##### 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 December 31, 2005
 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 DriveFountain Inn, South Carolina
    
    29644(Address of principal executive offices)
    
    (Zip Code)
  
  
  þ o
  o o þ
 o þ




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##### Table of Contents



PagePART I. FINANCIAL INFORMATIONItem 1. Financial Statements (Unaudited)Condensed consolidated balance sheetsDecember 31, 2005 and July 2, 2005
    
    
    3Condensed consolidated statements of operations  Three and six months ended December 31, 2005 and January 1, 2005
    
    
    4Condensed consolidated statements of cash flows  Six months ended December 31, 2005 and January 1, 2005
    
    
    5Notes to condensed consolidated financial statements
    
    
    6-14Item 2. Managements Discussion and Analysis of Financial Condition and Results of Operations
    
    
    15-30Item 3. Quantitative and Qualitative Disclosures about Market Risk
    
    
    30-31Item 4. Controls and Procedures
    
    
    31PART II. OTHER INFORMATIONItem 1. Legal Proceedings
    
    
    32Item 1A. Risk Factors
    
    
    32Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
    
    
    32Item 3. Defaults upon Senior Securities
    
    
    32Item 4. Submission of Matters to a Vote of Security Holders
    
    
    32Item 5. Other Information
    
    
    32Item 6. Exhibits
    
    
    32SIGNATURES
    
    
    33CERTIFICATIONS
    
    
    34-37EX-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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##### Table of Contents



PART I. FINANCIAL INFORMATION
 
 ITEM 1. FINANCIAL STATEMENTS
 
 
 December 31, 2005
    
    
    July 2, 2005ASSETSCURRENT ASSETSCash
    
    $
    501
    
    
    $
    282Accounts receivable:Factor
    
    
    32,714
    
    
    
    37,039Less allowances for returns
    
    
    152
    
    
    
    10132,562
    
    
    
    36,938InventoriesFinished goods
    
    
    5,581
    
    
    
    10,004Work in process
    
    
    14,877
    
    
    
    19,507Raw materials and supplies
    
    
    4,840
    
    
    
    5,79725,298
    
    
    
    35,308Deferred income taxes
    
    
    586
    
    
    
    1,159Other assets
    
    
    1,816
    
    
    
    1,357TOTAL CURRENT ASSETS
    
    
    60,763
    
    
    
    75,044ASSETS HELD FOR SALE
    
    
    2,487
    
    
    
    1,900PROPERTY, PLANT AND EQUIPMENT, at cost
    
    
    87,115
    
    
    
    128,830Less accumulated depreciation
    
    
    51,397
    
    
    
    87,96935,718
    
    
    
    40,861DEFERRED LOAN COSTS AND OTHER ASSETS
    
    
    182
    
    
    
    237$
    99,150
    
    
    $
    118,042LIABILITIES AND SHAREHOLDERS EQUITYCURRENT LIABILITIESTrade accounts payable
    
    $
    6,604
    
    
    $
    8,349Revolving credit facility
    
    
    23,735
    
    
    
    28,444Accrued income taxes payable
    
    
    13,695
    
    
    
    13,695Payable to affiliates
    
    
    3,780
    
    
    
    3,780Accrued employee compensation
    
    
    360
    
    
    
    4,937Accrued restructuring
    
    
    3,266
    
    
    
    1,054Accrued and sundry liabilities
    
    
    5,230
    
    
    
    4,815TOTAL CURRENT LIABILITIES
    
    
    56,670
    
    
    
    65,074LONG-TERM DEBT
    
    
    30,941
    
    
    
    30,941NON-CURRENT DEFERRED INCOME TAXES
    
    
    586
    
    
    
    1,159TOTAL LIABILITIES
    
    
    88,197
    
    
    
    97,174SHAREHOLDERS EQUITYCommon Stock  par value $0.01 a share  authorized
3,000 shares, issued and outstanding 100 shares
Additional paid-in capital
    
    
    51,792
    
    
    
    51,792Accumulated deficit
    
    
    (40,839
    )
    
