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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

FORM 10-Q

(Mark One)

OR

For the transition period from                     to                    

Goody’s Family Clothing, Inc.

(865) 966-2000

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x  No o

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act). Yes x  No o

APPLICABLE ONLY TO CORPORATE ISSUERS:

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.

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Goody’s Family Clothing, Inc.
Index to Form 10-Q
November 1, 2003

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PART 1 — FINANCIAL INFORMATION

Item 1 — Condensed Consolidated Financial Statements

Goody’s Family Clothing, Inc. and Subsidiaries
Condensed Consolidated Statements of Operations (Unaudited)
(In thousands, except per share amounts)

See accompanying Notes to Condensed Consolidated Financial Statements and Independent Accountants’ Review Report.

3

Goody’s Family Clothing, Inc. and Subsidiaries
Condensed Consolidated Balance Sheets
(Dollars in thousands, except per share amounts)

See accompanying Notes to Condensed Consolidated Financial Statements and Independent Accountants’ Review Report.

4

Goody’s Family Clothing, Inc. and Subsidiaries
Condensed Consolidated Statements of Cash Flows (Unaudited)
(In thousands)

See accompanying Notes to Condensed Consolidated Financial Statements and Independent Accountants’ Review Report.

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Goody’s Family Clothing, Inc. and Subsidiaries
Notes to Condensed Consolidated Financial Statements
(Unaudited)

(1) Basis of presentation

The accompanying condensed consolidated financial statements of Goody’s Family Clothing, Inc. and subsidiaries (the “Company”) are unaudited and have been prepared pursuant to the rules and regulations of the Securities and Exchange Commission for interim financial statements. In the opinion of the Company’s management, the accompanying unaudited condensed consolidated financial statements include all adjustments, consisting primarily of normal and recurring adjustments, necessary for a fair presentation of the Company’s financial position, results of operations and cash flows for the interim periods presented. Due to the seasonal nature of the Company’s business, the results of operations for the interim periods are not necessarily indicative of the results that may be achieved for the entire year. The condensed consolidated financial statements should be read in conjunction with the audited consolidated financial statements and the notes thereto contained in the Company’s Annual Report on Form 10-K for its fiscal year ended February 1, 2003.

(2) Stock-Based Compensation

The Company has options outstanding under four stock option plans: the Goody’s Family Clothing, Inc. Amended and Restated 1991 Stock Incentive Plan (the “1991 Plan”), the Goody’s Family Clothing, Inc. Amended and Restated 1993 Stock Option Plan (the “1993 Plan”), the Goody’s Family Clothing, Inc. Amended and Restated 1997 Stock Option Plan (the “1997 Plan”) and the Amended and Restated Discounted Stock Option Plan for Directors (the “Directors’ Plan”).

On February 2, 2003, the Company adopted Statement of Financial Accounting Standards No. 148, “Accounting for Stock-Based Compensation — Transition and Disclosure — an Amendment of Financial Accounting Standards Board (“FASB”) Statement No. 123,” (“SFAS 148”). SFAS 148 requires additional disclosures in the footnotes of both interim and annual financial statements regarding the method the Company uses to account for stock-based compensation and the effect of such method on reported results.

The Company accounts for its stock option plans under the recognition and measurement principles of APB Opinion No. 25, “Accounting for Stock Issued to Employees,” and related Interpretations. No stock-based employee compensation cost is reflected in net earnings, as all options granted under those plans had an exercise price equal to the market value of the underlying common stock on the date of grant. However, expense is recorded in connection with stock options issued under the Directors’ Plan to non-employee directors and this expense has been insignificant. Interim proforma information regarding net income and earnings per share is required by SFAS 148, which requires that the information be determined as if the Company had accounted for its employee stock options granted under the fair value method of that statement. The following table illustrates the effect on net earnings and earnings per common share if the Company had applied the fair value recognition provisions of SFAS 148, to stock-based employee compensation (in thousands, except per share amounts):

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Goody’s Family Clothing, Inc. and Subsidiaries
Notes to Condensed Consolidated Financial Statements — continued
(Unaudited)

The weighted-average fair value of each stock option included in the preceding pro forma amounts was estimated using the Black-Scholes option-pricing model and is amortized over the vesting period of the underlying options.

