ST JOHN KNITS INTERNATIONAL INC - 10-Q Quarterly Report

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

x	QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended May 2, 2004

¨	TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from to

Commission File Number 333-73107

ST. JOHN KNITS INTERNATIONAL, INCORPORATED

(Exact name of registrant as specified in its charter)


Delaware		52-2303510
(State or other jurisdiction of incorporation or organization)		(I.R.S. Employer Identification Number)

17622 Armstrong Avenue Irvine, California		92614
(Address of principal executive offices)		(Zip Code)

Registrant’s telephone number, including area code: (949) 863-1171

Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No ¨

Indicate by check mark whether the Registrant is an accelerated filer (as defined in Exchange Act Rule 12b-2). Yes ¨ No x

The number of outstanding shares of Registrant’s Common Stock, par value $0.01 per share, was 6,289,953 shares as of June 15, 2004.

PART I. FINANCIAL INFORMATION

Item 1. Financial Statements

ST. JOHN KNITS INTERNATIONAL, INCORPORATED

CONSOLIDATED BALANCE SHEETS

(unaudited)


	May 2, 2004			November 2, 2003
A S S E T S
Current assets:
Cash and cash equivalents	$	26,117,388		$	19,265,499
Accounts receivable, net		27,109,155			31,458,163
Inventories		65,929,411			60,116,314
Deferred income tax benefit		14,955,723			14,955,723
Other		4,928,910			5,177,772

Total current assets		139,040,587			130,973,471

Property and equipment:
Machinery and equipment		70,242,671			69,691,007
Leasehold improvements		54,573,488			54,004,212
Buildings		21,887,634			25,717,272
Furniture and fixtures		17,823,238			16,600,716
Land		7,519,899			8,798,320
Construction in progress		1,414,235			707,005

		173,461,165			175,518,532
Less - Accumulated depreciation and amortization		95,639,944			88,391,898

		77,821,221			87,126,634

Deferred financing costs, net		5,964,889			6,972,572
Deferred income tax benefit		1,919,697			1,919,697
Other assets		6,661,835			7,296,645

	$	231,408,229		$	234,289,019

LIABILITIES AND STOCKHOLDERS’ DEFICIT
Current liabilities:
Accounts payable	$	7,525,223		$	11,515,439
Accrued expenses		23,489,834			22,032,299
Current portion of long-term debt		23,592,944			18,892,088
Accrued interest expense		4,136,630			4,102,795
Income taxes payable		5,333,779			5,522,444

Total current liabilities		64,078,410			62,065,065

Long-term debt, net of current portion (Note 5)		215,725,876			231,755,065
Deferred rent		5,913,630			5,603,938
Deferred income tax liability		140,659			151,233

Total liabilities		285,858,575			299,575,301

Redeemable common stock, par value $0.01 per share; issued and outstanding - 879,362 shares		25,501,498			26,380,860

Commitments and contingencies (Note 8)

Stockholders’ deficit:
Common stock, par value $0.01 per share; authorized - 10,000,000 shares, issued and outstanding - 5,577,257 shares		55,772			55,772
Additional paid-in capital		116,651,780			115,772,005
Cumulative translation adjustment		718,526			735,172
Unrealized loss on securities		—			(42,012	)
Accumulated deficit		(197,377,922	)		(208,188,079	)

Total stockholders’ deficit		(79,951,844	)		(91,667,142	)

	$	231,408,229		$	234,289,019

See accompanying notes.

ST. JOHN KNITS INTERNATIONAL, INCORPORATED

CONSOLIDATED STATEMENTS OF INCOME AND COMPREHENSIVE INCOME

(unaudited)


	Thirteen Weeks Ended						Twenty-six Weeks Ended
	May 2, 2004			May 4, 2003			May 2, 2004			May 4, 2003
Net sales	$	100,422,708		$	87,595,390		$	204,049,060		$	185,891,031
Cost of sales		42,883,198			34,921,318			90,214,153			78,535,503

Gross profit		57,539,510			52,674,072			113,834,907			107,355,528
Selling, general and administrative expenses		44,419,225			42,516,320			87,652,367			81,834,368

Operating income		13,120,285			10,157,752			26,182,540			25,521,160
Interest expense		5,424,411			6,551,694			10,980,975			13,158,264
Other income (expense)		117,324			(551,870	)		231,344			(803,547	)

Income before income taxes		7,813,198			3,054,188			15,432,909			11,559,349
Income taxes		3,076,145			1,107,410			4,622,339			4,608,478

Net income	$	4,737,053		$	1,946,778		$	10,810,570		$	6,950,871

Comprehensive income, net of tax:
Net income	$	4,737,053		$	1,946,778		$	10,810,570		$	6,950,871
Foreign currency translation adjustments		(233,334	)		26,391			(16,646	)		31,932
Unrealized gain on securities		—			1,257			—			1,257

Comprehensive income	$	4,503,719		$	1,974,426		$	10,793,924		$	6,984,060

Earnings per common share:
Basic	$	0.73		$	0.30		$	1.67		$	1.08

Diluted	$	0.73		$	0.29		$	1.67		$	1.03

Shares used in the calculation of earnings per common share:
Basic		6,456,619			6,456,619			6,456,619			6,459,068

Diluted		6,456,619			6,696,866			6,456,619			6,722,682

See accompanying notes.

ST. JOHN KNITS INTERNATIONAL, INCORPORATED

CONSOLIDATED STATEMENTS OF CASH FLOWS

(unaudited)


	Twenty-six Weeks Ended
	May 2, 2004			May 4, 2003
Cash flows from operating activities:
Net income	$	10,810,570		$	6,950,871
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization		8,426,877			8,391,526
Amortization of discount on 12.5% notes due 2009		69,200			69,200
Amortization of deferred loan costs		1,075,732			999,546
(Gain) loss on disposal of property and equipment		(461,345	)		547,357
Partnership losses		461,251			438,472
Decrease in accounts receivable		4,349,008			7,673,493
(Increase) decrease in inventories		(5,813,097	)		3,484,550
(Increase) decrease in other current assets		248,862			(396,544	)
Increase in other assets		(50,619	)		(266,911	)
Increase (decrease) in accounts payable		(3,990,216	)		755,089
Increase in accrued expenses		1,457,535			1,500,580
Increase in accrued interest expense		33,835			564,853
Decrease in income taxes payable		(188,665	)		(2,491,694	)
Increase in deferred rent		309,692			336,496

Net cash provided by operating activities		16,738,620			28,556,884

Cash flows from investing activities:
Proceeds from sale of property and equipment		5,012,655			20,500
Purchase of property and equipment		(3,678,250	)		(7,653,763	)
Sale of short-term investments		—			6,713
Capital distributions from partnership		255,000			200,000

Net cash provided by (used in) investing activities		1,589,405			(7,426,550	)

Cash flows from financing activities:
Principal payments on long-term debt		(11,396,394	)		(4,321,730	)
Redemption of redeemable common stock		—			(5,000,000	)
Financing fees and expenses		(68,049	)		—

Net cash used in financing activities		(11,464,443	)		(9,321,730	)

Effect of exchange rate changes		(11,693	)		53,103

Net increase in cash and cash equivalents		6,851,889			11,861,707
Beginning balance, cash and cash equivalents		19,265,499			30,129,208

Ending balance, cash and cash equivalents	$	26,117,388		$	41,990,915

ST. JOHN KNITS INTERNATIONAL, INCORPORATED

CONSOLIDATED STATEMENTS OF CASH FLOWS (CONTINUED)

(unaudited)


	Twenty-six Weeks Ended
	May 2, 2004			May 4, 2003
Supplemental disclosures of cash flow information:
Cash received for interest income	$	116,722		$	263,855

Cash paid for:
Interest expense	$	9,762,108		$	11,491,865

Income taxes	$	4,831,869		$	7,110,523

Supplemental disclosure of noncash financing activity:
Conversion of accrued interest to subordinated notes	$	—		$	532,961

Unrealized gain on securities	$	—		$	2,136

Adjustment of redeemable common stock to fair value	$	(879,362	)	$	(4,651,825	)

See accompanying notes.

ST. JOHN KNITS INTERNATIONAL, INCORPORATED

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)

1. Basis of Presentation and Company Operations

The accompanying unaudited consolidated financial statements of St. John Knits International, Incorporated (“SJKI”) and its subsidiaries, including St. John Knits, Inc. (“St. John”), reflect all adjustments (which include only normal recurring adjustments) considered necessary to present fairly the financial position, results of operations and cash flows for the periods presented. SJKI and its subsidiaries are collectively referred to herein as “the Company”. The accompanying unaudited consolidated financial statements and notes thereto should be read in conjunction with the financial statements and notes included in the Company’s Annual Report on Form 10-K for the year ended November 2, 2003 as filed with the Securities and Exchange Commission on February 2, 2004.

The results of operations for the periods presented are not necessarily indicative of the operating results that may be expected for the year ending October 31, 2004.

