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SECURITIES AND EXCHANGE COMMISSION WASHINGTON, DC 20549
 FORM 10-Q (Mark One) x     Quarterly report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 o     For the quarterly period ended March 27, 2004 x     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     001-31309 PHOENIX FOOTWEAR GROUP, INC. 
  Delaware
    
    15-0327010(State or Other Jurisdiction of
Incorporation or Organization)
    
    (IRS Employer
Identification No.)5759 Fleet Street, Suite 220, Carlsbad, California
    
    92008(Address of Principal Executive Offices)
    
    (Zip Code)
 (760) 602-9688 
     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     o Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act). Yes     o          No     x Indicate the number of shares outstanding of each of the issuers classes
of common stock, as of the latest practicable date. CLASS
Common, $0.01 par value
    
    OUTSTANDING AT APRIL 29, 2004
5,098,297




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PHOENIX FOOTWEAR GROUP, INC.
QUARTERLY REPORT ON FORM 10-Q TABLE OF CONTENTS PagePART I     FINANCIAL INFORMATIONItem 1. Financial Statements and Notes to Financial
Statements
Consolidated Condensed Balance Sheets as of March 27, 2004 (unaudited) and
December 27, 2003
    
    
    3Consolidated Condensed Statements of Operations for the Three Months Ended
March 27, 2004 and March 29, 2003 (unaudited)
    
    
    4Consolidated Condensed Statements of Cash Flows for the Three Months
Ended March 27, 2004 and March 29, 2003 (unaudited)
    
    
    5Notes to Consolidated Condensed Financial Statements
    
    
    6Item 2. Managements Discussion and Analysis of Financial Condition and Results of Operations
    
    
    10Item 3. Quantitative and Qualitative Disclosures About Market Risk
    
    
    15Item 4. Controls and Procedures
    
    
    15PART II     OTHER INFORMATIONItem 1. Legal Proceedings
    
    
    16Item 2. Changes in Securities and Use of Proceeds
    
    
    16Item 3. Defaults Upon Senior Securities
    
    
    16Item 4. Submission of Matters to a Vote of Security Holders
    
    
    16Item 5. Other Information
    
    
    16Item 6. Exhibits and Reports on Form 8-K
    
    
    16EXHIBIT 31.1EXHIBIT 31.2EXHIBIT 32.1
 2




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PART I: FINANCIAL INFORMATION Item 1. Consolidated Condensed Financial Statements 
 PHOENIX FOOTWEAR GROUP, INC.
CONSOLIDATED CONDENSED BALANCE SHEETS March 27,
    
    December 27,2004
    
    2003(Unaudited)ASSETSCURRENT ASSETS:Cash
    
    $
    
    
    
    $
    1,058,000Accounts receivable (less allowances of $868,000 in 2004 and $1,026,000 in 2003)
    
    
    14,755,000
    
    
    
    8,083,000Inventoriesnet
    
    
    11,969,000
    
    
    
    12,717,000Other receivable
    
    
    695,000
    
    
    
    530,000Other current assets
    
    
    1,556,000
    
    
    
    803,000Total current assets
    
    
    28,975,000
    
    
    
    23,191,000PLANT AND EQUIPMENTNet
    
    
    1,964,000
    
    
    
    1,623,000OTHER ASSETS:Other assetsnet
    
    
    72,000
    
    
    
    115,000Goodwill
    
    
    5,232,000
    
    
    
    5,178,000Unamortizable intangibles
    
    
    3,820,000
    
    
    
    3,820,000Intangible assets, net
    
    
    1,715,000
    
    
    
    1,766,000Other receivable
    
    
    189,000
    
    
    
    718,000Total other assets
    
    
    11,028,000
    
    
    
    11,597,000TOTAL ASSETS
    
    $
    41,967,000
    
    
    $
    36,411,000LIABILITIES AND STOCKHOLDERS EQUITYCURRENT LIABILITIES:Accounts payable
    
    $
    5,590,000
    
    
    $
    4,782,000Accrued expenses
    
    
    1,247,000
    
    
    
    1,077,000Contingent liability
    
    
    1,942,000
    
    
    
    1,942,000Notes payablecurrent
    
    
    1,661,000
    
    
    
    1,661,000Deferred income tax
    
    
    195,000
    
    
    
    195,000Income taxes payable
    
    
    742,000
    
    
    
    111,000Total current liabilities
    
    
    11,377,000
    
    
    
    9,768,000OTHER LIABILITIES:Notes payablenoncurrent
    
    
    4,713,000
    
    
    
    4,941,000Note payable, line of credit
    
    
    7,580,000
    
    
    
    5,480,000Deferred income tax liability
    
    
    1,235,000
    
    
    
    1,235,000Total other liabilities
    
    
    13,528,000
    
    
    
    11,656,000Total liabilities
    
    
    24,905,000
    
    
    
    21,424,000STOCKHOLDERS EQUITY:Common stock, $.01 par value50,000,000 shares authorized; 5,098,000 and 5,061,000 shares
issued in 2004 and 2003, respectively
    
    
    51,000
    
    
    
    51,000Additional paid-in-capital
    
    
    11,835,000
    
    
    
    11,190,000Retained earnings
    
    
    6,556,000
    
    
    
    5,320,00018,442,000
    
    
    
    16,561,000Less: Treasury stock at cost, 500,000 and 603,000 shares in 2004 and 2003, respectively
    
    
    (1,380,000
    )
    
    
    (1,574,000
    )Total stockholders
equity
    
    
    17,062,000
    
    
    
    14,987,000TOTAL LIABILITIES AND STOCKHOLDERS EQUITY
    
    $
    41,967,000
    
    
    $
    36,411,000
 See notes to consolidated condensed financial statements. 3




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PHOENIX FOOTWEAR GROUP, INC.
CONSOLIDATED CONDENSED STATEMENTS OF OPERATIONS
(Unaudited)

Three Months EndedMarch 27,
    
    March 29,2004
    
    2003NET SALES
    
    $
    18,638,000
    
    
    $
    9,207,000COST OF GOODS SOLD
    
    
    10,492,000
    
    
    
    5,187,000GROSS PROFIT
    
    
    8,146,000
    
    
    
