================================================================================
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended August 3, 2008
Commission File No. 0-12781
CULP, INC.
(Exact name of registrant as specified in its charter)
NORTH CAROLINA 56-1001967
(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or other organization)
1823 Eastchester Drive
High Point, North Carolina 27265-1402
(Address of principal executive offices) (zip code)
(336) 889-5161
(Registrant's telephone number, including area code)
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 the filing
requirements for at least the past 90 days. [X] YES NO [ ]
Indicate by check mark whether the registrant is a large accelerated filer, an
accelerated filer, a non-accelerated filer, or a smaller reporting company. See
definitions of "accelerated filer, large accelerated filer, and smaller
reporting company" in Rule 12b-2 of the Exchange Act. (Check one);
Large accelerated filer [ ] Accelerated filer [X] Non-accelerated filer [ ]
Smaller Reporting Company [ ]
Indicate by check mark whether the registrant is a shell company (as defined in
Rule 12b-2 of the Exchange Act). [ ] YES NO [X]
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practicable date:
Common shares outstanding at August 3, 2008: 12,648,027
Par Value: $0.05 per share
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INDEX TO FORM 10-Q
For the period ended August 3, 2008
Page
----
Part I - Financial Statements
-----------------------------
Item 1. Financial Statements:
------------------------------
Consolidated Statements of Net Income -- Three Months Ended
August 3, 2008 and July 29, 2007 I-1
Consolidated Balance Sheets -- August 3, 2008, July 29, 2007 and
April 27, 2008 I-2
Consolidated Statements of Cash Flows -- Three Months Ended
August 3, 2008 and July 29, 2007 I-3
Consolidated Statements of Shareholders' Equity I-4
Notes to Consolidated Financial Statements I-5
Cautionary Statement Concerning Forward-Looking Information I-23
Item 2. Management's Discussion and Analysis of Financial Condition and
------------------------------------------------------------------------
Results of Operations I-23
---------------------
Item 3. Quantitative and Qualitative Disclosures About Market Risk I-37
-------------------------------------------------------------------
Item 4. Controls and Procedures I-37
--------------------------------
Part II - Other Information
---------------------------
Item 1. Legal Proceedings II-1
--------------------------
Item 1A. Risk Factors II-1
---------------------
Item 6. Exhibits II-1
------------------
Signatures II-3
Item 1: Financial Statements
-----------------------------
CULP, INC.
CONSOLIDATED STATEMENTS OF NET INCOME
FOR THE THREE MONTHS ENDED AUGUST 3, 2008 AND JULY 29, 2007
UNAUDITED
(Amounts in Thousands, Except for Per Share Data)
THREE MONTHS ENDED
------------------------------------------------------------------------------
Amounts Percent of Sales
----------------------------- -----------------------------
August 3, July 29, % Over August 3, July 29,
2008 2007 (Under) 2008 2007
-------------- ------------- ------------- ------------ --------------
Net sales $ 59,321 65,230 (9.1)% 100.0 % 100.0 %
Cost of sales 51,919 56,174 (7.6)% 87.5 % 86.1 %
-------------- ------------- ------------- ------------ --------------
Gross profit 7,402 9,056 (18.3)% 12.5 % 13.9 %
Selling, general and
administrative expenses 5,384 6,321 (14.8)% 9.1 % 9.7 %
Restructuring expense 402 432 (6.9)% 0.7 % 0.7 %
-------------- ------------- ------------- ------------ --------------
Income from operations 1,616 2,303 (29.8)% 2.7 % 3.5 %
Interest expense 431 818 (47.3)% 0.7 % 1.3 %
Interest income (34) (58) (41.4)% (0.1)% (0.1)%
Other expense 14 232 (94.0)% 0.0 % 0.4 %
-------------- ------------- ------------- ------------ --------------
Income before income taxes 1,205 1,311 (8.1)% 2.0 % 2.0 %
Income taxes * 424 460 (7.8)% 35.2 % 35.1 %
-------------- ------------- ------------- ------------ --------------
Net income $ 781 851 (8.2)% 1.3 % 1.3 %
============== ============= ============= ------------ --------------
Net income per share, basic $ 0.06 0.07 (14.3)%
Net income per share, diluted 0.06 0.07 (14.3)%
Average shares outstanding, basic 12,648 12,583 0.5 %
Average shares outstanding, diluted 12,736 12,728 0.1 %
* Percent of sales column is calculated as a % of income before income taxes.
See accompanying notes to consolidated financial statements.
I-1
CULP, INC.
CONSOLIDATED BALANCE SHEETS
AUGUST 3, 2008, JULY 29, 2007 AND APRIL 27, 2008
UNAUDITED
(Amounts in Thousands)
Amounts Increase
---------------------------- (Decrease)
August 3, July 29, ---------------------------- * April 27,
2008 2007 Dollars Percent 2008
------------- ------------- ------------- ----------- -------------
Current assets:
Cash and cash equivalents $ 6,352 9,017 (2,665) (29.6)% 4,914
Accounts receivable 20,164 23,903 (3,739) (15.6)% 27,073
Inventories 34,862 42,159 (7,297) (17.3)% 35,394
Deferred income taxes 4,472 5,376 (904) (16.8)% 4,380
Assets held for sale 5,610 1,906 3,704 194.3 % 5,610
Income taxes receivable 160 - 160 100.0 % 438
Other current assets 1,627 1,649 (22) (1.3)% 1,328
------------- ------------- ------------- ----------- -------------
Total current assets 73,247 84,010 (10,763) (12.8)% 79,137
Property, plant and equipment, net 33,950 36,901 (2,951) (8.0)% 32,939
Goodwill 4,114 4,114 - 0.0 % 4,114
Deferred income taxes 29,144 26,220 2,924 11.2 % 29,430
Other assets 2,335 2,831 (496) (17.5)% 2,409
------------- ------------- ------------- ----------- -------------
Total assets $ 142,790 154,076 (11,286) (7.3)% 148,029
============= ============= ============= =========== =============
Current liabilities:
Current maturities of long-term debt $ 7,378 13,849 (6,471) (46.7)% 7,375
Current portion of obligation under a
capital lease 692 - 692 100.0 % -
Lines of credit - 2,641 (2,641) (100.0)% -
Accounts payable-trade 17,249 16,776 473 2.8 % 21,103
Accounts payable - capital expenditures 1,020 1,219 (199) (16.3)% 1,547
Accrued expenses 5,534 8,484 (2,950) (34.8)% 8,300
Accrued restructuring costs 1,495 3,047 (1,552) (50.9)% 1,432
Income taxes payable - current 33 856 (823) (96.1)% 150
------------- ------------- ------------- ----------- -------------
Total current liabilities 33,401 46,872 (13,471) (28.7)% 39,907
Accounts payable - capital expenditures 1,275 - 1,275 100.0 % 1,449
Income taxes payable - long-term 5,069 3,765 1,304 34.6 % 4,802
Deferred income taxes 1,363 - 1,363 100.0 % 1,464
Obligation under capital lease 458 - 458 100.0 % -
Long-term debt, less current maturities 13,980 22,094 (8,114) (36.7)% 14,048
------------- ------------- ------------- ----------- -------------
Total liabilities 55,546 72,731 (17,185) (23.6)% 61,670
Shareholders' equity 87,244 81,345 5,899 7.3 % 86,359
------------- ------------- ------------- ----------- -------------
Total liabilities and
shareholders' equity $ 142,790 154,076 (11,286) (7.3)% 148,029
============= ============= ============= =========== =============
Shares outstanding 12,648 12,635 13 0.1 % 12,648
============= ============= ============= =========== =============
* Derived from audited financial statements.
See accompanying notes to consolidated financial statements.
I-2
CULP, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE THREE MONTHS ENDED AUGUST 3, 2008 AND JULY 29, 2007
UNAUDITED
(Amounts in Thousands)
THREE MONTHS ENDED
-------------------------------
Amounts
-------------------------------
August 3, July 29,
2008 2007
--------------- --------------
Cash flows from operating activities:
Net income $ 781 851
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation 1,258 1,447
Amortization of other assets 79 90
Stock-based compensation 98 140
Excess tax benefit related to stock options exercised - (21)
Deferred income taxes 90 (518)
Restructuring expenses, net of gain on sale of related
assets - 160
Changes in assets and liabilities:
Accounts receivable 6,909 5,387
Inventories 532 (1,529)
Other current assets (299) 175
Other assets (5) (327)
Accounts payable - trade (3,854) (5,251)
Accrued expenses (2,757) (186)
Accrued restructuring 63 (235)
Income taxes payable 428 889
--------------- --------------
Net cash provided by operating activities 3,323 1,072
--------------- --------------
Cash flows from investing activities:
Capital expenditures (986) (1,113)
Proceeds from the sale of buildings and equipment - 702
--------------- --------------
Net cash used in investing activities (986) (411)
--------------- --------------
Cash flows from financing activities:
Payments on vendor-financed capital expenditures (599) (70)
Payments on long-term debt (65) (2,169)
Payments on capital lease obligation (235) -
Proceeds from common stock issued - 405
Excess tax benefit related to stock option exercises - 21
--------------- --------------
Net cash used in financing activities (899) (1,813)
--------------- --------------
Increase (decrease) in cash and cash equivalents 1,438 (1,152)
Cash and cash equivalents at beginning of period 4,914 10,169
--------------- --------------
Cash and cash equivalents at end of period $ 6,352 9,017
=============== ==============
See accompanying notes to consolidated financial statements.
I-3
CULP, INC.
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
UNAUDITED
(Dollars in thousands, except share data)
Capital
Contributed Accumulated
Common Stock in Excess Other Total
-------------------- of Par Retained Comprehensive Shareholders'
Shares Amount Value Earnings Loss Equity
---------- --------- ----------- --------- -------------- --------------
Balance, April 29, 2007 12,569,291 $ 629 46,197 32,255 (4) $ 79,077
Cumulative effect of adopting FASB
Interpretation No. 48 - - - 847 - 847
Net income - - - 5,385 - 5,385
Stock-based compensation - - 618 - - 618
Loss on cash flow hedge, net of taxes - - - - (44) (44)
Excess tax benefit related to stock
options exercised - - 17 - - 17
Common stock issued in connection
with stock option plans 78,736 3 456 - - 459
---------- --------- ----------- --------- -------------- --------------
Balance, April 27, 2008 12,648,027 632 47,288 38,487 (48) 86,359
Net income - - - 781 - 781
Stock-based compensation - - 98 - - 98
Gain on cash flow hedge, net of taxes - - - - 6 6
---------- --------- ----------- --------- -------------- --------------
Balance, August 3, 2008 12,648,027 $ 632 47,386 39,268 (42) $ 87,244
========== ========= =========== ========= ============== ==============
See accompanying notes to consolidated financial statements.
I-4
Culp, Inc.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
1. Basis of Presentation
The accompanying unaudited consolidated financial statements of Culp, Inc. and
subsidiaries (the "company") include all adjustments, which are, in the opinion
of management, necessary for fair presentation of the results of operations and
financial position. All of these adjustments are of a normal recurring nature
except as disclosed in note 14 to the consolidated financial statements. Results
of operations for interim periods may not be indicative of future results. The
unaudited consolidated financial statements should be read in conjunction with
the audited consolidated financial statements, which are included in the
company's annual report on Form 10-K filed with the Securities and Exchange
Commission on July 9, 2008 for the fiscal year ended April 27, 2008.
The company's three months ended August 3, 2008 and July 29, 2007 represent 14
and 13 week periods, respectively.
2. Significant Accounting Policies
Significant accounting policies adopted by the company in fiscal 2009 are as
follows:
Fair Value Measurements:
The company adopted SFAS No. 157, Fair Value Measurements ("SFAS 157") and SFAS
No. 159, The Fair Value Option for Financial Assets and Financial Liabilities
("SFAS 159"), on April 28, 2008. SFAS 157 (1) creates a single definition of
fair value, (2) establishes a framework for measuring fair value, and (3)
expands disclosure requirements about items measured at fair value. SFAS 157
applies to both items recognized and reported at fair value in the financial
statements and items disclosed at fair value in the notes to the financial
statements. SFAS 157 does not change existing accounting rules governing what
can or what must be recognized and reported at fair value in the company's
financial statements, or disclosed at fair value in the company's notes to the
financial statements. Additionally, SFAS 157 does not eliminate practicability
exceptions that exist in accounting pronouncements amended by SFAS 157 when
measuring fair value. As a result, the company will not be required to recognize
any new assets or liabilities at fair value.
Prior to SFAS 157, certain measurements of fair value were based on the price
that would be paid to acquire an asset, or received to assume a liability (an
entry price). SFAS 157 clarifies the definition of fair value as the price that
would be received to sell an asset, or paid to transfer a liability, in an
orderly transaction between market participants at the measurement date (that
is, an exit price). The exit price is based on the amount that the holder of the
asset or liability would receive or need to pay in an actual transaction (or in
a hypothetical transaction if an actual transaction does not exist) at the
measurement date. In some circumstances, the entry and exit price may be the
same; however, they are conceptually different.
Fair value is generally determined based on quoted market prices in active
markets for identical assets or liabilities. If quoted market prices are not
available, the company uses valuation techniques that place greater reliance on
observable inputs and less reliance on unobservable inputs. In measuring fair
value, the company may make adjustments for risks and uncertainties, if a market
participant would include such an adjustment in its pricing.