Company Operations

The Company is a leading designer, manufacturer and marketer of women’s clothing and accessories. The Company’s products are distributed primarily through specialty retailers and company-owned retail boutiques and outlet stores in the United States and internationally. All intercompany and interdivisional transactions and accounts have been eliminated.

Definition of Fiscal Year

The Company utilizes a 52-53 week fiscal year whereby the fiscal year ends on the Sunday nearest to October 31. The quarters also end on the Sunday nearest the end of the quarter, which accordingly were May 2, 2004 and May 4, 2003.

Dividends

SJKI has not paid any cash dividends to its common stockholders since 1999 and does not anticipate the payment of any cash dividends on its common stock in the future.

2. Stock Option Plan

The Company has one stock-based employee compensation plan, the 1999 St. John Knits International, Incorporated Stock Option Plan (the “Plan”). Options granted under the Plan are nonstatutory stock options. The exercise price of the stock options represents the estimated fair market value of the Company’s common stock on the date of grant. The Company accounts for the plan under the recognition and measurement principles of Accounting Principles Board (“APB”) Opinion No. 25, “Accounting for Stock Issued to Employees, and Related Interpretations”. No stock-based employee compensation cost is reflected in net income, as all options granted under the Plan have an exercise price equal to the estimated fair market value of the underlying common stock on the date of grant. The following table illustrates the effect on net income and earnings per common share if the Company had applied the fair value recognition provisions of Statement of Financial Accounting Standards (“SFAS”) No. 123, “Accounting for Stock-Based Compensation”.

ST. JOHN KNITS INTERNATIONAL, INCORPORATED

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

(unaudited)


	Thirteen Weeks Ended				Twenty-six Weeks Ended
	May 2, 2004		May 4, 2003		May 2, 2004		May 4, 2003
	(in thousands, except per share amounts)
Net income, as reported	$	4,737	$	1,947	$	10,811	$	6,951

Less: total stock-based employee compensation expense determined under the fair value based method for all awards, net of related tax effects		110		154		433		290

Pro forma net income	$	4,627	$	1,793	$	10,378	$	6,661

Earnings per common share

Basic – as reported	$	0.73	$	0.30	$	1.67	$	1.08

Basic – pro forma	$	0.72	$	0.28	$	1.61	$	1.03

Diluted – as reported	$	0.73	$	0.29	$	1.67	$	1.03

Diluted – pro forma	$	0.72	$	0.27	$	1.61	$	0.99

3.	Earnings Per Common Share

Basic earnings per common share is computed by dividing income allocated to common stockholders by the weighted average number of common shares outstanding, excluding the dilutive effect of common stock equivalents, including stock options. Diluted earnings per common share includes all dilutive items and is calculated based upon the treasury stock method, which assumes that all dilutive securities were exercised and that the proceeds received were applied to repurchase outstanding shares at the average market price during the period.

The following is a reconciliation of the Company’s weighted average shares outstanding for the purpose of calculating basic and diluted earnings per common share for all periods presented:


	Thirteen Weeks Ended		Twenty-six Weeks Ended
	May 2, 2004	May 4, 2003	May 2, 2004	May 4, 2003
Weighted average shares outstanding	6,456,619	6,456,619	6,456,619	6,459,068
Add: dilutive effect of stock options	—	240,247	—	263,614

Shares used to calculate diluted earnings per share	6,456,619	6,696,866	6,456,619	6,722,682

4.	Inventories

Inventories are comprised of the following:


	May 2, 2004		November 2, 2003
Raw materials	$	16,815,766	$	14,432,876
Work-in-process		11,419,930		9,920,428
Finished products		37,693,715		35,763,010

	$	65,929,411	$	60,116,314

ST. JOHN KNITS INTERNATIONAL, INCORPORATED

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

(unaudited)

5.	Long-term Debt

Long-term debt consists of the following:


	May 2, 2004		November 2, 2003
Senior credit facility:
Tranche A	$	18,149,211	$	28,174,234
Tranche B		120,269,790		121,629,146

		138,419,001		149,803,380
Senior subordinated 12.5% notes, net of discount		99,288,866		99,219,666
Other		1,610,953		1,624,107

		239,318,820		250,647,153
Less – Current portion		23,592,944		18,892,088

	$	215,725,876	$	231,755,065

6.	Redeemable Common Stock

During May 2004, pursuant to Mr.Gray’s request, the Company redeemed 166,666 shares of SJKI’s common stock beneficially owned by him at a total cost of approximately $5.0 million.

7.	Recent Accounting Pronouncements

In January 2003, the Financial Accounting Standards Board (“FASB”) issued Interpretation (“FIN”) No. 46, “Consolidation of Variable Interest Entities” and in December 2003, issued Interpretation No. 46 (R) (revised December 2003) “Consolidation of Variable Interest Entities – An Interpretation of Accounting Research Bulletin (“ARB”) No. 51.” In general, a variable interest entity is a corporation, partnership, trust, or any other legal structure used for business purposes that either (a) does not have equity investors with voting rights or (b) has equity investors that do not provide sufficient financial resources for the entity to support its activities. FIN 46 requires certain variable interest entities to be consolidated by the primary beneficiary of the entity if the investors in the entity do not have the characteristics of a controlling financial interest or do not have sufficient equity at risk for the entity to finance its activities without additional subordinated financial support from other parties. FIN 46 (R) clarifies the application of ARB 51, “Consolidated Financial Statements,” to certain entities in which equity investors do not have the characteristics of a controlling financial interest or do not have sufficient equity at risk for the entity to finance its activities without subordinated financial support from other parties. The consolidation requirements of FIN 46 apply immediately to variable interest entities created after January 31, 2003. The consolidation requirements apply to older entities in the first fiscal year or interim period beginning after June 15, 2003. Certain of the disclosure requirements apply in all financial statements issued after January 31, 2003, regardless of when the variable interest entity was established. FIN 46 (R) applies immediately to variable interest entities created after December 31, 2003, and to variable interest entities in which an enterprise obtains an interest after that date. It applies no later than the first reporting period ending after December 15, 2004, to variable interest entities in which an enterprise holds a variable interest (other than special purpose) that it acquired before January 1, 2004. FIN 46 (R) applies to public enterprises as of the beginning of the applicable interim or annual period. The adoption of FIN 46 and FIN 46 (R) did not have a material impact on its financial position or results of operations because the Company has no variable interest entities.

ST. JOHN KNITS INTERNATIONAL, INCORPORATED

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

(unaudited)

In May 2003, the FASB issued SFAS No. 150, “Accounting for Certain Instruments with Characteristics of Both Liabilities and Equity”, which establishes standards for how an issuer classifies and measures certain financial instruments with characteristics of both liabilities and equity. SFAS 150 requires that an issuer classify a financial instrument that is within its scope, which may have previously been reported as equity, as a liability (or an asset in some circumstances). This statement is effective for financial instruments entered into or modified after May 31, 2003, and otherwise is effective at the beginning of the first interim period beginning after June 15, 2003. In October 2003, the FASB deferred implementation of paragraphs 9 and 10 of SFAS 150 regarding parent company treatment of minority interest for certain limited life entities and certain other mandatorily redeemable financial instruments. This deferral is for an indefinite period. The adoption of SFAS 150 did not have a material impact on the Company’s financial position or results of operations.

In December 2003, the Securities and Exchange Commission released Staff Accounting Bulletin (“SAB”) No. 104, “Revenue Recognition”, which supersedes SAB 101, “Revenue Recognition in Financial Statements.” SAB 104 clarifies existing guidance regarding revenues for contracts which contain multiple deliverables to make it consistent with Emerging Issues Task Force (“EITF”) No. 00-21, “Accounting for Revenue Arrangements with Multiple Deliverables.” The adoption of SAB 104 did not have a material impact on the Company’s revenue recognition policies, its financial position or results of operations.

8.	Commitments and Contingencies

During the normal course of business, the Company has made certain indemnities, commitments and guarantees under which it may be required to make payments in relation to certain transactions. These indemnities include those given to various lessors in connection with facility leases for certain claims arising from such facility or lease. The Company has also issued guarantees, in the form of letters of credit, to cover contractual commitments, including merchandise purchases from foreign vendors and to secure the payment for potential future workers’ compensation claims. The Company had $15.6 million of letters of credit outstanding at May 2, 2004. Of this total, $13.8 million is related to potential future workers’ compensation claims. The Company has accrued a liability for the estimated claims, both reported and incurred but not yet reported, on the accompanying consolidated balance sheets. The duration of these indemnities, commitments and guarantees varies and in certain cases is indefinite. The majority of these indemnities, commitments and guarantees do not provide for any limitation of the maximum potential future payments the Company could be obligated to make. The Company has not recorded any significant liabilities for these indemnities, commitments and guarantees in the accompanying consolidated balance sheets other than as noted.

The Company is involved from time to time in litigation incidental to its business. Management believes that the outcome of any current litigation will not have a material effect upon the results of operations or financial condition of the Company.

