ITEM 1 - BUSINESS
GENERAL
Nitches, Inc. (the "Company" or "Nitches") has been in the wholesale clothing business since 1973, and imports finished garments manufactured to its specifications from approximately 12 foreign countries. The Company sells all-cotton and cotton blend knit and woven clothing primarily for the female consumer. Retail customers include Cavendars, Costco, Kohl's, Mervyns, Sears, and Sheplers. The Company sells garments to these and other retailers through its own sales force and through independent sales representatives. Nitches provides fashionable clothing to the popularly priced market segment that generally retails between $10 and $35 per item. The Company competes primarily on the basis of price, quality, the desirability of its fabrics, and the reliability of its delivery and service.
Over the past five years, the apparel market has been marked by deflation and reduced profit margins in certain markets. The success and consolidation of retailers has given retailers leverage to attempt to reduce profit margins to suppliers such as the Company. The Company's response has been to discontinue product lines in areas where it did not believe it could maintain a reasonable profit margin. On August 22, 1995, the Company sold various assets associated with its junior, girls and maternity product lines to a third party buyer. On October 31, 1995, the Company sold the remaining inventory in such product lines at cost and granted the buyer an exclusive, worldwide license to use various tradenames registered by the Company for these product lines. At that time, the Company also ceased purchasing garments that had previously been sold under the tradenames licensed to the buyer. On September 1, 1997, the Company sold its assets associated with its dress product line to a third party buyer and in January 1998 the Company discontinued its activewear product line.
PRODUCT DEVELOPMENT AND DESIGN
The Company develops merchandise lines for production and importation in two principal ways: (l) it develops its own lines of clothing styles which are displayed in Company showrooms and which are also shown to retailers by independent sales representatives ("Company Brand"), and (2) it works with major retailers in developing product lines which the Company then has manufactured and imported and which are generally sold under private retailer labels. Styles developed by the Company are sold under both Company trademarks and private retailer labels.
The Company currently owns a total of 41 federally registered trademarks. While trademarks owned by the Company have always been important to its marketing and competitive strategy, prior to 1995 they were not central factors influencing its sales. However, subsequent to its reorganization in fiscal year 1995, its trademarks in sleepwear and western wear have become more important in identifying the Company's products. Western wear shirts are sold primarily under the Company labels Adobe Rose and Southwest Canyon. Western wear jeans are sold under the label Posted through a licensing agreement with a third party supplier. Sleepwear garments are produced in a variety of fabrics and styles, including robes, pajamas, nightshirts and nightgowns which are sold under the Body Drama label and retailers' private labels.
The Company occasionally creates original garment shapes or bodies (styles). More importantly, the Company produces garments with original fabric prints and designs. The Company also responds to frequent style changes in the women's clothing business by maintaining a continuous program adapting to current trends in style and fabric. In an effort to continually stay abreast of current fashion trends, representatives of the Company shop at exclusive department and specialty stores in the United States, Europe, Japan and other countries which are known to sell merchandise with advanced styling direction. The Company also seeks input from selected customers. The Company then selects styles, fabrics and colors that it believes reflect current fashion trends.
With regard to private label sales, the Company's sales personnel meet with buyers representing retailers who custom order products by style, fabric, and color. These buyers may provide samples to the Company or may select styles already available in Company showrooms. The Company has an established reputation for its ability to arrange for foreign manufacture on a reliable, expeditious and cost-effective basis.
SOURCES OF SUPPLY
Approximately 98% of the garments sold by the Company are manufactured abroad. Contracting with foreign manufacturers enables the Company to take advantage of prevailing lower labor rates, with the consequent ability to produce a quality garment which can be retailed in the popular, value and moderate price ranges. The Company owns 100% of the outstanding capital stock of a Hong Kong corporation which performs production coordination, quality control and sample production services for the Company. No material manufacturing is performed and no significant assets are maintained outside the United States by the Company or its subsidiaries. Furthermore, the Company has production control liaison offices in Sri Lanka, United Arab Emirates, and India.
As a result of import restrictions on certain garments imposed by bilateral trade agreements between the United States and certain foreign countries, the Company has sought diversity in the number of countries in which it has manufacturing arrangements. The percentage of total purchases from particular countries varies from period to period based upon quota availability and price considerations. The Company has arranged, and will continue to arrange, for production in the United States when economically feasible to meet special needs.
The following table shows the percentage of the Company's total purchases, not including freight charges, duties and commissions, from each country for the years ended August 31, 2000, 1999 and 1998.
The Company arranges for the production of garments with suppliers on a purchase order basis, with each order generally backed by an irrevocable letter of credit. The Company does not have any long-term contractual arrangements with manufacturers. This provides the Company with flexibility regarding the selection of manufacturers for future production of goods. The Company believes that another manufacturer could replace the loss of any particular manufacturer in any country in a reasonable time period. However, in the event of the loss of a major manufacturer the Company could experience a temporary interruption in supply.
In some cases, the manufacturer or agent with which the Company contracts for production may subcontract work. Most of the listed countries have numerous suppliers, which have the technical capability to manufacture garments of the type sold by the Company.