I-5
Culp, Inc.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
SFAS 157 establishes a fair value hierarchy that distinguishes between
assumptions based on market data (observable inputs) and the company's
assumptions (unobservable inputs). Determining where an asset or liability falls
within that hierarchy depends on the lowest level input that is significant to
the fair measurement as a whole. An adjustment to the pricing method used within
either level 1 or level 2 inputs could generate a fair value measurement that
effectively falls in a lower level in the hierarchy. The hierarchy consists of
three broad levels as follows:
Level 1 - Quoted market prices in active markets for identical assets or
liabilities;
Level 2 - Inputs other than level 1 inputs that are either directly or
indirectly observable, and
Level 3 - Unobservable inputs developed using the company's estimates and
assumptions, which reflect those that market participants would use.
The following table presents information about assets and liabilities measured
at fair value on a recurring basis:
Fair value measurements at August 3, 2008 using:
---------------------------------------------------------------------------------------------------------------
Quoted prices in
active markets Significant
for identical Significant other unobservable
assets observable inputs inputs
---------------------------------------------------------------------------------------------------------------
(amounts in thousands) Level 1 Level 2 Level 3 Total
---------------------------------------------------------------------------------------------------------------
Assets:
None Not applicable Not applicable Not applicable Not applicable
Liabilities:
Interest Rate Swap Agreement Not applicable 66 Not applicable 66
As shown above, the interest rate swap derivative is valued based on fair value
provided by the company's bank and is classified within level 2 of the fair
value hierarchy. The determination of where an asset or liability falls in the
hierarchy requires significant judgment. The company evaluates its hierarchy
disclosures each quarter based on various factors and it is possible that an
asset or liability may be classified differently from quarter to quarter.
However, the company expects that changes in classifications between different
levels will be rare.
Most derivative contracts are not listed on an exchange and require the use of
valuation models. Consistent with SFAS 157, the company attempts to maximize the
use of observable market inputs in its models. When observable inputs are not
available, the company defaults to unobservable inputs. Derivatives valued based
on models with significant unobservable inputs and that are not actively traded,
or trade activity is one way, are classified within level 3 of the fair value
hierarchy.
Some financial statement preparers have reported difficulties in applying SFAS
157 to certain nonfinancial assets and nonfinancial liabilities, particularly
those acquired in business combinations and those requiring a determination of
impairment. To allow the time to consider the effects of the implementation
issues that have arisen, the FASB issued FSP FAS 157-2 ("FSP 157-2") on February
12, 2008 to provide a one-year deferral of the effective date of SFAS 157 for
I-6
Culp, Inc.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
nonfinancial assets and nonfinancial liabilities, except those that are
recognized or disclosed in financial statements at fair value on a recurring
basis (that is, at least annually). As a result of FSP 157-2, the company has
not yet adopted SFAS 157 for nonfinancial assets and liabilities that are valued
at fair value on a non-recurring basis. FSP 157-2 is effective for the company
in fiscal 2010 and the company is evaluating the impact that the application of
SFAS 157 to those nonfinancial assets and liabilities will have on its financial
statements.
In February 2007, the FASB issued SFAS 159, The Fair Value Option for Financial
Assets and Financial Liabilities. SFAS 159 provides the company with an option
to elect fair value as the initial and subsequent measurement attribute for most
financial assets and liabilities and certain other items. The fair value option
election is applied on an instrument-by-instrument basis (with some exceptions),
is irrevocable, and is applied to an entire instrument. The election may be made
as of the date of initial adoption for existing eligible items. Subsequent to
initial adoption, the company may elect the fair value option at initial
recognition of eligible items, on entering into an eligible firm commitment, or
when certain specified reconsideration events occur. Unrealized gains and losses
on items for which the fair value option has been elected will be reported in
earnings.
Upon adoption of SFAS 159 on April 28, 2008, the company did not elect to
account for any assets and liabilities under the scope of SFAS 159 at fair
value.
3. Asset Acquisition - Mattress Fabric Segment
Pursuant to an Asset Purchase Agreement among the company, Bodet & Horst USA, LP
and Bodet & Horst GMBH & Co. KG (collectively "Bodet & Horst") dated August 11,
2008, the company purchased certain assets and assumed certain liabilities of
the knitted mattress fabric operation of Bodet & Horst, including its
manufacturing operation in High Point, North Carolina. The purchase involves the
equipment, inventory, and intellectual property associated with the High Point
manufacturing operation, which has served as the company's primary source of
knitted mattress fabric for six years. Demand for this product line has grown
significantly, as knits are increasingly being utilized on mattresses at volume
retail price points. The company is assuming the lease of the building where the
operation is located and intends to continue operating the business in that
location. The purchase price for the assets is cash in the amount of $10.5
million, plus the assumption of certain liabilities, subject to adjustment after
closing for changes in working capital through the date of closing. Also, in
connection with the purchase, the company entered into a six-year consulting and
non-compete agreement with the principal owner of Bodet & Horst, providing for
payments to the owner in the amount of $75,000 per year for the agreement's full
six-year term.
The acquisition was financed by $11.0 million of unsecured notes pursuant to a
Note Purchase Agreement (" 2008 Note Agreement") dated August 11, 2008. The 2008
Note Agreement has a fixed interest rate of 8.01% and a term of seven years.
Principal payments of $2.2 million per year are due on the notes beginning three
years from the date of the 2008 Note Agreement. The 2008 Note Agreement contains
customary financial and other covenants as defined in the 2008 Note Agreement.
In connection with the 2008 Note Agreement, the company entered into a Consent
and Fifth Amendment (the "Consent and Amendment") that amends the previously
existing unsecured note purchase agreements. The purpose of the Consent and
Amendment is for the existing note holders to consent to the 2008 Note Agreement
I-7
Culp, Inc.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
and to provide that certain financial covenants in favor of the existing note
holders will be on the same terms as those contained in the 2008 Note Agreement.
4. Stock-Based Compensation
On June 17, 2008, the company granted two employees 25,000 options to purchase
shares of common stock at the fair market value on the date of grant. These
options will vest over five years and expire ten years after the date of grant.
The fair value of these option awards were estimated on the date of grant using
the Black-Scholes option-pricing model. The fair value of stock options granted
to these two employees during the three-month period ended August 3, 2008, was
$5.00 per share using the following assumptions:
Grant on June 17, 2008
--------------------------------------------------------------------------------
Risk-free interest rate 4.23%
Dividend yield 0.00%
Expected volatility 66.18%
Expected term (in years) 8.0
--------------------------------------------------------------------------------
The assumptions utilized in the model are evaluated and revised, as necessary,
to reflect market conditions, actual historical experience, and groups of
employees that have similar exercise patterns that are considered separately for
valuation purposes. The risk-free interest rate for periods within the
contractual life of the option was based on the U.S. Treasury yield curve in
effect at the time of grant. The company does not plan to issue any dividends,
and, therefore, the yield is 0.00%. The expected volatility was derived using a
term structure based on historical volatility and the volatility implied by
exchange-traded options on the company's common stock. The expected term of the
options is the contractual term of the stock options and expected employee
exercise and post-vesting employment termination trends.
The company recorded $98,000 and $140,000 of compensation expense for stock
options within selling, general, and administrative expense for the three-month
periods ended August 3, 2008 and July 29, 2007, respectively. The remaining
unrecognized compensation costs related to unvested awards at August 3, 2008 was
$894,562 which is expected to be recognized over a weighted average period of
3.0 years.
5. Accounts Receivable
A summary of accounts receivable follows:
--------------------------------------------------------------------------------
(dollars in thousands) August 3, 2008 April 27, 2008
--------------------------------------------------------------------------------
Customers $ 22,044 $ 28,830
Allowance for doubtful accounts (1,381) (1,350)
Reserve for returns and allowances and discounts (499) (407)
--------------------------------------------------------------------------------
$ 20,164 $ 27,073
--------------------------------------------------------------------------------
I-8
Culp, Inc.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
A summary of the activity in the allowance for doubtful accounts follows:
--------------------------------------------------------------------------------
Three months ended
(dollars in thousands) August 3, 2008 July 29, 2007
--------------------------------------------------------------------------------
Beginning balance $ (1,350) $ (1,332)
Provision (recovery) of bad debt expense (94) 17
Net write-offs 63 155
--------------------------------------------------------------------------------
Ending balance $ (1,381) $ (1,160)
--------------------------------------------------------------------------------
A summary of the activity in the allowance for returns and allowances and
discounts accounts follows:
--------------------------------------------------------------------------------
Three months ended
(dollars in thousands) August 3, 2008 July 29, 2007
--------------------------------------------------------------------------------
Beginning balance $ (407) $ (570)
Provision for returns and allowances
and discounts (632) (762)
Discounts taken 540 690
--------------------------------------------------------------------------------
Ending balance $ (499) $ (642)
--------------------------------------------------------------------------------
6. Inventories
Inventories are carried at the lower of cost or market. Cost is determined using
the FIFO (first-in, first-out) method.
A summary of inventories follows:
--------------------------------------------------------------------------------
(dollars in thousands) August 3, 2008 April 27, 2008
--------------------------------------------------------------------------------
Raw materials $ 10,083 $ 9,939
Work-in-process 1,227 1,682
Finished goods 23,552 23,773
--------------------------------------------------------------------------------
$ 34,862 $ 35,394
--------------------------------------------------------------------------------
7. Other Assets
A summary of other assets follows:
--------------------------------------------------------------------------------
(dollars in thousands) August 3, 2008 April 27, 2008
--------------------------------------------------------------------------------
Cash surrender value - life insurance $ 1,269 $ 1,269
Non-compete agreement, net 717 789
Other 349 351
--------------------------------------------------------------------------------
$ 2,335 $ 2,409
--------------------------------------------------------------------------------
The company recorded a non-compete agreement related to the ITG asset purchase
agreement at its fair value based on valuation techniques. At August 3, 2008 and
April 27, 2008, the gross carrying amount of this non-compete agreement was $1.1
I-9
Culp, Inc.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
million. At August 3, 2008 and April 27, 2008 accumulated amortization for this
non-compete agreement was $431,000 and $359,000, respectively. The non-compete
agreement is amortized on a straight-line basis over the four year life of the
agreement. Amortization expense for this non-compete agreement for the
three-month period ended August 3, 2008 and July 29, 2007 was $72,000.
Amortization expense during the next three fiscal years follows: FY 2009 -
$215,000; FY 2010 - $287,000; and FY 2011 - 215,000.
8. Accounts Payable - Capital Expenditures
The company has certain vendor financed arrangements regarding capital
expenditures that bear interest with fixed interest rates ranging from 6% to
7.14%. At August 3, 2008 and April 27, 2008, the company had total amounts due
regarding capital expenditures totaling $2.3 million and $3.0 million,
respectively. The payment requirements of these arrangements during the next
three years are: Year 1 - $1.0 million; Year 2 - $725,000; and Year 3 -
$550,000.
9. Accrued Expenses
A summary of accrued expenses follows:
--------------------------------------------------------------------------------
(dollars in thousands) August 3, 2008 April 27, 2008
--------------------------------------------------------------------------------
Compensation, commissions and related benefits $ 2,990 $ 5,690
Interest 500 186
Accrued rebates 144 241
Other 1,900 2,183
--------------------------------------------------------------------------------
$ 5,534 $ 8,300
--------------------------------------------------------------------------------
10. Long-Term Debt and Lines of Credit
A summary of long-term debt and lines of credit follows:
--------------------------------------------------------------------------------------------------
(dollars in thousands) August 3, 2008 April 27, 2008
--------------------------------------------------------------------------------------------------
Unsecured term notes $ 14,307 $ 14,307
Real estate loan - I 3,773 3,828
Real estate loan - II 2,500 2,500
Canadian government loan 778 788
--------------------------------------------------------------------------------------------------
21,358 21,423
Current maturities of long-term debt (7,378) (7,375)
--------------------------------------------------------------------------------------------------
Long-term debt, current maturities of long-term debt $ 13,980 $ 14,048
--------------------------------------------------------------------------------------------------
Lines of credit $ - $ -
--------------------------------------------------------------------------------------------------
Total borrowings $ 21,358 $ 21,423
--------------------------------------------------------------------------------------------------
Unsecured Term Notes- Bodet & Horst Acquisition
In connection with the Bodet & Horst Asset Purchase Agreement, the company
entered into the 2008 Note Agreement dated August 11, 2008. The 2008 Note
Agreement provides for the issuance of $11.0 million of unsecured term notes
I-10
Culp, Inc.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
with a fixed interest rate of 8.01% and a term of seven years. Principal
payments of $2.2 million per year are due on the notes beginning three years
from the date of the 2008 Note Agreement. The 2008 Note Agreement contains
customary financial and other covenants as defined in the 2008 Note Agreement.
Unsecured Term Notes- Existing
The company's existing unsecured term notes have a fixed interest rate of 8.80%
(payable semi-annually in March and September and subject to prepayment
provisions each fiscal quarter as defined in the agreement) and are payable over
an average remaining term of 1.6 years through March 2010. The principal
payments are required to be paid in annual installments over the next two years
as follows: March 2009 - $7.2 million; and March 2010 - $7.1 million.