9.	Segment Information

The Company has two reportable business segments, wholesale and retail sales. The Company’s wholesale sales business consists primarily of seven divisions; Knitwear, Sport, Shoes, Jewelry, Accessories, Fragrance and Home Accessories. Retail sales are generated through the Company’s boutiques and outlet stores. Management evaluates segment performance based primarily on revenue and earnings from operations. Inter-segment sales are recorded at the Company’s wholesale selling prices and eliminated, along with any profit in ending inventory, through the eliminations column. Interest expense, the equity in the net income of investees accounted for by the equity method and income taxes are not allocated to the segments. The Company’s chief operational decision making group is presently comprised of the Co-Chief Executive Officers and the Chief Financial Officer.

ST. JOHN KNITS INTERNATIONAL, INCORPORATED

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

(unaudited)

Segment information is summarized as follows for the periods indicated:


	Wholesale		Retail		Eliminations			Total
	(in thousands)
Second Quarter Fiscal 2004
Net sales	$	78,379	$	44,044	$	(22,000	)	$	100,423
Operating income		12,890		3,224		(2,994	)		13,120
Capital expenditures		1,506		568		—			2,074
Depreciation and amortization		2,337		1,836		—			4,173

Second Quarter Fiscal 2003
Net sales	$	73,702	$	36,575	$	(22,682	)	$	87,595
Operating income		12,416		2,219		(4,477	)		10,158
Capital expenditures		2,450		2,699		—			5,149
Depreciation and amortization		2,425		1,542		—			3,967

First Six Months Fiscal 2004
Net sales	$	162,598	$	90,221	$	(48,770	)	$	204,049
Operating income		30,171		3,831		(7,819	)		26,183
Capital expenditures		2,265		1,413		—			3,678
Depreciation and amortization		4,766		3,661		—			8,427

First Six Months Fiscal 2003
Net sales	$	153,376	$	77,559	$	(45,044	)	$	185,891
Operating income		28,565		4,935		(7,979	)		25,521
Capital expenditures		3,779		3,875		—			7,654
Depreciation and amortization		4,945		3,447		—			8,392

10.

Supplemental Condensed Consolidated Financial Information

The Company’s payment obligations under the senior subordinated notes are guaranteed by certain of the Company’s wholly owned subsidiaries (the “Guarantor Subsidiaries”). Such guarantees are full, unconditional and joint and several. Except for restrictions under applicable law, there are no material restrictions on distributions from the Guarantor Subsidiaries to SJKI. Separate financial statements of the Guarantor Subsidiaries are not presented because the Company’s management has determined that they would not be material to investors. The following supplemental financial information sets forth, on an unconsolidated basis, balance sheet, statement of income, and statement of cash flow information for the Parent Company (consisting of SJKI and St. John), for the Guarantor Subsidiaries and for the Company’s other subsidiaries (the “Non-Guarantor Subsidiaries”). During the third quarter of fiscal 2003, the Company set up a new entity to hold its retail operations. The new company operates under the name of St. John Apparel, LLC and is a Guarantor Subsidiary. The supplemental financial information reflects the investments of the Parent Company in the Guarantor Subsidiaries and Non-Guarantor Subsidiaries using the equity method of accounting. The supplemental financial information is presented for the periods as of May 2, 2004 and November 2, 2003, and for the 13 and 26 week periods ended May 2, 2004 and May 4, 2003.

ST. JOHN KNITS INTERNATIONAL, INCORPORATED

SUPPLEMENTAL CONDENSED CONSOLIDATING BALANCE SHEET

MAY 2, 2004

(UNAUDITED)


(Amounts in thousands)	PARENT COMPANY			GUARANTOR SUBSIDIARIES		NON-GUARANTOR SUBSIDIARIES			ELIMINATIONS			CONSOLIDATED
ASSETS

Current assets:
Cash, cash equivalents and investments	$	24,583		$	475	$	1,059		$	—		$	26,117
Accounts receivable, net		22,776			2,834		1,499						27,109
Inventories (1)		22,826			38,242		4,861						65,929
Deferred income tax benefit		14,956											14,956
Other		4,332			466		131						4,929
Intercompany accounts receivable		8,020								(8,020	)		—

Total current assets		97,493			42,017		7,550			(8,020	)		139,040

Property and equipment, net		39,270			29,998		8,553						77,821
Investment in subsidiaries		63,434								(63,434	)		—
Receivable from consolidated subsidiaries		18,191								(18,191	)		—
Deferred financing costs		5,965											5,965
Deferred income tax benefit		1,920											1,920
Other assets		3,339			1,036		2,287						6,662

Total assets	$	229,612		$	73,051	$	18,390		$	(89,645	)	$	231,408

LIABILITIES AND STOCKHOLDERS’ EQUITY (DEFICIT)

Current liabilities:
Accounts payable	$	7,073		$	—	$	452		$	—		$	7,525
Accrued expenses		19,691			3,107		691						23,489
Current portion of long-term debt		23,593											23,593
Accrued interest expense		4,137											4,137
Intercompany accounts payable							8,020			(8,020	)		—
Income taxes payable		8,600					(3,266	)					5,334

Total current liabilities		63,094			3,107		5,897			(8,020	)		64,078

Intercompany payable					6,319		11,872			(18,191	)		—
Long-term debt, net of current portion		215,428					298						215,726
Deferred rent		5,400			514								5,914
Deferred income tax liability		151											151

Total liabilities		284,073			9,940		18,067			(26,211	)		285,869

Redeemable common stock		25,501											25,501

Total stockholders’ equity (deficit)		(79,962	)		63,111		323			(63,434	)		(79,962	)

Total liabilities and stockholders’ equity (deficit)	$	229,612		$	73,051	$	18,390		$	(89,645	)	$	231,408

(1)	Inventories are shown at cost (without intercompany profits) for all entities

ST. JOHN KNITS INTERNATIONAL, INCORPORATED

SUPPLEMENTAL CONDENSED CONSOLIDATING BALANCE SHEET

NOVEMBER 2, 2003


(Amounts in thousands)	PARENT COMPANY			GUARANTOR SUBSIDIARIES		NON-GUARANTOR SUBSIDIARIES			ELIMINATIONS			CONSOLIDATED
ASSETS

Current assets:
Cash, cash equivalents and investments	$	18,492		$	306	$	467		$	—		$	19,265
Accounts receivable, net		27,017			2,769		1,672						31,458
Inventories (1)		16,082			39,945		4,089						60,116
Deferred income tax benefit		14,956											14,956
Prepaid expenses and other		3,890			1,170		118						5,178
Intercompany accounts receivable		4,628								(4,628	)		—

Total current assets		85,065			44,190		6,346			(4,628	)		130,973

Property and equipment, net		46,384			31,976		8,767						87,127
Investment in subsidiaries		65,882								(65,882	)		—
Receivable from consolidated subsidiaries		22,330								(22,330	)		—
Deferred financing costs		6,972											6,972
Deferred income tax benefit		1,920											1,920
Other assets		4,090			1,031		2,176						7,297

Total assets	$	232,643		$	77,197	$	17,289		$	(92,840	)	$	234,289

LIABILITIES AND STOCKHOLDERS’ EQUITY (DEFICIT)

Current liabilities:
Accounts payable	$	10,733		$	—	$	782		$	—		$	11,515
Accrued expenses		19,050			2,200		783						22,033
Current portion of long-term debt		18,892											18,892
Accrued interest expense		4,103											4,103
Intercompany accounts payable							4,628			(4,628	)		—
Income taxes payable		8,079					(2,557	)					5,522

Total current liabilities		60,857			2,200		3,636			(4,628	)		62,065

Intercompany payable					10,311		12,019			(22,330	)		—
Long-term debt, net of current portion		231,456					299						231,755
Deferred rent		5,465			139								5,604
Deferred income tax liability		151											151

Total liabilities		297,929			12,650		15,954			(26,958	)		299,575

Redeemable common stock		26,381											26,381

Total stockholders’ equity (deficit)		(91,667	)		64,547		1,335			(65,882	)		(91,667	)

Total liabilities and stockholders’ equity (deficit)	$	232,643		$	77,197	$	17,289		$	(92,840	)	$	234,289

(1)	Inventories are shown at cost (without intercompany profits) for all entities

ST. JOHN KNITS INTERNATIONAL, INCORPORATED

SUPPLEMENTAL CONDENSED CONSOLIDATING STATEMENT OF INCOME

THIRTEEN WEEKS ENDED MAY 2, 2004

(UNAUDITED)


(Amounts in thousands)	PARENT COMPANY		GUARANTOR SUBSIDIARIES		NON-GUARANTOR SUBSIDIARIES			ELIMINATIONS			CONSOLIDATED
Net sales	$	53,302	$	43,507	$	3,614		$	—		$	100,423
Cost of sales		20,549		20,853		1,481						42,883