    4,020,000OPERATING EXPENSES:Selling, general and administrative expenses
    
    
    5,811,000
    
    
    
    2,853,000Other expensenet
    
    
    34,000
    
    
    
    476,000Total operating expenses
    
    
    5,845,000
    
    
    
    3,329,000OPERATING INCOME
    
    
    2,301,000
    
    
    
    691,000INTEREST EXPENSE
    
    
    170,000
    
    
    
    66,000EARNINGS BEFORE INCOME TAXES
    
    
    2,131,000
    
    
    
    625,000INCOME TAX PROVISION
    
    
    895,000
    
    
    
    250,000NET EARNINGS
    
    $
    1,236,000
    
    
    $
    375,000NET EARNINGS
PER SHARE (Note 2)Basic
    
    $
    0.27
    
    
    $
    0.10Diluted
    
    $
    0.24
    
    
    $
    0.10SHARES OUTSTANDING:Basic
    
    
    4,533,466
    
    
    
    3,666,188Diluted
    
    
    5,108,598
    
    
    
    3,863,136


See notes to consolidated condensed financial statements.

4




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PHOENIX FOOTWEAR GROUP, INC.
CONSOLIDATED CONDENSED STATEMENTS OF CASH FLOWS
(Unaudited) Three Months EndedMarch 27,
    
    March 29,2004
    
    2003CASH FLOWS FROM OPERATING ACTIVITIES:Net earnings
    
    $
    1,236,000
    
    
    $
    375,000Adjustments to reconcile net earnings to net cash used
by operating activities:Depreciation and amortization
    
    
    164,000
    
    
    
    48,000Allocation of shares in defined contribution plan
    
    
    854,000
    
    
    
    402,000Loss on sale of property and equipment
    
    
    
    
    
    
    8,000Changes in assets and liabilities:(Increase) decrease in:Accounts receivable  net
    
    
    (6,672,000
    )
    
    
    (1,486,000
    )Inventories  net
    
    
    748,000
    
    
    
    (1,211,000
    )Other current receivable
    
    
    (165,000
    )
    
    
    (229,000
    )Other current assets
    
    
    (753,000
    )
    
    
    (601,000
    )Other noncurrent assets
    
    
    571,000
    
    
    
    542,000Increase (decrease) in:Accounts payable
    
    
    544,000
    
    
    
    1,414,000Accrued expenses
    
    
    116,000
    
    
    
    (12,000
    )Income taxes payable
    
    
    631,000
    
    
    
    159,000Net cash used by operating activities
    
    
    (2,726,000
    )
    
    
    (591,000
    )CASH FLOWS FROM INVESTING ACTIVITIES:Purchases of equipment
    
    
    (454,000
    )
    
    
    (39,000
    )Proceeds from disposal of property and equipment
    
    
    
    
    
    
    457,000Net cash provided (used) by investing activities
    
    
    (454,000
    )
    
    
    418,000CASH FLOWS FROM FINANCING ACTIVITIES:Net
borrowings on note payableline of credit
    
    
    2,100,000
    
    
    
    Repayments of notes payable
    
    
    (228,000
    )
    
    
    Bank overdraft
    
    
    265,000
    
    
    
    Issuance of common stock
    
    
    85,000
    
    
    
    52,000Purchases of treasury stock
    
    
    (100,000
    )
    
    
    (129,000
    )Net cash provided (used) by financing activities
    
    
    2,122,000
    
    
    
    (77,000
    )NET DECREASE IN CASH
    
    
    (1,058,000
    )
    
    
    (250,000
    )CASHBeginning of period
    
    
    1,058,000
    
    
    
    1,265,000CASHEnd of period
    
    $
    
    
    
    $
    1,015,000SUPPLEMENTAL
CASH FLOW INFORMATION Cash paid
during the period for:Interest
    
    $
    169,000
    
    
    $
    43,000Income taxes
    
    $
    264,000
    
    
    $
    45,000
 See notes to consolidated condensed financial statements. 5




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PHOENIX FOOTWEAR GROUP, INC.
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS Description of Business and Summary of Significant Accounting Policies 1. Basis of Presentation The accompanying unaudited consolidated condensed financial statements of
Phoenix Footwear Group, Inc. (the Company) have been prepared in accordance
with generally accepted accounting principles for interim financial information
and with the instructions to Form 10-Q and Article 10 of Regulation S-X.
Accordingly, they do not include all of the information and notes required by
generally accepted accounting principles for complete financial statements. In
the opinion of management, all adjustments which are of a normal recurring
nature, necessary for fair presentation have been included in the accompanying
financial statements. These financial statements should be read in conjunction
with the consolidated financial statements and notes included in the Companys
Annual Report on Form 10-K filed with the Securities and Exchange Commission
for the fiscal year ended December 27, 2003. The results of operations for the
three months ended March 27, 2004, or for any other interim period, are not
necessarily indicative of the results that may be expected for the full year. On May 22, 2003, the Board of Directors authorized a two-for-one stock split
which became effective on June 12, 2003. All references in these consolidated
financial statements and notes related to numbers of shares and per share
amounts have been restated to reflect the effect of the stock split. Principles of Consolidation The consolidated financial statements consist of Phoenix Footwear Group, Inc.
and its wholly owned subsidiaries, Penobscot Shoe Company (Penobscot), H.S.
Trask & Co (Trask) and Royal Robbins, Inc. (Robbins). Intercompany
accounts and transactions have been eliminated in consolidation. Accounting Period Effective January 1, 2003, the Company changed its year-end to a fiscal year
that is the 52- or 53-week period ending the Saturday nearest to December 31st.
The first quarter consisted of the 13 weeks ended March 27, 2004. 2.     Goodwill and Intangible
Assets Effective January 1, 2002, the Company adopted SFAS
No. 142, Goodwill and Other Intangible Assets.
As a result of adopting SFAS No. 142, the Companys
goodwill and certain intangible assets are no longer amortized,
but are subject to an annual impairment test. The following sets
forth the intangible assets by major asset class: March 27, 2004
    
    December 27, 2003UsefulLife
    
    
    
    Accumulated
    
    Net Book
    
    
    
    Accumulated
    
    Net Book(Years)
    
