HAMPSHIRE GROUP LTD (HAMP) - Description of business

Company Description
General ------- Hampshire Group, Limited is a holding company that markets apparel for men and women through four wholly-owned subsidiaries: Hampshire Designers, Inc., Item-Eyes, Inc., SB Corporation (doing business as David Brooks) and Shane Hunter, Inc.We believe that Hampshire Designers is the largest designer and marketer of sweaters in North America. Item-Eyes is a leading designer and marketer of related separates. David Brooks(R), which we acquired in October 2005, designs and markets a range of women's sportswear for the "better" market and Shane Hunter, which we acquired in January 2006, designs and markets apparel in children, juniors, missy, petite and maternity sizes to mass merchant retailers.Our products, both branded and private label, are marketed in the moderate and better markets through multiple channels of distribution including national and regional department stores, mass market retailers and specialty stores. All of our companies source the manufacture of their products through quality manufacturers. Keynote Services, Limited, our Hong Kong based subsidiary, assists with the sourcing and quality control needs of Hampshire Designers and Item-Eyes.Strengths and Strategy ---------------------- Our primary strength is our ability to design, develop, source and deliver quality products within a given price range, while providing superior levels of customer service. We have developed international sourcing abilities which permit us to deliver quality merchandise at a competitive price to our markets, which are primarily located within the United States.The process for the design and development of our products depends on whether the product is branded or private-label. Branded products are designed by our experienced design team, incorporating aspects of the latest fashion trends together with the consistent appeal of the brand name. These products are further refined in collaboration with manufacturers, resulting in a high-quality product to meet specified price points. Private label products are designed by our design team in collaboration with the retailers, under whose labels the products will be marketed.The quality of our garments is assured in a variety of ways. Each garment is manufactured using the finest quality yarns and each must undergo a rigorous quality assurance checks. In international sourcing, we use our own personnel, as well as factory personnel, independent inspection agencies and independent ------------------------------------------------------------------------------- Cautionary Disclosure Regarding Forward-Looking StatementsWhen used in this document in general and in the Outlook Section of Management's Discussion and Analysis in particular, the words "expects", "anticipates" and similar expressions are intended to identify forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Such statements are subject to certain risks and uncertainties which could cause actual results to differ materially from those projected. Readers are cautioned not to place undue reliance on these forward-looking statements which speak only as of the date hereof. The Company undertakes no obligation to republish or revise forward-looking statements to reflect events or circumstances after the date hereof or to reflect the occurrences of unanticipated events. Readers are also urged to carefully review and consider the various disclosures made by the Company, which attempt to advise interested parties of the factors that affect the Company's business in this report, as well as the other filings of the Company under the United States of America Securities Exchange Act of 1934. ------------------------------------------------------------------------------- -3-test labs to ensure that our products meet the high quality standards required by our customers. In some instances, direct field audits are performed by our personnel, and from time to time by customers' quality control personnel.All of our distribution is coordinated through domestic facilities, primarily through public warehouses located in California. These distribution facilities are linked electronically to the majority of our customers using our Quick Response program and an Electronic Data Interchange, or EDI, system. By providing just-in-time delivery of merchandise through our distribution facilities in the United States and through sophisticated order fulfillment techniques, we provide an important value-added service to our customers.Through the acquisitions of David Brooks and Shane Hunter, we have taken significant steps forward in achieving our long-term strategy of building a more diversified apparel company. David Brooks has positioned us to enter the women's better market and should serve as a strong building block for future growth in this market. Shane Hunter's product mix allows us to serve our customers needs for children's, juniors' and maternity sizes and their position with mass merchant retailers significantly strengthens our opportunities in that area.Organization ------------ We have a long history of providing women's and men's branded and private-label sweaters and women's woven and knit related separates to the moderate-price sector of most major department stores and mass merchants in the United States as well as specialty retail store chains and catalog companies. Through our acquisition of David Brooks, we increased our offerings to the better market and to our specialty store distribution channel. With our recent acquisition of Shane Hunter, we have strengthened our distribution channel to mass merchants and broadened our product offerings to include children's, juniors' and maternity sizes. We use both our own sales force and independent sales representatives to sell our products. With our established international