In connection with the 2008 Note Agreement, the company entered into a Consent
and Amendment that amends the previously existing unsecured note purchase
agreements. The purpose of the Consent and Amendment is for the existing note
holders to consent to the 2008 Note Agreement and to provide that certain
financial covenants in favor of the existing note holders will be on the same
terms as those contained in the 2008 Note Agreement.
Real Estate Loan - I
The company has a real estate loan that is secured by a lien on the company's
corporate headquarters office located in High Point, NC. This term loan bears
interest at the one-month LIBOR plus an adjustable margin (all in rate of 4.96%
at August 3, 2008) based on the company's debt/EBITDA ratio, as defined in the
agreement and is payable in monthly installments through September 2010, with a
final payment of $3.3 million in October 2010.
Real Estate Loan - II
The company has a term loan in the amount of $2.5 million in connection with the
ITG asset purchase agreement. This term loan is secured by a lien on the
company's corporate headquarters office located in High Point, NC and bears
interest at the one-month LIBOR plus an adjustable margin (all in rate of 5.48%
at August 3, 2008) based on the company's debt/EBITDA ratio, as defined in the
agreement. This agreement requires the company to pay interest monthly with the
entire principal due on June 30, 2010.
Revolving Credit Agreement - United States
The company has an unsecured credit agreement that provides for a revolving loan
commitment of $6.5 million, including letters of credit up to $5.5 million. This
agreement expires on December 31, 2008, and bears interest at the one-month
LIBOR plus an adjustable margin (all in rate of 4.96% at August 3, 2008) based
on the company's debt/EBITDA ratio, as defined in the agreement. As of August 3,
2008, there were $1.3 million in outstanding letters of credit (all of which
related to workers compensation) and no borrowings outstanding under the
agreement.
I-11
Culp, Inc.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
Revolving Credit Agreement - China
The company's China subsidiary has an unsecured revolving credit agreement with
a bank in China to provide a line of credit available up to approximately $5.0
million, of which approximately $1.0 million includes letters of credit. This
agreement bears interest at a rate determined by the Chinese government. There
were no borrowings outstanding under the agreement as of August 3, 2008.
Canadian Government Loan
The company has an agreement with the Canadian government for a term loan that
is non-interest bearing and is payable in 48 equal monthly installments
commencing December 1, 2009. The proceeds were used to partially finance capital
expenditures at the company's Rayonese facility located in Quebec, Canada.
Overall
The company's loan agreements require that the company maintain compliance with
certain financial ratios. At August 3, 2008, the company was in compliance with
these financial covenants.
As of August 3, 2008, the principal payment requirements of long-term debt
during the next five years are: Year 1 - $7.4 million; Year 2 - $10.0 million;
Year 3 - $3.5 million; Year 4 - $195,000; Year 5 - $195,000; and thereafter -
$65,000.
11. Capital Lease Obligation
In May 2008, the company entered into a capital lease to finance the
construction of certain equipment related to its mattress fabrics segment. The
lease agreement contains a bargain purchase option and bears interest at 8.5%.
The lease agreement requires principal payments totaling $1.4 million to
commence on July 1, 2008, and to be paid in quarterly installments through April
2010. This agreement is secured by equipment with a carrying value of $2.4
million. The principal payments required over the next two years are as follows:
Year 1 - $692,000; and Year 2 - $458,000.
At August 3, 2008, the company has recorded $1.4 million for equipment under
capital leases. This balance is reflected in property, plant, and equipment in
the accompanying consolidated balance sheet as of August 3, 2008. No
depreciation expense was recorded on the equipment related to this lease for the
three-month period ending August 3, 2008, as the equipment will be placed into
service in the company's second quarter of fiscal 2009.
12. Interest Rate Hedging
In connection with one of the company's real estate loans, the company was
required to have an agreement to hedge the interest rate risk exposure on the
real estate loan. The company entered into a $2,170,000 notional principal
interest rate swap, which represents 50% of the principal amount of the real
estate loan, that effectively converted the floating rate LIBOR based payments
to fixed payments at 4.99% plus the spread calculated under the real estate loan
agreement. This agreement expires October 2010.
The company accounts for the interest rate swap as a cash flow hedge whereby the
fair value of this contract is reflected in other assets if the contract is in
I-12
Culp, Inc.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
the company's favor or accrued expenses if the contract is in the bank's favor
in the accompanying consolidated balance sheets with the offset recorded as
accumulated other comprehensive loss. The fair value of the interest rate swap
was approximately $66,000 and $75,000 in the bank's favor at August 3, 2008 and
April 27, 2008, respectively.
13. Cash Flow Information
Payments for interest and income taxes follows:
--------------------------------------------------------------------------------
Three months ended
(dollars in thousands) August 3, 2008 July 29, 2007
--------------------------------------------------------------------------------
Interest $ 159 $ 207
Net income tax (refund) payments (53) 254
--------------------------------------------------------------------------------
The company financed $1.4 million of its capital expenditures through a capital
lease for the three months ended August 3, 2008 (see note 11). The company did
not finance any of its capital expenditures for the three months ended July 29,
2007. Interest costs of $42,000 for the construction of qualifying fixed assets
were capitalized and are being amortized over the related assets' estimated
useful lives for the three months ended August 3, 2008. No interest costs were
capitalized for the three months ended July 29, 2007.
14. Restructuring and Restructuring Related Charges
The following summarizes the fiscal 2009 activity in the restructuring accrual
(dollars in thousands):
---------------------------------------------------------------------------------------------------------------------------
Employee
Termination Lease Lease
Employee Benefit Termination Termination
Termination Payments and Other and Other Balance
Balance, Benefit Net of Cobra Exit Cost Exit Cost August 3,
(dollars in thousands) April 27, 2008 Adjustments Premiums Adjustments Payments 2008
---------------------------------------------------------------------------------------------------------------------------
December 2006 Upholstery fabrics (1) $ 990 $ 436 $ (230) $ (12) $ (83) $ 1,101
September 2005 Upholstery fabrics (2) 178 - - - (19) 159
August 2005 Upholstery fabrics (3) 2 5 (7) - - -
Fiscal 2005 Upholstery fabrics (4) 27 (27) - - - -
Fiscal 2003 Culp Decorative fabrics (5) 235 - - - - 235
---------------------------------------------------------------------------------------------------------------------------
Totals $ 1,432 $ 414 $ (237) $ (12) $ (102) $ 1,495 (6)
---------------------------------------------------------------------------------------------------------------------------
(1) The restructuring accrual at August 3, 2008, represents employee
termination benefits and lease termination and exit costs of $885 and $216,
respectively. The restructuring accrual at April 27, 2008, represents
employee termination benefits and lease termination and exit costs of $679
and $311, respectively.
(2) The restructuring accrual at August 3, 2008, represents other exit costs of
$159. The restructuring accrual at April 27, 2008, represents other exit
costs of $178.
(3) The restructuring accrual at April 27, 2008, represents employee
termination benefits of $2.
(4) The restructuring accrual at April 27, 2008, represents employee
termination benefits of $27.
(5) The restructuring accrual at August 3, 2008 and April 27, 2008 represents
and lease termination and other exit costs of $235.
I-13
Culp, Inc.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
(6) The company's existing restructuring plans as of August 3, 2008, have been
substantially completed.
The following summarizes restructuring and related charges incurred for the
three-month period ending August 3, 2008 (dollars in thousands):
----------------------------------------------------------------------------------------------------------------------------
Sales
Operating Lease Proceeds from
Costs on Termination Write-Downs Asset Employee Equipment
Closed and Other of Buildings Inventory Movement Termination With No
(dollars in thousands) acilities Exit Costs and Equipment Markdowns Costs Benefits Carrying Value Total
----------------------------------------------------------------------------------------------------------------------------
December 2006 Upholstery
fabrics (7) $ 14 $ (12) $ - $ - $ - $ 436 $ - $ 438
August 2005 Upholstery
fabrics (8) - - - - - 5 - 5
Fiscal 2005 Upholstery
fabrics (9) - - - - - (27) - (27)
----------------------------------------------------------------------------------------------------------------------------
Totals $ 14 $ (12) $ - $ - $ - $ 414 $ - $ 416
----------------------------------------------------------------------------------------------------------------------------
(7) Of this total charge, $12 was recorded in cost of sales, $2 was recorded in
selling, general and administrative expense, and $424 was recorded in
restructuring expense in the 2009 Consolidated Statement of Net Income.
(8) This $5 charge was recorded in restructuring expense in the 2009
Consolidated Statement of Net Income.
(9) This $27 credit was recorded in restructuring expense in the 2009
Consolidated Statement of Net Income.
The following summarizes restructuring and related charges for the three-month
period ending July 29, 2007. (dollars in thousands):
Sales
Operating Lease Proceeds from
Costs on Termination Write-Downs Asset Employee Equipment
Closed and Other of Buildings Inventory Accelerated Movement Termination With No
(dollars in thousands) Facilities Exit Costs and Equipment Markdowns Depreciation Costs Benefits Carrying Value Total
------------------------------------------------------------------------------------------------------------------------------------
December 2006 Upholstery
fabrics (10) $ 481 $ 333 $ 362 $ 57 $ - $ 54 $ (87) $ (202) $ 998
September 2005 Upholstery
fabrics (11) - - - - - - (26) - (26)
August 2005 Upholstery
fabrics (12) - - - - - - (10) - (10)
Fiscal 2005 Upholstery
fabrics (13) - 34 - - - - (18) - 16
Fiscal 2003 Culp Decorative
fabrics (14) 5 - - - - - (8) - (3)
------------------------------------------------------------------------------------------------------------------------------------
Totals $ 486 $ 367 $ 362 $ 57 $ - $ 54 $ (149) $ (202) $ 975
------------------------------------------------------------------------------------------------------------------------------------
(10) Of this total charge, $512 was recorded in cost of sales, $26 was recorded
in selling, general, and, administrative expense, and $460 was recorded in
restructuring expense in the 2008 Consolidated Statement of Net Income.
(11) This $26 credit was recorded in restructuring expense in the 2008
Consolidated Statement of Net Income.
(12) This $10 credit was recorded in restructuring expense in the 2008
Consolidated Statement of Net Income.
(13) This $16 charge was recorded in restructuring expense in the 2008
Consolidated Statement of Net Income.
I-14
Culp, Inc.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
(14) The charge of $5 for operating costs on closed plant facilities was
recorded in cost of sales in the 2008 Consolidated Statement of Net Income.
The $8 credit for employee termination benefits was recorded in
restructuring expense in the 2008 Consolidated Statement of Net Income.
Consolidation of China Operations
On September 3, 2008, the board of directors approved changes to the upholstery
fabric operations, including the consolidation of facilities in China and
reduction of excess manufacturing capacity, which will involve exit and disposal
charges to be incurred by the company. This action is in response to the
extremely challenging industry conditions for upholstery fabrics and is expected
to result in pre-tax charges of approximately $3.9 million, of which $3.5
million is expected to be non-cash items and $400,000 is expected to result in
cash expenditures. The company anticipates the charges to be made up of
approximately $2.1 million for accelerated depreciation related to leasehold
improvements on facilities being exited, $1.4 million for fixed asset
write-downs, $250,000 for lease termination costs, and $100,000 for employee
termination benefits and other costs related to dismantling, disposal, and
moving of equipment and related assets. All these charges are expected to be
incurred in the company's second and third quarters of fiscal 2009. The plant
consolidations are expected to be completed by the end of the third quarter of
fiscal 2009.
15. Net Income Per Share
Basic net income per share is computed using the weighted-average number of
shares outstanding during the period. Diluted net income per share uses the
weighted-average number of shares outstanding during the period plus the
dilutive effect of stock options calculated using the treasury stock method.
Weighted average shares used in the computation of basic and diluted net income
per share follows:
--------------------------------------------------------------------------------
Three months ended
(amounts in thousands) August 3, 2008 July 29, 2007
--------------------------------------------------------------------------------
Weighted average common shares outstanding, basic 12,648 12,583
Effect of dilutive stock options 88 145
--------------------------------------------------------------------------------
Weighted average common shares outstanding, diluted 12,736 12,728
--------------------------------------------------------------------------------
Options to purchase 247,875 and 79,750 shares of common stock were not included
in the computation of diluted net income per share for the three months ended
August 3, 2008 and July 29, 2007, respectively, because the exercise price of
the options was greater than the average market price of the common shares.
16. Comprehensive Income
Comprehensive income is the total income and other changes in shareholders'
equity, except those resulting from investments by shareholders and
distributions to shareholders not reflected in net income.
I-15
Culp, Inc.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
A summary of comprehensive income follows:
--------------------------------------------------------------------------------
Three months ended
(dollars in thousands) August 3, 2008 July 29, 2007
--------------------------------------------------------------------------------
Net income $ 781 $ 851
Gain on cash flow hedge, net of income taxes 6 4
--------------------------------------------------------------------------------
Comprehensive income $ 787 $ 855
--------------------------------------------------------------------------------
17. Segment Information
The company's operations are classified into two business segments: mattress
fabrics and upholstery fabrics. The mattress fabrics segment manufactures and
sells fabrics to bedding manufacturers. The upholstery fabrics segment
manufactures and sells fabrics primarily to residential and commercial
(contract) furniture manufacturers.