The Company believes that the production capacity of foreign manufacturers with which it has developed, or is developing, a relationship is adequate to meet the Company's production requirements for the foreseeable future. However, because of existing and potential import restrictions, the Company continues to attempt to diversify its sources of supply.
When management believes, based on previous experience and market performance, that additional orders for certain garments will be received, it may cause production runs to be made in amounts in excess of firm customer orders. This may allow the Company to achieve overall lower costs as well as to be able to respond more quickly to customer delivery requirements. The Company bears the consequent risk if garments purchased in advance of receipt of customer purchase orders do not sell.
QUALITY CONTROL
Company representatives regularly visit manufacturers to inspect garments and monitor production facilities in order to assure timely delivery, maintain quality control and issue inspection certificates. Furthermore, through these representatives and independent inspectors from major retailers, the Company ensures that the factories the Company uses for production adhere to policies consistent with prevailing labor laws. A sample of garments from a percentage of each production run is inspected before each shipment. Letters of credit arranged by the Company require, as a condition to the release of funds to the supplier, that a representative of the Company sign an inspection certificate.
MARKETING AND DISTRIBUTION
The Company sells its products through an established sales network consisting of both in-house sales personnel and independent sales representative organizations. The Company does not generally advertise, although customers sometimes feature the Company's products in their advertisements. For both Company Brand and Private Label sales, employees operating in Company showrooms in New York City and Los Angeles represent the Company in soliciting orders nationally from approximately 10 major customers. In addition, senior executives of the Company have primary responsibility for sales to certain key accounts. The Company's products are also marketed by nineteen commissioned sales representative organizations, all of which are independent contractors, and each of which has been assigned a primary area of responsibility.
At present, most garments are shipped by suppliers in bulk form to the Company's warehouse in San Diego, where they are sorted, stored and packed for distribution to customers. From time to time, the Company may rent additional short-term warehouse space as needed to accommodate its requirements during peak shipping periods. In addition, to facilitate shipping to customers, some of its overseas suppliers perform sorting, price ticketing, hanging, and packing functions.
Purchase orders may be canceled by the Company's customers in the event of late delivery or in the event of receipt of nonconforming goods. Late deliveries usually are attributable to production or shipping delays beyond the Company's control. In the event of canceled purchase orders, rejections or returns, the Company will sell garments to other retailers, off-price discount stores or garment jobbers. The Company has, in the past, often been able to recover from its manufacturers some portion of its expenses or losses associated with sales below cost for causes attributable to manufacturing problems. However, the Company has also historically experienced losses on merchandise that is rejected or returned.
As a result of the Company's elimination of lower margin product lines, the Company's business has become more concentrated on certain significant customers. Two customers (Mervyn's and Sears) accounted for 33.4% and 15.7%, respectively, of the Company's net sales in fiscal 2000. The same customers accounted for 28.5% and 13.0%, respectively, of the Company's net sales in fiscal 1999. While the Company believes its relationships with its major customers are good, because of competitive changes and availability of the types of garments sold by the Company from a number of other suppliers, there is the possibility that any customer could lower, or raise, the amount of business it does with the Company. If the Company experiences a significant decrease in sales to any of its major customers, and is unable to replace such sales volume with sales to other major customers, there could be a material adverse financial effect on the Company.
IMPORT RESTRICTIONS
The ability of the Company to import garments is regulated by import restrictions that limit the specific number of garments that may be imported from any country for a specific period. Government import quotas of various types are imposed on substantially all of the products imported by the Company from substantially all of the countries from which the Company purchases garments. Because of these quota restrictions, the Company has sought diversity in the number of countries in which it has garments manufactured.
The Agreement on Textile and Clothing (the "ATC"), which became effective on January 1, 1995, provided the basic guidelines for administering import quotas and related matters. The ATC contains three provisions that will affect the Company's business to varying degrees in the future. First, the ATC requires that import quotas be phased out in four stages over a ten-year period. However, quotas on substantially all of the garments imported by the Company are not scheduled to be phased out until the year 2005. Second, over the first six years, import tariffs will be
reduced from an average of 19% to 17.5%. While the tariff reductions apply to most apparel items, the size of the reductions are extremely small and are not likely to have a material impact on the Company's overall cost of merchandise. Finally, new rules of origin took effect on July 1, 1996 whereby the country in which the garment is assembled is deemed the country of origin instead of the country in which the fabric is cut. The biggest impact of the rule change has been on garments produced in China, which assembles large quantities of apparel cut in nearby countries such as Macao, Singapore and Taiwan. Approximately 20.65% of the Company's garments were produced in China, Hong Kong, and Macao in fiscal 2000. The Company does not expect a significant disruption in its garment purchases as a result of the country of origin rule change.
The Company closely monitors the status of applicable import quotas and the extent to which they are being filled. The Company bases its production decisions, in part, on whether a particular supplier country has entered into an agreement with the United States restricting trade in certain garments and, if so, the extent to which the applicable quota imposed for a particular year is expected to be filled by a scheduled shipment date. In some cases, the Company has responded to the anticipated exhaustion of a particular quota by having goods manufactured and shipped prior to the receipt of purchase orders or well in advance of scheduled delivery dates in order to be assured that garments will be imported into the United States before the applicable quota is filled. In these instances, the Company is required to hold garments in inventory, sometimes for several months, before shipment to customers. This can occur, normally, toward the end of a calendar year.