sourcing relationships, we have the ability to respond quickly to changing fashion trends.Products -------- We have significantly expanded and diversified our product lines. A decade ago, our product line primarily consisted of women's full-fashion, Luxelon(R) (acrylic yarn) sweaters marketed under the Designers Originals(R) label. Although Designers Originals, which is celebrating its 50th anniversary in 2006, remains an important brand for us, our expanded product line permits us to supply many more departments of our existing customers and helps us attract new customers.Hampshire Designers - Hampshire Designers serves the entire market from "better" down through the mass merchant market. For women, in addition to the Designers Original line, we offer sweaters under the brands Hampshire Studio(R), Mercer Street Studio(R), DO by Designers Originals(R), Levi's(R), as well as various private labels of our customers. Hampshire Studio and Mercer Street Studio are labels used for specific customers on distinct lines of sweaters. DO by Designers Originals is a new line of sweaters that we are introducing during 2006 that will feature more contemporary styling.For men and young men, we offer sweaters under the licensed names of Geoffrey Beene(R), Dockers(R) and Levi's(R), as well as various private labels of our customers. In addition, we also utilize two of our own brands, Nick Danger(R) and Spring + Mercer(R). Nick Danger offers contemporary sweaters, knits, wovens and bottoms to the moderate market, while Spring + Mercer is a more upscale line featuring cashmere and luxury blend sweaters, as well as knit and woven tops. The emphasis with each of the brands is on compelling products that feature high quality and great value. These brands cover the entire range of department store offerings, from middle-of-the-road, "main floor" styles to fashion-forward, designer sweaters for the "better" departments of our customers. -4-Item-Eyes - Item-Eyes offers related sportswear, including jackets, sweater, pants, skirts and "soft dressing", targeted toward the moderate market under labels such as Requirements(R), RQT by Requirements(R), R.E.Q. by Requirements(R), Tara Ryan(R) and Nouveaux(R), as well as the private labels of our customers.David Brooks - David Brooks offers a complete line of classic American sportswear to the women's "better" market, including jackets, sweaters, knits, wovens and bottoms, under both the David Brooks label and the private labels of our customers.Shane Hunter - Shane Hunter offers apparel in children, junior, missy, petite and maternity sizes to mass merchant retailers under our own Aqua-Blues(R) label, as well as the private labels of our customers.Customers --------- We have long-term relationships with many of our customers. We sell our products principally into the moderate-price sector of most major department stores and mass merchants in the United States and also to specialty retail stores and catalog companies. Over the past few years, we have seen a decrease in the number of our significant customers due to the consolidation of the retail industry; however, we do not believe that the overall number of retail stores selling our products has decreased. We continue to seek new international markets for our products and, domestically, we have begun a number of new initiatives, primarily through Nick Danger, David Brooks and Shane Hunter to grow our specialty store and mass merchant business.Sales to our three largest customers, Kohl's Department Stores, May Company and JC Penney Company during 2005, represented 25%, 9% and 7%, respectively, of total annual sales. These same three customers represented 18%, 9% and 9%, respectively, of total sales during 2004; and 15%, 14%, and 10%, respectively, of total sales during 2003. Our five largest customers accounted for approximately 54% of total sales in 2005, compared with 50% and 52% in 2004 and 2003, respectively. For each of the last three years, more than 96% of our sales were to customers located in the United States. Sales outside of the United States were principally to customers in Canada.Competition ----------- The apparel market remains highly competitive. Competition is primarily based on product design, price, quality and service. While we face competition from domestic manufacturers and distributors, our primary competition comes from manufacturers located in Southeast Asia. We also compete for private label programs with the internal sourcing departments of many of our customers.Our ability to compete is enhanced by our in-house design abilities and our international sourcing relationships. Our strong financial position, including significant liquid assets and low debt, further enhances our ability to compete. The acquisitions of David Brooks and Shane Hunter are the most recent examples of our ongoing efforts to deploy our financial resources in a manner that helps us to enhance our competitiveness by broadening our apparel offering and product lines to reach different markets.Seasonality ----------- Although we sell apparel throughout the year, our business is highly seasonal with more than 70% of annual sales for fiscal 2005 occurring during the third and fourth quarters, primarily due to the large concentration of sweaters in our product mix. -5-Effects of Changing Prices -------------------------- We are subject to increased prices for the products we source, but have historically been able to maintain our gross margin by achieving sourcing efficiencies, controlling costs in other parts of our operations and, when necessary, passing along a portion of our cost increases to our customers through higher selling prices.Backlog ------- Our sales order backlog as of March 3, 2006 was approximately $146 million (including approximately $23.5 million of orders of David Brooks and Shane Hunter), compared