The company evaluates the operating performance of its segments based upon
income (loss) from operations before restructuring and related charges or
credits and certain unallocated corporate expenses. Unallocated corporate
expenses primarily represent compensation and benefits for certain executive
officers and all costs related to being a public company. Segment assets include
assets used in the operations of each segment and primarily consist of accounts
receivable, inventories, and property, plant and equipment. The mattress fabrics
segment also includes in segment assets, assets held for sale, goodwill and
other non-current assets associated with the ITG acquisition. The upholstery
fabrics segment also includes assets held for sale in segment assets.
Financial information for the company's operating segments as follows:
------------------------------------------------------------------------------------------------------
Three months ended
(dollars in thousands) August 3, 2008 July 29, 2007
------------------------------------------------------------------------------------------------------
Net sales:
Mattress Fabrics $ 35,561 $ 36,536
Upholstery Fabrics 23,760 28,694
------------------------------------------------------------------------------------------------------
$ 59,321 $ 65,230
------------------------------------------------------------------------------------------------------
Gross profit:
Mattress Fabrics $ 6,344 $ 5,805
Upholstery Fabrics 1,070 3,768
------------------------------------------------------------------------------------------------------
Total segment gross profit 7,414 9,573
Restructuring related charges (12) (1) (517) (3)
------------------------------------------------------------------------------------------------------
$ 7,402 $ 9,056
------------------------------------------------------------------------------------------------------
Selling, general, and administrative expenses:
Mattress Fabrics $ 2,128 $ 2,042
Upholstery Fabrics 2,484 3,318
I-16
Culp, Inc.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
------------------------------------------------------------------------------------------------------
Total segment selling, general, and
administrative expenses 4,612 5,360
Unallocated corporate expenses 770 935
Restructuring related charges 2 (1) 26 (3)
------------------------------------------------------------------------------------------------------
$ 5,384 $ 6,321
------------------------------------------------------------------------------------------------------
Income (loss) from operations:
Mattress Fabrics $ 4,216 $ 3,763
Upholstery Fabrics (1,414) 450
------------------------------------------------------------------------------------------------------
Total segment income from operations 2,802 4,213
Unallocated corporate expenses (770) (935)
Restructuring and related charges (416) (2) (975) (4)
------------------------------------------------------------------------------------------------------
Total income from operations 1,616 2,303
Interest expense (431) (818)
Interest income 34 58
Other expense (14) (232)
------------------------------------------------------------------------------------------------------
Income before income taxes $ 1,205 $ 1,311
------------------------------------------------------------------------------------------------------
(1) The $12 represents other operating costs associated with a closed plant
facility. The $2 represents other operating costs associated with a closed
plant facility. These charges relate to the Upholstery Fabrics segment.
(2) The $416 represents $414 for employee termination benefits, $14 for other
operating costs associated with a closed plant facility, and a credit of
$12 for lease termination and other exit costs. Of this total charge, $12,
$2, and $402 are included in cost of sales, selling, general, and
administrative expense, and restructuring expense, respectively. These
charges relate to the Upholstery Fabrics segment.
(3) The $517 represents restructuring related charges of $460 for other
operating costs associated with closed plant facilities and $57 for
inventory markdowns. The $26 represents other operating costs associated
with closed plant facilities. These charges relate to the Upholstery
Fabrics segment.
(4) The $975 represents $486 for other operating costs associated with closed
plant facilities, $367 for lease termination costs, $362 for write-downs
of a building and equipment, $57 for inventory markdowns, $54 for asset
movement costs, a credit of $149 for employee termination benefits, and a
credit of $202 for sales proceeds received on equipment with no carrying
value. Of this total charge, $517, $26, and $432 are included in cost of
sales, selling, general, and administrative expense, and restructuring
expense, respectively. These charges relate to the Upholstery Fabrics
segment.
I-17
Culp, Inc.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
Balance sheet information for the company's operating segments follow:
-----------------------------------------------------------------------------------------------------
(dollars in thousands) August 3, 2008 April 27, 2008
-----------------------------------------------------------------------------------------------------
Segment assets:
Mattress Fabrics
Current assets (5) $ 26,355 $ 27,572
Assets held for sale 35 35
Non-compete agreement, net 717 789
Goodwill 4,114 4,114
Property, plant and equipment (6) 22,893 21,687
-----------------------------------------------------------------------------------------------------
Total mattress fabrics assets 54,114 54,197
-----------------------------------------------------------------------------------------------------
Upholstery Fabrics
Current assets (5) 28,671 34,895
Assets held for sale 792 792
Property, plant and equipment (7) 11,020 11,214
-----------------------------------------------------------------------------------------------------
Total upholstery fabrics assets 40,483 46,901
-----------------------------------------------------------------------------------------------------
Total segment assets 94,597 101,098
Non-segment assets:
Cash and cash equivalents 6,352 4,914
Assets held for sale 4,783 4,783
Income taxes receivable 160 438
Deferred income taxes 33,616 33,810
Other current assets 1,627 1,328
Property, plant and equipment 37 38
Other assets 1,618 1,620
-----------------------------------------------------------------------------------------------------
Total assets $ 142,790 $ 148,029
-----------------------------------------------------------------------------------------------------
Three months ended
(dollars in thousands) August 3, 2008 July 29, 2007
-----------------------------------------------------------------------------------------------------
Capital expenditures (8):
Mattress Fabrics $ 1,967 $ 339
Upholstery Fabrics 305 507
-----------------------------------------------------------------------------------------------------
Total capital expenditures $ 2,272 $ 846
-----------------------------------------------------------------------------------------------------
Depreciation expense:
Mattress Fabrics $ 758 $ 897
Upholstery Fabrics 500 550
-----------------------------------------------------------------------------------------------------
Total segment depreciation expense $ 1,258 $ 1,447
-----------------------------------------------------------------------------------------------------
(5) Current assets represent accounts receivable and inventory for the
respective segment.
(6) The $22.9 million at August 3, 2008, represents property, plant, and
equipment located in the U.S. of $14.7 million, located in Canada of $8.1
million, and various corporate allocations of $160,000. The $21.7 million
at April 27, 2008, represents property, plant, and equipment located in
the U.S. of $13.1 million, located in Canada of $8.4 million, and various
corporate allocations of $168,000.
(7) The $11.0 million at August 3, 2008, represents property, plant, and
equipment located in China of $8.9 million, located in the U.S. of $1.6
million, and various corporate allocations of $480,000. The $11.2 million
at April 27, 2008, represents property, plant, and equipment located in
China of $9.0 million, located in the U.S. of $1.7 million, and various
corporate allocations $501,000.
I-18
Culp, Inc.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
(8) Capital expenditure amounts are stated on the accrual basis. See
Consolidated Statement of Cash Flows for capital expenditure amounts on a
cash basis.
18. Income Taxes
Effective Income Tax Rate
The effective income tax rate (income taxes as a percentage of income before
income taxes) for the three month periods ended August 3, 2008 and July 29, 2007
were 35.2% and 35.1%, respectively. The company's income tax expense and
effective income tax rate for the three month periods ended August 3, 2008 and
July 29, 2007, were based upon the estimated effective income tax rate
applicable for the full year after giving effect to any significant items
related specifically to interim periods. The effective income tax rate can be
impacted over the fiscal year by the mix and timing of actual earnings from the
company's U.S. operations and foreign sources versus annual projections and
changes in foreign currencies in relation to the U.S. dollar.
Deferred Income Taxes
In making the judgment about the realization of the U.S. net deferred tax
assets, management has considered both negative and positive evidence, and
concluded that sufficient positive evidence exists to overcome the cumulative
losses experienced in recent years. Specifically, management considered the
following, among other factors: nature of the company's products; history of
positive earnings in the mattress fabrics segment; capital projects that have
further enhanced the company's globally competitive cost structure in the
mattress fabrics segment; the incremental sales volume from the purchase of
certain assets from International Textile Group, Inc. (ITG) related to the
mattress fabric product line of ITG's Burlington House Division, the purchase of
certain assets from Bodet & Horst related to its knitted mattress fabric
operation; recent restructuring actions in the U.S. upholstery fabrics business
to adjust the U.S. cost structure and bring U.S. manufacturing capacity in line
with demand; development of offshore manufacturing and sourcing programs to meet
changing demands of upholstery fabric customers in the U.S.; and inter-company
agreements with the company's China subsidiaries are expected to be in place in
fiscal 2009 for various consulting services and intellectual property.
Management's analysis of taxable income also included the following
considerations: none of the company's net operating loss carryforwards have
previously expired unused; the U.S. federal carryforward period is 20 years; and
the company's current income tax loss carryforwards principally expire in 14-20
years; fiscal 2022 through 2028.
Uncertainty In Income Taxes
At August 3, 2008, the company had $5.1 million of total gross unrecognized tax
benefits, of which $4.7 million represents the amount of gross unrecognized tax
benefits that, if recognized would favorably affect the income tax rate in
future periods. The total gross unrecognized tax benefits of $5.1 million as of
August 3, 2008, are classified as income taxes payable -long-term in the
accompanying consolidated balance sheets.
The company anticipates that the amount of unrecognized tax benefits will
I-19
Culp, Inc.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
increase by approximately $550,000 by the end of the fiscal year. This increase
primarily relates to double taxation under applicable tax treaties with foreign
tax jurisdictions.
19. Statutory Reserves
The company's subsidiaries located in China are required to transfer 10% of
their net income, as determined in accordance with the People's Republic of
China (PRC) accounting rules and regulations, to a statutory surplus reserve
fund until such reserve balance reaches 50% of the company's registered capital.
The transfer to this reserve must be made before distributions of any dividend
to shareholders. As of August 3, 2008, the company's statutory surplus reserve
was $1.5 million, representing 10% of accumulated earnings and profits
determined in accordance with PRC accounting rules and regulations. The surplus
reserve fund is non-distributable other than during liquidation and can be used
to fund previous years' losses, if any, and may be utilized for business
expansion or converted into share capital by issuing new shares to existing
shareholders in proportion to their shareholding or by increasing the par value
of the shares currently held by them provided that the remaining reserve balance
after such issue is not less than 25% of the registered capital.
20. Commitments and Contingencies
The company leased a manufacturing facility in Chattanooga, Tennessee from
Joseph E. Proctor d/b/a Jepco Industrial Warehouses (the "Landlord') for a term
of 10 years. This lease expired on April 30, 2008. The company closed this
facility approximately five years ago and has not occupied the facility except
to provide supervision and security. The company continued to make its lease
payments to the landlord as required by the lease. A $1.4 million lawsuit was
filed by the Landlord on April 10, 2008, in the Circuit Court for Hamilton
County Tennessee to collect the remainder of the rent due under the lease for
the months of March and April of 2008, additional expenses to be paid by the
company for March and April 2008, including utilities, insurance, property
taxes, and other tenant-paid expenses that would result in the triple net rent
due the Landlord, and for extensive repairs, refitting, renovation, and capital
improvement items the Landlord alleges he is entitled to have the company pay
for. The Landlord unilaterally took possession of the leased premises on or
about March 10, 2008, even though the lease was in good standing and the company
was entitled to complete possession. Consequently, the company has paid their
lease payments through March 10, 2008 but the Landlord has not accepted the
company's position. The company will assert the repossessory action of the
Landlord as a bar to his further action under the lease to collect any items
from the company. A significant portion of the Landlord's claim relates to the
company's alleged liability for physical damage to the premises, to refit the
premises to its original condition, and to make physical improvements or
alterations to the premises. The company disputes the matters described in this
litigation and intends to defend itself vigorously.
A lawsuit was filed against the company and other defendants (Chromatex, Inc.,
Rossville Industries, Inc., Rossville Companies, Inc. and Rossville Investments,
Inc.) on February 5, 2008 in United States District Court for the Middle
District of Pennsylvania. The plaintiffs are Alan Shulman, Stanley Siegel, Ruth
Cherenson as Personal Representative of Estate of Alan Cherenson, and Adrienne
Rolla and M.F. Rolla as Executors of the Estate of Joseph Byrnes. The plaintiffs
I-20
Culp, Inc.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
were partners in a general partnership that formerly owned a manufacturing plant
in West Hazleton, Pennsylvania (the "Site"). Approximately two years after this
general partnership sold the Site to defendants Chromatex, Inc. and Rossville
Industries, Inc. the company leased and operated the Site as part of the
company's Rossville/Chromatex division. The lawsuit involves court judgments
that have been entered against the plaintiffs and against defendant Chromatex,
Inc. requiring them to pay costs incurred by the United States Environmental
Protection Agency ("USEPA") responding to environmental contamination at the
Site, in amounts approximating $8.6 million. Neither USEPA nor any other
governmental authority has asserted any claim against the company on account of
these matters. The plaintiffs seek contribution from the company and other
defendants and a declaration that the company and the other defendants are
responsible for environmental response costs under environmental laws and
certain agreements. The company does not believe it has any liability for the
matters described in this litigation and intends to defend itself vigorously. In
addition, the company has an indemnification agreement with certain other
defendants in the litigation pursuant to which the other defendants agreed to
indemnify the company for any damages it incurs as a result of the environmental
matters that are subject of this litigation and consequently no reserve has been
recorded.
In addition to the above, the company is involved in legal proceedings and
claims which have arisen in the ordinary course of business. These actions, when
ultimately concluded and settled, will not, in the opinion of management, have a
material adverse effect upon the financial position, results of operations or
cash flows of the company.
