----

**SECURITIES AND EXCHANGE COMMISSION****Washington, D.C. 20549**

**Form 10-Q**

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

**For the quarterly period ended: November 30, 2004**

**Commission File Number 0-13851**

**NITCHES, INC.**

**(Exact name of registrant as specified in its charter)**

| **California**                 |   | **95-2848021**                             |
|--------------------------------|--------|--------------------------------------------|
| **(State of   Incorporation)** |   | **(I.R.S.   Employer Identification No.)** |

**10280 Camino Santa Fe, San Diego, California 92121****(Address of principal executive offices)**

**Registrant’s telephone number: (858) 625-2633**

**Securities registered pursuant to Section 12(b) of the Act:**

| **Title of each class**        |   | **Name of each   exchange on which registered** |
|--------------------------------|--------|-------------------------------------------------|
|                                |   |                                                 |
| **Common Stock, no par value** |   | **NASDAQ SmallCap Market**                      |

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

As of November 30, 2004 the Registrant had 1,171,169 shares of common stock outstanding.

----

**PART I  - FINANCIAL INFORMATION**

**Item 1.  Financial Statements**

**NITCHES, INC.  AND SUBSIDIARIES**Condensed Consolidated Balance Sheets

|                                                                                                |   | **November   30,   2004** |               | **August 31,   2004** |   |
|-----------------------------------------------------------------------------------------------------|--------|---------------------------|--------------------|-----------------------|--------|
|                                                                                                |   |                           |                    |                  |        |  |   |
|                                                                                                |   | **(Unaudited)**           |               |                  |   |   |
| **ASSETS**                                                                                          |   |                      |               |                  |   |   |   |
| Current assets:                                                                                     |   |                      |               |                  |   |   |   |
| Cash and cash   equivalents                                                                         |   | $                         | 180,000            |                  | $      | 219,000 |   |
| Receivables:                                                                                        |   |                      |               |                  |   |   |   |
| Trade accounts, less   allowances                                                                   |   |                      | 2,759,000          |                  |   | 3,555,000 |   |
| Due from affiliates and   employees                                                                 |   |                      | 25,000             |                  |   | 32,000 |   |
|                                                                                                |   |                           |                    |                  |        |  |   |
| Total receivables                                                                                   |   |                      | 2,784,000          |                  |   | 3,587,000 |   |
| Refundable income taxes                                                                             |   |                      | 172,000            |                  |   | —   |   |
| Inventories, less   allowances                                                                      |   |                      | 4,465,000          |                  |   | 3,373,000 |   |
| Deferred income taxes                                                                               |   |                      | 288,000            |                  |   | 288,000 |   |
| Other current assets                                                                                |   |                      | 341,000            |                  |   | 89,000 |   |
|                                                                                                |   |                           |                    |                  |        |  |   |
| Total current assets                                                                                |   |                      | 8,230,000          |                  |   | 7,556,000 |   |
| Furniture, fixtures and equipment, net                                                              |   |                      | 33,000             |                  |   | 37,000 |   |
| Deferred income taxes                                                                               |   |                      | 12,000             |                  |   | 12,000 |   |
| Other assets                                                                                        |   |                      | 17,000             |                  |   | 17,000 |   |
|                                                                                                |   |                           |                    |                  |        |  |   |
|                                                                                                |   | $                         | 8,292,000          |                  | $      | 7,622,000 |   |
|                                                                                                |   |                           |                    |                  |        |  |   |
| **LIABILITIES AND SHAREHOLDERS’   EQUITY**                                                     |   |                      |               |                  |   |   |   |
| Current liabilities:                                                                                |   |                      |               |                  |   |   |   |
| Accounts payable                                                                                    |   | $                         | 2,308,000          |                  | $      | 1,366,000 |   |
| Accrued expenses                                                                                    |   |                      | 472,000            |                  |   | 519,000 |   |
| Income taxes payable                                                                                |   |                      | —   |                  |   | 54,000 |   |
|                                                                                                |   |                           |                    |                  |        |  |   |
| Total current   liabilities                                                                         |   |                      | 2,780,000          |                  |   | 1,939,000 |   |
| Long term liabilities:                                                                              |   |                      |               |                  |   |   |   |
| Loss on investment in   Designer Intimates, Inc.                                                    |   |                      | 63,000             |                  |   | 222,000 |   |
| Shareholders’ equity:                                                                          |   |                      |               |                  |   |   |   |
| Preferred stock, no par   value; 25,000,000 shares authorized, no shares issued or outstanding      |   |                      | —   |                  |   | —   |   |
| Common stock, no par   value; 50,000,000 shares authorized; 1,171,169 shares issued and outstanding |   |                      | 1,495,000          |                  |   | 1,495,000 |   |
| Retained earnings                                                                                   |   |                      | 3,954,000          |                  |   | 3,966,000 |   |
|                                                                                                |   |                           |                    |                  |        |  |   |
| Total shareholders’   equity                                                                   |   |                      | 5,449,000          |                  |   | 5,461,000 |   |
|                                                                                                |   |                           |                    |                  |        |  |   |
|                                                                                                |   | $                         | 8,292,000          |                  | $      | 7,622,000 |   |
|                                                                                                |   |                           |                    |                  |        |  |   |

