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Business Description GENERAL Founded in 1882, the Company is a leading manufacturer and marketer of textile products for the home fashions and apparel fabrics markets. The Company designs, manufactures and markets a coordinated line of value-added home fashions products consisting of packaged bedroom furnishings such as comforters, sheets, pillowcases, shams, bed skirts, decorative pillows and draperies. These products are marketed under the "Dan River" brand name as well under licenses from, among others, "Colours by Alexander Julian," "D. Porthault," "John Wilman," "Liberty" and "Nautica." Dan River also manufactures and markets a broad range of high quality woven cotton and cotton-blend apparel fabrics and believes that it is the leading supplier of men's dress shirting fabrics in North America (based on net sales). On February 3, 1997, the Company acquired substantially all of the assets and certain liabilities of Cherokee, which was a competitor of the Company and a supplier of yarn-dyed fabrics to men's and women's shirting manufacturers and of sportswear fabrics to the converting trade. The assets purchased consisted primarily of two woven fabrics manufacturing facilities located in Spindale, North Carolina and Sevierville, Tennessee and a finishing facility located in Harris, North Carolina, together with associated real property, machinery and equipment, inventories and receivables. The Company presently intends to continue the current operations of all three facilities. The following table sets forth for the periods indicated the dollar amount and percentage of total net sales of the Company attributable to home fashions products and apparel fabrics: PRO FORMA FISCAL YEAR PRO NINE MONTHS ENDED NINE MONTHS -------------------------------------- FORMA ------------------- ENDED FISCAL SEPT. 28, SEPT. 27, SEPT. 27, (IN MILLIONS) Dollar amount: Home fashions products. $180.4 $179.4 $213.3 $231.8 $243.2 $243.2 $173.1 $183.0 $183.0 Apparel fabrics........ 152.6 138.2 158.2 153.0 136.4 237.4 98.9 161.2 170.4 Total................ $333.0 $317.6 $371.5 $384.8 $379.6 $480.6 $272.0 $344.2 $353.4 Percentage: Home fashions products. 54.2% 56.5% 57.4% 60.2% 64.1% 50.6% 63.6% 53.2% 51.8% Apparel fabrics........ 45.8 43.5 42.6 39.8 35.9 49.4 36.4 46.8 48.2 Total................ 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% (1) Gives effect to the Cherokee Acquisition as if it had been consummated at the beginning of each of the periods presented. BUSINESS STRATEGY The Company's principal business objective is to continue to expand the sales of its home fashions products and apparel fabrics, while improving the overall profitability of its operations. The primary components of the Company's business strategy include the following: . Capitalize on Profit Opportunities in Home Fashions Market. The Company focuses on the sale of higher thread count percale products (180 threads per square inch and above), printed products and accessory items (products other than individually packaged sheets and pillowcases) which enhance the Company's competitiveness, sales growth and profitability. The Company's net sales attributable to home fashions products have been driven by improved product and customer mix and product innovation. The Company's customer-specific marketing strategy is designed to (i) create specialized products that provide differentiation from competitors and enable both the Company and its customers to increase sales and margins, and (ii) attract value conscious consumers by offering high quality products at reasonable prices. Accordingly, the Company works directly with retailers to develop value- added, fashion-oriented products (as opposed to solid color commodity products) that are periodically updated to respond to changing consumer preferences, thereby improving retailers' inventory turn rates and associated profitability. . Expand Distribution of Home Fashions Products Through Strategic Relationships with Major Retailers. The Company aggressively markets its home fashions products to, and has developed significant business relationships with, key retailers in all retail trade classes, including department stores, mass merchandisers, discount stores, national chain stores, specialty stores and warehouse clubs. Establishing and expanding these key distribution channels has strengthened consumer recognition of the "Dan River" brand name and increased sales. The Company has established strategic relationships with large, high volume retailers such as Wal-Mart Stores, Inc., Kmart Corporation, Federated Department Stores, Inc., J.C. Penney Company, Inc. and The May Department Stores Company, by providing high quality products together with superior customer service. . Enhance Strong Apparel Fabrics Market Position. Dan River seeks to enhance its position as a leading producer of apparel fabrics by focusing on customer relationships, anticipating fashion trends, developing new innovative products and reducing manufacturing lead times. Management believes