Import restrictions have, in some cases, increased the cost of finished goods to the Company as a result of increased competition for a restricted supply of goods. The Company's future results may also be affected by additional bilateral or unilateral trade restrictions, a significant change in existing quotas, political instability resulting in the disruption of trade from exporting countries, or the imposition of additional duties, taxes and other charges on imports.
Because of import restrictions, embargo and utilization of quota, the Company may be unable, from time to time, to import certain types of garments. Because of the Company's dependence on foreign suppliers, a significant tightening or utilization of import quotas for the types of garments imported by the Company, applicable to a substantial number of countries from which the Company imports, could force the Company to seek other sources of supply and to take other actions which could increase costs of production. This could also cause delays in production and result in cancellation of orders. Any of these factors could result in an adverse financial impact on the Company.
The Company believes it has the ability to locate, establish relationships with and develop manufacturing sources in countries where the Company has not previously operated. Whenever possible, the Company moves production to countries in which applicable quotas remain unfilled or to countries in which no quotas are imposed. The Company may also shift production to non-quota garments if a market for such garments exists. The time required to commence contract production in supplier countries ranges from several weeks in the case of a country with a relatively well developed garment manufacturing industry to four months or more for a country in which there are less developed capabilities. The cost to the Company of arranging for production in a country generally involves management time and associated travel expenses.
BACKLOG
At August 31, 2000 and August 31, 1999, the Company had unfilled customer orders of $16.2 million and $15.7 million, respectively, with such orders generally scheduled for delivery by January 2001 and 2000, respectively. The increase in backlog is primarily in the western wear product lines. These amounts include both confirmed orders and unconfirmed orders which the Company believes, based on industry practice and past experience, will be confirmed. While cancellations, rejections and returns have generally not been material in the past, there can be no assurance that cancellations, rejections and returns will not reduce the amount of sales realized from the backlog of orders at August 31, 2000.
RAW MATERIALS
A substantial majority of the clothing sold by the Company is made of l00% cotton, although the Company also utilizes cotton blends, polyester and rayon fabrics. All of these fabrics are readily available in most countries in which the Company contracts for production and are easily imported to those countries that do not have an internal supply of such fabric. The Company is not dependent on a single source of supply for fabric that is not readily replaceable.
COMPETITION
The women's clothing business is highly competitive and consists of many manufacturers and distributors, none of which accounts for a significant percentage of total sales, but many of which are larger and have substantially greater resources than the Company. The Company competes with a number of companies which import clothing from abroad for wholesale distribution, with domestic retailers having established foreign manufacturing capabilities and with domestically produced goods. Management believes that the Company competes upon the basis of price, quality, the desirability of its fabrics and styles, and the reliability of its service and delivery. In addition, the Company has developed long-term working relationships with manufacturers and agents which presently provide the Company with reliable sources of supply. The Company's ability to compete effectively is dependent, in part, on its ability to retain managerial personnel with experience in locating, developing and maintaining reliable sources of supply and to retain experienced sales and product development personnel.
EMPLOYEES
As of October 7, 2000, the Company had 35 full-time employees, of whom nine worked in executive, administrative or clerical capacities and 26 worked in sales, design, and production. The Company may also employ temporary personnel on a seasonal basis. None of the Company's employees are represented by a union. The Company considers its working relationships with its employees to be good and has never experienced an interruption of its operations due to any kind of labor dispute.
CAUTIONARY STATEMENT UNDER THE PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995
Statements in the annual report on Form 10-K under the caption "Business", as well as oral statements that may be made by the Company or by officers, directors or employees of the Company acting on the Company's behalf, that are not historical fact constitute "forward-looking statements" within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. Forward-looking statements involve known and unknown risks and uncertainties which may cause the Company's actual results in future periods to differ materially from forecasted results. Those risks include a softening of retailer or consumer acceptance of the Company's products, pricing pressures and other competitive forces, or unanticipated loss of a major customer. In addition, the Company's business, operations and financial condition are subject to reports and statements filed from time to time with the Securities and Exchange Commission.
ITEM 2
ITEM 2 - PROPERTIES
The Company leases one showroom in New York and one in Los Angeles with an aggregate monthly gross rental of approximately $14,000. The Los Angeles showroom lease expires in July, 2001 and the New York lease expires in September, 2002. The Company leases a 30,000 square foot warehouse with administrative offices in San Diego with a monthly lease payment of approximately $17,000. The lease expires in September 2002. The Company may lease additional short-term warehouse space from time to time as needed.
ITEM 3
ITEM 3 - LEGAL PROCEEDINGS
There are no material legal proceedings to which the Company or any of its subsidiaries was a party in the fiscal year ended August 31, 2000.
ITEM 4
ITEM 4 - SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
There were no matters submitted to a vote of security holders during the fourth quarter of fiscal 2000.
