##### Table of Contents



UNITED STATES SECURITIES AND EXCHANGE COMMISSION
 Washington, D.C. 20549
 FORM 10-Q
 þ
    
    QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
 For the quarterly period ended April 1, 2006
 OR
 o
    
    TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE
SECURITIES EXCHANGE ACT OF 1934
 For the transition period from  to
 Commission File number 333-376-17
 DELTA MILLS, INC.
 
  DELAWARE
    
    13-2677657(State or other jurisdiction of
incorporation or organization)
    
    (I.R.S. Employer
Identification No.)700 North Woods Drive
Fountain Inn, South Carolina
    
    29644(Address of principal executive offices)
    
    (Zip Code)
  
  
  þ o
  o o þ
 o þ




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PagePART I. FINANCIAL INFORMATIONItem 1. Financial Statements (Unaudited)Condensed consolidated balance sheets  April 1, 2006 and July 2, 2005
    
    3Condensed consolidated statements of operations 
Three and nine months ended April 1, 2006 and April 2, 2005
    
    4Condensed consolidated statements of cash flows 
Nine months ended April 1, 2006 and April 2, 2005
    
    5Notes to condensed consolidated financial statements
    
    6 - 15Item 2. Managements Discussion and Analysis of Financial Condition and Results of Operations
    
    16 - 33Item 3. Quantitative and Qualitative Disclosures about Market Risk
    
    33 - 34Item 4. Controls and Procedures
    
    34PART II. OTHER INFORMATIONItem 1. Legal Proceedings
    
    35Item 1A. Risk Factors
    
    35Item 6. Exhibits
    
    35SIGNATURES
    
    36CERTIFICATIONS
    
    37 - 40EX-31.1 SECTION 302 CERTIFICATION OF THE CEOEX-31.2 SECTION 302 CERTIFICATION OF THE CFOEX-32.1 SECTION 906 CERTIFICATION OF THE CEOEX-32.2 SECTION 906 CERTIFICATION OF THE CFO
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PART I. FINANCIAL INFORMATION
 
 ITEM 1. FINANCIAL STATEMENTS
 
 
 April 1, 2006
    
    
    July 2, 2005ASSETSCURRENT ASSETSCash
    
    $
    324
    
    
    $
    282Accounts receivable:Factor
    
    
    27,214
    
    
    
    37,039Less allowances for returns
    
    
    121
    
    
    
    10127,093
    
    
    
    36,938InventoriesFinished goods
    
    
    3,287
    
    
    
    10,004Work in process
    
    
    16,923
    
    
    
    19,507Raw materials and supplies
    
    
    4,918
    
    
    
    5,79725,128
    
    
    
    35,308Deferred income taxes
    
    
    548
    
    
    
    1,159Other assets
    
    
    780
    
    
    
    1,357TOTAL CURRENT ASSETS
    
    
    53,873
    
    
    
    75,044ASSETS HELD FOR SALE
    
    
    584
    
    
    
    1,900PROPERTY, PLANT AND EQUIPMENT, at cost
    
    
    87,178
    
    
    
    128,830Less accumulated depreciation
    
    
    52,610
    
    
    
    87,96934,568
    
    
    
    40,861DEFERRED LOAN COSTS AND OTHER ASSETS
    
    
    154
    
    
    
    237$
    89,179
    
    
    $
    118,042LIABILITIES AND SHAREHOLDERS EQUITYCURRENT LIABILITIESTrade accounts payable
    
    $
    7,197
    
    
    $
    7,209Outstanding checks payable
    
    
    1,315
    
    
    
    1,299Revolving credit facility
    
    
    16,225
    
    
    
    28,444Accrued income taxes payable
    
    
    13,695
    
    
    
    13,695Payable to affiliates
    
    
    3,780
    
    
    
    3,780Accrued employee compensation
    
    
    600
    
    
    
    4,778Accrued restructuring
    
    
    2,580
    
    
    
    1,054Accrued and sundry liabilities
    
    
    3,465
    
    
    
    4,815TOTAL CURRENT LIABILITIES
    
    
    48,857
    
    
    
    65,074LONG-TERM DEBT
    
    
    30,941
    
    
    
    30,941NON-CURRENT DEFERRED INCOME TAXES
    
    
    548
    
    
    