Gross profit		32,753		22,654		2,133			—			57,540

Selling, general and administrative expenses		19,391		22,212		2,816						44,419

Operating income (loss)		13,362		442		(683	)		—			13,121

Interest expense		5,424										5,424
Other income (expense)		176				(60	)					116

Income (loss) before income taxes		8,114		442		(743	)		—			7,813
Income taxes		3,440				(364	)					3,076

Income (loss) before equity in income (loss) of consolidated subsidiaries		4,674		442		(379	)		—			4,737
Equity in income of consolidated subsidiaries		63							(63	)		—

Net income (loss)	$	4,737	$	442	$	(379	)	$	(63	)	$	4,737

ST. JOHN KNITS INTERNATIONAL, INCORPORATED

SUPPLEMENTAL CONDENSED CONSOLIDATING STATEMENT OF INCOME

THIRTEEN WEEKS ENDED MAY 4, 2003

(UNAUDITED)


(Amounts in thousands)	PARENT COMPANY			GUARANTOR SUBSIDIARIES			NON-GUARANTOR SUBSIDIARIES			ELIMINATIONS		CONSOLIDATED
Net sales	$	85,490		$	55		$	2,050		$	—	$	87,595
Cost of sales		33,952			24			945					34,921

Gross profit		51,538			31			1,105			—		52,674
Selling, general and administrative expenses		40,325			545			1,646					42,516

Operating income (loss)		11,213			(514	)		(541	)		—		10,158
Interest expense		6,552											6,552
Other expense		(398	)					(154	)				(552	)

Income (loss) before income taxes		4,263			(514	)		(695	)		—		3,054
Income taxes		1,713			(216	)		(390	)				1,107

Income (loss) before equity in loss of consolidated subsidiaries		2,550			(298	)		(305	)		—		1,947
Equity in loss of consolidated subsidiaries		(603	)								603		—

Net income (loss)	$	1,947		$	(298	)	$	(305	)	$	603	$	1,947

ST. JOHN KNITS INTERNATIONAL, INCORPORATED

SUPPLEMENTAL CONDENSED CONSOLIDATING STATEMENT OF INCOME

TWENTY-SIX WEEKS ENDED MAY 2, 2004

(UNAUDITED)


(Amounts in thousands)	PARENT COMPANY			GUARANTOR SUBSIDIARIES			NON-GUARANTOR SUBSIDIARIES			ELIMINATIONS		CONSOLIDATED
Net sales	$	107,481		$	89,254		$	7,314		$	—	$	204,049
Cost of sales		41,584			45,305			3,325					90,214

Gross profit		65,897			43,949			3,989			—		113,835

Selling, general and administrative expenses		37,113			45,346			5,193					87,652

Operating income (loss)		28,784			(1,397	)		(1,204	)		—		26,183

Interest expense		10,981											10,981
Other income (expense)		362			(40	)		(91	)				231

Income (loss) before income taxes		18,165			(1,437	)		(1,295	)		—		15,433
Income taxes		5,330						(708	)				4,622

Income (loss) before equity in loss of consolidated subsidiaries		12,835			(1,437	)		(587	)		—		10,811
Equity in loss of consolidated subsidiaries		(2,024	)								2,024		—

Net income (loss)	$	10,811		$	(1,437	)	$	(587	)	$	2,024	$	10,811

ST. JOHN KNITS INTERNATIONAL, INCORPORATED

SUPPLEMENTAL CONDENSED CONSOLIDATING STATEMENT OF INCOME

TWENTY-SIX WEEKS ENDED MAY 4, 2003

(UNAUDITED)


(Amounts in thousands)	PARENT COMPANY			GUARANTOR SUBSIDIARIES			NON-GUARANTOR SUBSIDIARIES			ELIMINATIONS		CONSOLIDATED
Net sales	$	180,210		$	1,252		$	4,429		$	—	$	185,891
Cost of sales		75,588			812			2,136					78,536

Gross profit		104,622			440			2,293			—		107,355
Selling, general and administrative expenses		77,104			1,674			3,056					81,834

Operating income (loss)		27,518			(1,234	)		(763	)		—		25,521
Interest expense		13,158											13,158
Other expense		(456	)		(192	)		(156	)				(804	)

Income (loss) before income taxes		13,904			(1,426	)		(919	)		—		11,559
Income taxes		5,771			(599	)		(564	)				4,608

Income (loss) before equity in loss of consolidated subsidiaries		8,133			(827	)		(355	)		—		6,951
Equity in loss of consolidated subsidiaries		(1,182	)								1,182		—

Net income (loss)	$	6,951		$	(827	)	$	(355	)	$	1,182	$	6,951

ST. JOHN KNITS INTERNATIONAL, INCORPORATED

SUPPLEMENTAL CONDENSED CONSOLIDATING STATEMENT OF CASH FLOWS

TWENTY-SIX WEEKS ENDED MAY 2, 2004

(UNAUDITED)


(Amounts in thousands)	PARENT COMPANY			GUARANTOR SUBSIDIARIES			NON-GUARANTOR SUBSIDIARIES			ELIMINATIONS			CONSOLIDATED
OPERATING ACTIVITIES:

Net income (loss)	$	10,811		$	(1,437	)	$	(587	)	$	2,024		$	10,811
Adjustments to reconcile net income (loss) to net cash provided by operating activities:
Depreciation and amortization		3,886			3,613			928						8,427
Amortization of discount on 12.5% notes due 2009		69												69
Amortization of deferred loan costs		1,076												1,076
(Gain) loss on disposal of property and equipment		(505	)		44									(461	)
Partnership losses		461												461
Equity in loss of consolidated subsidiaries		2,024									(2,024	)		—
Deferred rent		(65	)		375									310
Changes in operating assets and liabilities:
Accounts receivable		4,248			(66	)		167						4,349
Intercompany receivables (net)		4,309			(3,992	)		(317	)					—
Inventories		(6,742	)		1,703			(774	)					(5,813	)
Other current assets		(448	)		704			(7	)					249
Other assets		61			(5	)		(108	)					(52	)
Accounts payable		(3,615	)					(375	)					(3,990	)
Accrued expenses		(2,586	)		908			3,135						1,457
Accrued interest expense		34												34
Income taxes payable		519						(708	)					(189	)

Net cash provided by operating activities		13,537			1,847			1,354			—			16,738

INVESTING ACTIVITIES:

Proceeds from sale of property and equipment		5,013												5,013
Purchase of property and equipment		(1,240	)		(1,678	)		(760	)					(3,678	)
Capital distributions from partnership		255												255

Net cash used in investing activities		4,028			(1,678	)		(760	)		—			1,590

FINANCING ACTIVITIES:

Principal payments of long-term debt		(11,396	)											(11,396	)
Financing fees and expenses		(68	)											(68	)

Net cash used in financing activities		(11,464	)		—			—			—			(11,464	)

Effect of exchange rate changes		(10	)					(2	)					(12	)

Net increase in cash and cash equivalents		6,091			169			592						6,852
Beginning balance, cash and cash equivalents		18,492			306			467						19,265

Ending balance, cash and cash equivalents	$	24,583		$	475		$	1,059		$	—		$	26,117

Supplemental disclosures of cash flow information:
Cash received for interest income	$	117		$	—		$	—		$	—		$	117

Cash paid for:
Interest expense	$	9,759		$	—		$	3		$	—		$	9,762

Income taxes	$	4,832		$	—		$	—		$	—		$	4,832

Supplemental disclosures of noncash financing activities:

Adjustment of redeemable common stock to fair value	$	(879	)	$	—		$	—		$	—		$	(879	)

ST. JOHN KNITS INTERNATIONAL, INCORPORATED

SUPPLEMENTAL CONDENSED CONSOLIDATING STATEMENT OF CASH FLOWS

TWENTY-SIX WEEKS ENDED MAY 4, 2003

(UNAUDITED)


(Amounts in thousands)	PARENT COMPANY			GUARANTOR SUBSIDIARIES			NON-GUARANTOR SUBSIDIARIES			ELIMINATIONS			CONSOLIDATED
OPERATING ACTIVITIES:

Net income (loss)	$	6,951		$	(827	)	$	(355	)	$	1,182		$	6,951
Adjustments to reconcile net income (loss) to net cash provided by (used in) operating activities:
Depreciation and amortization		7,366			629			397						8,392
Amortization of discount on 12.5% notes due 2009		69												69
Amortization of deferred loan costs		1,000												1,000
Loss on disposal of property and equipment		547												547
Partnership losses		438												438
Equity in loss of consolidated subsidiaries		1,182									(1,182	)		—
Cash provided by changes in operating assets and liabilities:
Accounts receivable		7,653			36			(16	)					7,673
Intercompany receivables (net)		(3,007	)		(513	)		3,520						—
Inventories		3,044			311			130						3,485
Other current assets		72			1			(470	)					(397	)
Other assets		(44	)		24			(247	)					(267	)
Accounts payable		755												755
Accrued expenses		1,104			337			60						1,501
Accrued interest expense		565												565
Income taxes payable		(1,924	)					(568	)					(2,492	)
Deferred rent		337												337

