NITCHES INC - Quarter Report: 2007 May (Form 10-Q)

     Valuation of Goodwill, Long-Lived Assets and Intangible Assets. We evaluate goodwill, long-lived assets and intangible assets for potential impairment on an annual basis during our fourth fiscal quarter, subsequent to the completion of financial projections for the following fiscal year. We may make an evaluation between annual tests in certain circumstances such as a significant change in business climate, unanticipated competition, loss of key personnel, or adverse action or assessment by a regulator such as import quotas or duties. Any of these circumstances could cause us to conclude that impairment exists and that the net book value of goodwill, long-lived assets and/or intangible assets is impaired. Any resulting impairment loss could have a material adverse impact on our financial condition and results of operations.

     Contingencies and Litigation. Our management evaluates contingent liabilities including threatened or pending litigation in accordance with SFAS No. 5, "Accounting for Contingencies" and records accruals when the outcome of these matters is deemed probably and the liability could be reasonably estimated.

Results of Operations

Nine Months Ended May 31, 2007 Compared to the Nine Months Ended May 31, 2006

     Net sales for the nine months ended May 31, 2007 were $69.2 million, an increase of $29.6 million or 74.6% as compared to the nine months ended May 31, 2006. This increase was attributable primarily to increased sales for our sleepwear, men's sportswear and women's private label apparel, as well as the inclusion of revenues associated with our home décor product line acquired in July 2006.

     Cost of goods sold for the nine months ended May 31, 2007 were $52.0 million compared to $28.0 for the same period a year ago. Cost of goods sold as a percent of net sales increased 4.5%, generating a lower gross profit margin of 24.8% for the nine months ended May 31, 2007, as compared to 29.3% for the year earlier period. The decrease in gross margin came as the result of increased private label sales and a high volume sale of branded product to a national retailer, both at a lower average gross margin. Our product mix constantly changes to reflect customer mix, fashion trends and changing seasons. Consequently, gross margin is likely to vary on a quarter-to-quarter basis and in comparison to gross margins generated in the same period of prior fiscal years.

     Selling, general and administrative expenses for the nine months ended May 31, 2007 were $16.0 million, an increase of $6.1 million as compared to the same period a year ago. The increase was due primarily to the consolidation of selling, general and administrative costs for Designer Intimates, Inc., which was acquired in October 2005, the home décor line which was acquired on July 1, 2006, and the Saguaro® assets which were acquired on October 24, 2006. Selling, general and administrative expenses for the period included $7.9 million of selling and merchandising expenses and $2.5 million of shipping and warehousing expenses. This compares with $4.2 million of selling and merchandising expenses and $1.4 of shipping and warehousing expenses incurred during the nine months ended May 31, 2006. Selling, general and administrative expenses as a percent of net sales decreased to 23.0% from 24.7% in the prior period, due to the inclusion of higher sales from Designer Intimates and the home décor line at a correspondingly lower selling, general and administrative expense rate.

     Interest expense in the current period was $752,000, an increase of $393,000 as compared to $359,000 for the nine months ended May 31, 2006. This increase was due primarily to increased advances under our factoring agreement and the inclusion of the interest expense for Designer Intimates for the full nine months of fiscal 2007. Interest expense was also impacted by higher interest rates charged on advances due to an increase in the prime lending rate from 7.75% at May 31, 2006 to 8.25% at May 31, 2007.

Three Months Ended May 31, 2007 Compared to the Three Months Ended May 31, 2006

     Net sales for the three months ended May 31, 2007 were $19.5 million, an increase of $6.9 million or 54.8% as compared to the three months ended May 31, 2006. This increase was primarily attributable to additional unit sales of our menswear product lines and the inclusion of sales of our home décor product line.

     Cost of goods sold for the three months ended May 31, 2007 were $14.7 million compared to $8.9 for the same period a year ago. Cost of goods sold as a percent of net sales increased 4.8%, generating a lower gross profit margin of 24.6% for the three months ended May 31, 2007 as compared to 29.4% for the year earlier period. The decrease in gross margin came primarily as the result of a higher cost of sales in our women's sleepwear and men's sportswear lines. Our product mix constantly changes to reflect customer mix, fashion trends and changing seasons. Consequently, gross margin is likely to vary on a quarter-to-quarter basis and in comparison to gross margins generated in the same period of prior fiscal years.