to approximately $159 million as of March 2, 2005. The timing of the placement of seasonal orders by customers affects the backlog; accordingly, a comparison of backlog from year to year is not necessarily indicative of a trend in sales for the year.Trademarks and Licenses ----------------------- We consider our owned trademarks to have significant value in the marketing of our products. In addition, we have entered into licensing agreements to manufacture and market sweaters under certain labels for which we pay royalties based on the volume of sales. The licensing agreements are generally for a three-year term, with an option to renew for an additional three-years provided we have met certain sales thresholds.Electronic Information Systems ------------------------------ In order to schedule production, fill customer orders, transmit shipment data to the customers' distribution centers and invoice electronically, we have developed a number of integrated electronic information systems applications. Approximately 95% of all our orders for 2005 were received electronically. In some instances, our customers' computer systems generate these orders based on sales and inventory levels. We electronically send advance shipment notices and invoices to our customers, which results in the timely updating of their inventory systems.Credit and Collection --------------------- We manage our credit and collection functions by approving and monitoring our customers' credit lines. Credit limits are determined by past payment history and financial information obtained from credit agencies and other sources. The majority of high-risk accounts are factored with financial institutions to reduce high credit risk. We believe that our review procedures and our credit and collection staff have contributed significantly in minimizing our losses from bad debt.Employees --------- As of March 3, 2006, subsequent to the Shane Hunter acquisition, we had approximately 370 employees. The Company is not party to any collective bargaining agreement, except for an agreement with UNITE Labor Union covering 18 hourly employees of Item-Eyes through September 2007. We believe our relationship with our employees is good.Governmental Regulation and Trade Agreements -------------------------------------------- The apparel industry and our business are subject to a wide variety of international trade agreements as well as federal, state and local regulations. We believe we are in compliance in all material respects with these agreements and regulations. -6-International trade agreements in particular can have a significant impact on the apparel industry and consequently on our business. These agreements generally provide for tariffs, which impose a duty charge on the product being imported, and quotas, which limit the amount of a product that may be imported from a specific county, both of which increase the cost of importing a product.Primary among the many multilateral and bilateral trade agreements existing between the United States and certain foreign countries is the World Trade Organization (WTO), which is the governing body for international trade among the 140 originating member countries, including the United States. As part of that agreement, international textile and apparel quotas then in existence were phased out over ten years. Effective January 1, 2005, all such quota restrictions involving trade with WTO member countries were terminated. The United States and China concluded a new Memorandum of Understanding for exports from China covering the period between January 1, 2006 and December 31, 2008. This agreement was implemented with the intent of avoiding market disruption as part of the safeguard actions allowed under China's accession to the WTO in December 2001. The Memorandum of Understanding established agreed levels of quotas to regulate exports in 34 different product categories; but lightweight knit-to-shape cotton and synthetic sweaters, our largest single product offering, are now no longer subject to quota and quantities exported to the United States are no longer restrained. During the past 60 days, there has been some delay in clearing the lightweight sweaters through United States Customs due to confusion of its classification; but management does not anticipate any customer cancellations as a result of the delays.In addition to the WTO, apparel imports into the United States are affected by other trade agreements and legislation. Most important are the North American Free Trade Agreement (NAFTA), which has eliminated all apparel tariffs and quotas between Canada, Mexico and the United States, and legislation granting similar trade benefits to 23 Caribbean countries. Further, the African Growth and Opportunity Act (AGOA) of 2000 gave 38 countries in sub-Saharan Africa similar trade privileges on apparel and certain other products imported into the United States.ITEM 1A - RISK FACTORSIn addition to other information included in this report, the following factors should be considered in evaluating our business and its future prospects. The risks described below may not be the only risks we face. Additional risks that we do not yet know of or that we currently think are immaterial may also impair our business. If any of the events or circumstances described as risks below or elsewhere in this report actually occurs, our business, results of operations or financial condition could be materially and adversely affected.We rely on our key customers, and a significant decrease in business from or the loss of any one of these customers would substantially reduce our revenues and adversely affect our business. -------------------------------------------------------------------------------- Five of our customers account for significant portions of our revenues. We do not have long-term agreements with any of our