The accompanying notes are an integral part of these financial statements.

2

**NITCHES, INC. AND SUBSIDIARIES**Consolidated Statements of Income (Unaudited)

|                                         |   | **Three Months Ended    November 30,** |      |
|----------------------------------------------|--------|----------------------------------------|-----------|
|                                         |   |                                        |      |
|                                         |   | **2004**                               |      | **2003** |   |
|                                         |   |                                        |           |   |  |  |   |
| Net sales                                    |   | $                                      | 6,337,000 |   | $ | 6,796,000 |   |
| Cost of goods sold                           |   |                                   | 4,689,000 |   |   | 5,064,000 |   |
|                                         |   |                                        |           |   |  |  |   |
| Gross profit                                 |   |                                   | 1,648,000 |   |   | 1,732,000 |   |
| Selling, general and administrative expenses |   |                                   | 1,922,000 |   |   | 1,687,000 |   |
|                                         |   |                                        |           |   |  |  |   |
| Income/(loss) from operations                |   |                                   | (274,000  | ) |   | 45,000 |   |
| Interest expense                             |   |                                   | (6,000    | ) |   | (11,000 | ) |
| Income from unconsolidated subsidiary        |   |                                   | 159,000   |   |   | 468,000 |   |
|                                         |   |                                        |           |   |  |  |   |
| Income/(loss) before income taxes            |   |                                   | (121,000  | ) |   | 502,000 |   |
| Provision/(benefit) for income taxes         |   |                                   | (109,000  | ) |   | 13,000 |   |
|                                         |   |                                        |           |   |  |  |   |
| Net income/(loss)                            |   | $                                      | (12,000   | ) | $ | 489,000 |   |
|                                         |   |                                        |           |   |  |  |   |
| Earnings per share                           |   | $                                      | (0.01     | ) | $ | 0.42 |   |
|                                         |   |                                        |           |   |  |  |   |
| Shares outstanding                           |   |                                   | 1,171,169 |   |   | 1,171,169 |   |
|                                         |   |                                        |           |   |  |  |   |

The accompanying notes are an integral part of these financial statements.