that (i) the significant reduction in manufacturing costs achieved through its aggressive facility modernization program, (ii) the increase in the size of its apparel fabrics operations and attendant reduction in fixed costs on a per unit basis as a result of the Cherokee Acquisition and (iii) its diverse customer base will make Dan River's apparel fabrics business less sensitive to the cyclicality experienced by the textile industry in general and will further increase the Company's profitability. Management also believes that demand for apparel fabrics manufactured in North America and the Caribbean will continue to increase as a result of NAFTA, and the Caribbean Basin Recovery Act and the increasing importance of geographic proximity in enabling shortened delivery times. The Company believes the Cherokee Acquisition will enhance its ability to benefit from this opportunity. . Reduce Production Costs and Improve Productivity. The Company is a low cost producer. During the past five fiscal years, the Company has invested approximately $150 million in an extensive facility modernization program focused on installing the most advanced manufacturing technologies making the Company more competitive and cost- efficient. As a result of this program as well as other improvements made by the current management team since the Company was acquired in 1989, the Company has significantly increased productivity, reduced costs and improved product quality. From fiscal 1990 through September 1997, the Company substantially improved productivity by (i) increasing weaving efficiencies within its home fashions and apparel fabrics operations by 12% and 11%, respectively, (ii) increasing square yards of greige (unfinished) fabrics produced per man hour within its home fashions and apparel fabrics operations by 151% and 48%, respectively, and (iii) increasing square yards of finished fabrics produced per man hour by 11%. During the same period, the Company achieved significant cost reductions by (i) reducing off-quality production of home fashions products and apparel fabrics by 46% and 45%, respectively, (ii) reducing pounds of waste generated by its manufacturing operations and (iii) reducing its manufacturing work force by 30% excluding the effect of the Cherokee Acquisition. The Company intends to continue to modernize its operations and improve its low cost position. . Attain Textile Industry Leadership in Information Technology. The Company has invested significantly in information technology to provide improved and differentiated services. The Company has implemented an advanced supply chain management system which reduces manufacturing lead-time and enhances the Company's ability to respond to customers' requirements. The Company's electronic data interchange (EDI) systems, quick response customer delivery programs and point-of-sale decision support systems enable customers to maintain lower inventory levels and react faster to changes in product demand, thereby improving their operating results. In addition, the Company employs continuous inventory replenishment and dedicated manufacturing programs with certain customers to enhance service. Planned investments in information technology include the implementation of a new enterprise resource planning (ERP) system along with additional continuous inventory replenishment programs. . Enhance Financial Flexibility. The Company seeks to maintain a capital structure that will position it for growth through expansion of existing operations and potential acquisitions as well as provide stability during cyclical downturns. The textile industry generally, and in particular marketers of home fashions products, have undergone significant consolidation in recent years and the Company anticipates that this trend will continue. The Company believes that, following completion of the Offering, its strong balance sheet will enable it to capitalize on attractive acquisition opportunities. HOME FASHIONS OPERATIONS Products The Company designs, manufactures and markets a coordinated line of value- added home fashions products, consisting of packaged bedroom furnishings such as comforters, sheets, pillowcases, shams, bed skirts, decorative pillows and draperies which are marketed under the "Dan River" brand name, as well as under various other trademarks and licenses from, among others, "Colours by Alexander Julian," "D. Porthault," "John Wilman," "Liberty" and "Nautica." Home fashions products are offered in a wide variety of styles and patterns, including fashion designs and, to a lesser extent, solid colors. Products range from a 120-thread count muslin sheet of blended polyester and cotton to a top-of-the-line 250-thread count percale 100% cotton sheet. The Company focuses on value-added, higher margin products, such as percales and printed products and accessory items (products other than sheets and pillowcases), which the Company believes enhance its competitiveness and will enable it to increase sales. The Company believes that its percentage of net sales of home fashions products