    1,159TOTAL LIABILITIES
    
    
    80,346
    
    
    
    97,174SHAREHOLDERS EQUITYCommon Stock  par value $0.01 a share  authorized
3,000 shares, issued and outstanding 100 sharesAdditional paid-in capital
    
    
    51,792
    
    
    
    51,792Accumulated deficit
    
    
    (42,959
    )
    
    
    (30,924
    )TOTAL SHAREHOLDERS EQUITY
    
    
    8,833
    
    
    
    20,868COMMITMENTS AND CONTINGENCIES$
    89,179
    
    
    $
    118,042
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Three
    
    
    Three
    
    
    Nine
    
    
    NineMonths Ended
    
    
    Months Ended
    
    
    Months Ended
    
    
    Months EndedApril 1,
    
    
    April 2,
    
    
    April 1,
    
    
    April 2,2006
    
    
    2005
    
    
    2006
    
    
    2005Net sales
    
    $
    32,659
    
    
    $
    40,064
    
    
    $
    100,193
    
    
    $
    114,814Cost of goods sold
    
    
    31,306
    
    
    
    40,192
    
    
    
    98,964
    
    
    
    116,058GROSS PROFIT (LOSS)
    
    
    1,353
    
    
    
    (128
    )
    
    
    1,229
    
    
    
    (1,244
    )Selling, general and administrative expenses
    
    
    2,327
    
    
    
    2,396
    
    
    
    6,486
    
    
    
    7,724Impairment and restructuring expenses
    
    
    
    
    
    
    
    
    
    
    2,828
    
    
    
    7,350Other operating income
    
    
    70
    
    
    
    321
    
    
    
    208
    
    
    
    382OPERATING LOSS
    
    
    (904
    )
    
    
    (2,203
    )
    
    
    (7,877
    )
    
    
    (15,936
    )Interest expense
    
    
    (1,216
    )
    
    
    (1,352
    )
    
    
    (4,158
    )
    
    
    (3,908
    )Gain on extinguishment of debt
    
    
    
    
    
    
    500
    
    
    
    
    
    
    
    500LOSS BEFORE INCOME TAXES
    
    
    (2,120
    )
    
    
    (3,055
    )
    
    
    (12,035
    )
    
    
    (19,344
    )Income tax benefit
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (3,743
    )NET LOSS
    
    $
    (2,120
    )
    
    $
    (3,055
    )
    
    $
    (12,035
    )
    
    $
    (15,601
    )
  4




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Nine Months Ended
    
    
    Nine Months EndedApril 1, 2006
    
    
    April 2, 2005OPERATING ACTIVITIESNet loss
    
    $
    (12,035
    )
    
    $
    (15,601
    )Adjustments to reconcile net loss to net cash
provided by (used in) operating activities:Depreciation
    
    
    3,642
    
    
    
    6,030Amortization
    
    
    83
    
    
    
    82Impairment and restructuring expenses
    
    
    2,828
    
    
    
    7,350Change in deferred income taxes
    
    
    
    
    
    
    (3,740
    )Gain on early retirement of debt
    
    
    
    
    
    
    (500
    )Gains on disposition of property
and equipment
    
    
    (60
    )
    
    
    (245
    )Stock-based compensation expense
    
    
    19
    
    
    
    44Deferred compensation
    
    
    (4,239
    )
    
    
    (527
    )Changes in operating assets and liabilities
    
    
    17,978
    
    
    
    (5,203
    )NET CASH PROVIDED BY (USED IN)
OPERATING ACTIVITIES
    
    
    8,216
    
    
    
    (12,310
    )INVESTING ACTIVITIESProperty, plant and equipment:Purchases
    
    
    (610
    )
    
    
    (364
    )Proceeds of dispositions
    
    
    4,639
    
    
    
    6,202NET CASH PROVIDED BY
INVESTING ACTIVITIES
    
    
    4,029
    
    
    
    5,838FINANCING ACTIVITIESProceeds from revolving lines of credit
    
    
    102,190
    
    
    
    129,579Repayments on revolving lines of credit
    
    
    (114,409
    )
    
    
    (123,083
    )Changes in outstanding checks payable
    
    
    16
    
    
    
    Repurchase and retirement of long-term debt
    
    
    
