| DELTA APPAREL INC ITEM 1A RISK FACTORS We operate in a rapidly-changing, highly competitive business environment that involves substantial risks and uncertainties, including, but not limited to, the risks identified below |
| The risks described below are not the only risks that we face |
| Additional risks not presently known to us or that we currently do not view as material, may become material, and may impair our business operations |
| Any of these risks could cause, or contribute to causing, our actual results to differ materially from expectations |
| ACQUISITION We anticipate closing on the acquisition of Fun-Tees, Inc |
| on or around October 2, 2006; however, the closing of the acquisition is subject to the satisfaction of various closing conditions, including obtaining all necessary consents |
| The agreement can be terminated under various circumstances, including, among others, by us if we are unable to obtain satisfactory financing and by either party if the transaction fails to close by October 31, 2006 |
| The success of the acquisition is dependent on our ability to integrate Fun-Tees into our existing textile operations, and to achieve the anticipated synergies with our activewear division |
| If we are unable to successfully integrate our operations, it could have a material adverse effect on our results of operations |
| PRICING PRESSURES Prices in our industry have generally been dropping over the past several years, even though demand for our products has increased since fiscal year 1998 |
| The price declines have resulted from factors largely outside of our control, such as the industry’s transfer of manufacturing out of the United States, excess supply capacity, and changing raw material prices |
| In addition, intense competition to gain market share has led some competitors to sell substantial amounts of goods at prices against which we cannot profitably compete |
| Demand for our products is dependent on the general demand for Activewear Apparel and the availability of alternative sources of supply |
| Our strategy in this market environment is to be a low-cost producer and to differentiate ourselves by providing quality service to our customers |
| Even if this strategy is successful, its results may be offset by reductions in demand or price declines |
| COMPETITION We sell our products in a highly competitive market in which numerous distributors and manufacturers compete, some of which are larger, more diversified and have greater financial resources than we do |
| Competition in the Activewear Apparel industry is generally based upon price, service, delivery time, quality and flexibility, with the relative importance of each factor depending upon the needs of particular customers and the specific product offering |
| With respect to branded product lines, competition is mainly based upon consumer recognition and preference |
| If we are unable to remain competitive in the areas of quality, price, design, marketing, product development, manufacturing, and distribution, it could have a material adverse effect on our results of operations |
| FASHION TRENDS The Retail-Ready Apparel segment comprises our business units primarily focused on more specialized apparel garments to meet consumer preferences and fashion trends |
| The popularity, supply and demand for particular apparel products can change significantly from year to year based on prevailing fashion trends and other factors |
| Our ability to adapt to fashion trends in designing our products is important to the success in the Retail-Ready Apparel segment |
| If we are unable to quickly adapt to consumer preferences in the design of our products, it could have a material adverse effect on our results of operations |
| In addition, a slow-down in the economy could cause changes in the demand for apparel products, which could have a material adverse effect on our results of operations |
| YARN PRICING AND AVAILABILITY Yarn is the primary raw material used in our manufacturing processes |
| As described above in “Raw Materials”, in conjunction with the sale of our yarn spinning facility, we entered into a five-year agreement with Parkdale to supply our yarn requirements |
| During this five-year period, we will purchase from Parkdale all yarn required by Delta Apparel and our wholly owned subsidiaries for use in our manufacturing operations (excluding yarns 7 _________________________________________________________________ [40]Table of Contents that Parkdale did not manufacture as of the date of the agreement in the ordinary course of its business or due to temporary Parkdale capacity restraints) |
| The purchase price of yarn is based upon the cost of cotton plus a fixed conversion cost |
| We fix the cotton prices as a component of the purchase price of yarn in advance of the shipment of finished yarn from Parkdale |
| Prices are set according to prevailing prices, as reported by the New York Cotton Exchange, at the time we elect to fix specific cotton prices |
| Thus, we are subject to the commodity risk of cotton prices and cotton price movements which could result in unfavorable yarn pricing for us |
| While we believe that we will be competitive with other companies in setting the price of cotton purchased for future production, any significant increase in the price of cotton could have a material adverse effect on our results of operations |