attributable to these higher margin products is among the highest in the industry. Dan River has established itself as an innovator in merchandising home fashions products. The Company was a leader in introducing the complete bed ensemble, which it markets under the name "Bed-in-a-Bag." The "Bed-in-a-Bag" complete bed ensemble consists of a comforter with matching sheets, pillowcases, shams and a dust ruffle. This merchandising concept capitalizes on the Company's design capabilities and manufacturing flexibility, enabling the Company to develop and manufacture customer-specific "Bed-in-a-Bag" products. These packaged sets, which accounted for 40.3% of the Company's net sales of home fashions products for the first nine months of fiscal 1997, provide attractive profit margins for the Company and its customers, while offering consumers value and convenience. In addition, "Bed-in-a-Bag" complete bed ensembles increase retailers' inventory turns and help them avoid markdowns on unsold products. Dan River also manufactures and sells home fashions products manufactured from yarn-dyed fabrics (as opposed to printed or solid-colored fabrics), which have expanded the styling available in this product line. Management believes that the Company's ability to manufacture wide-width, yarn-dyed fabrics in short runs in a wide variety of innovative styles, such as woven plaids, for use in home fashions products differentiates the Company from its competitors. Customers The Company distributes home fashions products through key retailers in all retail trade classes including department stores, specialty home fashions stores, direct marketers, national chains, mass merchants and regional discounters. The Company markets its home fashions products to over 600 customers, none of which accounted for more than 10% of the Company's total net sales in fiscal 1996. The Company has pursued and established strong relationships with large, high volume retailers including Wal-Mart Stores, Inc., Kmart Corporation, Federated Department Stores, Inc., J.C. Penney Company, Inc. and The May Department Stores Company. As a supplement to its primary distribution channels, a Dan River subsidiary operates factory outlet stores which sell home fashions products directly to consumers. The factory outlet stores sell first-quality and close-out merchandise, as well as seconds, and are located off highway exits and in tourist areas, avoiding the creation of a perceived threat to the traditional Dan River home fashions retailer. Sales through the Company's factory outlet stores accounted for approximately 2% of total home fashions products sales in fiscal 1996 and are not expected to grow significantly as a percentage of total home fashions products sales. Sales and Marketing The home fashions products sales and marketing staff consists of approximately 60 persons and is headquartered in New York City, with satellite offices in Atlanta, Boston, Chicago, Dallas, Los Angeles, Minneapolis, Philadelphia and San Francisco. These marketing professionals, stylists and product development personnel work as early as one year in advance of a retail selling season to develop new fabrics, styles, colors, constructions and finishes. The Company's stylists monitor trends by periodically traveling throughout the world to attend trade shows, meet with home fashions retailers and conduct market research. Together with the marketing group, stylists often work directly with the Company's customers to create fabrics that respond to rapidly changing fashion trends and customer needs. New styles are also developed internally for the April and October bed and bath home textile trade shows, where they are shown to buyers and are placed in production based on customer acceptance. Orders for home fashions products are filled from inventory or, if inventory is not available, products are manufactured and generally shipped within six to 12 weeks of order placement. APPAREL FABRICS OPERATIONS Products The Company manufactures and markets a broad range of high quality woven cotton and cotton-blend fabrics, which are marketed primarily to manufacturers of men's, women's and children's clothing. The Company's yarn-dyed and piece- dyed woven apparel fabrics include oxford cloth, pinpoint oxford cloth, fancy broad cloth, seer-suckers, mid and light weight denim, twills and chambrays. As a result of the Cherokee Acquisition, the Company believes that it is the leading manufacturer of men's dress shirting fabrics in North America (based on net sales). In fiscal 1996, the Company manufactured and sold approximately 27 million yards of shirting fabric, approximately 71% of which was oxford cloth. The Company also manufactures and distributes apparel fabrics to uniform manufacturers and for use in decorating and crafts, 100% cotton fabrics to the furniture market and greige (unfinished) fabrics to converters. Management believes that the Company enjoys a reputation as a leader in creating new fabric styles and designs within the apparel fabrics market. Management also believes that the