    
    
    
    (500
    )NET CASH PROVIDED BY (USED IN)
FINANCING ACTIVITIES
    
    
    (12,203
    )
    
    
    5,996INCREASE (DECREASE) IN CASH
    
    
    42
    
    
    
    (476
    )Cash beginning of period
    
    
    282
    
    
    
    585CASH AT END OF PERIOD
    
    $
    324
    
    
    $
    109
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April 1, 2006
    
    July 2, 2005Current assets
    
    $
    200
    
    
    $
    105Non-current assets
    
    
    1,975
    
    
    
    Current liabilities
    
    
    4,028
    
    
    
    2,128Non-current liabilities
    
    
    
    
    
    
    434Stockholders deficit
    
    
    (1,853
    )
    
    
    (2,457
    )
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Nine Months EndedApril 1, 2006
    
    April 2, 2005Net sales  Intercompany commissions
    
    $
    2,259
    
    
    $
    2,586Cost and expenses
    
    
    1,654
    
    
    
    2,409Net income
    
    
    605
    
    
    
    177
   1.
    
    Government business:
 
    
    revenues remaining at approximately the fiscal year 2006 level for fiscal year 2007
and beyond
    
    minimal disruption in order flow from the factors discussed in Item 2. Managements
Discussion and Analysis of Financial Condition and Results of Operations  Management
Overview and Company Outlook  Our Government Business
    
    U.S. government funding for military uniforms is not materially delayed or decreased
as a result of delays in the budgeting process or other demands on government resources
    
    a moderation in the rate of increase in energy and chemical costs
    
    continued credit approval of the government businesss customer base by our factor GMAC
 2.
    
    Commercial cotton business:
 
    
    maintaining fiscal year 2005 revenue levels in fiscal year 2006 and beyond
    
    improved margins based on the continuation of current trends in sales prices and raw material costs
    
    a moderation in the rate of increase in energy and chemical costs
    
    continued credit approval of the commercial cotton businesss customer base by our factor GMAC
 3.
    
    Payment terms required by our principal vendors and suppliers do not become materially
more stringent
  1.
    
    the foregoing assumptions remain valid;2.
    
    The Company enters into the New Credit Facility or a substantially similar extension,
renewal or refinancing of the existing GMAC revolving credit agreement; and3.
    
    with respect to the tender offer:
 
    
    The tender offer results in the acquisition by the Company of all of the outstanding
Notes; or
    
    A majority of the outstanding Notes are tendered and purchased by the Company
pursuant to the tender offer, the necessary Consents to amend the Senior Notes
indenture are received, and the Company is able to purchase the remaining outstanding
Notes at a substantial discount prior to March 31, 2007; or
    
    If the tender offer and consent solicitation are not successful, the Company is able
to purchase the outstanding Notes at a substantial discount prior to March 31, 2007.
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
    
    On August 9, 2005, the Company entered into a waiver and amendment that (i) waived the
Companys noncompliance with the minimum EBITDA covenant for the fourth quarter ended
July 2, 2005, (ii) allowed for the payout of deferred compensation plan participant
account balances, (iii) set required minimum EBITDA levels for each quarter of fiscal
year 2006, (iv) provided that it will be an event of default if the Company and GMAC do
not enter into a written amendment establishing required EBITDA levels for the remainder
of the term of the credit facility, (v) provided for a $3.0 million supplement to the
allowed asset-based availability that was available through February of 2006 (the Company
would owe a $30,000 fee for any calendar month in which the Company used, on more than
three days, all or part of this supplemental amount) and (vi) increased the applicable
margin on Eurodollar loans from 3% to 4%.
    