customers and purchases generally occur on an order-by-order basis. A decision by any of our major customers, whether motivated by marketing strategy, competitive conditions, financial difficulties or otherwise, to decrease significantly the amount of merchandise purchased from us or to change their manner of doing business with us, could substantially reduce our revenues and materially adversely affect our profitability.The retail industry has in the past several years, experienced a great deal of consolidation and other ownership changes and we expect such changes to be ongoing. In the future, retailers may further consolidate, undergo restructurings or reorganizations, realign their affiliations or reposition their stores' target markets. In late 2005, for instance, Federated Department Stores and May Department Stores Company merged. The full impact of the merger on the Company has not yet been determined. Any of these types of actions could decrease the number of stores that carry our products or increase the ownership concentration within the retail industry. These changes could decrease our opportunities in the market, increase our reliance on a smaller number of customers and decrease our negotiating strength with them. -7-Our business could be adversely affected by financial instability experienced by our customers. -------------------------------------------------------------------------------- During the past several years, various retailers have experienced significant financial difficulties, which have resulted in bankruptcies, liquidations and store closings. We sell our products primarily to national and regional department and mass-market stores in the United States on credit and evaluate each customer's financial condition on a regular basis in order to determine the credit risk we take in selling goods to them. The financial difficulties of a customer could cause us to curtail business with that customer and we may be unable to shift sales to another viable customer. We may also assume more credit risk relating to receivables of a customer experiencing financial instability. Should these circumstances arise with respect to our customers, our inability to shift sales or to collect on our trade accounts receivable from any one of our customers could substantially reduce our revenues and have a material adverse effect on our financial condition and results of operations.We are dependent upon the revenues generated by our licensing alliances and the loss or inability to renew certain licenses could reduce our revenue and consequently reduce our net income. -------------------------------------------------------------------------------- We currently license from third parties the Geoffrey Beene(R), Dockers(R) and Levi's(R) brands for specific products. These licenses vary in length of term, renewal conditions and royalty obligations. The term of each of these licenses is three years with automatic renewals depending upon whether we achieve certain targeted sales goals. We may not be able to renew or extend any of these licenses on favorable terms, if at all. If we are unable to renew or extend any one of these licenses, we could experience a decrease in net sales.We may not be able to anticipate consumer preferences and fashion trends, which could negatively affect acceptance of our products by retailers and consumers and result in a significant decrease in net sales. -------------------------------------------------------------------------------- Our failure to anticipate, identify and respond effectively to changing consumer demands and fashion trends could adversely affect acceptance of our products by retailers and consumers and may result in a significant decrease in net sales or leave us with a substantial amount of unsold inventory. Our products must appeal to a broad range of consumers whose preferences cannot be predicted with certainty and who are subject to rapid change. We may not be able to continue to develop appealing styles or successfully meet constantly changing consumer demands in the future. In addition, any new products or brands that we introduce may not be received successfully by retailers and consumers. If our products are not received successfully by retailers and consumers and we are left with a substantial amount of unsold inventory, we may be forced to rely on markdowns or promotional sales to dispose of excess inventory. If this occurs, our business, financial condition, results of operations and prospects may be harmed.We primarily use foreign suppliers for our raw materials and the manufacture of our products, which poses risks to our business operations. -------------------------------------------------------------------------------- During fiscal 2005, in excess of 70% of our products were produced by independent manufacturers located in the People's Republic of China. Although no single supplier is critical to our production needs, any of the following could adversely affect the production and delivery of our products and, as a result, have an adverse effect on our business, financial condition and results of operations:o political or labor instability in countries where contractors and suppliers are located; o political or military conflict involving the United States; o heightened terrorism security concerns, which could subject imported goods to additional, more frequent or more thorough inspections, leading to delays in deliveries or impoundment of goods for extended periods; o a significant decrease in availability or increase in cost of raw materials, particularly petroleum-based synthetic fabrics; o disease epidemics and health-related concerns, such as the SARS outbreak in recent years and currently the Avian flu, which could result in closed factories, reduced workforces and scrutiny or embargo of goods produced in infected