3

**NITCHES, INC.  AND SUBSIDIARIES**Condensed Consolidated Statements of Cash Flows (Unaudited)

|                                                  |   |                                  |               |     |   |               |   |
|-------------------------------------------------------|--------|---------------------------------------|--------------------|----------|--------|--------------------|--------|
|                                                  |   | **Three Months Ended   November 30,** |               |
|                                                  |   |                                       |               |
|                                                  |   | **2004**                              |               | **2003** |   |
|                                                  |   |                                       |                    |     |        |                    |   |
| Net income/(loss)                                     |   | $                                     | (12,000            | )        | $      | 489,000            |   |
| Cash flows from operating activities:                 |   |                                  |               |     |   |               |   |
| Depreciation and   amortization                       |   |                                  | 7,000              |     |   | 6,000              |   |
| (Increase) decrease in   accounts receivable          |   |                                  | 803,000            |     |   | (667,000           | )      |
| (Increase) decrease in   inventories and other assets |   |                                  | (1,344,000         | )        |   | 129,000            |   |
| (Increase) in   refundable income taxes               |   |                                  | (172,000           | )        |   | —   |   |
| Increase in trade   payables and accrued expenses     |   |                                  | 895,000            |     |   | 505,000            |   |
| (Decrease) in income   taxes payables                 |   |                                  | (54,000            | )        |   |               |   |
| Non-cash income from   unconsolidated subsidiary      |   |                                  | (159,000           | )        |   | (468,000           | )      |
|                                                  |   |                                       |                    |     |        |                    |   |
| Net cash provided by   operating activities           |   | $                                     | (36,000            | )        | $      | (6,000             | )      |
| Cash flows from investing activities:                 |   |                                  |               |     |   |               |   |
| Capital expenditures                                  |   |                                  | (3,000             | )        |   | —   |   |
| Cash flows from financing activities:                 |   |                                  | —   |     |   | —   |   |
|                                                  |   |                                       |                    |     |        |                    |   |
| Net increase (decrease) in cash and cash equivalents  |   |                                  | (39,000            | )        |   | (6,000             | )      |
| Cash and cash equivalents at beginning of period      |   |                                  | 219,000            |     |   | 110,000            |   |
|                                                  |   |                                       |                    |     |        |                    |   |
| Cash and cash equivalents at end of period            |   | $                                     | 180,000            |     | $      | 104,000            |   |
|                                                  |   |                                       |                    |     |        |                    |   |
| Supplemental disclosures of cash flow information:    |   |                                  |               |     |   |               |   |
| Cash paid during the   period:                        |   |                                  |               |     |   |               |   |
| Interest                                              |   | $                                     | 6,000              |     | $      | 11,000             |   |
| Income taxes                                          |   |                                  | 116,000            |     |   | (77,000            | )      |
| Non-cash investing activity:                          |   |                                  |               |     |   |               |   |
| Accrued earnings of   unconsolidated subsidiary       |   | $                                     | 159,000            |     | $      | 468,000            |   |

The accompanying notes are an integral part of these financial statements.

4

**NITCHES, INC. AND SUBSIDIARIES**Notes to Condensed Consolidated Financial Statements

***1.          Description of Business:***

          Nitches, Inc. (the “Company”) is a wholesale importer and distributor of clothing manufactured to its specifications and distributed in the United States under Company brand labels and private retailer labels.  The Company’s product lines include women’s sleepwear and western wear and men’s casual wear.

***2.          Condensed Financial Statements:***

          The accompanying unaudited consolidated financial statements have been prepared in accordance with the instructions to Form 10-Q.  They do not include all information and footnotes necessary for a fair presentation of financial position and results of operations and cash flows in conformity with generally accepted accounting principles in the United States of America.  These consolidated financial statements should be read in conjunction with the consolidated financial statements and related notes contained in the Company’s Annual Report on Form 10-K for the year ended August 31, 2004.  In the opinion of Management, all adjustments considered necessary for a fair presentation have been included in the interim period.  Operating results for the three months ended November 30, 2004 are not necessarily indicative of the results that may be expected for the year ending August 31,2005.

***3.          Earnings Per share:***

          At November 30, 2004, there were no stock options or similar instruments outstanding and therefore no dilutive effect to the number of shares outstanding. 

***4.          Inventories:***

|                |   | **November   30,   2004** |      | **August 31,   2004** |   |
|---------------------|--------|---------------------------|-----------|-----------------------|--------|
|                |   |                           |           |                  |        |  |   |
| Fabric and trim     |   | $                         | 406,000   |                  | $      | 141,000 |   |
| Work in progress    |   |                      | 1,534,000 |                  |   | 1,225,000 |   |
| Finished goods      |   |                      | 2,603,000 |                  |   | 2,092,000 |   |
| Markdown allowances |   |                      | (78,000   | )                     |   | (85,000 | ) |
|                |   |                           |           |                  |        |  |   |
|                |   | $                         | 4,465,000 |                  | $      | 3,373,000 |   |
|                |   |                           |           |                  |        |  |   |