    On September 30, 2005, the Company entered into a further waiver and amendment to its
revolving credit agreement with GMAC. The credit facility amendment included a waiver
with respect to the Companys requirement to provide financial statements for the fiscal
year ended July 2, 2005 reported on without qualification by the Companys independent
registered public accounting firm, set new required minimum EBITDA levels for each
quarter of fiscal year 2006 and increased the applicable margin on Eurodollar loans from
4% to 5% and the applicable margin on prime rate loans from 0.75% to 2.75%. GMAC also
required an appraisal of the Companys inventory within 45 days, which was provided.
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WeightedAverageShares
    
    
    PriceOutstanding at July 2, 2005
    
    
    331,409
    
    
    $
    6.75Granted
    
    
    
    
    
    
    N/AExercised
    
    
    
    
    
    
    N/AForfeited
    
    
    (13,750
    )
    
    $
    6.75Outstanding at April 1, 2006
    
    
    317,659
    
    
    $
    6.75Option price range  April 1, 2006
    
    
    
    
    
    $
    6.75Option price range  Exercised Shares
    
    
    
    
    
    
    N/AOptions available for grant  April 1, 2006
    
    
    
    
    
    
    99,091Options Exercisable  April 1, 2006
    
    
    
    
    
    
    317,659Weighted average fair value  Options Granted
    
    
    
    
    
    
    N/A
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Service Shares
    
    Performance SharesTotal
    
    Stock
    
    Phantom
    
    Stock
    
    PhantomShares
    
    Awards
    
    Awards
    
    Awards
    
    AwardsOutstanding at July 2, 2005
    
    
    58,827
    
    
    
    17,650
    
    
    
    11,767
    
    
    
    17,646
    
    
    
    11,764Granted
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Exercised
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Forfeited
    
    
    5,334
    
    
    
    1,600
    
    
    
    1,067
    
    
    
    1,600
    
    
    
    1,067Outstanding at April 1, 2006
    
    
    53,493
    
    
    
    16,050
    
    
    
    10,700
    
    
    
    16,046
    
    
    
    10,697
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(In thousands)
    
    Three Months
    
    
    Nine MonthsEnded
    
    
    Ended4/2/2005
    
    
    4/2/2005Net loss, as reported
    
    $
    (3,055
    )
    
    $
    (15,601
    )Add stock-based employee compensation expense
included in reported net loss, net of tax
    
    
    11
    
    
    
    44Less total stock-based compensation expense
determined under fair value based method, net
of related tax effects
    
    
    (11
    )
    
    
    (44
    )Pro forma net loss
    
    $
    (3,055
    )
    
    $
    (15,601
    )
        12




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2006 Business Plan
  Asset Impairment
  Restructuring
  13




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EmployeeTermination
    
    
    OtherCosts
    
    
    Expenses
    
    
    TotalRestructuring liability at July 2, 2005
    
    $
    993,000
    
    
    $
    61,000
    
    
    $
    1,054,000Restructuring charge recognized during
the quarter ended October 1, 2005
    
    
    2,728,000
    
    
    
    100,000
    
    
    
    2,828,000Less payments made during the quarter
ended October 1, 2005
    
    
    263,000
    
    
    
    9,000
    
    
    
    272,000Less payments made during the quarter
ended December 31, 2005
    
    
    288,000
    
    
    
    56,000
    
    
    
    344,000Less payments made during the quarter
ended April 1, 2006
    
    
    686,000
    
    
    
    
    
    
    
    686,000Restructuring liability at April 1, 2006
    
    $
    2,484,000
    
    
    $
    96,000
    
    
    $
    2,580,000
 2005 Realignment Plan
  Asset Impairment
   Restructuring
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® ®
  CAUTIONARY STATEMENT CONCERNING FORWARD-LOOKING INFORMATION
     Management Overview and Company Outlook
 The Current Environment.
   16




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Exit from the Synthetics Business.
  Our Cotton Business.
   17




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Our Commercial Cotton (Khaki) Business.
   Our Government Business.
       18




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Third Quarter Fiscal Year 2006.
    1.
    
    Unabsorbed fixed manufacturing costs associated with running our plants at less than
full capacity.2.
    
    Substantial energy cost increases especially in the cost of natural gas used in our
finishing operation.3.
    
    Depressed prices for our commercial cotton products due to domestic overcapacity and
imports.
  Strategic Planning
  1.
    
    In March of 2007 our current revolving credit facility with GMAC matures.2.
    
    On September 1, 2007 our Senior Notes mature.
  Senior Notes Tender Offer and Consent Solicitation.
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GMAC Credit Facility Amendment (the New Credit Facility).
  New Credit
Facility
 
    
    The New Credit Facility will have a three-year term and will consist of a $31 million
revolving credit facility and up to a $9 million term loan facility. Delta Mills
factoring arrangement with GMAC will also be amended and extended for a term of three
years.
    