21. Recently Issued Accounting Pronouncements
In December 2007, the FASB issued SFAS No. 141 (revised 2007) "Business
Combinations." SFAS No. 141 requires the acquiring entity in a business
combination to recognize all assets acquired and liabilities assumed in the
transaction; establishes the acquisition-date fair value as the measurement
objective for all assets acquired and liabilities assumed; and requires the
acquirer to disclose all information required to evaluate and understand the
nature and financial effect of the business combination. This statement is
effective for acquisition dates on or after the beginning of the first annual
reporting period beginning after December 15, 2008. This statement is effective
for the company in fiscal 2010 and is not expected to have a material effect on
our consolidated financial statements to the extent we do not enter into a
business acquisition subsequent to adoption.
In March 2008, the FASB issued Statement No. 161, "Disclosures about Derivative
Instruments and Hedging Activities, An Amendment of FASB Statement No. 133."
SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activities",
does not provide adequate information about how derivative and hedging
activities affect an entity's financial position, financial performance, and
cash flows. Accordingly, SFAS No. 161 requires enhanced disclosures about an
entity's derivative and hedging activities and thereby improves transparency of
financial reporting. SFAS No. 161 is effective for fiscal and interim periods
beginning after November 15, 2008 and is effective for the company in third
quarter of fiscal 2009. The adoption of the provisions of SFAS No. 161 is not
expected to have a material effect on the company's financial position.
In April 2008, the FASB issued FASB Staff Position (FSP) No. 142-3,
"Determination of the Useful Life of Intangible Assets" (FSP 142-3). The
guidance is intended to improve the consistency between the useful life of a
recognized intangible asset under SFAS No. 142, "Goodwill and Other Intangible
Assets", and the period of expected cash flows used to measure the fair value of
the asset under SFAS No. 141(R), "Business Combinations", and other guidance
I-21
Culp, Inc.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
under U.S. generally accepted accounting principles (GAAP). FSP 142-3 is
effective for financial statements issued for fiscal years beginning after
December 15, 2008 and interim periods within those years. This statement is
effective for the company in fiscal 2010 and is not expected to have a material
effect on our consolidated financial statements to the extent we do not enter
into a business acquisition subsequent to adoption.
In May 2008, the FASB issued SFAS No. 162,"The Hierarchy of Generally Accepted
Accounting Principles (SFAS 162)." SFAS 162 identifies the sources of accounting
principles and the framework for selecting the principles to be used in the
preparation of financial statements of nongovernmental entities that are
presented in conformity GAAP in the United States (the GAAP hierarchy). SFAS 162
is effective 60 days following the SEC's approval of the Public Company
Accounting Oversight Board amendments to AU section 411,"The Meaning of Present
Fairly in Conformity with Generally Accepted Accounting Principles." The
adoption of SFAS 162 is not expected to have a material impact on the company's
results of operations, financial condition, and equity.
I-22
CAUTIONARY STATEMENT CONCERNING FORWARD-LOOKING INFORMATION
This report and the exhibits attached hereto contain statements that may be
deemed "forward-looking statements" within the meaning of the federal securities
laws, including the Private Securities Litigation Reform Act of 1995 (Section
27A of the Securities Act of 1933 and Section 27A of the Securities and Exchange
Act of 1934). Such statements are inherently subject to risks and uncertainties.
Further, forward looking statements are intended to speak only as of the date on
which they are made. Forward-looking statements are statements that include
projections, expectations or beliefs about future events or results or otherwise
are not statements of historical fact. Such statements are often but not always
characterized by qualifying words such as "expect," "believe," "estimate,"
"plan" and "project" and their derivatives, and include but are not limited to
statements about expectations for the company's future operations or success,
sales, gross profit margins, operating income, SG&A or other expenses, and
earnings, as well as any statements regarding future economic or industry trends
or future developments. Factors that could influence the matters discussed in
such statements include the level of housing starts and sales of existing homes,
consumer confidence, trends in disposable income, increases in utility and
energy costs, and general economic conditions. Decreases in these economic
indicators could have a negative effect on the company's business and prospects.
Likewise, increases in interest rates, particularly home mortgage rates, and
increases in consumer debt or the general rate of inflation, could affect the
company adversely. In addition, changes in consumer preferences for various
categories of furniture and bedding coverings, as well as changes in costs to
produce such products (including import duties and quotas or other import costs)
can have a significant effect on demand for the company's products. Changes in
the value of the U.S. dollar versus other currencies can affect the company's
financial results because a significant portion of the company's operations are
located outside the United States. Strengthening of the U.S. dollar against
other currencies could make the company's products less competitive on the basis
of price in markets outside the United States, and strengthening of currencies
in Canada and China can have a negative impact on the company's sales of
products produced in those countries. Further, economic and political
instability in international areas could affect the company's operations or
sources of goods in those areas, as well as demand for the company's products in
international markets. Also, the level of success in integrating the acquisition
of assets from Bodet & Horst could affect the company's ability to meet its
profitability goals. Finally, unanticipated delays or costs in executing
restructuring actions could cause the cumulative effect of restructuring actions
to fail to meet the objectives set forth by management. Further information
about these factors, as well as other factors that could affect the company's
future operations or financial results and the matters discussed in
forward-looking statements are included in Item 1A "Risk Factors" section in the
company's Form 10-K filed with the Securities and Exchange Commission on July 9,
2008 for the fiscal year ended April 27, 2008.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
--------------------------------------------------------------------------------
OF OPERATIONS
-------------
Results of Operations
The following analysis of financial condition and results of operations should
be read in conjunction with the Financial Statements and Notes and other
exhibits included elsewhere in this report.
Overview
The company's fiscal year is the 52 or 53 week period ending on the Sunday
closest to April 30. The company's three months ended August 3, 2008, and July
29, 2007, represent 14 and 13 week periods, respectively. The company has
operations classified into two business segments: mattress fabrics and
upholstery fabrics. The mattress fabrics segment primarily manufacturers,
sources and sells fabrics to bedding manufacturers. The upholstery fabrics
segment sources, manufactures and sells fabrics primarily to residential and
I-23
commercial (contract) furniture manufacturers. We believe that Culp is the
largest marketer of mattress fabrics in North America, and one of the largest
marketers of upholstery fabrics for furniture in North America, both measured by
total sales.
The company evaluates the operating performance of its segments based upon
income (loss) from operations before restructuring and related charges or
credits and certain unallocated corporate expenses. Unallocated corporate
expenses represent primarily compensation and benefits for certain executive
officers and all costs related to being a public company. Segment assets include
assets used in operations of each segment and primarily consist of accounts
receivable, inventories, and property, plant, and equipment. The mattress
fabrics segment also includes assets held for sale, goodwill and other
non-current assets associated with the ITG acquisition in its segment assets.
The upholstery fabrics segment also includes assets held for sale in its segment
assets.
The following tables set forth the net sales, gross profit, selling, general and
administrative expenses and operating income (loss) by segment for the three
months ended August 3, 2008, and July 29, 2007.
I-24
CULP, INC.
SALES, GROSS PROFIT AND OPERATING INCOME (LOSS) BY SEGMENT
FOR THE THREE MONTHS ENDED AUGUST 3, 2008 AND JULY 29, 2007
(Amounts in thousands)
THREE MONTHS ENDED (UNAUDITED)
--------------------------------------------------------------------
Amounts Percent of Sales
------------------------- ----------------------------
August 3, July 29, % Over August 3, July 29,
Net Sales by Segment 2008 2007 (Under) 2008 2007
--------------------------------------------- ----------- ----------- ---------- ------------- -------------
Mattress Fabrics $ 35,561 36,536 (2.7)% 59.9 % 56.0 %
Upholstery Fabrics 23,760 28,694 (17.2)% 40.1 % 44.0 %
----------- ----------- ---------- ------------- -------------
Net Sales $ 59,321 65,230 (9.1)% 100.0 % 100.0 %
=========== =========== ========== ============= =============
Gross Profit by Segment Gross Profit Margin
--------------------------------------------- ----------------------------
Mattress Fabrics $ 6,344 5,805 9.3 % 17.8 % 15.9 %
Upholstery Fabrics 1,070 3,768 (71.6)% 4.5 % 13.1 %
----------- ----------- ---------- ------------- -------------
Subtotal 7,414 9,573 (22.6)% 12.5 % 14.7 %
Restructuring related charges (12)(1) (517)(3) (97.7)% (0.0)% (0.8)%
----------- ----------- ---------- ------------- -------------
Gross Profit $ 7,402 9,056 (18.3)% 12.5 % 13.9 %
=========== =========== ========== ============= =============
Sales, General and Administrative expenses
by Segment Percent of Sales
--------------------------------------------- ----------------------------
Mattress Fabrics $ 2,128 2,042 4.2 % 6.0 % 5.6 %
Upholstery Fabrics 2,484 3,318 (25.1)% 10.5 % 11.6 %
Unallocated Corporate expenses 770 935 (17.6)% 1.3 % 1.4 %
----------- ----------- ---------- ------------- -------------
Subtotal 5,382 6,295 (14.5)% 9.1 % 9.7 %
Restructuring related charges 2 (1) 26 (3) (92.3)% 0.0 % 0.0 %
----------- ----------- ---------- ------------- -------------
Selling, General and Administrative expenses 5,384 6,321 (14.8)% 9.1 % 9.7 %
=========== =========== ========== ============= =============
Operating income (loss) by Segment Operating Income (Loss) Margin
--------------------------------------------- ----------------------------
Mattress Fabrics $ 4,216 3,763 12.0 % 11.9 % 10.3 %
Upholstery Fabrics (1,414) 450 N.M. (6.0)% 1.6 %
Unallocated corporate expenses (770) (935) 17.6 % (1.3)% (1.4)%
----------- ----------- ---------- ------------- -------------
Subtotal 2,032 3,278 (38.0)% 3.4 % 5.0 %
Restructuring expense and restructuring
related charges (416)(2) (975)(4) (57.3)% (0.7)% (1.5)%
----------- ----------- ---------- ------------- -------------
Operating income $ 1,616 2,303 (29.8)% 2.7 % 3.5 %
=========== =========== ========== ============= =============
Depreciation by Segment
---------------------------------------------
Mattress Fabrics $ 758 897 (15.5)%
Upholstery Fabrics 500 550 (9.1)%
----------- ----------- ------------
Total Depreciation 1,258 1,447 (13.1)%
=========== =========== ============
(1) The $12 represents other operating costs associated with a closed plant
facility. The $2 represents other operating costs associated with a closed
plant facility.
(2) The $416 represents $414 for employee termination benefits, $14 for other
operating costs associated with a closed plant facility, and a credit of
$12 for lease termination and other exit costs. Of this total charge, $12,
$2, and $402 are included in cost of sales, selling, general, and
administrative expense, and restructuring expense, respectively.
(3) The $517 represents restructuring related charges of $460 for other
operating costs associated with closed plant facilities and $57 for
inventory markdowns. The $26 represents other operating costs associated
with a closed plant facility.
(4) The $975 represents $486 for other operating costs associated with closed
plant facilities, $367 for lease termination costs, $362 for write-downs of
a building and equipment, $57 for inventory markdowns, $54 for asset
movement costs, a credit of $149 for employee termination benefits, and a
credit of $202 for sales proceeds received on equipment with no carrying
value. Of this total charge, $517, $26 and $432 are included in cost of
sales, selling, general, and administrative expense, and restructuring
expense, respectively.
I-25
Three months ended August 3, 2008 compared with the Three Months ended July 29,
2007
Overview
For the three months ended August 3, 2008, net sales decreased 9% to $59.3
million compared with $65.2 million for the first quarter of fiscal 2008. The
company reported net income of $781,000 or $0.06 per diluted share, for the
first quarter of fiscal 2009, which included restructuring and related pre-tax
charges of $416,000. The company reported net income of $851,000, or $0.07 per
diluted share, for the first quarter of fiscal 2008, which included
restructuring and related pre-tax charges of $975,000.
Restructuring and Related Charges
On September 3, 2008, the board of directors approved changes to the upholstery
fabric operations, including the consolidation of facilities in China and
reduction of excess manufacturing capacity, which will involve exit and disposal
charges to be incurred by the company. This action is in response to the
extremely challenging industry conditions for upholstery fabrics and is expected
to result in pre-tax charges of approximately $3.9 million, of which $3.5
million is expected to be non-cash items and $400,000 is expected to result in
cash expenditures. The company anticipates the charges to be made up of
approximately $2.1 million for accelerated depreciation related to leasehold
improvements on facilities being exited, $1.4 million for fixed asset
write-downs, $250,000 for lease termination costs, and $100,000 for employee
termination benefits and other costs related to dismantling, disposal, and
moving of equipment and related assets. All these charges are expected to be
incurred in the company's second and third quarters of fiscal 2009. The plant
consolidations are expected to be completed by the end of the third quarter of
fiscal 2009.
During the first quarter of fiscal 2009, total restructuring and related charges
were $416,000, of which $414,000 related to employee termination benefits,
$14,000 for other operating costs associated with a closed plant facility, and a
credit of $12,000 for lease termination and other exit costs. Of this total
charge, $12,000 was recorded in cost of sales, $2,000 was recorded in selling,
general, and administrative expense, and $402,000 was recorded in restructuring
expense in the 2009 Consolidated Statement of Net Income. These charges
primarily relate to the December 2006 Upholstery Fabrics restructuring plan.