Company's customers look to its design and styling professionals to help identify new product ideas and anticipate fashion trends in the domestic apparel market. The Company has a library with over one million yarn-dyed fabric samples to help develop new product ideas. The Company's product development professionals work independently as well as directly with customers to develop new fabric styles and constructions. In addition, the Company's product development personnel increasingly work directly with retailers to develop fabrics. These retailers often specify that the Company's fabrics be used by their suppliers in the manufacture of garments to be sold by them. The Company believes that it is a leader in wrinkle resistant technology for shirting fabrics and markets Dri-Don(R) blended easy care fabrics and 100% cotton Wrinkl-Shed(R) fabrics. As a result of the Cherokee Acquisition, the Company now manufactures and markets fabrics utilizing Tencel lyocell, an innovative new fiber. These versatile, innovative fabrics are used primarily in manufacturing women's sportswear. Customers The Company distributes its apparel fabrics primarily to domestic manufacturers of men's, women's and children's clothing which, in turn, operate sewing plants throughout the United States and the Caribbean. The Company's customers market clothing manufactured from its apparel fabrics under such brand names as Arrow, Brooks Brothers, Hathaway, Levi Strauss, Liz Claiborne, L.L. Bean, Manhattan, Osh Kosh B'Gosh and Van Heusen, as well as under private labels through retailers such as J.C. Penney Company, Inc. and Sears, Roebuck & Co. The Company markets uniform fabrics to customers such as Cintas Corporation and Red Kap, and distributes apparel fabrics to home sewing retailers such as Wal-Mart Stores, Inc., Fabric-Centers of America, and through various wholesale distributors, for use in decorating and crafts, as well as garment sewing. Sales and Marketing The Company's apparel fabrics, sales and marketing staff consists of approximately 55 persons and is headquartered in New York City, with satellite offices in Chicago, Dallas, Danville, High Point (North Carolina), Los Angeles and San Francisco. Apparel fabrics are generally "made to order" products. Fabrics are manufactured and generally shipped within nine to 12 weeks of order placement. Orders for apparel fabrics are based on customer selections from offerings of color, content, construction, design and finish, and fabrics are made to customer specifications, which may be developed jointly with the customer. Fabric stylists and computerized fabric design capability aid in the process of fabric development and samples are created for customer approval. Once customer approval and delivery requirements are received, orders are committed to production. MANUFACTURING PROCESS Production Dan River is a vertically integrated manufacturer involved in all aspects of the woven textile manufacturing process, from spinning and weaving to dyeing, finishing, and sewing. Substantially all of the Company's facilities for the manufacture of home fashions products are located in Danville, Virginia. As a result of the acquisition of Cherokee, with spinning and weaving facilities located in Spindale, North Carolina and Sevierville, Tennessee and finishing facilities located in Harris, North Carolina, the Company added almost a million square feet of manufacturing and warehousing floor space dedicated to the manufacture of apparel fabrics in addition to its existing apparel fabrics manufacturing facilities in Danville. During the past five fiscal years, the Company has invested approximately $150 million in an extensive facility modernization program focused on installing the most advanced manufacturing technologies in an effort to be the low cost manufacturer in the industry. See "Risk Factors--Substantial Capital Requirements." Within its home fashions operations, the Company has installed modern, high-speed air-jet looms; automatic sheet cutting, hemming and folding equipment; lower cost open-end spinning equipment; and computerized comforter equipment. Within its apparel fabrics operations, the Company has modernized its yarn preparation processes through the installation of more efficient, lower cost, open-end spinning, carding, drawing and combing equipment. The Company's ongoing capital improvement programs have modernized and streamlined substantially all significant components of the manufacturing process for both home fashions products and apparel fabrics, helping the Company reduce lead times, minimize inventory levels and maximize flexibility to respond to changing market conditions, while at the same time increasing the quality of its products. At Dan River's manufacturing facilities, raw cotton and synthetic fibers are spun into cotton and polyester-blend yarns. Much of the yarn used in the manufacture of apparel fabrics is dyed before being woven into fabric, as opposed to yarn used in the manufacture of home fashions products, which typically is not dyed. Yarn is then woven into fabric