    The purpose of the New Credit Facility will be to provide funds for the Offer and (at a
discount satisfactory to the lender) any other purchase of the Senior Notes, for working
capital purposes and for related expenses.
    
    The borrowing base under the revolving credit facility will consist of the sum of (i) up
to 90% of eligible factored accounts receivable, and (ii) up to the lesser of (x) 50% of
the lower of cost or market of eligible inventory or (y) $15 million, less (a) an
availability block of up to $7 million, and less (b) such reserves as are determined from
time to time by the lender, which reserves may include a portion or all of the amount of
the term loan facility as described below. The revolving credit facility will include a $2
million sublimit for letters of credit, and will mature three years from closing of the New
Credit Facility. As described below, after completion of the Offer and depending in part
on how many Senior Notes are tendered in the Offer, the New Credit Facility may require
that some or all of the term loan facility be reserved against the borrowing base under the
revolving credit portion of the New Credit Facility. We refer to the amount of the term
loan facility that will not be required to be reserved against the revolving credit
facilitys borrowing base as the Unreserved Term Loan Facility.
    
    The term loan facility will be up to $9 million. Borrowings needed to fund the Offer
must be made under the term loan facility. The term loan facility will include a multiple
draw feature with the proceeds to fund purchase of the Senior Notes pursuant to the Offer
or (at a discount satisfactory to the lender) otherwise. Any permitted draws under the
term loan facility must be made prior to March 31, 2007. The term loan will amortize
monthly based on a five-year level principal amortization schedule with repayment of all
outstanding amounts required three years from closing.
    
    Promptly following closing of the Offer, we must grant first priority liens in favor of
the lender on all or substantially all of our machinery and equipment and, subject to the
lender receiving environmental reports satisfactory to it, on all or substantially all of
our real property. The size of the Unreserved Term Loan Facility (which will be reduced by
any future sales of assets that are included in the calculation of the Unreserved Term Loan
Facility amount) will be determined by the lender based in large part on the appraised
values of (and results of environmental reports respecting) certain of the fixed assets
that constitute collateral from time to time under the New Credit Facility. The appraisals
of the fixed assets to be included in the calculation of the Unreserved Term Loan Facility
amount have been obtained, and we estimate that within approximately 2 weeks GMAC will
obtain the environmental reports respecting the real property expected to be included in
the calculation of the Unreserved Term Loan Facility amount.
    
    Any outstanding borrowings under the term loan facility in excess of the Unreserved Term
Loan Facility will be required to be reserved against the borrowing base under the
revolving credit facility.
    
    Revolving credit loans will bear interest at prime plus 2.75% per annum. The term loan
will bear interest at prime plus 4.00% per annum. In addition, the New Credit Facility
will provide for other charges and fees to be paid to the lender.
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
    
    Covenants under the New Credit Facility will include restrictions (which have not yet
been determined) respecting minimum earnings before interest, taxes, depreciation and
amortization, maximum leverage, minimum fixed charge coverage and capital expenditures and
possibly other restrictions.
    
    Proceeds of asset sales (above a level to be negotiated) will be required to be applied
to repay amounts outstanding under the New Credit Facility. Repayments resulting from the
sale of fixed assets will reduce the term loan facility. Sales of fixed assets that are
included in the calculation of the Unreserved Term Loan Facility amount will also reduce
the Unreserved Term Loan Facility amount. Delta Mills is currently listing for sale its
Pamplico plant and related real property (which will not be taken into account in the
calculation of the Unreserved Term Loan Facility amount) at a listing price of
approximately $2.5 million. In addition, the Company currently anticipates listing for
sale approximately 53 acres of land (which is expected to be included in the calculation of
the Unreserved Term Loan Facility amount) that is adjacent to, but not needed for the
operations of, its Beattie plant, but has not yet determined the listing price for this
property. Any net proceeds from the sale of these properties will be used to prepay the
term loan under the New Credit Facility. In addition, any net proceeds from the sale of
the 53 acres of land adjacent to the Beattie plant will reduce the amount of the Unreserved
Term Loan Facility by the collateral value of that land. The Company cannot, however, be
certain that either of these properties will sell at a price equal or approximately equal
to its listing price.
    