***5.          Trade accounts receivable:***

          Pursuant to the terms of an agreement between Nitches and a factor, Nitches sells a majority of its trade accounts receivable to the factor on a pre-approved, non-recourse basis.  The price at which the accounts are sold is the invoice amount reduced by the factor commission (.3% of the invoice amount) and all selling discounts.  For accounts sold to the factor without recourse, the factor is responsible for collection, assumes all credit risk, and obtains all of the rights and remedies against the company’s customers.  For such accounts, payment is due from the factor upon the earlier of the payment of the receivable to the factor by the customer, or the maturity of the receivable (generally 180 days from the date of shipment to the customer).  As of November 30, 2004, non-recourse receivables totaled $4,097,000.

          Trade accounts receivable not sold to the factor remain in the custody and control of the Company and the Company maintains all credit risk on those accounts as well as accounts which are sold to the factor with recourse.  The combined credit risk for non-factored and recourse receivables as of November 30, 2004, totaled $520,000.

          The Company may request payment from the factor in advance of the collection date or maturity.  Any such advance payments are assessed an interest charge through the collection date or maturity at the factor’s prime rate less 1.5% (one and one half percent) per annum.  The company’s obligations with respect to advances from the factor are limited to the interest charges thereon.  Advance payments are limited to a maximum of 85% (eighty-five percent) of eligible accounts receivable.  The factoring agreement also provides for the issuance of irrevocable letters of credit for the Company’s purchase of inventory in the normal course of its business.  Letters of credit are subject to a $6 million limit. All assets of the company collateralize the advances and letters of credit.  The Company’s Chairman has also provided a personal guaranty in connection with thefactoring arrangement.

5

**NITCHES, INC.  AND SUBSIDIARIES**Notes to Condensed Consolidated Financial Statement (continued)

          The status of the Company’s trade accounts receivable and letters of credit are as follows:

|                                                       |   | **November   30,   2004** |       | **August 31,   2004** |   |
|------------------------------------------------------------|--------|---------------------------|------------|-----------------------|--------|
|                                                       |   |                           |            |                  |        |  |   |
| Receivables assigned to factor:                            |   |                      |       |                  |   |   |   |
| Non-recourse                                               |   | $                         | 4,097,000  |                  | $      | 5,028,000 |   |
| Recourse                                                   |   |                      | 158,000    |                  |   | 121,000 |   |
| Advances from factor                                       |   |                      | (1,605,000 | )                     |   | (1,939,000 | ) |
|                                                       |   |                           |            |                  |        |  |   |
| Due from factor                                            |   |                      | 2,650,000  |                  |   | 3,210,000 |   |
| Non-factored accounts receivable                           |   |                      | 362,000    |                  |   | 837,000 |   |
| Allowance for customer credits and doubtful accounts       |   |                      | (253,000   | )                     |   | (492,000 | ) |
|                                                       |   |                           |            |                  |        |  |   |
|                                                       |   | $                         | 2,759,000  |                  | $      | 3,555,000 |   |
|                                                       |   |                           |            |                  |        |  |   |
| Contingent liabilities for irrevocable letters of   credit |   | $                         | 2,416,000  |                  | $      | 2,390,000 |   |
|                                                       |   |                           |            |                  |        |  |   |

***6.          Dividends:***

          The Company did not pay any dividends during the current period or the prior fiscal year.

***7.          Significant Customers:***

          Sales to two separate customers, Kohl’s and Mervyn’s, accounted for 45.5% and 12.9%, respectively, of the Company’s net sales in the three months ended November 30, 2004.  Kohl’s and Mervyn’s accounted for 50.0% and 13.7%, respectively, of the Company’s net sales in the three months ended November 30, 2003.

          Two customers, Kohl’s and Mervyn’s, accounted for 49.2% and 21.1% respectively of the Company’s trade receivable balance as of November 30, 2004.  Three customers, Kohl’s, Mervyn’s and Sears accounted for 48.6%, 16.8% and 11.0% respectively of the Company’s trade receivable balance as of November 30, 2003.  