areas; -8-o imposition of regulations, quotas or duties relating to imports, which, among other things, could limit our ability to produce products in cost-effective countries that have the labor force and expertise required; o any action by the Chinese government to change the fixed currency exchange rate of the yuan against the dollar or to permit the exchange rate to float; and o significant fluctuation of the value of the dollar against other foreign currencies.If our manufacturers fail to use acceptable ethical business practices, our business could be adversely affected. -------------------------------------------------------------------------------- We require our manufacturers to operate in compliance with applicable laws, rules and regulations regarding working conditions, employment practices and environmental compliance. However, we do not control our independent manufacturers or their labor and other business practices. If one of our manufacturers violates labor or other laws or implements labor or other business practices that are generally regarded as unethical in the United States, the shipment of products to us could be interrupted and our reputation could be damaged. Any of these events could have a material adverse effect on our revenues and, consequently, on our results of operations.Our business could be harmed if we do not deliver quality products in a timely manner. -------------------------------------------------------------------------------- Our sourcing, logistics and technology functions operate within substantial production and delivery requirements and subject us to the risks associated with unaffiliated manufacturers, transportation and other risks. If we do not comply with customer product requirements or meet their delivery requirements, our customers could reduce the purchase prices, require significant margin support, reduce the amount of business they do with us, or cease to do business with us, all of which would harm our business.We may face challenges integrating the David Brooks and Shane Hunter businesses or any other businesses we may acquire, which may negatively impact our business. -------------------------------------------------------------------------------- As part of our strategy of making selective acquisitions, we acquire new brands and product categories. These and future acquisitions have inherent risks, including the risk that the projected sales and net income from the acquisition may not be generated, the risk that the integration is more costly and takes longer than anticipated, risks of retaining key personnel, and risks associated with unanticipated events and unknown legal liabilities. Any of these risks may harm our business.We operate in a highly competitive and fragmented industry and our failure to compete successfully could result in a loss of one or more significant customers. -------------------------------------------------------------------------------- The apparel industry is highly competitive and fragmented. Our competitors include numerous apparel designers, manufacturers, importers and licensors, many of which have greater financial and marketing resources than us. We believe that the principal competitive factors in the apparel industry are:o brand name and brand identity, o timeliness, reliability and quality of products and services provided, o market share and visibility, o price, o the ability to anticipate customer and consumer demands, and o anticipate and maintain appeal of products to our customers.The level of competition and the nature of our competitors varies by product segment with low-margin, mass-market manufacturers being our main competitors in the less expensive segment of the market and domestic and foreign designers and licensors competing with us in the more upscale segment of the market. -9-Increasingly, we experience competition from our customers' own in-house private label offerings. If we do not maintain our brand names and identities and continue to provide high quality and reliable services on a timely basis at competitive prices, we may not be able to continue to compete in our industry. If we are unable to compete successfully, we could lose one or more of our significant customers could negatively impact our sales and financial performance.We are dependent on certain key personnel, the loss of whom could negatively impact our ability to manage our business and thereby adversely affect our business. -------------------------------------------------------------------------------- Our future success depends to a significant extent on retaining the services of certain executive officers and directors. Our key executives are each party to an employment agreement with the Company of varying lengths. While we have no reason to believe that any of these employment agreements will not be renewed prior to its expiration, the loss of the services of any one of these individuals, or any other key member of management, could have a material adverse effect on our ability to manage our business.We have expanded the risk factors from that of prior reports on Form 10-K, not because our risk factors have increased, but to respond to the requirements of The Securities and Exchange Commission regarding the inclusion of Risk Factors. We believe that the risk factors described above, with the exception of those presented by our foreign sourcing of products, have confronted our business since its inception, as they generally confront all businesses. The other risk factors described above confront all businesses engaged in foreign sourcing of products. We also believe that the best measure of our ability to respond to the several risk factors, at least for the past five years, can be found in Item 6 - Selected Consolidated Financial Data.ITEM 1B - UNRESOLVED STAFF COMMENTSThere are no unresolved staff comments.