PART II
ITEM 5
ITEM 5 - MARKET FOR THE REGISTRANT'S COMMON STOCK AND RELATED SHAREHOLDER MATTERS
The Company's Common Stock trades on The NASDAQ SmallCap Market under the symbol NICH. The number of record holders of the Common Stock was 131 on October 12, 2000. The Company believes that there are a significant number of beneficial owners of its Common Stock whose shares are held in "street name". The closing sales price of the Common Stock on October 12, 2000 was $5.594 per share.
The high and low stock closing sale prices, for each fiscal quarter of the last two years were as follows:
The Company does not have a quarterly dividend policy. However, during fiscal year 2000, the Company declared and paid the following special dividends:
ITEM 6
ITEM 6 - SELECTED FINANCIAL DATA (In thousands, except per share amounts)
(1) See Management's Discussion and Analysis on page 10.
ITEM 7
ITEM 7 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
YEARS ENDED AUGUST 31, 2000 AND 1999
Net sales for the fiscal year ended August 31, 2000 increased approximately $7.9 million or 25.1% compared to the fiscal year ended August 31, 1999 due to an increase of unit sales, primarily in the Company's sleepwear product lines. Overall, sales returns and allowances decreased by 2%, while cost of sales as a percentage of net sales increased by 2%. Thus, the gross profit margin in the aggregate remained relatively consistent from fiscal 1999 to fiscal 2000.
Selling, general and administrative expenses increased in dollar amount from $7.3 million in fiscal 1999 to $7.4 million in fiscal 2000, and decreased as a percent of net sales (23.1% in fiscal 1999 to 18.8% in fiscal 2000). The increase in dollar amount was due to primarily salaries and commissions.
YEARS ENDED AUGUST 31, 1999 AND 1998
Net sales for the fiscal year ended August 31, 1999 increased approximately $432,000 or 1.4% compared to the fiscal year ended August 31, 1998. The increase was due primarily to an increase in private label sleepwear sales, which offset the effect of the discontinuance of the activewear product line in fiscal year 1998 and a decrease in sales of the western wear product line in the fourth quarter of fiscal year 1999.
Gross margins increased from 23.4% for the fiscal year ended August 31, 1998 to 26.0% for the fiscal year ended August 31, 1999. This increase was the result of private label sleepwear customers selecting more fashionable styles with higher gross margins for shipment during the fourth quarter and significantly improved inventory control in all product lines resulting in fewer goods being sold off-price. Improving inventory control results in less excess inventory or aged goods, which generally have to be sold off-price.
The Company's product mix constantly changes to reflect customer mix, fashion trends and changing seasons. Consequently, gross margins are likely to vary on a quarter-to-quarter basis and in comparison to gross margins generated in the same period of prior fiscal years.
Selling, general and administrative expenses decreased in dollar amount from $8.4 million in fiscal 1998 to $7.3 million in fiscal 1999, and decreased as a percent of net sales (27.2% in fiscal 1998 to 23.1% in fiscal 1999). The decrease in dollar amount and percentage of sales was due to the Company's reductions in certain expenses, primarily salaries and commissions.
Interest expense increased in the current year due to a nonrecurring assessment imposed in fiscal year 1999 by the California Franchise Tax Board in connection with the audit of the Company's federal tax returns for fiscal years 1992 through 1994. The audit has been completed and the Company has paid all taxes, penalties, and interest owing as of February 1999. Interest income decreased in fiscal 1999 due to payments received on the purchase agreement for the dress product line effective September 1, 1998.
LIQUIDITY AND CAPITAL RESOURCES
The Company's working capital of $6.8 million at August 31, 2000 increased from the August 31, 1999 level of $6.0 million, while the Company's current ratio increased from 3.04:1 at August 31, 1999 to 3.23:1 at August 31, 2000. The principal reason for the increase in working capital and in current ratio was the utilization of the Company's loss carryforwards as reflected in the income tax receivable at August 31, 1999.
On October 21, 1998, the Company purchased and retired approximately 1,050,000 shares of its outstanding common stock for $4 per share in connection with a self-tender offer. The total cost of the transaction was approximately $4.3 million. Additionally, the Company purchased during fiscal year 1999, as part of its ongoing stock repurchase program, approximately 60,000 shares at an average price of $3.22 per share.
Effective October 1, 1998, the Company entered into new agreements with Congress Talcott Corporation West ("Congress"), including a Discount Factoring Agreement, Addendum to Discount Factoring Agreement, Trade
Financing Agreement, Inventory Security Agreement, Financial Covenant Agreement and Agreement to Issue Letter of Credit Guaranties (collectively, the "Discount Factoring Agreement"). Effective March 31,1999, the assets of the Congress factoring business were purchased by the CIT Group/Commercial Services, Inc. ("CIT"). The Company sells substantially all of its trade receivables to CIT on a pre-approved, non-recourse basis. The Company attempts to make the shipments for non-factored customer sales on a COD basis or ensure that the customers' payments are backed by a commercial or standby letter of credit issued by the customer's bank. The amount of the Company's receivables which were recourse and were not made on a COD basis or supported by commercial or standby letters of credit at August 31,2000 was approximately $460,000 of which approximately $255,000 has been collected through October 31, 2000.