    Gross
    
    Amortization
    
    Value
    
    Gross
    
    Amortization
    
    ValueNon-amortizing:Trademarks and tradenames (1)
    
    
    
    
    
    $
    3,820,000
    
    
    $
    
    
    
    $
    3,820,000
    
    
    $
    3,820,000
    
    
    $
    
    
    
    $
    3,820,000Amortizing:Customer lists(2)
    
    
    5-13
    
    
    
    1,513,000
    
    
    
    78,000
    
    
    
    1,435,000
    
    
    
    1,513,000
    
    
    
    43,000
    
    
    
    1,470,000Other(3)
    
    
    2-5
    
    
    
    311,000
    
    
    
    31,000
    
    
    
    280,000
    
    
    
    311,000
    
    
    
    15,000
    
    
    
    296,000Total intangible assets
    
    
    
    
    
    $
    1,824,000
    
    
    $
    109,000
    
    
    $
    1,715,000
    
    
    $
    1,824,000
    
    
    $
    58,000
    
    
    $
    1,766,000    (1)
    Acquired through acquisition transactions.(2)
    The gross balance of
customer lists acquired during fiscal 2003 business acquisition
transactions was $1.5 million as of March 27, 2004 and
December 27, 2003, respectively. The accumulated amortization at March 27, 2004 and December 27, 2003, was
    $78,000 and
    $43,000,
    respectively.(3)
    The gross balance of other intangibles acquired during fiscal
2003 business acquisition
    transactions was
    $311,000 as of March 27, 2004 and December 27, 2003, respectively. The accumulated amortization balance
at March 27, 2004 and
    December 27, 2003 was
    $31,000 and
    $15,000,
    respectively. 6




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Intangible assets with definite lives are amortized using the
straight-line method over periods ranging from 2 to 13 years.
During the quarter ended March 27, 2004 and March 29,
2003, aggregate amortization expense
was approximately $51,000 and $-0-, respectively. Amortization expense
related to intangible assets at March 27, 2004 in each of the next five
fiscal years and
beyond is expected to be incurred as follows: Remainder of 2004
    
    $
    155,0002005
    
    
    205,0002006
    
    
    196,0002007
    
    
    196,0002008
    
    
    181,0002009
    
    
    129,000Thereafter
    
    
    653,000$
    1,715,000 Changes in goodwill during the quarter ended March 27, 2004
related to additional professional fees incurred in connection
with our fiscal 2003 acquisitions. 3. Accounts Payable. Accounts payable at March 27, 2004 includes a cash overdraft amount of $265,000. 4. Stock-Based Compensation The Company has elected to
follow Accounting Principles Board (APB) Opinion No. 25,
Accounting for Stock Issued to Employees, and related
interpretations, in accounting for its stock-based compensation.
Under APB Opinion No. 25, compensation expense is recognized
when the market price of the stock underlying an award on the date of
grant exceeds any related exercise price. No employee stock-based compensation expense was
recorded for the quarters ended March 27, 2004 and
March 29, 2003. Pro forma information
regarding net earnings and earnings per share is required by SFAS
No. 123, and SFAS No. 148 are as follows: Three Months EndedMarch 27,
    
    March 29,2004
    
    2003Net earnings, as reported
    
    $
    1,236,000
    
    
    $
    375,000Deduct: Total stock-based employee compensation
    expense determined under fair value based method for all awards,
    net of related tax effects
    
    
    (582,000
    )
    
    
    (112,000
    )Pro forma net earnings
    
    $
    654,000
    
    
    $
    263,000Earnings per common share:Basic  as reported
    
    $
    0.27
    
    
    $
    0.10Basic  pro forma
    
    $
    0.14
    
    
    $
    0.07Diluted  as reported
    
    $
    0.24
    
    
    $
    0.10Diluted  pro forma
    
    $
    0.13
    
    
    $
    0.07 The pro forma amounts reflected above may not be
representative of future disclosures since the estimated fair
value of stock options is amortized to expense as the options
vest and additional options may be granted in future years. The
weighted average fair value of the stock options granted was $4.82
and $2.05 for the quarters ended March 27, 2004 and
March 29, 2003, respectively. The fair value of employee
stock options was estimated at the date of grant using the
Black-Scholes option-pricing model with the following
assumptions: Three Months EndedMarch 27,
    
    March 29,2004
    
    2003Dividend yield
    
    
    0%
    
    
    
    0%Expected volatility
    
    
    43.5%
    
    
    
    43.4%Risk free interest rates
    
    
    3.91%
    
    
    
    4.47%Expected lives
    
    
    9.6 years
    
    
    
    9.1 years The Black-Scholes option valuation model was
developed for use in estimating the fair value of traded options
which have no vesting restrictions and are fully transferable.
In addition, option valuation models require the input of highly
subjective assumptions including the expected stock price
volatility. Because the Companys employee stock options
have characteristics significantly different from those of
traded options, and because changes in subjective input
assumptions can materially affect the fair value estimates, in
managements opinion, the existing models do not
necessarily provide a reliable single measure of the fair value
of grants under the Companys employee stock-based
compensation plans. 5. Per Share Data In addition to shares outstanding held by the public, the Companys defined
contribution 401(k) savings plan held approximately 500,000 shares as of March
27, 2004, which were issued during 2001 in connection with the termination of
the Companys defined benefit pension plan. These shares, while eligible to
vote, are classified as treasury stock and therefore are not outstanding for
purpose of determining per share earnings until the time that such shares are
allocated to employee accounts. This allocation is occurring over a seven-year
period which commenced in 2002. During the first quarter of 2004, approximately
114,000 shares were allocated to the defined contribution 401(k) savings plan.
Basic net earnings per share is computed by dividing net earnings by the
weighted average number of common shares outstanding for the period. Diluted
net earnings per share is calculated by dividing net earnings and the effect of
assumed conversions by the weighted average number of common and, when
applicable, potential common shares outstanding during the period. A
reconciliation of the numerators and denominators of basic and diluted income
per share is presented below. 7




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Three Months EndedMarch 27,
    
    March 29,2004
    
    2003Basic net earnings per share:Net earnings
    
    $
    1,236,000
    
    
    $
    375,000Weighted average common shares outstanding
    
    
    4,533,466
    
    
    