     Selling, general and administrative expenses for the three months ended May 31, 2007 were $5.3 million, an increase of $1.8 million as compared to a year ago. The increase was due in part to supporting additional sales made in the period, as well as additional operating costs incurred as a result of our acquisitions of the home décor line on July 1, 2006, and the Saguaro® assets which were acquired on October 24, 2006. Selling, general and administrative expenses for the period included $2.5 million of selling and merchandising expenses and $1.0 million of shipping and warehousing expenses. This compares with $1.4 million of selling and merchandising expenses and $500,000 of shipping and warehousing expenses incurred during the three months ended May 31, 2006. Selling, general and administrative expenses as a percent of net sales decreased to 27.1% from 27.9% in the prior period, due to higher sales in the current period at a lower expense rate, offset in part by the additional home décor and Saguaro expenses previously noted.

     Interest expense was $206,000 in the current period, an increase of $70,000 as compared to $136,000 for the three months ended May 31, 2006. This increase was due to higher interest rates charged on increased advances under our factoring agreement as a result of our increased working capital requirements. Interest expense was also impacted by higher interest rates charged on advances due to an increase in the prime lending rate from 7.75% at May 31, 2006 to 8.25% at May 31, 2007.

Liquidity and Capital Resources

     Working capital at May 31, 2007 was $5.6 million, an increase of $1.9 million from $3.6 million at August 31, 2006. Our current ratio increased to 1.35:1 at May 31, 2007 from 1.17:1 at August 31, 2006. This slight increase resulted primarily from a reduction in current liabilities partially offset by a reduction in inventories.

     Net cash used by operating activities for the nine month period ended May 31, 2007 was approximately $946,000. The increase in cash used by operating activities during the period was primarily the result of a decrease in net income and accounts payable and an increase in accounts receivable, offset by a decrease in inventory.

     Net cash used by investing activities for the nine month period ended May 31, 2007 was $50,000 in capital expenditures.

     Net cash provided by financing activities for the nine month period ended May 31, 2007 was approximately $1.1 million, which was attributable to Sojitz's investment of $1.5 million and advances from CIT in accordance with the terms of the factoring agreement, offset by the repayment of notes payable.

     Subsequent to the end of the quarter, on June 21, 2007 we sold $3.15 million of 12.0% Subordinated Convertible Debentures and Common Stock Purchase Warrants to purchase up to 577,500 shares of our common stock, resulting in net proceeds to us of $2.95 million, after deduction of fees and expenses.

     We sell substantially all of our trade receivables to CIT on a pre-approved, non-recourse basis. We attempt to make any recourse shipments on a cash-on-delivery basis or ensure that the customers' payments are backed by a commercial or standby letter of credit issued by the customers' bank. The amount of our receivables that were non-recourse at May 31, 2007 was $13.6 million. The amount of our receivables that were recourse and were not made on a COD basis or supported by commercial or standby letters of credit at May 31, 2007 was approximately $655,000, of which approximately $264,000 had been collected through June 30, 2007.

     Payment for non-recourse factored receivables is made at the time customers make payment to CIT or, if a customer is financially unable to make payment, within approximately 180 days of the invoice due date. Under the factoring agreement, we can request advances in anticipation of customer collections at the prime rate (currently 8.25%) less one and one-half percent (1.5%). The amount of advances available to us is limited to eighty-five percent (85%) of non-recourse factored receivables and fifty percent (50%) of eligible finished goods inventory.

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     We may issue import letters of credit through CIT for the purchase of inventory in the normal course of our operations. Letters of credit are subject to a $12.0 million aggregate limit. At May 31, 2007, we had outstanding letters of credit of approximately $3.1 million for the purchase of finished goods, which had been opened through CIT.

     The factoring agreement does not contain any financial covenants to which we must adhere. Advances are collateralized by all of our assets as well as a personal guaranty of our chairman, who also serves as our chief executive officer and chief financial officer. CIT can terminate the factoring agreement on 30-days written notice. We believe the factoring agreement with CIT, along with our expected cash flow from operating activities and our current levels of working capital are adequate to fulfill our liquidity needs for the foreseeable future.