Net cash provided by (used in) operating activities		26,108			(2	)		2,451			—			28,557

INVESTING ACTIVITIES:

Proceeds from sale of property and equipment		21												21
Purchase of property and equipment		(5,596	)					(2,058	)					(7,654	)
Sale of short-term investments		7												7
Capital distributions from partnership		200												200

Net cash used in investing activities		(5,368	)		—			(2,058	)		—			(7,426	)

FINANCING ACTIVITIES:

Principal payments of long-term debt		(3,985	)					(337	)					(4,322	)
Redemption of redeemable common stock		(5,000	)											(5,000	)

Net cash used in financing activities		(8,985	)		—			(337	)		—			(9,322	)

Effect of exchange rate changes		12						41						53

Net increase (decrease) in cash and cash equivalents		11,767			(2	)		97			—			11,862
Beginning balance, cash and cash equivalents		29,411			2			716						30,129

Ending balance, cash and cash equivalents	$	41,178		$	—		$	813		$	—		$	41,991

Supplemental disclosures of cash flow information:
Cash received for interest income	$	264		$	—		$	—		$	—		$	264

Cash paid for:
Interest expense	$	11,490		$	—		$	3		$	—		$	11,493

Income taxes	$	7,111		$	—		$	—		$	—		$	7,111

Supplemental disclosures of noncash financing activities:
Conversion of accrued interest to subordinated notes	$	533		$	—		$	—		$	—		$	533

Unrealized gain on securities	$	2		$	—		$	—		$	—		$	2

Adjustment of redeemable common stock to fair value	$	(4,652	)	$	—		$	—		$	—		$	(4,652	)

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

Results of Operations

The following table is derived from the Company’s Consolidated Statements of Income and sets forth, for the periods indicated, the results of operations as a percentage of net sales:


	Percentage of Net Sales Thirteen Weeks Ended (“Second Quarter”)				Percentage of Net Sales Twenty-six Weeks Ended (“Six Months”)
	May 2, 2004		May 4, 2003		May 2, 2004		May 4, 2003
Net sales	100.0	%	100.0	%	100.0	%	100.0	%

Cost of sales	42.7		39.9		44.2		42.2

Gross profit	57.3		60.1		55.8		57.8

Selling, general and administrative expenses	44.2		48.5		43.0		44.0

Operating income	13.1		11.6		12.8		13.8

Interest expense	5.4		7.5		5.4		7.1

Other income (expense)	0.1		(0.6	)	0.2		(0.4	)

Income before income taxes	7.8		3.5		7.6		6.3

Income taxes	3.1		1.3		2.3		2.5

Net income	4.7	%	2.2	%	5.3	%	3.8	%

Second Quarter Fiscal 2004 Compared to Second Quarter Fiscal 2003

Net sales for the second quarter of fiscal 2004 increased by $12.8 million, or 14.6% as compared to the second quarter of fiscal 2003. This increase was principally attributable to (i) an increase in sales by company-owned retail boutiques of approximately $6.7 million, partially due to the relocation of two existing retail boutiques located in Beverly Hills, California and Chicago, Illinois and the addition of two new retail boutiques which were opened after the end of the first quarter of fiscal 2003, (ii) an increase in sales to domestic wholesale customers of approximately $3.5 million, (iii) an increase in international sales of approximately $1.8 million, due in part to our expanding operations in Japan and (iv) an increase in sales by company-owned retail outlet stores of approximately $0.8 million, due to the addition of three new retail outlet stores which were opened after the end of the first quarter of fiscal 2003. Sales for company-owned retail boutiques open at least one year increased 21.3% during the second quarter of fiscal 2004 as compared to the second quarter of fiscal 2003. The overall increase in net sales was primarily due to a shift in sales to higher priced garments during the second quarter of fiscal 2004 as compared to the same period of the prior year.

Gross profit for the second quarter of fiscal 2004 increased by $4.9 million, or 9.2% as compared with the second quarter of fiscal 2003, but decreased as a percentage of net sales to 57.3% from 60.1%. This decrease as a percentage of net sales was primarily the result of a decrease in the gross profit margin for the Knit product line due to a change in the mix of the products being manufactured and sold and increased labor costs, combined with a decrease in the gross profit margin for the Sport product line due to a change in the mix of products being manufactured and sold. These decreases were partially offset by an increase in the gross profit margin resulting from increased sales at company-owned retail boutiques, which on a consolidated basis have a higher gross profit margin than sales to wholesale customers.

Selling, general and administrative expenses for the second quarter of fiscal 2004 increased by $1.9 million, or 4.5%, over the second quarter of fiscal 2003, but decreased as a percentage of net sales to 44.2% from 48.5%. Selling, general and administrative expenses increased during the period primarily due to an increase of approximately $2.0 million resulting from the opening of two new retail boutiques, the relocation of four retail boutiques, the expansion of two retail boutiques and the opening of three retail outlet stores since the end of the first quarter of fiscal 2003, an increase in costs related to the Company’s expanding operations in Japan of approximately $0.9 million and an increase in commission expense for boutique employees of approximately $0.5 million related to the increase in sales. These increases were partially offset by a decrease in advertising expenses of approximately $0.8 million, a decrease in bad debt expenses of approximately $0.5 million and a decrease of approximately $0.5 million due to the closure of the St. John Home Stores.

Operating income for the second quarter of fiscal 2004 increased by $3.0 million, or 29.2% as compared to the second quarter of fiscal 2003. Operating income as a percentage of net sales increased to 13.1% from 11.6% during the same period. This increase in operating income as a percentage of net sales was due to a decrease in selling, general and administrative expenses as a percentage of net sales, partially offset by a decrease in the gross profit margin for the period.

Interest expense for the second quarter of fiscal 2004 decreased by $1.1 million, or 17.2% from the second quarter of fiscal 2003. This decrease was primarily due to a decrease in the debt balance from the end of the second quarter of fiscal 2003 and a reduction in interest rates on the Company’s variable rate debt.

First Six Months Fiscal 2004 Compared to First Six Months Fiscal 2003

Net sales for the first six months of fiscal 2004 increased by $18.2 million, or 9.8% as compared to the first six months of fiscal 2003. This increase was principally attributable to (i) an increase in sales by company-owned retail boutiques of approximately $10.8 million, partially due to the relocation of two existing retail boutiques located in Beverly Hills, California and Chicago, Illinois and the addition of two new retail boutiques which were opened after the end of fiscal 2003, (ii) an increase in international sales of approximately $3.3 million, (iii) an increase in sales by company-owned retail outlet stores of approximately $3.1 million, due to the addition of three new retail outlet stores which were opened after the end of fiscal 2003 and (iv) an increase in sales to domestic wholesale customers of approximately $2.1 million. These increases were partially offset by a decrease in sales of approximately $1.3 million for the St. John Home stores which were closed during the first six months of fiscal 2003. Sales for company-owned retail boutiques open at least one year increased 15.5% during the first six months of fiscal 2004 as compared to the first six months of fiscal 2003. The overall increase in net sales was primarily due to a shift in sales to higher priced garments during the first six months of fiscal 2004 as compared to the same period of the prior year.

Gross profit for the first six months of fiscal 2004 increased by $6.5 million or 6.0% as compared with the first six months of fiscal 2003, but decreased as a percentage of net sales to 55.8% from 57.8%. This decrease as a percentage of net sales was primarily the result of a decrease in the gross profit margin for the Knit product line due to a change in the mix of the products being manufactured and sold and increased labor costs, combined with a decrease in the gross profit margin for the Sport product line due to a change in the mix of products being manufactured and sold. These decreases were partially offset by an increase in the gross profit margin resulting from increased sales at company-owned retail boutiques, which on a consolidated basis have a higher gross profit margin than sales to wholesale customers.

Selling, general and administrative expenses for the first six months of fiscal 2004 increased by $5.8 million, or 7.1%, over the first six months of fiscal 2003, but decreased as a percentage of net sales to 43.0% from 44.0%. Selling, general and administrative expenses increased during the period primarily due to (i) an increase of approximately $5.0 million resulting from the opening of two new retail boutiques, the relocation of four retail boutiques, the expansion of two retail boutiques and the opening of three retail outlet stores since the end of fiscal 2003, (ii) an increase in costs related to the Company’s expanding operations in Japan of approximately $1.7 million, (iii) an increase in commission expense for boutique employees of approximately $0.8 million related to the increase in sales, (iv) an increase in promotional expenses for the boutiques of approximately $0.8 million and (v) approximately $0.5 million in costs related to the closure of one of the Company’s manufacturing facilities during the first quarter of fiscal 2003. These increases were partially offset by a decrease in advertising expenses of approximately $2.0 million, a decrease of approximately $1.7 million due to the closure of the St. John Home Stores and a decrease in design sample expenses and bad debt expenses of approximately $0.6 million each.