on looms to produce unfinished fabric. After weaving, fabric may be marketed as greige (unfinished) goods that are finished in accordance with customer specifications. Fabric utilized in the manufacture of home fashions products is finished by bleaching, dyeing and/or printing. The Company also supplements its printing through the use of third party manufacturers in order to meet customer demand for its products. The Company cuts and sews fabric in home fashions products, such as prepackaged sheets, pillowcases and accessory products at its sewing and cutting facilities and supplements production from these facilities through the use of third party contractors. Once packaged, final products are sold to the Company's customers. Apparel fabrics are finished through combinations of bleaching, dyeing, napping and applying various finishes. The Company's finishing facilities are capable of finishing over 190 million yards of fabric per year. Dan River believes its finishing capabilities enable it to originate new fabrics rapidly and vary production to meet market trends and demands. The Company's finishing facilities also finish fabric on a commission basis for outside customers. During fiscal 1997, the Company completed construction of a new 258,000 square foot home fashions finished goods warehouse and distribution center which is located adjacent to its new home fashions accessory sewing plant in Danville, Virginia. The Company believes the new warehouse will enable it to better and more efficiently service its home fashions customers and accommodate further growth of its home fashions business. Dan River has engineered its manufacturing processes to meet the quick response delivery requirements of its customers. Quick response techniques reduce turnaround time (the time required to process a particular order) which improves customer service and production efficiency. Furthermore, Dan River has the capability to offer electronic data interchange programs to all of its customers. These programs minimize the lead time for customer orders and permit a more efficient, targeted manufacturing schedule, as well as improvements in efficiency, communications, planning and processing times at each stage of production. The Company has electronic data interchange programs in place with most of its major home fashions products customers. Quality Improvement Program Dan River has a program of quality improvement designed to establish common standards of quality and performance at each stage of the manufacturing process. These standards are used to set goals and measure performance. Statistical process control techniques have been introduced throughout the Company's manufacturing facilities. Modern systems have been installed to assist in controlling the dyeing and finishing of yarn and fabric. Computerized monitoring of key manufacturing processes is being installed and real-time information is being integrated into the overall quality system. Dan River's capital improvement program and the related modernization of manufacturing processes and information systems are also important components in its quality improvement program. Product testing is done in the Company's laboratories in its facilities, which are certified by both federal government agencies, private sector customers and certification bodies. All products are subjected to statistical sampling plans designed to assure compliance to specifications. PRODUCT DEVELOPMENT As part of its customer-specific marketing strategy, the Company works directly with its customers to develop new fabric constructions, patterns, textures and colors. The Company has equipment in its facilities dedicated to sample manufacturing where it tests new fabric concepts in actual end-use products. Extensive evaluation of a product is conducted prior to committing fabrics to mill production. Fabrics are sometimes introduced in cooperation with a retailer, in which case a test run of the fabric is produced, manufactured (by a third party garment manufacturer) and delivered to a retailer for test sales. Based upon the results of internal evaluations and these retail tests, new fabrics are introduced into the marketplace. RAW MATERIALS Dan River uses substantial quantities of cotton in its manufacturing operations. By law, U.S. textile companies are generally prohibited from importing cotton, subject to certain exceptions which take effect primarily when the U.S. price of cotton exceeds the world price. Cotton is an agricultural product subject to weather conditions and other factors affecting agricultural markets. Accordingly, the price of cotton is subject to considerable fluctuation. See "Risk Factors--Possible Adverse Effect of Fluctuations in Price and Availability of Cotton." Dan River purchases cotton primarily in the domestic market directly from merchants or through brokers. Generally, the Company seeks to purchase sufficient amounts of cotton to cover existing order commitments (approximately three months); however, the Company may purchase cotton in advance of orders on terms that it