    3,666,188Basic net earnings per share
    
    $
    0.27
    
    
    $
    0.10Diluted net earnings per share:Net earnings
    
    $
    1,236,000
    
    
    $
    375,000Weighted average common shares outstanding
    
    
    4,533,466
    
    
    
    3,666,188Effect of stock options outstanding
    
    
    575,132
    
    
    
    196,948Weighted average common and potential common shares outstanding
    
    
    5,108,598
    
    
    
    3,863,136Diluted net earnings per share
    
    $
    0.24
    
    
    $
    0.10
 6. Debt The Company has a loan agreement which consists of a revolving line of credit
(revolver) and a term loan facility in the amount of $6.8 million. Under the
terms of the agreement, the borrowing base for the revolver is based on certain
balances of accounts receivable and inventory, as defined in the agreement. As
of March 27, 2004 the maximum credit amount under the revolver is $15.0 million
during the months of June through the following January and $18.0 million
during the months of February through the following May, reduced by a $2.0
million amortized term loan and outstanding letters of credit. The revolver
expires on May 1, 2005 and has an interest rate of LIBOR plus 275 basis points
(LIBOR with a 90 day maturity was 1.11% on March 27, 2004) or the prime rate
plus .25% (prime was 4.0% at March 27, 2004). Effective June 30, 2004, the
interest rate ranges from LIBOR plus 175 to 300 basis points depending on the
level of the Companys debt to earnings ratio. The revolver is secured by
accounts receivable, inventory and equipment. The term loans, which are
subject to similar interest rate changes as the revolver, are payable through
2008 and are also secured by account receivables, inventory and
equipment. The term loans bear interest at a rate as selected by us,
equal to LIBOR plus 300 basis points, or prime rate plus .375%. Long-term debt as of March 27, 2004 and December 27, 2003 consisted of the
following: 2004
    
    2003Revolving line of credit to bank;
secured by accounts receivable,
inventory and equipment; interest
due monthly at LIBOR plus 275 basis
points
    
    $
    7,000,000
    
    
    $
    5,000,000Revolving line of credit to bank;
secured by accounts receivable,
inventory and equipment; interest
due monthly at Prime plus .25%
    
    
    580,000
    
    
    
    480,000Term loan payable to bank in annual
installments of $750,000 through
2006, interest due monthly at LIBOR
plus 300 basis points
    
    
    2,250,000
    
    
    
    2,250,000Term loan payable to bank in
quarterly installments of $150,000
through 2008, interest due monthly
at LIBOR plus 300 basis points
    
    
    2,700,000
    
    
    
    2,850,000Term loan payable to bank in
monthly installments of $25,000
through 2008, interest due monthly
at LIBOR plus 300 basis points
    
    
    1,400,000
    
    
    
    1,475,000Note payable to financial
institution; collateralized by
vehicle; interest at 0%; principal
payable $493 monthly; remaining
principal balance due July 2007
    
    
    20,000
    
    
    
    21,000Note payable to financial
institution; collateralized by
vehicle; interest at 4.9%;
principal payable $574 monthly;
remaining principal balance due May
2004
    
    
    2,000
    
    
    
    3,000Note payable to financial
institution; collateralized by
vehicle; interest at 6.9%;
principal payable $551 monthly;
remaining principal balance due May
2004
    
    
    2,000
    
    
    
    3,00013,954,000
    
    
    
    12,082,000Less: current portion
    
    
    1,661,000
    
    
    
    1,661,000Noncurrent portion
    
    $
    12,293,000
    
    
    $
    10,421,000
 The aggregate principal payments of notes payable are as follows: 2004
    
    $
    1,661,0002005
    
    
    9,234,0002006
    
    
    1,656,0002007
    
    
    903,0002008
    
    
    500,000Total
    
    $
    13,954,000
 8




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The line of credit and the note payable to bank contain certain financial
covenants relative to average borrowed funds to earnings ratio, net earnings,
current ratio, and cash flow coverage. In addition, the payment or declaration
of dividends and distributions is prohibited unless a written consent from the
lender is received. 7. Other expense -net Other expense-net, of $34,000 for the quarter ended March 27, 2004 consists
primarily of expenses incurred in connection with non-capitalizable acquisition
activities. The prior year quarter expense of $476,000 consisted primarily of
costs associated with the relocation of the Companys corporate headquarters
from Old Town, Maine to Carlsbad, California and the discontinued Antigua
Enterprises acquisition effort. In accordance with Statement of Financial
Accounting Standards (SFAS) No. 146, Accounting for Costs Associated with Exit
or Disposal Activities, the relocation costs have been recorded as incurred at
their fair values for the quarter ended March 29, 2003. 9