Operating income for the first six months of fiscal 2004 increased by $0.7 million, or 2.6% as compared to the first six months of fiscal 2003. Operating income as a percentage of net sales decreased to 12.8% from 13.8% during the same period. This decrease in operating income as a percentage of net sales was due to a decrease in the gross profit margin which was partially offset by a decrease in selling, general and administrative expenses as a percentage of net sales.

Interest expense for the first six months of fiscal 2004 decreased by $2.2 million, or 16.6% from the first six months of fiscal 2003. This decrease was primarily due to a decrease in the debt balance from the end of fiscal 2003 and a reduction in interest rates on the Company’s variable rate debt.

Other expenses decreased from $0.8 million for the first six months of fiscal 2003 to income of approximately $0.2 million for the first six months of fiscal 2004. This change was primarily due to a gain of approximately $0.4 million recorded on the sale of one of the Company’s manufacturing facilities and royalty income of approximately $0.3 million recorded during the first six months of fiscal 2004.

The income tax rate for the first six months of fiscal 2004 decreased to 30.0% from 39.9% for the first six months of fiscal 2003. This decrease was primarily due to an adjustment recorded during the first quarter of fiscal 2004 to reduce the Company’s tax liability for potential income tax audit issues which were resolved during the period. The Company anticipates an income tax rate of approximately 39% for the remainder of fiscal 2004.

Liquidity and Capital Resources

The Company’s primary cash requirements are to fund payments required to service the Company’s debt, to fund the Company’s working capital needs, primarily inventory and accounts receivable, and for the purchase of property and equipment. During the first six months of fiscal 2004, cash provided by operating activities was $16.7 million. Cash provided by operating activities was primarily generated by net income and a decrease in accounts receivable, while cash used in operating activities was primarily used to fund an increase in inventories and a decrease in accounts payable. The decrease in accounts receivable was primarily due to lower wholesale sales in April 2004 as compared to October 2003. The increase in inventory was primarily due to an increase in the inventory of raw materials and work in process at the Company’s manufacturing facilities. Cash provided by investing activities was $1.6 million during the first six months of fiscal 2004. The principal source of cash provided by investing activities was the sale of the Company’s manufacturing facility in Van Nuys, California and the sale and subsequent leaseback of the Company’s manufacturing facility located in San Ysidro, California, while the principal use of cash in investing activities was for (i) the construction of leasehold improvements for scheduled upgrades to company-owned retail boutiques, (ii) the construction of leasehold improvements for scheduled new, relocated or expanded retail boutiques, (iii) the construction of St. John shops within the Company’s major wholesale customer locations and (iv) costs incurred to upgrade the Company’s computer systems. Cash used in financing activities was $11.5 million during the first six months of fiscal 2004, resulting from scheduled payments made on the Company’s long-term debt and required prepayments of $4.4 million made from proceeds resulting from the sale of the properties noted above.

As of May 2, 2004, the Company had approximately $75.0 million in working capital and $26.1 million in cash and cash equivalents. The Company’s principal source of liquidity is internally generated funds. As part of its credit facility with a syndicate of banks, the Company also has a $25.0 million revolving commitment, which expires on July 31, 2005. The revolving commitment is secured and borrowings thereunder bear interest at the Company’s choice of the bank’s borrowing rate (4.0% at May 2, 2004) plus 1.75% or LIBOR (1.125% at May 2, 2004) plus 2.75%. The availability of funds under the revolving commitment is subject to the Company’s continued compliance with certain covenants, including a covenant that sets the maximum amount the Company can spend annually on the acquisition of fixed or capital assets, and certain financial covenants, including a maximum leverage ratio, a minimum fixed charge coverage ratio and a minimum interest expense coverage ratio. As of May 2, 2004, the Company was in compliance with all covenants and no amounts were outstanding under the revolving commitment. The Company had $15.6 million of letters of credit outstanding at May 2, 2004 which reduces the amount available under the revolving commitment by a corresponding amount. The Company invests its excess cash in a money market fund.

Total debt outstanding decreased $11.3 million to $239.3 million during the six months ended May 2, 2004. This decrease was due to scheduled principal payments and $4.4 million of prepayments made during the period. The Company’s outstanding debt was comprised of bank borrowings of $138.4 million and senior subordinated 12.5% notes (“12.5% notes”) of $100.0 million, excluding the unamortized issue discount of $0.7 million.

The Company is currently negotiating to sell and lease back four company-owned facilities located in Irvine, California. If consummated, it is expected that the transaction would result in net proceeds of approximately $20.0 million. The Company is required to use any net proceeds to prepay a portion of its bank borrowings. The Company would lease these properties back for a period of 15 years with initial annual lease payments of approximately $1.7 million, increasing over the life of the lease.

The Company’s primary ongoing cash expenditures are for debt service and the purchase of property and equipment. The Company’s debt service requirements consist primarily of principal and interest payments on bank borrowings and interest on the senior subordinated notes. The Company believes it will be able to finance its debt service and capital expenditure requirements with internally generated funds and availability under the revolving credit facility through fiscal 2005. Beyond fiscal 2005, the Company will have a significant increase in the principal payments required on its bank borrowings resulting from the maturity of its senior credit facilities. As a result, the Company will probably need to seek to raise additional capital or refinance such debt in order to satisfy its obligations. The Company’s ability to fund its capital investment requirements, interest and principal payment obligations and working capital requirements and to comply with all of the financial covenants under its debt agreements depends on its future operating performance and cash flow, which in turn are subject to prevailing economic conditions and to financial, business and other factors, some of which are beyond the Company’s control.

During its normal course of business, the Company has made certain indemnities, commitments and guarantees under which it may be required to make payments in relation to certain transactions. These indemnities include those given to various lessors in connection with facility leases for certain claims arising from such facility or lease. The Company has also issued guarantees, in the form of letters of credit, to cover contractual commitments, including merchandise purchases from foreign vendors and to secure the payment for potential future workers’ compensation claims. The Company had $15.6 million of letters of credit outstanding at May 2, 2004. Of this total, $13.8 million is related to potential future workers’ compensation claims. The Company has accrued a liability for the estimated claims, both reported and incurred but not yet reported. The duration of these indemnities, commitments and guarantees varies and in certain cases is indefinite. The majority of these indemnities, commitments and guarantees do not provide for any limitation of the maximum potential future payments the Company could be obligated to make. The Company has not recorded any significant liabilities for these indemnities, commitments and guarantees in the accompanying consolidated balance sheets other than as noted.

The Company anticipates purchasing property and equipment of approximately $11.5 million during the remainder of fiscal 2004, but is not contractually committed to do so. The estimated $11.5 million will be used principally for (i) the construction of leasehold improvements for the expansion or relocation of four of the Company’s retail boutiques, (ii) upgrades to the Company’s manufacturing operations, including the purchase of electronic knitting machines, (iii) the construction of St. John shops within the Company’s major wholesale customer locations and (iv) upgrades to the Company’s computer systems.

SJKI must rely on distributions, loans and other intercompany cash flows from its subsidiaries to generate the funds necessary to satisfy the repayment of its outstanding loans. Except for restrictions under applicable law, there are no material restrictions on distributions to the Company from the Company’s wholly owned subsidiaries that have guaranteed the Company’s payment obligations under its 12.5% notes.

The Company may repurchase, from time to time, a portion of its 12.5% notes, subject to market conditions and other factors. No assurance can be given as to whether or when or at what prices such repurchases will occur. In addition, the Company may be required to repurchase up to $5.0 million annually of the common stock beneficially owned by Bob Gray, Marie Gray or Kelly Gray (the “Gray family”). In May 2004, as provided in the stockholder’s agreement, pursuant to Mr. Gray’s request, the Company redeemed 166,666 shares of SJKI’s common stock beneficially owned by him at a total cost of approximately $5.0 million.

SJKI has not paid any cash dividends since 1999 and does not anticipate the payment of any cash dividends on its common stock in the future. SJKI’s ability to pay dividends is restricted by the terms of its senior secured credit facilities and 12.5% notes.

The Company’s EBITDA (EBITDA generally represents the net income of the Company excluding the effects of interest expense, income taxes, depreciation and a majority of the items included in other income and expense) as defined in its credit agreement for its senior secured credit facilities was approximately $35.8 million and $34.3 million for the first six months of fiscal 2004 and 2003, respectively, and $18.1 million and $14.3 million for the second quarter of fiscal 2004 and 2003, respectively. EBITDA as defined by the Company may not be consistent with similarly titled measures of other companies. EBITDA is not a defined term under generally accepted accounting principles (“GAAP”) and is not an alternative to operating income or cash flow from operations as determined under GAAP. EBITDA is used to calculate certain covenants under the Company’s credit agreement, including a maximum leverage ratio and minimum fixed charge and interest expense coverage ratios. The Company believes that EBITDA provides additional information for determining its ability to meet future debt service requirements; however, EBITDA should not be construed as an indication of the Company’s operating performance or as a measure of liquidity.