(3) Credit arrangements

In May 2001, the Company entered into a five-year $130,000,000 syndicated revolving loan and security agreement that provides for cash borrowings for general corporate purposes, including a $95,000,000 sub-facility for the issuance of letters of credit. Borrowings under this credit facility are limited by collateral formulas, based principally upon the Company’s eligible inventories. The credit facility is secured primarily by the Company’s inventories, receivables and cash and cash equivalents. If availability (as calculated pursuant to the credit facility) falls below $25,000,000, the Company would be required, for a period of time, to comply with a financial covenant requiring it to maintain minimum levels of tangible net worth based on formulas. The Company’s availability did not fall below $25,000,000 during the thirty-nine weeks ended November 1, 2003 or November 2, 2002 and therefore was not required to comply with this financial covenant. The credit facility also contains certain discretionary provisions that enable the lender to reduce availability. The credit facility bears interest at LIBOR plus an applicable margin or the prime rate. In June 2003, the credit facility was amended to permit cash dividends on the common stock in an amount equal to (i) $3,500,000 (but not to exceed $10,000,000 in the aggregate during the remaining term of the credit facility) plus (ii) 50% of the Company’s consolidated net income for the immediately preceding fiscal year. In addition, in June 2003 the lenders agreed to waive any events of default which could be deemed to have occurred by reason of the Court’s decision in the Hilfiger Matter described below. At November 1, 2003, the Company had no borrowings and $22,741,000 in letters of credit (not yet reflected in accounts payable) outstanding under the facility. These letters of credit generally have terms of less than one year and are primarily used to facilitate the purchase of import merchandise.

(4) Recent accounting pronouncements

FASB Interpretation (“FIN”) No. 45, “Guarantor’s Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others”, was issued in November 2002. This interpretation requires guarantors to account at fair value for and disclose certain types of guarantees. The interpretation’s disclosure requirements were effective for the Company’s year ended February 1, 2003; the interpretation’s measurement requirements were effective for guarantees issued or modified after December 31, 2002. Historically, the Company has not incurred significant costs related to performance under these types of guarantees. No liabilities have been recorded for these obligations on the Company’s consolidated balance sheet as of November 1, 2003.

FIN No. 46, “Consolidation of Variable Interest Entities”, was issued in January 2003. This interpretation requires consolidation of variable interest entities (“VIE”) (also formerly referred to as “special purpose entities”) if certain conditions are met. The interpretation applies immediately to VIE’s created after January 31, 2003, and to interests obtained in VIE’s after January 31, 2003. Beginning the first fiscal year or interim period commencing after December 15, 2003, the interpretation also applies to VIE's created or interests obtained in VIE's before February 1, 2003. The Company does not expect this interpretation to have an impact on its consolidated financial statements.

In May 2003, the FASB issued Statement No. 150, “Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity” (“SFAS No. 150”). SFAS No. 150 established standards for how an issuer classifies and measures certain financial instruments with characteristics of both liabilities and equity. SFAS No. 150 is effective for financial instruments entered into or modified after May 31, 2003 and otherwise is effective at the beginning of the first interim period beginning after June 15, 2003. The provisions of SFAS No. 150 did not have an impact on the Company’s consolidated financial statements.

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Goody’s Family Clothing, Inc. and Subsidiaries
Notes to Condensed Consolidated Financial Statements — continued
(Unaudited)

(5) Restructuring Charge

The Company recorded a restructuring charge during the fourth quarter of fiscal 2001 of approximately $1,335,000 for an announced reduction in the Company’s work force that was completed during 2002. The reduction resulted in the elimination of jobs located at its corporate office and distribution center in Knoxville, Tennessee, and its distribution center in Russellville, Arkansas. The charge included the costs associated with severance, health benefits, outplacement services and professional fees related to developing and implementing the restructuring plan. During the third quarter of fiscal 2002, the Company made payments related to the restructuring of $9,000. During the remainder of fiscal 2002, payments related to the restructuring charge totaled $33,000 and net credits to income were $1,000, leaving no accrued restructuring charge on the balance sheet as of February 1, 2003.

(6) Contingencies

Class Action Proceeding

In February 1999, a lawsuit was filed in the United States District Court for the Middle District of Georgia and was served on the Company and Robert M. Goodfriend, its Chairman of the Board and Chief Executive Officer, by 20 named plaintiffs, generally alleging that the Company discriminated against a class of African-American employees at its retail stores through the use of discriminatory selection and compensation procedures and by maintaining unequal terms and conditions of employment. The plaintiffs further alleged that the Company maintained a racially hostile working environment.

On February 28, 2003, a proposed Consent Decree was filed with the Court for its preliminary approval. The proposed Consent Decree sets forth the proposed settlement of the class action race discrimination lawsuit. Ultimately, class action certification was sought in the lawsuit only with respect to alleged discrimination in promotion to management positions and the proposed Consent Decree is limited to such claims. Generally, the proposed settlement provides for a payment by the Company in the aggregate amount of $3.2 million to the class members (including the named plaintiffs) and their counsel, as well as the Company’s implementation of certain policies, practices and procedures regarding, among other things, training of employees. The Company’s employer liability insurance underwriter has funded $3.1 million of such payment to a third party administrator. The proposed Consent Decree explicitly provides that it is not an admission of liability by the Company and the Company continues to deny all of the allegations. On April 30, 2003, the Court granted preliminary approval of the proposed Consent Decree, and a hearing was held on June 30, 2003 regarding the adequacy and fairness of the proposed settlement. At such hearing, the Court requested that plaintiffs’ counsel take certain action. Plaintiffs’ counsel has since notified the Court that such action has been taken and requested the Court to grant final approval of the Consent Decree. The parties are still waiting for the Court’s response. There can be no assurance that such final approval to the Consent Decree will be granted or that the settlement will not be overturned on appeal.