Payment for non-recourse factored receivables is made at the time customers make payment to CIT or, if a customer is financially unable to make payment, within approximately 180 days of the invoice due date. Under the Discount Factoring Agreement, the Company can request advances in anticipation of customer collections at CIT's prime rate (currently 9.5%) less one-half percent, and open letters of credit through CIT. The amount of borrowings by the Company, including a portion of outstanding letters of credit, are limited to certain percentages of outstanding accounts receivable and finished goods inventory owned by the Company. Borrowings are collateralized by all of the assets of the Company as well as a $1 million guaranty by the Company's president, Mr. Wyandt. At August 31, 2000, the Company had outstanding letters of credit of approximately $4.5 million for the purchase of finished goods, which had been opened, through CIT. Under the Discount Factoring Agreement, the Company is required to maintain $5 million of net worth and $5 million of working capital. The Discount Factoring Agreement can be terminated by CIT on 60-days prior written notice.
Effective August 31, 1998, the Company merged with its wholly owned subsidiary Body Drama, Inc. The merger resulted in the elimination of a deferred income tax liability of approximately $973,000. The deferred income tax liability was generated in 1991 when the Company sold a 49% interest in Body Drama, Inc. to the public in an initial public offering, and represented a potential tax liability in the event that the Company were to sell its interest in its Body Drama, Inc. subsidiary to a third party. Body Drama, Inc. repurchased the 49% interest in a self tender offer which took place in Fiscal 1995. The merger of the Company with Body Drama, Inc. resulted in the elimination of the potential liability and a resulting increase in the book value of the Company.
OTHER INFORMATION
INVENTORY
In its ordinary course of operations, the Company generally makes some sales below its normal selling prices or below cost. Based on prior experience, management believes this will be true for some inventory held or acquired after August 31, 2000. The amount of such sales depends on several factors, including general economic conditions, market conditions within the apparel industry, the desirability of the styles held in inventory and competitive pressures from other garment suppliers.
The Company's inventory increased from $5.0 million at August 31, 1999 to $5.1 million at August 31, 2000. The Company has established an inventory markdown reserve as of August 31, 2000, which management believes will be sufficient for current inventory that is expected to be sold below cost in the future. There can be no assurance that the Company will realize its expected selling prices, or that the inventory markdown reserve will be adequate, for items in inventory as of August 31, 2000 for which customer sales orders have not yet been received. The inventory markdown reserve is calculated based on specific identification of aged goods and styles that are slow moving or selling off-price.
IMPACT OF EXCHANGE RATES
While the Company purchased over 90% of its products from foreign manufacturers in fiscal 2000, all of its purchases are denominated in United States dollars. Because the Company's products are sold primarily in the United States, in dollar denominated transactions, the Company does not engage in hedging or other arbitrage to reduce currency risk. A prolonged increase in the value of the dollar versus foreign currencies could enhance the Company's purchasing power for new purchase orders and reduce its cost of goods sold. Conversely, a prolonged decrease in the value of the dollar relative to foreign currencies could result in an increase in the Company's cost of manufacturing for new purchase orders and costs of goods sold.
IMPACT OF INFLATION AND DEFLATION
Management does not believe that inflation has had any material impact upon the Company's revenues or income from operations to date. However, continued deflation in women's clothing prices may put pressure on gross margins in the future. Resistance on the part of the consumer to increases in prices and the increasing fabric and labor costs may lead to an increased cost of goods on a percentage basis.
CAUTIONARY STATEMENT UNDER THE PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995
Statements in the annual report on Form 10-K under the caption "Management's Discussion and Analysis of Financial Condition and Results of Operations", as well as oral statements that may be made by the Company or by officers, directors or employees of the Company acting on the Company's behalf, that are not historical fact constitute "forward-looking statements" within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. Forward-looking statements involve known and unknown risks and uncertainties which may cause the Company's actual results in future periods to differ materially from forecasted results. Those risks include, among others, a softening of retailer or consumer acceptance of the Company's products, pricing pressures and other competitive forces, or unanticipated loss of a major customer. In addition, the Company's business, operations and financial condition are subject to reports and statements filed from time to time with the Securities and Exchange Commission.
ITEM 8
ITEM 8 - FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
NITCHES, INC. AND SUBSIDIARIES
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS FILED WITH THE ANNUAL REPORT OF THE COMPANY ON FORM 10-K
INDEPENDENT AUDITOR'S REPORT
Board of Directors and Shareholders Nitches, Inc. San Diego, California
We have audited the accompanying consolidated balance sheets of Nitches, Inc. and subsidiaries as of August 31, 2000 and 1999 and the related consolidated statements of income, shareholders' equity and cash flows for each of the years in the three-year period ended August 31, 2000. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Nitches, Inc. and subsidiaries as of August 31, 2000 and 1999 and the results of their operations and their cash flows for each of the years in the three-year period ended August 31, 2000 in conformity with generally accepted accounting principles.
Moss Adams LLP
Los Angeles, California October 13, 2000
NITCHES, INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS
ASSETS
The accompanying notes are an integral part of these consolidated financial statements.