The table below shows the reconciliation from net income to EBITDA (as adjusted per the terms of the credit agreement) for the first six months and second quarter of fiscal years 2004 and 2003:


	Thirteen Weeks Ended					Twenty-six Weeks Ended
	May 2, 2004			May 4, 2003		May 2, 2004			May 4, 2003
	(in thousands)					(in thousands)
Net income	$	4,737		$	1,947	$	10,811		$	6,951

Income taxes		3,076			1,107		4,622			4,608

Interest expense		5,424			6,552		10,981			13,158

Other (income) expense		(117	)		552		(231	)		804

Depreciation and amortization		4,173			3,967		8,427			8,392

Deferred rent expense		167			156		310			336

Gain on sale of fixed assets		390			—		390			—

Licensing income		126			11		268			11

Accrued letter of credit fees		135			—		248			—

Adjusted EBITDA	$	18,111		$	14,292	$	35,826		$	34,260

Off-Balance Sheet Arrangements

The Company does not have any off-balance sheet arrangements within the meaning of Securities and Exchange Commission regulation S-K Item 303(a)(4).

Credit Facility

The Company is a party to a credit agreement with a syndicate of banks, which initially provided for an aggregate principal amount of loans totaling $215.0 million. The credit agreement consists of three facilities: (i) tranche A facility totaling $75.0 million which matures July 31, 2005, (ii) tranche B facility totaling $115.0 million which matures July 31, 2007 and (iii) the revolving credit facility totaling $25.0 million which matures July 31, 2005.

Borrowings under the tranche A facility and the revolving credit facility bear interest at a floating rate, which is based upon the leverage ratio of the Company, but cannot exceed the bank’s borrowing rate plus 1.75% or LIBOR plus 2.75%. Borrowings under the tranche B facility bear interest at a floating rate, which is also based upon the leverage ratio of the Company, but cannot exceed the bank’s borrowing rate plus 2.75% or LIBOR plus 3.75%. In addition, the Company is required to pay a commitment fee on the unused portion of the revolving credit facility of up to 0.5% per year.

Borrowings under the tranche A facility began to mature quarterly on November 2, 1999, while borrowings under the tranche B facility began to mature quarterly on November 2, 2000. The credit agreement permits the Company to prepay loans and to permanently reduce revolving credit commitments, in whole or in part, at any time. In addition, the Company is required to make mandatory prepayments of the tranche A and B facilities, subject to certain exceptions, in amounts equal to (i) 75% of excess cash flow (as defined in the Company’s credit agreement); (ii) 75% of the net cash proceeds of a permitted asset sale (as defined in the Company’s credit agreement) and (iii) 100% of the net cash proceeds of certain dispositions of assets or issuances of debt or equity of the Company or any of its subsidiaries (in each case, subject to certain exceptions and subject to a reduction to zero based upon the Company’s financial performance).

The obligations of the Company under the credit agreement are guaranteed by each domestic subsidiary of the Company, and to the extent no adverse tax consequences would result from such guarantees, each foreign subsidiary of the Company. The credit agreement and the related guarantees are secured by (i) a pledge of 100% of the capital stock of each domestic subsidiary of the Company and 65% of each foreign subsidiary of the Company and (ii) a security interest in, and mortgage on, substantially all the assets of the Company and each domestic subsidiary of the Company and to the extent no adverse tax consequences would result therefrom, each foreign subsidiary of the Company.

The credit agreement requires the Company to comply with specified financial ratios, including a minimum interest coverage ratio, a maximum leverage ratio and a minimum fixed charge coverage ratio. Each ratio is calculated using EBITDA. In the event of non-compliance with any of these ratios, the Company would be in default under the credit agreement. The credit agreement also contains additional covenants that, among other things, restrict the ability of the Company to dispose of assets, incur additional indebtedness, pay dividends, create liens on assets, make investments, loans or advances and engage in mergers or consolidations. The credit agreement prohibits the Company from declaring or paying any dividends or making any payments with respect to the Company’s senior subordinated notes if it fails to perform its obligations under, or fails to meet the conditions of, the credit agreement or if such payment creates a default under the credit agreement. The credit agreement contains customary events of default. In the event of default, the total amount of the outstanding debt plus any accrued interest would become immediately due and payable. At May 2, 2004, the Company was in compliance with all covenants.

Senior Subordinated 12.5% Notes

In addition to the credit facilities described above, the Company has $100.0 million of 12.5% notes outstanding. The 12.5% notes are unsecured and mature on July 1, 2009. The 12.5% notes bear interest at a rate of 12.5% per year and were issued at 98.616% of the actual face value. Interest on such notes is payable semiannually to the holders of record. The notes are subject to redemption by the Company on or after July 1, 2004 at a premium starting at 6.25% and decreasing to zero at July 1, 2008. The indenture governing the notes limits, among other things, the payment of dividends, the incurrence of additional indebtedness and other restricted payments. The indenture contains customary events of default.

Redeemable Common Stock

SJKI is a party to a stockholders’ agreement with Vestar/Gray Investors, LLC, Vestar Capital Partners III, L.P. and the Gray family, which states, among other things, that prior to a public offering of SJKI common stock, if Bob Gray ceases to serve as Chairman or Chief Executive Officer of St. John or SJKI or if the employment with SJKI of Marie Gray or Kelly Gray ceases for any reason, then he or she will have the right to require SJKI to purchase the shares of SJKI common stock beneficially owned by them, at fair value, up to a maximum of $5.0 million of such common stock for all the Grays during any 12 month period. If any of the Grays are terminated without “cause” or resigns for “good reason,” as these terms are defined in their employment agreements with the Company, then he or she will have the right to require SJKI to purchase the shares of SJKI common stock beneficially owned by them, up to a maximum of 25% of the total shares held by such terminated or resigning Gray employee during any 12 month period. This agreement may be limited by the terms of the agreements related to the credit facilities and the senior subordinated notes. In May 2004, as provided in the stockholder’s agreement, pursuant to Mr. Gray’s request, the Company redeemed 166,666 shares of SJKI’s common stock beneficially owned by him at a total cost of approximately $5.0 million.

The value of the Company’s redeemable common stock, as reported on the Company’s consolidated balance sheets, decreased from $26.4 million at November 2, 2003 to $25.5 million at May 2, 2004. This reduction was due to a decrease in the fair market value of the Company’s common stock.

Critical Accounting Policies

The Company’s consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States. As such, the Company is required to make estimates and assumptions that affect the reported amounts of assets and liabilities at the balance sheet dates and the reported amounts of revenue and expense during the reporting periods. Actual results could significantly differ from such estimates.

The Company believes that the following accounting policies are among the most critical because they involve significant judgments and uncertainties and could potentially result in materially different results under different assumptions and conditions.

Inventories

Inventories are stated at the lower of the cost to purchase and/or manufacture the inventory or the current estimated market value (lower of cost or market). The Company regularly reviews its inventory quantities on hand and records a provision for excess and obsolete inventory based primarily on the Company’s estimated forecast of product demand and production requirements. Any significant change in the anticipated demand for the Company’s products could cause the Company to revise its estimate of excess and obsolete inventory, which could affect the Company’s reported results.

Revenue Recognition

Sales to the Company’s wholesale customers are recognized when the goods are shipped and title passes. Sales are recognized upon purchase by customers at the Company’s retail store locations at the point of sale. The Company has recorded reserves to estimate sales returns by customers based on historical sales return results. Actual return rates have historically been within management’s expectations and the reserves established. However, in the unlikely event that the actual rate of sales returns by customers changes significantly, the Company’s reported results could be affected.

Wholesale Markdowns

The Company has arrangements with some of its major wholesale customers which may result in the Company reimbursing them for markdowns. The Company records an estimate of its liability under these arrangements at the time of sale, based upon historical experience. These estimates are based in part on projected sales and markdowns for these customers into the future. While historical experience has been within management’s expectations, any significant variation from the projected sales or markdowns could cause the Company to change its estimates. Any such change in the Company’s estimates could affect the Company’s reported results.

Long-lived Assets

During the normal course of business, the Company acquires tangible long-lived assets. The Company periodically evaluates the recoverability of the carrying amount of these assets. An impairment is assessed when the undiscounted expected future cash flows derived from an asset are less than its carrying amount. Impairments are recognized in operating income as they are realized. The Company uses its best judgment, based upon the most current facts and circumstances surrounding the specific assets, when applying these impairment rules. Changes in the assumptions used could have a significant impact on the Company’s assessments of the recoverability. Many factors, including changes to the Company’s business and the global economy, could significantly impact management’s decision to retain or dispose of certain of its long-lived assets.