    Events of default under the New Credit Facility will include the circumstance of any
Senior Notes remaining outstanding on March 31, 2007.
    
    Closing of the New Credit Facility is subject to the fulfillment of several conditions,
such as that no material adverse change will have occurred in the business, operations,
assets, properties, liabilities, profits, prospects or financial position of the Company.
    If the Senior Notes Tender Offer and Consent Solicitation are Not Successful.
  21




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In Conclusion.
    
    
    As discussed in Note C to our consolidated financial statements in Item 1 above, the Company has suffered recurring
losses from operations and has uncertainties with regard to its ability to operate within the availability established
by its revolving credit facility.
    
    Delays or reductions in federal government funding for the purchase of military fabrics could reduce the running
schedules, and hence the profitability, of our government business.
    
    If the federal government were to change its policy respecting U.S. sourcing requirements for military fabrics and
permit sourcing from foreign competitors with lower production costs, our government business would be materially
adversely affected.
    
    Due in part to the United States military involvement in Iraq and Afghanistan and the transition to a new military
uniform, our government business is at near historic high levels. It is unlikely that this situation will continue
indefinitely.
    
    Changes in the retail demand for khaki products could reduce our apparel manufacturer customers demand for our
commercial cotton products.
    
    The continuation  or exacerbation  of adverse competitive conditions in the apparel and textile industries,
particularly, but not limited to, continued pressure from imports, primarily from China, and the high level of
overcapacity in the domestic textile industry, could prevent us from returning to profitability.
    
    Continued high energy costs and the associated effect on the U.S. economy reduce the profitability of our business by
increasing our production costs and reducing retail demand for the apparel products of our commercial customers and
therefore the demand for our commercial cotton products.
    
    Material increases in the costs of yarn and greige fabric could adversely affect our business.
    
    Because we compete with foreign textile companies, increases in the strength of the U.S. dollar against the currencies
of our foreign competitors (which reduce the price for their goods compared to ours) would generally impair our
competitive position.
    
    Changes in U.S. and international trade regulations, including without limitation the end of quotas on textile and
apparel products among WTO member states in January 2005, have had a significant adverse impact on our
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competitive position. The effect on us of the Dominican Republic  Central
American U.S. Free Trade Agreement (DR-CAFTA), which will eliminate duties on
apparel coming from DR-CAFTA member states, remains to be seen. Further
changes in trade regulations could adversely impact our competitive position
and profitability.
    
    The success of our business plan is dependent on
predictable plant operating schedules supported by
timely customer orders in both the commercial and the
government product lines. We believe that some of
our customers are concerned about the uncertainties
facing the Company. Our business would be materially
adversely affected if our customers were to transfer
a material portion of their fabric requirements to
our competitors, whether as a result of these
concerns or otherwise.
    
    We have relied on waivers and amendments from Delta
Mills credit facility lender, GMAC, in order to be
in compliance with the credit facility covenants.
Were GMAC to refuse to waive or cure by amendment any
future default and accelerate the credit facility,
our ability to refinance the debt would be doubtful.
If GMAC were to accelerate the credit facility in an
event of default, holders of Delta Mills Senior Notes
or the indenture trustee could also accelerate the
Senior Notes.
    
    The outstanding $30,941,000 principal balance of
Delta Mills 9.625% Senior Notes is due on September
1, 2007. Our current revolving credit facility
matures in March 2007. We will need to refinance the
revolving credit debt and refinance or restructure
the Senior Notes prior to March 2007 in order to be
able to continue operations. Particularly in light
of our results over the last several fiscal quarters
and the continued challenges in our industry, there
is significant uncertainty and no assurance that a
refinancing or restructuring can be successfully
accomplished in a timely fashion or at all. If the
tender offer and consent solicitation described above
is not successfully completed or we are unable to
enter into the New Credit Facility as anticipated,
numerous factors will affect whether we are able to
refinance our revolving credit debt and refinance or
restructure the Senior Notes, including, among other
factors, our operating results and our ability to
obtain the necessary financing for any selected
course of action.
    
    Our ability to borrow under the Companys revolving
credit facility is based, and our ability to incur
revolving credit loans under the anticipated New
Credit Facility will be based, primarily on a formula
under which the Company may borrow up to
approximately 90% of outstanding accounts receivable
balances plus approximately 50% of certain inventory
balances. If, due to the timing of billings to
customers, inventories increase and accounts
receivable decrease, the Company may be unable to
borrow the funds needed to respond to customer
demands or to meet other needs for cash.
    