    
    (30,924
    )TOTAL SHAREHOLDERS EQUITY
    
    
    10,953
    
    
    
    20,868COMMITMENTS AND CONTINGENCIES$
    99,150
    
    
    $
    118,042
  3




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##### Table of Contents



Three
    
    
    Three
    
    
    Six
    
    
    SixMonths Ended
    
    
    Months Ended
    
    
    Months Ended
    
    
    Months EndedDecember 31,
    
    
    January 1,
    
    
    December 31,
    
    
    January 1,2005
    
    
    2005
    
    
    2005
    
    
    2005Net sales
    
    $
    36,763
    
    
    $
    39,310
    
    
    $
    67,534
    
    
    $
    74,750Cost of goods sold
    
    
    36,607
    
    
    
    40,735
    
    
    
    67,658
    
    
    
    75,866GROSS PROFIT (LOSS)
    
    
    156
    
    
    
    (1,425
    )
    
    
    (124
    )
    
    
    (1,116
    )Selling, general and administrative expenses
    
    
    2,063
    
    
    
    2,608
    
    
    
    4,159
    
    
    
    5,328Impairment and restructuring expenses
    
    
    
    
    
    
    7,350
    
    
    
    2,828
    
    
    
    7,350Other operating income
    
    
    76
    
    
    
    25
    
    
    
    138
    
    
    
    61OPERATING LOSS
    
    
    (1,831
    )
    
    
    (11,358
    )
    
    
    (6,973
    )
    
    
    (13,733
    )Interest expense
    
    
    (1,468
    )
    
    
    (1,265
    )
    
    
    (2,942
    )
    
    
    (2,556
    )LOSS BEFORE INCOME TAXES
    
    
    (3,299
    )
    
    
    (12,623
    )
    
    
    (9,915
    )
    
    
    (16,289
    )Income tax benefit
    
    
    
    
    
    
    (2,399
    )
    
    
    
    
    
    
    (3,743
    )NET LOSS
    
    $
    (3,299
    )
    
    $
    (10,224
    )
    
    $
    (9,915
    )
    
    $
    (12,546
    )
  4




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Six Months Ended
    
    
    Six Months EndedDecember 31, 2005
    
    
    January 1, 2005OPERATING ACTIVITIESNet loss
    
    $
    (9,915
    )
    
    $
    (12,546
    )Adjustments to reconcile net loss to net cash
provided by (used in) operating activities:Depreciation
    
    
    2,428
    
    
    
    4,381Amortization
    
    
    55
    
    
    
    55Impairment and restructuring expenses
    
    
    2,828
    
    
    
    7,350Change in deferred income taxes
    
    
    
    
    
    
    (3,737
    )Gains on disposition of property
and equipment
    
    
    (26
    )
    
    
    Deferred compensation
    
    
    (4,239
    )
    
    
    (258
    )Changes in operating assets and liabilities
    
    
    11,642
    
    
    
    2,568NET CASH PROVIDED BY (USED IN)
OPERATING ACTIVITIES
    
    
    2,773
    
    
    
    (2,187
    )INVESTING ACTIVITIESProperty, plant and equipment:Purchases
    
    
    (547
    )
    
    
    (221
    )Proceeds of dispositions
    
    
    2,702
    
    
    
    NET CASH USED IN (PROVIDED BY)
INVESTING ACTIVITIES
    
    
    2,155
    
    
    
    (221
    )FINANCING ACTIVITIESProceeds from revolving lines of credit
    
    
    69,680
    
    
    
    80,075Repayments on revolving lines of credit
    
    
    (74,389
    )
    
    
    (77,384
    )NET CASH PROVIDED BY (USED IN)
FINANCING ACTIVITIES
    
    
    (4,709
    )
    
    
    2,691INCREASE IN CASH
    
    
    219
    
    
    
    283Cash beginning of period
    
    
    282
    
    
    