Hilfiger Matter, Sun Matter and Related Insurance Matters

In July 2000, Tommy Hilfiger Licensing, Inc. (“Hilfiger”) commenced an action against the Company in the United States District Court for the Northern District of Georgia, alleging, among other things, counterfeiting and trademark infringement (the “Hilfiger Matter”). A bench trial for the Hilfiger Matter concluded on March 13, 2003 and on May 9, 2003, the Court rendered its decision, awarding damages to Hilfiger in the amount of approximately $11.0 million, plus reasonable attorney’s fees and costs.

In June 2002, Hilfiger brought an action against Sun Apparel, Inc. (“Sun”), a Goody’s denim supplier, alleging trademark infringement arising out of Sun’s manufacture of the allegedly infringing labels that gave rise to Hilfiger’s trademark infringement claims against Goody’s (the “Sun Matter”). Goody’s had agreed to pay for the defense of the Sun Matter because of certain indemnification obligations it had to Sun.

At the time the Hilfiger Matter commenced, the Company’s primary liability insurer indicated that it would reimburse Goody’s for its legal fees and expenses. In February 2003, after several unsuccessful attempts to obtain such

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Goody’s Family Clothing, Inc. and Subsidiaries
Notes to Condensed Consolidated Financial Statements — continued
(Unaudited)

reimbursement, Goody’s filed an insurance coverage action against the insurers. Following the commencement of such action, the primary insurer agreed to reimburse Goody’s for a substantial portion of its past and future legal expenses. However, the insurance carriers reserved their rights regarding their obligations to indemnify Goody’s against damages resulting from the Hilfiger claims and the Sun Matter and the carriers asserted certain defenses against their indemnity obligations. On May 13, 2003, Fireman’s Fund Insurance Company (“Fireman’s Fund”), the excess layer (umbrella insurance) carrier, commenced an action against Goody’s in the Chancery Court for Knox County, Tennessee seeking a declaratory judgment against Goody’s declaring that it has no duty to indemnify Goody’s in the Hilfiger Matter (the Goody’s suit against the insurers and the Fireman’s Fund suit against the Company are collectively referred to herein as the “Insurance Matters”).

In June 2003, the Company reached a settlement agreement with Tommy Hilfiger resolving all outstanding issues arising out of the Hilfiger Matter. Under the settlement, the Company agreed to make an $11.0 million cash payment to Tommy Hilfiger. The settlement amount also encompassed the settlement of the Sun Matter. In June 2003, the Company also reached an agreement in principle with its insurance carriers regarding the Insurance Matters and a definitive settlement agreement with its insurance carriers was executed in July 2003. As a result of the combined settlements, in the second quarter of fiscal 2003, the Company reversed $4,441,000 ($0.08 per diluted share after taxes) of the pre-tax charge of $7,996,000 ($0.15 per diluted share after taxes) previously recorded in the first quarter of fiscal 2003 based upon the Company’s earlier estimates in connection with these matters. Accordingly, for the thirty-nine weeks ended November 1, 2003, the Company has recorded a pre-tax charge of $3,571,000 ($0.07 per diluted share after taxes) in connection with these matters.

Other Matters

In addition, the Company is a party to various other legal proceedings arising in the ordinary course of its business. The Company has various insurance policies in place in the event of unfavorable outcomes from such proceedings. The insurance companies’ level of, and willingness to, support their coverage could vary depending upon the circumstances of each particular case. As such, there can be no assurance as to the level of support available from insurance policies. The Company does not currently believe that the ultimate outcome of all such pending legal proceedings (other than the class action proceeding noted in the foregoing paragraphs), individually and in the aggregate, would have a material adverse effect on the Company’s financial position, results of operations or cash flows.

(7) Reclassifications

Certain reclassifications have been made to the condensed consolidated financial statements of prior periods to conform to the current period presentation.

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INDEPENDENT ACCOUNTANTS’ REVIEW REPORT

Board of Directors and Shareholders
Goody’s Family Clothing, Inc.
Knoxville, Tennessee:

We have reviewed the accompanying condensed consolidated balance sheets of Goody’s Family Clothing, Inc. and Subsidiaries (the “Company”) as of November 1, 2003 and November 2, 2002, and the related condensed consolidated statements of operations for the thirteen and thirty-nine week periods then ended and of cash flows for the thirty-nine week periods then ended. These interim financial statements are the responsibility of the Company’s management.

We conducted our reviews in accordance with standards estab