During the first quarter of fiscal 2008, total restructuring and related charges
were $975,000, of which $486,000 related to other operating costs associated
with closed plant facilities, $367,000 for lease termination costs, $362,000 for
write-downs of a building and equipment, $57,000 for inventory markdowns,
$54,000 for asset movement costs, a credit of $149,000 for employee termination
benefits, and a credit of $202,000 for sales proceeds received on equipment with
no carrying value. Of this total charge, $517,000 was recorded in cost of sales,
$26,000 was recorded in selling, general, and administrative expense, and
$432,000 was recorded in restructuring expense in the 2008 Consolidated
Statement of Net Income. These charges primarily relate to the December 2006
Upholstery Fabrics restructuring plan.
Mattress Fabrics Segment
Asset Acquisition
Pursuant to an Asset Purchase Agreement among the company, Bodet & Horst USA, LP
and Bodet & Horst GMBH & Co. KG (collectively "Bodet & Horst") dated August 11,
2008, the company purchased certain assets and assumed certain liabilites of the
knitted mattress fabric operation of Bodet & Horst, including its manufacturing
operation in High Point, North Carolina. The purchase involves the equipment,
inventory, and intellectual property associated with the High Point
manufacturing operation, which has served as the company's primary source of
knitted mattress fabric for six years. Demand for this product line has grown
significantly, as knits are increasingly being utilized on mattresses at volume
I-26
retail price points. The company is assuming the lease of the building where the
operation is located and intends to continue operating the business in that
location. The purchase price for the assets is cash in the amount of $10.5
million, plus the assumption of certain liabilities, subject to adjustment after
closing for changes in working capital through the date of closing. Also, in
connection with the purchase, the company entered into a six-year consulting and
non-compete agreement with the principal owner of Bodet & Horst, providing for
payments to the owner in the amount of $75,000 per year for the agreement's full
six-year term.
The acquisition was financed by $11.0 million of unsecured notes pursuant to a
Note Purchase Agreement ("2008 Note Agreement") dated August 11, 2008. The 2008
Note Agreement has a fixed interest rate of 8.01% and a term of seven years.
Principal payments of $2.2 million per year are due on the notes beginning three
years from the date of the 2008 Note Agreement. The 2008 Note Agreement contains
customary financial and other covenants as defined in the 2008 Note Agreement.
In connection with the 2008 Note Agreement, the company entered into a Consent
and Fifth Amendment (the "Consent and Amendment") that amends the previously
existing unsecured note purchase agreements. The purpose of the Consent and
Amendment is for the existing note holders to consent to the 2008 Note Agreement
and to provide that certain financial covenants in favor of the existing note
holders will be on the same terms as those contained in the 2008 Note Agreement.
Net Sales -- Mattress fabrics (known as mattress ticking) net sales for the
first quarter of fiscal 2009 were $35.6 million, a 3% decrease compared with
$36.5 million for the first quarter of fiscal 2008. On a unit volume basis,
total yards sold for the first quarter of fiscal 2009 decreased by 4.7% compared
with the first quarter of fiscal 2008. This trend reflects moderately softer
consumer bedding demand in the first quarter of fiscal 2009 and the planned
discontinuance of certain products from the ITG acquisition.
The average selling price of $2.49 for the first quarter of fiscal 2009
increased 2.1% over the same period a year ago. This trend reflects a shift in
product mix.
Operating Income -- For the first quarter of fiscal 2009, the mattress fabrics
segment reported operating income of $4.2 million, or 11.9% of net sales,
compared to $3.8 million, or 10.3% of net sales, for the first quarter of fiscal
2008. Selling, general, and administrative expenses as a percentage of net sales
were 6.0% in the first quarter of fiscal 2009 compared with 5.6% in the first
quarter of fiscal 2008.
Mattress fabrics continues to be a driving force in the company's business and
accounted for 60% of the company's net sales for the first quarter of fiscal
2009 compared with 56% for the first quarter of fiscal 2008. During the first
quarter of fiscal 2009, the company completed a $5.0 million capital project to
significantly strengthen its woven fabrics manufacturing operations and provide
further reactive capacity to its customers. Additionally, the expanded capacity
this capital project provides, should effectively position the company to pursue
future growth opportunities. The recent acquisition of the knitted mattress
fabrics operation of Bodet & Horst will further enhance the company's strong
service platform with improved supply logistics from pattern inception to fabric
delivery, allowing accelerated responsiveness and greater stability. With the
weaving expansion and the completion of the Bodet & Horst acquisition, the
company now has a large and modern, vertically integrated manufacturing platform
in all major product categories of the mattress fabrics industry.
Segment assets -- Segment assets consist of accounts receivable, inventory,
assets held for sale, a non-compete agreement associated with the ITG
acquisition, goodwill, and property, plant, and equipment. As of August 3, 2008,
accounts receivable and inventory totaled $26.4 million compared with $27.6
million at April 27, 2008. As of August 3, 2008, and April 27, 2008, the
carrying value of assets held for sale was $35,000. The company expects that the
final sale and disposal of these assets will be completed within a year from the
date the plan of sale was adopted.
I-27
As of August 3, 2008 and April 27, 2008, the carrying value of the non-compete
agreement was $717,000 and $789,000, respectively. As of August 3, 2008 and
April 27, 2008, the carrying value of the segment's goodwill was $4.1 million.
Also as of August 3, 2008, property, plant and equipment totaled $22.9 million
compared with $21.7 million at April 27, 2008. The $22.9 million at August 3,
2008, represents property, plant, and equipment located in the U.S. of $14.7
million, located in Canada of $8.1 million, and various corporate allocations of
$160,000. The $21.7 million at April 27, 2008, represents property, plant, and
equipment located in the U.S. of $13.1 million, located in Canada of $8.4
million, and various corporate allocations of $168,000.
Upholstery Fabrics Segment
Net Sales -- Upholstery fabric net sales (which include both fabric and cut and
sewn kits) for the first quarter of fiscal 2009 were $23.8 million, a 17%
decline compared with $28.7 million in the first quarter of fiscal 2008. On a
unit volume basis, total yards sold (which excludes fabric used in cut and sewn
kits) for the first quarter of fiscal 2009 decreased by 17% compared with the
first quarter of fiscal 2008. Average selling prices of $4.36 increased 3.5% for
the first quarter of fiscal 2009 compared with the first quarter of fiscal 2008.
Upholstery fabrics sales reflect substantially lower demand industry wide, as
well as continued very weak demand for U.S. produced upholstery fabrics, driven
by consumer preference for leather and suede furniture and other imported
furniture and fabrics. Net sales of upholstery fabrics produced outside the
company's U.S. manufacturing operations were $17.4 million in the first quarter
of fiscal 2009, a decrease of 8% from $18.9 million in the first quarter of
fiscal 2008. Net sales of U.S. produced upholstery fabrics were $6.3 million in
the first quarter of fiscal 2009, a decrease of 35% from $9.8 million in the
first quarter of fiscal 2008.
Operating Income (Loss) - The upholstery fabrics segment had an operating loss
for the first quarter of fiscal 2009 of $1.4 million compared with operating
income of $450,000 for the first quarter of fiscal 2008. These results reflect
the very difficult operating environment for the retail furniture industry. The
uncertain economy, housing crisis, and high energy costs have continued to
significantly influence consumer demand for furniture and have adversely
affected the company's upholstery fabrics business for both U.S. produced and
non U.S. produced goods. In response to this environment and our first quarter
results, the company immediately put into operation a profit improvement plan in
the upholstery fabrics business, including the following major actions in the
second quarter of fiscal 2009:
o Implemented a modest price increase on certain upholstery fabrics
during the second fiscal quarter; and wherever possible, obtain price
concessions from suppliers on certain high volume items where we could
not increase our selling prices.
o Implemented a 20% reduction in selling, general and administrative
expenses, totaling approximately $2.0 million on an annual basis. This
initiative was completed by the end of August 2008.
o Consolidating our China operations into fewer facilities and reducing
excess manufacturing capacity over the next five months, which will
lower costs by approximately $2.0 million on an annual basis. (See
Restructuring and Related Charges section for further details).
Selling, general and administrative expenses for first quarter of fiscal 2009
were down 25% from the first quarter of fiscal 2008. This reduction is due to
the company's restructuring activities, and this year over year improvement is
expected to continue throughout fiscal 2009 based on the above actions described
above.
Management remains cautiously optimistic about the company's long-term prospects
in the upholstery fabrics business because of the following: a) we have been
I-28
receiving significantly higher fabric placements, including cut and sewn kits
with a broader base of customers; b) a declining base of competitors due to the
challenging economic environment; c) the improving value we are providing to our
customers from our China and U.S. operations; d) the benefits realized through
operational improvements being made in our Anderson, South Carolina, velvet
facility; and e) the expected results from our profit improvement plan. While
these are all favorable indicators, management remains committed to taking
additional steps if necessary to address the low profitability of the company's
upholstery fabric operations, regardless of prevailing economic and business
conditions. The company could experience additional inventory markdowns,
write-downs of its property, plant, and equipment, and further restructuring
charges in the upholstery fabric operations if sales and profitability continue
to decline and further restructuring actions become necessary.
Segment Assets -- Segment assets consist of accounts receivable, inventory,
property, plant, and equipment, and assets held for sale. As of August 3, 2008,
accounts receivable and inventory totaled $28.7 million compared to $34.9
million at April 27, 2008. This decline reflects lower sales and improved
working capital management. As of August 3, 2008, property, plant, and equipment
totaled $11.0 million compared to $11.2 million at April 27, 2008. The $11.0
million at August 3, 2008, represents property, plant, and equipment located in
China of $8.9 million, located in the U.S. of $1.6 million, and various
corporate allocations of $480,000. The $11.2 million at April 27, 2008,
represents property, plant, and equipment located in China of $9.0 million,
located in the U.S. of $1.7 million, and various corporate allocations of
$501,000.
At August 3, 2008 and April 27, 2008, this segment had assets held for sale with
a carrying value of $792,000 for certain equipment related to the company's U.S.
upholstery fabric operations. The company expects that the final sale and
disposal of these assets will be completed within a year from the date the plan
of sale was adopted.
Other Income Statement Categories
Selling, General and Administrative Expenses - Selling, general, and
administrative expenses (SG&A) for the company as a whole were $5.4 million for
the first quarter of fiscal 2009 compared with $6.3 million for the first
quarter of fiscal 2008, a decrease of 15%. As a percent of net sales, SG&A
expenses were 9.1% in the first quarter of fiscal 2009 compared with 9.7% in the
first quarter of fiscal 2008. This trend primarily reflects the company's
restructuring efforts associated with its U.S. upholstery fabric operations.
Interest Expense (Income) -- Interest expense for the first quarter of fiscal
2009 was $431,000 compared to $818,000 for the first quarter of fiscal 2008.
This trend primarily reflects lower outstanding balances on the company's
existing unsecured term notes and the decrease in the one-month LIBOR, which is
the interest rate upon which the company's real estate loans are based. Interest
expense is expected to increase for the remainder of fiscal 2009 due to the
financing needed for the Bodet & Horst asset acquisition. Interest income was
$34,000 for the first quarter of fiscal 2009 compared to $58,000 for the first
quarter of fiscal 2008. This trend reflects lower cash and cash equivalent
balances, which were invested in money market funds.
I-29
Other Expense - Other expense for first quarter of fiscal 2009 was $14,000
compared with $232,000 for the first quarter of fiscal 2008. This change
primarily reflects fluctuations in foreign currency exchange rates for
subsidiaries domiciled in China and Canada.
Income Taxes
Effective Income Tax Rate
The effective income tax rates (income taxes as a percentage of income before
income taxes) for the three month periods ended August 3, 2008 and July 29, 2007
were 35.2% and 35.1%, respectively. The company's income tax expense and
effective income tax rates for the three month periods ended August 3, 2008 and
July 29, 2007, were based upon the estimated effective income tax rate
applicable for the full year after giving effect to any significant items
related specifically to interim periods. The effective income tax rate can be
impacted over the fiscal year by the mix and timing of actual earnings from the
company's U.S. operations and foreign sources versus annual projections and
changes in foreign currencies in relation to the U.S. dollar.
Deferred Income Taxes
In making the judgment about the realization of the U.S. net deferred tax
assets, management has considered both negative and positive evidence, and
concluded that sufficient positive evidence exists to overcome the cumulative
losses experienced in recent years. Specifically, management considered the
following, among other factors: nature of the company's products; history of
positive earnings in the mattress fabrics segment; capital projects that have
further enhanced the company's globally competitive cost structure in the
mattress fabrics segment; the incremental sales volume from the purchase of
certain assets from International Textile Group, Inc. (ITG) related to the
mattress fabric product line of ITG's Burlington House Division, the purchase of
certain assets from Bodet & Horst related to its knitted mattress fabric
operation; recent restructuring actions in the U.S. upholstery fabrics business
to adjust the U.S. cost structure and bring U.S. manufacturing capacity in line
with demand; development of offshore manufacturing and sourcing programs to meet
changing demands of upholstery fabric customers in the U.S.; and inter-company
agreements with the company's China subsidiaries are expected to be in place in
fiscal 2009 for various consulting services and intellectual property.
Management's analysis of taxable income also included the following
considerations: none of the company's net operating loss carryforwards have
previously expired unused; the U.S. federal carryforward period is 20 years; and
the company's current income tax loss carryforwards principally expire in 14-20
years; fiscal 2022 through 2028.