***8.          Minority Interest:***

          In October 2002 the Company acquired a 28% interest in Designer Intimates, Inc., which owns 100% of NAP, Inc., a New York-based intimate apparel company.  Designer Intimates had acquired NAP from its founders and obtained a credit line of approximately $12 million from HSBC, later assumed by CIT, secured by the inventory and accounts receivable of NAP and the guarantees of shareholders of Designer Intimates.  Nitches guarantees $3 million of this credit line and this guarantee formed the consideration from Nitches for its 28% ownership interest in Designer Intimates.  In the event of a call on this guaranty by CIT, Nitches has a contract with the remaining shareholders of Designer Intimates to limit Nitches’ exposure to 28% of the called value, subject to the maximum guaranty of $3.0 million.

          Nitches reports any income or loss from the ongoing operation of Designer Intimates using the equity method of accounting, whereby Nitches’ 28% interest in Designer Intimates is reported as a single line item on the Consolidated Statement of Income.  For the three months ended November 30, 2004, the Company recognized $159,000 in income from the unconsolidated subsidiary.  This income is reported net of tax and is not taxable to the Company.  For that same period, Designer Intimates earned net income of $568,000 on sales of $23.3 million.  For the three months ended November 30, 2003, the Company recognized $468,000 in income from the unconsolidated subsidiary.  For that same period, Designer Intimates had net income of $1,667,000 on sales of $37.1 million.  Cumulative losses on this investment of $63,000 and $222,000 are shown as a liability on the consolidated balancesheet as of November 30, 2004 and August 31, 2004, respectively. 

6

          Nitches has introduced Designers Intimates to the factories that Nitches uses for its own sleepwear product line. This provides access to a lower cost production base than Designer Intimates has had in Turkey where it has historically produced over ninety percent of it products which are predominantly robes and lounge wear.  In an agreement with Designer Intimates, Nitches has produced a line of sleepwear under the Dockers label.  This product contributed approximately $1.8 million dollars of sales for Nitches in the current period.  As of November 30, 2004, Nitches had a backlog of approximately $2.6 million for this product line.

          Following are the unaudited condensed financial statements of Designer Intimates, Inc. as of November 30, 2004 for the 3 month period then ended:

**Designer Intimates, Inc. Consolidated Balance Sheet**(Unaudited)

|                                            |   | **November   30,   2004** |               | **August 31,   2004** |   |
|-------------------------------------------------|--------|---------------------------|--------------------|-----------------------|--------|
|                                            |   |                           |                    |                  |        |  |   |
|                                            |   | **(Unaudited)**           |               |                  |   |   |
| **ASSETS**                                      |   |                      |               |                  |   |   |   |
| Current assets:                                 |   |                      |               |                  |   |   |   |
| Cash and cash   equivalents                     |   | $                         | 156,000            |                  | $      | 120,000 |   |
| Trade accounts   receivable, less allowances    |   |                      | 1,413,000          |                  |   | —   |   |
| Inventories                                     |   |                      | 4,339,000          |                  |   | 5,301,000 |   |
| Deferred income taxes                           |   |                      | 125,000            |                  |   | 125,000 |   |
| Other current assets                            |   |                      | 73,000             |                  |   | 87,000 |   |
|                                            |   |                           |                    |                  |        |  |   |
| Total current assets                            |   |                      | 6,106,000          |                  |   | 5,633,000 |   |
| Furniture, fixtures and equipment, net          |   |                      | 561,000            |                  |   | 651,000 |   |
| Goodwill                                        |   |                      | 2,548,000          |                  |   | 2,548,000 |   |
| Other intangibles, subject to amortization      |   |                      | 155,000            |                  |   | 201,000 |   |
| Other assets                                    |   |                      | 150,000            |                  |   | 175,000 |   |
|                                            |   |                           |                    |                  |        |  |   |
|                                            |   | $                         | 9,520,000          |                  | $      | 9,208,000 |   |
|                                            |   |                           |                    |                  |        |  |   |
| **LIABILITIES AND SHAREHOLDERS’   EQUITY** |   |                      |               |                  |   |   |   |
| Current liabilities:                            |   |                      |               |                  |   |   |   |
| Due to factor                                   |   | $                         | —   |                  | $      | 317,000 |   |
| Accounts payable                                |   |                      | 8,565,000          |                  |   | 8,561,000 |   |
| Accrued expenses                                |   |                      | 862,000            |                  |   | 770,000 |   |
| Income taxes payable                            |   |                      | 315,000            |                  |   | 350,000 |   |
|                                            |   |                           |                    |                  |        |  |   |
| Total current   liabilities                     |   |                      | 9,742,000          |                  |   | 9,998,000 |   |
| Shareholders’ equity:                      |   |                      |               |                  |   |   |   |
| Common stock                                    |   |                      | 3,000              |                  |   | 3,000 |   |
| Retained earnings                               |   |                      | (225,000           | )                     |   | (793,000 | ) |
|                                            |   |                           |                    |                  |        |  |   |
| Total shareholders’   equity               |   |                      | (222,000           | )                     |   | (790,000 | ) |
|                                            |   |                           |                    |                  |        |  |   |
|                                            |   | $                         | 9,520,000          |                  | $      | 9,208,000 |   |
|                                            |   |                           |                    |                  |        |  |   |