NITCHES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
The accompanying notes are an integral part of these consolidated financial statements.
NITCHES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
The accompanying notes are an integral part of these consolidated financial statements.
NITCHES, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS
The accompanying notes are an integral part of these consolidated financial statements.
NITCHES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. DESCRIPTION OF BUSINESS
Nitches, Inc. (the "Company") is a wholesale importer and distributor primarily of women's clothing manufactured to its specifications and distributed in the United States under Company brand labels and private retailer labels.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Principles of Consolidation:
The consolidated financial statements include the accounts of Nitches, Inc. and its subsidiaries. The Company's wholly owned subsidiaries include Nitches Far East Limited and Body Drama Far East Limited. Prior to August 31, 1998, Body Drama, Inc. was a wholly owned subsidiary of Nitches, Inc. consolidated in the financial statements of Nitches, Inc. Effective August 31, 1998, Body Drama, Inc. was merged into Nitches, Inc. and Body Drama, Inc. ceased to exist as a separate legal entity. All significant inter-company transactions and balances are eliminated in consolidation.
Financial Instruments:
Financial instruments consist of cash and cash equivalents, accounts receivable, and accounts payable. The carrying amount approximates fair value because of their short maturity.
Concentration of Credit Risk:
The Company sells a majority of its accounts receivable to a financial institution. Under the agreement, the financial institution purchases trade accounts receivable and assumes substantially all credit risks. The Company is responsible for following up on adjustments claimed by customers. Accounts that are not sold remain the credit risk of the Company. Such accounts are diverse and are subject to credit approval and ongoing evaluation by the Company. Management considers the credit risk with respect to all receivables to be low. Historically, the Company has not experienced significant loss due to uncollectible accounts receivable.
Cash balances are periodically maintained in amounts in excess of FDIC insured limits in high quality financial institutions. Management considers the risk of loss to be low.
Inventories:
Inventories are stated at the lower of cost (first-in, first-out method) or market.
Furniture, Fixtures and Equipment:
Furniture, fixtures and equipment are stated at cost. Depreciation is computed using the straight-line method based on the estimated useful lives of the related assets, which range from three to ten years. Leasehold improvements are amortized using the straight-line method over the shorter of the estimated useful lives of the assets or the remaining term of the related lease. Maintenance and repair costs are charged to expense as incurred. When assets are retired or sold, the assets and accumulated depreciation are removed from the respective accounts and any profit or loss on the disposition is credited or charged to income.
Earnings Per Share:
The computation of net income per common share is based on the weighted average number of common shares outstanding plus common share equivalents arising from dilutive stock options.
The weighted average number of common shares and common share equivalents outstanding for basic and diluted earnings per share was 1,064,680 for fiscal 2000, 1,225,914 for fiscal 1999; and 2,218,479 for fiscal 1998.
NITCHES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
Revenue Recognition:
The Company recognizes revenue as of the date merchandise is shipped to its customers.
Income Taxes:
The Company records income taxes using an asset and liability method. Under this method, deferred Federal and state income tax assets and liabilities are provided for temporary differences between the financial reporting basis and the tax-reporting basis of the consolidated assets and liabilities. Income taxes are further explained in Note 8.
Cash Flow Statement:
For purposes of the statement of cash flows, the Company considers all highly liquid instruments purchased with a maturity of three months or less to be cash equivalents.
Estimates:
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.
Recently issued accounting pronouncements:
During 1999, the Financial Accounting Standards Board (FASB) issued Statements of Financial Accounting Standard No. 135 ("Rescission of FASB Statement No. 75 and Technical Corrections"), No. 136 ("Transfers of Assets to a Not-for-Profit Organization or Charitable Trust that Raises or Holds Contributions for Others") and No. 137 ("Accounting for Derivative Instruments and Hedging Activities--Deferral of the Effective Date of Financial Accounting Standard Statement No. 133--an amendment of Financial Accounting Standard Statement No. 133") which are effective for years after 1999. Management believes these pronouncements will not have a material effect on the Company's financial statements or disclosures.
3. INVENTORIES
NITCHES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
4. FURNITURE, FIXTURES AND EQUIPMENT
5. TRADE ACCOUNTS
Pursuant to the terms of an agreement between Nitches and a factor, Nitches sells a majority of its trade accounts receivable to a factor on a pre-approved, non-recourse basis. The Company may request advances in anticipation of customer collections and open letters of credit through the factor, all of which are collateralized by all of the Company's assets. Outstanding advances are charged interest at the factor's prime rate less one half percent. Advances and contingent liabilities for irrevocable letters of credit outstanding are as follows:
The factoring agreement allows the Company to borrow up to $15,000,000, limited by certain percentages of outstanding accounts receivable and finished goods inventory owned by the Company. Outstanding borrowings are collateralized by accounts receivable and inventories. The President has provided a $1,000,000 personal guarantee in connection with the factoring arrangement.
6. OTHER CURRENT ASSETS
Other current assets at August 31, 1999 included an unsecured non-interest bearing working capital advance, due on demand, of $420,000 to an unrelated apparel company.