Uncertainty In Income Taxes
At August 3, 2008, the company had $5.1 million of total gross unrecognized tax
benefits, of which $4.7 million represents the amount of gross unrecognized tax
benefits that, if recognized would favorably affect the income tax rate in
future periods. The total gross unrecognized tax benefits of $5.1 million as of
August 3, 2008, are classified as income taxes payable -long-term in the
accompanying consolidated balance sheets.
The company anticipates that the amount of unrecognized tax benefits will
increase by approximately $550,000 by the end of the fiscal year. This increase
primarily relates to double taxation under applicable tax treaties with foreign
tax jurisdictions.
I-30
Liquidity and Capital Resources
Liquidity - The company's sources of liquidity include cash and cash
equivalents, cash flow from operations, assets held for sale, and amounts
available under its unsecured revolving credit lines. These sources have been
adequate for day-to-day operations. The company believes its sources of
liquidity continue to be adequate to meets its needs.
Cash and cash equivalents as of August 3, 2008, were $6.4 million compared with
$4.9 million as of April 27, 2008. The company's cash position reflects
improvement in cash flow from operations of $3.3 million for the three months
ended August 3, 2008 compared with $1.1 million for the three months ended July
29, 2007. This increase in cash flow from operations reflects significant
improvement in working capital management. The company's cash position also
reflects cash outlays for capital expenditures of $986,000, and payments on
vendor-financed capital expenditures, a capital lease obligation, and long-term
debt totaling $899,000 for the three months ended August 3, 2008.
The company is taking further steps to support is liquidity, including ongoing
efforts to improve working capital turnover, sell certain assets, and further
reduce selling, general, and administrative expenses in its upholstery fabrics
segment. Effective October 29, 2007, the company adopted a plan to sell its
corporate headquarters, as the company is only utilizing one-half of the
available space and with the sale can lower costs and reduce debt. The carrying
value of the company's corporate headquarters is approximately $4.8 million and
is recorded in assets held for sale in the Consolidated Balance Sheets. The
company will use the sales proceeds will be applied against the outstanding $6.3
million mortgage balance.
The company's cash position may be adversely affected by factors beyond its
control, such as weakening industry demand, delays in receipt of payment on
accounts receivable, and the availability of trade credit.
Working Capital -- Accounts receivable as of August 3, 2008 decreased $3.7
million or 16% in comparison to July 29, 2007. This decrease is primarily
related to the decrease in sales volume in the first quarter of fiscal 2009
compared with the first quarter of fiscal 2008. Days sales outstanding totaled
31 days at August 3, 2008 and July 29, 2007, respectively. Inventories as of
August 3, 2008, decreased $7.3 million or 17% in comparison to July 29, 2007.
This decrease in inventories primarily reflects lower sales volume and improved
inventory management. Inventory turns for the first quarter of fiscal 2009 were
5.9 versus 5.4 for the first quarter of fiscal 2008. Operating working capital
(comprised of accounts receivable and inventories, less accounts payable) was
$35.5 million at August 3, 2008, down from $48.1 million at July 29, 2007.
Working capital turnover was 6.0 and 5.2 at August 3, 2008 and July 29, 2007,
respectively.
Financing Arrangements
Unsecured Term Notes- Bodet & Horst Acquisition
In connection with the Bodet & Horst Asset Purchase Agreement, the company
entered into the 2008 Note Agreement dated August 11, 2008. The 2008 Note
Agreement provides for the issuance of $11.0 million of unsecured term notes
with a fixed interest rate of 8.01% and a term of seven years. Principal
payments of $2.2 million per year are due on the notes beginning three years
from the date of the 2008 Note Agreement. The 2008 Note Agreement contains
customary financial and other covenants as defined in the 2008 Note Agreement.
I-31
Unsecured Term Notes- Existing
The company's existing unsecured term notes have a fixed interest rate of 8.80%
(payable semi-annually in March and September and subject to prepayment
provisions each fiscal quarter as defined in the agreement) and are payable over
an average remaining term of 1.6 years through March 2010. The principal
payments are required to be paid in annual installments over the next two years
as follows: March 2009 - $7.2 million; and March 2010 - $7.1 million.
In connection with the 2008 Note Agreement, the company entered into a Consent
and Amendment that amends the previously existing unsecured note purchase
agreements. The purpose of the Consent and Amendment is for the existing note
holders to consent to the 2008 Note Agreement and to provide that certain
financial covenants in favor of the existing note holders will be on the same
terms as those contained in the 2008 Note Agreement.
Real Estate Loan - I
The company has a real estate loan that is secured by a lien on the company's
corporate headquarters office located in High Point, NC. This term loan bears
interest at the one-month LIBOR plus an adjustable margin (all in rate of 4.96%
at August 3, 2008) based on the company's debt/EBITDA ratio, as defined in the
agreement and is payable in monthly installments through September 2010, with a
final payment of $3.3 million in October 2010.
Real Estate Loan - II
The company has a term loan in the amount of $2.5 million in connection with the
ITG asset purchase agreement. This term loan is secured by a lien on the
company's corporate headquarters office located in High Point, NC and bears
interest at the one-month LIBOR plus an adjustable margin (all in rate of 5.48%
at August 3, 2008) based on the company's debt/EBITDA ratio, as defined in the
agreement. This agreement requires the company to pay interest monthly with the
entire principal due on June 30, 2010.
Revolving Credit Agreement - United States
The company has an unsecured credit agreement that provides for a revolving loan
commitment of $6.5 million, including letters of credit up to $5.5 million. This
agreement expires on December 31, 2008, and bears interest at the one-month
LIBOR plus an adjustable margin (all in rate of 4.96% at August 3, 2008) based
on the company's debt/EBITDA ratio, as defined in the agreement. As of August 3,
2008, there were $1.3 million in outstanding letters of credit (all of which
related to workers compensation) and no borrowings outstanding under the
agreement.
Revolving Credit Agreement - China
The company's China subsidiary has an unsecured revolving credit agreement with
a bank in China to provide a line of credit available up to approximately $5.0
million, of which approximately $1.0 million includes letters of credit. This
agreement bears interest at a rate determined by the Chinese government. There
were no borrowings outstanding under the agreement as of August 3, 2008.
Canadian Government Loan
The company has an agreement with the Canadian government for a term loan that
is non-interest bearing and is payable in 48 equal monthly installments
commencing December 1, 2009. The proceeds were used to partially finance capital
expenditures at the company's Rayonese facility located in Quebec, Canada.
I-32
Overall
The company's loan agreements require that the company maintain compliance with
certain financial ratios. At August 3, 2008, the company was in compliance with
these financial covenants.
As of August 3, 2008, the principal payment requirements of long-term debt
during the next five years are: Year 1 - $7.4 million; Year 2 - $10.0 million;
Year 3 - $3.5 million; Year 4 - $195,000; Year 5 - $195,000; and thereafter -
$65,000.
Capital Expenditures
Capital expenditures for the three months ended August 3, 2008 were
approximately $2.3 million, of which $986,000 was paid in cash and approximately
$1.4 million was financed through a capital lease. The capital spending of $2.3
million consisted of $2.0 million from the mattress fabrics segment and $305,000
from the upholstery fabrics segment. Depreciation expense for the three months
ended August 3, 2008 was approximately $1.3 million, of which $758,000 related
to the mattress fabrics segment and $500,000 related the upholstery fabrics
segment.
The company currently expects total capital expenditures to be approximately
$4.0 million in fiscal 2009, of which $2.6 million will be paid in cash and $1.4
million was financed through a capital lease on a project initiated prior to the
end of fiscal 2008. The capital spending of $4.1 million primarily relates to
the mattress fabrics segment. The company currently estimates depreciation
expense to be $8.1 million for fiscal 2009, of which $4.0 million relates to the
mattress fabrics segment and $4.1 million relates to the upholstery fabrics
segment (which includes $2.1 million of accelerated depreciation related to
leasehold improvements on facilities exited in China). The company expects the
availability of funds from cash flow from operations and its revolving credit
lines to fund its remaining capital needs.
The company has certain vendor financed arrangements regarding capital
expenditures that bear interest with fixed interest rates ranging from 6% to
7.14%. The payment requirements for accounts payable-capital expenditures (both
vendor-financed and non-vendor financed during the three years are: Year 1 -
$1.0 million; Year 2 - $725,000; and Year 3 - $550,000.
In May 2008, the company entered into a capital lease to finance the
construction of certain equipment related to its mattress fabrics segment. The
lease agreement contains a bargain purchase option and bears interest at 8.5%.
The lease agreement requires principal payments totaling $1.4 million to
commence on July 1, 2008, and to be paid in quarterly installments through April
2010. This agreement is secured by equipment with a carrying value of $2.4
million. The principal payments required over the next two years are as follows:
Year 1 - $692,000; and Year 2 - $458,000.
Critical Accounting Policies and Recent Accounting Developments
Significant accounting policies adopted by the company in fiscal 2009 are as
follows:
Fair Value Measurements:
The company adopted SFAS No. 157, Fair Value Measurements ("SFAS 157") and SFAS
No. 159, The Fair Value Option for Financial Assets and Financial Liabilities
("SFAS 159"), on April 28, 2008. SFAS 157 (1) creates a single definition of
fair value, (2) establishes a framework for measuring fair value, and (3)
expands disclosure requirements about items measured at fair value. SFAS 157
applies to both items recognized and reported at fair value in the financial
statements and items disclosed at fair value in the notes to the financial
statements. SFAS 157 does not change existing accounting rules governing what
can or what must be recognized and reported at fair value in the company's
I-33
financial statements, or disclosed at fair value in the company's notes to the
financial statements. Additionally, SFAS 157 does not eliminate practicability
exceptions that exist in accounting pronouncements amended by SFAS 157 when
measuring fair value. As a result, the company will not be required to recognize
any new assets or liabilities at fair value.
Prior to SFAS 157, certain measurements of fair value were based on the price
that would be paid to acquire an asset, or received to assume a liability (an
entry price). SFAS 157 clarifies the definition of fair value as the price that
would be received to sell an asset, or paid to transfer a liability, in an
orderly transaction between market participants at the measurement date (that
is, an exit price). The exit price is based on the amount that the holder of the
asset or liability would receive or need to pay in an actual transaction (or in
a hypothetical transaction if an actual transaction does not exist) at the
measurement date. In some circumstances, the entry and exit price may be the
same; however, they are conceptually different.
Fair value is generally determined based on quoted market prices in active
markets for identical assets or liabilities. If quoted market prices are not
available, the company uses valuation techniques that place greater reliance on
observable inputs and less reliance on unobservable inputs. In measuring fair
value, the company may make adjustments for risks and uncertainties, if a market
participant would include such an adjustment in its pricing.
SFAS 157 establishes a fair value hierarchy that distinguishes between
assumptions based on market data (observable inputs) and the company's
assumptions (unobservable inputs). Determining where an asset or liability falls
within that hierarchy depends on the lowest level input that is significant to
the fair measurement as a whole. An adjustment to the pricing method used within
either level 1 or level 2 inputs could generate a fair value measurement that
effectively falls in a lower level in the hierarchy. The hierarchy consists of
three broad levels as follows:
Level 1 - Quoted market prices in active markets for identical assets or
liabilities;
Level 2 - Inputs other than level 1 inputs that are either directly or
indirectly observable, and
Level 3 - Unobservable inputs developed using the company's estimates and
assumptions, which reflect those that market participants would use.
The following table presents information about assets and liabilities measured
at fair value on a recurring basis:
Fair value measurements at August 3, 2008 using:
---------------------------------------------------------------------------------------------------------------
Quoted prices in
active markets Significant
for identical Significant other unobservable
assets observable inputs inputs
---------------------------------------------------------------------------------------------------------------
(amounts in thousands) Level 1 Level 2 Level 3 Total
---------------------------------------------------------------------------------------------------------------
Assets:
None Not applicable Not applicable Not applicable Not applicable
Liabilities:
Interest Rate Swap Agreement Not applicable 66 Not applicable 66
As shown above, the interest rate swap derivative is valued based on fair value
provided by the company's bank and is classified within level 2 of the fair
value hierarchy. The determination of where an asset or liability falls in the
hierarchy requires significant judgment. The company evaluates its hierarchy
I-34
disclosures each quarter based on various factors and it is possible that an
asset or liability may be classified differently from quarter to quarter.
However, the company expects that changes in classifications between different
levels will be rare.
Most derivative contracts are not listed on an exchange and require the use of
valuation models. Consistent with SFAS 157, the company attempts to maximize the
use of observable market inputs in its models. When observable inputs are not
available, the company defaults to unobservable inputs. Derivatives valued based
on models with significant unobservable inputs and that are not actively traded,
or trade activity is one way, are classified within level 3 of the fair value
hierarchy.
Some financial statement preparers have reported difficulties in applying SFAS
157 to certain nonfinancial assets and nonfinancial liabilities, particularly
those acquired in business combinations and those requiring a determination of
impairment. To allow the time to consider the effects of the implementation
issues that have arisen, the FASB issued FSP FAS 157-2 ("FSP 157-2") on February
12, 2008 to provide a one-year deferral of the effective date of SFAS 157 for
nonfinancial assets and nonfinancial liabilities, except those that are
recognized or disclosed in financial statements at fair value on a recurring
basis (that is, at least annually). As a result of FSP 157-2, the company has
not yet adopted SFAS 157 for nonfinancial assets and liabilities that are valued
at fair value on a non-recurring basis. FSP 157-2 is effective for the company
in fiscal 2010 and the company is evaluating the impact that the application of
SFAS 157 to those nonfinancial assets and liabilities will have on its financial
statements.
