accommodate the increased shipping volume. Personnel costs increased primarily due to staffing of our new initiatives, including Calvin Klein women’s suits and dresses, Sean John women’s sportswear and Exsto men’s sportswear for Wal*Mart.
Interest and finance charges, net for the three-month period ended October 31, 2006 were $2.7 million compared to $2.2 million for the comparable period last year. Interest expense increased due to a 170 basis point increase in our average interest rate offset, in part, by slightly lower average borrowings for the quarter.
Income tax expense for the three months ended October 31, 2006 was $15.7 million compared to $10.7 million in the comparable period last year. The effective rate for the current period was 40.3% compared to 42.0% for the comparable prior period. The effective tax rate in the current period was lower because income tax expense in the current period includes the reversal of tax reserves of approximately $970,000 as a result of the completion of a Federal income tax audit.
Nine months ended October 31, 2006 compared to nine months ended October 31, 2005
Net sales for the nine months ended October 31, 2006 increased to $328.2 million from $254.9 million in the same period last year. Net sales of licensed apparel increased to $197.6 million from $146.1 million, primarily as a result of an increase of $36.3 million in net sales of Calvin Klein licensed product, including outerwear, suits and dresses. Net sales of non-licensed apparel increased to $130.6 million from $108.8 million, primarily due to an increase in new and existing private label programs for both men’s and women’s outerwear.
Gross profit increased to $89.9 million, or 27.4% of net sales, for the nine month period ended October 31, 2006, from $68.8 million, or 27.0% of net sales, in the same period last year. The gross profit percentage in our licensed apparel segment was 30.7% in the nine month period ended October 31, 2006 compared to 29.5% in the same period last year. Sales of Calvin Klein licensed product, including outerwear, suits and dresses and Kenneth Cole outerwear were the primary reason for the an increase in both margin dollars and gross profit as a percentage of sales in our licensed apparel segment. The gross profit percentage in our non-licensed segment was 22.4% in the nine month period ended October 31, 2006 compared to 23.6% in the same period last year. The gross profit percentage in our non-licensed apparel segment decreased primarily due to a decrease in commission fee income of $2.0 million. There is no cost of goods sold component associated with these transactions.
Selling, general and administrative expenses increased $15.8 million to $64.8 million in the nine month period ended October 31, 2006 from $49.0 million in the same period last year. Selling, general and administrative expenses increased primarily as a result of increases in personnel costs ($6.2 million), advertising and promotion ($2.8 million), facility costs ($2.6 million) and depreciation and amortization ($1.2 million). Personnel and facility costs increased primarily due to costs related to the businesses we acquired in July 2005, as well as due to increases in personnel costs with respect to the staffing of our new initiatives, including Calvin Klein women’s suits and dresses, Sean John women’s sportswear and Exsto. Facility costs also increased as a result of the use of third party warehouses to accommodate the increased shipping volume and additional space leased in our Secaucus warehouse facility that was added in August 2005. Advertising and promotion increased primarily due to national and co-operative advertising required under our license agreements. The amount of advertising required is generally based on a percentage of net sales of licensed product. Depreciation and amortization expense increased as a result of the amortization of the identifiable intangibles we acquired in July 2005.
Interest and finance charges, net for the nine month period ended October 31, 2006 were $4.6 million compared to $2.8 million for the comparable period last year. Interest expense increased primarily as a result of debt incurred in connection with the acquisitions and, to a lesser extent, due to an increase in interest rates.
Income tax expense for the nine months ended October 31, 2006 was $7.8 million compared to $7.1 million in the comparable period last year. The effective rate for the current period was 38.2%
Table of Contentscompared to 42.0% for the comparable prior period. The effective tax rate in the current period was lower because income tax expense in the current period includes the reversal of tax reserves of approximately $970,000 as a result of the completion of a Federal income tax audit.