7. ACCRUED EXPENSES
NITCHES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
8. INCOME TAXES
The components of the provision for income taxes are as follows:
Net deferred income tax assets at August 31, 2000 and 1999 consist of the tax effects of temporary differences related to the following:
A long term deferred income tax liability at August 31, 1997 related to the gain recognized for financial statement purposes in connection with a sale of stock and initial stock offering of Body Drama in 1991. As a result of the merger of Body Drama, Inc. into Nitches, Inc. as of August 31, 1998, a deferred tax liability was eliminated and a deferred tax benefit was recorded.
NITCHES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
8. INCOME TAXES (CONTINUED)
Differences between the statutory Federal income tax rate and the effective tax rate as a percentage of pre-tax income are as follows:
In 1999, the Company settled an examination by the California Franchise Tax Board for fiscal years 1992 through 1994. The resulting assessments did not have a material adverse impact on the financial position of the Company.
9. EMPLOYEE BENEFIT PLANS
The Company has a 401(k) Savings Plan, whereby employees may make investments in various independent funds and Company stock. The Company may match employee contributions to this Plan on a discretionary basis or contribute on a profit sharing basis. The Company made no matching or profit sharing contributions to this Plan in fiscal 2000, 1999, or 1998.
10. STOCK OPTIONS AND DIVIDENDS
Executive Stock Options
During fiscal 1999, certain directors and officers exercised 346,670 options and received 162,500 shares of common stock. These options were exercised without cash consideration to the Company for a reduced number of shares. The $164,000 charge to common stock in fiscal 1999 in the accompanying financial statements represents the income tax benefit to the Company as a result of these transactions. No stock options are outstanding as of August 31, 2000.
Accounting for Stock Options
The Company has adopted the disclosure-only provision of Statement of Financial Accounting Standards No. 123 "Accounting for Stock-Based Compensation." Accordingly, no compensation cost was recognized for the stock option plans. Had compensation cost for the Company's stock option plan been determined based on the fair value at the grant date for awards in fiscal years ended 1999 and 1998 consistent with the provisions of SFAS No. 123, the Company's net earnings and earnings per share would have been reduced to the pro forma amounts indicated in the following table.
NITCHES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
10. STOCK OPTIONS AND DIVIDENDS (CONTINUED)
The fair value of each option grant was estimated on the date of grant using the Black-Scholes option-pricing model with the following weighted average assumptions used: dividend yield of 0%; expected volatility of 57.4%; risk-free interest rate of 6.36%; and expected lives of three years. As of August 31, 2000, no options are outstanding.
DIVIDENDS
During fiscal 2000, the company declared and paid dividends of $1.65 per share.
11. LEASES
The Company has lease commitments expiring at various dates through October 2002, principally for real property and equipment. The aggregate minimum rental commitments for future years ending August 31 for all non-cancelable leases having initial or remaining terms of one or more years are as follows:
The Company's leases for real property are generally subject to rent escalation based on increases in the consumer price or other indices with certain minimum and maximum increases. Rent expense, net of sublease income, was approximately $403,000, $512,000, and $407,000, during fiscal 2000, 1999 and 1998, respectively.
12. OPERATING SEGMENTS
The Company's products comprise a single operating segment. No significant assets are maintained outside the United States. Sales are made at a variety of customers throughout the United States. Sales to two separate customers accounted for 33.4% and 15.7%, respectively, of the Company's net sales in the fiscal year ended August 31, 2000. Three customers accounted for 26.5%, 25.7%, and 10.3%, respectively, of the Company's trade receivable balance at August 31, 2000.
13. SALE OF PRODUCT LINES
The Company holds a $600,000 note receivable relating to the sale of product lines in 1995. The Company fully reserved the note and is accounting for it on a cost recovery basis, recording income when the buyer makes payments on the note. Interest payments of 4% per year are payable until March 15, 2001, at which time the principal and any unpaid interest are due and payable. Interest income of $32,000 was received during the year ended August 31, 2000.
NITCHES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
14. TENDER OFFERS AND RELATED PARTY TRANSACTIONS
On October 21, 1998, the Company purchased and retired 1,049,500 shares of its outstanding common stock for $4 per share in connection with a self-tender offer. The total cost of the transaction to the Company was approximately $4,300,000. Cash and cash equivalents, together with proceeds from borrowings under the new factoring agreement were used to purchase the tendered shares. The Company's president subsequently purchased approximately 330,000 shares from its chairman and a director at the $4 per share tender price. Additionally, the Company purchased, as part of its ongoing stock repurchase program, 60,350 shares at an average price of $3.22 per share. The stock repurchase plan authorizes management to make purchases from time to time in the open market or through privately negotiated transactions. The timing of the future repurchases, if any, and the amount of shares will be based on management's ongoing assessment of the Company's working capital requirements and liquidity.
Nitches purchased labor and administrative services from Kuma Sport, Inc., which is 40% owned by a director of Nitches, on a monthly basis, at fair market rates. The Company purchased labor and administrative services from Kuma Sport, Inc. for approximately $774,000 and $674,000 in the fiscal years ending August 31, 2000 and 1999, respectively.