Foreign Currency Translation

The Company sells its products to wholesale customers located in various parts of Europe in the customers’ local currencies, Euros and British Pounds. The Company also purchases its shoes, leather goods and other raw material items from vendors located in Europe in Euros. Fluctuations in the exchange rates can have an effect on the sales revenues and expenses recorded in connection with such transactions. For fiscal years 2004 and 2003, the Company made the decision to stop its hedging of such foreign currencies and to allow its sales and purchases to act as a natural hedge. This decision was based upon the fact that the sales and purchases made in the foreign currencies were similar in amounts over each of the fiscal years. If these amounts vary in the future or if the Company changes its policy on hedging for these currencies, it could affect the Company’s reported results.

Accounts Receivable

The Company performs ongoing credit evaluations of its wholesale customers and adjusts credit limits based upon payment history and the customer’s current financial status. The Company continuously monitors its customer payments and maintains a provision for estimated credit losses based upon the Company’s historical experience and any specific customer collection issues that have been identified. The Company’s accounts receivable are concentrated in the apparel industry, primarily with its three major wholesale customers. The risk of collection is concentrated within this industry and with these specific customers. As a result of this concentration, a change in the creditworthiness of the companies within the apparel industry could cause the Company to revise its estimate of credit losses, which could affect the Company’s reported results.

Insurance Program

The Company is partially self-insured for its workers’ compensation insurance coverage. Under this insurance program the Company is liable for a deductible of $500,000 for each individual claim. The Company records a liability for the estimated cost of claims both reported and incurred but not reported based upon its historical experience. The estimated costs include the estimated future cost of all open claims. The Company will continue to adjust the estimates as the actual experience dictates. A significant change in the number or dollar amount of claims could cause the Company to revise its estimate of potential losses and affect its reported results.

Inflation

The Company does not believe that inflation had a material impact on the sales reported for the first six months of fiscal year 2004.

Forward Looking Statements

This Quarterly Report on Form 10-Q contains certain statements which describe the Company’s beliefs concerning future business conditions and the outlook for the Company based on currently available information. Wherever possible, the Company has identified these “forward looking” statements (as defined in Section 21E of the Securities Exchange Act of 1934) by words such as “anticipates”, “believes”, “estimates”, “expects” and other similar expressions. The forward looking statements and associated risks set forth herein may include or relate to: (i) the Company’s anticipated purchases of property and equipment during the remainder of fiscal 2004, (ii) the Company’s belief that it will be able to fund its debt service and capital expenditure requirements with internally generated funds and the use of its revolving credit facility through fiscal 2005 and (iii) the Company’s anticipation that it will not pay cash dividends on its common stock in the future.

These forward looking statements are subject to risks, uncertainties and other factors which could cause the Company’s actual results, performance or achievements to differ materially from those expressed in, or implied by, these statements. In addition to the factors that may be described in this report, the following factors could cause actual results to differ from those expressed in any forward looking statements made by the Company: (i) the financial strength of the retail industry and the level of consumer spending for apparel and accessories, (ii) the financial health of the Company’s principal customers, (iii) the Company’s ability to develop, market and sell its products, (iv) competition from other manufacturers and retailers of women’s clothing and accessories, (v) general economic conditions and (vi) the ability of the Company to meet the financial covenants under its credit facilities and indenture. The Company undertakes no obligation to review or update publicly any forward looking statement.

Item 3. Quantitative and Qualitative Disclosures About Market Risk

The Company has exposure to fluctuations in foreign currency exchange rates for the revenues derived from sales to its foreign customers denominated in foreign currency. In order to reduce the effects of such fluctuations, under established risk management practices, the Company may enter into foreign exchange forward contracts. These contractual arrangements are typically entered into with a major financial institution. The Company does not hold derivative financial instruments for speculative trading. The primary business objective of this program is to secure the anticipated profit on sales denominated in foreign currencies. The Company’s primary exposure to foreign exchange fluctuation is on the Euro. The Company also purchases its shoes and leather goods, as well as various other raw materials, from companies located in Europe. The purchase of these items is completed in Euros. In order to reduce the effect of the fluctuation in the exchange rate between the Euro and the U.S. dollar, the Company may enter into forward contracts. The Company did not hold any forward contracts at May 2, 2004.

The Company made a decision to use its sales made in Euros as a natural hedge for the purchases of inventory items made in Euros for each of fiscal years 2004 and 2003. There can be no assurance that this strategy will fully offset the Company’s foreign currency exposure.

The Company is also exposed to market risks related to fluctuations in interest rates on its variable rate debt, which consists primarily of bank borrowings under the credit agreement. The Company also holds fixed rate subordinated notes. For fixed rate debt, changes in interest rates generally affect the fair market value, but not earnings or cash flows. Conversely, for variable rate debt, changes in interest rates generally do not influence fair market value, but do affect future earnings and cash flows. The Company has managed its exposure to changes in interest rates by issuing part of its debt with a fixed interest rate. Assuming that the balance of variable rate debt remains constant, a one percentage point increase in LIBOR from the first day of the year would result in an annual increase in interest expense of approximately $1.4 million.

Item 4. Controls and Procedures

The Company maintains disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended (the “Exchange Act”)) that are designed to ensure that information required to be disclosed in the Company’s reports filed under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission rules and forms, and that such information is accumulated and communicated to the Company’s management, including the Company’s Co-Chief Executive Officers and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure. In designing and evaluating the disclosure controls and procedures, management recognized that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives, and management necessarily was required to apply its judgment in evaluating the cost-benefit relationship of possible controls and procedures.

The Company carried out an evaluation under the supervision and with the participation of management, including its Co-Chief Executive Officers and Chief Financial Officer, of the effectiveness of the design and operation of its disclosure controls and procedures as of May 2, 2004, the end of the period covered by this report. Based on that evaluation, the Company’s Co-Chief Executive Officers and Chief Financial Officer concluded that the Company’s disclosure controls and procedures were effective at the reasonable assurance level as of May 2, 2004.

There have been no changes in the Company’s internal control over financial reporting (as defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) during the quarter ended May 2, 2004 that materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.

PART II. OTHER INFORMATION

Item 1. Legal Proceedings

None

Item 2. Changes in Securities, Use of Proceeds and Issuer Purchases of Equity Securities

None

Item 3. Defaults upon Senior Securities

None

Item 4. Submission of Matters to a Vote of Security Holders

None

Item 5. Other Information

None

Item 6. Exhibits and Reports on Form 8-K

(a) Exhibits required by Item 601 of Regulation S-K.



31.1		Certification of Co-CEO pursuant to Section 302 of the Sarbanes-Oxley Act of 2002

31.2		Certification of Co-CEO pursuant to Section 302 of the Sarbanes-Oxley Act of 2002

31.3		Certification of CFO pursuant to Section 302 of the Sarbanes-Oxley Act of 2002

32.1		Certification Pursuant to 18 U.S.C. Section 1350, As Adopted Pursuant to Section 906 of The Sarbanes-Oxley Act of 2002 – Co-Chief Executive Officer

32.2		Certification Pursuant to 18 U.S.C. Section 1350, As Adopted Pursuant to Section 906 of The Sarbanes-Oxley Act of 2002 – Co-Chief Executive Officer

32.3		Certification Pursuant to 18 U.S.C. Section 1350, As Adopted Pursuant to Section 906 of The Sarbanes-Oxley Act of 2002 – Chief Financial Officer

(b) Reports on Form 8-K.

1. On June 8, 2004, the Company filed a Form 8-K with the Securities and Exchange Commission reporting that Richard Cohen was appointed as Chief Executive Officer.

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, thereunto duly authorized.

Date: June 15, 2004


ST. JOHN KNITS INTERNATIONAL, INCORPORATED (REGISTRANT)

By:		/s/ KELLY GRAY
		Kelly Gray
		Co-Chief Executive Officer

By:		/s/ BRUCE FETTER
		Bruce Fetter
		Co-Chief Executive Officer

By:		/S/ ROGER G. RUPPERT
		Roger G. Ruppert
		Executive Vice President-Finance and Chief Financial Officer (Principal Financial Officer and Principal Accounting Officer)

EXHIBIT INDEX


Exhibit Number		Description of Exhibit
31.1		Certification of Co-CEO pursuant to Section 302 of the Sarbanes-Oxley Act of 2002

31.2		Certification of Co-CEO pursuant to Section 302 of the Sarbanes-Oxley Act of 2002

31.3		Certification of CFO pursuant to Section 302 of the Sarbanes-Oxley Act of 2002

32.1		Certification Pursuant to 18 U.S.C. Section 1350, As Adopted Pursuant to Section 906 of The Sarbanes-Oxley Act of 2002 – Co-Chief Executive Officer

32.2		Certification Pursuant to 18 U.S.C. Section 1350, As Adopted Pursuant to Section 906 of The Sarbanes-Oxley Act of 2002 – Co-Chief Executive Officer

32.3		Certification Pursuant to 18 U.S.C. Section 1350, As Adopted Pursuant to Section 906 of The Sarbanes-Oxley Act of 2002 – Chief Financial Officer