Liquidity and Capital Resources
Our primary cash requirements are to fund our seasonal build up in inventories and accounts receivable, primarily during our second and third fiscal quarters each year. Due to the seasonality of our business, we generally reach our maximum borrowing under our asset-based credit facility during our third fiscal quarter. The primary sources to meet our cash requirements during the course of a year are borrowings under this credit facility and cash generated from operations. At October 31, 2006, we had cash and cash equivalents of $5.9 million and outstanding borrowings of $123.3 million compared to cash and cash equivalents of $2.7 million and outstanding borrowings of $119.5 million at October 31, 2005.
Private Placement
On July 13, 2006, we completed a private placement of our common stock and five-year warrants to purchase our common stock pursuant to a securities purchase agreement between us and a group of investors resulting in aggregate proceeds to the Company of $15,165,000. The net proceeds of this placement were used to repay a portion of our outstanding balance under our revolving credit line.
We issued 1,500,000 shares of our common stock to the investors at a price of $10.11 per share. We also issued to the investors warrants to purchase an aggregate of up to 375,000 shares of our common stock, exercisable beginning six months after the closing date of the private placement, at an exercise price of $11.00 per share, subject to adjustment upon the occurrence of specified events, including customary weighted average price anti-dilution adjustments.
For two years after the closing date of the private placement, the investors will, subject to exceptions and qualifications specified in the purchase agreement, have a right of first refusal with respect to the proposed sale by us of our equity or equity equivalent securities at an effective price per share of $10.00 or less.
We also entered into a registration rights agreement with the investors, in which we agreed to file a registration statement with the Securities and Exchange Commission to register under the Securities Act of 1933, as amended, resales from time to time of the shares, any warrant shares issued upon exercise of the warrants and an additional 500,000 shares of our common stock sold to the investors by Mr. Aron Goldfarb, the Company’s founder and father of our Chief Executive Officer, on July 13, 2006. We filed the registration statement within the required time period and the registration statement has been declared effective by the SEC.
Financing Agreement
We have a financing agreement with The CIT Group/Commercial Services, Inc., as Agent, for a consortium of banks. The financing agreement, which expires on July 11, 2008, is a senior secured credit facility providing for borrowings in the aggregate principal amount of up to $195.0 million. The facility consists of a revolving line of credit and a term loan.
The revolving line of credit provides for a maximum line ranging from $45 million to $165 million at specific times during the year, provided that there are no borrowings outstanding for at least 45 days during the period from December 1 through April 30 each year. We satisfied this requirement for the most recent period. Amounts available under the line are subject to borrowing base formulas and over advances as specified in the financing agreement. Borrowings under the line of credit bear interest at our option at the prime rate or LIBOR plus 2.25%.
The amount borrowed under the line of credit varies based on our seasonal requirements. As of October 31, 2006, direct borrowings were $99.1 million and our contingent liability under open letters of credit was approximately $16.4 million compared to direct borrowings of $88.7 million and contingent liability under open letters of credit of $7.8 million as of October 31, 2005.
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Table of ContentsThe term loan in the original principal amount of $30 million is payable over three years with eleven quarterly installments of principal in the amount of $1,650,000. Payment of quarterly installments began on December 31, 2005, with the remaining balance of $11,850,000 due on maturity of the loan. Mandatory prepayments are required under the term loan commencing with the fiscal year ending January 31, 2007 to the extent of 50% of excess cash flow, as defined. We expect that we will be required to make a mandatory prepayment of a portion of the term loan with respect to the fiscal year ending January 31, 2007. The term loan bears interest, at our option, at prime plus 1% (9.25% at November 1, 2006) or LIBOR plus 3.25% (8.62% at November 1, 2006). The balance due on the term loan at October 31, 2006 was $23.4 million.
The financing agreement requires us, among other things, to maintain tangible net worth at specified levels, achieve specified earnings before interest, taxes, depreciation and amortization and maintain minimum fixed charge coverage ratios as defined. It also limits capital expenditures and payments for cash dividends and stock redemption to $1.5 million plus an additional amount for stock redemptions based on the proceeds of sales of equity securities. As of October 31, 2006, we were in compliance with these covenants. The financing agreement is collateralized by all of our assets.