    We rely on the willingness of our principal vendors
and suppliers to supply us product in accordance with
reasonable payment terms. Any significant tightening
of these terms could materially adversely affect our
operations.
    
    We believe that the success of our business depends
on our ability to retain employees in the face of
continued pressures in the industry, and there can be
no assurance that we will be able to do so.
    
    The impact of natural disasters such as hurricanes,
acts of terrorism and other instances of Force
Majeure could have unforeseen adverse impacts on our
business and financial condition.
    
    The future discovery of currently unknown conditions,
such as environmental matters and similar items,
could result in significant unforeseen liability or
costs to us and disrupt our ability to successfully
execute our business plan.
 23




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Results of Operations
Third Quarter of Fiscal Year 2006 Versus Third Quarter of Fiscal Year 2005
  Three Months
    
    Three MonthsEnded
    
    Ended
    
    Increase/ (Decrease)April 2, 2006
    
    April 2, 2005
    
    From 2005 to 2006Net Sales
    
    $
    32,659
    
    
    $
    40,064
    
    
    $
    (7,405
    )% of Net Sales
    
    
    100.00
    %
    
    
    100.00
    %Gross Profit (Loss)
    
    
    1,353
    
    
    
    (128
    )
    
    
    1,481% of Net Sales
    
    
    4.14
    %
    
    
    (0.32
    )%Selling, General and Administrative Expenses
    
    
    2,327
    
    
    
    2,396
    
    
    
    (69
    )% of Net Sales
    
    
    7.13
    %
    
    
    5.98
    %Other Income
    
    
    70
    
    
    
    321
    
    
    
    (251
    )Operating Loss
    
    
    (904
    )
    
    
    (2,203
    )
    
    
    (1,299
    )% of Net Sales
    
    
    (2.77
    )%
    
    
    (5.50
    )%Interest Expense
    
    
    (1,216
    )
    
    
    (1,352
    )
    
    
    136% of Net Sales
    
    
    (3.72
    )%
    
    
    (3.37
    )%Gain on extinguishment of debt
    
    
    
    
    
    
    500
    
    
    
    (500
    )Loss Before Income Taxes
    
    
    (2,120
    )
    
    
    (3,055
    )
    
    
    (935
    )% of Net Sales
    
    
    (6.49
    )%
    
    
    (7.63
    )%Income Tax Benefit
    
    
    
    
    
    
    
    
    
    
    % of Net Sales
    
    
    0.00
    %
    
    
    0.00
    %Net Loss
    
    $
    (2,120
    )
    
    $
    (3,055
    )
    
    
    935% of Net Sales
    
    
    (6.49
    )%
    
    
    (7.63
    )%Order Backlog
    
    $
    42,785
    
    
    $
    61,930
    
    
    $
    (19,145
    )
 24




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##### Table of Contents



Net Sales:
  Gross Profit (Loss):
  Selling, General and Administrative Expenses:
  Operating Loss:
  Interest Expense:
  Gain on extinguishment of debt:
  Income Tax Benefit:
  Net Loss:
  Order Backlog:
   25




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##### Table of Contents



Results of Operations
First Nine Months of Fiscal Year 2006 Versus First Nine Months of Fiscal Year 2005
  Nine Months
    
    Nine MonthsEnded
    
    Ended
    
    Increase/ (Decrease)April 1, 2006
    
    April 2, 2005
    
    From 2005 to 2006Net Sales
    
    $
    100,193
    
    
    $
    114,814
    
    
    $
    (14,621
    )% of Net Sales
    
    
    100.00
    %
    
    
    100.00
    %Gross Profit (Loss)
    
    
    1,229
    
    
    
    (1,244
    )
    
    
    2,473% of Net Sales
    
    
    1.23
    %
    
    
    (1.08
    )%Selling, General and Administrative Expenses
    
    
    6,486
    
    
    
    7,724
    
    
    
    (1,238
    )% of Net Sales
    
    
    6.47
    %
    
    
    6.73
    %Impairment and Restructuring Expenses
    
    
    2,828
    
    
    