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Item 2. Managements Discussion and Analysis of Financial Condition and Results
of Operations The following discussion should be read in conjunction with the historical
consolidated financial statements and the related notes and the other financial
information included in the Companys Annual Report onForm 10-Kfiled with the
Securities and Exchange Commission for the fiscal year ended December 27, 2003.
This discussion contains forward-looking statements that involve risks and
uncertainties. Our actual results could differ materially from those
anticipated in these forward-looking statements as a result of any number of
factors, including those set forth under Risk Factors and under other
captions contained elsewhere in the Companys 2003 Annual Report onForm 10-K. In this presentation the Company discusses pro forma organic sales growth,
which is a non-GAAP financial measure of reported sales based on our pro forma
net sales for the first quarter of fiscal 2003. Management believes that
discussing pro forma organic sales growth provides a better understanding of
the Companys net sales performance and trends than reported revenue because it
allows for more meaningful comparisons of current-period revenue to that of
prior periods on a comparable basis. Securities and Exchange Commission rules
require supplemental explanation and reconciliation, which is provided at
Results of OperationsFiscal Quarter Ended March 27, 2004 Compared to Fiscal
Quarter Ended March 29, 2003Reconciliation. Overview We are a mens and womens footwear and apparel company. We design,
develop and market branded dress and casual footwear and apparel. We sell over
80 different styles of footwear and over 250 different styles of apparel
products. By emphasizing traditional style, quality and fit, we believe we can
better maintain a loyal consumer following that is less susceptible to
fluctuations due to changing fashion trends and consumer preferences. As a
result, a significant number of our product styles carry over from
year-to-year. In addition, our design and product development teams seek to
create and introduce new products and styles that complement these longstanding
core products, are consistent with our brand images and meet our high quality
standards. We believe our brands have significant potential for growth through
increases in product assortment, brand extensions and expansion of our retail
channels. We intend to continue our previously announced acquisition program and
pursue acquisitions of sustainable niche brands in the footwear and apparel
industry that we believe could complement or expand our business, or augment
our market coverage. We seek companies or product lines that we believe have
consistent historical cash flow and brand growth potential and can be purchased
at a reasonable price. We also may acquire businesses that we feel could
provide us with important relationships or otherwise offer us growth
opportunities. We plan to fund our future acquisitions through bank financing,
seller debt or equity financing and public or private equity financing.
Although we are actively seeking acquisitions, as of the date of this Quarterly
Report on Form 10-Q we have no agreements with respect to any such
acquisitions, and there can be no assurance that we will be able to identify
and acquire such businesses or obtain necessary financing on favorable terms. As part of this program, in the last two quarters of fiscal 2003, we
acquired H.S. Trask & Co., a mens footwear company, and Royal Robbins, Inc.,
an apparel company. These acquisitions added to our portfolio of brands, diversified our
product offerings and customer base and provided a base for significant
additional revenues in the future. Since making these acquisitions, we have
been able to further integrate their operations with our infrastructure and
take advantage of duplicative overhead and operational inefficiencies. The
increase in revenues and operating expenses during the first quarter ended
March 27, 2004 as compared to the prior year period primarily relates to our
newly acquired brands. Results of Operations The following table sets forth selected consolidated operating results for
each of the quarterly periods indicated and for each of the last two fiscal
years, presented as a percentage of net sales. 
 Fiscal Year Ended
    
    Quarter EndedDecember 31,
    
    December 27,
    
    March 29,
    
    March 27,2002
    
    2003
    
    2003
    
    2004Net sales
    
    
    100
    %
    
    
    100
    %
    
    
    100
    %
    
    
    100
    %Costs of goods sold
    
    
    62
    %
    
    
    57
    %
    
    
    56
    %
    
    
    56
    %Gross profit
    
    
    38
    %
    
    
    43
    %
    
    
    44
    %
    
    
    44
    %
 
 10




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##### Table of Contents



Fiscal Year Ended
    
    Quarter EndedDecember 31,
    
    December 27,
    
    March 29,
    
    March 27,2002
    
    2003
    
    2003
    
    2004Operating
expenses and other
expense  net
    
    
    28
    %
    
    
    36
    %
    
    
    36
    %
    
    
    31
    %Operating income
    
    
    10
    %
    
    
    7
    %
    
    
    8
    %
    
    
    13
    %Interest expense
    
    
    2
    %
    
    
    2
    %
    
    
    1
    %
    
    
    1
    %Earnings before income taxes
    
    
    8
    %
    
    
    5
    %
    
    
    7
    %
    
    
    12
    %Income tax
provision
    
    
    3
    %
    
    
    3
    %
    
    
    3
    %
    
    
    5
    %Net earnings
    
    
    5
    %
    
    
    2
    %
    
    
    4
    %
    
    
    7
    %
 Fiscal Quarter Ended March 27, 2004 Compared to Fiscal Quarter Ended March 29,
2003. Net Sales Net sales for the first quarter ended March 27, 2004 increased $9.4
million or 102%, increasing to $18.6 million from $9.2 million for the first quarter of
fiscal 2003. Of this increase, $7.7 million is attributable to acquired brand
revenue associated with the H.S. Trask®, Ducks
Unlimited®, and Royal Robbins®
brand acquisitions that occurred during the second half of fiscal 2003.
Giving effect to these acquisitions as if they occurred on January 1, 2003, the
Company had $1.8 million in pro forma organic net sales growth for the
Companys five brands, or 10.4%, based on $16.9 million in pro forma net sales
in the first quarter ended March 29, 2003. The pro forma net sales growth
during the current quarter was primarily due to strong acceptance of these
brands spring product lines at retail. Some of these product lines included
new designs that we had invested in developing in fiscal 2003. We expect to
continue this level of investment in product design and development
throughout fiscal 2004. Gross Profit Gross
profit for the first quarter of fiscal 2004 increased 103% to $8.1 million as
compared to $4.0 million for the comparable prior year period. Gross margin as
a percentage of net sales remained constant at 44% for both periods. The
increase in gross profit was primarily related to the addition of the H.S.
Trask®, Ducks Unlimited®, and Royal
Robbins® product lines. Operating Expenses Selling, general and administrative expenses were $5.8 million, or 31% of net
sales, for the first quarter of fiscal 2004 as compared to $2.9 million or 31% of net sales for the first quarter of fiscal
2003. This dollar increase was primarily related to increased operating costs
associated with supporting a higher sales volume and our recently acquired
brands. Our
Other expense  net was $34,000 for the first quarter of fiscal 2004 and
consisted primarily of expenses incurred in connection with non-capitalizable
acquisition activities. Our Other expense  net of
$476,000 for the first quarter of fiscal 2003 consisted primarily of costs associated with the relocation
of our corporate headquarters from Old Town, Maine to Carlsbad,
California and the discontinued Antigua Enterprises acquisition effort. Interest Expense Interest
expense for the first quarter of fiscal 2004 was $170,000 as compared to $66,000
in the comparable prior year period. This increase was a result of higher
average outstanding indebtedness during the current quarter as compared to the
prior year period and included $40,000 related to the expensing of deferred
financing costs. This increased indebtedness was incurred to fund acquisitions
in the second half of fiscal 2003. Income Tax Provision We
recorded income tax expense for the first quarter of fiscal 2004 of
$895,000 as compared to $250,000 for the comparable prior year
period. Our effective tax rates during the quarters ended March 27, 2004 and March 29, 2003
were 42% and 40%, respectively. The increased effective tax rate for
fiscal 2004
reflects our current operations, corporate structure and asset base. Deferred
income taxes reflect the net tax effects of temporary differences between the
carrying amounts of assets and liabilities, for financial reporting purposes,
and the amounts used for income tax purposes. 11