Contractual Obligations and Commercial Commitments

     As of May 31, 2007, we had no off-balance sheet arrangements. The following summarizes our contractual obligations at May 31, 2007 and the effect those obligations are expected to have on our liquidity and cash flow in future periods:

	Payments due/Commitments expiring per period
	Total Amounts			Less than										Over
	Committed			1 year			1-3 years			4-5 years				5 years
Operating leases	$	5,829,000		$	813,000		$	1,766,000		$	1,089,000			$	2,161,000
Employment agreement		728,000			190,000			538,000			-
Letters of credit		3,091,000			3,091,000			-			-				-
Guarantees		3,000,000			-			-			3,000,000	*			-
Total obligations and commitments	$	12,648,000		$	4,094,000		$	2,304,000		$	4,089,000			$	2,161,000

*

Guarantee of Nitches under separate Designer Intimates, Inc. factoring agreement with CIT, due on demand

Inventory

     Our inventory decreased 43.7% to $7.0 million at May 31, 2007, from $12.4 million at August 31, 2006, in line with lower order backlog for the fourth quarter of fiscal 2007 as compared to the first quarter of fiscal 2007. Compared to inventories of $6.4 million at May 31, 2006, inventories ending the current period increased 9.4%, in line with the comparative increase in customer orders and the inclusion of home décor inventory at the end of the current period. We believe that our current inventory mix and unit levels are appropriate to respond to anticipated market demand.

     In our ordinary course of operations, we generally make some sales below normal selling prices or below cost. Based on prior experience, our management believes this will be true for some inventory held on or acquired after May 31, 2007. The amount of such sales depends on several factors, including general economic conditions, market conditions within the apparel industry, the desirability of the styles held in inventory and competitive pressures from other garment suppliers.

     We have established an inventory markdown reserve as of May 31, 2007, which our management believes will be sufficient for current inventory that is expected to sell below cost in the future. There can be no assurance that we will realize our expected selling prices, or that the inventory markdown reserve will be adequate, for items in inventory as of May 31, 2007 for which customer sales orders have not yet been received. The inventory markdown reserve is calculated based on specific identification of aged goods and styles that are slow-moving or selling off-price.

Backlog

     As of May 31, 2007, we had on-hand unfilled customer orders of $45.2 million as compared to $38.8 million at May 31, 2006, with such orders generally scheduled for delivery by November 2007 and 2006, respectively. The increase in backlog is due primarily to the inclusion of the home décor product line order backlog, an increase in orders for our branded women's sleepwear and branded men's sportswear lines, and earlier receipt of private label women's sportswear orders.

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     Backlog amounts include both confirmed and unconfirmed orders that we believe, based on industry practice and past experience, will be confirmed. While cancellations, rejections and returns have generally not been material in the past, there can be no assurance that cancellations, rejections and returns will not reduce the amount of sales realized from the backlog of orders at May 31, 2007. Because of our reliance upon a few major accounts, any deteriorating financial performance by one or more of these customers could lead to the cancellation of existing orders and/or an inability to secure future orders, which would have a material adverse financial effect on us.

Impact of Exchange Rates

     While we purchase over 98% of our products from foreign manufacturers, all of our purchases are denominated in United States dollars. Because our products are sold primarily in the United States, in United States dollar denominated transactions, we do not engage in hedging or other arbitrage to reduce currency risk. An increase in the value of the United States dollar versus foreign currencies could enhance our purchasing power for new purchase orders and reduce our cost of goods sold. Conversely, a decrease in the value of the United States dollar relative to foreign currencies could result in an increase in both our cost of manufacturing for new purchase orders and costs of goods sold.

Impact of Inflation and Deflation

     Our management does not believe that inflation has had any material impact upon our revenues or income from operations in the current period. Our management believes that the apparel sector in which we operate has been in a period of deflation, contrary to the modest inflation experienced in the economy in general. The persistence of the consumer to buy "on sale" merchandise has put pressure on retail gross margins, which in turn has led to downward pressure from retailers on wholesale gross margins, in the form of selling cost adjustments taken as deductions against invoices issued by us. In the apparel industry, these are commonly referred to as markdown allowances or chargebacks. Without a corresponding decrease in fabric and labor prices, these markdown allowances have led to a decline in wholesale gross margins. Our management believes these modest deflationary pressures will persist into the foreseeable future.