deems advantageous, and while the Company does not speculate on the price of cotton, it may hedge prices from time to time through forward contracts and the futures and options markets. The Company also uses significant quantities of polyester, which is available from several sources. Although the Company has always been able to obtain sufficient supplies of both cotton and polyester, any shortage or interruption in the supply or variations in the quality of either could have a material adverse effect on the Company's business. Additionally, fluctuations in cotton and polyester prices can significantly affect the Company's profitability, particularly on a short term basis, since Dan River and other textile manufacturers cannot always mirror such fluctuations in the pricing of their products. See "Risk Factors--Cyclical Nature of Textile Industry." The Company also uses various other raw materials, such as dyes and chemicals, in its manufacturing operations. The Company believes these materials are readily available from a number of sources. Dan River also supplements its internal manufacturing capabilities by purchasing yarn and unfinished fabrics from outside sources and by contracting with third parties for various manufacturing services, including certain printing and sewing operations. During fiscal 1996, approximately 14% of the yarn and 5% of unfinished fabrics used in the Company's manufacturing operations were purchased from outside sources and approximately 5% of printing and finishing services and 8% of sewing operations were performed by third parties. During the first nine months of fiscal 1997, approximately 14% of the yarn and 12% of unfinished fabrics used in the Company's manufacturing operations were purchased from outside sources, and 9% of finishing services and 8% of sewing operations were performed by third parties. TRADEMARKS AND LICENSES The Company holds licenses to produce and sell home fashions products under "Colours by Alexander Julian," "D. Porthault," "John Wilman," "Liberty" and "Nautica" and certain other names or marks, and to use certain designs on its home fashions textile products. Such licenses generally provide that the Company has the exclusive right for a limited period, generally three years subject to renewal for additional periods, to use the respective brand name in the sale of certain types of products in certain geographic regions. Dan River also holds non-exclusive licenses with respect to the use and advertising of certain processes or synthetic fibers or fabrics. Management believes that the failure of the Company to continue to hold any one of its licenses or trademarks (other than "Dan River") would not have a material adverse effect on the Company's business. Dan River has registered the "Bed-in-a-Bag" name as a trademark. In February 1997, a competitor filed a Petition for Cancellation of the trademark in the United States Patent and Trademark Office (the "U.S. Patent Office"). Dan River filed its answer to the Petition for Cancellation and intends to vigorously defend the action. The Petition challenges only the exclusivity of the trademark and not the Company's right to continue to use the phrase in connection with its products. Therefore, while the Company cannot predict the outcome of this matter, the Company believes that the loss of such exclusivity would not have a material adverse effect on the Company's business or prospects. COMPETITION The Company's competitive position varies by product line. Competitive factors include price, product styling and differentiation, quality, flexibility of production and finishing, delivery time and customer service. The Company sells its products primarily to domestic customers and competes with both large, integrated textile manufacturers and numerous smaller companies specializing in limited segments of the market. Some competitors have significantly greater financial resources than Dan River. See "Risk Factors--Intense Competition." The Company is one of several domestic manufacturers of home fashions products. Certain of the Company's competitors have a significantly greater share of the domestic market than the Company, including WestPoint Stevens Inc., Springs Industries, Inc. and Fieldcrest Cannon, Inc., which management believes collectively account for over 50% of the home fashions bedding products market. With the acquisition of Cherokee, the Company believes that it is a leading producer of lightweight yarn-dyed woven cotton and cotton-blend apparel fabrics in North America. With respect to men's shirtings, management believes the Company is the largest producer of oxford cloth and pima cotton pinpoint oxford cloth and the leading producer of lightweight yarn-dyed dress shirting fabrics in North America (based on net sales). In the sportswear fabrics market, the Company is one of a number of domestic producers. The Company is subject to foreign competition. The Company believes that over half of the apparel fabrics (much in the form of imported garments) and approximately 15% of the home fashions products