Subsidiary Loan
PT Balihides, our inactive Indonesian subsidiary, had a separate credit facility with an Indonesian bank. In December 2002, we closed the manufacturing facility operated by this subsidiary. The notes payable under this facility represent borrowings as of October 31, 2006 of approximately $770,000. The loan is collateralized by the property, plant, and equipment of this subsidiary. No other G-III entity has guaranteed this loan. We continue to be in discussions with the bank regarding settlement of this debt.
Cash from Operating Activities
We used $105.4 million of cash in operating activities during the nine months ended October 31, 2006, primarily as a result of increases of $130.2 million in accounts receivable and $32.9 million in inventory, offset, in part, by an increase in accounts payable and accrued expenses of $35.1 million and our net income of $12.7 million. The increases in these operating cash flow items are consistent with our seasonal pattern. The increase in accounts receivable for the nine months is a result of a majority of our sales occurring during our significant fall shipping season. The increase in inventory is a result of anticipated fourth quarter orders to be shipped which include the latter part of our fall shipping season. It also includes inventory for our less seasonal sportswear businesses. The increase in accounts payable and accrued expenses is primarily attributable to the increased purchasing activity for the fall season.
Cash from Investing Activities
We used $5.2 million of cash in investing activities in the nine months ended October 31, 2006. We paid $3.4 million to the sellers of the acquired companies as contingent purchase price based on attaining performance goals as defined in the respective purchase agreements. The sellers are entitled to earn-out payments through the year ending January 31, 2009. We incurred capital expenditures of $1.9 million in the nine months ended October 31, 2006 for the renovation of our new warehouse space in South Brunswick, New Jersey and the renovation of showroom space.
Cash from Financing Activities
Cash from financing activities provided $109.5 million in the nine months ended October 31, 2006 primarily from net proceeds of $15.0 million from our private placement and net borrowings of $99.1 million under our credit facility. Borrowings under the credit line were used to finance our accounts receivable and inventory during the fall shipping season and for other working capital purposes. During the nine months ended October 31, 2006, we repaid $4.9 million of our term loan which represents three quarterly installment payments. Mandatory prepayments are required under
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Table of Contentsthe term loan commencing with the fiscal year ending January 31, 2007 to the extent of 50% of excess cash flow, as defined. We expect that we will be required to make a mandatory prepayment of a portion of the term loan with respect to the fiscal year ending January 31, 2007. This mandatory payment would be payable on May 1, 2007.
Critical Accounting Policies
Our discussion of results of operations and financial condition relies on our consolidated financial statements that are prepared based on certain critical accounting policies that require management to make judgments and estimates that are subject to varying degrees of uncertainty. We believe that investors need to be aware of these policies and how they impact our financial statements as a whole, as well as our related discussion and analysis presented herein. While we believe that these accounting policies are based on sound measurement criteria, actual future events can and often do result in outcomes that can be materially different from these estimates or forecasts. The accounting policies and related estimates described in our Annual Report on Form 10-K for the year ended January 31, 2006 are those that depend most heavily on these judgments and estimates. As of October 31, 2006, there have been no material changes to our critical accounting policies.
Effects of Recently Issued Accounting Pronouncements
In June 2006, the Financial Accounting Standards Board issued FASB Interpretation No. 48, ‘‘Accounting for Uncertainty in Income Taxes’’ (‘‘FIN 48’’). FIN 48 clarifies the accounting for uncertainty in income taxes recognized in our financial statements in accordance with FASB Statement No. 109 ‘‘Accounting for Income Taxes.’’ FIN 48 also prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a return, as well as guidance on derecognition, classification, interest and penalties and financial statement reporting disclosures. FIN 48 is effective for fiscal years beginning after December 15, 2006. We are currently evaluating the requirements and impact of FIN 48 on our consolidated financial statements, and will adopt the provisions on February 1, 2007.