Future Operating Results

     Business conditions in the apparel sector continue to be characterized by limited consumer demand and persistent discounting of merchandise by retailers. The propensity of consumers to seek "on sale" merchandise has sustained the use of significant discounting by most retailers to stimulate sales. In general, retailers have to sell more units in order to achieve sales equal to last year. We do not expect significant improvement in business conditions in the apparel sector in which we operate. Furthermore, we expect to incur significant expense related to internal controls documentation, testing and remediation requirements as mandated by Sarbanes-Oxley legislation with which we must be in compliance by August 31, 2008. In view of the market uncertainties and economic pressures facing us, our management remains conservative in its approach to the remainder of fiscal 2007 and planning for fiscal 2008.

Forward Looking Information and Factors that May Affect Future Results

     Our disclosure and analysis in this report contains forward-looking information about our financial results and estimates, business prospects that involve substantial risks and uncertainties. From time to time, we also may provide oral or written forward-looking statements in other materials we release to the public. Forward-looking statements give our current expectations or forecasts of future events. You can identify these statements by the fact that they do not relate strictly to historic or current facts. They use words such as "anticipate," "estimate," "expect," "project," "intend," "plan," "believe," "target," "forecast" and other words and terms of similar meaning in connection with any discussion of future operating or financial performance. In particular, these include statements relating to future actions, future performance, new products and product categories, the outcome of contingencies, such as legal proceedings, and financial results. Among the factors that could cause actual results to differ materially are the following:

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• our ability to:

		o		achieve solid, sustainable revenue growth;
		o		maintain and enhance our product line;
		o		successfully introduce new products and product categories;
		o		successfully integrate acquisitions, including the acquisition of Designer Intimates, Inc., the home décor product line of Taresha LLC and the Saguaro® mark and related trademarks from Impex Inc.;
		o		cost effectively acquire and retain customers;
		o		compete against existing and new competitors;
		o		manage expenses associated with necessary general and administrative investments;
		o		cost efficiently manage inventories; and
		o		grow our revenues and leverage our operating infrastructure to enhance profitability;

• general consumer sentiment and economic conditions that may affect levels of discretionary customer purchases of our products; and
• competition from existing and potential new competitors, including pricing pressures and other competitive forces.
  
  

     We cannot guarantee that any forward-looking statement will be realized, although we believe we have been prudent in our plans and assumptions. Achievement of future results is subject to risks, uncertainties and inaccurate assumptions. Should known or unknown risks or uncertainties materialize, or should underlying assumptions prove inaccurate, actual results could vary materially from past results and those anticipated, estimated or projected. Investors should bear this in mind as they consider forward-looking statements.

     We undertake no obligation to publicly update forward-looking statements, whether as a result of new information, future events or otherwise. You are advised, however, to consult any further disclosures we make on related subjects in our Forms 10-Q, 8-K and 10-K reports filed with the SEC. Our Annual Report on Form 10-K filing for the fiscal year ended August 31, 2006 listed various important factors that could cause actual results to differ materially from expected and historic results. We note these factors for investors as permitted by the Private Securities Litigation Reform Act of 1995. Readers can find them in Part I, Item 1A, of that filing under the heading "Risk Factors." We incorporate that section of that Form 10-K in this filing and investors should refer to it. You should understand that it is not possible to predict or identify all such factors. Consequently, you should not consider any such list to be a complete set of all potential risks or uncertainties.

ITEM 3. Quantitative and Qualitative Disclosures about Market Risk

     Market risk represents the potential impact to our financial position, results of operations or cash flows due to adverse changes in the financial markets. We are exposed to market risk from changes in the base interest rate of our variable rate debt. As of August 31, 2006, a one percent change in interest rates would increase or decrease our annual interest expense by approximately $82,000. There has been no material changes in market risk exposures from those disclosed in our Annual Report on Form 10-K for the fiscal year ended August 31, 2006.