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##### Table of Contents



Net Earnings Our
net earnings for the first quarter of fiscal 2004 were $1.2 million as
compared to $375,000 for the first quarter of fiscal 2003, which represents a 230%
increase in our net earnings. Our net earnings per diluted share were
$0.24 for the first quarter of 2004 as compared to $0.10 per diluted
share for the first quarter of fiscal 2003,
which represents a 140% increase in net earnings per diluted share. This
improvement is a result of the Companys increased net sales
from the fiscal 2003
acquisitions, along with successful integration of these new brands and the
Companys continuing efforts of cost controls in inventory management and
sourcing. Reconciliation The non-GAAP financial measure of pro forma organic sales growth discussed
above under the heading  Results of Operations  Fiscal Quarter Ended March
27, 2004 Compared to Fiscal Quarter March 29, 2003  Net Sales, and
elsewhere in this report, does not replace the presentation of Phoenix
Footwears GAAP financial results and does not necessarily reflect the actual
financial results of the combined companies for the periods presented. In our
measure of pro forma net sales, we have included unaudited prior year period
net sales of H.S. Trask and Royal Robbins. This information is provided to
present the combined companies results as if they were combined
during the first quarter of fiscal 2003. The sales figures for these acquisitions are
internally prepared and unaudited, and have not been reviewed by our
independent accountants. A reconciliation of the non-GAAP financial measures
contained in this report to the most comparable GAAP measures is as follows: Unaudited Pro Forma NetSalesfor the Three Months EndedMarch 29, 2003(in thousands)Phoenix Footwear Group, Inc. (Actual)
    
    $
    9,207Acquired Brands (H.S. Trask & Co., Royal
Robbins, Inc.)
    
    
    7,678Net Sales
    
    $
    16,885
 Seasonal and Quarterly Fluctuations The following sets forth our net sales and income (loss) from operations
summary operating results for the quarterly periods indicated (in thousands). Fiscal 2003First Quarter
    
    Second Quarter
    
    Third Quarter
    Fourth QuarterNet sales
    
    $
    9,207
    
    
    $
    7,552
    
    
    $
    11,002
    
    
    $
    11,316Income (loss) from operations
    
    $
    691
    
    
    $
    (353
    )
    
    $
    1,714
    
    
    $
    495
 Fiscal 2004First Quarter
    
    Second Quarter
    
    Third Quarter
    
    Fourth QuarterNet sales
    
    $
    18,638
    
    
    
    
    
    
    
    
    
    
    
    Income from operations
    
    $
    2,301
    
    
    
    
    
    
    
    
    
    
    
    
 Our quarterly results of operations have fluctuated, and we expect will
continue to fluctuate in the future, as a result of seasonal variances. Net
sales and income from operations in our first and third quarters typically are
stronger than in our second and fourth quarters. Liquidity and Capital Resources Our primary liquidity requirements continued to include debt service, capital
expenditures, working capital needs and financing for acquisitions. We have
historically met these liquidity needs with cash flows from operations,
borrowings under our term loans and revolving credit facility, and seller
financing in acquisitions. We presently have a $24.8 million secured credit facility with Manufacturers
and Traders Trust Company. This credit facility includes three term loans
totaling $6.8 million in principal used in connection with our past
acquisitions, and a revolving credit facility with maximum availability running
from $15.0 million during the months of June through the following January to
$18.0 million during 12




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##### Table of Contents



the months from February through the following May. The aggregate amount that
we may borrow under the revolving credit facility at any time is limited by a
borrowing base formula, which is determined according to our inventory and
accounts receivable levels, less a $2.0 million amortized term loan and
outstanding letters of credit. The agreement is secured by substantially all of
our assets. Amounts borrowed under our revolving credit facility bear interest at a rate,
as selected by us, equal to LIBOR plus 275 basis points (LIBOR with a 90-day maturity was
1.11% on March 27, 2004), or the prime rate plus .25% (prime was 4.0% at March
27, 2004). The weighted average interest rate on the balance of our revolver
was 3.67% at March 27, 2004. The term loans bear interest at a rate, as
selected by us, equal to LIBOR plus 300 basis points, or the prime rate plus .375%. At
March 27, 2004, the weighted average interest rate on the term loans was 3.58%. Our credit facility contains covenants that restrict, among other things, our
ability to incur additional indebtedness, pay dividends, create certain liens
and make acquisitions. Our credit facility also contains certain financial
maintenance covenants, which, among other things, specify capital expenditure
limits, a maximum average borrowed funds to EBITDA ratio, current ratios and
minimum cash flow coverage ratio and net earnings requirements. In the event we
violate any of these covenants, or violate any other provision of our lending
arrangement, our credit agreement provides that our lender has the right to
accelerate repayment of all amounts outstanding under the agreement and/or to
commence foreclosure proceedings on our assets. We were in compliance with all
covenants at March 27, 2004. The outstanding balances for the revolving credit facility and our term loans
at March 27, 2004 were $7.6 million and $6.4 million, respectively. The
available borrowing capacity under the revolving credit facility, net of
outstanding letters of credit of $2.0 million and other borrowing base
limitations, was approximately $5.4 million at March 27, 2004. Future uses of
proceeds of the revolving credit facility are restricted to funding our working
capital requirements and capital expenditures. The revolving credit facility matures on May 1, 2005. Our $2.3 million term
loan is payable in three remaining consecutive $750,000 installments due on the
first day of May in each subsequent year. Our $2.7 million term loan is payable
in 18 remaining consecutive quarterly $150,000 installments, due on May 1,
August 1, November 1 and February 1 of each year. Our $1.4 million term loan is
payable in 56 remaining monthly $25,000 payments due on the first day of each
month. Cash Flows Used By Operations.During the
first quarters ended March 27, 2004
and March 29, 2003, our net cash used by operations was $2.7 million and $591,000,
respectively. The increase in cash used by operating activities was primarily
due to the increase in accounts receivable related to increased sales. Working capital at the end of the
first quarter of fiscal 2004 was approximately
$17.6 million, compared to approximately $13.4 million at the end of fiscal
2003. The improvement in working capital at the end of the first quarter of
fiscal 2004 compared to the end of fiscal 2003 is due primarily to the impact of our
fiscal 2003 acquisitions. These acquisitions caused us to increase our short
and long term debt and caused increases in our accounts receivable balances.
Our current ratio, the relationship of current assets to current liabilities,
increased to 2.55 at the end of the first quarter of fiscal 2004
from 2.37 at the end of fiscal 2003 due
primarily to our fiscal 2003 acquisitions. Accounts receivable days decreased
from 76 days at the end of fiscal 2003 to 57 days at the end of the first
quarter of fiscal 2004, reflective of reduced payment terms and a higher ratio of
quarterly sales to average accounts receivables. Investing
Activities.In the first quarter of fiscal 2004, our cash used in
investing activities totaled $454,000 compared to cash provided by investing
activities in the first quarter of fiscal 2003 of $418,000. During the first
quarter of fiscal 2004 cash used in investing activities was primarily due to
purchases of equipment. Cash provided by investing activities in the
first quarter of fiscal 2003 consisted mostly of net proceeds from the disposal
of property and equipment. Financing
Activities.For the first quarter of fiscal 2004, our net cash provided
by financing activities was $2.1 million compared to cash used by financing
activities of $77,000 for the first quarter of fiscal 2003. The cash provided
in the current year quarter was primarily generated from net
borrowings of $2.1 million. Cash used for financing activities in the comparable prior year
quarter relates primarily to the repurchase of common stock from our 401(k) plan
upon the election of terminated plan participants, partially offset by cash
received from stock option exercises. This increase was primarily due to
additional cash requirements associated with our newly acquired brands. 13