In February 2007, the FASB issued SFAS 159, The Fair Value Option for Financial
Assets and Financial Liabilities. SFAS 159 provides the company with an option
to elect fair value as the initial and subsequent measurement attribute for most
financial assets and liabilities and certain other items. The fair value option
election is applied on an instrument-by-instrument basis (with some exceptions),
is irrevocable, and is applied to an entire instrument. The election may be made
as of the date of initial adoption for existing eligible items. Subsequent to
initial adoption, the company may elect the fair value option at initial
recognition of eligible items, on entering into an eligible firm commitment, or
when certain specified reconsideration events occur. Unrealized gains and losses
on items for which the fair value option has been elected will be reported in
earnings.
Upon adoption of SFAS 159 on April 28, 2008, the company did not elect to
account for any assets and liabilities under the scope of SFAS 159 at fair
value.
Recently Issued Accounting Standards
In December 2007, the FASB issued SFAS No. 141 (revised 2007) "Business
Combinations." SFAS No. 141 requires the acquiring entity in a business
combination to recognize all assets acquired and liabilities assumed in the
transaction; establishes the acquisition-date fair value as the measurement
objective for all assets acquired and liabilities assumed; and requires the
acquirer to disclose all information required to evaluate and understand the
nature and financial effect of the business combination. This statement is
effective for acquisition dates on or after the beginning of the first annual
reporting period beginning after December 15, 2008. This statement is effective
for the company in fiscal 2010 and is not expected to have a material effect on
our consolidated financial statements to the extent we do not enter into a
business acquisition subsequent to adoption.
In March 2008, the FASB issued Statement No. 161, "Disclosures about Derivative
Instruments and Hedging Activities, An Amendment of FASB Statement No. 133."
SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activities",
does not provide adequate information about how derivative and hedging
activities affect an entity's financial position, financial performance, and
cash flows. Accordingly, SFAS No. 161 requires enhanced disclosures about an
entity's derivative and hedging activities and thereby improves transparency of
financial reporting. SFAS No. 161 is effective for fiscal and interim periods
I-35
beginning after November 15, 2008 and is effective for the company in third
quarter of fiscal 2009. The adoption of the provisions of SFAS No. 161 is not
expected to have a material effect on the company's financial position.
In April 2008, the FASB issued FASB Staff Position (FSP) No. 142-3,
"Determination of the Useful Life of Intangible Assets" (FSP 142-3). The
guidance is intended to improve the consistency between the useful life of a
recognized intangible asset under SFAS No. 142, "Goodwill and Other Intangible
Assets", and the period of expected cash flows used to measure the fair value of
the asset under SFAS No. 141(R), "Business Combinations", and other guidance
under U.S. generally accepted accounting principles (GAAP). FSP 142-3 is
effective for financial statements issued for fiscal years beginning after
December 15, 2008 and interim periods within those years. This statement is
effective for the company in fiscal 2010 and is not expected to have a material
effect on our consolidated financial statements to the extent we do not enter
into a business acquisition subsequent to adoption.
In May 2008, the FASB issued SFAS No. 162,"The Hierarchy of Generally Accepted
Accounting Principles (SFAS 162)." SFAS 162 identifies the sources of accounting
principles and the framework for selecting the principles to be used in the
preparation of financial statements of nongovernmental entities that are
presented in conformity GAAP in the United States (the GAAP hierarchy). SFAS 162
is effective 60 days following the SEC's approval of the Public Company
Accounting Oversight Board amendments to AU section 411,"The Meaning of Present
Fairly in Conformity with Generally Accepted Accounting Principles." The
adoption of SFAS 162 is not expected to have a material impact on the company's
results of operations, financial condition, and equity.
Contractual Obligations
Unsecured Term Notes- Bodet & Horst Acquisition
In connection with the Bodet & Horst Asset Purchase Agreement, the company
entered into the 2008 Note Agreement dated August 11, 2008. The 2008 Note
Agreement provides for the issuance of $11.0 million of unsecured term notes
with a fixed interest rate of 8.01% and a term of seven years. Principal
payments of $2.2 million per year are due on the notes beginning three years
from the date of the 2008 Note Agreement. The 2008 Note Agreement contains
customary financial and other covenants as defined in the 2008 Note Agreement.
Capital Lease Obligation
In May 2008, the company entered into a capital lease to finance the
construction of certain equipment related to its mattress fabrics segment. The
lease agreement contains a bargain purchase option and bears interest at 8.5%.
The lease agreement requires principal payments totaling $1.4 million to
commence on July 1, 2008, and to be paid in quarterly installments through April
2010. This agreement is secured by equipment with a carrying value of $2.4
million. The principal payments required over the next two years are as follows:
Year 1 - $692,000; and Year 2 - $458,000.
Inflation
The cost of certain of the company's raw materials, principally yarn from
petroleum derivatives, and utility/energy costs, have continued to impact on our
financial results in fiscal 2009 as oil and energy prices increased and had an
impact on the company's financial results. Any significant increase in the
company's raw material costs, utility/energy costs and general economic
inflation could have a material adverse impact on the company, because
competitive conditions have limited the company's ability to pass significant
operating cost increases on to its customers.
I-36
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
-------------------------------------------------------------------
The company is exposed to market risk from changes in interest rates on debt and
foreign currency exchange rates. The company's market risk sensitive instruments
are not entered into for trading purposes. The company's exposure to interest
rate risk consists of floating rate debt based on the London Interbank Offered
Rate (LIBOR) plus an adjustable margin under the company's revolving credit
agreement in the United States and its real estate term loans. As of August 3,
2008, there were $6.3 million in borrowings outstanding under the company's real
estate term loans and no borrowings under the company's revolving credit
agreement in the United States. In connection with the first real estate term
loan, the company entered into a $2,170,000 notional principal interest rate
swap agreement, which represents 50% of the principal amount on the real estate
term loan, and effectively converts the floating rate LIBOR based payments to
fixed payments at 4.99% plus the spread calculated under the real estate term
loan agreement. The company's unsecured term notes issued in connection with the
Bodet & Horst acquisition have a fixed interest rate of 8.01%, the existing
unsecured term notes have a fixed interest rate of 8.80%, and the Canadian
government loan is non-interest bearing. The company's revolving credit
agreement associated with its China subsidiary bears interest at a rate
determined by the Chinese government. There were no borrowings outstanding under
this agreement at August 3, 2008. At August 3, 2008, $17.0 million of the
company's total borrowings of $21.4 million are at a fixed rate or non-interest
bearing. Thus, the company would not expect any foreseeable change in the
interest rates to have a material effect on the company's financial results.
The company is exposed to market risk from changes in the value of foreign
currencies for their subsidiaries domiciled in China and Canada. The company
generally does not use financial derivative instruments to hedge foreign
currency exchange rate risks associated with its foreign subsidiaries. At August
3, 2008, the company did not have any foreign currency contracts outstanding.
The company's foreign subsidiaries use the United States dollar as their
functional currency. A substantial portion of the company's imports purchased
outside the United States are denominated in U.S. dollars. A 10% change in
either exchange rate at August 3, 2008, would not have a significant impact on
the company's results of operations or financial position.
ITEM 4. CONTROLS AND PROCEDURES
--------------------------------
The company has conducted an evaluation of the effectiveness of its disclosure
controls and procedures as of August 3, 2008, the end of the period covered by
this report. This evaluation was conducted under the supervision and with the
participation of management, including our Chief Executive Officer and Chief
Financial Officer. Based upon that evaluation, we have concluded that these
disclosure controls and procedures were effective, to ensure that information
required to be disclosed in the reports filed by us and submitted under the
Securities Exchange Act of 1934, as amended (the "Exchange Act") is recorded,
processed, summarized, and reported as and when required. Further, we concluded
that our disclosure controls and procedures have been designed to ensure that
information required to be disclosed in reports filed by us under the Exchange
Act is accumulated and communicated to management, including our Chief Executive
Officer and Chief Financial Officer, in a manner to allow timely decisions
regarding the required disclosures.
There has been no change in our internal control over financial reporting that
occurred during the quarter ended August 3, 2008 that has materially affected,
or is reasonably likely to materially affect, our internal control over
financial reporting.
I-37
Part II - Other Information
---------------------------
Item 1. Legal Proceedings
There has not been any material changes with regards to our legal proceedings
during the three months ended August 3, 2008. Our legal proceedings are
disclosed in the company's annual report on Form 10-K filed with the Securities
and Exchange Commission on July 9, 2008 for the fiscal year ended April 27,
2008.
Item 1A. Risk Factors
In addition to the information set forth below in the quarterly report on Form
10-Q, you should carefully consider the factors discussed the factors discussed
in Part 1, Item 1A "Risk Factors" in our annual report on Form 10-K filed with
Securities and Exchange Commission on July 9, 2008 for the fiscal year ended
April 27, 2008.
Difficulties In Integrating Our Recent Acquisition Could Negatively Affect The
Profits of our Mattress Fabrics Segment
Pursuant to an asset purchase agreement among the company and Bodet & Horst
dated August 11, 2008, the company purchased certain assets of their knitted
mattress fabric operation (see additional disclosures on pages I-26 and I-27).
We expect the asset acquisition to increase the profits of our mattress fabric
segment, but our success will depend upon our ability to successfully integrate
this product line into our business. These integration activities will place
substantial demands on our management, operational resources, and service
capabilities. If we experience customer dissatisfaction or operational problems
as a result of integrating the additional business acquired, our mattress
fabrics business could be negatively affected.
Item 6. Exhibits
The following exhibits are filed as part of this report.
3(i) Articles of Incorporation of the company, as amended, were filed
as Exhibit 3(i) to the company's Form 10-Q for the quarter ended
July 28, 2002, filed September 11, 2002, and are incorporated
herein by reference.
3(ii) Restated and Amended Bylaws of the company, as amended November
12, 2007, were filed as Exhibit 3.1 to the company's Form 8-K
dated November 12, 2007, and incorporated herein by reference.
10.1 Form of stock option agreement for options granted to executive
officers on June 17, 2008 pursuant to the 2007 Equity Incentive
Plan.
10.2 Written summary of Culp Home Fashions Division Management
Incentive Plan.
10.3 Written summary of Culp Inc. Corporate Management Incentive Plan.
II-1
10.4 Asset Purchase Agreement among Culp Inc., Bodet & Horst USA, LP
and Bodet & Horst GMBH & Co. KG, dated August 11, 2008, filed as
Exhibit 10.1 to the company's Form 8-K dated August 11, 2008, and
incorporated herein by reference.
10.5 Note Purchase Agreement among Culp, Inc., Mutual of Omaha
Insurance Company and United of Omaha Insurance Company dated
August 11, 2008, filed as Exhibit 10.2 to the company's Form 8-K
dated August 11, 2008, and incorporated herein by reference.
10.6 Consent and Fifth Amendment to Note Purchase Agreement dated
August 11, 2008, by and among Culp, Inc., Life Insurance Company
of North America, Connecticut General Life Insurance Company,
Beachside & Co., MONY Life Insurance Company, United of Omaha
Life Insurance Company, Mutual of Omaha Life Insurance Company,
and Prudential Retirement Insurance and Annuity Company, filed as
Exhibit 10.3 to the company's Form 8-K dated August 11, 2008, and
incorporated herein by reference.
31.1 Certification of Chief Executive Officer Pursuant to Section 302
of Sarbanes-Oxley Act of 2002.
31.2 Certification of Chief Financial Officer Pursuant to Section 302
of Sarbanes-Oxley Act of 2002.
32.1 Certification of Chief Executive Officer Pursuant to Section 906
of Sarbanes-Oxley Act of 2002.
32.2 Certification of Chief Financial Officer Pursuant to Section 906
of Sarbanes-Oxley Act of 2002.
II-2
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
CULP, INC.
(Registrant)
Date: September 10, 2008 By: /s/ Kenneth R. Bowling
-------------------------------------------------
Kenneth R. Bowling
Vice President and Chief Financial Officer
(Authorized to sign on behalf of the registrant
and also signing as principal financial officer)
By: /s/ Thomas B. Gallagher, Jr.
-------------------------------------------------
Thomas B. Gallagher, Jr.
Corporate Controller
(Authorized to sign on behalf of the registrant
and also signing as principal accounting officer)
II-3
EXHIBIT INDEX
Exhibit Number Exhibit
-------------- -------
10.1 Form of stock option agreement for options granted to
executive officers on June 17, 2008 pursuant to the 2007
Equity Incentive Plan.
10.2 Written summary of Culp Home Fashions Division Management
Incentive Plan.
10.3 Written summary of Culp Inc. Corporate Management Incentive
Plan.
31.1 Certification of Chief Executive Officer Pursuant to Section
302 of Sarbanes-Oxley Act of 2002.
31.2 Certification of Chief Financial Officer Pursuant to Section
302 of Sarbanes-Oxley Act of 2002.
32.1 Certification of Chief Executive Officer Pursuant to Section
906 of Sarbanes-Oxley Act of 2002.
32.2 Certification of Chief Financial Officer Pursuant to Section
906 of Sarbanes-Oxley Act of 2002.