ITEM 4. Controls and Procedures

     (a) Disclosure Controls and Procedures. Disclosure controls and procedures are controls and other procedures that are designed to ensure that information required to be disclosed in our reports filed pursuant to the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the SEC's rules and forms and that such information is accumulated and communicated to our management, including our chief executive officer and chief financial officer, as appropriate, to allow for timely decisions regarding required disclosure.

     Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within our company have been detected. The design of any system of controls is based in part upon a cost-benefit analysis and certain assumptions about the likelihood of future events, and any design may not succeed in achieving its stated goals under all potential future conditions. While our management does not believe that our controls will prevent all errors or all instances of fraud, our disclosure controls and procedures are designed to provide a reasonable assurance of achieving their objectives.

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     As required by SEC Rule 13a-15(b), we carried out an evaluation, under the supervision and with the participation of our management, including our chief executive and financial officer, of the effectiveness of the design and operation of our disclosure controls and procedures as of May 31, 2007, the end of the period covered by this report. Based on that evaluation, our chief executive officer and chief financial officer concluded that our disclosure controls and procedures were effective at the reasonable assurance level as of May 31, 2007.

     (b) Changes In Internal Controls Over Financial Reporting. We made changes in our internal control over financial reporting (as defined in Rules 13a-15(f) and 15d-15(f) of the Exchange Act) during our most recent fiscal quarter that has materially affected, or is likely to materially affect, our internal control over financial reporting. Effective April 1, 2007, we experienced a change in accounting personnel. Our controller resigned for personal reasons and was replaced. We have retained a consultant to perform those functions.

PART II - OTHER INFORMATION

ITEM 1A. Risk Factors

     There have been no material changes from the risk factors disclosed in Part 1, Item 1A, of our Annual Report on Form 10-K for the fiscal year ended August 31, 2006.

ITEM 6. Exhibits

Exhibit No.		Description
4.1		Securities Purchase Agreement between Nitches, Inc. and the signatories thereto dated June 21, 2007 (1)
4.2		Form of 12% Convertible Subordinated Debenture (1)
4.3		Form of Common Stock Purchase Warrant (1)
4.4		Registration Rights Agreement between Nitches, Inc. and the signatories thereto dated June 21, 2007 (1)
10.1		Stock Purchase Agreement between Nitches, Inc. and Sojitz Corporation dated April 23, 2007 (2)
31.1		Certification pursuant to Rule 13a-14(a)/15d-14(a) of the Securities Exchange Act of 1934, as amended, by Chief Executive Officer and Chief Financial Officer
32.1		Certification pursuant to 18 U.S.C. §1350 by Chief Executive Officer and Chief Financial Officer

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(1) Incorporated by reference to the registrant's Current Report on Form 8-K filed on April 25, 2007
(2) Incorporated by reference to the registrants Current Report on Form 8-K filed on June 21, 2007

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SIGNATURES

     Pursuant to the requirement of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned there unto duly authorized.

		NITCHES, INC.
		(Registrant)
July 23, 2007	By:	/s/ Steven P. Wyandt
		Steven P. Wyandt
		As Principal Financial Officer and on behalf of
		the Registrant

EXHIBIT INDEX

Exhibit No.		Description
4.1		Securities Purchase Agreement between Nitches, Inc. and the signatories thereto dated June 21, 2007 (1)
4.2		Form of 12% Convertible Subordinated Debenture (1)
4.3		Form of Common Stock Purchase Warrant (1)
4.4		Registration Rights Agreement between Nitches, Inc. and the signatories thereto dated June 21, 2007 (1)
10.1		Stock Purchase Agreement between Nitches, Inc. and Sojitz Corporation dated April 23, 2007 (2)
31.1		Certification pursuant to Rule 13a-14(a)/15d-14(a) of the Securities Exchange Act of 1934, as amended, by Chief Executive Officer and Chief Financial Officer
32.1		Certification pursuant to 18 U.S.C. §1350 by Chief Executive Officer and Chief Financial Officer

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(1) Incorporated by reference to the registrant's Current Report on Form 8-K filed on April 25, 2007
(2) Incorporated by reference to the registrants Current Report on Form 8-K filed on June 21, 2007

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