15. EMPLOYMENT AGREEMENTS
The Company has an Employment Agreement expiring August 31, 2001 with its President. The annual base salary through January 1, 2001, excluding bonuses and employee benefits, is $250,000. In the event that the President is terminated without cause prior to the expiration of the Employment Agreement, he will receive the salary remaining through the end of the term of the Employment Agreement and a continuation of certain employee benefits.
16. CONTINGENCY
Management initiated a program to prepare the Company's computer systems and applications for the year 2000. The Company incurred internal staff costs and other expenses related to infrastructure and facilities enhancements necessary to prepare the systems for the year 2000. Certain internal applications were modified and testing and conversion of system applications were completed. The Company continues to assess its vendors, customers and other third parties as to their year 2000 compliance.
17. QUARTERLY RESULTS OF OPERATIONS (UNAUDITED)
The following is a summary of the quarterly results of operations for the years ended August 31, 2000 and 1999:
NITCHES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
ITEM 9
ITEM 9 - CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
None.
PART III
ITEM 10
ITEM 10 - DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The information required as to this Item is incorporated herein by reference from the data under the caption "Information Concerning Nominees, Directors and Executive Officers" in the Proxy Statement ("2000 Proxy Statement") to be used in connection with the solicitation of proxies to be voted at the Registrant's annual meeting of shareholders to be held in November 2000, to be filed with the Commission in October 2000.
ITEM 11
ITEM 11 - EXECUTIVE COMPENSATION
The information required as to this Item is incorporated herein by reference from the data under the captions "Executive Officer Compensation", "Board Compensation Committee Report on Executive Compensation" and "Employment Agreements" in the 2000 Proxy Statement.
ITEM 12
ITEM 12 - SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The information required as to this Item is incorporated herein by reference from the data under the caption "Principal Shareholders" in the 2000 Proxy Statement.
ITEM 13
ITEM 13 - CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information required as to this Item is incorporated herein by reference from the data under the caption "Certain Relationships and Related Transactions" in the 2000 Proxy Statement.
PART IV
ITEM 14
ITEM 14 - EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
(a) Documents filed as part of this report:
1. The following consolidated financial statements of the Registrant are included as part of this report:
Consolidated Balance Sheets as of August 31, 2000 and 1999;
Consolidated Statements of Operations for the years ended August 31, 2000, 1999 and 1998;
Consolidated Statements of Shareholders' Equity for the years ended August 31, 2000, 1999 and 1998;
Consolidated Statements of Cash Flows for the years ended August 31, 2000, 1999 and 1998;
Notes to Consolidated Financial Statements; and Independent Auditor Report
2. The following financial statement schedules of the Registrant are included as part of this report:
Report of independent auditors on schedule
Schedule II - Valuation and Qualifying Accounts and Reserves
All other schedules are omitted because they are not required, are inapplicable or the information is otherwise shown in the financial statements or notes thereto.
3 The following exhibits are filed herewith or incorporated by reference as indicated. Exhibit numbers refer to Item 601 of Regulation S-K:
(b) Exhibits and Reports on Form 8-K. None
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FOOTNOTES
(1) Incorporated by reference from Registrant's Form 10-K filed on November 23, 1988 for the fiscal year ended August 31, 1988.
(2) Incorporated by reference from Registrant's Form 10-K filed on November 21, 1989 for the fiscal year ended August 31, 1989.
(3) Incorporated by reference from Form S-1 filed on August 26, 1991 by Body Drama, Inc., Commission file number 33-42417, Exhibit 10.2.
(4) Incorporated by reference from Registrant's Form 10-K filed on November 21, 1991 for the fiscal year ended August 31, 1991.
(5) Incorporated by reference from Registrant's Form 10-K filed on November 23, 1992 for the fiscal year ended August 31, 1992.
(6) Incorporated by reference from Schedule 13E-4 filed on July 20, 1995.
(7) Incorporated by reference from Registrant's Definitive Proxy Statement filed November 13, 1995.
(8) Incorporated by reference from Registrant's Form 10-K filed on November 3, 1995 for the fiscal year ended August 31, 1995.
(9) Incorporated by reference in Schedule 13E-4 filed with the SEC on August 18, 1998 and amendments related thereto.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, there unto duly authorized.
Date: October 31, 2000
NITCHES, INC.
By: /s/ Steven P. Wyandt ------------------------------------ Steven P. Wyandt, President
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated.
Independent Auditor's Report
To the Board of Directors and Shareholders Nitches, Inc. and Subsidiaries San Diego, California
Our audit of the consolidated financial statements of Nitches, Inc. and Subsidiaries referred to in our report dated October 13, 2000 appearing in item 8 in this Annual Report of Form 10-K also included an audit of the information included in the financial statement schedule listed in item 14(a) of this Form 10-K. In our opinion, the information included in the financial statement schedule presents fairly, in all material respects, the information set forth therein when read in conjunction with the related consolidated financial statements.
MOSS ADAMS LLP
Los Angeles, California October 13, 2000
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SCHEDULE II
NITCHES, INC.
VALUATION AND QUALIFYING ACCOUNTS AND RESERVES
EXHIBIT INDEX
* Incorporated by reference; see page 27.