| In addition, if Parkdale’s operations are disrupted and it is not able to provide us with our yarn requirements, we may need to obtain yarn from alternative sources |
| We may not be able to enter into arrangements with substitute suppliers on terms as favorable as our current terms with Parkdale, which could have a material adverse effect on our results of operations |
| DISRUPTION IN DISTRIBUTION OPERATIONS We have company-owned and leased distribution facilities located throughout the United States |
| Any significant interruption in the operation of any of these facilities may delay shipment of merchandise to our customers, damage our reputation or otherwise have a material adverse effect on our financial condition and results of operations |
| Moreover, a failure to successfully coordinate the operations of these facilities also could have a material adverse effect on our financial condition and results of operations |
| INFORMATION SYSTEMS We depend on information systems to manage our inventory, process transactions, respond to customer inquiries, purchase, sell and ship goods on a timely basis and maintain cost-effective operations |
| We may experience operational problems with our information systems as a result of system failures, viruses, or other causes |
| Any material disruption or slowdown of our systems could cause operational delays that could have a material adverse effect on our results of operations |
| CREDIT RISK We are exposed to the risk of financial non-performance by our customers on a significant amount of our sales |
| Our extension of credit involves considerable judgment and is based on an evaluation of each customer’s financial condition and payment history |
| We monitor our credit risk exposure by periodically obtaining credit reports and updated financials on our customers |
| In addition, we mitigate our risk of loss by obtaining credit insurance on a portion of our accounts receivable |
| We maintain an allowance for doubtful accounts for potential credit losses based upon our historical trends and other available information |
| However, the inability to collect on sales to significant customers or a group of customers could have a material adverse effect on our results of operations |
| TRANSPORTATION COSTS We incur significant freight costs to transport our goods from our domestic textile plants to off-shore sewing facilities and then to bring our goods back into the United States |
| In addition, we incur transportation expenses to ship our products to our customers |
| Transportation costs significantly increased during fiscal year 2006 and had an unfavorable impact on our results of operations |
| Further significant increases in the costs of freight and transportation could have a material adverse effect on our results of operations, as there can be no assurance that these increased costs could be passed to our customers |
| ENERGY CONSUMPTION AND PRICES Our manufacturing operations require high inputs of energy, and therefore changes in energy prices impact on our gross profits |
| Energy costs significantly increased during fiscal year 2006 and had an unfavorable impact on our results of operations |
| We are focusing on manufacturing methods that will reduce the amount of energy used in the production of our apparel products to mitigate the rising costs of energy |
| However, further significant increases in energy prices could have a material adverse effect on our results of operations, as there can be no assurance that these increased costs could be passed to our customers |
| GOODWILL AND INTANGIBLE ASSETS When we acquire a business, a portion of the purchase price of the acquisition may be allocated to goodwill and other identifiable intangible assets |
| The amount of the purchase price which is allocated to goodwill and other intangible assets is determined by the excess of the purchase price over the net identifiable assets acquired |
| Under current accounting standards, if we determine goodwill or intangible assets are impaired, we would be required to write down the value of these assets |
| We conduct an annual review to determine whether goodwill and other identifiable intangible assets are impaired |
| We completed such an impairment analysis for our fiscal year ended July 1, 2006, and concluded that no impairment charge was necessary |
| There can, however, be no assurance that we will not be required to take an impairment charge in the future, which could have a material adverse effect on our results of operations |
| AVAILABILITY OF CASH Significant operating losses or significant uses of cash in our operations could cause us to be unable to pay our debts as they become due and to default on our credit facility, which would have an adverse effect on the value of our common shares |
| Our credit agreement contains customary representations and warranties, funding conditions and events of default |
| A breach of one or more covenants or any other event of default under the credit agreement could result in an acceleration of our obligations under the agreement, in the foreclosure on any assets subject to liens in favor of 8 _________________________________________________________________ [41]Table of Contents the credit agreement’s lenders, and in the inability of us to borrow additional amounts under the credit agreement |