    585CASH AT END OF PERIOD
    
    $
    501
    
    
    $
    868
  5




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December 31, 2005
    
    July 2, 2005Current assets
    
    $
    216
    
    
    $
    105Non-current assets
    
    
    1,975
    
    
    
    Current liabilities
    
    
    4,257
    
    
    
    2,128Non-current liabilities
    
    
    
    
    
    
    434Stockholders deficit
    
    
    (2,066
    )
    
    
    (2,457
    )
  Three Months EndedDecember 31, 2005
    
    January 1, 2005Net sales  Intercompany commissions
    
    $
    1,529
    
    
    $
    1,678Cost and expenses
    
    
    1,137
    
    
    
    1,737Net income (loss)
    
    
    392
    
    
    
    (59
    )
 6




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##### Table of Contents



1.
    
    Government business:
 
    
    revenues remaining at the fiscal year 2005 level for fiscal year 2006 and beyond
    
    minimum disruption from the problems associated with the transition to the new
uniform as discussed in Item 2. Managements Discussion and Analysis of Financial
Condition and Results of Operation  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 the costs of recovering from recent
hurricanes and 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.
    
    Exit of the synthetics business:
 
    
    the collection of substantially all of the associated accounts receivable
 4.
    
    Payment terms required by our principal vendors and suppliers do not become materially
more stringent.
    7




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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 Delta Mills 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 is available through February of 2006 (the Company
will owe a $30,000 fee for any calendar month in which the Company uses, 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 has been provided.
   8




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WeightedAverageShares
    
    PriceOutstanding at July 2, 2005
    
    
    331,409
    
    
    $
    6.75Granted
    
    
    
    
    
    
    N/AExercised
    
    
    
    
    
    
    N/AForfeited
    
    
    (7,500
    )
    
    $
    6.75Outstanding at December 31, 2005
    
    
    323,909
    
    
    $
    6.75Option price range  December 31, 2005
    
    
    
    
    
    $
    6.75Option price range  Exercised Shares
    
    
    
    
    
    
    N/AOptions available for grant  December 31, 2005
    
    
    
    
    
    
    92,841Options Exercisable  December 31, 2005
    
    
    
    
    
    
    323,909Weighted average fair value  Options Granted
    
    
    
    
    
    
    N/A
    9




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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
    
    
    3,334
    
    
    
    1,000
    
    
    
    667
    
    
    
    1,000
    
    
    
    667Outstanding at December 31, 2005
    
    
    55,493
    
    
    
    16,650
    
    
    
    11,100
    
    
    
    16,646
    
    
    
    11,097
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Three Months
    
    
    Six MonthsEnded
    
    
    Ended1/1/2005
    
    
    1/1/2005(In thousands)Net loss, as reported
    
    $
    (10,224
    )
    
    $
    (12,546
    )Add stock-based employee compensation expense
included in reported net loss, net of tax
    
    
    16
    
    
    
    33Less total stock-based compensation expense
determined under fair value based method, net
of related tax effects
    
    
    (16
    )
    
    
    (33
    )Pro forma net loss
    
    $
    (10,224
    )
    
    $
    (12,546
    )
    11




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2006 Business Plan
  12




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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
    
    
    
    344,000Restructuring liability at December 31, 2005
    
    $
    3,170,000
    
    
    $
    96,000
    
    
    $
    3,266,000
 2005 Realignment Plan
   13




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14




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Item 2.
    
    MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
   CAUTIONARY STATEMENT CONCERNING FORWARD-LOOKING INFORMATION
     Management Overview and Company Outlook
 The Current Environment.
   15




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Synthetics Business.
  Our Cotton Business.
   16




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Our Commercial Cotton (Khaki) Business.
   Our Government Business.
   1.
    
    The transition to the new uniform has been problematic for all of our
garment-manufacturing customers, causing some volatility in the order flow. The rate of
production continues to improve but has not reached optimum levels.2.
    