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##### Table of Contents



Contractual Obligations The Company experienced no material changes outside of the ordinary course
of business with respect to the contractual obligations set forth in the Annual
Report on Form 10-K for the year ended December 27, 2003. Off-Balance Sheet Arrangements We have no off-balance sheet arrangements other than operating leases. We
do not believe that these operating leases are material to our current or
future financial condition, results of operations, liquidity, capital resources
or capital expenditures. We are exposed to interest rate changes primarily as a result of our line
of credit and long-term debt, which we use to maintain liquidity and to fund
capital expenditures and expansion. Our market risk exposure with respect to
this debt is to changes in the prime rate in the U.S. and changes in LIBOR.
Our revolving line of credit and our term loans provide for interest on
outstanding borrowings at rates tied to the prime rate or, at our election,
tied to LIBOR. At December 27, 2003 and March 27, 2004, we had $12.1 million
and $14.0 million, respectively, in outstanding borrowings under our credit
facility. A 1.0% increase in interest rates on our current borrowings would
have had a $139,000 impact on income before income taxes. We do not enter into
derivative or interest rate transactions for speculative purposes. Critical Accounting Policies: As of March 27, 2004, the Companys consolidated critical accounting
policies and estimates have not changed materially from those set forth in the
Annual Report on Form 10-K for the year ended December 27, 2003. CAUTIONARY STATEMENT CONCERNING FORWARD LOOKING STATEMENTS This Quarterly Report on Form 10-Q and the Securities and Exchange
Commission filings that are incorporated by reference into this report contain
forward-looking statements within the meaning of Section 27A of the
Securities Act of 1933, as amended, or the Securities Act, and Section 21E of
the Securities Exchange Act of 1934, as amended, or the Exchange Act. The
Company intends that these forward-looking statements be subject to the safe
harbors created by those sections. These forward-looking statements include, but are not limited to,
statements relating to the Companys anticipated financial performance,
business prospects, new developments, new merchandising strategies and similar
matters, and/or statements preceded by, followed by or that include the words
believes, could, expects, anticipates, estimates, intends, plans,
projects, seeks, or similar expressions. The Company has based these
forward-looking statements on the Companys current expectations and
projections about future events, based on the information currently available
to us. These forward-looking statements are subject to risks, uncertainties and
assumptions, including those described under the heading Risk Factors, in the
Companys Annual Report on Form 10-K for the year ended December 27, 2003, that
may affect the operations, performance, development and results of the
Companys business. You are cautioned not to place undue reliance on these
forward-looking statements, which speak only as of the date stated, or if no
date is stated, as of the date of this Quarterly Report on Form 10-Q. The
Company undertakes no obligation to publicly update or revise any
forward-looking statements, whether as a result of new information, future
events or any other reason except as required under applicable law. In light of
these risks, uncertainties and assumptions, the forward-looking events
discussed in this Quarterly Report on Form 10-Q may not occur. Investors should also be aware that while the Company does, from time to
time, communicate with securities analysts, it is against the Companys policy
to disclose to them any material non-public information or other confidential
commercial information. Accordingly, investors should not assume that the
Company agrees with any statement or report issued by any analyst irrespective
of the content of the statement or report. Furthermore, the Company has a policy against issuing publishing financial
forecasts or projections issued by others or confirming financial forecasts, or
projections issued by others. Thus, to the extent that reports issued by
securities analysts contain any projections, forecasts or opinions, such
reports are not the responsibility of the Company. 14