| In addition, our agreement is an asset-based revolving credit facility |
| Our ability to borrow under the agreement depends on our accounts receivable and inventory levels |
| A significant deterioration in our accounts receivable or inventory levels could restrict our ability to borrow funds |
| MARKET PRICE OF DELTA APPAREL SHARES Various investment banking firms have informed us that public companies with relatively small market capitalizations have difficulty generating institutional interest, research coverage or trading volume |
| This illiquidity can translate into price discounts as compared to industry peers or to the shares’ inherent value |
| We believe that the market perceives us to have a relatively small market capitalization |
| This could lead to our shares trading at prices that are significantly lower than our estimate of their inherent value |
| As of August 18, 2006, we had outstanding 8cmam540cmam751 shares of common stock |
| We believe that approximately 59dtta1prca of our stock is beneficially owned by persons who beneficially own more than 5prca of the outstanding shares of our common stock and related individuals, and that of this, approximately 34dtta9prca of the outstanding stock is beneficially owned by institutional investors who own more than 5prca of the outstanding shares |
| Sales of substantial amounts of our common stock in the public market by any of these large holders could adversely affect the market price of the common stock |
| PRINCIPAL SHAREHOLDERS EXERT SUBSTANTIAL INFLUENCE As of August 18, 2006, two members of our board of directors and related individuals had or shared the voting power with respect to approximately 24dtta2prca of the outstanding shares of our common stock |
| These individuals will exert substantial influence with respect to all matters submitted to a vote of shareholders, including the election of our directors |
| In addition, our directors, executive officers and related individuals, as a group (comprised of 12 people), owned 29dtta0prca of our stock as of August 18, 2006, and therefore will exert substantial influence with respect to all matters submitted to a vote of shareholders, including the election of directors |
| POLITICAL AND ECONOMIC UNCERTAINTY IN HONDURAS AND MEXICO We have two company-operated sewing facilities in Honduras and one company-operated sewing facility in Mexico |
| In conjunction with the acquisition of FunTees in fiscal year 2007, we will be adding a facility in El Salvador |
| If the labor markets tighten in these countries, it could have adverse effects on the industries located in the applicable country |
| In addition, economic or legal changes could occur that affect the way in which we conduct our business in these countries |
| For example, a growing economy could lower unemployment which could increase wage rates or make it difficult to retain employees or employ enough people to meet demand |
| The government could also decide to add additional holidays or change employment law increasing our costs to operate in that country |
| Domestic unrest or political instability in any of these countries could also disrupt our operations |
| Any of these political, social or economic conditions could adversely affect our results of operations |
| US TRADE REGULATIONS Our products are subject to foreign competition, which in the past has been faced with significant US government import restrictions |
| Foreign producers of apparel often have significant labor cost advantages |
| Given the number of these foreign producers, the substantial elimination of import protections that protect domestic apparel producers could materially adversely affect our business |
| The extent of import protection afforded to domestic apparel producers has been, and is likely to remain, subject to political considerations |
| The North American Free Trade Agreement or “NAFTA” became effective on January 1, 1994 and has created a free-trade zone among Canada, Mexico and the United States |
| NAFTA contains a rule of origin requirement that products be produced in one of the three countries in order to benefit from the agreement |
| NAFTA has phased out all trade restrictions and tariffs among the three countries on apparel products competitive with ours |
| During fiscal 2001, we completed our sewing expansion into Mexico in order to take advantage of the NAFTA benefits |
| Subsequent repeal or alteration of NAFTA could seriously adversely affect our results of operations |
| Under the United States-Caribbean Basin Trade Partnership Act (often referred to as the “CBI Parity Bill”), effective October 1, 2000, quotas and duties were eliminated on apparel imported from certain Caribbean basin countries, provided such apparel is made from US fabric (made from US yarn) formed and cut in the United States |
| The same exemption from quotas and duties applies to apparel made from US fabric (made from US yarn) cut in a Caribbean basin country if US thread is used |
| This Act also exempts a limited amount of knit apparel (other than outerwear T-shirts) made from regional fabric (made from US yarn), and T-shirts (other than underwear T-shirts) using fabric (made from US yarn) formed in a Caribbean basin country |