    Our government business is significantly affected by the timing and amount of federal
budget allocations to the procurement of military uniforms. Proposed allocations for the
U.S. Governments fiscal year beginning October 1, 2005 were consistent with our
expectations and support our estimate that our government sales in fiscal year 2006 will
remain near the same high level as in fiscal year 2005, which were
near historic levels. The timing for funding to move through the supply chain is uncertain; however, production and sales rates
substantially improved in our second fiscal quarter as compared to the first fiscal
quarter.3.
    
    Funding shortages and the problems encountered by the garment manufacturers in fiscal
year 2005 disrupted the governments planned transition from the old battle dress uniform
to the new one. Consequently, the government placed a stop work order on the old battle
dress uniform in order to maintain manageable inventory levels. The government accepted
responsibility for the stop work order and negotiated settlements with the various garment
manufacturers with respect to their inventory and the inventory of their fabric suppliers.
As a result of this settlement process, as of October 1, 2005, all of our finished fabric
associated with the stop work order was sold to the appropriate garment manufacturer and we
do not anticipate any further impact from the stop work order.
  17




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##### Table of Contents



Second Quarter Fiscal Year 2006.
    1.
    
    Unabsorbed fixed manufacturing costs associated with running our plants at less than
full capacity.2.
    
    Substantial energy costs increases especially in the costs 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 revolving credit facility with GMAC matures.2.
    
    In August of 2007 our Senior Notes mature.
  The Termination of the Deferred Compensation Plan.
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GMAC Amendment.
   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
 19




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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 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 2006 Business Plan is dependent on predictable plant operating schedules supported by
timely customer orders in both the commercial and the government product lines.
    
    We have relied on waivers and amendments from the Companys 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 the Companys 9.625% Senior Notes is due in August 2007.
Our 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. 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 our revolving credit facility is based primarily on a formula under which we
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, we 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.
 20




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Results of Operations
Second Quarter of Fiscal Year 2006 Versus Second Quarter of Fiscal Year 2005
  Three Months
    
    Three MonthsEnded
    
    Ended
    
    Increase/ (Decrease)December 31, 2005
    
    January 1, 2005
    
    From 2005 to 2006Net Sales
    
    $
    36,763
    
    
    $
    39,310
    
    
    $
    (2,547
    )% of Net Sales
    
    
    100.00
    %
    
    
    100.00
    %Gross Profit (Loss)
    
    
    156
    
    
    
    (1,425
    )
    
    
    1,581% of Net Sales
    
    
    0.42
    %
    
    
    (3.63
    )%Selling, General and Administrative Expenses
    
    
    2,063
    
    
    
    2,608
    
    
    
    (545
    )% of Net Sales
    
    
    5.61
    %
    
    
    6.63
    %Impairment and restructuring expenses
    
    
    
    
    
    
    7,350
    
    
    
    (7,350
    )Other Income
    
    
    76
    
    
    
    25
    
    
    
    51Operating Loss
    
    
    (1,831
    )
    
    
    (11,358
    )
    
    
    (9,527
    )% of Net Sales
    
    
    (4.98
    )%
    
    
    (28.89
    )%Interest Expense
    
    
    (1,468
    )
    
    
    (1,265
    )
    
    
    (203
    )% of Net Sales
    
    
    (3.99
    )%
    
    
    (3.22
    )%Loss Before Income Taxes
    
    
    (3,299
    )
    
    
    (12,623
    )
    
    
    (9,324
    )% of Net Sales
    
    
    (8.97
    )%
    
    
    (32.11
    )%Income Tax Benefit
    
    
    
    
    
    
    (2,399
    )
    
    
    2,399% of Net Sales
    
    
    0.00
    %
    
    
    (6.10
    )%Net Loss
    
    $
    (3,299
    )
    
    $
    (10,224
    )
    
    
    6,925% of Net Sales
    
    
    (8.97
    )%
    
    
    (26.01
    )%Order Backlog
    
    $
    39,913
    
    
    $
    59,840
    
    
    $
    (19,927
    )
 21




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Net Sales:
  Gross Profit (Loss):
  Selling, General and Administrative Expenses:
  Impairment and Restructuring Expenses:
  Operating Loss:
  Interest Expense:
  Income Tax Benefit:
  Net Loss:
  Order Backlog:
   22