    7,350
    
    
    
    (4,522
    )Other Income
    
    
    208
    
    
    
    382
    
    
    
    (174
    )Operating Loss
    
    
    (7,877
    )
    
    
    (15,936
    )
    
    
    8,059% of Net Sales
    
    
    (7.86
    )%
    
    
    (13.88
    )%Interest Expense
    
    
    (4,158
    )
    
    
    (3,908
    )
    
    
    250% of Net Sales
    
    
    (4.15
    )%
    
    
    (3.40
    )%Gian on extinguishment of debt
    
    
    
    
    
    
    500
    
    
    
    (500
    )Loss Before Income Taxes
    
    
    (12,035
    )
    
    
    (19,344
    )
    
    
    7,309% of Net Sales
    
    
    (12.01
    )%
    
    
    (16.85
    )%Income Tax Benefit
    
    
    0
    
    
    
    (3,743
    )
    
    
    3,743% of Net Sales
    
    
    0.00
    %
    
    
    (3.26
    )%Net Loss
    
    $
    (12,035
    )
    
    $
    (15,601
    )
    
    
    3,566% of Net Sales
    
    
    (12.01
    )%
    
    
    (13.59
    )%
 26




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##### Table of Contents



Net Sales:
  Gross Profit (Loss):
  Selling, General and Administrative Expenses:
  Impairment and Restructuring Expenses:
  Operating Loss:
  Interest Expense:
  Gain on extinguishment of debt:
  Income Tax Benefit:
  Net Loss:
  27




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##### Table of Contents



Liquidity and Sources of Capital
 Liquidity.
 1.
    
    Government business:
 
    
    revenues remaining at approximately the fiscal year 2006 level for fiscal year 2007
and beyond
    
    minimal disruption in order flow from the factors discussed in Management Overview
and Company Outlook  Our Government Business
    
    U.S. government funding for military uniforms is not materially delayed or decreased
as a result of delays in the budgeting process or other demands on government resources
    
    a moderation in the rate of increase in energy and chemical costs
    
    continued credit approval of the government businesss customer base by our factor GMAC
 2.
    
    Commercial cotton business:
 
    
    maintaining fiscal year 2005 revenue levels in fiscal year 2006 and beyond
    
    improved margins based on the continuation of current trends in sales prices and raw material costs
    
    a moderation in the rate of increase in energy and chemical costs
    
    continued credit approval of the commercial cotton businesss customer base by our factor GMAC
 3.
    
    Payment terms required by our principal vendors and suppliers do not become materially
more stringent
  1.
    
    the foregoing assumptions remain valid;2.
    
    The Company enters into the New Credit Facility or a substantially similar extension, renewal
or refinancing of the existing GMAC revolving credit agreement; and3.
    
    with respect to the tender offer:
 
    
    The tender offer results in the acquisition by the Company of all of the outstanding
Notes; or
    
    A majority of the outstanding Notes are tendered and purchased by the Company
pursuant to the tender offer, the necessary Consents to amend the Senior Notes
indenture are received, and the Company is able to purchase the remaining outstanding
Notes at a substantial discount prior to March 31, 2007; or
    
    If the tender offer and consent solicitation are not successful, the Company is able
to purchase the outstanding Notes at a substantial discount prior to March 31, 2007.
  28




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Sources and Uses of Cash.
   Delta Mills 9.625% Senior Notes.
  The GMAC Revolving Credit Facility.
 29




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##### Table of Contents



Restrictive Covenants.
 Cross-Default Clause in the Indenture.
 Need for Refinancing or Restructuring by 2007.
  30




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Other Matters.
     CRITICAL ACCOUNTING POLICIES
  Impairment of Long  Lived Assets
 31




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Income Taxes Accounting for Income Taxes
  32




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Inventories
     
  Commodity Risk Sensitivity
  33




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Interest Rate Sensitivity
   
        34




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31.1
    
    Certification of CEO Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.31.2
    
    Certification of CFO Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.32.1
    
    Certification of CEO Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.32.2
    
    Certification of CFO Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
 35




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##### Table of Contents



Delta Mills, Inc.(Registrant)Date May 16, 2006
    
    
    
    By: /s/ W.H. Hardman, Jr.W.H. Hardman, Jr.Chief Financial Officer
 36