| We believe that the CBI Parity Bill gives us a competitive advantage relative to apparel manufacturers outside of the Caribbean and improves our competitive position relative to apparel manufacturers inside the non-NAFTA countries |
| Subsequent repeal or adverse alteration of the CBI Parity Bill could put us at a competitive disadvantage relative to such manufacturers |
| On August 2, 2005, the Central America Free Trade Agreement (“CAFTA”) was signed into law |
| CAFTA creates a free-trade zone among the United States, El Salvador, Nicaragua, Guatemala, Honduras, and Costa Rica |
| Although we are currently operating duty-free in our Central American facilities through the CBI Parity Bill, CAFTA provides further 9 _________________________________________________________________ [42]Table of Contents assurance that this will continue |
| Subsequent repeal or alteration of CAFTA could seriously adversely affect our results of operations |
| In addition, several of our competitors have established textile production in Central America, which could result in lower manufacturing costs for them |
| This might cause the selling prices of our products to decline, which could have a material adverse effect on our results of operations |
| The World Trade Organization or “WTO”, a multilateral trade organization, was formed in January 1995 and is the successor to the General Agreement on Tariffs and Trade or “GATT” |
| This multilateral trade organization has set forth mechanisms by which world trade in clothing is being progressively liberalized by phasing-out quotas and reducing duties over a period of time that began in January of 1995 |
| As it implements the WTO mechanisms, the US government is negotiating bilateral trade agreements with developing countries (which are generally exporters of textile and apparel products) that are members of the WTO to encourage them to reduce their tariffs on imports of textiles and apparel in exchange for reductions by the United States in tariffs on imports of textiles and apparel |
| The remaining quotas were eliminated on January 1, 2005, significantly changing the competitiveness of many countries as apparel sourcing locations |
| As we believe that we are a low-cost producer of high quality apparel, we do not expect this to have a material impact on our results of operations in future years if NAFTA, CBI Parity and CAFTA remain in place |
| In addition, the US Government may take other action to improve the impact of a possible influx of textile products from China |
| There is, however, no assurance that our future results will not be impacted by increased global competition |
| ENVIRONMENTAL RULES Our operations must meet extensive federal, state and local regulatory standards in the areas of safety, health and environmental pollution controls |
| There can be no assurance that interpretations of existing regulations, future changes in existing laws, or the enactment of new laws and regulations will not require substantial additional expenditures |
| Similarly, the extent of our liability, if any, for the discovery of currently unknown problems or conditions, or past failures to comply with laws, regulations and permits applicable to our operations cannot be determined |
| OUTSIDE PRODUCTION We have historically relied upon third party suppliers for up to 40prca of our sewing production |
| Any shortage of supply or significant price increases from our suppliers could adversely affect our results of operations |
| TRADEMARKS We rely on the strength of our trademarks, including the Soffe®, Intensity Athletics®, DELTA®, QUAIL HOLLOW^TM, Junkfood® and Sweet and Sour® brands |
| We have incurred legal costs in the past to establish and protect these trademarks, but these costs have not been significant |
| We may in the future be required to expend resources to protect these trademarks |
| The loss or limitation of the exclusive right to use our trademarks could adversely affect our sales and results of operations |
| LICENSE AGREEMENTS Our Retail-Ready Apparel segment relies on its licensed products for a substantial part of its sales |
| Although we are not dependent on any single license, we believe our license agreements in the aggregate are of significant value to our business |
| The loss or failure to obtain license agreements could adversely affect our sales and results of operations |
| KEY MANAGEMENT Our success depends upon the talents and continued contributions of our key management, many of whom would be difficult to replace |
| The loss or interruption of the services of these executives could have a material adverse effect on our business, financial condition and results of operations |
| Although we maintain employment agreements with certain members of key management, we cannot be assured that the services of such personnel will continue |
| We do not, however, maintain an employment agreement with Robert W Humphreys, President and Chief Executive Officer |
| We believe our future success depends on our ability to retain and motivate our key management, our ability to integrate new members of management into our operations and the ability of all personnel to work together effectively as a team |