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##### Table of Contents



Item 3. Quantitative and Qualitative Disclosures About Market Risk We are exposed to interest rate changes primarily as a result of our line of
credit and long-term debt, which we use to maintain liquidity and to fund
capital expenditures and expansion. Our market risk exposure with respect to
this debt is to changes in the prime rate in the U.S. and changes in LIBOR.
Our revolving line of credit and our term loans provide for interest on
outstanding borrowings at rates tied to the prime rate or, at our election,
tied to LIBOR. At December 27, 2003 and March 27, 2004, we had $12.1 million
and $14.0 million, respectively, in outstanding borrowings under our credit
facility. A 1.0% increase in interest rates on our current borrowings would
have had a $139,000 impact on income before income taxes. The Company does not
have any foreign currency risk. The Company does not enter into any of these
transactions for speculative purposes. 
 Item 4. Controls and Procedures An evaluation was performed under the supervision of the Companys management,
including the Chief Executive Officer (CEO) and Chief Financial Officer (CFO),
of the effectiveness of the design and operation of the Companys disclosure
controls and procedures (as defined in Securities Exchange Act of 1934 (the
Exchange Act) Rules 13a-15(e) and 15-d-15(e)) as of the end of the period
covered by this report. Based on that evaluation, the Companys management,
including the CEO and CFO, concluded that the Companys disclosure controls and
procedures were effective to provide reasonable assurance that information we
are required to disclose in reports that we file or submit under the Exchange
Act is recorded, processed, summarized and reported within the time periods
specified in SEC rules and forms. Notwithstanding the foregoing, there can be no assurance that the Companys
disclosure controls and procedures will detect or uncover all failures of
persons within the Company and its consolidated subsidiaries to disclose
material information otherwise required to be set forth in the Companys
periodic reports. There are inherent limitations to the effectiveness of any
system of disclosure controls and procedures, including the possibility of
human error and the circumvention or overriding of the controls and procedures.
Accordingly, even effective disclosure controls and procedures can only
provide reasonable, not absolute, assurance of achieving their control
objectives. There has been no change in the Companys internal controls over financial
reporting that occurred during the last fiscal quarter that has materially
affected, or is reasonably likely to materially affect, the Companys internal
controls over financial reporting. 15




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##### Table of Contents



Part II  Other Information 
 Item 1. Legal Proceedings   None 
 Item 2. Changes in
Securities and Use of Proceeds  (e) The following table provides information about purchases by the
Company and affiliated purchasers during the three months ended March 27, 2004
of its common stock: COMPANY PURCHASES OF EQUITY SECURITIES (c)
    
    (d)Total Number of
    
    Maximum Number ofShares Purchased as
    
    Shares that May Yet(a)
    
    (b)
    
    Part of Publicly
    
    Be Purchased UnderTotal Number of
    
    Average Price Paid
    
    Announced Plans or
    
    the Plans orPeriod
    
    Shares Purchased
    
    Per Share
    
    Programs(1)
    
    Programs(2)12/28/03- 1/27/04
    
    
    2,406
    
    
    $
    7.50
    
    
    
    2,406
    
    
    
    809,8871/28/04 -2/28/04
    
    
    28,854
    (3)
    
    $
    8.95
    
    
    
    8,634
    
    
    
    807,4812/29/04-3/27/04
    
    
    1,000
    (4)
    
    $
    10.00
    
    
    
    0
    
    
    
    798,847
 (1) In May 2002, the Company announced that the board of directors had
authorized a stock repurchase program to repurchase shares of our outstanding
common stock in the open market or privately negotiated transactions from time
to time. Under this program the Company has repurchased shares in private
transactions from our 401(k) plan upon the election of plan participants at
prevailing market prices. No limit on the duration of the program or the
amount that could be repurchased was set by the board of directors. In March
2004 the Companys board of directors terminated the portion of this program
that provided for open market purchases previously announced stock repurchase
program. No shares were repurchased in open market transactions during the
first quarter of 2004 prior to termination of that portion of the stock
repurchase program. (2) As of March 27, 2004, 478,513 unallocated shares are held by the
401(k) plan, and 320,334 shares have been allocated to participants. Under the
terms of the plan, approximately 120,000 unallocated shares are allocated to
participants annually. All allocated shares are eligible for repurchase from
the plan. (3) Includes 10,920 shares purchased by Kenneth E. Wolf, Chief Financial
Officer and his family members in open market transactions, and 9,000 shares
purchased by family members of James Riedman Chairman and Chief Executive
Officer, in open market transactions. (4) This purchase was made by Francisco Morales, president of our Royal
Robbins, Inc. subsidiary, in a private party transaction. 
 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  Exhibit 10.1  Employment Agreement by and between Phoenix Footwear Group,
Inc. and James R. Riedman dated January 1, 2004 (incorporated by reference
to Exhibit 10.17 to Form 10-K filed by Phoenix Footwear Group, Inc. on
March 26, 2004 (SEC File No. 001-31309))Exhibit 31.1  Section 302 Certification of Chief Executive Officer 16




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##### Table of Contents



Exhibit 31.2  Section 302 Certification of Chief Financial Officer and
TreasurerExhibit 32.1  Section 906 Certification of Chief Executive Officer and
Chief Financial Officer and Treasurer b) Forms 8-K  1)
    
    On March 26, 2004, the Company filed a report on Form 8-K/A
announcing an amendment to correct the Form 8-K filed on February 13,
2004, which inadvertently filed the press release pursuant to Item 5,
to furnish the press release under Item 12 and amend and restate the
prior filing in its entirety.2)
    
    On February 24, 2004, the Company filed a report on Form 8-K
announcing the Company may file a registration statement with the
Securities and Exchange Commission by the end of the second quarter
of 2004 for a proposed follow-on offering.3)
    
    On February 12, 2004, the Company filed a report on Form 8-K
announcing the Companys results of operations for its fourth quarter
and full year 2003 results.4)
    
    On January 14, 2004, the Company filed a report on Form 8-K/A
amending its Report on Form 8-K, filed with the Securities and
Exchange Commission on November 5, 2003, to update its report of this
transaction and file the financial statements and pro forma financial
information required by Item 7 of Form 8-K. Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned, thereunto, duly authorized. PHOENIX FOOTWEAR GROUP, INC.
Registrant Date: May 11, 2004
    
    /s/ James R. Riedman
James R. Riedman
Chairman and Chief Executive OfficerDate: May 11, 2004
    
    /s/ Kenneth E. Wolf
Kenneth E. Wolf
Chief Financial Officer and Treasurer
 17




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##### Table of Contents



EXHIBIT INDEX ExhibitNo.
    
    Description of ExhibitExhibit 10.1
    
    Employment Agreement by and between Phoenix Footwear Group,
Inc. and James R. Riedman dated January 1, 2004 (incorporated by
reference to Exhibit 10.17 to Form 10-K filed by Phoenix Footwear
Group, Inc. on March 26, 2004 (SEC File No. 001-31309))Exhibit 31.1
    
    Section 302 Certification of Chief Executive OfficerExhibit 31.2
    
    Section 302 Certification of Chief Financial Officer and TreasurerExhibit 32.1
    
    Section 906 Certification of Chief Executive Officer and Chief Financial Officer and Treasurer
 18