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Results of Operations
First Six Months of Fiscal Year 2006 Versus First Six Months of Fiscal Year 2005
  Six Months
    
    Six MonthsEnded
    
    Ended
    
    Increase/ (Decrease)December 31, 2005
    
    January 1, 2005
    
    From 2005 to 2006Net Sales
    
    $
    67,534
    
    
    $
    74,750
    
    
    $
    (7,216
    )% of Net Sales
    
    
    100.00
    %
    
    
    100.00
    %Gross Loss
    
    
    (124
    )
    
    
    (1,116
    )
    
    
    992% of Net Sales
    
    
    (0.18
    )%
    
    
    (1.49
    )%Selling, General and Administrative Expenses
    
    
    4,159
    
    
    
    5,328
    
    
    
    (1,169
    )% of Net Sales
    
    
    6.16
    %
    
    
    7.13
    %Impairment and Restructuring Expenses
    
    
    2,828
    
    
    
    7,350
    
    
    
    (4,522
    )Other Income
    
    
    138
    
    
    
    61
    
    
    
    77Operating Loss
    
    
    (6,973
    )
    
    
    (13,733
    )
    
    
    6,760% of Net Sales
    
    
    (10.33
    )%
    
    
    (18.37
    )%Interest Expense
    
    
    (2,942
    )
    
    
    (2,556
    )
    
    
    386% of Net Sales
    
    
    (4.36
    )%
    
    
    (3.42
    )%Loss Before Income Taxes
    
    
    (9,915
    )
    
    
    (16,289
    )
    
    
    6,374% of Net Sales
    
    
    (14.68
    )%
    
    
    (21.79
    )%Income Tax Benefit
    
    
    0
    
    
    
    (3,743
    )
    
    
    3,743% of Net Sales
    
    
    0.00
    %
    
    
    (5.01
    )%Net Loss
    
    $
    (9,915
    )
    
    $
    (12,546
    )
    
    
    2,631% of Net Sales
    
    
    (14.68
    )%
    
    
    (16.78
    )%
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##### Table of Contents



Net Sales:
  Gross Loss:
  Selling, General and Administrative Expenses:
  Impairment and Restructuring Expenses:
  Operating Loss:
  Interest Expense:
  Income Tax Benefit:
  Net Loss:
  Liquidity and Sources of Capital
 Liquidity.
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##### Table of Contents



1.
    
    Government business:
 
    
    revenues remaining at the fiscal year 2005 level for fiscal year 2006 and beyond
    
    minimum disruption from the problems associated with the transition to the new
uniform as 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 the costs of recovering from recent
hurricanes and 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.
    
    Exit of the synthetics business:
 
    
    the collection of substantially all of the associated accounts receivable
 4.
    
    Payment terms required by our principal vendors and suppliers do not become materially
more stringent.
  Sources and Uses of Cash.
 25
    Table of Contents       Delta Mills 9.625% Senior Notes.
 The GMAC Revolving Credit Facility.
 26
    Table of Contents    
    
    On August 9, 2005, the Company and GMAC 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 is available through February of 2006 (the
Company will owe a $30,000 fee for any calendar month in which the Company uses, 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
required an appraisal of the Companys inventory within 45 days, which has been provided.
 Restrictive Covenants.
 Cross-Default Clause in the Indenture.
 Need for Refinancing or Restructuring by 2007. 27
    Table of Contents    Other Matters.
   CRITICAL ACCOUNTING POLICIES
  Impairment of Long  Lived Assets 28
    Table of Contents       Income Taxes Accounting for Income Taxes
  29
    Table of Contents      Inventories
     
  Commodity Risk Sensitivity
 30
    Table of Contents    Interest Rate Sensitivity
   
       31




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##### Table of Contents



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.
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Delta Mills, Inc.(Registrant)Date
February 14, 2006
    
    By: /s/ W.H. Hardman, Jr.W.H. Hardman, Jr.Chief Financial Officer
 33