7

**Designer Intimates, Inc. Consolidated Income Statements**(Unaudited)

|                              |   | **Three   Months Ended   November 30** |       |
|-----------------------------------|--------|----------------------------------------|------------|
|                              |   |                                        |       |
|                              |   | **2004**                               |       | **2003** |   |
|                              |   |                                        |            |   |  |  |   |
| Net Sales                         |   | $                                      | 23,312,000 |   | $ | 37,097,000 |   |
| Cost of sales                     |   |                                   | 18,782,000 |   |   | 29,922,000 |   |
|                              |   |                                        |            |   |  |  |   |
| Gross profit                      |   |                                   | 4,530,000  |   |   | 7,175,000 |   |
| Operating expenses                |   |                                   | 3,366,000  |   |   | 4,167,000 |   |
| Amortization of intangible assets |   |                                   | 47,000     |   |   | 46,000 |   |
|                              |   |                                        |            |   |  |  |   |
| Income from operations            |   |                                   | 1,117,000  |   |   | 2,962,000 |   |
| Interest expenses                 |   |                                   | 114,000    |   |   | 111,000 |   |
| Other (income)                    |   |                                   | (15,000    | ) |   | (16,000 | ) |
|                              |   |                                        |            |   |  |  |   |
| Income before income taxes        |   |                                   | 1,018,000  |   |   | 2,867,000 |   |
| Provision for income taxes        |   |                                   | 450,000    |   |   | 1,200,000 |   |
|                              |   |                                        |            |   |  |  |   |
| Net income                        |   | $                                      | 568,000    |   | $ | 1,667,000 |   |
|                              |   |                                        |            |   |  |  |   |

***9.          New Accounting Pronouncements:***

          The FASB did not issue any new Statements of Financial Accounting Standards during the current period.

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

CRITICAL ACCOUNTING POLICIES

*          Revenue Recognition. *The Company recognizes revenue at the time products are shipped based on its terms of F.O.B. shipping point, where risk of loss and title transfers to the buyer at time of shipment.  The Company records sales in accordance with SEC Staff Accounting Bulletin No. 104, *Revenue Recognition*.  Under these guidelines, revenue is recognized when all of the following exist: persuasive evidence of a sale arrangement exists, delivery of the product has occurred, the price is fixed or determinable and payment is reasonably assured.  Provisions are made currently for estimated product returns and sales allowances.

          *Allowances for Sales Returns, Doubtful Accounts and Other. *Sales are recorded net of estimated future returns, uncollectible accounts receivable and other customer related allowances.  Management analyzes historical returns and bad debt expense, current economic trends, changes in customer demand and sell-through of our products when evaluating the adequacy of these allowances.  In addition, the Company may provide warehousing credits and other allowances to certain customers in accordance with industry practice.  These reserves are determined based on historical experience, budgeted customer allowances and existing commitments to customers.  Although management believes it has established adequate reserves with respect to these items, actual activity could vary from management’s estimates and such variances could have a material impact on reported results.  AtNovember 30, 2004, trade accounts receivable balance was $2.8 million, net of allowances of $253,000 and factor advances of $1.6 million, as compared to the balance of $3.6 million, net of allowances of $492,000 and factor advances of $1.9 million at August 31, 2004.  At November 30, 2003, the trade accounts receivable balance was $1.5 million, net of allowances for doubtful accounts of $243,000 and factor advances of $3.4 million. 