sold in the U.S. are manufactured overseas. One of the Company's business strategies is to seek niche apparel fabrics markets that are less susceptible to foreign competition. The Company believes that its domestic manufacturing base and emphasis on shortening production and delivery times allow the Company to respond more quickly than foreign producers to changing fashion trends and to its domestic customers' delivery schedules. The extent of import protection afforded by the U.S. government to domestic textile producers has been, and is likely to remain, subject to considerable domestic political deliberation. The Company benefits from protections afforded to apparel manufacturers based in certain Caribbean and Central American countries which ship finished garments into the U.S. under Item 9802.00.80 of the Harmonized Tariff Schedule of the U.S. as authorized by the Caribbean Basin Recovery Act. Item 9802.00.80 reduces certain tariffs which would otherwise apply to apparel garments manufactured outside the U.S. and shipped into the U.S., provided that the garments are manufactured from fabric produced and cut domestically. Item 9802.00.80 is beneficial for Dan River and other domestic producers of apparel fabrics, because it creates an attractive manufacturing base for apparel in close proximity to the U.S. In January 1995, a multilateral trade organization, the WTO, was established to replace the GATT. This new body has set forth the mechanisms by which world trade in textiles and clothing will be progressively liberalized with the elimination of quotas and the reduction of duties. The implementation began in January 1995 with the phasing-out of quotas and the reduction of duties to take place over a 10-year period. The selection of products at each phase is made by each importing country and must be drawn from each of the four main textile groups: tops and yarns, fabrics, made-up textile products and apparel. The elimination of quotas and the reduction of tariffs under the WTO may result in increased imports of certain textile products and apparel into North America. These factors could make the Company's products less competitive against low cost imports from developing countries. See "Risk Factors-- Possible Adverse Effect of Government Policy and Import Regulations." NAFTA, which was entered into by the United States, Canada and Mexico and became effective on January 1, 1994, has created the world's largest free- trade zone. The agreement contains safeguards sought by the U.S. textile industry, including a rule of origin requirement that products be processed in one of the three countries in order to benefit from NAFTA. NAFTA will phase out all trade restrictions and tariffs on textiles and apparel among the three countries. In addition, NAFTA requires merchandise to be made from yarns and fabrics originating in North America in order to avoid trade restrictions. Thus, not only must apparel be made from North American fabric but the fabric must be woven from North American spun yarn. Although management believes that the Company may benefit from NAFTA, there can be no assurance that the removal of these barriers to trade will not have a material adverse effect on the Company's business. See "Risk Factors--Possible Adverse Effect of Government Policy and Import Regulations." ORDER BACKLOG The Company's order backlog was approximately $134.4 million at September 27, 1997, as compared to approximately $97.0 million at September 28, 1996, which was prior to the Cherokee Acquisition. Substantially all of the orders on hand at September 27, 1997 are expected to be filled within four months of that date. PROPERTIES On February 3, 1997, the Company acquired substantially all of the assets of Cherokee, including greige manufacturing facilities in Spindale, North Carolina and Sevierville, Tennessee, and a finishing plant in Harris, North Carolina. The Company owns the North Carolina facilities, totaling approximately 588,000 square feet of manufacturing space. The Company leases the Sevierville, Tennessee facility (consisting of approximately 384,000 feet of manufacturing space) with an option to purchase the facility for nominal consideration in 2018. The North Carolina real estate and the machinery and equipment at all of these facilities are subject to liens securing borrowings by the Company under the Credit Facilities funded in connection with the acquisition of Cherokee. Substantially all of Dan River's other apparel fabrics facilities, and substantially all of its home fashions and corporate facilities, are located in Danville, Virginia. Most of the Danville facilities are owned by the Company. The owned facilities occupy a total of approximately 5,680,000 square feet, with approximately 2,600,000 square feet of space currently used for manufacturing. The Company's 116,000 square foot accessory sewing plant and new 258,000 square foot distribution center are leased, with an option to purchase for nominal consideration upon repayment of debt incurred in the construction of these facilities. The Company