We adopted SFAS 123R on February 1, 2006 using the modified prospective method. Under this method, we are required to recognize compensation cost, on a prospective basis, for the portion of outstanding awards for which the requisite service has not yet been rendered as of February 1, 2006, based upon the grant-date fair value of those awards calculated under SFAS 123 for pro forma disclosure purposes. Under SFAS 123R, we are required to measure the cost of services received in exchange for stock options and similar awards based on the grant-date fair value of the award and recognize this cost in the statement of operations over the period during which an award recipient is required to provide service in exchange for the award. The pro forma disclosures previously permitted under SFAS 123 no longer will be an alternative to financial statement recognition.
Item 3. Quantitative and Qualitative Disclosures About Market Risk
There are no material changes to the disclosure made with respect to these matters in our Annual Report on Form 10-K for the year ended January 31, 2006.
Item 4. Controls and Procedures
As of the end of the period covered by this report, our management, including the Chief Executive Officer and Chief Financial Officer, carried out an evaluation of the effectiveness of the design and operation of the Company’s disclosure controls and procedures (as such term is defined in Rule 13a-15(e) under the Exchange Act). Based on that evaluation, the Company’s Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures are designed to ensure that information required to be disclosed by us in the reports that we file or submit under the Exchange Act is (i) recorded, processed, summarized and reported, within the time periods specified in the Commission’s rules and forms and (ii) accumulated and communicated to our management, including our principal executive and principal financial officers, as appropriate to allow timely decisions regarding required disclosure. During our last fiscal quarter, there were no changes in our internal control over financial reporting that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
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Table of ContentsPART II
Item 1A. Risk Factors
In addition to the other information set forth in this report, you should carefully consider the factors discussed in ‘‘Item 1A. Risk Factors’’ in our Annual Report on Form 10-K for the year ended January 31, 2006, which could materially affect our business, financial condition or future results. The risks described in our Annual Report on Form 10-K are not the only risks facing our company. Additional risks and uncertainties not currently known to us or that we currently deem to be immaterial also may materially adversely affect our business, financial condition and/or operating results.
Item 6. Exhibits
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| 31 | .1 | | | | Certification by Morris Goldfarb, Chief Executive Officer of G-III Apparel Group, Ltd., pursuant to Section 302 of the Sarbanes-Oxley Act of 2002, in connection with G-III Apparel Group, Ltd.’s Quarterly Report on Form 10-Q for the fiscal quarter ended October 31, 2006. |
| 31 | .2 | | | | Certification by Neal S. Nackman, Chief Financial Officer of G-III Apparel Group, Ltd., pursuant to Section 302 of the Sarbanes-Oxley Act of 2002, in connection with G-III Apparel Group, Ltd.’s Quarterly Report on Form 10-Q for the fiscal quarter ended October 31, 2006. |
| 32 | .1 | | | | Certification by Morris Goldfarb, Chief Executive Officer of G-III Apparel Group, Ltd., pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, in connection with G-III Apparel Group, Ltd.’s Quarterly Report on Form 10-Q for the fiscal quarter ended October 31, 2006. |
| 32 | .2 | | | | Certification by Neal S. Nackman, Chief Financial Officer of G-III Apparel Group, Ltd., pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, in connection with G-III Apparel Group, Ltd.’s Quarterly Report on Form 10-Q for the fiscal quarter ended October 31, 2006. |
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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
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| | | | G-III APPAREL GROUP, LTD.
(Registrant) |
| Date: December 14, 2006 | | | By: | | | /s/ Morris Goldfarb |
| | | | | | | Morris Goldfarb |
| | | | | | | Chief Executive Officer |
| Date: December 14, 2006 | | | By: | | | /s/ Neal S. Nackman |
| | | | | | | Neal S. Nackman |
| | | | | | | Chief Financial Officer |
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