8

          *Inventory.*The Company marks down its inventory for estimated obsolescence or unmarketable inventory equal to the difference between the cost of inventory and the estimated net realizable value based on assumptions about age of the inventory, future demand and market conditions. This process provides for a new basis for the inventory until it is sold.  If actual market conditions are less favorable than those projected by management, additional inventory markdowns may be required.  The Company’s inventory balance was $4.5 million, net of inventory markdowns of $78,000, at November 30, 2004, as compared to an inventory balance of $3.4 million, net of inventory markdowns of $85,000, at August 31, 2004.  At November 30, 2003, the inventory balance was $4.9 million, net of inventory markdowns of $142,000. 

***Results of Operations***

**Three Months Ended November 30, 2004 Compared to the Three Months Ended November 30, 2003**

          Net sales for the three months ended November 30, 2004, decreased $458,000 as compared to the three months ended November 30, 2003.  This decrease was attributable to a decrease in unit sales in the Company’s sleepwear product line.

          Cost of sales as a percent of net sales decreased .5%, generating a higher gross profit margin of 26.0% for the three months ended November 30, 2004 as compared to 25.5% for the year earlier period.  The increase in gross margin came as the result of higher gross margins realized in the Company’s sleepwear line.  The Company’s 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 first quarter of fiscal 2004 increased $235,000 as compared to a year ago, due to an increase in selling commissions associated with the Company’s sleepwear line and increased professional service fees associated with expanded governance activity and compliance with Sarbanes-Oxley regulations.  Expenses included $1.0 million of selling and merchandising expenses and $316,000 of shipping and warehousing expenses.  This compares with $603,000 of selling and merchandising expenses and $277,000 of shipping and warehousing expenses incurred during the quarter ended November 30, 2003.  Expenses increased as a percent of net sales to 30.3% from 24.8% in the prior period, due to the decrease in net sales and the increased expenditures in the categories noted above.

          Interest expense decreased $5,000 in the current quarter to $6,000 as compared to $11,000 for the three months ended November 30, 2003.  This decline was due to reduced advances under the Company’s factoring agreement and in spite of higher interest rates charged on these advances.

          The Company’s income tax provision for the three months ended November 30, 2004, reflects a $109,000 tax benefit accrued at an estimated 39% tax rate on the Company’s pretax loss for the quarter of $274,000.  The Company also utilized an estimated tax rate of 39% for the three months ended November 30, 2003.  The Company recognized a $13,000 expense in the prior period on pretax income of $33,000.

***Investment in Unconsolidated Subsidiary***

          In October 2002 the Company acquired a 28% interest in Designer Intimates, Inc., which owns 100% of NAP, Inc., a New York-based intimate apparel company.  Designer Intimates had acquired NAP from its founders and obtained a credit line of approximately $12 million from HSBC, later assumed by CIT, secured by the inventory and accounts receivable of NAP and the guarantees of shareholders of Designer Intimates.  Nitches guarantees $3 million of this credit line and this guarantee formed the consideration from Nitches for its 28% ownership interest in Designer Intimates. In the event of a call on this guaranty by CIT, Nitches has a contract with the remaining shareholders of Designer Intimates to limit Nitches’ exposure to 28% of the called value, subject to the maximum guaranty of $3.0 million.

          Nitches reports any income or loss from the ongoing operation of Designer Intimates using the equity method of accounting, whereby Nitches’ 28% interest in Designer Intimates is reported as a single line item on the Consolidated Statement of Income.  For the three months ended November 30, 2004, the Company recognized $159,000 in income 

9

from the unconsolidated subsidiary.  This income is reported net of tax and is not taxable to the Company.  For that same period, Designer Intimates had net income of $568,000 on sales of $23.3 million.  Cumulative losses on this investment of $63,000 and $222,000 are shown as a liability on the consolidated balance sheet as of November 30, 2004 and August 31, 2004, respectively.

