the term of the credit agreement to January 15, 2007. Under the Company's RBCA up to $65 million of revolving credit availability is provided, of which $19.1 million was borrowed and outstanding and approximately $3.3 million was utilized for outstanding commercial and stand-by letters of credit as of April 2, 2005. At April 2, 2005, $19.3 million was available for future borrowings under the RBCA. The Company believes that cash flows from operating activities and borrowings under the RBCA will be adequate to meet the Company's short- term and future liquidity requirements prior to the maturity of the RBCA in fiscal 2007, although no assurance can be given in this regard. On March 1, 2005 the Company and Holdings amended their existing revolving bank credit agreement. The terms of the amendment reduced the interest rates in effect at the time of the amendment and revised certain restrictive financial covenant requirements. Under the amended RBCA, Holdings is required to maintain a minimum of $5 million of borrowing availability, as defined in the agreement. Should borrowing availability be less than $10 million but more than $5 million Holdings is required to maintain a fixed charge coverage ratio of not less than 1.05 to 1.0, as defined in the agreement. Under the previous agreement, at its most restrictive level, Holdings was required to maintain a fixed charge coverage ratio of not less than 1.15 to 1.0. The Company anticipates paying dividends to Holdings to enable Holdings to pay corporate income taxes, pursuant to a Tax Sharing Agreement, interest on the 11.375% Notes, fees payable under management agreements, fees payable under a non-competition agreement, and certain other ordinary course expenses. Holdings is dependent upon the cash flows of the Company to provide funds to service the 11.375% Notes. At April 2, 2005, Holdings' debt to third parties totaled approximately $24.5 million. The 11.375% Notes annual cash flow requirements commenced in March 2005 with a semi-annual cash installment of approximately $1.4 million. Additionally, Holdings' cumulative non-cash preferred stock ("Holdings Preferred Stock") dividends total approximately $1.5 million annually. Dividends on the Holdings Preferred Stock have been accumulating and have not been paid in cash. Mandatory redemption of the Holdings Preferred Stock is required in fiscal 2009 and fiscal 2017. SEASONALITY AND INFLATION The Company experiences seasonal fluctuations in its sales and profitability, with generally higher sales and gross profit in the first and second quarters of its fiscal year. The seasonality of sales and profitability is primarily due to higher college bookstore sales during the first two fiscal quarters. Sales at the Company's Resort and Corporate divisions typically show little seasonal variations. The impact of inflation on the Company's operations has not been significant to date. However, there can be no assurance that a high rate of inflation in the future would not have an adverse effect on the Company's operating results. OFF-BALANCE SHEET ARRANGEMENTS The Company does not have any off-balance sheet arrangements that have or are reasonably likely to have a current or future material effect on the Company's financial condition, changes in financial condition, revenues or expenses, results of operations, liquidity, capital expenditures or capital resources. 16 ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK DERIVATIVE AND MARKET RISK DISCLOSURE The Company's market risk exposure is primarily due to possible fluctuations in interest rates. The fixed rate portion of the Company's long-term debt does not bear significant interest rate risk. An immediate 10% change in interest rates would not have a material effect on the Company's results of operations over the next fiscal year, although there can be no assurances that interest rates will not significantly change. ITEM 4. CONTROLS AND PROCEDURES An evaluation was performed under the supervision and with the participation of the Company's management, including the Chief Executive Officer and the Chief Financial Officer, of the effectiveness of the design and operation of the Company's disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) as of the end of the period ended April 2, 2005. Based on that evaluation, the Company's management, including the Chief Executive Officer and the Chief Financial Officer, concluded that the Company's disclosure controls and procedures are effective in timely alerting them to material information relating to the Company (including its consolidated subsidiaries) required to be included in the Company's periodic SEC filings. There have been no significant changes in the Company's internal controls or in other factors that could significantly affect internal controls, nor were any corrective actions required with regard to significant deficiencies and material weaknesses. 17 PART II - OTHER INFORMATION Item 1. Legal Proceedings The Company is not a party to any pending legal proceeding the resolution of which, the management of the Company believes, would have a material adverse effect on the Company's results of operations or financial condition, nor to any other pending legal proceedings other than ordinary, routine litigation incidental to its business. Item 2. Changes in Securities None. Item 3. Defaults Upon Senior Securities None. Item 4. Submission of Matters to a Vote of Security Holders None. Item 5. Other Information None. Item 6. Exhibits Exhibit Number Description ------- ----------- 31.1 Certification of Principal Executive Officer. 31.2 Certification of Principal Financial Officer. 18 SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. GFSI, INC. May 3, 2005 /s/ J. Craig Peterson - ------------------------------------------------- J. Craig Peterson Senior Vice President and Chief Financial Officer 19 EX-31.1 2 exh31_1.txt Exhibit 31.1 CERTIFICATION OF PRINCIPAL EXECUTIVE OFFICER REGARDING GFSI, INC.'S QUARTERLY REPORT ON FORM 10-Q FOR THE PERIOD ENDED APRIL 2, 2005 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 presented in this Quarterly Report; 4. The registrant's other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f))for the registrant and have: (a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, 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) Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. (c) Evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this Quarterly Report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this Quarterly Report based on such evaluation; and (d) Disclosed in this Quarterly Report any change in the registrant's internal control over financial reporting that occurred during the registrant's most recent fiscal quarter that has materially affected, or is reasonably likely to materially affect, the registrant's internal control over financial reporting; and 5. The registrant's other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant's auditors and the audit committee of the registrant's board of directors (or persons performing the equivalent function): (a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant's ability to record, process, summarize and report financial information; and (b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal control over financial reporting. Date: May 3, 2005 /s/ Robert M. Wolff - ----------------------- Robert M. Wolff Chairman and Chief Executive Officer EX-31.2 3 exh31_2.txt Exhibit 31.2 CERTIFICATION OF PRINCIPAL FINANCIAL OFFICER REGARDING GFSI, INC.'S QUARTERLY REPORT ON FORM 10-Q FOR THE PERIOD ENDED APRIL 2, 2005 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 presented in this Quarterly Report; 4. The registrant's other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e))and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have: (a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, 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) Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. (c) Evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this Quarterly Report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this Quarterly Report based on such evaluations; and (d) Disclosed in this Quarterly Report any change in the registrant's internal control over financial reporting that occurred during the registrant's most recent fiscal quarter that has materially affected, or is reasonably likely to materially affect, the registrant's internal control over financial reporting; and 5. The registrant's other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant's auditors and the audit committee of the registrant's board of directors (or persons performing the equivalent function): (a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant's ability to record, process, summarize and report financial information; and (b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal control over financial reporting. Date: May 3, 2005 /s/ J. Craig Peterson - ------------------------- J. Craig Peterson Senior Vice President and Chief Financial Officer -----END PRIVACY-ENHANCED MESSAGE-----