leases approximately 873,000 square feet of additional warehouse and manufacturing space in Danville. Dan River also owns a yarn mill in Alabama. The Company has entered into a definitive agreement to sell such yarn mill, which sale is subject to customary closing conditions. The Company leases each of its marketing and sales offices and, through its subsidiary, Dan River Factory Stores, Inc., the Company leases seven factory outlet stores in Georgia, Illinois, Maryland, Ohio, South Carolina and Tennessee, each of which averages approximately 6,000 square feet of total space. The Company owns its factory outlet store in Danville, Virginia. The Company's manufacturing facilities generally operate on a five, six or seven day 24-hour per day schedule depending on the nature of the operations and demand for specific products of the Company, as well as other factors. The Company believes that its existing facilities are adequate to service existing demand for the Company's products. The Company considers its plants and equipment to be in good condition. GOVERNMENTAL REGULATION Dan River is subject to various federal, state and local environmental laws and regulations limiting the discharge of pollutants and the storage, handling and disposal of a variety of substances. In particular, the Company's dyeing and finishing operations result in the discharge of substantial quantities of wastewater and in emissions to the atmosphere. The Company is subject to the federal Clean Water and Clean Air Acts, and related state and local laws and regulations. The Company's operations also are governed by laws and regulations relating to workplace safety and worker health, principally the Occupational Safety and Health Act and regulations thereunder, which, among other things, establish cotton dust, formaldehyde, asbestos and noise standards, and regulate the use of hazardous chemicals in the workplace. The Company believes that it is currently in compliance in all material respects with the environmental or health and safety laws and regulations and does not believe that the cost of, or any operational constraints or modifications required to assure, future compliance with such laws or regulations will have a material adverse effect on its results of operations or financial condition. However, there can be no assurance that environmental requirements will not become more stringent in the future or that the Company will not incur significant costs to comply with such requirements. At the property formerly owned by Cherokee at Spindale, North Carolina, there is groundwater contamination consisting of diesel fuel, for which the owner of an adjoining property has acknowledged responsibility. The neighboring landowner is engaged in cleanup operations under the direction of the North Carolina Department of Health, Environment and Natural Resources. Prior to purchasing the Spindale property, the Company identified additional contamination, consisting primarily of benzene in excess of applicable action levels, that the Company believes, based on reports from its environmental consultant, also originates on the adjoining property. The Company also believes cleanup of the benzene contamination may not be required under current North Carolina policy, and that in the event the Company is required to clean up the contamination, it may be eligible to apply for funding from the North Carolina underground storage tank trust fund. In addition, liabilities arising from environmental contamination associated with pre- closing operation of Cherokee's facilities were excluded in connection with the Company's purchase of Cherokee's assets and therefore not assumed by the Company. Furthermore, the Company believes that any contamination on the Spindale property prior to the closing is subject to an indemnity from Cherokee, for which an amount adequate to cover the likely cost of cleanup has been placed in an escrow fund until May 1998. In any event, the Company believes that if it were required to clean up the currently known contamination because it is the owner of the affected property, the cost of such cleanup would not have a material adverse effect on its results of operations or financial condition. EMPLOYEES At September 27, 1997, the Company had approximately 5,500 employees, of which approximately 4,700 were hourly employees. Of these hourly employees, approximately 3,600 are located primarily in the Company's Danville, Virginia operations and represented by a collective bargaining agreement which expires on January 1, 2002. The Company believes that its relations with its employees are good. LEGAL PROCEEDINGS From time to time, the Company is a party to litigation arising in the ordinary course of its business. The Company is not currently a party to any litigation that management believes, if determined adversely to the Company, would have a material adverse effect on the Company. A competitor has filed a Petition for Cancellation with the U.S. Patent Office challenging the Company's "Bed-in-a-Bag" trademark. See "--Trademarks and Licenses."