          Nitches has introduced Designers Intimates to the factories that Nitches uses for its own sleepwear product line. This provides access to a lower cost production base than Designer Intimates has had in Turkey where it has historically produced over ninety percent of it products which are predominantly robes and lounge wear.  In an agreement with Designer Intimates, Nitches has produced a line of sleepwear under the Dockers label.  This product contributed approximately $1.8 million dollars of sales for Nitches in the current period.  As of November 30, 2004, Nitches had a backlog of approximately $2.6 million for this product line.

***Liquidity and Capital Resources***

          Working capital decreased to $5.4 million at November 30, 2004 from $5.6 million at August 31, 2004.  The current ratio decreased to 3.0:1 at November 30, 2004 from 3.9:1 at August 31, 2004, due to a higher percentage increase in current liabilities of 43.4% versus an 8.9% rise in current assets.  Current liabilities increased in line with increased operating expenses for the current period and increased purchases that generated the higher inventory level at the period end.  Current assets increased due to a rise in inventory from $3.4 million to $4.5 million, offset by a lower current period accounts receivable balance of $2.8 million versus $3.6 million at the end of the prior fiscal year due to a shift in the timing of revenue earlier in the current period and shorter duration credit terms extended to customers.

          The Company sells substantially all of its trade receivables to a factor (CIT) on a pre-approved, non-recourse basis. The Company attempts to make any recourse shipments on a COD 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 the Company’s receivables that were recourse and were not made on a COD basis or supported by commercial or standby letters of credit at November 30, 2004 was approximately $502,000, of which approximately $106,000 had been collected through December 31, 2004.

          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, the Company can request advances in anticipation of customer collections at the prime rate (currently 4.00%) less one and one-half percent (1.5%).  The amount of advances available to the Company is limited to eighty-five percent (85%) of non-recourse factored receivables.

          The Company may issue import letters of credit through CIT for the purchase of inventory in the normal course of its operations.  Letters of credit are subjected to a limit of $6 million.  At November 30, 2004, the Company had outstanding letters of credit of approximately $2.4 million for the purchase of finished goods, which had been opened through CIT.

          The factoring agreement does not contain any financial covenants to which the Company must adhere.  Advances are collateralized by all of the assets of the Company as well as a personal guaranty of the Company’s Chairman.  The factoring agreement can be terminated by CIT on 30-days written notice.  The company believes the factoring agreement with CIT, along with expected cash flow from operating activities and current levels of working capital are adequate to fulfill the Company’s liquidity needs for the foreseeable future.

***Contractual Obligations and Commercial Commitments***

|                                  |   | **Payments   due/Commitments expiring per period** |      |
|---------------------------------------|--------|----------------------------------------------------|-----------|
|                                  |   |                                                    |      |
|                                  |   | **Total   Amounts   Committed**                    |      | **Less than   1 year** |   | **1-3 years** |   | **4-5 years** |   | **Over   5 years** |   |
|                                  |   |                                                    |           |   |  |  |   |  |  |   |  |  |   |  |  |   |
| Operating leases                      |   | $                                                  | 590,000   |   | $ | 367,000 |   | $ | 223,000 |   |   |   |   |   |   |   |
| Letters of credit                     |   |                                               | 2,416,000 |   |   | 2,416,000 |   |   |   |   |   |   |   |   |   |   |
| Guarantees                            |   |                                               | 3,000,000 |   |   |   |   |   |   |   |   | 3,000,000 | * |   |   |   |
|                                  |   |                                                    |           |   |  |  |   |  |  |   |  |  |   |  |  |   |
| Total obligations &   commitments |   | $                                                  | 6,006,000 |   | $ | 2,783,000 |   | $ | 223,000 |   | $ | 3,000,000 |   | $ | —   |   |
|                                  |   |                                                    |           |   |  |  |   |  |  |   |  |  |   |  |  |   |